policyholder information statement on shenandoah life insurance co

IMPORTANT NOTICE: This document is the Official Policyholder Information Statement, approved by the State Corporation Commission of the Commonwealth of Virginia following the hearing held on October 11, 2011.

SHENANDOAH LIFE INSURANCE COMPANY

2301 Brambleton Avenue S.W. Roanoke, Virginia 24015

Policyholder Information Statement, Part Two, Information About Shenandoah and Its Businesses, Including Financial Statements

The Policyholder Information Statement Part One: (a) summarizes the highlights of Shenandoah’s Rehabilitation Plan (including the Plan of Conversion, which governs the Conversion); (b) describes the formula providing Eligible Policyholders with the potential to receive compensation in conjunction with the Conversion; (c) explains the vote of Members to be held at the Special Meeting on the proposal to approve the Plan of Conversion; (d) provides information to help Members decide how to vote, including certain special considerations which may affect Policyholders’ rights and compensation; and (e) clarifies that the Conversion would not diminish Policy guaranteed benefits, values, and rights, or increase Policy premiums or contributions above their contractual maximum rates, with the exception of the elimination of Members’ voting rights as a result of the Conversion, the modification of the terms of the Participating Policies with respect to the payment of dividends, and subject to any Extension of Moratorium on Cash Withdrawals.

This Policyholder Information Statement Part Two contains information about Shenandoah Life Insurance Company (the “Company” or “Shenandoah”) and its businesses, including financial statements.

Policyholders are urged to read both Parts One and Two of the Policyholder Information Statement.

Capitalized terms not defined in this Policyholder Information Statement Part Two are used as defined in the Glossary of the Policyholder Information Statement Part One. Each term defined in the Glossary is printed in boldface the first time it appears in Policyholder Information Statement Part One.

In deciding how to vote on the Plan of Conversion, Members must rely on their own examination of the Company and the terms of the Plan of Conversion, including the merits and risks involved. NO FEDERAL OR STATE COMMISSION OR SECURITIES REGULATORY AUTHORITY HAS CONFIRMED THE ACCURACY OR DETERMINED THE ADEQUACY OF THIS POLICYHOLDER INFORMATION STATEMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

Policyholder Information Statement - Part Two

TABLE OF CONTENTS Page

SUMMARY ................................................................................................................................... 4

THE COMPANY’S HISTORY ................................................................................................... 4

RATINGS ...................................................................................................................................... 6

CUSTOMERS ............................................................................................................................... 7

EMPLOYEES ............................................................................................................................... 7

MANAGEMENT .......................................................................................................................... 7

THE COMPANY’S OPERATIONS ........................................................................................... 8

UNDERWRITING AND PRICING.......................................................................................... 11

REINSURANCE ......................................................................................................................... 12

INSURANCE RESERVES......................................................................................................... 12

PROPERTIES............................................................................................................................. 13

LEGAL PROCEEDINGS .......................................................................................................... 13

INVESTMENTS ......................................................................................................................... 14

REGULATION ........................................................................................................................... 18

EFFECT ON SHENANDOAH’S SURPLUS OF NON-COMPLIANCE WITH CERTAIN INVESTMENT RESTRICTIONS REQUIRED BY CHAPTER 14 OF THE VIRGINIA INSURANCE CODE .................................................................................................................. 25

RESTRICTIONS ON EXTRAORDINARY DIVIDENDS..................................................... 26

SELECTED HISTORICAL FINANCIAL INFORMATION ................................................ 26

UNITED PROSPERITY’S PLAN FOR FUTURE OPERATIONS ...................................... 31

RISK FACTORS APPLICABLE TO MEMBERS AND POLICYHOLDERS.................... 34


SUMMARY You should read the entire Policyholder Information Statement Part Two carefully, including the “Risk Factors Applicable to Members and Policyholders” section and the consolidated financial statements and the notes to those statements. References to “$,” “US$,” or “dollars” are to United States dollars. The Glossary beginning on page G-1 of the Policyholder Information Statement Part One includes definitions of certain terms. Each term defined in the Glossary is printed in boldface the first time it appears in Policyholder Information Statement Part One.

THE COMPANY’S HISTORY Early History

Shenandoah was chartered as a Stock Insurance Company in 1914 as a result of a growing need to provide insurance coverage to the community of Roanoke, Virginia. The Company sold its first Policy in 1916. By 1921, Shenandoah was one of the foremost mortgage lenders in southwestern Virginia and had expanded its geographic territory into other states. In that year, Shenandoah sold nearly $7 million in life insurance. In 1924, the Company entered the group insurance market and in 1949, Shenandoah moved its home office to the current location on Brambleton Avenue. The Company converted from a Stock Insurance Company to a mutual insurance company in 1955.

In the early 1980s, Shenandoah was one of the first companies to offer universal life insurance policies, and it has continued to invest and expand its product portfolio and its distribution systems. In recent years, Shenandoah expanded its business model and became a premier provider of senior market products and a recognized low-cost underwriter of group dental plans, particularly in the small case market. The Company reinvented its individual insurance distribution model in 1998, and has continued to invest in technology and innovative distribution platforms. Recent History

In early 2008, Shenandoah was seeking a high quality asset class in which to invest. In January of 2008, Shenandoah purchased approximately $35.8 million of preferred stock issued by two government sponsored enterprises (“GSEs”), the Federal National Mortgage Association (“FNMA” or “Fannie Mae”), and the Federal Home Loan Mortgage Corporation (“FHLMC” or “Freddie Mac”). Shenandoah purchased an additional $13.9 million of Fannie Mae preferred stock in March of 2008, raising its total investment in these GSEs to approximately $49.7 million. At the time of the purchases, these preferred securities were rated Aa3 by Moody’s and AA- by S&P, and the purchases complied with the Company’s investment policy guidelines.

The Company monitored these investments closely during the first half of 2008 as the U.S. and global equity markets continued to deteriorate. In mid-July, Moody’s and S&P downgraded their ratings of the GSEs’ preferred stock by one notch. Shenandoah’s positions in the GSEs continued to remain within investment policy guidelines and were thoroughly discussed at the Company’s Investment Committee meeting in late-July of 2008.


In late-August of 2008, Moody’s downgraded its rating of the GSEs’ preferred stock to

Baa3, creating an investment policy variance. Company management discussed the variance with the Chairman of the Board and the Investment Committee Chairwoman, and recommended holding the positions to avoid realizing a large loss, as prices had fallen significantly during July and August. The Investment Committee agreed with the recommendation, and granted the necessary investment policy variance.

On September 7, 2008, Secretary of the Treasury Henry M. Paulson, Jr. announced that the Department of the Treasury was placing the GSEs into conservatorship and suspending the payment of dividends on their preferred stock. Secretary Paulson also announced that any preferred stock value would be eliminated prior to a capital infusion by the government. Prices on the GSEs’ preferred stock plummeted immediately to approximately ten cents on the dollar, reducing the value of the Company’s admitted assets by approximately $45 million.

On September 26, 2008, A.M. Best downgraded its rating of Shenandoah from “A-” to a “B++” with a negative outlook. The downgrade was based on the Company’s significant exposure to the GSEs and its relatively high exposure to commercial mortgages, collateralized debt obligations (“CDOs”), and other structured securities. Although the Company’s 2008 year-to-date Statutory Accounting Principles (“SAP”) pre-tax operating earnings were at record high levels, SAP net investment losses totaled nearly $70 million through the end of the third quarter of 2008 and contributed significantly to a 38% decline in SAP surplus from approximately $126 million as of December 31, 2007, to approximately $78 million as of September 30, 2008.

The Company’s management became increasingly concerned as financial and credit markets continued to deteriorate during the fourth quarter of 2008, resulting in further weakening of the Company’s financial condition. Management, the Board of Directors, and advisors hired by the Company responded initially to the GSEs’ conservatorship by asking the Virginia Congressional delegation to intercede with, among others, the Department of the Treasury and the Federal Housing Finance Agency (the “FHFA”), on behalf of insurance companies that were affected adversely by Secretary Paulson’s announcement because they had large investment holdings of the GSEs’ preferred stock. Meanwhile, the Company’s former Chief Executive Officer (“CEO”) placed several calls to CEOs of other insurance companies in an effort to find a company with the interest and necessary financial strength to buy or merge with Shenandoah.

With the prospect of securing government relief diminishing each week, the Company commenced merger discussions in early October of 2008 with OneAmerica Financial Partners (“OneAmerica”). OneAmerica’s CEO and Chief Financial Officer held brief talks with various members of Shenandoah’s management in October 2008.

On November 12, 2008, the Company received notice from the FHFA Director’s office that no direct relief would be made available to insurance companies affected adversely by the conservatorship of the GSEs, but that the FHFA would support any Congressional legislation to provide favorable tax treatment for insurers’ GSEs-related investment losses. On November 19, 2008, the Company announced that it had signed a letter of intent for a proposed merger that would result in Shenandoah becoming a subsidiary of OneAmerica. Prior to making the


announcement, representatives from Shenandoah and OneAmerica briefed A.M. Best and the Virginia Bureau of Insurance (the “Bureau”) on the rationale and advantages of the proposed merger. The letter of intent provided OneAmerica with exclusivity and prevented Shenandoah from pursuing offers from other potential buyers or merger partners.

OneAmerica and Shenandoah agreed to an aggressive timetable for the merger, in hopes of signing a definitive merger agreement by mid-December of 2008 and finalizing the transaction by mid-year 2009. OneAmerica provided Shenandoah management with an extensive list of due diligence items in late-November, and these items were completed and forwarded to OneAmerica over a three-week period ending December 19, 2008.

During January of 2009, OneAmerica continued to perform its due diligence of Shenandoah while the definitive merger agreement and disclosure schedules were being drafted. OneAmerica’s due diligence uncovered errors in Shenandoah’s reserve calculations, the correction of which would reduce the Company’s SAP surplus by approximately $23 million on its December 31, 2008, financial statements. OneAmerica had initially estimated that improving A.M. Best’s rating of Shenandoah to “A” would require a capital infusion of $100-125 million, but the corrections to Shenandoah’s reserve calculations raised the estimate of the required capital infusion to $150-200 million.

On February 6, 2009, OneAmerica informed Shenandoah that its Board of Directors had voted to terminate the letter of intent concerning the proposed merger. Given Shenandoah’s significantly weakened financial position and lack of any other suitors as the result of the exclusivity arrangement with OneAmerica, the Commission placed the Company in receivership on February 12, 2009.

RATINGS

Insurance companies are assigned financial strength ratings by rating agencies based

upon factors relevant to policyholders. Ratings provide both industry participants and insurance consumers meaningful information on specific insurance companies. Higher ratings generally indicate financial stability and a stronger ability to pay claims.

A.M. Best’s ratings for insurance companies range from “A++” to “S,” with “A++” and “A+” ratings assigned to companies that in A.M. Best’s opinion have achieved superior overall performance when compared to the norms of the life insurance industry and have demonstrated a strong ability to meet their policyholder and other contractual obligations. Fitch’s ratings range from “AAA” to “D,” with “AAA” and “AA” ratings assigned to insurance companies that have demonstrated financial strength and a very strong capacity to meet policyholder and contract holder obligations on a timely basis. Moody’s ratings range from “Aaa” to “C,” with “A (“Excellent”)” ratings assigned to insurers that have demonstrated excellent financial security. Standard & Poor’s ratings range from “AAA” to “R,” with “AAA” and “AA” ratings assigned to insurance companies that have demonstrated very strong financial security. In evaluating an insurer’s financial and operating performance, these rating agencies review its profitability, leverage and liquidity, as well as its book of business, the adequacy and soundness of its


reinsurance, the quality and estimated market value of its assets, the adequacy of its policy reserves, and the experience and competency of its management.

Until Shenandoah was placed in receivership, the Company enjoyed high ratings from

A.M. Best and other rating agencies.

While in receivership, Shenandoah has been prohibited from selling any policies. Shenandoah’s ratings indicate its receivership status and hazardous financial condition. If the Plan of Conversion is approved by an affirmative vote of Members and consummated, the Deputy Receiver and the Company believe that Shenandoah’s ratings would improve as the result of the capital infusion that United Prosperity would provide. Following its emergence from receivership, the Company expects to resume the marketing of insurance products, including certain new products, which the Company believes will not be ratings sensitive. In addition, over time, it is anticipated that Shenandoah would regain its former strong ratings, which would allow the Company to resume marketing products that require high financial ratings, like asset-based products, Shenandoah’s largest product line pre-receivership, and would make its insurance products more attractive to distributors and customers.

CUSTOMERS

As of September 30, 2011, there are 179,540 policies in-force.

EMPLOYEES

As of February 12, 2009, the Company had 284 employees. The Company has suffered from employee attrition since the beginning of the receivership. Common reasons for leaving the Company have included lack of job security and/or job growth. As of September 30, 2011, the Company had 147 employees. After the Company emerges from receivership and regulators permit it to resume selling policies, United Prosperity anticipates that the Company would hire additional employees to fill marketing and other positions that are currently vacant.

MANAGEMENT

Prior to the entry of the receivership order on February 12, 2009, Shenandoah was

managed under the direction of its Board of Directors. During receivership, the powers of the Board of Directors have been assumed by the Deputy Receiver. Effective upon the Closing, United Prosperity would establish a new Board of Directors which, pursuant to Shenandoah’s Amended Bylaws and Amended Articles of Incorporation, would assume governance of the Company effective upon the later of Closing or entry of the Order Terminating Rehabilitation Proceedings. The table below lists the directors and executive officers who United Prosperity, as the sole shareholder of converted Shenandoah, would put in place after Closing:


Directors

Name Age Position Craig A. Huff 46 Director Matthew T. Popoli 35 Director Gregg M. Zeitlin 43 Director Heidi Hutter 53 Director Jose Montemayor 60 Director Jay Novik 66 Director, Chairman of Board Executive Officers

Name Age Position TBD Chief Executive Officer Heidi Hutter 53 Interim Chief Operating

Officer Mary Ann Peltier 56 Senior Vice President, Chief

Actuary and Secretary Michael Coffman 52 Senior Vice President, Chief

Financial Officer, and Treasurer

Paulus Moore 51 Vice President – Information Systems and Services

More information is available about these individuals in the Form A, which can be accessed either on the State Corporation Commission’s docket search web site (http://docket.scc.virginia.gov:8080/vaprod/main.asp), or on the Company web site (www.shenlife.com).

THE COMPANY’S OPERATIONS

Below is a comprehensive overview of Shenandoah, including business lines, strategies, principles, and other material matters relevant to its operations. Current Profile

Overview: Although Shenandoah is not permitted to market or issue new Policies while in

receivership, the Company continues to renew and service a diversified range of existing individual Policies in thirty-one states and the District of Columbia, which are focused on the middle income senior and small to mid-size business markets. Since the receivership began, Shenandoah has sold its group business to another insurer but continues to service group Policies during the transition.


Company Products Prior to Receivership

Prior to receivership, the Company offered a diverse line of insurance products to the public, both on an individual and a group insurance basis. The inventory available to the public ranged from single premium and whole life products, to annuities, as well as various employer sponsored group products. Below is a general overview of the products that Shenandoah marketed to the insurance public prior to receivership. Individual Insurance Products Life Products

1. Single premium life products (Legacy Solution III and Living Legacy III). 2. Final expense whole life product (Shenandoah New Vista). 3. Pre-need whole life product (Virginia only) designed for sale by funeral

directors and pre-need representatives to fund pre-paid funeral contracts. 4. Variety of universal life products:

a. Altis I – high target premium for maximum cash accumulation; b. Altis II – term type coverage for a guaranteed period with option to

continue coverage; and c. Altis 100+ – secondary guarantee product with limited pay

options. 5. Shenandoah and Mortgage Protector Term plans with rates guaranteed for

10, 15, 20, 25, or 30 years and with a minimum face amount of $50,000. Optional return of premium rider.

6. Shenandoah Whole Life, a participating plan paying dividends and offering permanent coverage with a minimum face amount of $5,000.

Annuities

1. Index Solution I, II, III – equity index products with competitive interest

rates and various investment options. 2. Single premium deferred annuities – Safe Solution II and Safe Choice II

offering tax deferred cash accumulation with competitive interest rates, a variety of withdrawal options, and an optional nursing home surrender charge waiver rider.

3. Single premium immediate annuity offering a lifetime income option or fixed period option.

4. Flexible premium deferred annuity I and II with competitive interest rates, withdrawal provisions, and very attractive surrender charges, ideal for funding IRAs.


Medicare Supplement

1. Plans A-G

2. Medicare Select (limited to the State of Florida through one distribution partner, Ameri-Life Group L.L.C.)

Group Segments

Employer-sponsored as well as employee-paid (voluntary) plans. 1. Small Group: 2-9 employees, high participation, and employer

contribution to premium. Limited product options to streamline administration and mitigate anti-selection.

2. True Group: 10+ employees with 75% minimum participation. Non-contributory or contributory with payroll deduction.

3. Voluntary: Usually 100% employee paid, low participation requirements.

Markets Shenandoah has historically found its niche in the smaller rural case market, with an average case size of 15-20 employees. Dental

Represented 65% of Shenandoah’s group premium. Included indemnity and preferred provider organization (“PPO”) plans, with features such as DenteMax. Provided network access for PPO plans, all Policy administration was conducted in-house, and all insurance risk was retained by Shenandoah. Very low voluntary participation requirements were a competitive feature—only 2 employees were required. Optional orthodontia rider was available on groups of any size. Life Group Life and accidental death and dismemberment (“AD&D”) represented approximately 20% of group premium. The AD&D rider was 100% reinsured and excess risk life amounts were ceded. Product was previously sold as a stand-alone or employer-sponsored voluntary plan. Conversion, portability, waiver of premium, and dependent coverage features were available. Claims were administered by Shenandoah. Short-Term Disability

Featured a unique claims-paying feature called StarProtect®, which paid up to four weeks True Group segment claims based only on employee and employer sections of the claim form, preventing delays. Shenandoah retained all the risk and administered claims in-house.


Long-Term Disability

One hundred percent reinsured, with the reinsurance partner rating, underwriting, and adjudicating claims on the Company’s behalf. Shenandoah handled billing, collecting premiums, and paying commissions. Vision

Introduced in 2008 with network partner, EyeMed Vision Care®. Two plans, Gold and Platinum, offered basic and more comprehensive coverage, respectively, for eye exams and materials. Shenandoah retained all insurance risk. EyeMed issued identification cards and administered claims on this block.

Risk Selection/Rating

As with most group insurance, there was limited individual underwriting. The predominant risk control was a requirement that enrollees be actively employed. Evidence of insurability was required for late entrants and life amounts in excess of guarantee issue limits. Small groups were manually rated based on census and basic group information such as industry and location. Voluntary life and disability were step-rated to protect against selection by age. Where experience was credible, standard experience rating techniques were used.

UNDERWRITING AND PRICING

Prior to receivership, the Company followed detailed underwriting practices and

procedures to assess and quantify the nature and size of risks it was willing to accept as well as the amount and type of reinsurance level appropriate for a particular type of risk.

For individual life insurance, the level of medical and other data collected on the prospective insured varied with the size of the death benefit requested. For small death benefits, the Company gathered limited medical information. For large death benefits, the Company required extensive medical, financial, and other data from the prospective insured. These practices and procedures were designed to result in policies that produced mortality experience consistent with the assumptions used in pricing the product. The pricing of the Company’s products varied depending on the age, occupational classification, type/amount of coverage/features purchased, and additional ratings or exclusions based on medical history. For individual cases, the Company underwrote each prospective insured based on the client’s occupation, financial, and medical history.

For all of the Company’s individual insurance and group insurance products, Shenandoah based its underwriting practices on the historical claims experience for that particular product. This experience included not only the historical mortality and/or morbidity experience of its existing individual or group insurance contracts, but also the experience of the overall individual or group insurance industry and the general population. In order to mitigate any exposure to higher risk business and to stay abreast of market trends, the Company actively monitored its


claims experience and the underwriting standards of its competitors. The Company’s underwriters evaluated policy applications on the basis of the information provided by the applicant and others. The Company also used a variety of medical tests to evaluate policy applications, depending on the size of the policy, the age of the applicant, and other factors.

Product pricing was reflective of the Company’s underwriting standards and was based on the expected Policyholder benefits, expenses, persistency, and investment returns. Shenandoah had designed products to protect it against greater than expected mortality and morbidity experience. The Company reviewed pricing frequently to ensure consistency with recent claims experience and developed new products, pricing, or underwriting guidelines as it deemed necessary. For its group business, the Company also employed experience rating. Experience rating is the process by which the premium charged to a group policyholder reflects a credit for positive historical experience or a charge for poor experience. Small group pricing must also meet stringent regulatory requirements.

The Company priced both its immediate annuities and its deferred annuities using historical annuity mortality experience as well as current and expected future investment yields.

REINSURANCE

Shenandoah followed standard industry practice by ceding portions of its individual and group life and disability insurance risks to other insurance companies. This permitted the Company to write larger Policies than it would otherwise be comfortable writing. Shenandoah usually entered into annually-renewable term insurance contracts, which focus on pure mortality risk. As of December 31, 2010, the amount of statutory premiums ceded to third-party reinsurers totaled $42,473,829.

INSURANCE RESERVES

Prior to receivership, Shenandoah established and reported liabilities on its balance sheet to meet future obligations using both SAP and generally accepted accounting principles (“GAAP”). Since receivership, the Company has discontinued preparing GAAP financial statements. The reserves are based on actuarially recognized methods using prescribed mortality and morbidity tables and assumptions for estimating future Policy benefits and claim experience. After the Closing Date, the Company expects these reserve amounts, along with future premiums to be received on the Policy and investment earnings on these amounts, to suffice to meet its contractual and Policy obligations. Reserves include amounts for claims incurred but not reported (“IBNR”), claims reported but not yet paid, and claims in the process of settlement. Upon emergence from receivership and the resumption of reporting GAAP financials, it is important to note that the Company’s GAAP-based reserves may vary from those calculated using only SAP. Life Insurance Reserves

Shenandoah calculates reserves for IBNR claims using its historical loss experience with due consideration to current in-force volumes. Reserves for claims that are in the course of


settlement and/or resisted are calculated on a similar basis. The life waiver reserve liability measures the present value of waiver of premium benefits under the Company’s group and individual life insurance contracts. It uses industry mortality and morbidity tables and an appropriate discount rate to calculate this liability. Reserves for the Company’s individual life products are calculated using methodologies, industry mortality tables, and interest rates as defined by state regulation. For policies with a cash value or a cash surrender value, these reserves are usually at least equal to the cash value or cash surrender value of the underlying policy.

Disability Insurance Reserves

Reserves for long term disability insurance represent the present value of estimated future benefits for current claimants. Claim benefit payments on long term disability insurance Policies consist of payments made monthly, in accordance with the contractual terms of the Policy. These payments begin at the claimant’s eligibility date as defined in the Policy and end upon the earliest of the claimant’s recovery, the expiration of contract limitations included in the Policy, or the claimant’s death.

At the beginning of the receivership, Shenandoah’s aggregate reserve liabilities were as

follows:

Product/Line As of December 31, 2008 of Business Direct Ceded Net Total

Life Insurance $ 744,412,689 $ 126,765,518 $ 617,647,171 Annuities $ 619,835,194 – $ 619,835,194 Supplementary Contracts with Life

Contingencies $ 21,461,113 – $ 21,461,113 Accidental Death Benefits $ 454,990 $ 5,739 $ 449,251 Disability – Active Lives $ 573,217 $ 271,424 $ 301,793 Disability – Disabled Lives $ 9,636,848 $ 419,843 $ 9,217,005 Miscellaneous reserves $ 65,693,191 – $ 65,693,191 Totals $ 1,462,067,242 $ 127,462,524 $ 1,334,604,718

PROPERTIES

Shenandoah owns its home office complex in Roanoke, Virginia at 2301 Brambleton Avenue S.W., Roanoke, Virginia 24015. In addition, the Company has foreclosed on one office building located in Richardson, Dallas County, Texas.

LEGAL PROCEEDINGS

Shenandoah is regularly involved in litigation, both as a defendant and as a plaintiff, but primarily as a defendant. Litigation naming the Company as a defendant ordinarily arises out of its business operations as a provider of life insurance and annuities. In addition, state regulatory bodies, such as state insurance departments, the Department of Labor, and other regulatory


bodies regularly make inquiries and conduct examinations or investigations concerning the Company’s compliance with, among other things, insurance laws, securities laws, and the Employee Retirement Income Security Act (“ERISA”).

While she cannot predict the outcome of any pending or future litigation, examination, or investigation, the Deputy Receiver does not believe that any pending matter will have a material adverse effect on the Company’s business, financial condition or results of operations.

INVESTMENTS

As of February 12, 2009, the Liquidation Value of Shenandoah’s investment portfolio was estimated to have been at least $232 million less than the value at which the assets were carried on the Company’s books, largely as a result of unrealized losses. Investments that incurred heavy unrealized losses at that date, or as of the date of the first financial statement subsequent to receivership, included, but were not limited to, the following:

1. Certain illiquid asset backed securities (“ABSs”) (comprising

approximately 17.5% of Shenandoah’s admitted assets).

2. Preferred Stock of Fannie Mae and Freddie Mac (comprising approximately $49.7 million, or approximately 3% of Shenandoah’s admitted assets).

3. Certain trust preferred securities and other hybrid securities (comprising approximately 14.8% of Shenandoah’s admitted assets).

The charts below reflect the book value, market value, and net difference between book

and market value of Shenandoah’s investment portfolio as of the dates specified. For the most part, market values of securities were determined by using the Wall Street pricing services predominantly relied upon by the industry including the National Association of Insurance Commissioners (“NAIC”) Securities Valuation Office (SVO), Interactive Data Corp., Dynamic Credit Partners, LLC, and various outside brokers. In some instances (for example where pricing service data was unavailable or unreliable), market values of securities were based on broker quotes, with comparison to available market data to determine the reasonableness of such quotes. For illiquid structured investment securities, Shenandoah used the services of an investment advisory firm to make best estimates of the market values of the securities based on projected future cash flows. Such estimated market values of securities are subject to a high degree of variability, and actual prices received from the sale of securities may differ materially from the estimated market values tabulated below. The estimates are made only with respect to those investment securities which can be traded in the capital markets and exclude other, non-marketable, assets.


Date Book Value Estimated Market

Value

Amount By Which Estimated Market

Value Exceeds (or is Less Than) Book

Value 1/31/2009 $ 1,263,041,651 $ 1,030,949,515 $ (232,092,136)2/28/2009 $ 1,263,036,654 $ 1,022,925,368 $ (240,111,286)3/5/2009 $ 1,259,206,000 $ 1,012,793,000 $ (246,413,000)

3/31/2009 $ 1,238,997,750 $ 1,010,277,445 $ (228,720,305)6/30/2009 $ 1,228,811,230 $ 1,085,939,476 $ (142,871,754)9/30/2009 $ 1,133,773,688 $ 1,059,856,211 $ (73,917,477)

12/31/2009 $ 1,087,881,748 $ 1,043,579,025 $ (44,302,723)3/31/2010 $ 1,138,301,801 $ 1,105,114,095 $ (33,187,706)6/30/2010 $ 1,133,106,304 $ 1,125,925,102 $ (7,181,202)9/30/2010 $ 1,121,969,719 $ 1,168,315,025 $ 46,345,306

12/31/2010 $ 1,149,465,352 $ 1,158,029,126 $ 8,563,774 3/31/2011 $ 1,148,752,966 $ 1,158,469,891 $ 9,716,925 6/30/2011 $ 1,143,511,955 $ 1,173,339,551 $ 29,827,596 8/31/2011 $ 1,147,271,851 $ 1,200,586,838 $ 53,314,987

$(400,000,000)

$(200,000,000)

$-

$200,000,000

$400,000,000

$600,000,000

$800,000,000

$1,000,000,000

$1,200,000,000

$1,400,000,000

1/31

/200

9

3/31

/200

9

5/31

/200

9

7/31

/200

9

9/30

/200

9

11/3

0/20

09

1/31

/201

0

3/31

/201

0

5/31

/201

0

7/31

/201

0

9/30

/201

0

11/3

0/20

10

1/31

/201

1

3/31

/201

1

5/31

/201

1

7/31

/201

1

Book Value Market Value Difference in Book & Market Values


Yield on Shenandoah’s Investment Portfolio

Shenandoah’s overall portfolio yield has remained fairly steady throughout the receivership, although it has trended down slightly. The slightly lower yields reflect efforts to improve credit quality for newly invested securities and a downward trend in yields in the capital markets since the beginning of the receivership. As anticipated by the Receivership Team, the overall portfolio investment yield declined further after implementation of Pacific Investment Management Company, LLC’s (“PIMCO”) and the Company’s recommendations on improving the credit quality and liquidity of Shenandoah’s investment portfolio.

Shenandoah’s Structured Investment Products

As part of the financial rehabilitation strategy, the Deputy Receiver approved engaging a consultant with significant experience in analyzing, trading, and managing structured investment products, to provide an analysis of Shenandoah’s ABSs. The consultant analyzed several securities subject to recent changes to statutory accounting requirements implemented by the NAIC in Statement of Statutory Accounting Principle (“SSAP”) 43R, adopted September 30, 2009. SSAP 43R requires that an impaired structured security product be valued on the basis of future discounted cash flows rather than on the basis of market value, unless it is rated NAIC 6 (the designation for obligations that are at or near default), in which case it must be marked-to-market. From its analysis of the fifteen securities in the Company’s investment portfolio that were not rated NAIC 6, the consultant concluded that Shenandoah could report an increase in surplus of $2.8 million as of September 30, 2009. Additionally, the firm also concluded that Shenandoah should take a write-down of $2.2 million on another ABS as of September 30, 2009.

Independently, the consultant analyzed eight securities held in the Company’s investment portfolio that were rated NAIC 6. The consultant concluded that, as of September 30, 2009, Shenandoah should further reduce its reported surplus to reflect a more realistic assessment of the market values of those eight securities. The consultant’s valuation indicated that the total market value of those eight securities was only $1.54 million as of September 30, 2009 (versus the previous valuation of $2.58 million). As a result, Shenandoah’s reported surplus was reduced by approximately $1 million as of September 30, 2009.

On February 9, 2010, the consultant completed its updated analysis of Shenandoah’s ABSs as of December 31, 2009. As of December 31, 2009, Shenandoah booked a capital loss of approximately $1.6 million, and reduced its reported surplus by $0.6 million, as the result of the consultant’s analyses. As of December 31, 2010, PIMCO completed its analysis and the Company recorded a total of $6.9 million of other than temporarily impaired (“OTTI”) investment write-downs in 2010. Certain OTTI losses ($4.2 million) were interest related losses and, therefore, transferred to the interest maintenance reserve liability, a component of reserves required by SAP.

Shenandoah’s Mortgage Loan Portfolio

As of September 30, 2011, the book value of Shenandoah’s mortgage loan portfolio was approximately $193 million. The credit quality of Shenandoah’s mortgage loan portfolio had


historically exceeded insurance industry averages as reported by A.M. Best. However, in 2011, Shenandoah’s mortgage loan performance is now below that of insurance industry averages. Mortgage performance has slipped because of mortgage loan restructurings for certain borrowers experiencing cash flow difficulties, and all of these mortgage restructurings occurred after the financial crisis hit the U.S. capital markets in the latter part of year 2008. The Receivership Team, in conjunction with Shenandoah’s mortgage loan department, has actively worked to oversee these loans, and made revisions as necessary to prevent defaults. However, future losses are possible given the current concerns surrounding the commercial real estate market. The following table provides information regarding Shenandoah’s internal watch list for troubled or problem mortgage loans:

31-Dec-09 31-Dec-10 30 September-11 # of Loans Loan

Balance # of Loans Loan

Balance # of Loans Loan

Balance Problem Loans

2 $2,393,668

3 $6,544,624 3 $6,038,836

General Monitoring

28 $36,833,248

22 $30,771,313 9 $15,946,796

Total: Current Watch List Loans

30 $39,226,916 25 $37,315,937 12 $21,985,632

In general, Shenandoah’s mortgage loan portfolio is concentrated in commercial property (i.e., approximately 75% of the portfolio consists of retail, office, and warehouse properties) in Virginia, Florida, Tennessee, Texas, North Carolina, Georgia, Kentucky, Indiana, South Carolina, and Ohio. As of September 30, 2011, Shenandoah’s blended loan-to-value (“LTV”) ratio (one of the key risk factors that lenders assess) for its entire mortgage loan portfolio was 44.87%, considered very good given the current economic circumstances. Generally, as the amount of equity increases, the risk of default declines. More importantly, a low LTV ratio indicates greater or more effective collateralization and therefore less risk.

As of September 30, 2011, all of the mortgage loans in Shenandoah’s portfolio were current, although some were current based on modified terms, and the Company had foreclosed on one property in Dallas, Texas. The Company has engaged a professional firm to manage and sell that property, though a sale is unlikely until conditions are more favorable.

Outsourcing of Investment Management

At the start of the receivership, an Investment Committee, composed of representatives from the Bureau of Insurance and the Receivership Team, was established to oversee the Company’s investments, among other tasks. The Deputy Receiver initially retained T. Rowe Price Associates, Inc. (“TRPA”) as the investment adviser for Shenandoah. TRPA conducted an independent evaluation of Shenandoah’s investment portfolio and formulated a strategy for dealing with problem assets and re-evaluating the asset mix to stabilize the portfolio and maximize Policyholder value.


Later, the Receivership Team engaged PIMCO to replace TRPA as the investment services advisor for Shenandoah because PIMCO has the specialized resources and expertise to analyze and advise on the more difficult and volatile securities in Shenandoah’s portfolio. PIMCO and the Deputy Receiver executed an Investment Management Agreement, effective May 17, 2010.

PIMCO then began an in-depth analysis of Shenandoah’s investment portfolio, determining valuations for the securities, including those that had become hard to value due to a very limited trading market. Upon completing the analysis, PIMCO provided the Receivership Manager with a list of securities that PIMCO recommended be held or sold (or purchased to replace sold securities). The Deputy Receiver provided specific instructions to PIMCO regarding which securities to sell (the “Final Sell List”), subject to favorable market conditions for those securities. Upon approval of the Final Sell List, PIMCO began active management of Shenandoah’s investment portfolio, subject to modified investing guidelines. The Deputy Receiver has since authorized the full implementation of the investment guidelines. In addition, PIMCO has completed the sales of all the securities on the Final Sell List.

Outsourcing of Investment Accounting

On May 14, 2010, Shenandoah finalized an Agreement with SunGard iWorks LLC (“SunGard”) to provide investment accounting services for the Company. All investment accounting functions are being outsourced to SunGard, which coordinates its accounting functions with PIMCO’s investment management functions. During this transition period, Shenandoah has maintained both its prior accounting platform (i.e., PAM) and the new SunGard platform. The final SunGard conversion will be complete in early 2012, at which time the Company will discontinue its reliance on the PAM system. The Company will realize cost and time savings for its investment accounting functions as a result of the outsourcing and change in providers.

Between now and the Closing, the Deputy Receiver will use her best efforts to minimize

or reduce the Company’s investment risk by balancing securities’ returns, liquidity, duration, and risks. If the Rehabilitation Plan is approved and implemented, United Prosperity and its advisors are expected to conduct their own comprehensive review of Shenandoah’s post-Closing investment portfolio, with the goals of: (1) rebalancing the Company’s investment portfolio to match United Prosperity’s approach to managing investment risk, (2) remaining in compliance with Virginia law while maximizing investment returns, and (3) implementing an appropriate asset-liability matching strategy.

REGULATION

Shenandoah is subject to extensive regulation at both the state and federal level. State Insurance Regulation

Shenandoah is subject to regulation and supervision by the insurance authorities in each jurisdiction in which it transacts business (currently, Shenandoah is licensed to transact business in thirty-one states and the District of Columbia, although its licenses have been expressly


suspended or effectively restricted during the receivership). State insurance laws generally establish supervisory agencies with broad administrative and supervisory powers related to granting and revoking licenses, transacting business, establishing guaranty associations, licensing agents, approving policy forms, regulating premium rates for some lines of business, establishing reserve requirements, prescribing the form and content of required financial statements and reports, determining the reasonableness and adequacy of statutory capital and surplus, and regulating the types and amount of investments permitted. State insurance laws generally require an insurer to register with state regulatory authorities and to file reports, including information concerning capital structure, ownership, financial condition, intercompany transactions and general business operations, including transactions involving the transfer of assets, loans, or payment of dividends between an insurer and its affiliates. Each jurisdiction in which an insurance company is licensed also requires the filing of various reports relating to financial condition, including detailed annual and summary quarterly statutory-basis financial statements.

State insurance regulatory authorities and other state law enforcement agencies and

attorneys general from time to time make inquiries concerning whether the Company is in compliance with the regulations covering its business. The Company responds to such inquiries in a manner it deems appropriate and takes corrective action if warranted.

State insurance regulators and the NAIC are continually re-examining existing laws and regulations, drafting proposed legislation for passage by state legislatures, and proposing new regulations for adoption by insurance authorities. In recent years, a number of new laws and regulations related to insurer solvency and market conduct have been proposed, including those focusing on:

• Insurance company investments; • RBC guidelines; • The implementation of non-statutory guidelines and the circumstances

under which dividends may be paid; • Product approvals; • Agent licensing; • Underwriting practices; and • Insurance and annuity sales practices.

For example, the NAIC has promulgated proposed changes to SAP. These initiatives

may be adopted by the various states in which Shenandoah is licensed, but the ultimate content, timing, and impact of any statutes and regulations adopted by the states cannot be determined at this time. Surplus and Capital Requirements

Insurance regulators have the discretionary authority, in connection with ongoing licensing, to limit or prohibit an insurance company from issuing new policies if, in the regulators’ judgment, the insurer does not maintain sufficient surplus or is in hazardous financial condition. Regulators may also limit an insurer’s issuance of new life insurance policies and


annuity contracts above an amount based upon the face amount and premiums of policies of a similar type issued in the prior year. RBC

The NAIC has established risk-based capital (“RBC”) standards for life insurance companies as well as a model act (“RBC Model Act”) for proposed adoption by the various states’ legislatures. All fifty states and the District of Columbia have adopted the RBC Model Act or a substantially similar law or regulation. The RBC Model Act provides that life insurance companies must submit an annual RBC report to state regulators reporting their RBC based on four categories of risk: (i) asset risk, (ii) insurance risk, (iii) interest rate risk, and (iv) business risk. For each of the four categories, the capital requirement is determined by applying factors to various asset, premium, and reserve items, with the factors being higher for those items with greater underlying risk and lower for less risky items. The formula is intended to be used by insurance regulators as an early warning tool to identify companies that may be thinly capitalized for purposes of initiating further regulatory action.

If an insurer’s total adjusted capital falls below specified levels, the insurer is subject to different degrees of regulatory action depending upon the magnitude of the shortfall. These actions range from requiring the insurer to propose actions to correct the capital deficiency to placing the insurer under regulatory control. On February 12, 2009, it was determined that Shenandoah’s RBC had fallen below the specified level for regulatory action under Virginia law, the Company was in a hazardous financial condition, and therefore subject to regulatory control by the Commission.

Pursuant to the Rehabilitation Plan, United Prosperity would inject sufficient new capital

(up to a maximum of $100 million) to raise Shenandoah’s RBC to at least 350% of authorized control level (“ACL”). Guaranty Funds

All fifty states of the United States, the District of Columbia, and Puerto Rico have insurance laws requiring insurers to participate as members of the life or health insurance guaranty association of each jurisdiction in which they do business. These associations are organized to guarantee the contractual obligations, up to statutory limits, under insurance policies and annuity contracts issued by impaired or insolvent insurance companies. To meet these obligations, these associations levy assessments on all member insurers based on the proportionate share of the premiums written by each member in the lines of business in which the impaired or insolvent insurer is engaged. Some states permit member insurers to recover assessments paid through full or partial premium tax offsets, usually over a period of years.

Since the start of the receivership, the Deputy Receiver has requested that the guaranty associations defer or abate any assessments of Shenandoah. Many associations have granted these requests while others have continued to request payment. The Deputy Receiver considers those associations which continue to request payment to be general creditors of Shenandoah and the outstanding balances will be due and payable upon emergence from receivership.


In addition, it is anticipated that if the Rehabilitation Plan (including the Plan of

Conversion) is approved, coverage by guaranty associations would not be triggered and Policyholders would retain the full benefits and cash value of their Policies without the need for guaranty associations to be involved.

Statutory Investment Valuation Reserves

Insurers are required to establish an interest maintenance reserve for net realized capital gains and losses on fixed maturity securities, net of tax, related to changes in interest rates (the “Interest Maintenance Reserve” or “IMR”). The Interest Maintenance Reserve applies to all types of fixed maturity investments, including bonds, preferred stocks, mortgage-backed securities, and mortgage loans. The Interest Maintenance Reserve is required to be amortized into statutory earnings on a basis reflecting the remaining period to maturity of the fixed maturity securities sold. These reserves are required by state insurance regulators to be established as a liability on a life insurer’s statutory financial statements, but do not affect financial statements prepared in accordance with GAAP.

Life insurance companies are also required to establish an asset valuation reserve to help

insulate statutory policyholder surplus from fluctuations in the market value of, and/or realized gains or losses on, bonds, stocks, mortgage loans, real estate, and other invested assets, other than fluctuations captured by the Interest Maintenance Reserve (the “Asset Valuation Reserve”). Although classified as a reserve account, the Asset Valuation Reserve does not represent an obligation of the Company. The Asset Valuation Reserve has two components:

• a “default component,” which provides for future credit-related losses on fixed maturity investments; and

• an “equity component,” which provides for losses on all types of equity

investments, including equity securities and real estate.

The Asset Valuation Reserve (“AVR”) generally captures all realized and unrealized gains or losses on invested assets, other than those resulting from changes in interest rates. Each year the amount of an insurer’s Asset Valuation Reserve will fluctuate as additional gains or losses are absorbed by the reserve. To adjust for such changes over time, an annual contribution must be made to the Asset Valuation Reserve equal to a basic contribution plus 20% of the difference between the reserve objective and the actual Asset Valuation Reserve.

Future additions to the AVR will reduce Shenandoah’s future statutory capital and surplus, as the Company will increase such reserve to the amount required by insurance regulations. AVR reserve increases will rise faster in year 2011 than prior years because the reserve must compensate for certain adverse financial events of the Company arising between year 2008 and the present. These adverse financial events are as follows:


1. The AVR reserve was lowered in recent years because of the Company’s capital losses on investment securities, and this reserve must now be restored; and

2. The AVR’s component for mortgage reserves will increase because the

Company’s mortgage loan experience has turned worse than the insurance industry average, and adverse experience greater than the insurance industry means that higher AVR reserves must be accrued by the Company.

As a result of the above, AVR increases will have a material effect on the Company’s growth in statutory capital and surplus for year 2011. NAIC Insurance Regulatory Information System Ratios

The NAIC has developed a set of financial tests known as the Insurance Regulatory Information System (“IRIS”), for early identification of companies which may require special attention by insurance regulators. Insurance companies submit data on an annual basis to the NAIC. This data is used to calculate IRIS ratios covering various categories of financial data, with defined “usual ranges” for each category. There are twelve key IRIS ratios for life insurance companies. Departure from the usual ranges on four or more of the ratios may lead to inquiries from individual states’ insurance departments. Regulation of Investments

Shenandoah is subject to state laws and regulations that require diversification of insurers’ investment portfolios. Some of these laws and regulations also limit the amount of investments in specified investment categories, such as below–investment-grade fixed maturity securities, equity real estate, other equity investments and derivatives. Failure to comply with these laws and regulations would cause investments exceeding regulatory limitations to be treated as non-admitted assets for purposes of measuring statutory surplus or, in some instances, require divestment. Non-admitted assets are assets or portions of those assets that are not permitted to be reported as admitted assets in an insurance company’s annual statement. As a result, certain assets which normally would be accorded value in the financial statements of non-insurance companies are accorded no value or only partial value, thereby reducing the reported statutory policyholder surplus of the insurance company.

Pursuant to section 38.2-1413 of the Virginia Code, with exceptions enumerated therein,

“[n]o domestic insurer shall have at any one time any combination of investments in or loans upon the security of the property and securities of any one obligor or issuer aggregating an amount exceeding the lesser of five percent of the insurer’s total admitted assets or twenty percent of the insurer’s surplus to policyholders.” Pursuant to section 38.2-1401 of the Virginia Code, non-exempt investments in any single issuer that exceed the applicable limit are considered “Category 2 investments.” Section 38.2-1405 of the Virginia Code provides that “[i]n applying any percentage limitations based on the insurer’s total admitted assets or surplus to policyholders, there shall be used as a base, without regard to percentage limitations, those


assets or surplus to policyholders as shown by the insurer’s most recent annual or quarterly statement on file with the Commission pursuant to §§ 38.2-1300 and 38.2-1301.”

The Bureau granted Shenandoah’s request for a statutory receivership exemption from

section 38.2-1413, such that none of Shenandoah’s investments are considered Category 2 investments for statutory accounting purposes so long as Shenandoah is in receivership. Once Shenandoah emerges from receivership, the Company would no longer be exempt from section 38.2-1413, and some of its assets might be deemed non-admitted to the extent that they exceed these limits.

In addition, as of December 31, 2010, Shenandoah was in violation of sections 38.2-1433 and 38.2-1414(A)(13) of the Virginia Code because it exceeded certain maximum investment limitations for foreign securities as allowed under applicable law. The violation meant that Shenandoah could incur financial penalties from certain foreign investment holdings. On May 9, 2011, pursuant to Shenandoah’s request, the Bureau granted a statutory receivership exemption from sections 38.2-1433 and 38.2-1414(A)(13) of the Virginia Code and allowed all foreign investments to be considered as admitted assets of the Company. This exemption exists for the duration of the receivership, until the foreign securities in question are sold. Statutory Examination

As part of their routine regulatory oversight, state insurance departments conduct periodic detailed examinations of the books, records, and accounts of insurers domiciled in their states. These examinations are generally conducted in cooperation with the departments of two or three other states under guidelines promulgated by the NAIC. State insurance laws, rather than federal bankruptcy laws, govern the liquidation or rehabilitation of insurance companies that are in a hazardous financial condition or that have become impaired or insolvent.

State insurance departments also periodically perform market conduct examinations of the sales practices of insurance companies, including life insurance companies such as Shenandoah; however no violations have been reported regarding the Company’s sales practices. Federal Insurance Initiatives

Although the federal government generally does not directly regulate the insurance industry, federal initiatives often have an impact on the insurance business. Current and proposed measures that may significantly affect the insurance business generally include limitations on anti-trust immunity, minimum solvency requirements, and health care reform. Congressional committees have held hearings with respect to the optional federal chartering and regulation of insurance companies and agencies. Although no Congressional bills have yet been introduced, there are currently proposals made by insurance and banking trade associations which, if enacted as law, would provide for uniform federal regulation of the insurance industry.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, which became law in July 2010, creates a new source of regulation and supervision of the insurance industry at the federal level and may result in a level of federal involvement in the affairs of troubled insurers


deemed capable of contributing to a systemic crisis in the insurance industry or the U.S. financial system. In addition, this act created the Federal Insurance Office, with broad authority to advise the Secretary of the Treasury on prudential insurance policy issues. These developments are very recent and it is not yet possible to predict to what extent they will result in federal regulation affecting the Company.

The Deputy Receiver also cannot predict whether other federal initiatives will be adopted or what impact, if any, such initiatives, if adopted as laws, may have on Shenandoah’s business, financial condition or results of operations. Tax Legislation

Changes in tax laws could make some of the Company’s products more or less attractive to consumers. Currently, the Internal Revenue Code provides favorable federal income tax treatment to holders of various types of life insurance and annuity products. For example, increases in the cash value of life insurance and annuity products are tax-deferred during the product’s accumulation period and life insurance death benefits paid to the beneficiary after the insured’s death are generally not subject to federal income taxation. Withdrawals from life insurance products also receive generally favorable tax treatment. In addition, interest on certain loans secured by the cash value of life insurance policies owned by businesses on key employees qualify for a tax deduction, within certain limitations, even though investment earnings during the accumulation period are tax-deferred.

In the past, legislation has been proposed that, if enacted, would have curtailed the tax-favored treatment of certain insurance and annuity products. The enactment of any such legislation would likely result in a significant reduction in sales of converted Shenandoah’s products. Privacy of Customer Information

Federal law and regulation requires Shenandoah to protect the security and confidentiality of customer information and to notify customers about the Company’s policies and practices relating to the collection, disclosure, security, and confidentiality of customer information. Federal and state laws also regulate the disclosure of customer information. Congress and state legislatures are expected to consider additional regulation relating to privacy and other aspects of customer information. ERISA Considerations

Shenandoah issues group annuity contracts to employee benefit plans that are subject to ERISA requirements. Generally, group annuity contracts are considered guaranteed benefit policies under ERISA because they are supported by the insurer’s general account, with the result that the contracts are considered assets of the ERISA plans, but the underlying assets of the insurer are not considered plan assets. Thus, the actions taken by the insurer with respect to its general account are not subject to ERISA’s prohibited transactions and fiduciary rules.


With respect to employee welfare benefit plans subject to ERISA, Congress periodically has considered amendments to the law’s federal preemption provision, which if enacted would expose insurers to state law causes of action, and accompanying extra-contractual damages, such as punitive damages, in lawsuits involving, for example, group life and group disability claims. To date, all such proposed amendments to ERISA have been defeated.

EFFECT ON SHENANDOAH’S SURPLUS OF NON-COMPLIANCE WITH CERTAIN INVESTMENT RESTRICTIONS REQUIRED BY

CHAPTER 14 OF THE VIRGINIA INSURANCE CODE

As discussed above, Chapter 14 of the Virginia Insurance Code places certain restrictions on an insurance company’s investments. As a result of those restrictions, the Commission determined that although Shenandoah properly reported that it was Solvent on a statutory basis as of December 31, 2009, and December 31, 2010, it would have been statutorily Insolvent as of those dates and today if the Bureau had not granted Shenandoah statutory receivership exemptions from certain Chapter 14 restrictions.

For all relevant dates, the lesser of section 38.2-1413 of the Virginia Code’s two applicable limits was twenty percent of Shenandoah’s surplus, such that the limit on non-exempt investments from any single issuer was $15,658,599 as of December 31, 2008. These limits did not have a material adverse effect on Shenandoah’s surplus for the December 31, 2008, reporting period.

Pursuant to section 38.2-1403 of the Virginia Code, “[t]he value of Category 2 investments shall be excluded from the value of admitted assets to the extent the value of Category 2 investments exceeds seventy-five percent of the amount by which an insurer’s surplus to policyholders exceeds its minimum capital and surplus.” Application of Section 38.2-1403 of the Virginia Code to Shenandoah’s annual statement for the year ended December 31, 2009, therefore, would normally result in Shenandoah’s surplus to Policyholders being reduced by $270,689,297 to negative ($270,288,188).

However, section 38.2-1400 of the Virginia Code provides that an insurer in receivership may, upon request, be exempted from the application of any one or more provisions of Chapter 14 of the Virginia Insurance Code. The Bureau has granted Shenandoah’s request for an exemption from section 38.2-1413, such that none of Shenandoah’s investments are considered Category 2 investments for statutory accounting purposes so long as Shenandoah is in receivership. Therefore, Shenandoah, in receivership, reported a surplus of $401,109 for the year ended December 31, 2009. The Bureau later granted a statutory receivership exemption from sections 38.2-1433 and 38.2-1414(A)(13), of which the Company was in violation as of December 31, 2010.

Without the benefit of the section 38.2-1400 receivership exemptions, Shenandoah’s $15 million statutory surplus as of December 31, 2010, would be materially impacted, such that it could neither be permitted to emerge from receivership nor to resume conducting the business of insurance, and potentially would have reduced going concern value as an insurance company.


As of the date of the October 11, 2011, hearing and subject to the benefit of the exemptions, Shenandoah had statutory surplus of approximately $14 million. Pursuant to the Rehabilitation Plan, United Prosperity would inject sufficient new capital (up to a maximum of $100 million) to raise Shenandoah’s RBC to at least 350% of ACL. The Title 38.2, Chapter 14, investment restrictions of the Virginia Insurance Code (from which Shenandoah would no longer be exempted) would be based upon the resulting increased surplus. Based on that level of surplus, Chapter 14 would no longer require a material disallowance of admitted assets, Shenandoah would be Solvent, and the Company would have adequate surplus and RBC. Therefore, the Deputy Receiver believes that after filing its first post-receivership financial statement, rehabilitated Shenandoah could pay the previously deferred general creditor claims, and continue to pay insurance claims in full, subject to the Extension of Moratorium on Cash Withdrawals (to which the Hardship Request Procedure would continue to apply).

RESTRICTIONS ON EXTRAORDINARY DIVIDENDS

Virginia insurance laws and regulations restrict the payment of extraordinary dividends declared by insurance companies, including life insurance providers such as Shenandoah. An insurance company is prohibited from paying an extraordinary dividend unless it obtains the Commission’s approval. The Commission must approve or disapprove the dividend within thirty days after receiving notice of the declaration of the dividend. If the Commission does not disapprove the dividend within thirty days, the distribution is considered approved. An extraordinary dividend is one which, together with the amount of dividends and distributions paid by the insurance company during the immediately preceding twelve months, exceeds the lesser of (i) 10% of the insurance company’s surplus to policyholders as of the preceding December 31st, or (ii) the insurance company’s statutory net gain from its operations for the preceding calendar year. In determining whether a dividend is extraordinary, an insurer may carry forward statutory net gain from its operations from the second and third preceding years less dividends paid in the second and immediately preceding years. Further, an insurance company may not pay a dividend unless, after such payment, its surplus to policyholders would be reasonable in relation to its outstanding liabilities and adequate to meet its financial needs. The Commission may bring an action to enjoin or rescind the payment of any dividend or distribution that would cause the insurance company’s statutory surplus to be unreasonable or inadequate. At this time, no extraordinary dividends have been contemplated within the terms and conditions of the Rehabilitation Plan.

SELECTED HISTORICAL FINANCIAL INFORMATION General Financial Condition

Prior to receivership, Shenandoah filed quarterly and annual financial statements with state insurance regulators in accordance with SAP. As of December 31, 2008, Shenandoah’s reported net admitted assets totaled $1,610,753,446, its reported liabilities totaled $1,589,262,644, and its resulting surplus was $21,490,802. Insurance regulators and members of the insurance industry often refer to a company’s “capital ratio” as a measure of its financial condition. While that ratio may be calculated in a variety of different ways, a common formula


for its determination is the sum of (i) capital, and (ii) surplus, and (iii) the insurer’s Asset Valuation Reserve; divided by the aggregate liabilities of the insurer, excluding Asset Valuation Reserve. Applying this methodology, the Company’s reported capital ratio for year-end 2008 would have been 1.48%. In 2008, a capital ratio in the range of 8% to 9% would have been considered average by industry standards. Consequently, the Company’s ratio of 1.48% was considered inadequate and indicative of undercapitalization.

The following chart shows the Company’s admitted assets, liabilities, Asset Valuation Reserve, capital, and surplus and resulting capital ratio for each of years 2004 – 2008 (determined in each instance at December 31st of the year).

All amounts, except capital ratio, shown in $ millions.

Year Admitted

Assets Liabilities AVR Surplus Capital Ratio

2004 $1,407 $1,289 $3.55 $117 9.38% 2005 $1,528 $1,409 $4.06 $119 8.75% 2006 $1,584 $1,463 $7.13 $121 8.75% 2007 $1,665 $1,539 $9.18 $126 8.77% 2008 $1,611 $1,589 $2.34 $21 1.48%

As disclosed in the chart above, Shenandoah’s capital ratio remained fairly steady from 2004 through 2007, but dropped substantially in 2008, due in large part to precipitous declines in 2008 in the market value of Shenandoah’s substantial investments in preferred stock of the Fannie Mae and Freddie Mac, as well as other investments, including certain ABSs and structured securities. Under applicable accounting rules some of these investments were required to be marked-to-market and treated as “other-than-temporary-impairments.”

By September 30, 2008, Shenandoah’s surplus had decreased to $78,292,995 from $125,789,807 at December 31, 2007. As of December 31, 2008, Shenandoah’s surplus had further declined to $21,490,802. As of December 31, 2009, if not for an exemption from certain statutory accounting requirements prescribed by the Bureau of Insurance that restrict assets from being considered admitted assets if those assets are in excess of single issuer limitations and the insurance company does not have the underlying capital and surplus to support such investments (discussed in more detail above), Shenandoah would have reported a negative surplus amount in the Annual Statement for 2009.

GAAP Financial Results of the Company at December 31, 2008

As of December 31, 2008, Shenandoah’s GAAP assets totaled $1,822,754,000, its liabilities totaled $1,780,199,000, and its resulting surplus was $42,555,000. As of December 31, 2007, Shenandoah’s admitted assets totaled $1,923,714,000, its liabilities totaled $1,710,582,000, and its surplus was $213,132,000. Thus, from 2007 to 2008, Shenandoah’s assets declined by $100,960,000 or 5.2%, its liabilities increased by $69,617,000 or 4.1%, and its surplus declined by $170,578,000, or 80.0%, due primarily to precipitous declines in the values


of Shenandoah’s investments during 2008. Due to the receivership, Shenandoah did not finalize GAAP 2008 financial statements and did not prepare GAAP financial statements in 2009.

Statutory Financial Results at December 31, 2009

As reported in Shenandoah’s 2009 Annual Statement on a statutory accounting basis, as of December 31, 2009, Shenandoah’s admitted assets totaled $1,428,653,193, its liabilities totaled $1,428,252,084, and its resulting surplus was $401,109, or a decline of more than 90% from the Company’s total surplus as of December 31, 2008.

The decrease in Shenandoah’s surplus from December 31, 2008, to December 31, 2009, was primarily the result of $29.2 million in realized losses in Shenandoah’s investment portfolio over the twelve-month period, as well as $142 million in OTTI asset write-downs, recorded from 2008 through 2009, of Fannie Mae and Freddie Mac preferred stock (approximately $50 million), ABSs (approximately $35 million), corporate (primarily financial) securities (approximately $24 million), and a structured investment vehicle with Sigma Finance(approximately $17 million). In addition, surplus was also negatively impacted by an $8.6 million reduction in the value of the Company’s deferred tax asset. As of December 31, 2009, the primary credit concerns in Shenandoah’s investment portfolio were ABSs and bank security investments, which have historically been depressed below book values.

In addition, during 2010, the Company discovered that it had calculated incorrectly the 2007 reserves for certain whole life products, as the result of which its liabilities, as of December 31, 2007, were understated by $6,783,721. Accordingly, on December 22, 2010, the Company filed an amended 2008 Annual Statement to reflect the decrease in surplus as of December 31, 2007.

For a number of reasons, primarily attributable to realized investment losses, OTTI asset write-downs, and insurance reserve increases, Shenandoah experienced a dramatic reduction in its capital and surplus shortly before the date of the Receivership Order. After receivership, the Deputy Receiver retained TRPA to identify and document an approved source, secondary source, and contingency source believed to be well-known and reliable services for pricing each type of security in the Company’s portfolio, and to use that pricing information to estimate the market value of Shenandoah’s portfolio at February 12, 2009. TRPA concluded that, as of that date, the portfolio’s market value was at least $232 million less than the value at which it had been carried on Shenandoah’s most recent internal financial statements. Many of the securities in the portfolio were in default or illiquid and could not be sold within a reasonable amount of time, or were investments for which there was no ready market due to their precipitous drop in value. Other securities were near default or subject to other restrictions which served to make their sale impracticable.

The Deputy Receiver and the rest of the Receivership Team have succeeded in stabilizing the Company’s financial condition through various remedial actions, including the following:

1. The marshalling of assets that could be converted to cash or cash-equivalents;


2. The Deputy Receiver’s imposition of the Moratorium on Cash Withdrawals;

3. The suspension of all payments of principal and interest on Shenandoah’s $20 million Surplus Notes;

4. The Deputy Receiver’s imposition of the Moratorium on Payment of Subordinate Claims;

5. The request and, in some cases receipt, of abatements of the guaranty association assessments which were submitted to the Company by various state insurance guaranty associations;

6. The Deputy Receiver’s imposition of the Moratorium on Dividend Payments, the Fourth Directive Declaring Interest Rates, and the Moratorium on Declaration of Dividends;

7. The strengthening of insurance reserves; and

8. The reduction of operating costs.

To address the concerns raised by the quality and status of various securities and other investment holdings in Shenandoah’s portfolio, the Deputy Receiver’s experts and other consultants evaluated the market price of each security and anticipated changes in their market values. Following this analysis, the Deputy Receiver directed the Company’s investment manager to perform selective trades based on opportunities in the marketplace. In December 2010, after engaging a new investment manager experienced with troubled securities of the kind included in the Company’s investment portfolio, the Deputy Receiver directed a second comprehensive rebalancing of Shenandoah’s portfolio with the goals of maximizing portfolio value and liquidity, while mitigating credit and default risk. Due in part to the partial recovery of the financial markets during 2009 and 2010, the rebalancing of the portfolio largely achieved its goals. The value of Shenandoah’s investment portfolio, on a marked-to-market basis, increased from an amount which was $228 million less than the portfolio’s book value as of March 31, 2009, to $9 million more than the portfolio’s book value as of December 31, 2010 (a $237 million increase relative to book value). Portfolio liquidity has improved substantially since February 2009, when the Deputy Receiver’s consultants observed that at least 50% of the securities in the portfolio were illiquid, such that they could likely be sold only at severely depressed prices relative to book value. As of December 31, 2009, approximately 45% of the securities in the portfolio were classified by the SVO of the NAIC as category 2 or below, whereas as of December 31, 2010, subsequent to the rebalancing, approximately 26% of the portfolio’s securities are classified by the NAIC as category 2 or below. The statistics reflect a substantial improvement in both the liquidity and credit quality of Company investments over the receivership timeframe, and these improvements have better protected the interests and funds of Policyholders.

The chart below shows the last three years’ distribution of NAIC ratings for the Company’s bonds, preferred stocks, and surplus notes.


NAIC Ratings12/31/10 12/31/09 12/31/08

NAIC Ratings Distribution - $NAIC 1 784,110,399 584,073,849 680,817,441NAIC 2 203,269,290 387,209,984 467,993,942NAIC 3 51,122,858 66,716,184 43,757,478NAIC 4 7,514,250 20,516,628 1,839,157NAIC 5 9,627,972 1,016,494 1,155,000NAIC 6 6,210,021 2,847,652 1,405,540

1,061,854,790 1,062,380,792NAIC Ratings Distribution - %NAIC 1 73.84% 54.98% 56.88%NAIC 2 19.14% 36.45% 39.10%NAIC 3 4.81% 6.28% 3.66%NAIC 4 0.71% 1.93% 0.15%NAIC 5 0.91% 0.10% 0.10%NAIC 6 0.58% 0.27% 0.12%

Assuming approval of the Rehabilitation Plan (including the Plan of Conversion) by the Commission, and approval of the Plan of Conversion by the Members, the Receivership Team will continue active management of the Company’s investment portfolio until the Closing Date.

Statutory Financial Results at December 31, 2010

As reported in Shenandoah’s 2010 Annual Statement on a statutory accounting basis, as of December 31, 2010, Shenandoah’s admitted assets totaled $1,439,202,515, its liabilities totaled $1,424,198,256, and its resulting surplus by which assets exceed liabilities was $15,004,259, up from approximately $401,000 of surplus as of December 31, 2009.

The Company’s projected RBC (ACL)1 was $17.7 million as of December 31, 2010, resulting in a RBC ratio of 126%. RBC (ACL) was $15.5 million as of December 31, 2009, resulting in a RBC ratio of 11%.

Statutory Balance Sheet as of August 31, 2011 (Unaudited)

As of August 31, 2011, Shenandoah’s assets totaled $1,427,206, its liabilities totaled $1,413,107, and its resulting surplus was $14,099,000, down from $15,004,259 as of December 31, 2010.

1 RBC is a solvency tool to establish the minimum amount of capital that an insurance company needs to

support its overall business operations, as well as gauge when regulatory intervention is necessary. Companies that fail to meet statutorily established target levels trigger management or regulatory action level events. One target level is the ACL. If capital and surplus fall below 200% of ACL, Virginia insurance regulators expect the Company to develop a plan to improve the ratio above 200% of the ACL. If capital and surplus fall below 100% of ACL, Virginia insurance regulators are authorized to take control of the Company.


Statement of Net Assets as of February 12, 2009 (Unaudited)

As reported in Shenandoah’s Statement of Net Assets as of February 12, 2009, on a Liquidation Basis, Shenandoah’s total assets were $1,371,762,506, its liabilities totaled $1,489,979,610, and its resulting surplus was a negative $118,217,104 as of February 12, 2009, the date Shenandoah was found to be in a hazardous financial condition and placed into receivership. The Statement of Net Assets is also sometimes called a liquidation balance sheet.

Liquidation Basis Accounting assumes that the enterprise will no longer operate as a Going Concern. Assets are marked to their estimated net realizable value and liabilities are marked to their estimated settlement amount. The Statement of Net Assets reduces certain policy liabilities to cash surrender value rather than account value and assumes that all policyholders with cash value policies would have surrendered their policies and been charged surrender charges. The Statement of Net Assets for Shenandoah as of February 12, 2009, was prepared using reported assets and liabilities at estimated fair values as of the date of the Statement of Net Assets. Where available, market values were used to value assets and expected settlement costs were used to estimate liabilities. For all remaining assets and liabilities where reasonable fair values were not determinable, statutory accounting values, as established by Virginia law, were used.

It is not customary or a regulatory requirement to prepare a statutory statement as of the receivership date, and thus a statutory financial statement was not prepared on February 12, 2009.

In addition to the continuing internal rehabilitative efforts, the capital infusion proposed to be effected by United Prosperity upon Conversion, would improve materially the Company’s financial condition by raising the Company’s RBC to at least 350% of the ACL (subject to a $100 million cap on capital infusion). Immediately after consummation of the Conversion and Sale, Shenandoah would have the fully-paid capital stock and surplus required by Applicable Law, as well as an RBC ratio almost twice of what is required in Virginia. Shenandoah would then emerge from receivership, resume writing new business and continue paying Policyholder claims in full, subject temporarily to the Extension of Moratorium on Cash Withdrawals.

UNITED PROSPERITY’S PLAN FOR FUTURE OPERATIONS

Communication and Outreach

United Prosperity has initiated what it intends to be extensive communications with Policyholders, creditors, agents, and other interested parties to advise them of forthcoming changes and events involving Shenandoah and to explain the possible temporary Extension of Moratorium on Cash Withdrawals and how the Conversion would improve the Company’s financial condition. In addition, the Company’s policyholder services department is available to answer Policyholder questions regarding the facts and circumstances surrounding the acquisition of the Company by United Prosperity.


Distribution and Growth Opportunities

United Prosperity’s affiliates hold a majority interest in AmeriLife Group LLC, which had been a major producer for the Company pre-receivership. Over the years, these two companies have worked together to develop several products. As part of the Rehabilitation Plan, and under United Prosperity’s guidance, the Company would begin the process of restoring relationships with agents, IMOs, and other former distributors.

United Prosperity believes that once the Company resumes writing new business, it can target several key areas for growth, such as:

1. Geographic Footprint: United Prosperity currently intends to explore the expansion of Shenandoah’s business into additional states where its products could be sold at acceptable levels of profitability. With the Company’s experience and success using IMOs to distribute its products, United Prosperity believes such an expansion would incur relatively low costs (the marginal cost of obtaining new state licenses and developing new IMO relationships) and could provide positive returns.

2. Distribution Channel Strategy: United Prosperity believes that the Company could obtain a higher rate of growth and a more stable distribution base by diversifying into additional channels, particularly direct marketing and online marketing. Accordingly, United Prosperity currently intends to expand the Company’s direct marketing capabilities and believes that the Company’s “Straight Through Processing” technology could be particularly valuable in this area.

3. Third-Party Services: The Company has a strong customer service reputation, operates in a relatively low-cost geographic area (representing an attractive business environment), and possesses advanced IT systems. The combination of these factors positions the Company as an excellent candidate to perform servicing and other work for third-party partners.

4. Fronting and Reinsurance: United Prosperity may consider developing fronting and reinsurance relationships with other insurers and reinsurers in order to assist the Company with entering or re-entering certain markets, particularly during the period when the Company does not have an A.M. Best rating.

Enhanced Product Portfolio

United Prosperity expects to take advantage of the Company’s platform to target the senior market, which it believes will experience rapid growth due to demographic trends. Current strengths of the Company include: (a) the Company’s long-standing reputation in the industry for prudent underwriting and insurance management; (b) the professionalism of its management group; (c) the commitment and high quality of the Company’s employees; and (d) the Company’s advanced level of technology (i.e., its “Straight Through Processing” application).


United Prosperity believes that its future core customer base will be older middle income families and that Shenandoah should develop products and a marketing program aimed at gaining market share with this increasingly healthier and longer living demographic. Accordingly, United Prosperity currently intends to create a portfolio of products specifically targeted towards the senior market.

During the six to nine-month period following the Closing Date, United Prosperity will work with the Company’s existing management to review the status of all Shenandoah’s pre-Receivership products, select those existing products most suitable to ongoing market preferences and the long-term stability of the Company, and work to create new long-term care and final expense products that would be attractive to underwrite and would grow Shenandoah’s policyholder base. Management would also use this development period to file new policy and annuity rates and forms with applicable regulatory authorities to enable the Company to begin writing new business at acceptable levels of profitability as soon as it is attractive to do so.

United Prosperity also believes that “non-standard” populations, which have the same insurance needs as the “standard” population, are currently underserved by the general life and health insurance industry, as companies tend to prefer underwriting “standard” and “preferred” risk policies. Consideration will be given to developing products that cater and appeal to these “non-standard” populations, priced at levels that will be profitable for the Company. United Prosperity expects to collaborate with the Company’s management in the development of these products.

In addition to traditional stand-alone life and health products, United Prosperity believes that a major opportunity for Shenandoah’s growth lies in “combination products” (such as combined annuity and long-term care policies or life and health related products), which can be tailored to meet the financial and health planning needs of seniors. Under the provisions of the Pension Protection Act of 2006, distributions of life insurance and annuity cash value may be made tax-free when used to pay for long-term care. United Prosperity currently intends to leverage the expertise of its and the Company’s management to make Shenandoah a market leader among mid-sized companies in this developing market segment.

Communications with Rating Agencies

United Prosperity recognizes the importance of obtaining a satisfactory rating from A.M. Best in order to properly support certain products. United Prosperity’s goal is to obtain a sufficiently high rating from A.M. Best to enable the Company to introduce all of the new products that it believes to be attractive to underwrite. Upon the future restoration of a sufficiently high A.M. Best rating to enable effective marketing, the Company could expand its product portfolio to include its traditional asset-based product portfolio. Following the Closing, United Prosperity would schedule meetings with A.M. Best and other applicable rating agencies to discuss, among other things, the status of the Company and United Prosperity’s plans for new business underwriting, management of the in-force block of business, and capitalization of the Company following the Closing.


Potential New Business

United Prosperity currently assumes that the Company will begin underwriting new business in 2013 and that the remainder of 2011 and 2012 will be used to (i) consummate the transactions contemplated by the Stock Purchase Agreement and the Rehabilitation Plan; (ii) stabilize Shenandoah post Conversion; (iii) prepare Shenandoah for any potential shock lapses in the absence of or after any Extension of Moratorium on Cash Withdrawals expires; (iv) review Shenandoah’s existing insurance products and potentially develop new products with features that may be attractive given market conditions; (v) obtain the Order Terminating Rehabilitation Proceeding, if such order was not entered prior to Closing; and (vi) obtain other necessary regulatory approvals. New underwriting may commence later than assumed here, depending on market and other conditions and depending on the Closing Date. This plan is subject to change depending on how profitably the Company believes it can write new business in each line, and when.

RISK FACTORS APPLICABLE TO MEMBERS AND POLICYHOLDERS

Many of the risks involved with the conversion of a mutual insurance company to a stock

insurance company are of concern primarily to would-be stockholder(s) of the converted company and their potential to benefit from future dividend distributions and/or increased market value of their stock in the converted company. Some of the same risk factors, albeit indirectly, might also be of concern to policyholders, in that the converted company’s future success and profitability may impact its ability to service and pay claims on its insurance policies. Other risk factors are of primary concern to members and policyholders, rather than prospective shareholders, of a converting mutual insurance company.

The Rehabilitation Plan involves a number of risks. Members should consider carefully,

in addition to the other information contained in the Policyholder Information Statement Part One and elsewhere in this Policyholder Information Statement Part Two, the following factors before voting on the Plan of Conversion which is an integral part of the Rehabilitation Plan.

IN REVIEWING THE REHABILITATION PLAN (INCLUDING THE PLAN OF CONVERSION), IT IS IMPORTANT FOR ALL POLICYHOLDERS TO BE AWARE,

IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS STATEMENT, OF THE FOLLOWING MATTERS:

As a consequence of the Conversion, Members would lose their Membership Interests (principally, the right to vote which, after Conversion, would be exercised exclusively by the Company’s shareholder(s)), and Policyholders would lose the right to share in any residual value if the converted Company were to be liquidated.

A mutual insurance company is generally operated for the benefit of its policyholders, who are the owners. Converting from a mutual insurance company to a Stock Insurance Company under the Plan of Conversion would result in a shareholder (United Prosperity, as sole shareholder following the acquisition), whose interests would need to be balanced with those of Policyholders.


Shareholder interests in a converted Shenandoah might differ from Policyholder interests.

In particular, shareholders are primarily interested in financial performance as it relates to the value of their shares or shareholder dividends, while Policyholders are primarily interested in financial performance as it relates to premium rates and the ability of their insurance company to pay claims. Although this potential conflict exists, the Deputy Receiver believes that Policyholders and shareholders would both benefit from business opportunities that the proposed Conversion would make possible, potentially leading to improved financial performance from both perspectives.

More importantly, however, Shenandoah has been in a hazardous financial condition for some time and in receivership since February 12, 2009. Despite their best efforts, the Deputy Receiver and her staff have not been able to fully rehabilitate the Company without an outside capital infusion. At the hearing on October 11, 2011, the Commission found that as of February 12, 2009, Shenandoah was Insolvent based on Liquidation Basis Accounting. The Commission also found that although Shenandoah had properly reported it was Solvent on a statutory basis as of December 31, 2009, and December 31, 2010, it would have been statutorily Insolvent as of those dates were it not for certain dispensation from reporting requirements of section 38.2-1400 of the Virginia Code available only because of the receivership. Without the receivership exemptions, Shenandoah would be statutorily Insolvent today, placing the Company in a position of risk that would have a detrimental effect on both Policyholders and the Commonwealth of Virginia if the Rehabilitation Plan were not implemented. However, if the Plan of Conversion is approved by Eligible Policyholders, immediately after consummation of the Conversion and Sale, Shenandoah would have the fully-paid capital stock and surplus required by Applicable Law, as well as an RBC ratio almost twice of what is required in Virginia.

United Prosperity would take measures to return Shenandoah to operating profitability, including initiatives to improve efficiencies, cost containment measures, pricing actions and, most importantly, the capital infusion that would enable Shenandoah to emerge from receivership and resume the sale of insurance products. However, although the Deputy Receiver believes that the proposed Sale and Acquisition would benefit Policyholders, there can be no assurance that a United Prosperity-controlled Shenandoah would prosper in the long term.

Shenandoah’s operating structure provides for local management of functions that involve direct contact with and service to customers, providers, and communities, such as benefit design, sales, marketing, underwriting (pricing), provider contracting, network management, and customer service. While United Prosperity has no plans to change this structure, there can be no assurance that functional decision-making will not become more or less centralized in the future. Competition from companies that may have greater financial resources, broader arrays of products, higher ratings, and stronger financial performance could impair converted Shenandoah’s ability to retain existing customers, attract new customers, and maintain profitability.

After emerging from receivership, Shenandoah’s ability to compete would depend on a number of factors including, scale, service, product features, product pricing, investment


performance, commission structure, distribution capabilities, financial strength ratings, and name recognition. Shenandoah would be competing with a large number of other insurers, some of whom might have advantages with regard to one or more of those competitive factors. The Company has been in receivership for an extended period of time and, upon emergence, the Company’s image in the marketplace may remain tarnished.

Shenandoah has been in receivership since February 12, 2009, during which time it has been prohibited from selling any insurance products. Some of Shenandoah’s pre-receivership distribution relationships might not be amenable to being restored, and the Company might need to develop new distribution channels for its products. Shenandoah’s potential need for new distribution channels could significantly delay or limit the resumption of sales of its insurance products, adversely affecting profitability.

In addition, because Shenandoah has not been active in the marketplace since February 12, 2009, Shenandoah and its products may have lost some of their pre-receivership appeal, and some re-branding might be needed. Shenandoah’s attempts to regain the good will of consumers could take time, and the Company’s reputation in the marketplace might never be restored to its very favorable pre-receivership status.

Furthermore, the Company has operated with the Moratorium on Cash Withdrawals which, despite the Hardship Request Procedure, has been unpopular with Policyholders, some of whom might be expected to surrender their Policies upon waiver, expiration, or early termination of the Extension of Moratorium on Cash Withdrawals. It is possible that Shenandoah would receive poor financial strength ratings upon emergence from receivership, which could spur Policy surrenders and withdrawals, while limiting sales.

Financial strength ratings are important factors in establishing the competitive position of insurance companies. Unfortunately, even with the large capital infusion that United Prosperity would make in the Sale and Acquisition—thus improving the Company’s financial position—it is possible that the major rating agencies could initially give Shenandoah a poor financial rating.

This potential for a poor rating could, among other things:

• Materially increase the number of full or partial Policy surrenders for all

or a portion of their net cash values and withdrawals by Policyholders; • Result in some distributors terminating their relationships with

Shenandoah and/or declining to resume selling Shenandoah’s products; and

• Limit new sales, particularly of products that require high financial

ratings, like asset-based products, which was Shenandoah’s largest product line pre-receivership.


Converted Shenandoah would remain vulnerable to dislocations and declines in the financial markets.

During receivership, the Deputy Receiver and her advisors have worked to improve the quality and liquidity of Shenandoah’s investment portfolio, on which the Company relies for income to maintain a healthy surplus and to pay its obligations as they become due. Nevertheless, the value of Shenandoah’s investment portfolio, and the income generated thereby, would remain vulnerable to dislocations and declines in the financial markets. No assurances can be given regarding the future performance of the financial markets generally, or of Shenandoah’s investment portfolio. A converted Shenandoah would remain vulnerable to changes in state and/or federal law.

Changes in state or federal law could affect the marketability or taxation of certain insurance products generally. No assurance can be given that any future legislative changes would benefit, or would not harm, converted Shenandoah. The efforts of a demutualized Shenandoah to mitigate any adverse effects of interest rate changes might prove ineffective.

As a general rule, favorable performance in domestic securities markets increases the value of Shenandoah’s investments in those markets. On the other hand, if domestic securities markets experience economic dislocations or sustained declines, the Company’s investment losses can reduce substantially the Company’s revenues and profits. Additionally, the Company’s assets, earnings, and ability to generate new sales in pre-receivership years increased due to significant growth in the retirement-oriented investment market. Some of that growth is attributable to the expansion of non-U.S. government mandated retirement savings programs. If these programs are reduced or eliminated, the Company’s post-receivership net income, revenues, and assets could suffer. Demutualized Shenandoah would attempt to mitigate adverse effects of interest rate changes on its operations. Converted Shenandoah’s efforts to reduce the impact of interest rate changes on its profitability and surplus might not be effective.

As a general practice the Company attempts to match the duration of its income-producing investments with the duration of its Policy liabilities, thereby mitigating the effect of interest rate changes on profitability and surplus. During a period of rising interest rates, Policy surrenders, withdrawals, and requests for Policy loans can increase as Policyholders seek to achieve higher returns. Despite all efforts to reduce the impact of rising interest rates, after Conversion the Company could be required to sell assets to raise the cash necessary to respond to such surrenders, withdrawals, and loans, thereby realizing capital losses on the assets sold.

During periods of low interest rates, Shenandoah could have difficulty maintaining the

rate it credits to customers since it is unable to reduce the rate that it credits to Policyholders under some products, such as guaranteed investment contracts and funding agreements. In


addition, borrowers might prepay or redeem mortgages and bonds that Shenandoah owns, which could force the Company to reinvest the proceeds at lower interest rates. Further, it could be more difficult for the Company to maintain the desired spread between the investment income it earns and its credited Policy interest rates during periods of low interest rates, thereby reducing Company profitability.

Changes in interest rates can also affect the profitability of commercial mortgage loans

originated by the Company in the future. During periods of rising interest rates, Shenandoah may originate fewer commercial mortgage loans and experience resulting declines in new mortgage loan fees. Declining interest rates may also result in new loans originated at lower interest rates, resulting in reduced profitability for the Company. The commercial mortgage sector and the financial soundness of real estate tenants will be influenced by certain economic factors that affect the stability of the U.S. economy, including job, manufacturing, and service sector growth and prosperity. The efforts of a converted Shenandoah to increase profitability and surplus could prove unsuccessful.

A converted Shenandoah would undertake steps to improve profitability in order to increase the Company’s surplus beyond the level that would result from United Prosperity’s capital infusion in connection with the Sale and Acquisition. However, Policy surrenders, withdrawals, and requests for Policy loans could adversely affect those efforts by requiring the Company to sell assets at an inopportune time in order to raise the cash necessary to respond to such surrenders, withdrawals, and loans, thereby realizing capital losses on the assets sold. Excessive Policy surrenders, withdrawals, and requests for Policy loans could reduce income and/or surplus to such an extent that regulatory action would again be necessary. If a converted Shenandoah is unable to attract and retain sales representatives and develop new distribution sources, sales of its products and services might not reach the volume required to support sustained operations.

Prior to receivership, Shenandoah distributed its insurance products through a variety of distribution channels, including its own internal sales representatives, independent marketing organizations (“IMOs”), independent brokers, and other third-party marketing organizations. Post-Conversion, the Company would need to attract and retain sales representatives to sell and service its products. However, strong competition exists among financial services companies for effective sales representatives. The Company would compete with other financial services companies for sales representatives primarily on the basis of its financial position, support services, and compensation and product features. If the Company were unable to attract and retain sufficient sales representatives to sell its products, its ability to compete and revenues from new sales would likely suffer.


The reserves of a converted Shenandoah for future Policy benefits and claims could prove to be inadequate, thus requiring the Company to increase liabilities.

The earnings of a converted Shenandoah would depend substantially upon the extent to which its actual future claims experience is consistent with the assumptions used in setting prices for its products both before and after receivership, and in establishing liabilities for future benefits under those products. The liability that the Company has established for future Policy benefits is based on assumptions concerning a number of factors, including the amount of premiums that it will receive in the future, rate of return on assets it purchases with premiums received, expected claims, expenses, and persistency, which is the measurement of the percentage of insurance policies remaining in force from year to year, as measured by premiums. However, due to the nature of the underlying risks and the high degree of uncertainty associated with the determination of the liabilities for unpaid Policy benefits and claims, the Company cannot determine precisely the amounts which it will ultimately pay to settle these liabilities. As a result, the Company may experience volatility in the level of its reserves from period to period. To the extent that actual claims experience is less favorable than the underlying assumptions, the Company could be required to increase its reserve for liabilities, thereby reducing its surplus. Expansive competition both in Virginia and in other markets could affect the profitability of the Company.

The life insurance and annuity industries are increasingly competitive both in Virginia and other states in which a converted Shenandoah would likely market its products. There is no assurance that such increased competition would not exert strong pressure upon Shenandoah’s future profitability, its ability to increase enrollment, or its ability to successfully pursue growth in areas both within and outside of Virginia. The investment portfolio of a converted Shenandoah would likely be subject to several risks which could diminish the value of invested assets and affect sales, profitability, and the investment returns credited to its customers. Note: An increase in defaults on the Company’s fixed maturity securities portfolio would reduce its profitability.

The investment portfolio of a converted Shenandoah would be subject to several risks that could diminish the value of its invested assets and affect its sales, profitability, and the investment returns. Although the Receivership Team has made substantial improvements in the portfolio during receivership, certain securities are still considered risky and have a higher likelihood of defaulting. Although steps have been taken to restructure the portfolio, a certain element of risk still remains and the portfolio will remain susceptible to continued weakness in the overall economy.

Moreover, continued volatility of the financial markets and the recent extended period of low interest rates could also impact Shenandoah’s portfolio. If interest rates rise, the value of the Company’s portfolio of fixed income securities would very likely decrease.


Note: An increased rate of delinquency and defaults on Shenandoah’s commercial mortgage loans, especially those with balloon payments, could decrease its profitability.

Shenandoah’s commercial mortgage loan portfolio faces both delinquency and default risk. Commercial mortgage loans of $204 million represented 14.8% of Shenandoah’s total invested assets as of December 31, 2010. Increased rates of default and/or delinquencies in the commercial mortgage market could significantly decrease the value of this portfolio and reduce the Company’s profits. As of September 30, 2011, the mortgage loan portfolio's book value has decreased by $11 million to $193 million, due in part to loan maturities, early loan payoffs, and general principal paydowns. A converted Shenandoah could have difficulty selling privately placed fixed maturity securities, commercial mortgage loans, and real estate investments, which are less liquid than publicly traded fixed maturity securities.

As of December 31, 2009, Shenandoah’s privately placed fixed maturity securities, commercial mortgage loans, and real estate investments represented approximately 30% of the value of all invested assets. If Shenandoah were to require significant amounts of cash on short notice, the Company might have difficulty selling its privately placed fixed maturity securities at attractive prices, in a timely manner, or both. Obtaining required approvals and satisfying closing conditions could delay or prevent completion of the Acquisition.

Completion of the Acquisition is conditioned upon the receipt of all required governmental authorizations, consents, orders, and approvals without burdensome conditions.

The Deputy Receiver and United Prosperity intend to seek diligently all of these required approvals and consents. However, the failure to obtain these approvals and consents could delay the completion of the Acquisition for a significant period of time. There can be no assurance that all required approvals and consents would be obtained without burdensome conditions. If the governmental consents and approvals are obtained, but contain burdensome conditions, then either party could opt not to consummate the Acquisition. Even if all of the required approvals and consents are obtained without burdensome conditions, or the requirements for them are waived, delay, or possible termination, of the Conversion and Acquisition could result if the approvals and consents are not timely received. Finally, United Prosperity may, in its sole discretion, delay Closing until May 4, 2012 (the date that is twelve (12) months after the signing of the Agreement). This option would have to be exercised within ninety (90) days of the Members’ vote. Changes in regulations or accounting standards could reduce the profitability of a converted Shenandoah.

Changes in insurance regulations could reduce the Company’s profitability. The business of insurance is subject to comprehensive state regulation and supervision by every state in which converted Shenandoah would do business. The primary purpose of state insurance regulation is


to protect policyholders, not stockholders. The laws of the various states establish insurance departments with broad powers to regulate such matters as:

• Licensing companies to transact business; • Licensing agents; • Admitting statutory assets; • Mandating a number of insurance benefits; • Regulating premium rates; • Approving policy forms; • Regulating unfair trade and claims practices; • Establishing statutory reserve requirements and solvency standards; • Fixing maximum interest rates on life insurance policy loans and

minimum rates for accumulation of surrender values; • Restricting various transactions between affiliates; and • Regulating the types, amounts, and valuation of investments.

State insurance regulators and the NAIC continually re-examine existing laws and

regulations, which therefore are always subject to change. Title 38.2 of the Virginia Code sets forth legislative enactments regarding the business of insurance in the Commonwealth of Virginia. Any changes to this statutory structure could affect the business of Shenandoah.

Additionally, federal legislation and administrative policies in areas such as employee benefit plan regulation, financial services regulation, and federal taxation could reduce Shenandoah’s profitability. For example, Congress has, from time to time, considered legislation relating to changes in ERISA to permit application of state law remedies, such as consequential and punitive damages, in lawsuits for wrongful denial of benefits, which, if adopted, could increase the Company’s exposure in future litigation. Additionally, new interpretations of existing laws and the passage of new legislation could adversely affect Shenandoah’s ability to sell new Policies and concurrently increase claims exposure on Policies previously issued. Moreover, reductions in contribution levels to defined contribution plans could decrease Shenandoah’s profitability. Changes in federal taxation could reduce sales of Shenandoah’s insurance, annuity, and investment products.

Current federal income tax laws generally permit the tax-deferred accumulation of earnings on the premiums paid by the holders of annuities and life insurance products. Taxes, if any, are payable on income attributable to a distribution under the contract for the year in which the distribution is made. Such incentives contributed significantly to the Company’s increase in assets, earnings, and new sales in pre-receivership years due to significant growth in the retirement-oriented investment market, some of which is attributable to the expansion of non-U.S. government mandated retirement savings programs. Congress has, from time to time, considered legislation that would reduce or eliminate the benefit of such deferral of taxation on the accretion of value within life insurance and non-qualified annuity contracts. Enactment of such legislation, including a simplified “flat” income tax structure with an exemption from


taxation for investment income, could result in fewer sales of Shenandoah’s insurance, annuity, and investment products. Repeal or modification of the federal estate tax could reduce converted Shenandoah’s revenues.

Repeal or modification of the federal estate tax could reduce Shenandoah’s revenues. Some types of insurance policies, such as survivorship life insurance policies, are often purchased for the purpose of providing cash to pay federal estate taxes. Repeal or modification of the federal estate tax could result in Policyholders reducing coverage under or surrendering such Policies. Litigation and regulatory investigations could adversely affect the Company’s financial strength and reduce its profitability.

Shenandoah is a plaintiff or defendant in various actions arising out of its insurance business and investment operations. It is, from time to time, also involved in various governmental and administrative proceedings. While the Deputy Receiver does not believe that any pending litigation, governmental, or administrative proceedings would have a material adverse effect on the Company’s business now or after rehabilitation, she cannot predict the outcomes of pending legal matters, and future legal proceedings could adversely affect the Company’s financial strength and reduce its profitability.

Moreover, life insurance companies have historically been subject to substantial litigation resulting from claims disputes and other matters. Most recently, some companies have faced extensive claims, including class-action lawsuits, alleging improper life insurance sales practices. Negotiated settlements of such class-action lawsuits have had a material adverse effect on the financial condition and results of operations of other life insurance companies. The Company could face adverse reactions to the Conversion, Sale, and Acquisition.

Some Policies are cancelable with minimal notice and are renewable periodically. The Deputy Receiver cannot assure that Policyholders and third-party providers would not respond negatively to the Rehabilitation Plan by canceling or declining to renew Policies.


policyholder information statement on shenandoah life insurance co

Documents