ITEM 1. BUSINESS GENERAL
Consumers Financial Corporation (the "Company") is an insurance holding company which, through its subsidiaries, is a leading provider of credit life and credit disability insurance in the Middle Atlantic region of the United States. The Company also owns and administers a small block of universal life insurance business, but no longer markets those products. The insurance subsidiaries are licensed in 33 states and the District of Columbia and currently conduct the majority of their business in the states of Pennsylvania, Delaware, Maryland, Nebraska, Ohio and Virginia. Credit insurance, which accounted for $30 million, or 88%, of the Company's total premium revenues in 1996, is marketed primarily through approximately 900 automobile dealers. In connection with its credit insurance operations, the Company also markets, as an agent, an automobile extended service warranty contract and, until mid-1996, assumed through reinsurance, certain underwriting risks on a small block of warranty business. Universal life insurance, which accounted for $3.7 million of premium and policy charge revenues, or 11% of the Company's total premiums and policy charges in 1996, was marketed, until 1992, through general agents, p e rsonal producing general agents and independent brokers. Additional information regarding the termination of marketing activities in the Individual Life Division and the sale of the majority of the Division s in-force business appears below under "Operations."
The Company, through its wholly-owned subsidiary, Interstate Auto Auction, Inc. ("Interstate"), has also conducted wholesale and retail automobile auctions of used vehicles for automobile dealers, banks and leasing companies. See Note of the Notes to Consolidated Financial Statements appearing elsewhere in the Form 10-K for a discussion of the sale of the operating assets of Interstate in November 1996 for cash in the amount of $4.85 million.
The Company was formed in 1966 as 20th Century Corporation (a Pennsylvania business corporation) and adopted its present name on May 30, 1980. The Company operates through its wholly-owned subsidiaries, principally Consumers Life Insurance Company (a Delaware life insurance company) ( Consumers Life ), Consumers Car Care Corporation (a Pennsylvania business corporation) and, until late 1996, Interstate (a Pennsylvania business corporation). Consumers Life Insurance Company of North Carolina (a North Carolina life insurance company) and Investors Fidelity Life Assurance Corp. (an Ohio life insurance company) are subsidiaries of Consumers Life Insurance Company.
T h e term "Company" when used herein refers to Consumers Financial Corporation and its subsidiaries unless the context requires otherwise. The Company's executive offices are located at 1200 Camp Hill By-Pass, Camp Hill, Pennsylvania 17011. Its telephone numbers are (717) 761-4230 and (800) 933- 3018.
The Company has historically operated in three industry segments: the Automotive Resource Division, which markets credit insurance and other products and services to its automobile dealer customers, the Individual Life Insurance Division and the Auto Auction Division. These segments exclude the corporate activities of Consumers Financial Corporation which are insignificant in relation to the three segments. The Automotive Resource segment consists principally of credit life and credit disability insurance which is sold primarily through automobile dealers and, to a limited extent, through banks and other financial institutions. This segment also generates commission revenues on sales of automobile warranty contracts and revenues from other related products and services. The Individual Life segment emphasized the sale of universal life products which were introduced in 1985, and had previously marketed whole-life, term, endowment and annuity products. Until its sale in 1996, the Auto Auction segment operated an automobile auction of used vehicles for automobile dealers, banks and leasing companies. Both the individual life insurance and the auto auction segments have been presented as discontinued operations in the Company's consolidated financial statements. See Note 5 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10- K.
In March 1992, the Company announced its decision to terminate the operations of its Individual Life Insurance Division. The phase-out plan included discontinuing the sale of insurance policies and the sale of the Company s existing block of individual business. Effective October 1, 1992, the Company sold its block of whole life, term and annuity products to an unaffiliated insurer but continued to administer the block of universal life policies. As of December 31, 1994, the Company sold its in-force block of direct universal life insurance business to an unaffiliated insurer. As part of that transaction, the Company irrevocably assigned to the same insurer, all of its right, title and interest to a block of universal life business which had been assumed previously from another unaffiliated insurer. The Company continued to administer these blocks of universal life business until May 1, 1995. The Company continues to own and administer an assumed block of universal life business issued by an unaffiliated insurer. In March 1997, the Company signed a definitive agreement with the direct writer whereby that company will recapture this business and pay the Company a recapture consideration of $1.05 million. See Note 21 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K for further information regarding this transaction.
In March 1996, the Company announced that it had retained a financial advisor to assist management in evaluating various alternatives to best serve the interests of its shareholders. The recent losses incurred in the Company s core credit insurance operation lead to this action in order to preserve shareholder value. The various alternatives which were considered include the sale of the insurance operations (either the existing business and the marketing organization or only the marketing organization), the sale of the auto auction business, the sale of the entire Company or a combination of the Company with another organization. During 1996, the Company solicited bids for both the insurance operations and the auto auction business. In October 1996, the Company entered into a merger agreement (the Merger Agreement ) with LaSalle Group, Inc., pursuant to which the Company will become a wholly-owned subsidiary of LaSalle. This transaction, which was approved by the Company s common shareholders on March 25, 1997, is subject to the approval of various state insurance department regulators. See Note 4 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K for additional information with respect to this matter.
The following table sets forth for the periods indicated the contribution to revenues, which are comprised of premiums written (before reinsurance ceded), policy charges, net investment income, realized investment gains and other revenues, of each of the product lines within the Company's remaining industry segment. Information relating to the discontinued individual life insurance and auto auction segments has been excluded.
The following table sets forth for the periods indicated the contribution to pre-tax income (loss) of each of the product lines within the Company s remaining industry segment. Information relating to the discontinued individual life insurance and auto auction segments has been excluded. OPERATIONS
The Company's principal subsidiaries, which are engaged in the credit insurance and, until 1992, the individual life insurance business, are Consumers Life Insurance Company, Consumers Life Insurance Company of North Carolina and Investors Fidelity Life Assurance Corp. Together these companies are licensed in 33 states and the District of Columbia. As noted in Item 1. - - General, the Company disposed of a significant portion of its individual life insurance business in October 1992 and December 1994 and, in March 1997, entered into an agreement to dispose of its remaining individual life business.
The following table sets forth the amounts of life insurance in force at the dates indicated:
For information concerning future policy benefits and unearned premiums, see Notes 1 and 10 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K. Reserves for life insurance are developed using generally accepted actuarial principles which are widely recognized in the insurance industry. Methods of developing credit disability insurance claims reserves vary widely in the industry. The Company's methods of establishing credit disability claims reserves are based on its prior claims experience. During the last three years, the difference between actual claims on credit disability policies and amounts reserved has not been significant.
Automotive Resource DIVISION
The Company sells credit insurance in connection with consumer credit transactions, substantially all of which are automobile purchases. Credit life insurance provides funds in the event of the insured's death for payment of a specified loan or loans owed by the insured. Similarly, credit disability insurance provides for the periodic paydown of such loans during the term of the insured's disability. In most cases, the entire premium is paid at the time the insurance is issued. Premiums collected are remitted to the Company net of commissions. Credit insurance generally is written on a decreasing term basis with the policy benefit initially being the full amount of the loan and thereafter decreasing in amounts corresponding to the repayment schedule. The primary beneficiary under credit insurance is the lender, with any proceeds in excess of the unpaid portion of the loan payable to a named second beneficiary or the insured's estate.
The Company underwrites all of its credit insurance certificates as to certain health matters including cancer, heart disease, AIDS and AIDS related complex (ARC). The Company also establishes maximum age limits beyond which individuals are not eligible for coverage. The Company believes that its comprehensive training programs increase the ability of its automobile dealer accounts to sell insurance to a significant percentage of automobile purchasers, which creates a larger and more diverse pool of insureds, thereby reducing its mortality and morbidity risk. The Company typically experiences a higher level of claims on disability policies during the first quarter of each year.
In April 1996, the Company discontinued marketing its credit insurance products in the state of North Carolina as a result of continued losses on that business. Written premiums in North Carolina were $327,000 in 1996 and $1.8 million in 1995. Certain credit insurance accounts in Virginia were also cancelled in 1996 because of unprofitable results. Those accounts produced premium revenues of $914,000 and $1,434,000 in 1996 and 1995, respectively. In July 1995, the Company discontinued marketing credit insurance in Kentucky. Written premiums in that state were $844,000 in 1995.
The Company's success in selling credit insurance is dependent upon establishing and maintaining favorable relationships with automobile dealers. To accomplish these goals, the Company provides finance and insurance training programs which assist dealers in arranging financing and increasing sales of credit insurance; it offers certain dealers the opportunity to participate in profits of the credit insurance business generated by them through reinsurance arrangements; and it provides administrative support and claims handling procedures to dealers. The Company also seeks the endorsement of local and s t a t e automobile dealer and other credit insurance producing member associations. In that regard, during 1996, the Company lost the Pennsylvania Automotive Association endorsement which it held since 1987. The Company does not believe the loss of the Pennsylvania endorsement will have a materially adverse impact on its future operating results, although the loss of the endorsement could result in the loss of up to 15% of the Company s Pennsylvania credit insurance premium revenues and service contract commission income. To assist the Company in developing dealer relationships, the Company employs two home office sales managers, one finance and insurance training specialist and 16 salaried field representatives who solicit and service accounts. The Company's dealer relationships may be terminated by the Company or the dealers at any time without penalty. In addition to its direct sales efforts, the Company also purchases closed blocks of credit insurance from unaffiliated companies and administers the purchased business until all coverages expire.
The credit insurance business is the major source of the Company's revenues and, until 1991, provided the majority of its profits as well. As indicated above, approximately 88% of the Company's premium revenues during 1996 were derived from its credit insurance business. Automobile sales account for substantially all of the credit insurance sold by the Company, and have been and will continue to be affected, directly and indirectly, by automobile prices, interest rates, the availability of consumer credit and general economic conditions. The credit insurance industry and the Company s credit business have both been adversely affected in recent years by the increase in the number of automobiles which are leased instead of purchased. This is principally due to the lack of availability of approved credit insurance products applicable to leases and to a reluctance on the part of automobile dealers to emphasize the sale of credit insurance products on lease transactions. The Company has credit insurance products available for lease transactions in most of the states in which it actively markets.
Effective July 31, 1996, the Company and its joint venture partner cancelled an agreement whereby the companies shared in the profits or losses from the credit insurance business written by the Company in Pennsylvania, the Company s most profitable credit insurance state. As a result, on credit insurance premiums produced in Pennsylvania after July 31, the Company will now retain the profits or losses which were previously shared with the joint venture partner. As consideration for terminating the venture, the Company has agreed to pay its former partner $500,000 in cash at the time the merger with LaSalle is consummated. In the event the LaSalle merger is not completed, any payment to the joint venture partner will be determined under a separate calculation.
The Company's ability to retain credit insurance premiums written is limited by applicable statutory surplus requirements. For this reason, the Company reinsures substantial percentages of its credit insurance premiums on a written basis under quota share agreements with unaffiliated insurance companies. These reinsurance agreements provide statutory surplus relief, thereby increasing the Company's capacity to write credit insurance. An effect of this reinsurance is, however, to reduce the profit that the Company might otherwise realize on its credit insurance business. The agreements contain an experience adjustment computation which results in the ultimate cost of this reinsurance being a stated percentage of the amount of statutory surplus provided. Security funds are maintained by the Company in amounts which are generally proportional to the ceded unearned premiums. This reinsurance does not discharge the Company's primary liability as the original insurer. See Note 20 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K for information concerning certain regulatory matters involving these reinsurance treaties.
The Company also markets, in an agency capacity, extended service automobile warranty products through its wholly-owned subsidiary, Consumers Car Care Corporation. These products are underwritten by unaffiliated insurance companies, administered by unaffiliated third party administrators and sold primarily through automobile dealers, who also sell the Company's credit i n surance. Until mid-1996, the Company also assumed, through another subsidiary, a portion of the risks on these extended service contracts pursuant to a reinsurance arrangement with one of the unaffiliated insurers who underwrite the business. Other related products and services are also offered to the Company's automobile dealer customers.
Individual Life Insurance DIVISION
In March of 1992, the Company announced the termination of this Division's marketing activities and announced its intent to sell its existing blocks of whole-life, term, annuity and universal life business. Effective October 1, 1992, the traditional whole-life, term and annuity business was sold for $5.6 million to the Londen Insurance Group of Phoenix, Arizona. In early 1993, the Company rejected offers it received for the sale of its universal life business after determining that the offers were too low in relation to the projected future profits on that block of business.
Effective December 31, 1994, the Company coinsured its direct universal life business and irrevocably assigned all its right, title and interest in a block of assumed universal life business (coinsured from AMEX Life Assurance Company on a 90% quota share basis) to American Merchants Life Insurance Company, Jacksonville, Florida, for $5.5 million. The Company continued to provide all policyholder administrative functions for this business pursuant to a service agreement until May 1, 1995.
The Company had experienced continuing losses in its individual life operation due to insufficient premium levels to support the cost of operations. With the sale of the direct universal life business and the AMEX business to American Merchants and the termination of operations of CLMC Insurance Agency, Inc. (a general agency which marketed life insurance and annuity products through unaffiliated insurers), significant reductions were made in various direct and indirect costs. Although the remaining block of assumed universal life business has generally been profitable, the Company has signed an agreement with the direct writer of the business whereby the direct writer will recapture the business effective January 1, 1997 and pay the Company a recapture consideration of $1.05 million. See Note 21 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K for additional information regarding this transaction.
As a result of the agreement to dispose of the remaining insurance business of the individual life insurance division, the operating results of this segment have been presented as discontinued operations in the Consolidated Financial Statements appearing elsewhere in this Form 10-K.
Auto Auction DIVISION As indicated previously, the business and the related operating assets of Interstate were sold in November 1996 for cash of $4.85 million. See Note 5 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K for further information concerning the sale and its impact on the Company s operating results. Prior to the sale, Interstate conducted wholesale automobile auctions of used vehicles at its facility in Mercer, Pennsylvania (about 50 miles north of Pittsburgh). The Youngstown Auto Auction business acquired in July of 1993 to expand the Company s auction operations, relocated to Lordstown, Ohio in 1994 in order to attract additional accounts and business to the auction. The Company subsequently ceased all operations at Lordstown effective December 31, 1994 and transferred a portion of its business operations to Interstate. In January 1995, Interstate began conducting the bi-weekly bank repossession auction previously held at Lordstown. This resulted in the termination, as of the end of 1994, of all of Lordstown s expenses while maintaining a portion of its revenue base at Interstate with virtually no incremental costs. Interstate s customers include automobile dealers and leasing companies. In connection with its weekly auctions, Interstate provides a body shop repair and conditioning service and an arbitration service through which disputes between buyers and sellers can be resolved.
In 1996, prior to the sale of the business, approximately 28,000 cars were registered for sale at Interstate through the regular weekly consignment auction, and approximately 57% of all vehicles registered were sold. In 1995, approximately 35,000 cars were registered for sale at Interstate through the regular weekly consignment auction, and approximately 56% of those vehicles were sold. In 1994, approximately 32,000 cars were registered and 59% of the cars registered were sold. Auction fees are generally paid by the seller for each vehicle sold and an additional fee is paid by the purchaser. The purchaser s fees vary according to the price paid for the automobile.
BEST'S RATINGS
In both 1996 and 1995, Consumers Life Insurance Company received a C rating (Marginal) from A.M. Best Company, principally because of its substantial amount of financial reinsurance and its relatively small capital base. In 1994 Consumers had a C- rating (Marginal). In 1992 and 1993, Consumers had an NA-9 rating (Not Rated at Company Request), which is assigned to any company which is otherwise eligible for a letter rating, but has requested that the rating not be published. The NA-9 designation was requested by Consumers while it completed the restructuring of its individual life insurance operations. In 1991, Consumers was rated "B" (Good). Consumers two operating subsidiaries, Consumers Life Insurance Company of North Carolina and Investors Fidelity Life Assurance Corp., are currently rated NR-2 (Insufficient Operating Experience). Best's letter ratings range from A++ (Superior) to D (Below Minimum Standards), with letters E and F assigned to companies under state supervision or in liquidation. Best's ratings are based on a comparative analysis of the statutory financial condition and operating performance of the companies, rated as determined by their publicly available reports.
INVESTMENTS
The Company's general investment policy with respect to assets of its insurance subsidiaries has been to invest primarily in fixed maturity securities and, to a lesser extent, in mortgages with intermediate terms (generally not more than seven years). Investments in mortgages have allowed the Company to obtain higher yields while maintaining maturities in the five to seven year range. Prior to the sale of the Company s direct universal life business, the Company's investment policy also included investing in certain mortgage-backed securities which provided competitive yields on assets supporting these interest sensitive products.
The Company's mortgage loan portfolio, which relates primarily to commercial real estate, is concentrated in the central Pennsylvania area. Specifically, about 73% of the $2.3 million in mortgage loan balances at December 31, 1996 are secured by properties within a 60 mile radius of Harrisburg. The Company considers this strategy to be conservative because this region has historically not been particularly susceptible to wide economic swings in recessionary times, due to the diversity of industries throughout the area and the presence of government operations and military installations. During the past two years, the Company has substantially reduced its investments in mortgage loans in order to improve its liquidity. See the Management s Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere in this Form 10-K for further information concerning mortgage loans and investments.
Investments in government and corporate bonds are limited to those with a Moody s or Standard & Poors rating of A or better. The Company buys U.S. Treasury Notes for their yield and superior liquidity features. The Company also purchases U.S. Government agency bonds and corporate bonds provided such bonds are part of large liquid issues (over $100 million) and, in the case of corporate bonds, represent economic balance and diversification. The Company may also buy foreign bonds denominated in U.S. dollars (Yankee Bonds), thereby avoiding exposure to foreign currency risk. Short-term investments are maintained primarily to meet anticipated cash requirements arising from operations. As of December 31, 1996, the fixed maturities portfolio did not contain any non-investment grade securities. The Company defines a non- investment grade security as any security rated below Baa3 by Moody s Investors Service and below BBB by Standard and Poor s Rating Service. The assets of the Company's non-insurance subsidiaries generally have been invested in short-term instruments.
The following table sets forth the Company's investment results for the periods indicated:
(1) Represents rental income related to three properties classified as non- investment real estate. (2) Includes $27,000 in interest which should have been included in 1994 income. If this income had been included in 1994, the yield in 1995 would have been 7.4% and the 1994 yield would have been 7.3%. (3) Includes $170,000 in rental income related to a property classified as non- investment real estate. Excluding this income, the real estate yield is 6.8%.
COMPETITION
The Company competes with numerous other credit insurance companies, many of which are larger than the Company and have greater financial and marketing resources. The principal competitive factors in the automobile credit insurance industry are commission levels, the quality of training for dealers, the ariety f related products, the availability of dealer incentive programs and the level of administrative support and efficiency of claims handling procedures. The Company believes that it is able to compete successfully on the basis of these factors.
The Company pays relatively high commissions in order to remain competitive in states that do not mandate maximum commissions. In states which have established maximum commissions by regulation, there is generally no commission competition among companies. The elimination of the existing commission limits in Pennsylvania, Maryland and Nebraska, the only states where the Company has any significant amount of business which regulate commission levels, could have a detrimental effect on the Company's business because agents could negotiate for higher commissions on the sale of credit insurance without a corresponding increase in premiums. The Company is not aware that any of these states is considering elimination of maximum commission regulations.
Because the Company markets its extended service warranty products primarily in connection with its marketing of credit insurance to automobile dealers, its ability to sell this product is a function of its ability to compete in the credit insurance market. The availability of financially sound insurance underwriters and capable third party warranty administrators are additional factors which affect the Company's ability to market its extended service warranty products effectively.
The marketing areas for the auto auction included western Pennsylvania, western New York, eastern Ohio and the West Virginia panhandle. Interstate competed with five automobile auctions in its market areas. The principal competitive factors in this business are the quality of management, the amount of auction fees charged, location in relation to major metropolitan markets, the quality of the physical plant and facilities and other services offered, such as title guarantees. The Company was able to compete effectively on the basis of these factors.
REGULATION
The Company's insurance subsidiaries are subject to regulation and supervision in the states in which they are licensed. The extent of such regulation varies from state to state, but, in general, each state has statutory restrictions and a supervisory agency which has broad discretionary administrative powers. Such regulation is designed primarily to protect policyholders and relates to the licensing of insurers and their agents, the approval of policy forms, the methods of computing financial statement reserves, the form and content of financial reports and the type and concentration of permitted investments. The Company's insurance subsidiaries are subject to periodic examination by the insurance departments in the states of their formation and are also subject to joint regulatory agency examination and market conduct examinations in the other states in which they are authorized to do business.
Certain states in which the Company is licensed have regulations limiting the credit insurance premium rates or the commissions payable to agents or, in some cases, limiting both rates and commissions payable. In addition, some states have regulations that require credit insurance claims ratios to be a specified percentage of earned premiums. If an insurer's claims ratio is below the prescribed benchmark, it is required to reduce premium rates and, conversely, if the claims ratio is higher than the benchmark, the insurer may request an increase in premium rates.
The dividends which a life insurance company may distribute are subject to regulatory requirements based upon minimum statutory capital and surplus and/or statutory earnings. In addition to regulatory considerations, the overall financial strength of each operating entity is considered before dividends are paid. Additionally, the amount of dividends a life insurance company can pay is subject to certain tax considerations. See Notes 2 and 17 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K.
The Company is also subject to regulation under the insurance holding company laws of various states in which it does business. These laws vary from state to state, but generally require insurance holding companies and insurers that are subsidiaries of holding companies to register and file certain reports, including information concerning their capital structures, ownership, financial condition and general business operations, and require prior regulatory agency approval of changes in control of an insurer, most dividends and intercorporate transfers of assets within the holding company structure. The purchase of more than 10% of the outstanding shares of the Company's common stock by one or more affiliated parties would require the prior approval of certain state insurance departments which regulate the Company.
EMPLOYEES AND AGENTS
As of December 31, 1996, the Company had approximately 54 full-time employees, including its management and sales personnel. In addition, as of that date there were approximately 900 licensed agents selling credit insurance and vehicle extended service contracts, most of whom were full-time employees of automobile dealers, banks and other financial institutions.
The Company has adequate insurance coverage against employee dishonesty, theft, forgery and alteration of checks and similar items. The Company does not have similar coverage for its agents. There can be no assurance that the Company will be able to continue to obtain such coverage in the future or that it will not experience uninsured losses.
ITEM 2.

ITEM 2. PROPERTIES
Since September 1989, the Company has maintained its executive and business offices in a leased building located at 1200 Camp Hill By-Pass, Camp Hill, Pennsylvania. The office building contains approximately 44,500 square feet of office space. Prior to 1993, the Company leased the entire facility at an annual rental of $421,000, plus insurance, taxes and utilities. As a result of the termination in 1992 of all new business functions in the Individual Life Insurance Division, the Company now occupies approximately 67% of the available office space. The Company has leased about 66% of the remaining space to third party tenants. Annual rental income to the Company under these sub-leases totals $83,000. In March of 1994, the Company exercised its option to acquire a 50% interest in its home office building, which reduced the Company s annual rent to $204,000. The option price was approximately $1.75 million. In late 1996, the Company, along with the other 50% owner, granted an option to purchase the home office building to an unrelated third party. The option expired in March 1997 and was not renewed. Except as otherwise noted, the business operations of the Company and all of the subsidiaries are conducted at the above address in Camp Hill, Pennsylvania.
In connection with its insurance operations, Consumers Life Insurance Company maintains a branch office in leased facilities in Philadelphia, Pennsylvania. The branch office primarily provides supervision, sales and service for credit insurance agents doing business in the eastern Pennsylvania, Delaware and New Jersey areas. Annual rental for this office is approximately $27,000.
Investors Fidelity Life Assurance Corp. maintains an office in leased facilities in Columbus, Ohio. This office primarily provides sales support and supervision for credit insurance agents in the State of Ohio. Annual rental for this office is approximately $13,000 plus insurance, taxes and utilities.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
The Company is a party to various lawsuits which are ordinary and routine litigation incidental to its business. None of these lawsuits is expected to have a materially adverse effect on the Company's financial condition or operations. See Note 14 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K for additional information concerning litigation matters.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the Fourth Quarter of 1996 to the shareholders of the Company for their consideration through the solicitation of proxies or otherwise. PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
CONSUMERS Financial Corporation common stock and Convertible Preferred Stock, Series A, are traded on the NASDAQ, National Market System. Ticker symbols are CFIN and CFINP, respectively.
Directors, officers and employees of Consumers Financial Corporation have a sizeable ownership position in Consumers, which is derived from the Company s belief that this provides a strong incentive for all parties involved to enhance shareholder value. At December 31, 1996, the Company s Employee Stock Ownership Plan held 10% of the total common stock outstanding.
As of December 31, 1996, there were 6,834 shareholders of record who collectively held 2,611,532 common shares and 130 shareholders of record of the Convertible Preferred Stock, Series A, who held 481,461 shares.
Dividends on both the Company s common stock and Convertible Preferred Stock, Series A, are declared by the Board of Directors. No common stock dividends were declared in either 1996 or 1995; however, common stock dividends had been paid for 14 consecutive years through 1994. The 1994 common stock cash dividend was $.05 per share. The Convertible Preferred Stock, Series A, dividends are paid quarterly on the first day of January, April, July and October. The annual Convertible Preferred Stock, Series A, cash dividend is $.85 per share.ITEM 6.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
A review of the significant factors which affected the Company's 1996 operating performance as well as its financial position at December 31, 1996 is presented below. Information relating to 1995 and 1994 is also presented for comparative purposes. This analysis should be read in conjunction with the Consolidated Financial Statements and the related Notes.
OVERVIEW
Because of the recurring losses in the Company s core credit insurance business, in early 1996, the Company began evaluating alternatives to best serve the interests of its shareholders. The Company considered several alternatives, including the following: (1) the sale of its insurance operations, (2) the sale of its credit insurance marketing organization (with retention and ongoing administration of inforce business), (3) the sale of its auto auction business, (4) the sale of the Company, (5) the reorganization of the Company or (6) the combination of the Company with another organization in the same or other line of business. In January 1996, the Company engaged a financial advisor to assist in evaluating the many alternatives to maximize shareholder value. The Company subsequently solicited bids for both its credit and universal life insurance operations and its auto auction business. In October 1996, the Company entered into an Agreement and Plan of Merger with LaSalle Group, Inc. ( LaSalle ) whereby the Company will become a wholly-owned subsidiary of LaSalle. The merger transaction, which is subject to insurance regulatory approval, was approved by the Company s common shareholders on March 25, 1997. See Note 4 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K for additional information with respect to the pending merger.
LaSalle's strategic plan following the merger includes focusing on and rebuilding the Company's core credit insurance operation by combining it with other credit insurance businesses LaSalle plans to acquire. Accordingly, in November 1996, the Company sold the business and related operating assets of Interstate Auto Auction, Inc. to an unrelated third party for cash in the amount of $4.85 million. In addition, in March 1997, the Company signed an agreement to sell its remaining block of individual life insurance business, following the sale of other blocks of individual life business in both 1992 and 1994. As a result of these sale transactions, in the Company's consolidated financial statements appearing elsewhere in this Form 10-K, the operating results and the net gain from disposal of both the individual life insurance and the auto auction segments have been reported as discontinued businesses for all periods presented. Further information regarding these transactions is presented later in this analysis and in Note 5 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K.
The Company reported a net loss for 1996 of $1.2 million ($.64 per share) compared to a loss of $1.6 million ($.78 per share) in 1995 and a loss of $913,000 ($.51 per share) in 1994. However, the loss from continuing operations was $2.7 million in 1996 compared to losses of $2.1 million and $2.5 million, on a restated basis, in 1995 and 1994, respectively. The higher 1996 loss from continuing operations is due primarily to the costs incurred by the Company in connection with valuing and offering for sale the Company's various businesses. Discontinued operations for 1996 include not only the operating results of each of the discontinued segments but also a $1.8 million gain on the disposal of the auto auction business and related assets and a loss of $914,000 arising from the write-off of deferred policy acquisition costs based on the consideration to be received in 1997 from the sale of the individual life insurance business.
The Company's remaining business segment, the Automotive Resource Division, continued to report operating losses in 1996. The Division's credit insurance results declined slightly from 1995 due to higher disability claims, which offset significantly lower general expenses.
A more detailed discussion of the operating performance of each of the Company's business segments, including the two discontinued businesses, is presented later in this analysis under Results of Operations.
The following table compares revenues and operating results for each of the past three years. Amounts for 1995 and 1994 have been restated to reflect the operating results of the individual life insurance and auto auction businesses as discontinued operations.
RESULTS OF OPERATIONS
The Company's pre-tax operating results for the past three years can be best understood through an analysis of each of its three business units. The Automotive Resource Division, the Company's core business, is now the only continuing business segment. The Division's principal product is credit insurance, which it markets primarily through automobile dealers in six key states. It also markets automobile extended service contracts in a general agency capacity and generates other revenues from services it provides to approximately 900 automobile dealer customers. The Individual Life Insurance Division has not written any new business since 1992. Closing on the sale of the Division's remaining block of insurance business took place on March 27, 1997. Auto auction operations were conducted through the Company's subsidiary, Interstate Auto Action, Inc., until the sale of Interstate's business and operating assets in late 1996.
Automotive Resource Division
Premium revenues from credit insurance, the Division's principal product, declined 9.5% in 1996 from $33.1 million to $30 million. In 1995, premiums decreased 3.3% from the $34.3 million in premiums written in 1994. The cancellation of unprofitable business played a major part in the reduction in premiums in both 1996 and in 1995. As a result of continued unprofitable results, all of the Division's accounts in the state of North Carolina and numerous accounts in Virginia and Ohio were canceled during 1996. A similar action was taken in the state of Kentucky in 1995. Excluding these accounts, the 1996 drop in premium revenues was nominal. The Division's credit insurance premium production remains significantly below pre-1990 levels due to the declines which occurred during the economic recession of the early 1990's. A consequence of the decline in written premiums has been a reduction in earned premiums, which in turn has resulted in a substantial increase in operating expense ratios since 1989. Higher expense ratios have been a key reason for the unprofitable operating results the Division has experienced in recent years. During 1996, the Company lost the endorsement of the Pennsylvania Automotive Association which it held since 1987. The Company believes that the loss of the endorsement will have some effect on its future premium production in Pennsylvania, although it is not expected to have a materially adverse impact on future operating results.
The Division's pre-tax operating results for 1996 declined from a $2.4 million loss in 1995 to a loss of $2.5 million. A significant increase in the credit disability claims ratio on retained business (i.e., business not reinsured to captive insurance companies) offset a $900,000 reduction in general expenses. General expenses in both years now include expenses which had previously been allocated to the discontinued Individual Life Insurance Division and, to a lesser extent, the discontinued Auto Auction Division. The Company does not believe the level of disability claims in 1996 and the claims ratio in 1996 are an indication of any unfavorable trend. In that regard, claims ratios in the first two months of 1997 are well below the ratios for the same period in 1996. While the Division's expense ratio improved in 1996, the present ratio is still higher than the ratio which is required to return the Division to profitability. As noted above, the increased expense ratio compared to the ratio in the late 1980's is a key reason for the Division's continued losses.
In July 1996, the Company and its joint venture partner canceled an agreement whereby the companies shared in the profits from the credit insurance business written by the Company in Pennsylvania, the Company's most profitable credit insurance state. As a result, on credit premiums produced in Pennsylvania after July, the Company will now retain the profits or losses which were previously shared with the joint venture partner. As consideration for terminating the venture, the Company has agreed to pay its former partner $500,000 in cash at the time the above-referenced merger with LaSalle is consummated. In the event the LaSalle merger is not completed, any payment to the joint venture partner will be determined under a separate calculation. If the proposed merger with LaSalle is completed, LaSalle's strategy to return the Company's credit insurance operation to profitability will include acquisitions of other credit insurance companies and other blocks of credit insurance business, expansion of the Company's marketing territory and growth in existing markets. LaSalle intends to provide additional capital not only to finance growth by also to build the insurance subsidiaries' capital base in order to improve the ratings of those companies by insurance rating agencies.
Individual Life Insurance Division
Operations in the Individual Life Insurance Division in 1996 and 1995 were limited to one closed block of assumed universal life business, following the sale of the Division's direct universal life business in 1994 and the sale of its traditional whole life and term business in 1992. In March 1997, the Company signed an agreement with World Insurance Company ("World"), pursuant to which World will recapture the universal life business previously assumed by the Company from World through a joint venture agreement which began in 1987. World will pay a recapture consideration to the Company in the amount of $1.05 million. In exchange, the Company will transfer to World assets supporting the net statutory basis policy reserves for this business. Based on the recapture consideration to be received, the Company has written off $1.4 million in deferred policy acquisition costs which are not recoverable. This write-off, which totaled $914,000 on an after-tax basis, has been presented as a loss on disposal of the discontinued segment in the Company's 1996 financial statements.
Excluding the write-off, the Division reported pre-tax income of $393,000 in 1996 compared to restated pre-tax income of $83,000 in 1995. The Division's operating results for 1996 reflect the elimination of any continuing overhead and indirect costs which had previously been allocated to this Division. The results for prior periods have been restated to also eliminate these costs. These reallocated costs totaled $292,000 in 1996 and $330,000 in 1995. Higher than normal claims costs in the first half of 1995 adversely affected the results for that year and are the principal reason for the lower earnings in 1995.
Auto Auction Division
On November 6, 1996, the Company sold the auto auction business and related operating assets (property and equipment and inventories) of Interstate Auto Auction to ADESA Pennsylvania, Inc. for cash of $4.85 million. The Division's pre-tax income for the first nine months of 1996, which excludes any continuing overhead, was $554,000 compared to income of $732,000, as restated to eliminate any continuing overhead, in 1995. The operating results of the auto auction after September 30, 1996, when the Company finalized its plan to dispose of the business, have been included with the gain realized on the disposal of the auction business. The auction generated an $84,000 pre-tax loss ($57,000 after taxes) during this period.
Approximately $1.7 million of the proceeds from the sale of the auto auction business was used to repay the remaining amount due on the Company's bank loans.
FINANCIAL CONDITION
A discussion of the important elements affecting the Company's financial position at December 31, 1996 and 1995 is presented below.
Invested Assets
Invested assets at December 31, 1996 totaled $51.2 million compared to $49 million at the end of 1995. The $3.1 million in proceeds received from the sale of the auto auction business, after repayment of the bank debt, is the primary reason for the increase in investments. Those proceeds were invested principally in bonds. Approximately $750,000 of the proceeds will be required in 1997 for Federal and state income taxes on the gain from this sale. The invested asset base also increased as a result of the sale of $1.2 million in non-investment real estate for cash, the proceeds from which were reinvested in bonds. In addition, during 1996, the Company completed the sale of all but one of the town homes in a real estate development acquired in 1995 through foreclosure. This property, which had a $1.5 million carrying value at December 31, 1995, was classified as non-investment real estate. The proceeds from the sales of the town home units have also been reinvested primarily in bonds.
The increases discussed above were partially offset by a $923,000 reduction in the carrying value of the Company's bond portfolio as a result of higher interest rates since the end of 1995. The Company's bond portfolio is carried at fair value pursuant to the requirements of Statement of Financial Accounting Standards No. 115, based on the Company's determination that all of its bonds should be considered as "available-for-sale", although the Company has no current intentions to sell any of these securities (except for approximately $8.3 million in bonds which were sold in 1997 in order to complete the above- referenced sale transaction with World - see the Individual Life Insurance Division section of this Management s Discussion and Analysis). The unrealized appreciation or depreciation on available-for-sale securities is reported as a separate component of shareholders' equity.
The Company s general investment policy continues to emphasize fixed maturity securities (primarily bonds) with Moody's or Standard and Poor's ratings of A or better and mortgage loans with terms generally not more than seven years. The Company has not invested in non-investment grade securities because the greater returns on such investments do not justify the potentially greater risks.
During 1996, the Company increased its loan loss reserves for mortgage loans and investment and non-investment real estate by $35,000. Loan loss reserves were increased by $93,000 and $450,000 in 1995 and 1994, respectively. Management believes that its reserves at December 31, 1996 are adequate to cover any possible losses which may develop in its mortgage loan and real estate portfolios. The carrying value of these investments at December 31, 1996 was $3.4 million compared to $10.7 million at the end of 1995.
During 1996, the Company's mortgage loan portfolio declined from $7 million to $2.3 million. The substantial reduction is the result of the early payoff of four mortgages with balances at the end of 1995 of $2.7 million and the sale to a local bank of seven loans with balances totaling $2 million. The proceeds from these transactions were reinvested primarily in bonds.
Liquidity
Liquidity refers to a company s ability to meet its financial obligations and commitments as they come due. The Company s operating subsidiaries have historically met most of their cash requirements from funds generated from operations, although, as discussed below, reduced credit insurance revenues over the past several years have had a significant impact on the insurance companies operating cash flows. The Company, as a holding company, has generally relied on its operating subsidiaries to provide it with sufficient cash funds to meet its debt service obligations, pay corporate expenses and shareholder dividends. In that regard, the life insurance subsidiaries are also subject to restrictions imposed by law on their ability to transfer cash to the Company in the form of dividends, loans or advances.
Dividends and other distributions to the Company from Consumers Life are limited in that the subsidiary is required to maintain minimum capital and surplus, determined in accordance with regulatory accounting practices. All distributions are further limited by Delaware state insurance laws to the greater of the previous year s earnings, computed in accordance with statutory accounting principles, or 10% of statutory capital and surplus as of the end of the previous year. In some instances such payments may require the prior approval of the insurance department. Also, any loans or advances to the Company of a material amount must be reported to the insurance department. The Company may have limited cash funds available to pay dividends in excess of amounts transferred from Consumers Life and other subsidiaries. In addition, separate restrictions apply to the surplus note owed to the Company by a subsidiary of Consumers Life. Note 2 of the Notes to Consolidated Financial Statements discusses these restrictions more specifically. The Company s non- life insurance operations, particularly its insurance agency business, provide sources of cash which are not subject to regulatory restrictions. Prior to its sale, the auto auction business was also a source of significant cash flows for the Company.
The principal sources of cash funds of the life insurance subsidiaries are premiums and investment income, as well as proceeds from sales and maturities of investments. These companies use cash primarily to pay commissions, claims and operating expenses. Credit insurance is the Company s principal product line and credit insurance premiums are therefore the Company s principal source of premium revenues. Credit insurance premium levels during the past five years are substantially lower than the premium levels prior to the economic recession in the early 1990's. This continued reduction in cash funds has depleted most of the Company s short-term cash reserves and has caused some decline in its long-term investment base. The assessment by the Company s management and its Board of Directors that this decrease in revenues and the related decline in operating results could not be reversed within a reasonable period of time led to the decision in early 1996 to evaluate other alternatives to best serve the interests of its shareholders. This evaluation process, in turn, led to the proposed merger transaction discussed in the Overview section of this Management s Discussion and Analysis and in Note 4 of the Notes to Consolidated Financial Statements.
During 1994, the funds generated from the sale and maturity of investments exceeded the funds used to acquire new investments, which was indicative of the Company s need for additional cash for operating needs. In 1995 and 1996, as a result of additional reductions in general expenses, the Company was able to reinvest the funds it generated from the sale and maturity of other investments. During 1994, a substantial amount of investments were sold in connection with the sale of the Company s direct universal life business to a third party. Cash and other assets were transferred to the reinsurer along with the Company's liability for future policy benefits on this business.
Capital Resources
The Company s total equity, including redeemable preferred stock, decreased by approximately $2.2 million during 1996. The decrease is attributable to (1) the current year net loss of $1.2 million, (2) the decline in the carrying value of the bond portfolio ($923,000 less $314,000 in applicable deferred income taxes), (3) $409,000 in dividends to preferred shareholders and (4) the purchase of treasury shares at a cost of $50,000. Shareholders equity per common share also decreased from $4.20 at December 31, 1995 to $3.31 at the end of 1996.
The Company continued to reduce its outstanding bank debt during 1996. During the first ten (10) months of the year, principal payments of $845,000 were made. On November 6, 1996, in conjunction with the sale of the auto auction business discussed above, the remaining $1.7 million in debt was repaid.
Inflation
Inflation influences the Company's Automotive Resource Division through its effects on automobile prices and interest rates. An increase in car prices not only affects the amount of credit insurance premiums collected, due to higher loan amounts, but also generally extends the term of car loans. Interest rates affect the consumers' ability to borrow funds which, in turn, affects automobile sales and ultimately the Company's marketing of credit insurance and related products. Because of regulatory standards, the Company's premium rates cannot be readily changed to reflect increased costs arising from inflationary trends.
MANAGEMENT S RESPONSIBILITY FOR FINANCIAL STATEMENTS
The management of the Company is responsible for the preparation, integrity and objectivity of the financial information contained in this Form 10-K. The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles. Such statements include informed estimates and judgements of management for those transactions that are not yet complete or for which the ultimate effects cannot be precisely determined. Financial information presented in this annual report is consistent with that in the financial statements.
Accounting procedures and related systems of internal control have been established to provide reasonable assurance that the books and records reflect the transactions of the Company and that established policies and procedures are properly implemented by qualified personnel. Such systems are evaluated regularly to determine their effectiveness.
The consolidated financial statements for the years ended December 31, 1996 and 1995 have been audited by Arthur Andersen LLP, independent auditors. The consolidated financial statements for the year ended December 31, 1994 have been audited by Ernst & Young LLP, independent auditors. Such audits were conducted in accordance with generally accepted auditing standards, and include a review and evaluation of our internal accounting control structure, tests of the accounting records and other auditing procedures they consider necessary to express their informed professional opinion on the consolidated financial statements.
The Board of Directors, with the assistance of its Audit Committee, monitors the financial and accounting operations of the Company. The Committee, composed of non-employee members of the Board of Directors, meets periodically with representatives of its independent auditing firm to discuss the scope of its audit and related reports. The Company s independent auditors have at all times full and free access to the Audit Committee, without management present, to discuss any matter that they believe should be brought to the attention of the Committee.
James C. Robertson R. Fredric Zullinger Chairman, Chief Executive Officer Chief Financial Officer and President
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
Board of Directors Consumers Financial Corporation
We have audited the accompanying consolidated balance sheets of Consumers Financial Corporation (a Pennsylvania corporation) and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, shareholders equity and cash flows for the years then ended. These financial statements and the schedules referred to below are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and the 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.
As discussed in Note 4 of the Notes to Consolidated Financial Statements, on October 30, 1996, the Company entered into an Agreement and Plan of Merger with LaSalle Group, Inc. (LaSalle). The merger is subject to the approval of the insurance regulators in the four states in which the Company s insurance subsidiaries are domiciled. In addition, the Company is addressing regulatory matters in various states, and the Company s plans relative to those matters are discussed in Note 20.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Consumers Financial Corporation and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for the years then ended, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedules listed in the index of financial statement schedules at Item 14(a) are presented for purposes of complying with the Securities and Exchange Commission s rules and are not part of the basic financial statements. The 1996 and 1995 amounts included in these schedules have been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP New York, New York March 28 , 1997
REPORT OF INDEPENDENT AUDITORS
Board of Directors Consumers Financial Corporation
We have audited the accompanying consolidated statement of operations, shareholders equity and cash flows of Consumers Financial Corporation and subsidiaries for the year ended December 31, 1994. Our audit also included the 1994 amounts in the financial statement schedules listed in the index at item 14(a). These financial statements and schedules are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements and the 1994 amounts in the schedules based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of the operations of Consumers Financial Corporation and subsidiaries and their cash flows for the year ended December 31, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, the 1994 amounts in the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
As discussed in Note 3 to the consolidated financial statements, in 1994 the Company changed its method of recognizing earnings on credit disability insurance.
ERNST & YOUNG LLP Philadelphia, Pennsylvania March 24, 1995
See notes to consolidated financial statements
See notes to consolidated financial statements
See notes to consolidated financial statements
CONSUMERS FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business
Consumers Financial Corporation is an insurance holding company which, through its subsidiaries, is a leading provider of credit life and credit disability insurance in the Middle Atlantic region of the United States.
Basis of financial statements
The financial statements have been prepared on the basis of generally accepted accounting principles (GAAP) which, as to the life insurance company subsidiaries, vary from reporting practices prescribed or permitted by regulatory authorities. Certain prior year amounts have been reclassified to conform with classifications used for 1996.
Principles of consolidation
The consolidated financial statements include the accounts of Consumers Financial Corporation (the Company) and its wholly-owned subsidiaries, the most significant of which are Consumers Life Insurance Company (Consumers Life), Interstate Auto Auction, Inc. (Interstate) and Consumers Car Care Corporation. Consumers Life Insurance Company of North Carolina, Investors Fidelity Life Assurance Corp. and Consumers Reinsurance Company are subsidiaries of Consumers Life. All material intercompany accounts and transactions have been eliminated. Use of estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.
Investments
Fixed maturities includes bonds, notes and certificates of deposit maturing after one year. Management determines the appropriate classification of bonds and notes at the time of purchase and reevaluates such designation as of each balance sheet date. These securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. All other bonds and notes are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of income taxes, reported as a separate component of shareholders equity. The amortized cost of securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. All certificates of deposits maturing after one year are deemed to be held to maturity. Equity securities (common and non-redeemable preferred stocks) held by the insurance subsidiaries are stated at fair value.
Mortgage loans on real estate are carried at the unpaid principal balance. Investment real estate is carried at the lower of cost or fair value. Policy loans are carried at their unpaid balance. Other invested assets, excluding real estate partnerships, and short-term investments are carried at cost. Investments in real estate partnerships are reported at equity.
Interest on fixed maturities and short-term investments is credited to income as it accrues on the principal amounts outstanding, adjusted for amortization of premiums and discounts computed by the interest method. Dividends are recorded as income on the ex-dividend dates. Loan origination and commitment fees are amortized, using the interest method, over the life of the mortgage loan. The accrual of interest on mortgage loans is generally discontinued when the full collection of principal is in doubt, or when the payment of principal or interest has become contractually 90 days past due.
Realized gains and losses and provisions for permanent losses on investments are included in the determination of operating income. Net unrealized appreciation or depreciation of debt securities and preferred and \ common stocks, which represents the difference between fair value and aggregate cost, is included in a separate shareholders' equity account. The "specific identification" method is used in determining the cost of investments sold.
Fair values of financial instruments
The following methods and assumptions were used by the Company in estimating its fair value disclosure for financial instruments:
Cash and short-term investments: The carrying amounts reported in the balance sheet for these instruments approximate their fair values.
Investment securities: Fair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturity securities not actively traded, fair values are estimated using values obtained from independent pricing services or, in the case of private placements, are estimated by discounting expected future cash flows using a current market rate applicable to the yield, credit quality and maturity of the investments. The fair values for equity securities are based on quoted market prices and are recognized in the balance sheet (see Note 6).
Mortgage loans and real estate and policy loans: The fair values for mortgage loans are estimated using discounted cash flow analyses, using interest rates currently being offered for similar loans to borrowers with similar credit ratings. Similarly, real estate fair values are estimated using discounted cash flow analyses. The carrying amounts for policy loans approximate their fair values.
Long-term debt: The carrying amount for long-term debt approximates its fair value. Deferred policy acquisition costs
The costs of acquiring new business, including costs incurred subsequent to the year of issue in excess of the ultimate level costs, principally commissions, certain sales salaries and those home office expenses that vary with and are primarily related to the production of new business, have been deferred. Deferred acquisition costs applicable to individual life insurance, excluding universal life-type policies and investment products, were amortized over the premium-paying period of the related policies in the manner which will charge each year's operations in direct proportion to the estimated receipt of premium revenue over the life of the contracts. Premium revenue estimates are made using the same interest, mortality and withdrawal assumptions as are used for computing liabilities for future policy benefits. Deferred policy acquisition costs related to universal life-type policies and investment products are amortized in relation to the present value of expected gross profits on the policies. Acquisition costs relating to single premium credit insurance are being amortized so as to charge each year's operations in direct proportion to premiums earned.
Property and equipment and depreciation
Property and equipment are stated at cost. Depreciation is being provided on the straight-line method over the estimated useful lives of the assets.
Other real estate
Real estate is carried at the lower of cost or fair value.
Intangibles
Costs in excess of underlying net assets of acquired companies and acquired intangible assets are being amortized over the estimated periods expected to benefit (5 - 40 years) using the straight-line and other methods which provide periodic charges to operations proportionate to the anticipated benefits to be received. These intangible assets are periodically reviewed for impairment, based on an assessment of future operations, to ensure that they are appropriately valued.
Future policy benefits
The liability for future policy benefits for individual life insurance has been provided on a net level premium method based on estimated investment yields, withdrawals, mortality and other assumptions which were appropriate at the time the policies were issued. Such estimates were based upon industry data and the Companies' past experience, as adjusted to provide for possible adverse deviation from the estimates. Benefit reserves for universal life products represent policy account balances before applicable surrender charges plus certain deferred policy initiation fees that are recognized in income over the term of the policies.
Unearned premiums
Unearned premiums for credit life and disability insurance contracts have been computed based upon the original and remaining term of the related policies as follows: decreasing term credit life on the Rule of 78's method, level term credit life using the Pro Rata method and, effective January 1, 1994, credit disability using a 65% - 35% weighted average of the Rule of 78's and Pro Rata methods. (see Note 3).
Recognition of premium revenue and related costs
For individual life insurance contracts, excluding universal life-type policies and investment products, premiums are recognized as revenue over the premium-paying period. Future benefits and expenses are associated with earned premiums, so as to result in recognition of profits principally over the premium-paying period. This association is accomplished by means of the provision for liabilities for future benefits and the deferral and amortization of acquisition costs. Provisions are also made for the risk of adverse deviation from the reserve assumptions over the lives of the contracts. Revenues for universal life-type policies and investment products consist of policy charges for the cost of insurance, policy administration, and surrenders assessed during the period, and expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances. For credit insurance, premiums are earned over the terms of the policies, as discussed above. Policy and contract claims include provisions for claims reported and claims incurred but not reported. The Company believes that the liabilities for claims and related expenses are adequate. Anticipated investment income is considered in determining whether future earned premiums on existing credit insurance will be sufficient to cover the present value of future benefits and maintenance expenses and to recover the unamortized portion of deferred policy acquisition costs.
Income taxes
The Company and its subsidiaries provide income taxes, for financial reporting purposes, on the basis of the liability method as required by Statement of Financial Accounting Standards No. 109.
New Accounting Standards
The Company adopted Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), in 1996. Under the provisions of SFAS 123, companies can elect to account for stock- based compensation plans using a fair-value based method or continue measuring compensation expense for those plans using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related Interpretations. The Company has elected to continue using the intrinsic value method to account for its stock-based compensation plans. SFAS 123 requires companies electing to continue using the intrinsic value method to make certain pro forma disclosures (see Note 16).
Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of (SFAS 121), was adopted as of January 1, 1996. SFAS standardized the accounting practices for the recognition and measurement of impairment losses on certain long-lived assets. The adoption of SFAS 121 had no material effect on the Company s results of operations or financial position.
2. BASIS OF FINANCIAL STATEMENTS
The more significant GAAP applied in the preparation of the financial statements that differ from life insurance statutory accounting practices prescribed or permitted by regulatory authorities (which are primarily designed to demonstrate solvency) are as follows:
(a) Investments in securities of unaffiliated companies are reported as described in Note 1, rather than in accordance with valuations established by the National Association of Insurance Commissioners (NAIC). Pursuant to NAIC valuations, bonds eligible for amortization are reported at amortized value; other securities are carried at values prescribed by or deemed acceptable to the NAIC, including common stocks, other than stocks of affiliates, at market value.
(b) Costs of acquiring new business are deferred and amortized rather than being charged to operations as incurred.
(c) The liability for future policy benefits and expenses on individual life insurance is based on conservative estimates of expected mortality, morbidity, interest, withdrawals, and future maintenance and settlement expenses, rather than on statutory rates for mortality and interest. For credit life insurance, the liability is based upon the unearned premium reserve, computed as described in Note 1, rather than on statutory rates for mortality and interest. The credit disability policy liability, principally the unearned premium reserve, is calculated as described in Note 1. Effective January 1, 1994, the statutory liability is computed using predominantly the average of the Rule of 78's and Pro Rata methods. Prior to 1994, the statutory liability was computed using primarily the Pro Rata method.
(d) Deferred income taxes, if applicable, are provided as described in Note 17.
(e) The statutory liabilities for the interest maintenance reserve and asset valuation reserve, designed to lessen the impact on surplus of market fluctuations of securities and mortgage loans, have not been provided in the financial statements.
(f) Certain assets are reported as assets rather than being charged directly to surplus and excluded from the balance sheets.
(g) Commission allowances pertaining to financing-type reinsurance agreements are not included in results of operations.
(h) Loan origination fees are deferred and recognized over the life of the applicable mortgage as an adjustment of yield rather than being reported in income as received.
(i) Revenues for universal life-type policies and investment products consist of policy charges primarily for the cost of insurance rather than premiums due and/or collected on such policies. Expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances rather than the increase in benefit reserves and gross benefit claims incurred for these types of policies.
Dividends and other distributions to the Company from Consumers Life are limited in that Consumers Life is required to maintain minimum capital and surplus in each of the states in which it is licensed, determined in accordance with regulatory accounting practices. The amount of minimum capital and surplus required is $5.5 million. All distributions are further limited by Delaware state insurance laws to the greater of previous year earnings, computed in accordance with statutory accounting principles, or 10% of statutory capital and surplus as of the end of the previous year. In some instances such payments may require the prior approval of the insurance department. Accordingly, based on amounts reported to regulatory authorities, at December 31, 1996, approximately $8.6 million of Consumers Life's net assets cannot generally be transferred to the parent company and $585,000 is available for transfer during 1996 as long as the minimum capital and surplus requirements mentioned above are maintained. Also, any loans or advances to the parent company of a material amount must be reported to the insurance department. The Company may have limited cash funds available to pay dividends in excess of amounts transferred from subsidiaries. In addition, separate restrictions apply to the surplus note owed to the Company by a subsidiary of Consumers Life. Payment of interest and repayment of principal on the note are permitted by the applicable state insurance department as long as the subsidiary's statutory capital and surplus exceeds $3 million.
The reported statutory capital and surplus of the life insurance subsidiaries was $5.9 million at December 31, 1996 and $7.1 million at December 31, 1995. After reflecting the impact of both the disallowed reinsurance treaty and the excess subsidiary investments discussed in Note 20, the statutory capital and surplus of the life insurance subsidiaries at December 31, 1995 would have been $4.6 million. The insurance companies combined statutory net income was $29,000 in 1996. In 1995, the companies reported a combined net loss of $3,589,000, and in they reported net income of $477,000.
Insurance laws require that certain amounts be deposited with various state insurance departments for the benefit and protection of policyholders. The approximate carrying amount of such deposits at both December 31, 1996 and 1995 was $5.3 million.
After receiving consent from the Delaware Insurance Department, the Company adopted, for statutory reporting purposes, an accelerated method of reserving disability unearned premiums. The change allows the Company to recognize revenue in a manner which more appropriately matches its incidence of claims. In addition to the use of this unearned premium method, the insurance subsidiaries have also requested and received approval from their respective domiciliary states to carry as an admitted asset a receivable for credit insurance premiums, net of commissions, which have been collected by the companies agents but have not yet been remitted to the companies. At December 31, 1996 and 1995, the premiums in process of collection receivable totaled $1.8 million and $2 million, respectively.
3. ACCOUNTING CHANGES
As of January 1, 1994, the Company changed its method of earning credit disability premiums for a substantial portion of its credit disability business. The method used prior to 1994 was computed based on the average of the Rule of 78's and the Pro Rata methods, while the new method utilizes a weighted average of those two methods, based on 65% of the Rule of 78's method and 35% of the Pro Rata method. The new weighted average method accelerates the premium earning pattern and provides a better matching of earned premiums with the incidence of incurred disability claims based on the Company s actual experience. The Company s method of amortizing deferred policy acquisition costs for credit disability business was also revised in proportion to the change in earned premiums.
The cumulative effect of this change on years prior to 1994 has been included in results of operations for 1994. This change reduced the 1994 net loss by $299,000 ($.11 per share).
4. PENDING MERGER
Because of the recurring losses in the Company s core credit insurance business, in early 1996, the Company began evaluating alternatives to best serve the interests of its shareholders. The Company considered several alternatives, including the following: (1) the sale of its insurance operations, (2) the sale of its credit insurance marketing organization (with retention and ongoing administration of inforce business), (3) the sale of its auto auction business, (4) the sale of the Company, (5) the reorganization of the Company or (6) the combination of the Company with another organization in the same or other lines of business.
In January 1996, the Company engaged a financial advisor to assist in evaluating the many alternatives to maximize shareholder value. In February 1996, the Company began soliciting bids for both its credit and universal life insurance operations and its auto auction business. From March until May 1996, 12 offers were received to buy the Company or segments of the Company, including one from LaSalle Group, Inc. (LaSalle), an investment management firm, which was structured as a cash merger. Following the completion of due diligence reviews and the submission of revised offers by the four highest bidders, the Company and its financial advisor reviewed and analyzed each offer. In October 1996, management recommended and advised the Company s Board of Directors to accept the revised offer from LaSalle.
On October 30, 1996, the Company entered into an Agreement and Plan of Merger with LaSalle and Consumers Acquisition Corp. ("CAC"), whereby CAC will be merged with and into the Company (the "Merger"). As the surviving corporation in the Merger, the Company will become a wholly-owned subsidiary of LaSalle. The Merger is subject to, among other things, the approval of insurance regulators in the four states in which the Company's insurance subsidiaries are domiciled. The Company s common shareholders approved the Merger at a Special Meeting held on March 25, 1997. The Agreement and Plan of Merger provides that the holders of the Company's outstanding common stock will receive cash in the amount of $3.92 per share, subject to certain adjustments. The Company's Preferred Stock will remain outstanding following the Merger, and the holders thereof will retain all of the rights and preferences which currently exist for such stock.
5. DISCONTINUED OPERATIONS
In late September 1996, the Company finalized a plan to dispose of the business and the related operating assets of Interstate as part of an overall plan to merge or otherwise combine its core insurance operations with those of another insurance company. On November 6, 1996, the Company sold Interstate s auto auction business and all of its property, plant and equipment and inventories to ADESA Pennsylvania, Inc., an unrelated third party, for cash of $4.85 million. The sale resulted in a fourth quarter after-tax gain of approximately $1.8 million. The gain on disposal includes a loss from operations of $84,000 from September 30, 1996 ( the measurement date) to December 31, 1996, less an income tax benefit of $28,000. Accordingly, in the accompanying financial statements, Interstate s operating results have been reported as discontinued operations for all periods presented. Interstate s non-operating net assets, principally cash, receivables, investments and trade payables, were retained by the Company.
In March 1997, the Company signed a Recapture Agreement to reinsure its remaining block of individual life insurance business back to the direct writer of the business (see Note 21). The Recapture Agreement provides that the direct writer will pay the Company a recapture consideration equal to $1.05 million in exchange for the transfer by the Company of assets in an amount equal to the net statutory policy reserves for this business. Based upon the recapture consideration to be received, the transaction will result in an after-tax loss of approximately $900,000. This loss has been reflected in the Company s 1996 financial statements.
The Company had previously sold a substantial portion of its direct and assumed universal life business to an unaffiliated company. The business written on a direct basis was coinsured to the acquiring company. The assumed business was transferred to the purchaser with approval of the direct writing company and with no recourse to the Company in the event the purchaser is unable to fulfill its obligations under the reinsurance agreement. These transactions, which took place on December 30, 1994, resulted in the transfer of $32.7 million in policy liabilities and $24.1 million in cash, mortgage loans and policy loans to the purchaser. In addition, $7.7 million in deferred policy acquisition costs were written off. The sale produced a pre-tax gain of $895,000, which was partially offset by a $492,000 loss on the sale of investments necessary to close on the transaction.
Accordingly, in the accompanying financial statements, the operating results of the Company s individual life insurance business have been reported as discontinued operations for all periods presented.
A summary of the results of operations of the discontinued segments is presented below:
At December 31, 1996 and 1995, the remaining net assets of the discontinued individual life insurance segment consisted of the following:
At December 31, 1995, the net assets of the discontinued auto auction business consisted of $1.8 million in property and equipment and $84,000 in inventories.
6. INVESTMENTS AND INVESTMENT INCOME
Investments, which are valued for financial statement purposes as described in Note 1, consist of the following at December 31, 1996:
A portion of the Company's invested funds is restricted as to use. Deposits are required with various state insurance departments for the benefit and protection of policyholders (see Note 2).
At December 31, 1996 and 1995, no mortgage loans or other loans were considered to be non-performing loans.
At December 31, 1996, approximately 81% of the Company's investments in mortgage loans were secured by commercial real estate and the remaining mortgage loans were secured by residential real estate.
Approximately 73% of the loans involved properties located in Central Pennsylvania. Such investments consist principally of first mortgage liens on completed income-producing properties, primarily office buildings . One mortgage loan exceeded 10% of shareholders equity at December 31, 1996, and two mortgage loans exceeded 10% of shareholders equity at December 31, 1995. The Company s mortgage loan valuation reserve at December 31, 1996 and 1995 was $100,000.
Accumulated depreciation on investment real estate amounted to $51,000 at December 31, 1995. At December 31, 1996, all the Company s real estate is classified as non-investment real estate, since the Company intends to sell these properties. Accumulated depreciation on the properties at the time they were reclassified totaled $22,663.
Net investment income is applicable to the following investments:
The amortized cost and estimated fair values of investments in debt securities at December 31, 1996 and 1995 are as follows:
The amortized cost and estimated fair value of debt securities at December 31, 1996, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Proceeds from sales of investments in debt securities and assets held for sale during 1996 were $4.1 million. Gross gains of $6,000 and gross losses of $20,000 were realized on those sales. Proceeds from such sales in 1995 were $4.1 million. Gross gains of $3,000 and gross losses of $29,000 were realized on those sales. Proceeds from sales in 1994 were $9.6 million. Gross gains of $41,000 and gross losses of $38,000 were realized on those sales.
A summary of the consolidated net realized gains (losses) and the change in the difference between cost and quoted or estimated fair value for fixed maturity investments is as follows:
Realized gains and losses in the years ended December 31, 1996, 1995 and 1994 also arose from the sale of other investments.