UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FOR ANNUAL AND TRASITION REPORTS

 

**FORM 10-K**

 

| x | ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] |
|---|-----------------------------------------------------------------------------------------------------|

|   | For the Fiscal Year ended December 31, 2005 or |
|--------|------------------------------------------------|

| [   ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] |
|-------|------------------------------------------------------------------------------------------------------------|

|   | For the Transition Period from | to |
|--------|--------------------------------|----|

Commission File Number 2-40764

 

**KANSAS CITY LIFE INSURANCE COMPANY**

(Exact Name of Registrant as Specified in its Charter)

 

|   | Missouri | 44-0308260 |  
 

(State or Other Jurisdiction of  

(I.R.S. Employer

 
 

Incorporation or Organization)  

Identification Number)

 

 

3520 Broadway, Kansas City, Missouri  

64111-2565   

 
 

(Address of Principal Executive Offices)  

(Zip Code)

 

Registrant's Telephone Number, including Area Code:   816-753-7000

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

 

Name of Each Exchange on

 

Title of Each Class  

Which Registered

 
 

None

None

 
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

None

(Title of Class)

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     

 

Yes     X

No  

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act)

 

Yes      X

No  

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

 

Yes  

No     X

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.       

 

Yes  

No     X

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act)

 

Yes  

No     X

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

As of December 31, 2005, 11,918,634 shares of the Company's capital stock par value $1.25 were outstanding, and the aggregate market value of the common stock (based upon the average bid and asked price according to Company records) on June 30, 2005 of Kansas City Life Insurance Company held by non-affiliates was approximately $191,947,111.

 

**-1-**

 

 

**KANSAS CITY LIFE INSURANCE COMPANY**

**TABLE OF CONTENTS**

 

 

PART I.................................................................................................................................

3

 

 

Item 1.  Business......................................................................................................................

3

Item 2.  Properties.....................................................................................................................

4

Item 3.  Legal Proceedings............................................................................................................

4

Item 4.  Submission of Matters to a Vote of Security Holders..................................................................

4

 

 

PART II.................................................................................................................................

5

 

 

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity  

Securities............................................................................................................................

5

Item 6.  Selected Consolidated Financial Data......................................................................................

7

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.......................

8

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk.......................................................

27

Item 8.  Financial Statements and Supplementary Data...........................................................................

30

Consolidated Balance Sheets......................................................................................................

30

Consolidated Statements of Income..............................................................................................

31

Consolidated Statements of Stockholders’ Equity.............................................................................

32

Consolidated Statements of Cash Flows........................................................................................

33

Notes to Consolidated Financial Statements....................................................................................

34

Report of Independent Registered Public Accounting Firm..................................................................

64

Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.....................

66

Item 9A.  Controls and Procedures..................................................................................................

66

Item 9B.  Other Information..........................................................................................................

66

 

 

PART III.................................................................................................................................

67

 

 

Item 10.  Directors and Executive Officers of the Registrant....................................................................

67

Item 11.  Executive Compensation...................................................................................................

70

Item 12.  Security Ownership of Certain Beneficial Owners and Management...............................................

73

Item 13.  Certain Relationships and Related Transactions........................................................................

78

Item 14.  Principal Accounting Fees and Services.................................................................................

78

 

 

PART IV.................................................................................................................................

80

 

 

Item 15.  Exhibits, Financial Statement Schedules................................................................................

80

 

 

Signatures................................................................................................................................

82

 

Supplemental Information............................................................................................................

83

 

 

Schedule I – Summary of Investments – Other Than Investments in Related Parties....................................

83

Schedule II – Condensed Financial Information of Registrant...............................................................

84

Schedule III – Supplementary Insurance Information........................................................................

87

Schedule IV – Reinsurance Information........................................................................................

88

Schedule V – Valuation and Qualifying Accounts............................................................................

89

 

 

 

 

**-2-**

 

 

**PART I**

 

**Item 1****. **BUSINESS**
 

Kansas City Life Insurance Company (the Company) was incorporated under the assessment laws of Missouri in 1895 as the Bankers Life Association.  In 1900, its present corporate title was adopted and it was reorganized as a legal reserve company in 1903.  

 

The Company primarily consists of three insurance companies:  Kansas City Life Insurance Company (Kansas City Life) the parent company, and wholly owned subsidiaries Sunset Life Insurance Company of America (Sunset Life) and Old American Insurance Company (Old American).  The Company also has several non-insurance subsidiaries that are neither material individually or in the aggregate.  

 

Kansas City Life markets its individual insurance products, including traditional, interest sensitive and variable products through a nationwide sales force of independent general agents.  Kansas City Life also markets group insurance products, which include life, dental and disability products through a nationwide sales force of independent general agents, group brokers and third-party marketing arrangements.  Kansas City Life operates in 48 states and the District of Columbia.  

 

Sunset Life individual insurance products include traditional and interest sensitive products.  To improve the efficiency of marketing efforts, the Sunset Life sales force has been integrated into the Kansas City Life sales force by appointing Sunset Life agents as agents of Kansas City Life effective January 1, 2006.  Sunset Life will continue as a life insurance company with its current block of business.  Sunset Life operates in 43 states and the District of Columbia.  Sunset Life’s administrative and accounting operations are part of the Company’s home office operations and administration.  

 

Old American sells final expense insurance products nationwide through its general agency system, with exclusive territories, using direct response marketing to supply agents with leads.  Old American operates in 46 states and the District of Columbia.  Old American’s administrative and accounting operations are part of the Company’s home office but it operates and maintains a separate and independent field force.

 

The Company has three reportable business segments:  Individual Insurance, Group Insurance and Old American.  The Individual Insurance segment consists of individual insurance products for both Kansas City Life and Sunset Life.  These products generate approximately 57% of consolidated revenues from customers.  Group Insurance segment revenues account for 17% of consolidated revenues from customers and the Old American segment accounts for 26% of consolidated revenues from customers.

 

The Company and its subsidiaries are subject to state regulations in their states of domicile and in the states in which they do business.  Although the federal government generally does not regulate the business of insurance, federal initiatives often have an impact on the business in a variety of ways, including the taxation of insurance companies and the tax treatment of insurance products.

 

The Company and its subsidiaries had 541 full-time employees as of December 31, 2005.  The Company considers relations with its employees to be good.

 

The Company operates in the life insurance sector of the financial services industry in the United States.  The industry is highly competitive with respect to pricing, selection of products and quality of service.  No single competitor or any small group of competitors dominate any of the markets in which the Company operates.

 

*Access to Public Filings*

 

The Company provides access to its annual report on Form 10-K, and will provide access as they become available during the year for all quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports filed with the Securities and Exchange Commission (SEC) under the 1934 Act, free of charge.  These documents may be accessed on The Company’s website at the following address:  http://www.kclife.com and will be provided as soon as is practicable after filing with the SEC, although not always on the same day.  They may also be found on the SEC’s website at http://www.sec.gov.

 

 

**-3-**

 

 

**Item 2****.****PROPERTIES**

 

The Company’s home office is located at 3520 Broadway in Kansas City, Missouri.  The Company owns and wholly occupies two five-story buildings on an eight acre site.

 

The Company owns various other properties held for investment.

 

**Item 3****.****LEGAL PROCEEDINGS**

 

The life insurance industry, including the Company and its subsidiaries, has been subject to an increase in litigation in recent years.  Such litigation has been pursued on behalf of purported classes of insurance purchasers, often questioning the conduct of insurers in the marketing of their products. 

 

In addition to the above, the Company and its subsidiaries are defendants in, or subject to, other claims or legal actions.  Some of these claims and legal actions are in jurisdictions where juries are given substantial latitude in assessing damages, including punitive damages.  Although no assurances can be given and no determinations can be made at this time, management believes that the ultimate liability, if any, with respect to these other claims and legal actions would have no material effect on the Company’s business, results of operations or financial position.

 

**Item 4****.****SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None.

 

 

**-4-**

 

 

 

**PART II**

 

**Item 5****.****MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES**

 

**STOCKHOLDER INFORMATION**

 

**CORPORATE HEADQUARTERS**

Kansas City Life Insurance Company

3520 Broadway

Post Office Box 219139

Kansas City, Missouri 64121-9139

Telephone:  (816) 753-7000 

Fax: (816) 753-4902

Internet: http://www.kclife.com

E-mail: kclife@kclife.com

 

**NOTICE OF ANNUAL MEETING**

The annual meeting of stockholders will be held at 9 a.m. on Thursday, April 20, 2006, at Kansas City Life's corporate headquarters.

 

**TRANSFER AGENT**

Cheryl Keefer, Assistant Secretary

Kansas City Life Insurance Company

Post Office Box 219139

Kansas City, Missouri 64121-9139

 

**10-K REQUEST**

Stockholders may request a free copy of Kansas City Life's Form 10-K, as filed with the Securities and Exchange Commission, by writing to Secretary, Kansas City Life Insurance Company.

 

**SECURITY HOLDERS**

As of January 31, 2006, Kansas City Life had approximately 545 security holders, including individual participants in security position listings.

 

**-5-**

 

 

 

**STOCK AND DIVIDEND INFORMATION**

**Stock Quotation Symbol**

NASDAQ—KCLI

 

The following table presents the high and low prices for the Company’s common stock for the periods indicated and the dividends declared per share during such periods.

 

 

 

 

Bid

 

 

Dividend

 

 

High

 

 

Low

 

 

Paid

 

*(per share)***

**2005:**

 

 

 

 

 

 

 

 

First quarter

$

50.58 

 

$

46.29 

 

$

0.27 

Second quarter

 

50.90 

 

 

45.00 

 

 

0.27 

Third quarter

 

52.55 

 

 

47.00 

 

 

0.27 

Fourth quarter

 

51.97 

 

 

49.73 

 

 

0.27 

 

 

 

 

 

$

1.08 

**2004:**

 

 

 

 

 

 

 

 

First quarter

$

48.20 

 

$

41.55 

 

$

0.27 

Second quarter

 

43.44 

 

 

36.92 

 

 

0.27 

Third quarter

 

44.83 

 

 

39.70 

 

 

0.27 

Fourth quarter

 

49.76 

 

 

39.80 

 

 

0.27 

 

 

 

 

 

$

1.08 

 

 

 

 

 

 

 

 

 

 

A quarterly dividend of $0.27 per share was paid February 14, 2006.

 

NASDAQ market quotations are compiled according to Company records and may reflect inter-dealer prices, without markup, markdown or commission and may not necessarily represent actual transactions.                

 

**-6-**

 

 

 

**Item 6****.****SELECTED CONSOLIDATED FINANCIAL DATA**

 

 

**SELECTED CONSOLIDATED FINANCIAL DATA**

(amounts in thousands, except share data)

 

 

 

 

 

 

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Insurance revenues

$

239,039 

 

$

250,101 

 

$

272,644 

 

$

248,581 

 

$

249,085 

 

Net investment income

 

194,608 

 

 

197,975 

 

 

194,763 

 

 

194,235 

 

 

203,091 

 

Realized investment gains (losses)

 

6,113 

 

 

45,929 

 

 

(29,280)

 

 

(18,240)

 

 

(15,748)

 

Other revenues

 

10,312 

 

 

8,468 

 

 

9,387 

 

 

14,779 

 

 

11,270 

 

 

Total revenues

$

450,072 

 

$

502,473 

 

$

447,514 

 

$

439,355 

 

$

447,698 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

$

36,184 

 

$

57,687 

 

$

14,793 

 

$

31,549 

 

$

29,922 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income, basic and diluted

$

3.03 

 

$

4.83 

 

$

1.24 

 

$

2.63 

 

$

2.49 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends to stockholders

$

1.08 

 

$

1.08 

 

$

1.08 

 

$

1.08 

 

$

1.08 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders' equity

$

57.07 

 

$

58.00 

 

$

54.04 

 

$

49.81 

 

$

47.04 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets

$

4,559,019 

 

$

4,666,146 

 

$

4,549,687 

 

$

3,865,252 

 

$

3,774,106 

Notes payable

 

27,282 

 

 

92,220 

 

 

133,670 

 

 

97,241 

 

 

96,779 

Stockholders' equity

 

680,219 

 

 

692,896 

 

 

644,438 

 

 

597,497 

 

 

565,684 

Life insurance in force

$

30,949,501 

 

$

30,980,928 

 

$

32,216,624 

 

$

26,591,093 

 

$

26,644,910 

 

 

**-7-**

 

 

 

**Item 7****:****MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations analyzes the consolidated financial condition, changes in financial position and results of operations for the three years ended December 31, 2005 of Kansas City Life Insurance Company and its consolidated subsidiaries.  The discussion should be read in conjunction with the Consolidated Financial Statements and Notes.  All dollar amounts are in thousands except share data.

 

**Overview**

 

Kansas City Life Insurance Company (the Company) is a financial services company.  The Company primarily consists of three life insurance companies:  Kansas City Life Insurance Company (Kansas City Life) the parent company, and wholly owned subsidiaries Sunset Life Insurance Company of America (Sunset Life) and Old American Insurance Company (Old American).

 

Kansas City Life offers traditional, interest sensitive, and variable life and annuity insurance products, in addition to a variety of group life and group accident and health insurance products, and is licensed in 48 states and the District of Columbia.

 

Sunset Life is a life insurance and annuity carrier and is licensed in 43 states and the District of Columbia.  To improve the efficiency of marketing efforts, the Sunset Life sales force has been integrated into the Kansas City Life sales force by appointing Sunset Life agents as agents of Kansas City Life effective January 1, 2006.  Sunset Life will continue as a life insurance company with its current block of business. 

 

Old American provides individual insurance products designed to meet final expense insurance needs.  Old American is licensed in 46 states and the District of Columbia.

 

The Company offers investment products and broker dealer services through its subsidiary Sunset Financial Services, Inc. (SFS) for both its proprietary and non-proprietary variable insurance products and mutual funds.  The Company offers banking services through its subsidiary Generations Bank, such as deposit accounts, loans and internet banking.

 

**Business Changes**

 

As of year-end 2005, the Company’s reportable business segments have been redefined from prior reports where Sunset Life was identified and reported as a separate operating segment.  In this and future reports, the results of Sunset Life are combined with the individual insurance business of Kansas City Life, into the Individual Insurance business segment.  While Sunset Life will continue as a life insurance company with its current block of business, its operating results are combined with the individual insurance business of Kansas City Life since the nature of the products and services, the types of customers and distribution methods are essentially the same as that of Kansas City Life.  The segment reporting of prior years has been restated for the change in reportable segments.  As a result, the Company now has three reportable business segments, which are defined based on the nature of theproducts and services offered:  Individual Insurance, Group Insurance and Old American.

 

On June 30, 2003, the Company acquired all of the issued and outstanding stock of GuideOne Life Insurance Company (GuideOne) from GuideOne Financial Group, Inc. and GuideOne Mutual Company.  The financial position and results of operations of GuideOne have been included in these financial statements on a GAAP basis using the purchase method of accounting since July 1, 2003.  As of October 1, 2003, GuideOne was merged into Kansas City Life.  For segment reporting purposes, GuideOne is included in the Individual Insurance segment.

 

**Cautionary Statement on Forward-Looking Information**

 

This report reviews the Company’s financial condition and results of operations, and historical information is presented and discussed.  Where appropriate, factors that may affect future financial performance are also identified and discussed.  Certain statements made in this report include “forward-looking statements” that fall within the meaning of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements include any statement that may predict, forecast, indicate or imply future results, performance or achievements rather than historical facts and may contain words like “believe,” “expect,” “estimate,” “project,” “forecast,” “anticipate,” “plan,” “will,” “shall,” and other words, phrases or 

 

**-8-**

 

 

expressions with similar meaning.  

 

Forward-looking statements are subject to known and unknown risks, uncertainties and other factors that may cause actual results to differ materially from those contemplated by the forward-looking statements.  Factors that could cause the Company’s future results to differ materially from expected results include, but are not limited to:

 

 

**•**

Changes in general economic conditions, including the performance of financial markets and interest rates; 

 

**•**

Increasing competition, which may affect the Company’s ability to sell its products;

 

**•**

Customer and agent response to new products, distribution channels and marketing initiatives;

 

**•**

Fluctuations in experience regarding current mortality, morbidity, persistency and interest rates relative to expected amounts used in pricing the Company’s products;

 

**•**

Changes in assumptions related to deferred acquisition costs and the value of business acquired;

 

**•**

Regulatory, accounting or tax changes that may affect the cost of, or the demand for, the Company’s products or services;

 

**•**

Unanticipated changes in industry trends and ratings assigned by nationally recognized rating organizations.  

 

The Company cannot give assurances that such statements will prove to be correct.  Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

 

**Critical Accounting Policies and Estimates**

 

The accounting policies below have been identified as critical to the understanding of the results of operations and financial position.  The application of these critical accounting policies in preparing the financial statements requires management to use significant judgments and estimates concerning future results or other developments, including the likelihood, timing or amount of one or more future transactions.  Actual results may differ from these estimates under different assumptions or conditions.  On an ongoing basis, estimates, assumptions and judgments are evaluated based on historical experience and various other information believed to be reasonable under the circumstances.  For a detailed discussion of other significant accounting policies, see Note 1 – Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements.

 

***Recognition of Revenues***

Premiums are included in insurance revenues in the Consolidated Statements of Income.  Premiums for traditional life insurance products are reported as revenue when due.  Traditional insurance products include whole life, term life, immediate annuities and supplementary contracts with life contingencies.  

 

Premiums on accident and health, disability and dental insurance are reported as earned ratably over the contract period in proportion to the amount of insurance protection provided.  A reserve is provided for the portion of premiums written which relates to unexpired terms of coverage.

 

Deposits relate to insurance products that include universal life, variable life, variable annuities, fixed deferred annuities and deposit products without life contingencies.  The cash flows from deposits are credited to policyholder account balances.  Deposits are not recorded as revenue, but revenues from such contracts consist of amounts assessed against policyholder account balances for mortality, policy administration and surrender charges, and are recognized in the period in which the benefits and services are provided.  Deposits are shown in the Consolidated Statements of Cash Flows.

 

The Company measures its sales or new business production with two components: new premiums recorded and new deposits received.  Premiums and deposits are subdivided into two categories: new and renewal.  New premiums and deposits are a measure of sales or new business production.  Renewal premiums and deposits occur as continuing business from existing customers. 

 

***Reinsurance***

Reinsurance is one of the tools that the Company uses to accomplish its business objectives.  A variety of reinsurance vehicles are currently in use, including individual and bulk arrangements on both coinsurance and mortality/morbidity only basis.  Reinsurance supports a multitude of corporate objectives including managing statutory capital, reducing volatility and surplus strain.  At the customer level, reinsurance increases the Company’s capacity, provides access to additional underwriting expertise, and generally makes it possible for us to offer products at competitive levels that we 

 

**-9-**

 

 

could not otherwise bring to market.  Reinsurance is an actively managed tool that has increased in importance over recent years and will continue to play a role in the Company’s future. Reinsurance receivables include amounts related to paid benefits and estimated amounts related to unpaid policy and contract claims, future policy benefits and policyholder account balances.

 

***Future Policy Benefits***

The Company establishes liabilities for amounts payable under insurance policies, including traditional life insurance, annuities and accident and health insurance.  Generally, amounts are payable over an extended period of time.  Principal assumptions used in pricing policies and in the establishment of liabilities for future policy benefits are mortality, morbidity, expenses, persistency, investment returns and inflation.  Differences between actual experience and assumptions used in the pricing of these policies and in the establishment of liabilities may result in variability of net income in amounts which may be material.

 

***Policyholder Account Balances***

Policyholder account balances include universal life insurance, fixed deferred annuity contracts and investment-type contracts.  The account balances for universal life contracts are equal to cumulative premiums, less contract charges and withdrawals, plus interest credited.  The account balances for fixed deferred annuities and investment-type contracts are equal to the cumulative deposits, less any applicable contract charges and withdrawals, plus interest credited.  The profitability of these products is also dependent on actual experience similar to traditional insurance products, and differences between actual experience and pricing assumptions may result in variability of net income in amounts which may be material.

 

***Deferred Acquisition Costs (DAC) and Value of Business Acquired (VOBA)***

Deferred acquisition costs (DAC), principally agent commissions and other selling, selection and issue costs, which vary with and are directly related to the production of new business, are capitalized as incurred.  These deferred costs are then amortized in proportion to future premium revenues or the expected future profits of the business, depending upon the type of product.  Profit expectations are based upon assumptions of future interest spreads, mortality margins, expense margins and policy and premium persistency experience.  These assumptions involve judgment and are compared to actual experience on an ongoing basis.  At least annually, a review is performed and if it is determined that the assumptions related to the profit expectations for interest sensitive and variable insurance products should be revised, the impact of the change is reported in the current period’s income as an unlocking adjustment.

 

When a new block of business is acquired, a portion of the purchase price is allocated to a separately identifiable intangible asset, called the value of business acquired (VOBA).  VOBA is established as the actuarially determined present value of future gross profits of the business acquired and is amortized in proportion to future premium revenues or the expected future profits, depending on the type of business acquired.  Similar to DAC, the assumptions regarding future experience can affect the carrying value of VOBA, including interest spreads, mortality, expense margins and policy and premium persistency experience.  Significant changes in these assumptions can impact the carrying balance of VOBA and produce changes that must be reflected in the current period’s income as an unlocking adjustment.

 

***Investments***

The Company’s principal investments are in fixed maturity securities, mortgage loans and real estate; all of which are exposed to three primary sources of investment risk: credit, interest rate and liquidity.  The fixed maturity securities, which are all classified as available for sale, are carried at their fair value in the Company’s balance sheet, with unrealized gains or losses recorded in accumulated other comprehensive income.  The investment portfolio is monitored regularly to ensure that investments which may be other than temporarily impaired are identified in a timely fashion and properly valued, and that impairments are charged against earnings as realized investment losses.  The valuation of the investment portfolio involves a variety of assumptions and estimates, especially for investments that are not actively traded.  Fair values are obtained from a variety of external sources. 

 

The Company has a policy and process in place to identify securities that could potentially have an impairment that is other-than-temporary.  This process involves monitoring market events that could impact issuers’ credit ratings, business climate, management changes, litigation and government actions, and other similar factors.  This process also involves monitoring late payments, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues.

 

At the end of each quarter, all securities are reviewed where fair value is less than ninety percent of amortized cost for six months or more to determine whether impairments should be recorded.  The analysis focuses on each issuer’s ability 

 

**-10-**

 

 

to service its debts and the length of time the security has been trading below cost.  This quarterly process includes an assessment of the credit quality of each investment in the entire securities portfolio.

 

The Company considers relevant facts and circumstances in evaluating whether the impairment of a security is other-than-temporary.  Relevant facts and circumstances considered include (1) the length of time the fair value has been below cost, (2) the financial position of the issuer, including the current and future impact of any specific events, and (3) the Company’s ability and intent to hold the security to maturity or until it recovers in value.  To the extent the Company determines that a security is deemed to be other than temporarily impaired, the difference between amortized cost and fair value would be charged to income as a realized investment loss.

 

There are a number of significant risks and uncertainties inherent in the process of monitoring impairments and determining if an impairment is other-than-temporary.  These risks and uncertainties include (1) the risk that the Company’s assessment of an issuer’s ability to meet all of its contractual obligations will change based on changes in the credit characteristics of that issuer, (2) the risk that the economic outlook will be worse than expected or have more of an impact on the issuer than anticipated, (3) the risk that fraudulent information could be provided to the Company’s investment professionals who determine the fair value estimates and other-than-temporary impairments, and (4) the risk that new information obtained by the Company or changes in other facts and circumstances lead the Company to change its intent to hold the security to maturity or until it recovers in value.  Anyof these situations could result in a charge to income in a future period.

 

***Income Taxes***

Deferred income taxes are recorded on the differences between the tax bases of assets and liabilities and the amounts at which they are reported in the consolidated financial statements.  Recorded amounts are adjusted to reflect changes in income tax rates and other tax law provisions as they become enacted.  Deferred income tax expenses or credits are based on the changes in the asset or liability from period to period.  Deferred income tax assets are subject to ongoing evaluation of whether such assets will be realized.  The ultimate realization of deferred income tax assets depends on generating future taxable income during the periods in which temporary differences become deductible.  If future taxable income is not expected a valuation allowance against deferred income tax assets may be required. 

 

**Consolidated Results of Operations**

 

The Company’s net income decreased $21.5 million in 2005, versus the prior year, to a total of $36.2 million.  Net income per share decreased 37% in 2005 to $3.03, compared with $4.83 for 2004 and $1.24 for 2003.  The decline in the results of the year was largely due to realized investment gains recorded in 2004.  In 2004, the Company sold a significant real estate holding that generated a $26.4 million realized investment gain, net of income taxes.  Declines in revenues in 2005 were generally offset by declines in policyholder benefits, interest credited to policyholder account balances and operating expenses.  

 

Net income, excluding the effects of realized investment gains and losses and related tax effects, increased 16% to  $32.2 million in 2005, compared to $27.8 million in 2004.  Net income, excluding the effects of realized investment gains and losses and related tax effects, increased as declines in insurance revenues and net investment income were less than the declines in policyholder benefits, interest credited to policyholder account balances and operating expenses.  Insurance revenues decreased, reflecting declines in premiums and contract charges, along with an increase in reinsurance premiums ceded.  A decline in contract charges resulted primarily from an unlocking adjustment of unearned revenues.  Net investment income declined on a year-to-date basis, reflecting a decrease in investment yields.  Policyholder benefits decreased, largely due to reduced death benefits and lower group accident andhealth benefits, primarily from the group dental line.  Interest credited to policyholder account balances declined as a result of lower crediting rates.  The amortization of deferred acquisition costs decreased $2.2 million due to the unlocking of assumptions.  Finally, operating expenses decreased, primarily due to cost savings resulting from the integration of GuideOne operations into the home office.  Also, reduced postretirement benefit costs and an adjustment in agent benefit plan accrual contributed to reduced expenses in 2005.  

 

The Company’s effective income tax rate decreased in 2005 from a tax rate expense of 29% in 2004 to a tax rate expense of 27%.  The Company’s effective income tax rate was a tax benefit of 60% in 2003.  The change in effective tax rates was primarily due to the increase in realized investment gains in 2004.  The Company’s effective income tax rate was also reduced from the tax benefit of low income housing tax credits by 7% in 2005, 5% in 2004 and 41% in 2003; together with the resolution and settlement of prior year income tax liabilities.

 

 

**-11-**

 

 

 

***Sales***

The Company measures sales in terms of new premiums and deposits.  Premiums are included in insurance revenues in the Consolidated Statements of Income, while deposits are shown in the Consolidated Statements of Cash Flows.  The first set of tables below reconciles premiums included in insurance revenues and provides detail by new and renewal business.  New premiums are also detailed by product.  The second set of tables reconciles deposits with the Consolidated Statements of Cash Flows and provides detail by new and renewal deposits.  New deposits are also detailed by product.

 

Total premiums declined 5% in 2005, primarily due to declines in individual life sales, in immediate annuity sales and group accident and health business.  New life premiums declined 2% in 2005, while new immediate annuity premiums declined 14% from the prior year.  New group life sales decreased 12% versus the prior year.  Renewal life premiums decreased 3% versus 2004.  New group and individual accident and health premiums declined 21% versus 2004, primarily the result of a decline of group dental sales.  In 2004, the Company terminated an unprofitable third-party marketing arrangement that provided sales growth but did not fulfill profit expectations.  Renewal accident and health sales decreased 2% versus a year ago due to the reduction of group accident and health premiums, as mentioned above, along with the elimination of an individual accident and health book of business.

 

New premiums declined 38% in 2004, primarily due to a 61% decrease in immediate annuity sales.  Annuity sales slowed in the second half of 2003, due in part to the Company’s emphasis on life insurance sales and changes in the marketplace.  

 

New individual life insurance premium sales increased 10% for 2004.  These increases were due to the addition of GuideOne at June 30, 2003 and an overall emphasis on life insurance sales.  In 2004, new group life premium sales decreased 23% and new group accident and health premium sales decreased 8%.  The variability in group product sales has largely been the result of changes in third-party marketing arrangements and the short-term nature of many group contracts.  Renewal premiums grew 2% in 2004.  

 

There was a decline in both premiums and deposits from 2003, which was largely the result of lower sales of fixed deferred and immediate annuities.  These declines were due to a change in consumer preferences for fixed–rate products in the low interest rate environment and changes made by the Company to its fixed deferred and immediate annuity products and distribution efforts. In August of 2003, the Company introduced a new fixed deferred annuity with lower interest guarantees that replaced previous products with higher interest guarantees.  In addition, the Company has focused its distribution efforts on agencies that write a balanced mix of life and annuity products, which has resulted in a lower volume of annuity sales.

 

 

 

2005

%

 

2004

%

 

2003

New premiums:

 

 

 

 

 

 

 

 

 

 

 

Individual life insurance

$

13,092 

(2)

 

$

13,420 

10 

 

$

12,247 

 

Immediate annuities

 

12,159 

(14)

 

 

14,137 

(61)

 

 

36,569 

 

Group life insurance

 

1,327 

(12)

 

 

1,507 

(23)

 

 

1,952 

 

Group accident and health insurance

 

9,612 

(18)

 

 

11,755 

(8)

 

 

12,833 

 

Individual accident and health insurance

 

- 

(100)

 

 

416 

(84)

 

 

2,610 

 

 

Total new premiums

 

36,190 

(12)

 

 

41,235 

(38)

 

 

66,211 

Renewal premiums

 

143,701 

(3)

 

 

147,646 

2 

 

 

145,257 

Total premiums

$

179,891 

(5)

 

$

188,881 

(11)

 

$

211,468 

 

New deposits declined 25% in 2005 versus 2004, including decreases in new fixed deferred annuity deposits of 29% and new variable annuities of 23%.  Reductions in fixed annuity deposits reflect the planned increased emphasis towards life products.  New universal life deposits declined 7% and new variable universal life deposits decreased 35%, primarily due to moderate performance of the equity markets.  Renewal deposits increased 1% in 2005.   

 

New deposits declined 41% in 2004 versus 2003, largely due to fixed deferred annuity sales which decreased 52% in 2004.  New deposits on universal life products increased 14% in 2004.  For 2004, new variable annuity deposits decreased 16% while new variable universal life deposits increased 10%.  Sales of variable products were slow during 2004, reflecting the moderate performance of the equity markets.  Renewal deposits increased 9% for 2004.

 

 

 

**-12-**

 

 

 

 

 

 

 

2005

%

 

2004

%

 

2003

New deposits:

 

 

 

 

 

 

 

 

 

 

 

Universal life insurance

$

10,004 

(7)

 

$

10,784 

14 

 

$

9,448 

 

Variable universal life insurance

 

2,210 

(35)

 

 

3,407 

10 

 

 

3,093 

 

Fixed deferred annuities

 

49,698 

(29)

 

 

69,769 

(52)

 

 

145,057 

 

Variable annuities

 

24,894 

(23)

 

 

32,356 

(16)

 

 

38,293 

 

 

Total new deposits

 

86,806 

(25)

 

 

116,316 

(41)

 

 

195,891 

Renewal deposits

 

155,807 

1 

 

 

154,817 

9 

 

 

142,198 

Total deposits

$

242,613 

(11)

 

$

271,133 

(20)

 

$

338,089 

 

***Insurance Revenues***

Insurance revenues consist of premiums and contract charges, less reinsurance ceded.  Insurance revenues were down 4% or $11.1 million to $239.0 million in 2005 versus a decrease of 8% or $22.5 million to $250.1 million in 2004.  Premiums were down 5% in 2005, after decreasing 11% in 2004.  Contract charges earned in 2005 decreased 1% but were up 5% in 2004 due to the full year impact of the addition of GuideOne’s portfolio of universal life and fixed deferred annuity products.  Contract charges decreased $1.0 million as a result of an unlocking adjustment.  Certain contract charges for universal life insurance are not recognized in income immediately but are deferred as unearned revenues and are amortized into income in a manner similar to the amortization of deferred acquisition costs.  These contract charges, which are recorded as unearned revenues, are recognized into income in proportion to theexpected future gross profits of the business.

 

Reinsurance ceded has increased from $48.8 million in 2003 to $54.5 million in 2004 and to $55.6 million in 2005.  The Company has expanded its use of reinsurance over the past few years and uses reinsurance as a means to mitigate its risks.  In 2005, reinsurance ceded increased $1.1 million over 2004.  In 2004, reinsurance ceded increased $5.7 million over 2003, primarily due to group accident and health products.  This reinsurance reduces the Company’s adverse fluctuations on the more volatile long-term disability and stop loss products.  In addition, the GuideOne acquisition resulted in an increase to reinsurance ceded in the individual life and individual accident and health product lines.

 

Insurance revenues are affected by the level of new sales, the type of products sold, and the persistency of policyholders, all of which may be influenced by economic conditions, as well as competitive forces.  Consumers continue to desire a broad portfolio of products with safety and competitive return objectives, which the Company strives to provide.  The Company offers a full range of products, including variable insurance products, which allow policyholders to participate in both the equity and fixed income markets.  Interest sensitive and traditional insurance products combine safety of principal with competitive interest returns.

 

***Investment Revenues***

Net investment income declined 2% in 2005 from 2004, which followed a 2% increase in 2004 from 2003.  Net investment income totaled $194.6 million in 2005 compared with $198.0 million in 2004, a decrease of $3.4 million.  In 2005 total invested assets declined versus the prior year and investment yields declined slightly versus 2004.  In 2004, total invested assets increased over the year, but the impact to investment income was partially offset by lower investment yields.  In 2003, the income from higher asset levels was directly offset by lower investment yields.

 

Included in net investment income for 2005, income from fixed maturity securities increased by $2.6 million or 2% from 2004.  Income from fixed maturity securities for 2004 had grown $10.4 million or 7% over the prior year.  The improvement in 2005 was due to an increase in average asset levels with investment yields essentially flat.  The 2004 improvement was due, in part, to increased balances of fixed maturity security investments of $147.6 million or 5% of the prior year’s balances.  In 2005, a decrease in equity securities accounts for a $0.7 million or 16% decrease in equity security investment income.  In 2004, equity security investment income declined 5% or $0.2 million.  

 

Despite a $28.0 million increase in mortgage loan assets in 2005, mortgage loan investment income declined 1% or $0.5 million, following a 2004 decline of $3.3 million or 9%.  The reduced income reflects a decline in available yields on new mortgages and the effects of prepayment on loans with rates higher than new loan rates.  In 2004, the decline in income from mortgage loans was primarily due to prepayments of commercial mortgages, which resulted in a $26.0 million reduction in mortgage loan balances during 2004.    

 

Following the sale of a substantial real estate holding in Arizona in 2004, real estate income declined $5.2 million or 40% in 2005.  In 2004, real estate income increased 19% or $2.1 million.  Short-term investment income increased $0.8 

 

**-13-**

 

 

 

million in 2005, following a $1.8 million decline in 2004.  

 

As previously discussed, the Company recorded net realized investment gains in 2005 of $6.1 million, down from the prior year’s total of $45.9 million.  However, in 2004 there was a $75.2 million improvement from net realized investment losses of $29.3 million in 2003.  The change from 2003 to 2004 was largely due to the sale of a significant real estate property in 2004 and the sale and write-down of other-than-temporarily impaired securities in 2003.  The following table provides detail concerning realized investment gains and losses over the three years ended December 31.

 

**Realized Investment Gains and Losses**

2005

 

2004

 

2003

Gross gains resulting from:

 

 

 

 

 

 

 

 

 

Sales of investment securities

$

3,991 

 

$

8,545 

 

$

9,467 

 

Investment securities called

 

989 

 

 

1,242 

 

 

2,469 

 

Sales of real estate

 

7,678 

 

 

44,735 

 

 

9,107 

 

Other investment gains

 

905 

 

 

443 

 

 

- 

 

 

Total gross gains

 

13,563 

 

 

54,965 

 

 

21,043 

Gross losses resulting from:

 

 

 

 

 

 

 

 

 

Sales of investment securities

 

(6,009)

 

 

(8,237)

 

 

(20,443)

 

Write-downs of investment securities

 

- 

 

 

(555)

 

 

(29,824)

 

Investment securities called

 

(599)

 

 

(476)

 

 

(839)

 

Sales of real estate

 

(927)

 

 

- 

 

 

- 

 

Other investment losses

 

- 

 

 

(72)

 

 

(96)

 

 

Total gross losses

 

(7,535)

 

 

(9,340)

 

 

(51,202)

Amortization of DAC and VOBA

 

85 

 

 

304 

 

 

879 

Realized investment gains (losses)

$

6,113 

 

$

45,929 

 

$

(29,280)

 

The Company realizes investment gains and losses in the normal course of business from several sources.  Although sales of securities resulted in significant net losses during 2003, sales of securities resulted in a net gain of $0.3 million in 2004 and a net loss of $2.0 million in 2005.  Sales of securities are generally the result of changes in the relative credit position of the issue or issuer, along with the requirements of managing the Company’s asset and liability position.  Other sources of realized investment gains and losses include write-downs of investment securities, investment securities that are called, sales of real estate and other miscellaneous investment gains and losses.

 

Many securities purchased by the Company contain call provisions, which allow the issuer to redeem the securities at a particular price.  Depending upon the terms of the call provision and price at which the security was purchased, a realized gain or loss may be realized.  Called securities have resulted in net realized gains during 2005 and the two prior years.

 

The most significant source of realized investment gain or loss during the past three years was the $44.7 million in realized gains from sales of real estate recorded during 2004.  More than 90% of these gains were from the sale of the Company’s 50% interest in a portfolio of properties near Paradise Valley Mall, referred to as Paradise Village properties in Phoenix, Arizona.  The property interests were sold in two transactions that were completed in late December 2004 for a total of $54.3 million.  Fifty million dollars of this total was attributable to the Company selling most of the property interests to the other 50% owner.  The remaining $4.3 million represented the sale of certain properties to a third-party.  The Company maintained its interests in the Paradise Village properties for more than twenty years.  During this period, the land was improved and primarily retail properties weredeveloped and leased.  As with the entirety of the Company’s real estate portfolio, the Paradise Village properties were consistently evaluated for continued holding or sale.  Changes in the demographic and competitive markets near the properties, along with relative values of retail properties in the Phoenix, Arizona market were factors in the Company’s decision to sell the Paradise Village properties.

 

The Company has a long history of investment in real estate.  Real estate investments totaled $81.9 million at December 31, 2005 and $91.5 million at December 31, 2004.  Property types include office, industrial, multi-family and single-family residential, along with unimproved land.  Properties have been acquired through individual purchases, build-to-suit and speculative development, and acquisition of other life insurance company investment portfolios.  The Companygenerally maintains its ownership interest in these properties with the long-term intention of earning positive cash flow and income by leasing the properties, along with the expectation of realizing capital appreciation upon sale.  As evidenced by the fluctuations in realized investment gains from sales of real estate of $7.7 million in 2005, $44.7 million 

 

**-14-**

 

 

in 2004, and $9.1 million in 2003.  The Company periodically sells certain real estate assets when management believes that the market and timing are perceived to be advantageous.

 

Other investment gains and losses can include the impact of a variety of smaller investment transactions.  These can include changes in the Company’s valuation reserve for losses in the commercial mortgage portfolio.

 

The following table provides credit quality information on fixed maturity securities as determined by one of the nationally recognized ratings firms as of December 31, 2005.  

 

 

 

 

 

 

 

 

% of

Investment

 

Amortized

 

 

Fair

 

Fair

Quality

 

Cost

 

 

Value

 

Value

 

 

 

 

 

 

 

 

 

Investment grade

$

2,681,258 

 

$

2,710,711 

 

95 

Below investment grade

 

 

 

 

 

 

 

 

(rated BB or lower)

 

149,668 

 

 

154,765 

 

5 

 

 

$

2,830,926 

 

$

2,865,476 

 

 

 

In recent years, the bond and equity markets have been adversely affected by large bankruptcy filings, defaults by companies within certain industries, and broad sector difficulties combined with a stressed economy.  Among the industry sectors that were particularly affected were airlines, energy and telecommunications.  

 

At the end of each quarter, all securities are reviewed where market value is less than ninety percent of amortized cost for six months or more to determine whether impairments need to be recorded.  The analysis focuses on each issuer’s ability to service its debts and the length of time the security has been trading below cost.  This quarterly process includes an assessment of the credit quality of each investment in the entire securities portfolio.  The Company considers relevant facts and circumstances in evaluating whether the impairment of a security is other-than-temporary.  Relevant facts and circumstances considered include (1) the length of time the fair value has been below cost; (2) the financial position of the issuer, including the current and future impact of any specific events; and (3) the Company’s ability and intent to hold the security to maturity or until it recovers in value.To the extent the Company determines that a security is deemed to be other than temporarily impaired, the difference between amortized cost and fair value is charged to income as a realized investment loss.  The Company's analysis of securities with other-than-temporary declines did not result in any write-downs of investments in 2005, but the Company identified $0.6 million in other-than-temporary declines in value in 2004.  For 2003, the Company recorded $29.8 million in other-than-temporary declines in value, which were largely due to investments in the airline industry.  At year-end 2005 and 2004, there were no investment securities in a distressed position greater than six months.  

 

The following table provides asset class detail of the investment portfolio.  Fixed maturity and equity securities represented 81% of the entire investment portfolio for 2005 and 2004.

 

**Percent of Invested Assets**

2005

 

2004

 

 

Amount

 

%

 

Amount

 

%

Fixed maturity securities

$

2,865,476 

 

79 

 

$

2,962,114 

 

79 

Equity securities

 

52,775 

 

2 

 

 

63,099 

 

2 

Mortgage loans

 

458,668 

 

13 

 

 

430,632 

 

12 

Real estate

 

81,870 

 

2 

 

 

91,519 

 

2 

Policy loans

 

101,088 

 

3 

 

 

108,546 

 

3 

Short-term

 

46,383 

 

1 

 

 

67,980 

 

2 

Other

 

2,179 

 

- 

 

 

2,081 

 

- 

 

Total

$

3,608,439 

 

100

 

$

3,725,971 

 

100

 

The securities portfolio had unrealized gains before taxes of $35.2 million at year-end 2005. The portfolio was broadly diversified across sectors.  A variety of measures have been employed to manage the portfolio’s credit and interest rate risks, as discussed later in this document in Item 7A – Quantitative and Qualitative Disclosures About Market Risk.

 

 

**-15-**

 

 

 

Mortgage loans comprise 13% of the investment portfolio at December 31, 2005, up from 12% at the end of 2004.  Approximately 95% of the mortgages are commercial loans on industrial warehouses and office properties.  None of the loans have been restructured nor have there been any loans in foreclosure over the past two years.  Prepayments declined in 2005, as mortgage loan rates were generally higher than the prior year.  However, prepayments increased in both 2004 and 2003 due to the lower interest rate environment.  The portfolio’s estimated fair value exceeded its carrying value by $7.7 million as of year-end 2005.  In 2004, the portfolio’s estimated fair value exceeded its carrying value by $13.0 million.  The Company does not hold mortgage loans of any borrower that exceed 5% of stockholders’ equity.

 

Real estate investments represented approximately 2% of the investment portfolio, the same as 2004.  However, in 2004, the Company sold Paradise Village properties, in Phoenix, Arizona.  The sale price totaled $54.3 million and the transaction was completed in December 2004.  The buyer of the real estate assumed the outstanding debt on the property of $15.3 million.  This sale generated a $26.4 million realized gain, net of income taxes in 2004.  

 

Real estate investments consist principally of office buildings and industrial warehouses that are both in use and under development, and investments in multi-family and single-family residential properties, including affordable housing.   The Company also invests in unimproved land for future development.  The real estate properties’ estimated fair value is well above the carrying value.  Real estate sales generated net realized gains of $6.8 million in 2005, $44.7 million in 2004 and $9.1 million in 2003.

 

***Policyholder Benefits***

Policyholder benefits consist of death benefits (mortality), annuity benefits, accident and health benefits, surrenders and the associated increase or decrease in reserves for future policy benefits.  Policyholder benefits declined 5% or $8.9 million in 2005 and 11% or $22.8 million in 2004.  The declines reflect lower death benefits and decreases in annuity premiums, which resulted in a decrease in reserves for future policy benefits.  Also, policyholder benefits for group accident and health declined in both 2005 and 2004, primarily due to the elimination of certain third-party marketing arrangements.

 

Death benefits declined 2% in 2005 but were up 1% in 2004.  The change in 2004 was primarily the result of a full year’s inclusion of the business obtained in the GuideOne acquisition compared to the six months of 2003.  Excluding the effect of the GuideOne acquisition, there was no significant variation in mortality experience over the period 2003 through 2005.  

 

***Interest Credited to Policyholder Account Balances***

Interest credited to policyholder account balances declined 5% or $4.4 million in 2005, primarily due to lower crediting rates.  Interest was credited to policyholder account balances for universal life, fixed deferred annuities and other investment-type products.  The amount of interest credited is a function of the crediting rate and policyholder account balances.  Policyholder account balances are impacted by deposits, benefits, surrenders and contract charges.  Interest credited to policyholder account balances increased $4.2 million in 2004 due to higher account balances.  The higher account balances were due to the GuideOne acquisition in 2003 and increased deposits.  The impact of increased account balances was partially offset by lower crediting rates in 2004 and 2003.  The average interest rate credited to policyholder account balances was 4.37% in 2005, 4.59% in 2004, and 4.95% in2003.**

 

***Amortization of Deferred Acquisition Costs (DAC) and Value of Business Acquired (VOBA)***

The amortization of DAC was $35.6 million in 2005 compared with $36.1 million in 2004 and $33.4 million in 2003.  The Company unlocked certain DAC assumptions which reduced amortization by $2.2 million in 2005, $0.1 million in 2004, and $1.8 million in 2003.  DAC profit expectations are based upon assumptions of future interest spreads, mortality margins, expense margins and policy and premium persistency experience.  At least annually, a review is performed of the assumptions related to profit expectations.  As warranted by a combination of historical results and expected future trends, the Company may unlock these assumptions and, accordingly, increase or decrease deferred acquisition costs. 

 

The amortization of VOBA was $6.8 million in 2005, $7.4 million in 2004 and $7.0 million in 2003.  Additional VOBA of $38.0 million was established on June 30, 2003 due to the acquisition of GuideOne.

 

***Operating Expenses***

Operating expenses consist of commissions and production allowances, net of the capitalization of commission and production allowances, and expenses from the Company’s operations.  In total, operating expenses declined 6% in 2005, following a 2% decline in 2004.  The decline in 2005 reflects expense savings realized in the consolidation of GuideOne 

 

**-16-**

 

 

 

into the home office of approximately of $3.9 million, reduced pension and postretirement benefit costs and the accrual for agents’ benefit plans.  Operating expenses declined in 2004 due to the decline in commissions and the capitalization thereon.  However, expenses from operations increased in 2004, primarily due to three factors.  First, an increase in independent public accounting firm fees due to the requirements of the Sarbanes-Oxley Act.  Second, the Company’s consolidation of business activities of the GuideOne acquisition into the homeoffice.  Finally, in 2003 the Company received a reimbursement on a legal claim that resulted in a reduction of legal fees.  Overall, operating expenses increased in 2003 due to increased commissions and increased pension expense.      

 

***Income Taxes***

The Company recorded income tax expense of $13.4 million or 27% of income before tax in 2005, compared to income tax expense of $24.0 million or 29% of income before tax in 2004.  The decline in the tax expense in 2005 versus 2004 was the result of substantial realized investment gains recorded in 2004, primarily as a result of the substantial sale of real estate that occurred in 2004.  In 2003, the Company recorded an income tax benefit of $5.6 million or 60% of income before tax for 2003, reflecting the impact of realized investment losses that year.  Income taxes will fluctuate depending upon items such as net income, realized investment gains and losses and affordable housing tax credits.

 

The income tax rate in the three years was reduced by tax credits generated from the Company’s investments in affordable housing.  The effect of the affordable housing credits on the effective tax rate was a tax benefit of $3.0 million or 6% in 2005, $4.2 million or 5% in 2004 and $3.7 million or 41% in 2003.

 

The Company establishes contingent tax liabilities, when appropriate, to provide for potential challenges by taxing jurisdictions.  In 2003, the Company’s effective tax rate was reduced by the reversal of a contingent tax liability relating to 1999, a tax year that closed in 2003.  The reversal of previously accrued taxes was a benefit of $4.1 million or 44% of income before tax for 2003.  There were no reversals of previously accrued taxes in 2004 and 2005.

 

**Operating Results by Segment**

 

The Company has three reportable business segments, which are defined based on the nature of the products and services offered:  Individual Insurance, Group Insurance and Old American.  The Individual Insurance segment consists of individual insurance products for both Kansas City Life and Sunset Life.  The Individual Insurance segment is marketed through a nationwide sales force of independent general agents.  The Group Insurance segment consists of sales of group life, group disability, stop loss and dental products.  This segment is marketed through a nationwide sales force of independent general agents, group brokers and third-party marketing arrangements.  Old American consists of individual insurance products designed primarily as final expense products.  These products are marketed through a nationwide general agency sales force with exclusive territories, using direct response marketing to supplyagents with leads.      

 

As of year-end 2005, the Company’s reportable segments have been redefined from prior reports where Sunset Life was identified and reported as a separate operating segment.  In this and future reports, the results of Sunset Life are combined with the individual insurance business of Kansas City Life, into the Individual Insurance segment.  To improve the efficiency of marketing efforts, the Sunset Life sales force has been integrated into the Kansas City Life sales force by appointing Sunset Life agents as agents of Kansas City Life effective January 1, 2006.  Sunset Life will continue as a life insurance company with its current block of business and its operating results are reported with the individual insurance business of Kansas City Life since the nature of the products and services, the types of customers and distribution methods are essentially the same as those of Kansas City Life.  Thesegment reporting of prior years has been restated for the change in the reportable segments.

 

 

**-17-**

 

 

 

***Individual Insurance***

The following table presents financial data of the Individual Insurance business segment for the years ended December 31.

 

 

 

 

 

2005

 

2004

 

2003

Insurance revenues:

 

 

 

 

 

 

 

 

 

Premiums

$                

58,001 

 

$                

62,375 

 

$                

79,369 

 

Contract charges

 

114,745 

 

 

115,710 

 

 

110,006 

 

Reinsurance ceded

 

(40,584)

 

 

(38,193)

 

 

(35,585)

 

 

 

Total insurance revenues

 

132,162 

 

 

139,892 

 

 

153,790 

Investment revenues:

 

 

 

 

 

 

 

 

 

Net investment income

 

181,311 

 

 

184,393 

 

 

180,598 

 

Realized investment gains (losses)

 

6,488 

 

 

46,026 

 

 

(25,013)

Other revenues

 

9,641 

 

 

6,155 

 

 

6,546 

 

 

 

Total revenues

 

329,602 

 

 

376,466 

 

 

315,921 

 

 

 

 

 

 

 

 

 

 

 

 

Policyholder benefits

 

105,810 

 

 

113,054 

 

 

123,696 

Interest credited to policyholder account balances

 

92,121 

 

 

96,497 

 

 

92,278 

Amortization of deferred acquisition costs 

 

 

 

 

 

 

 

 

 

and value of business acquired

 

29,011 

 

 

29,779 

 

 

26,389 

Operating expenses

 

56,638 

 

 

61,270 

 

 

62,025 

 

 

 

Total benefits and expenses

 

283,580 

 

 

300,600 

 

 

304,388 

 

 

 

 

 

 

 

 

 

 

 

 

Income before income tax expense (benefit)

 

46,022 

 

 

75,866 

 

 

11,533 

 **

 **

 

 

 

 

 

 

 

 

 

 

Income tax expense (benefit)

 

12,383 

 

 

22,761 

 

 

(4,538)

 **

 **

 

 

 

 

 

 

 

 

 

 

Net income

$

33,639 

 

$

53,105 

 

$

16,071 

 

 

This segment’s direct insurance revenues (total insurance revenues excluding reinsurance ceded) are primarily derived from premiums on traditional insurance products, principally term life and immediate annuities; and contract charges on interest sensitive insurance products, including universal life, fixed deferred annuities and variable life and annuities.  In 2005, this segment received 34% of its direct insurance revenues from premiums on traditional products, down slightly from 35% in 2004 and down from 42% in 2003.  This decrease in premiums and deposits from 2003 was attributable to a decrease in sales of fixed deferred and immediate annuities as described earlier.  These sales results were due to a continuing change in consumer preferences for fixed-rate products in the low interest rate environment of recent years.  In August of 2003, the Company introduced a new fixed deferred annuity withlower interest guarantees that replaced previous products.  Over the past three years, as the Company has focused its distribution efforts on agencies that market a balanced mix of life and annuity products, a declining volume of annuity sales has resulted.    

 

Contract charges declined $1.0 million in 2005.  However, they increased $5.7 million or 5% in 2004.  Contract charges declined in 2005 as the result of an unlocking adjustment.  Certain contract charges for universal life insurance are not recognized in income immediately but are deferred as unearned revenues and are amortized into income in a manner similar to the amortization of deferred acquisition costs or DAC.  These contract charges, which are recorded as unearned revenues, are recognized in income in proportion to the expected future gross profits of the business.  The increase in 2004 was due to the addition of GuideOne and a general aging of the business.  The Company purchased GuideOne at June 30, 2003, and 2003 results included an increase in contract charges from six months of GuideOne activity, while 2004 and 2005 were included for a full year of these operations.  

 

All of this segment’s products are marketed through a nationwide sales force of independent general agents.  This segment is central to the Company’s overall performance since it generated 93% of consolidated net income in 2005 and 92% of consolidated net income in 2004.  Excluding realized investment gains and losses, net of tax, this segment 

 

**-18-**

 

 

generated 91% of net income in 2005 and 83% of net income in 2004.  Customer revenues consist of insurance revenues and other revenues.  This segment produced 57% of customer revenues in all three years presented.  

 

Premium information is provided in the table below.  New premiums declined 11% or $2.1 million in 2005.  New premiums declined 54% or $23.6 million in 2004.  New premiums for individual life insurance increased 5% in 2005, following a 23% increase in 2004, reflecting the full year inclusion of GuideOne and the increased focus on the life insurance business.  Renewal premiums decreased 5% in 2005 but increased 19% in 2004 due to individual life insurance, primarily from the GuideOne acquisition.

 

 

 

 

2005

%

 

2004

%

 

2003

New premiums:

 

 

 

 

 

 

 

 

 

 

 

Individual life insurance

$

5,944 

5 

 

$

5,679 

23 

 

$

4,631 

 

Immediate annuities

 

12,159 

(14)

 

 

14,137 

(61)

 

 

36,569 

 

Individual accident and health insurance

 

- 

(100)

 

 

416 

(84)

 

 

2,610 

 

 

Total new premiums

 

18,103 

(11)

 

 

20,232 

(54)

 

 

43,810 

Renewal premiums

 

39,898 

(5)

 

 

42,143 

19 

 

 

35,559 

Total premiums

$

58,001 

(7)

 

$

62,375 

(21)

 

$

79,369 

 

Deposit information is provided in the table below.  New deposits declined 25% in 2005 to total $86.8 million.  This decrease is largely due to the planned decline in annuity deposits, which decreased 27%.  This decrease in annuity deposits is largely the result of decreases in fixed deferred and variable annuities, which decreased 29% and 23%, respectively.  New deposits decreased 41% or $79.6 million in 2004, largely due to lower fixed deferred annuity sales.  In 2003, the growth was driven by increases in universal life insurance, fixed deferred annuities, and variable annuities, partially offset by a decrease in variable universal life insurance sales.  Deposit levels in 2003 primarily resulted from expanded distribution through independent general agents, which the Company uses with limited and specific purposes. 

 

As previously mentioned, new fixed deferred annuity deposits declined in 2005.  Also, new variable annuity deposits were lower for 2005 due to moderate performance of the equity markets.  New universal life deposits declined $0.8 million or 7% versus 2004.  New universal life deposits increased 14% in 2004, reflecting an increased focus on life insurance and the GuideOne acquisition.  New variable life insurance deposits declined $1.2 million or 35% compared with 2004 but grew 10% during 2004.  Renewal deposits increased 1% in 2005 compared with 2004 and renewal deposits increased 9% in 2004 versus 2003.  These changes primarily reflect the increased annuities and business acquired from GuideOne in 2003.

 

 

 

 

2005

%

 

2004

%

 

2003

New deposits:

 

 

 

 

 

 

 

 

 

 

 

Universal life insurance

$

10,004 

(7)

 

$

10,784 

14 

 

$

9,448 

 

Variable universal life insurance

 

2,210 

(35)

 

 

3,407 

10 

 

 

3,093 

 

Fixed deferred annuities

 

49,698 

(29)

 

 

69,769 

(52)

 

 

145,057 

 

Variable annuities

 

24,894 

(23)

 

 

32,356 

(16)

 

 

38,293 

 

 

Total new deposits

 

86,806 

(25)

 

 

116,316 

(41)

 

 

195,891 

Renewal deposits

 

155,807 

1 

 

 

154,817 

9 

 

 

142,198 

Total deposits

$

242,613 

(11)

 

$

271,133 

(20)

 

$

338,089 

 

Insurance revenues decreased 6% in 2005 following a 9% decline in 2004.  A decline in premiums and an unlocking in contract charges, combined with an increase in reinsurance ceded premiums, accounted for the revenue decrease.  In 2004, individual life premiums and contract charges from interest sensitive products increased, compared with 2003, primarily from the GuideOne acquisition.  However, this increase was partially offset by a decrease in immediate annuity premiums and an increase in reinsurance premiums ceded.

 

Net investment income declined 2% in 2005 but grew 2% in 2004.  Investment income is driven by changes in both interest rates and asset levels.  The overall investment yields declined in 2005, 2004 and 2003.  The impact of declining yields in 2004 and 2003 was more than offset by increases in asset levels.  

 

Policyholder benefits consist of death benefits (mortality), annuity benefits, accident and health benefits, surrenders and 

 

**-19-**

 

 

the associated increase or decrease in reserves for future policy benefits.  Policyholder benefits decreased 6% or $7.2 million in 2005, following a 9% or $10.6 million decline in 2004.  These policyholder benefit declines primarily resulted from reduced immediate annuity sales.  Immediate annuity premiums are matched virtually dollar-for-dollar with a corresponding increase in future policy benefits.  Thus, as immediate annuity sales decline, so does reserves for future policy benefits.  Additionally, individual accident and health benefits decreased reflecting the termination of a block of business received in the GuideOne acquisition.  

 

Death benefits declined 6% in 2005 but were up 11% in 2004.  While death benefits improved in 2005, they were within pricing expectation ranges.  In 2004, death benefits increased primarily as a result of a full year’s inclusion of the business obtained in the GuideOne acquisition compared to the inclusion of only six month’s activity of 2003.  Excluding the effect of the GuideOne acquisition, there was no significant variation in mortality experience over the period 2003 through 2005.  

 

Interest was credited to policyholder account balances for universal life, fixed deferred annuities and other investment-type products.  The amount of interest credited is a function of the crediting rate and account balances, and account balances are impacted by deposits, benefits, surrenders and contract charges.  Interest credited to policyholder account balances decreased $4.4 million versus a year earlier, primarily due to lower crediting rates.  Interest credited increased $4.2 million in 2004 due to higher account balances.  The higher account balances were the result of the GuideOne acquisition in 2003 and new and renewal deposits.  The impact of increased account balances in 2004 and 2003 was partially offset by lower crediting rates.

 

The amortization of deferred acquisition costs has fluctuated over the past three years due to unlocking adjustments for assumption changes, which reflect the emergence of actual profit margins that were better than expected.  The amortization of deferred acquisition costs were reduced as follows: $2.2 million in 2005, $0.1 million in 2004, and $1.8 million in 2003.  

 

Operating expenses include commissions, net of the capitalization of certain commissions, expenses on operations and other expenses.  Commissions and capitalization of those commissions decreased in 2005.  Operating expenses decreased $3.9 million due to expense savings realized from the consolidation of GuideOne into the home office, reduced pension and postretirement benefit costs and the accrual for agents’ benefit plans.  Operating expenses declined in 2004 due to the decline in commissions and the capitalization thereon.  However, expenses from operations increased in 2004 primarily due to three factors.  First, an increase in independent public accounting firm fees due to the requirements of the Sarbanes-Oxley Act.  Second, the Company’s consolidation of business activities of the GuideOne acquisition into the home office.  Finally, in 2003, the Company received a reimbursement on a legalclaim that resulted in a reduction of legal fees.

 

Net income in this segment decreased 37% compared with 2004, primarily due to realized investment gains in 2004.  In 2004, net income increased 230% compared with 2003.  Income excluding realized investment gains, net of tax increased 27% or $6.2 million versus 2004.  The increase reflects reduced policyholder benefits, interest credited to policyholder account balances and operating expenses.  In 2004, income excluding realized investment gains, net of tax declined $9.1 million or 28%.  The change from 2003 to 2004 primarily reflected the decline in annuity sales, which more than offset declines in policyholder benefits.  Non-insurance subsidiaries are included in this segment, but they are not material to results of the segment.

 

**-20-**

 

 

 

***Group Insurance***

The following table presents financial data of the Group Insurance business segment for the years ended December 31.

 

 

 

 

 

2005

 

2004

 

2003

Insurance revenues:

 

 

 

 

 

 

 

 

 

Premiums

$                

50,783 

 

$                

52,935 

 

$                

56,266 

 

Reinsurance ceded

 

(9,913)

 

 

(10,552)

 

 

(6,648)

 

 

 

Total insurance revenues

 

40,870 

 

 

42,383 

 

 

49,618 

Investment revenues:

 

 

 

 

 

 

 

 

 

Net investment income

 

233 

 

 

323 

 

 

281 

Other revenues

 

661 

 

 

2,313 

 

 

2,752 

 

 

 

Total revenues

 

41,764 

 

 

45,019 

 

 

52,651 

 

 

 

 

 

 

 

 

 

 

 

 

Policyholder benefits

 

25,950 

 

 

27,959 

 

 

35,727 

Operating expenses

 

19,220 

 

 

19,710 

 

 

22,644 

 

 

 

Total benefits and expenses

 

45,170 

 

 

47,669 

 

 

58,371 

 

 

 

 

 

 

 

 

 

 

 

 

Loss before income tax benefit

 

(3,406)

 

 

(2,650)

 

 

(5,720)

 **

 **

 

 

 

 

 

 

 

 

 

 

Income tax benefit

 

(1,022)

 

 

(795)

 

 

(1,716)

 **

 **

 

 

 

 

 

 

 

 

 

 

Net loss

$

(2,384)

 

$

(1,855)

 

$

(4,004)

 

The Company offers several insurance products in the Group Insurance segment: dental, group life, short and long-term disability, vision, and stop loss.  Prior to 2005, this segment also offered administrative claims paying services, marketed as KCL Benefit Solutions.  

 

The Group Insurance segment markets its group products primarily to small and mid-size organizations.  Products are sold through a group representative sales force targeting a nationwide network of independent general agents and group brokers, along with the Company’s career general agents.  This sales network is Group’s core distribution system.  Additionally, the Company enters into selective third-party marketing arrangements to market group products.  In 2005, this segment generated 17% of the Company’s customer revenues, which is comparable to that of 2004 but down from 18% in 2003.  

 

The group market is highly competitive and group policies are periodically reviewed to ensure they conform to target claims, expenses and profit objectives.  Renewal terms that meet target pricing objectives are communicated to the group policyholder who may then decide to seek alternative bids from competing carriers.  In mid-year 2004, this business segment lost a large dental case with approximately $3.1 million of annual premiums because the renewal terms necessary to retain this customer were not in conformity with Company pricing and profit objectives.

 

On January 1, 2005, the Company sold its administrative claims paying services, KCL Benefit Solutions, to The Epoch Group, L. C. for $0.2 million in order to concentrate more directly on its core products.  Administrative claims paying services generated 4% of total insurance and other revenues for this segment at year-end 2004.  This line generated a $1.1 million loss for the Group Insurance segment in 2004 and a $1.6 million loss in 2003.  As a result of this sale, both other revenues and operating expenses declined in 2005 compared to the prior two years.  Other revenues for the Group Insurance segment declined $1.7 million or 71% in 2005 compared with 2004, and declined $0.4 million or 16% in 2004 compared to 2003.  

 

The Group Insurance segment has experienced losses in each of the three years presented.  Improvement efforts are focused in three areas.  First, grow the in-force premiums to achieve better expense ratios from fixed costs and overhead.  This will be achieved through increased individual productivity of the existing group representatives and through a continued expansion of the group distribution system.  The second area of focus for improvement is to increase the use of technology to achieve improved administrative efficiency and reduce expenses.  The third area of focus is to add new products to the portfolio, particularly voluntary products which tend to be more profitable and are increasingly becoming a larger share of the group marketplace.

 

**-21-**

 

 

 

Premium information is provided in the table below.  New premiums were down 18% in 2005 and 10% in 2004.  In 2005, the growth in new premiums for short-term disability and stop loss insurance (shown as other group insurance) were more than offset by a decline in new premiums for long-term disability and dental insurance.  New group life premiums declined 12% and 23% in 2005 and 2004, respectively.  Results from group life in 2003 were higher because of the acquisition of one large case.  New premiums for group dental insurance have decreased primarily due to a slowing of new sales production from the Company’s third-party marketing arrangements.  Renewal premiums have remained constant in 2005 compared to 2004, following a 4% decrease in 2004 versus 2003.

 

Total group premiums declined $2.2 million or 4% in 2005 compared with 2004.  The decline was primarily attributable to the termination of a large dental case at mid-year 2004, as discussed previously.  Second, during 2005, the life line discontinued a third-party marketing arrangement that generated a significant amount of new premiums relative to total premiums in years 2004 and 2003.  Group premiums declined $3.3 million or 6% in 2004 compared with 2003.  The decline was primarily a result of the Company discontinuing an unprofitable third-party marketing arrangement as of December 31, 2003.

 

The Company has used reinsurance in several of its group product lines to help mitigate risk.  Reinsurance on premiums declined $0.6 million or 6% in 2005 compared to 2004, reflecting the general decrease in total group premiums. 

 

 

 

 

2005

%

 

2004

%

 

2003

New premiums:

 

 

 

 

 

 

 

 

 

 

 

Group life insurance

$

1,327 

(12)

 

$

1,507 

(23)

 

$

1,952 

 

Group dental insurance

 

4,112 

(31)

 

 

5,956 

(34)

 

 

9,034 

 

Group disability insurance

 

1,971 

(38)

 

 

3,157 

8 

 

 

2,930 

 

Other group insurance

 

3,529 

34 

 

 

2,642 

204 

 

 

869 

 

 

Total new premiums

 

10,939 

(18)

 

 

13,262 

(10)

 

 

14,785 

Renewal premiums

 

39,844 

- 

 

 

39,673 

(4)

 

 

41,481 

Total premiums

$

50,783 

(4)

 

$

52,935 

(6)

 

$

56,266 

 

Policyholder benefits consist of death benefits (mortality), accident and health benefits and the associated increase or decrease in reserves for future policy benefits.  Policyholder benefits declined $2.0 million or 7% in 2005 and $7.8 million or 22% in 2004, primarily due to the elimination or discontinuation of certain third-party marketing arrangements or lines of business that did not meet profit expectations.

 

Operating expenses in this segment include commissions, expenses associated with operations, insurance related taxes and other expenses.  Expenses associated with operations in this segment are specifically and directly identified, but also include allocated expenses.  Operating expenses in this segment declined 3% in 2005 and 13% in 2004.  The reductions were due to a decrease in commissions related to the decline in sales and a decrease in operating expenses due to reductions in staffing from the sale of the administrative claims paying services, KCL Benefit Solutions.

 

The net loss in the Group Insurance segment increased $0.5 million or 29% in 2005 compared with 2004, primarily due to the decline in sales.  In 2004, the net loss decreased $2.1 million or 54% compared with 2003, primarily due to the reduction of policyholder benefits and operating expenses.

 

**-22-**

 

 

 

***Old American***

The following table presents financial data of the Old American business segment******for the years ended December 31.

 

 

 

 

 

2005

 

2004

 

2003

Insurance revenues:

 

 

 

 

 

 

 

 

 

Premiums

$                

71,107 

 

$                

73,571 

 

$                

75,833 

 

Reinsurance ceded

 

(5,100)

 

 

(5,745)

 

 

(6,597)

 

 

 

Total insurance revenues

 

66,007 

 

 

67,826 

 

 

69,236 

Investment revenues:

 

 

 

 

 

 

 

 

 

Net investment income

 

13,064 

 

 

13,259 

 

 

13,884 

 

Realized investment losses

 

(375)

 

 

(97)

 

 

(4,267)

Other revenues

 

10 

 

 

- 

 

 

89 

 

 

 

Total revenues

 

78,706 

 

 

80,988 

 

 

78,942 

 

 

 

 

 

 

 

 

 

 

 

 

Policyholder benefits

 

44,449 

 

 

44,142 

 

 

48,491 

Amortization of deferred acquisition costs 

 

 

 

 

 

 

 

 

 

and value of business acquired

 

13,418 

 

 

13,698 

 

 

14,035 

Operating expenses

 

13,830 

 

 

14,681 

 

 

12,998 

 

 

 

Total benefits and expenses

 

71,697 

 

 

72,521 

 

 

75,524 

 

 

 

 

 

 

 

 

 

 

 

 

Income before income tax expense 

 

7,009 

 

 

8,467 

 

 

3,418 

 **

 **

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

2,080 

 

 

2,030 

 

 

692 

 **

 **

 

 

 

 

 

 

 

 

 

 

Net income

$

4,929 

 

$

6,437 

 

$

2,726 

 

The Old American segment sells final expense insurance products nationwide through its general agency system with exclusive territories.  Using direct response marketing, Old American provides agents with sales leads.  Old American produced 26% of consolidated customer revenues in the past two years, up from 25% in 2003.  Old American’s net income declined in 2005, primarily from reduced premiums.  Net income increased in 2004, reflecting reduced realized investment losses and improved policy benefit ratios from favorable mortality.  Net income totaled $4.9 million in 2005, down from $6.4 million in 2004 but up from $2.7 million in 2003.  In 2005, this segment provided 14% of consolidated net income, up from 11% in 2004 and down from 18% in 2003.  Excluding realized investment gains and losses, this segment provided 15% of net income in 2005, 23% in 2004, and 16% in 2003.

 

Premium information is provided in the table below.  New premiums decreased 8% in 2005, but new premiums increased 2% in 2004.  Renewal premiums decreased 3% in both 2005 and 2004.  Old American continues to focus on the recruitment and development of new agencies and agents.  

 

2005

%

 

2004

%

 

2003

 

 

 

 

 

 

 

 

 

 

 

New premiums

$

7,148 

(8)

 

$

7,741 

2 

 

$

7,616 

Renewal premiums

 

63,959 

(3)

 

 

65,830 

(3)

 

 

68,217 

Total premiums

$

71,107 

(3)

 

$

73,571 

(3)

 

$

75,833 

 

Net investment income declined 2% or $0.2 million in 2005, 5% or $0.6 million in 2004.  These declines were due to the combination of lower investment yields and slightly lower asset levels.  Realized investment losses equaled $0.4 million in 2005, $0.1 million in 2004 and $4.3 million in 2003.  

 

Policyholder benefits consist of death benefits (mortality), accident and health benefits, surrenders, and the associated increase or decrease in reserves for future policy benefits.  Policyholder benefits increased 1% or $0.3 million in 2005 and decreased 9% or $4.3 million in 2004, primarily due to death benefits.  In 2004, death benefits declined.  However, in 2005, death benefits increased slightly.  In addition, the change in reserves for future policy benefits decreased due to lower premiums in both 2005 and 2004.

 

**-23-**

 

 

 

Policyholder benefit ratios (policyholder benefits divided by total revenues excluding realized investment gains and losses) increased in 2005 versus 2004 due to a decrease in revenues, while policyholder benefits were largely unchanged from 2004.  This same ratio improved in 2004 compared with 2003, reflecting improved policyholder benefits over a decline in revenues as identified in the table below.  These results are largely reflective of the combined effect of a decline in premiums and improved mortality over this timeframe.    

 

 

 

2005

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

Total revenue

$

78,706 

 

$

80,988 

 

$

78,942 

Less: Realized investment

 

 

 

 

 

 

 

 

 

losses

 

(375)

 

 

(97)

 

 

(4,267)

Revenue excluding realized 

 

 

 

 

 

 

 

 

investment losses

 

79,081 

 

 

81,085 

 

 

83,209 

 

 

 

 

 

 

 

 

 

 

Policyholder benefits

$

44,449 

 

$

44,142 

 

$

48,491 

 

 

 

 

 

 

 

 

 

 

Policyholder benefit ratio

 

56%

 

 

54%

 

 

58%

 

Operating expenses include commissions and production allowances, net of the capitalization of certain commission and production allowances, and expenses from operations.  Operating expenses declined in 2005 due to reduced salary and benefits, reflecting staffing fluctuations, reductions in leasehold expenses and a reduction in state insurance department fees related to the triennial examination expenses incurred in 2004.  In 2004, operating expenses increased primarily as the result of an increase from lead generation expenses and other marketing initiatives.

 

**Liquidity and Capital Resources**

 

***Liquidity***

The Company meets liquidity requirements primarily through positive cash flows from operations.  The Company has sufficient sources of liquidity to satisfy operational requirements.  Primary sources of cash flow are premiums, other insurance considerations and deposits, receipts for policyholder accounts, investment sales and maturities, investment income and access to credit from other financial institutions.  The principal uses of cash are for the insurance operations, including the purchase of investments, payments of insurance benefits, operating expenses, withdrawals from policyholder accounts, costs related to acquiring new business, dividends and income taxes.  

 

Cash provided from operations in each of the three years ended 2005, 2004 and 2003 was $50.1 million, $35.7 million, and $94.1 million, respectively.  The increase in cash provided from operations in 2005 was largely due to reductions in claims payments and operating expenses paid.  Net cash provided by investing activities was $46.6 million in 2005, but $48.3 million and $258.0 million in net cash was used in investing activities in 2004 and 2003, respectively.  Investment purchases are primarily a function of available cash.  During 2003, the Company had significant increases in assets due to sizable immediate and fixed deferred annuity sales, along with the purchase of GuideOne Life Insurance Company.  However, 2005 and 2004 reflected less of an increase in cash and investable assets due to reduced immediate and fixed deferred annuity sales.  

 

The Company’s investing activity decreased during 2005 and 2004.  The Company’s new investments in fixed maturity and equity securities totaled $554.7 million during 2005, $733.9 million in 2004, and $1,255.8 million in 2003.  New investments in mortgage loans totaled $109.6 million in 2005, $72.3 million 2004, and $149.3 million in 2003.  Approximately 20% of the securities portfolio was sold, called or matured in 2005, comparable to 19% in 2004, and  33% in 2003.  During 2005, the Company increased its purchases of real estate investments to $17.7 million, up from $8.3 million in 2004.  However, during 2004, the Company had several sales of real estate investments which resulted in realized gains.  The largest sale occurred in December 2004, totaling $54.3 million, which resulted in a realized investment gain of $26.4 million, net of applicable capital gains taxes.  The Company continually seeksreal estate investment opportunities to bolster its investment portfolio.  

 

Net cash used in financing activities was $89.8 million in 2005 and $3.4 million in 2004.  However, net cash of $169.2 million was provided by financing activities in 2003.  The increase in net cash used in 2005 versus 2004 was primarily 

 

**-24-**

 

 

due to an increase in the repayment of short-term borrowings, which were used for investment and liquidity purposes, and a decline in immediate and fixed deferred annuity deposits, net of withdrawals.  Deposits on policyholder account balances totaled $242.6 million in 2005, $271.1 million in 2004, and $338.1 million in 2003.  The decline over the three years primarily reflects decreased premium and deposit sales activity.  Withdrawals on policyholder account balances totaled $245.9 million in 2005, $205.7 million in 2004 and $180.8 million in 2003.  The increase in withdrawals over the three years is consistent with rising interest rates and improvements in the financial markets.  Net repayment of borrowings were $64.9 million and $41.5 million in 2005 and 2004, respectively.      

 

The above information excludes net proceeds from variable insurance products.  These proceeds are segregated into separate accounts and are not held in the Company’s general investments because the policyholders, rather than the Company, assume the underlying investment risks.  

 

***Separate Accounts***

At December 31, 2005, the Company had $367.9 million in separate account assets.  This is an increase of $13.9 million, from $354.0 million at December 31, 2004, which was primarily the result of positive investment performance.  Investment performance increased separate account assets by $25.1 million in 2005, $37.3 million in 2004, and $50.4 million in 2003.

 

Deposits on separate accounts declined in 2005 to total $49.4 million.  In 2004 and 2003, deposits were $64.6 million, and $68.4 million, respectively. 

 

***Debt and Short-Term Borrowing***

The Company and certain subsidiaries have access to borrowing capacity through their membership affiliation with the Federal Home Loan Bank (FHLB).  At December 31, 2005, outstanding balances under this agreement totaled $26.2 million.  All outstanding balances have maturities of less than one year.  The primary purpose for these borrowings is to ensure access to liquidity.  This is accomplished through the purchase of highly liquid marketable securities from the proceeds of these borrowings.

 

The Company has one real estate loan totaling $0.6 million and the Company has one construction loan related to investment properties totaling $0.5 million.

 

Borrowings totaled $27.3 million at year-end 2005, down from $92.2 million at year-end 2004.  The decrease in borrowings is largely due to reductions in borrowing from FHLB.  These particular borrowings decreased $62.2 million during the year.  The Company has access to unsecured revolving lines of credit of $60.0 million with two major commercial banks with no balances outstanding.  Both lines of credit will expire during 2006, and it is expected that the Company will renew these facilities. 

 

***Capital Resources***

The Company considers existing capital resources to be more than adequate to support the current level of business activities.

 

The following table shows the capital adequacy of the Company for the past two years.

 

 

2005

 

2004

Total assets less separate accounts

$

4,191,159 

 

$

4,312,163 

Total stockholders' equity

 

680,219 

 

 

692,896 

Ratio of stockholders' equity

 

 

 

 

 

to assets less separate accounts

 

16%

 

 

16%

 

The ratio of equity to assets less separate accounts has remained relatively constant.  Net unrealized gains on available for sale securities, which are included as a part of stockholders’ equity, decreased $34.6 million at December 31, 2005.  The decline reflects higher interest rates relative to prior year-end.  Net unrealized gains increased $5.2 million and $45.5 million at December 31, 2004 and 2003, respectively, reflecting lower interest rates and improving credit markets relative to December 31 of the prior years.

 

The Company’s statutory equity exceeds the minimum capital deemed necessary to support its insurance business, as determined by the risk based capital calculations and guidelines established by the National Association of Insurance 

 

**-25-**

 

 

Commissioners. The maximum stockholder dividends that can be paid out of stockholders’ equity in 2006 without prior approval of the Missouri Director of Insurance are $49.5 million - the statutory gain from operations at year-end 2005.

 

Stockholders’ equity per share, or book value, equaled $57.07 for year-end 2005, a 2% decrease for the year.  The stock repurchase program was extended by the Board of Directors through January 2007 to permit the purchase of up to one million of the Company’s shares on the open market, which would represent approximately 8% of the shares currently outstanding. No shares were purchased under this program during 2005.

 

On January 30, 2006, the Board of Directors declared a quarterly dividend of $0.27 per share, unchanged from the prior year, that was paid February 14, 2006 to stockholders of record as of February 9, 2006.  

 

Current legislative activities are not expected to have a significant impact on the ongoing operations of the Company.

 

***Contractual Obligations***

The following table summarizes the Company’s information about contractual obligations by due date and expiration date as of December 31, 2005.  Contractual obligations of the Company are those obligations fixed by agreement as to dollar amount and date of payment.

 

**Contractual Obligations**

 

 

 

 

Less than

 

 

 

 

 

 

 

After

(amounts in millions)

 

Total

 

1 year

 

1-3 years

 

4-5 years

 

5 years

Borrowings (1)

 

$

27.3 

 

$

26.7 

 

$

-  

 

$

0.6 

 

$

-  

Operating lease obligations (2)

 

 

6.8 

 

 

1.8 

 

 

4.9 

 

 

0.1 

 

 

-  

Purchase obligations (3)

 

 

1.4 

 

 

1.4 

 

 

-  

 

 

-  

 

 

-  

Mortgage loan commitments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and other investments (4)

 

 

20.4 

 

 

20.4 

 

 

-  

 

 

-  

 

 

-  

Annuity certain contracts (5)

 

 

70.1 

 

 

14.4 

 

 

24.0 

 

 

17.0 

 

 

14.7 

Insurance liabilities (6)

 

 

3,068.6 

 

 

320.2 

 

 

644.4 

 

 

606.0 

 

 

1,498.0 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total contractual obligations

 

$

3,194.6 

 

$

384.9 

 

$

673.3 

 

$

623.7 

 

$

1,512.7 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

Borrowings include long-term and short-term debt as described in the previous section – Debt and short-term borrowing.

 

(2)

As a lessee, the Company leases its mainframe computer and certain related support equipment.  The Company is also a lessee of an office building with a 20-year lease that began in 1989 with two five-year renewal options.  In 1998, the Company assigned the interest in the lease to a third-party for the remainder of the lease period.

 

(3)

Purchase obligations include contracts where the Company has a non-cancelable commitment to purchase goods and services.

 

(4)

Mortgage loan commitments to provide funding to originate commercial mortgage loans.  Mortgage loan commitments generally do not extend beyond 90 days.  Other investments are primarily commitments for real estate investments.

 

(5)

Annuity certain contracts are those insurance liabilities (included in future policyholder benefits and policyholder contract balances), which do not have life contingencies and have scheduled payments.  Annuity certain contracts without life contingencies consist of single premium immediate annuities, supplementary contracts and structured settlements. 

 

(6)

Insurance liabilities consist primarily of future policyholder benefits and policyholder contract balances for which the timing of cash flows is uncertain and which have life contingencies.  The schedule of payments for these liabilities can vary significantly because of the uncertainty of the timing of cash flows, which depend upon insurable events or policyholder surrenders.

 

 

**-26-**

 

 

 

**Item 7A****:****QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

The Company holds a diversified portfolio of investments that includes cash, bonds, preferred stocks, mortgage-backed securities, commercial mortgages and real estate.  Each of these investments is subject, in varying degree, to market risks that can affect their return and their fair value.  A majority of these assets are debt instruments of corporations or U.S. Government Sponsored Enterprises (GSE) and are considered fixed income investments.  Thus, the primary market risks affecting the Company’s portfolio are interest rate risk, credit risk and liquidity risk.

 

Interest rate risk arises from the price sensitivity of investments to changes in interest rates.  Coupon and dividend income represent the greatest portion of an investment’s total return for most fixed income instruments in stable interest rate environments.  The changes in the fair market price of such investments are inversely related to changes in market interest rates.  As interest rates fall, the coupon and dividend streams of existing fixed rate investments become more valuable and market values rise.  As interest rates rise, the opposite effect occurs.  

 

The Company’s investment portfolio decreased in value in 2005, primarily due to higher interest rates.  At year-end 2005, the fair value of the securities exceeded its book value by $35.2 million. 

 

Due to the complex nature of interest rate movements and their uneven effects on the value of fixed income investments, the Company uses sophisticated computer programs to help consider potential changes in the value of the portfolio.  Assuming that changes occur equally over the entire term structure of interest rates or yield curve, it is estimated that a 100 basis point increase in rates would translate to a $139.4 million loss of fair value for the $2.9 billion securities portfolio. Conversely, a 100 basis point rate decrease would translate to a $140.1 million increase in fair value.  

 

Market changes rarely follow a linear pattern in one direction for any length of time.  Within any diversified portfolio, an investor will likely find embedded options, both puts and calls, that change the structure of the cash flow stream.  Mortgage-backed securities are particularly sensitive to interest rate changes.  As long-term interest rates fall, homeowners become more likely to refinance their mortgage or move up to a larger home, causing a prepayment of the outstanding mortgage principal, which must then be reinvested at a lower rate.  Should interest rates rise suddenly, prepayments expected by investors may decrease, extending the duration of a mortgage pool.  This represents a further interest rate risk to investors.

 

As interest rates rise, policyholders may become more likely to surrender policies or to borrow against cash values, often to meet sudden needs in an inflationary environment or to invest in higher yielding opportunities elsewhere.  This risk of disintermediation may force the Company to liquidate parts of its portfolio at a time when the fair market value of fixed income investments is falling.  If interest rates fall, the Company may also be forced to invest new cash receipts at levels below the minimum guaranteed rates payable to policyholders, eroding profit margins.  The Company can usually adapt to small sudden changes in interest rates, or even large changes that occur over longer periods of time.  However, cash flow may increase or decrease over the course of the business cycle.  Therefore, the Company takes steps to ensure that adequate liquidity is available to meet obligations in a timely manner. To this end, the Company utilizes an asset/liability management program, and the Company maintains lines of credit with commercial banks and other short-term borrowing arrangements with financial institutions.  

 

The majority of the Company’s investments are exposed to varying degrees of credit risk.  Credit risk is the risk that the value of the investment may decline due to deterioration in the financial strength of the issuer and that the timely or ultimate payment of principal or interest might not occur.

 

The Company recorded realized investment gains in 2005 and 2004 compared to realized investment losses in 2003.  Realized investment losses have been primarily attributable to credit deterioration and bankruptcies in the airline and utility sectors.  A default by a rated issuer usually involves some loss of principal to the investor.  Losses can be mitigated by timely sales of affected securities or by active involvement in a restructuring process.  However, there can be no assurance that the efforts of an investor will lead to favorable outcomes in a bankruptcy or restructuring.  Information about the write-down of investment securities is provided in the table of Realized Investments Gains and Losses, under the section Consolidated Results of Operations in Item 7 - Management’s Discussion and Analysis.  

 

The Company mitigates credit risk by diversifying the investment portfolio across a broad range of issuers, investment sectors and security types, and by limiting the amount invested in any particular entity.  With the exception of certain GSE’s, there is no exposure to any single issuer greater than one percent of assets on a book value basis.  The Company 

 

**-27-**

 

 

also invests in securities carrying a lien against physical assets.  These securities can improve the likelihood of payment according to contractual terms and increase recovery amounts in the case of bankruptcy or restructuring.  

 

The Company currently holds $140.2 million of foreign bonds.  The foreign securities do not expose the Company directly to foreign currency risk as the securities are denominated in U.S. dollars.  As a result, the foreign currency risk lies with the issuer of the securities and may expose them to fluctuations in the foreign currency market.

 

As market interest rates fluctuate, so will the value of the Company's investment portfolio and its stockholders' equity.  At December 31, 2005, the Company had an unrealized investment gain of $17.5 million (net of related taxes, policyholder account balances and deferred acquisition costs), compared to $52.1 million at year-end 2004.  This decrease is primarily the result of increases in interest rates.  The Company continues its practice of the limited use of derivatives as a form of risk mitigation.     

 

***Asset/Liability Management***

Kansas City Life’s asset/liability management programs and procedures involve the monitoring of asset and liability durations for various product lines, cash flow testing under various interest rate scenarios to evaluate the potential sensitivity of assets and liabilities to interest rate movements, and the continuous rebalancing of assets and liabilities with respect to yield, risk, and cash flow characteristics.

 

Kansas City Life believes its asset/liability management programs and procedures, along with certain product features, provide protection for the Company against the effects of changes in interest rates under various scenarios.  

 

Cash flows and effective durations of the asset and liability portfolios are measured at points in time and are affected by changes in the level and term structure of interest rates, as well as changes in policyholder behavior.  Further, durations are managed on an individual product level, as well as an aggregate portfolio basis.  As a result, differences typically exist between the duration, cash flows and yields of assets versus liabilities on an individual portfolio and aggregate basis.  The Company’s asset/liability management programs and procedures enable management to monitor the changes, which have both positive and negative correlations among certain portfolios, and to make adjustments to asset mix, liability crediting rates and product terms so as to manage risk and profitability over time.  

 

The Company performs cash flow scenario testing through models of its in-force business.  These models reflect specific product characteristics and include assumptions based on current and anticipated experience regarding the relationships between short-term and long-term interest rates (i.e., the slope of the yield curve), credit spreads, market liquidity and other factors, including policyholder behavior in certain market conditions.  In addition, these models include asset cash flow projections, reflecting interest payments, sinking fund payments, principal payments, bond calls and mortgage prepayments.  

 

The Company has a risk that the asset or liability portfolio performance may differ from forecasted results as a result of unforeseen economic circumstances, estimates or assumptions that prove incorrect, unanticipated policyholder behavior or other factors.  The result of such deviation of actual versus expected performance could include excess or insufficient liquidity in future periods.  Excess liquidity, in turn, could result in reduced profitability on one or more product lines.  Insufficient liquidity could result in the need to generate liquidity through borrowing, asset sales or other means.  The Company believes that adherence to its asset/liability management programs will provide sufficient liquidity to enable it to fulfill its obligation to pay benefits under its various insurance and deposit contracts.  On a historical basis, the Company has not needed to liquidate assets to ensure sufficientcash flows.  The Company maintains borrowing lines on a secured and unsecured basis to provide additional liquidity, if needed.

 

The Company markets certain variable products.  The policyholder assumes essentially all the investment earnings risk for the portion of the account balance invested in the separate accounts.  However, the Company assesses certain charges based on the policy account values and changes to the account values can affect the Company's earnings.  The portion of the policyholder's account balance invested in the fixed general account, if any, is affected by many factors, including the absolute level of interest rates, relative performance of the fixed income and equity markets, and the spreads between interest yields on investments and rates credited to the policyholder's accounts.  

 

***Expected Cash Flows***

The table below details the nature of expected cash flows from the securities portfolio, including the cash flows from mortgage-backed securities pools, corporate bonds and commercial mortgages. Calls and prepayments represent the principal amount expected to return to the Company.  Total principal equals invested cash scheduled to return in each year, including maturities, calls, sinking funds and prepayments.

 

**-28-**

 

 

 

 

**Expected Cash Flows**

(amounts in millions)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

There-

 

 

 

Total

 

 

 

Fair

 

 

2006

 

 

2007

 

 

2008

 

 

2009

 

 

2010

 

 

 

after 

 

 

 

Principal

 

 

 

Value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds currently callable

$

- 

 

 

$

5 

 

 

$

4 

 

 

$

1 

 

 

$

- 

 

 

$

17 

 

 

$

27 

 

 

$

24 

 

Average interest rate

 

-   

% 

 

 

6.84 

% 

 

 

8.04 

% 

 

 

3.83 

% 

 

 

-   

% 

 

 

6.59 

% 

 

 

6.75 

% 

 

 

 

Mortgage-backed securities and CMO's

 

181 

 

 

 

104 

 

 

 

71 

 

 

 

64 

 

 

 

49 

 

 

 

224 

 

 

 

693 

 

 

 

668 

 

Average interest rate

 

4.62 

% 

 

 

4.97 

% 

 

 

5.05 

% 

 

 

5.15 

% 

 

 

5.51 

% 

 

 

5.44 

% 

 

 

5.09 

% 

 

 

 

All other securities

 

130 

 

 

 

207 

 

 

 

148 

 

 

 

150 

 

 

 

159 

 

 

 

1,310 

 

 

 

2,104 

 

 

 

2,173 

 

Average interest rate

 

6.00 

% 

 

 

4.92 

% 

 

 

5.90 

% 

 

 

5.85 

% 

 

 

5.62 

% 

 

 

5.96 

% 

 

 

5.86 

% 

 

 

 

Investment securities

 

311 

 

 

 

316 

 

 

 

223 

 

 

 

215 

 

 

 

208 

 

 

 

1,551 

 

 

 

2,824 

 

 

 

2,865 

 

Average interest rate

 

5.19 

% 

 

 

4.97 

% 

 

 

5.67 

% 

 

 

5.63 

% 

 

 

5.59 

% 

 

 

5.89 

% 

 

 

5.68 

% 

 

 

 

Mortgages

 

24 

 

 

 

23 

 

 

 

34 

 

 

 

38 

 

 

 

45 

 

 

 

295 

 

 

 

459 

 

 

 

466 

 

Average interest rate

 

7.78 

% 

 

 

7.06 

% 

 

 

6.92 

% 

 

 

6.90 

% 

 

 

6.11 

% 

 

 

7.00 

% 

 

 

6.94 

% 

 

 

 

Total

$

335 

 

 

$

339 

 

 

$

257 

 

 

$

253 

 

 

$

253 

 

 

$

1,846 

 

 

$

3,283 

 

 

$

3,331 

 

Average interest rate

 

5.38 

% 

 

 

5.11 

% 

 

 

5.84 

% 

 

 

5.82 

% 

 

 

5.68 

% 

 

 

6.07 

% 

 

 

5.83 

% 

 

 

 

 

 

 

 

**-29-**

 

**Item 8****.****FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**KANSAS CITY LIFE INSURANCE COMPANY**

**CONSOLIDATED BALANCE SHEETS**

(amounts in thousands, except share data)

 

 

 

 

 

 

December 31

 

 

 

 

 

2005

 

2004

**ASSETS**

 

 

 

 

 

 

 

Investments:

 

 

 

 

 

 

 

Fixed maturity securities available for sale, at fair value

 

 

 

 

 

 

 

 

(amortized cost:  2005 - $2,830,926; 2004 - $2,863,781)

$

2,865,476 

 

$

2,962,114 

 

Equity securities available for sale, at fair value

 

 

 

 

 

 

 

 

(cost: 2005 - $52,143; 2004 - $61,812)

 

52,775 

 

 

63,099 

 

Mortgage loans

 

 

458,668 

 

 

430,632 

 

Real estate

 

 

81,870 

 

 

91,519 

 

Policy loans

 

 

101,088 

 

 

108,546 

 

Short-term investments

 

46,383 

 

 

67,980 

 

Other investments

 

2,179 

 

 

2,081 

 

 

 

Total investments

 

3,608,439 

 

 

3,725,971 

 

 

 

 

 

 

 

 

 

 

Cash

 

 

 

 

10,985 

 

 

4,147 

Accrued investment income

 

40,002 

 

 

39,928 

Deferred acquisition costs

 

226,963 

 

 

229,712 

Value of business acquired

 

89,505 

 

 

96,853 

Reinsurance receivables

 

163,347 

 

 

156,839 

Property and equipment

 

29,954 

 

 

31,595 

Other assets

 

 

21,964 

 

 

27,118 

Separate account assets

 

367,860 

 

 

353,983 

 

 

 

Total assets

$

4,559,019 

 

$

4,666,146 

 

 

 

 

 

 

 

 

 

 

**LIABILITIES**

 

 

 

 

 

 

Future policy benefits

$

860,284 

 

$

863,754 

Policyholder account balances

 

2,278,418 

 

 

2,295,783 

Policy and contract claims

 

36,355 

 

 

34,200 

Other policyholder funds

 

93,197 

 

 

96,853 

Notes payable

 

 

27,282 

 

 

92,220 

Income taxes

 

 

40,155 

 

 

53,703 

Other liabilities

 

 

175,249 

 

 

182,754 

Separate account liabilities

 

367,860 

 

 

353,983 

 

 

 

Total liabilities

 

3,878,800 

 

 

3,973,250 

 

 

 

 

 

 

 

 

 

 

**STOCKHOLDERS' EQUITY**

 

 

 

 

 

Common stock, par value $1.25 per share

 

 

 

 

 

 

Authorized 36,000,000 shares,

 

 

 

 

 

 

 

 

issued 18,496,680 shares

 

23,121 

 

 

23,121 

Additional paid in capital

 

25,063 

 

 

24,279 

Retained earnings

 

 

756,807 

 

 

733,499 

Accumulated other comprehensive income (loss)

 

(8,406)

 

 

26,231 

Less treasury stock, at cost (2005 - 6,578,046 shares;

 

 

 

 

 

 

2004 - 6,550,287 shares)

 

(116,366)

 

 

(114,234)

 

 

 

Total stockholders' equity

 

680,219 

 

 

692,896 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities and stockholders' equity

$

4,559,019 

 

$

4,666,146 

 

*See accompanying Notes to Consolidated Financial Statements.***

 

**-30-**

 

 

 

**KANSAS CITY LIFE INSURANCE COMPANY**

**CONSOLIDATED STATEMENTS OF INCOME**

(amounts in thousands, except share data)

 

 

 

 

 

 

Year Ended December 31

 

 

 

 

2005

 

2004

 

2003

**REVENUES**

 

 

 

 

 

 

 

 

Insurance revenues:

 

 

 

 

 

 

 

 

 

Premiums

$                

179,891 

 

$                

188,881 

 

$                

211,468 

 

Contract charges

 

114,745 

 

 

115,710 

 

 

110,006 

 

Reinsurance ceded

 

(55,597)

 

 

(54,490)

 

 

(48,830)

 

 

 

Total insurance revenues

 

239,039 

 

 

250,101 

 

 

272,644 

Investment revenues:

 

 

 

 

 

 

 

 

 

Net investment income

 

194,608 

 

 

197,975 

 

 

194,763 

 

Realized investment gains (losses)

 

6,113 

 

 

45,929 

 

 

(29,280)

Other revenues

 

10,312 

 

 

8,468 

 

 

9,387 

 

 

 

Total revenues

 

450,072 

 

 

502,473 

 

 

447,514 

 

 

 

 

 

 

 

 

 

 

 

 

**BENEFITS AND EXPENSES**

 

 

 

 

 

 

 

 

Policyholder benefits

 

176,209 

 

 

185,155 

 

 

207,914 

Interest credited to policyholder account balances

 

92,121 

 

 

96,497 

 

 

92,278 

Amortization of deferred acquisition costs 

 

 

 

 

 

 

 

 

 

and value of business acquired

 

42,429 

 

 

43,477 

 

 

40,424 

Operating expenses

 

89,688 

 

 

95,661 

 

 

97,667 

 

 

 

Total benefits and expenses

 

400,447 

 

 

420,790 

 

 

438,283 

 

 

 

 

 

 

 

 

 

 

 

 

Income before income tax expense (benefit)

 

49,625 

 

 

81,683 

 

 

9,231 

 **

 **

 

 

 

 

 

 

 

 

 

 

Income tax expense (benefit)

 

13,441 

 

 

23,996 

 

 

(5,562)

 **

 **

 

 

 

 

 

 

 

 

 

 

**NET INCOME**

$

36,184 

 

$

57,687 

 

$

14,793 

 **

 **

 

 

 

 

 

 

 

 

 

 

Basic and diluted earnings per share:

 

 

 

 

 

 

 

 

 

Net income

$

3.03 

 

$

4.83 

 

$

1.24 

 

 

*See accompanying Notes to Consolidated Financial Statements.***

 

 

 

 

 

**-31-**

 

 

 

 

**KANSAS CITY LIFE INSURANCE COMPANY**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY**

(amounts in thousands, except share data)

 

 

 

 

 

Year Ended December 31

 

 

 

2005

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

**COMMON STOCK,** beginning and end of year

$

23,121 

 

$

23,121 

 

$

23,121 

 

 

 

 

 

 

 

 

 

 

 

**ADDITIONAL PAID IN CAPITAL**

 

 

 

 

 

 

 

 

Beginning of year

 

24,279 

 

 

23,310 

 

 

22,605 

Excess of proceeds over cost of treasury stock sold

 

784 

 

 

969 

 

 

705 

 

 

 

 

 

 

 

 

 

 

 

 

End of year

 

25,063 

 

 

24,279 

 

 

23,310 

 

 

 

 

 

 

 

 

 

 

 

**RETAINED EARNINGS**

 

 

 

 

 

 

 

 

Beginning of year

 

733,499 

 

 

688,800 

 

 

686,847 

Net income

 

36,184 

 

 

57,687 

 

 

14,793 

Stockholder dividends of $1.08 per share 

 

 

 

 

 

 

 

 

 

(2004 - $1.08; 2003 - $1.08)

 

(12,876)

 

 

(12,988)

 

 

(12,840)

 

 

 

 

 

 

 

 

 

 

 

 

End of year

 

756,807 

 

 

733,499 

 

 

688,800 

 

 

 

 

 

 

 

 

 

 

 

**ACCUMULATED OTHER COMPREHENSIVE**

 

 

 

 

 

 

 

 

 

**INCOME (LOSS)**

 

 

 

 

 

 

 

 

Beginning of year

 

26,231 

 

 

23,418 

 

 

(24,437)

Other comprehensive income (loss)

 

(34,637)

 

 

2,813 

 

 

47,855 

 

 

 

 

 

 

 

 

 

 

 

 

End of year

 

(8,406)

 

 

26,231 

 

 

23,418 

 

 

 

 

 

 

 

 

 

 

 

**TREASURY STOCK**, at cost

 

 

 

 

 

 

 

 

Beginning of year

 

(114,234)

 

 

(114,211)

 

 

(110,639)

Cost of 50,689 shares acquired

 

 

 

 

 

 

 

 

 

(2004 - 12,227 shares; 2003 - 96,472 shares)

 

(2,458)

 

 

(506)

 

 

(3,925)

Cost of 22,930 shares sold

 

 

 

 

 

 

 

 

 

(2004 - 34,027 shares; 2003 - 24,882 shares)

 

326 

 

 

483 

 

 

353 

 

 

 

 

 

 

 

 

 

 

 

 

End of year

 

(116,366)

 

 

(114,234)

 

 

(114,211)

 

 

 

 

 

 

 

 

 

 

 

**TOTAL STOCKHOLDERS' EQUITY**

$

680,219 

 

$

692,896 

 

$

644,438 

 

 

*See accompanying Notes to Consolidated Financial Statements.***

 

 

 

**-32-**

 

 

**KANSAS CITY LIFE INSURANCE COMPANY**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(amounts in thousands)

 

 

 

 

 

 

Year Ended December 31

 

 

 

 

2005

 

2004

 

2003

**OPERATING ACTIVITIES**

 

 

 

 

 

 

 

 

Net income

$

36,184 

 

$

57,687 

 

$

14,793 

Adjustments to reconcile net income to 

 

 

 

 

 

 

 

 

 

net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

 

Amortization of investment premium (discount)

 

10,493 

 

 

13,387 

 

 

4,287 

 

 

Depreciation

 

4,289 

 

 

5,175 

 

 

12,949 

 

 

Acquisition costs capitalized

 

(28,092)

 

 

(29,006)

 

 

(31,903)

 

 

Amortization of deferred acquisition costs

 

35,608 

 

 

36,080 

 

 

33,431 

 

 

Amortization of value of business acquired

 

6,821 

 

 

7,397 

 

 

6,993 

 

 

Realized investment (gains) losses

 

(6,113)

 

 

(45,929)

 

 

29,280 

 

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

Future policy benefits

 

(3,470)

 

 

1,345 

 

 

18,086 

 

 

 

Policyholder account balances

 

(19,263)

 

 

(3,342)

 

 

32,335 

 

 

 

Income taxes payable and deferred

 

5,064 

 

 

16,124 

 

 

(17,237)

 

 

Other, net

 

8,529 

 

 

(23,185)

 

 

(8,867)

 

 

Net cash provided

 

50,050 

 

 

35,733 

 

 

94,147 

 

 

 

 

 

 

 

 

 

 

 

 

**INVESTING ACTIVITIES**

 

 

 

 

 

 

 

 

Purchases of investments:

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

(548,979)

 

 

(726,948)

 

 

(1,251,481)

 

Equity securities

 

(5,690)

 

 

(6,957)

 

 

(4,279)

 

Mortgage loans

 

(109,561)

 

 

(72,265)

 

 

(149,344)

 

Real estate

 

(17,725)

 

 

(8,287)

 

 

(41,329)

 

Other investment assets

 

(98)

 

 

(1,179)

 

 

- 

Sales of investments:

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

175,317 

 

 

159,095 

 

 

188,849 

 

Equity securities

 

6,296 

 

 

4,730 

 

 

17,036 

 

Real estate

 

33,267 

 

 

72,092 

 

 

20,226 

 

Other investment assets

 

29,055 

 

 

9,717 

 

 

123,027 

Maturities and principal paydowns of investments:

 

 

 

 

 

 

 

 

 

Fixed maturity securities

 

394,366 

 

 

421,974 

 

 

725,589 

 

Equity securities

 

9,026 

 

 

2,765 

 

 

8,771 

 

Mortgage loans

 

82,414 

 

 

98,689 

 

 

158,195 

Net additions to property and equipment 

 

(1,061)

 

 

(1,686)

 

 

(969)

Insurance business acquired

 

- 

 

 

- 

 

 

(52,264)

 

 

Net cash provided (used)

 

46,627 

 

 

(48,260)

 

 

(257,973)

 

 

 

 

 

 

 

 

 

 

 

 

**FINANCING ACTIVITIES**

 

 

 

 

 

 

 

 

Proceeds from borrowings

 

45,315 

 

 

13,575 

 

 

35,061 

Repayment of borrowings

 

(110,252)

 

 

(55,025)

 

 

(634)

Deposits on policyholder account balances

 

242,613 

 

 

271,133 

 

 

338,089 

Withdrawals from policyholder account balances

 

(245,927)

 

 

(205,749)

 

 

(180,801)

Net transfers to separate accounts

 

5,213 

 

 

(12,009)

 

 

(9,427)

Change in other deposits

 

(12,577)

 

 

(3,239)

 

 

2,629 

Cash dividends to stockholders

 

(12,876)

 

 

(12,988)

 

 

(12,840)

Net disposition (acquisition) of treasury stock

 

(1,348)

 

 

946 

 

 

(2,867)

 

 

Net cash provided (used)

 

(89,839)

 

 

(3,356)

 

 

169,210 

 

 

 

 

 

 

 

 

 

 

 

 

Increase (decrease) in cash

 

6,838 

 

 

(15,883)

 

 

5,384 

Cash at beginning of year

 

4,147 

 

 

20,029 

 

 

14,645 

 

 

 

 

 

 

 

 

 

 

 

 

Cash at end of year

$

10,985 

 

$

4,146 

 

$

20,029 

 

*See accompanying Notes to Consolidated Financial Statements.***

 

**-33-**

 

 

 

**KANSAS CITY LIFE INSURANCE COMPANY**** |
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