Our international life business continued to grow at a double-digit pace. New annualized submitted premiums from the international market increased by more than 17% during 2004 compared to 2003. The development of new markets in the Pacific Rim and the expansion of existing markets in Latin America contributed to the growth in international revenues.
The development of a United States marketing operation continued during the year. Marketing was active in Missouri, Illinois, Texas and Oklahoma during 2004, and the addition of SPLIC in October 2004 brings an established presence in Louisiana with an experienced core of home service marketing representatives.
Management believes that the marketing activities of SPLIC can be expanded beyond its current levels.
Additionally, during 2004 we successfully completed a $12.5 million private placement of convertible preferred stock to a group of four institutional investors. The offering can be increased to $25 million under certain conditions. The preferred stock carries a 4% dividend and is mandatorily redeemable in five years if not converted prior to the redemption date. The dividends and redemptions are payable in shares of the Company’s Class A common stock. Management believes that this placement marks a significant step in the Company’s evolution as it brings institutional investors into the Company.
The Company operates in four primary segments-international life insurance, U.S. life insurance operations, U.S. accident and health operations and, with the acquisition of SPLIC and SPFIC, U.S. home service insurance operations. Prior to 2004, another segment-U.S. accident and health operations-existed, but that segment was exited in 2004 with the transfer of virtually all of such business to a third party carrier through a coinsurance arrangement.
The acceptance of applications for U.S. dollar denominated ordinary whole life insurance from high net worth foreign nationals is the foundation upon which the Company was built. For the past 35 years, we have participated in the foreign marketplace. Positive attributes of the foreign insurance market include:
• policies are typically larger face amounts than in the U.S.;
• the mortality is as good as or better than that experienced in the U.S.;
Beginning in 2002, expansion began into the Pacific Rim, particularly Taiwan. CICA has established relationships with a number of marketing organizations in the Pacific Rim, and during 2004, received approximately $2.4 million of annualized new submitted premium from that region. Additionally, Brazil, which has never been a country from which large volumes of premiums were received, began to develop adding $650,000 of new premiums. Overall, submitted annualized premiums for 2004 from the international markets totaled $16.7 million, compared to $13.5 million in 2003 and $13.2 million in 2002.
Management is pleased with the continued growth and expansion of the Company’s international production, particularly in light of the significant financial problems experienced by several South American countries in recent years. Argentina and Venezuela, in particular, experienced severe economic declines. These two countries represented more than 18% of the premium income of the Company in 2003. Argentina was historically a large source of new business for CICA, particularly as a new middle class emerged in that country’s society. During the late 1980’s, CICA (which had historically only focused on the upper income groups) began offering a plan in Argentina that was designed for this group that was popularly received. When the economic crises occurred, the middle class was severely impacted and CICA experienced a decrease in new business and an increase in lapsation from that market. Since that time, management has refocused its Argentine marketing organization on the high net worth individuals that have historically been the core group of insureds. During 2003 and 2004 surrenders declined. In 2004, production from that area amounted to more than $1.1 million and management has successfully motivated numerous marketers who had ceased production to return to recruiting new marketing representatives and writing applications. We are optimistic that as the economy improves, the volume of new business written in Argentina should increase to previous levels.
Total premium income from the international market amounted to $59.2 million in 2004, compared to $51.9 million in 2003 and $48.6 million in 2002. (See Note 11 of the “Notes to Consolidated Financial Statements” for an analysis of the results of the International Life segment.)
The Company’s focus historically has been on the international market because of the key advantages described above. However, throughout the Company’s history, it has always written U.S. business and through the acquisition of other U.S. life insurers, accumulated more than $13.6 million of annual U.S. life insurance premium in 2004 (excluding home service).
Additionally, the Company has a block of credit life and disability business written through furniture stores in Texas, Louisiana and Arkansas. This business is typically single premium and amounted to $1.1 million in 2004 and $851,000 in 2003. Total U.S. life premium income for 2004 (excluding home service) amounted to $13.6 million, compared to $11.2 million in 2003 and $6.2 million in 2002. Management intends to broaden the portfolio of U.S. products to include the same products as are offered to overseas clients.
The acquisition of SPLIC and SPFIC created a new segment for the Company. SPLIC has focused on writing ordinary whole life insurance utilizing the home service marketing distribution method, whereby employee/agents working “routes” make regular collections of premiums from clients. SPFIC also uses the home service method to write small fire policies on Louisiana residents. This marketing method dates back to the creation of the life insurance industry in the United States and SPLIC utilizes approximately 390 agents (307 of whom also represent SPFIC) to write and collect premiums. Because SPLIC and SPFIC were acquired on October 1, 2004, only the fourth quarter of their activities are included in 2004 results from operations.
halt the shrinkage in the premium income and serve as a base from which to expand the home service or debit business. SPLIC is made up of books of business from more than 100 small life insurance carriers that it had acquired during its history. For the last quarter of 2004, Home Service premium revenues amounted to $9.6 million, of which $8.5 million was life and $1.1 million was casualty.
We have historically maintained a small block of U.S. accident and health business, primarily through acquisitions in the mid-1990’s that brought other books of accident and health business, including some major medical business. However, the acquisition of CNLIC in 2002 substantially increased both the amount of accident and health business in force, as well as the volume of new business. Most of the accident and health business we acquired was unprofitable when we acquired it. Significant rate increases coupled with the non-renewal of the major medical business, would improve the performance of these acquired blocks over time.
amortization of cost of customer relationships acquired and other intangible assets acquired in the FAIC acquisition, combined with losses on the accident and health business, caused the earnings decrease.
Net investment income increased 18.7% to $17,005,000 from $14,322,000 in 2003 and $14,252,000 in 2002. The increase reflects the acquisition of SPLIC and SPFIC in October 2004. SPLIC and SPFIC contributed $2,875,000 to 2004 investment results, in the form of additional interest on bonds. The remaining companies’ investment income declined slightly during 2004 as a result of lower available interest rates and the sale of a significant amount of bonds during the third quarter to fund the acquisition of SPLIC and to provide the funds to transfer the accident and health business. During the second and third quarters of 2004, approximately $50 million of bonds were sold or matured to provide cash for the SPLIC acquisition. In addition, approximately $10 million of bonds were sold or matured so that cash in an amount equal to the accident and health reserves and claims payable could be transferred under the coinsurance agreement.
Due to the cession of the majority of the accident and health business, CICA experienced a minimal change in accident and health reserves for 2004. The change in future policy benefit reserves increased from $6,052,000 in 2002 to $7,904,000 in 2003. CICA’s life reserves increased $10.6 million in 2003, which offset decreases in accident and health reserves. This was due to an increase in persistency on the Company’s overseas business. These persistency improvements have led to an increase in policy reserves at an accelerated rate compared to the past. CICA’s accident and health reserves decreased
SPLIC’s reserves increased $233,000 between its October 1, 2004 acquisition and year-end.
CNLIC’s life reserves increased approximately $199,000 in 2004, compared to a decrease of approximately $258,000 in 2003, due primarily to sales of newly developed whole life products that carry increased reserves contrasted with the existing life business that was in force at the acquisition date. Due to the cession of all of its accident and health business, CNLIC had no change in associated reserves for 2004. In 2003, accident and health policy reserves for CNLIC decreased by approximately $3.0 million. The non-renewal of the major medical block of business accounted for $1.3 million of the decrease. In addition, CNLIC experienced high lapsation on new accident and health policies issued during 2003. Including the policies terminated from the non-renewal of the major medical business, the policy count for CNLIC accident and health policies decreased by approximately 33% during 2003 compared to 2002, resulting in associated policy reserves decreasing by approximately $1.7 million.
As noted in the table below, claims and surrenders decreased 8.9% from $40,445,000 for 2003 to $36,831,000 for 2004. The 2004 decrease primarily related to the cession of most of our accident and health business as discussed above, which offset the inclusion of SPLIC’s results for the fourth quarter of the year.
Endowment benefits increased 17.0% from $6,416,000 in 2003 to $7,509,000 in 2004. Endowments totaled $5,730,000 in 2002. CICA has a series of international policies that carry an immediate endowment benefit of an amount elected by the policyowner. This endowment is factored into the premium of the policy and is paid annually. Like policy dividends, endowments are factored into the premium and as such the increase should have no adverse impact on profitability.
Policy surrenders increased 2.3% from $17,986,000 in 2003 to $18,406,000 in 2004. The 2003 results represented a 7.2% increase over 2002 when surrenders amounted to $16,777,000. The 2004 increase was primarily due to the acquisitions of FAIC and MACLIC, discussed above, which generated $3,427,000 in additional surrenders, plus the inclusion of SPLIC which added $432,000. FAIC has experienced significantly higher surrender activity since its acquisition in 2003 due to the actions of former marketing associates placing numerous policies with other companies (see Table III). FAIC filed legal action against the individual primarily responsible for such replacements in the fourth quarter of 2004 and saw a sharp drop in replacement activity. The 2003 increase was directly related to the acquisitions of FAIC and MACLIC, discussed above, which generated $2,669,000 in surrenders. Surrenders for CICA declined 5.4% in 2003. The uncertain economic climate in several Latin American countries was the primary reason for the increased 2002 surrender activity. The economies in Argentina and Venezuela in particular were in near-depression during 2002. However, management is optimistic about the long-term prospects for these countries.
During 2004, commissions increased 16.7% to $21,274,000 from $18,228,000 in 2003 primarily due to the increase in the production of new life premiums during 2004 discussed above. Accident and health commissions on the business that was ceded in 2004 were approximately $2,608,000. In addition, the acquisitions of FAIC and MACLIC contributed an additional $1,324,000 of commissions to the 2004 increase, while SPLIC’s commissions during the fourth quarter of 2004 were $2,211,000. During 2003, commissions increased 11.6% to $18,228,000 from $16,339,000 in 2002. The 2003 increase was attributable to the acquisition of FAIC and MACLIC, whose 2003 commissions were $1,064,000. The
remainder of the 2003 increase was due to the 5.7% increase in production of new life insurance premiums.
Capitalized deferred policy acquisition costs increased 4.1% from $16,558,000 in 2003 to $17,241,000 in 2004 primarily due to the increase in new life production discussed above. These costs were $14,423,000 in 2002. Amortization of these costs was $8,438,000, $11,807,000, and $10,039,000 in 2004, 2003 and 2002, respectively. With most of the accident and health business ceded effective January 1, 2004, amortization of these costs was minimal in 2004. The 2003 increase related to the 5.7% increase in new life production. The 2002 increase included $1,518,000 of deferred policy acquisition costs that have been capitalized by CNLIC. The remainder of the increase related to the increase in new life production. Most of the 2002 increase related to the increased surrender activity caused by the uncertain economic climate in several Latin American countries.
For 2004, the Company’s expected tax rate increased to 33.9% from the 28.4% effective tax rate of the comparable 2003 period due to the Company no longer being eligible for the small life insurance company deduction available under the Internal Revenue Code due to the October 1, 2004 acquisition of SPLIC discussed above. The Company’s policy is to make its best estimate of the effective tax rate it expects to be applicable for the full year in its provision for income taxes on an interim basis. The acquisition of SPLIC will result in the life insurance company assets of the Company’s life insurance controlled group exceeding $500 million, making it ineligible for the small life insurance company deduction going forward.
Liquidity requirements are met primarily by funds provided from operations. Premium deposits and revenues, investment income and investment maturities are the primary sources of funds while investment purchases, policy benefits, and operating expenses are the primary uses of funds. Although the Company historically has not had to liquidate invested assets to provide cash flow, its investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs.
that available liquidity sources and future cash flows to be adequate to meet the demand for funds.
Stockholders’ equity increased from $127,027,000 at December 31, 2003 to $135,131,000 at December 31, 2004 primarily due to income earned during the period and recognition of a $2,394,000 beneficial conversion feature, net of accretion, in excess of unrealized losses, net of tax, of $(2,021,000) for 2004. Decreases in the market value of our bond portfolio caused by lower bond prices resulted in the increase in unrealized losses since December 31, 2003.
Invested assets increased 72.9% to $475,802,000 at December 31, 2004 from $275,188,000 at December 31, 2003. The increase relates to the assets of SPLIC, acquired in 2004. The increase in cash on hand at December 31, 2004 ($31.7 million versus $15 million at December 31, 2003) resulted from the call of fixed maturities during December 2004. Fixed maturities are categorized into two classifications: fixed maturities held-to-maturity, which are valued at amortized cost, and fixed maturities available-for-sale, which are valued at fair value. Fixed maturities available-for-sale and fixed maturities held-to-maturity were 92.5% and 1.6%, respectively, of invested assets at December 31, 2004. Fixed maturities held to maturity, amounting to $7,514,000 at December 31, 2004, consist of corporate bonds which are backed by the implied full faith and credit of the U.S. government, U.S. Treasury and U.S. government agency securities. Management has the intent and believes we have the ability to hold the held-to-maturity securities to maturity.
During 2004, fixed maturities available for sale grew to $440,053,000 from $237,506,000 at December 31, 2003. Included in this growth were more than $31 million of bonds issued by states and approximately $113 million of corporate bonds. The overall growth, as well as the change in mix, is directly related to the acquisition of SPLIC and SPFIC during 2004. During 2004, we disposed of approximately $50 million in bonds to finance the purchase of SPLIC and the reserve transfer on the TILIC reinsurance transaction.
Our cash balances at our primary depositories were significantly in excess of Federal Deposit Insurance Corporation coverage at December 31, 2004 and December 31, 2003. Management monitors the solvency of all financial institutions in which we have funds to minimize the exposure for loss. Management does not believe we are at significant risk for such a loss. During 2005, we intend to utilize high-grade commercial paper as a cash management tool to minimize excess cash balances and enhance returns. During 2003, the Company transferred its primary banking relationship from JP Morgan Chase to Regions Bank.
We do not utilize special purpose entities as investment vehicles. Nor do we invest in any such entities that engage in speculative activities of any description, and we do not use such investments to hedge our investment positions.
On July 12, 2004, the Company completed a private placement of $12.5 million of Series A-1 Senior Convertible Preferred Stock to four unaffiliated institutional investors. The terms and conditions of the Series A-1 Senior Convertible Preferred Stock are discussed in Note 8 to our consolidated financial statements. The initial recognition of the beneficial conversion feature and discounts on fair values of options and warrants issued in connection with the private placement resulted in $3,073,000 of additional paid-in capital for the Class A common stock and $2,994,000 of liabilities for options and warrants. Changes in the fair value of options and warrants are recognized in the statement of operations with a corresponding change in the liabilities for options and warrants. For the period ended December 31, 2004, there was a decrease in fair value of options and warrants of $256,000 and corresponding decrease in the related liabilities.
The Company signed a revolving line of credit agreement from Regions Bank for a $30 million credit facility for use in acquisitions in March 2004. On October 1, 2004, the Company entered into a Second Amendment to the Loan Agreement that converted into a term loan its $30 million advance against the line of credit made in connection with the acquisition of SPLIC. Under the term loan, the Company is obligated to repay the principal portion of the loan in ten semi-annual installments of $3,000,000 beginning on May 1, 2005, with the final installment of principal and any accrued and unpaid interest on November 1, 2009. Interest on the unpaid principal balance of the loan is required to be paid on the fifth day of each month following the end of each fiscal quarter of the Company. The interest rate is equal to a 30-day LIBOR (London InterBank Offered Rate) plus 1.8% per year (approximately 4.3% annually as of December 31, 2004).
In connection with the SPLIC acquisition, funds borrowed by the Company were re-loaned to CICA. CICA has issued to the Company a Subordinated Debenture in the principal amount of $30 million plus interest equal to 30-day LIBOR plus 1.8% per year. Because CICA is an insurance company formed under the laws of Colorado, any principal and accrued interest on the subordinated debenture is not a legal liability of CICA until repayment of interest or principal has received the prior written approval of the Commissioner of Insurance for the State of Colorado. CICA has filed with the Commissioner of Insurance requesting permission to retire the debenture in full.
Additionally, the Act imposes a duty upon public companies to document and test all internal controls and have such controls audited by independent auditors.
The payments related to the future policy benefits and claim liabilities reflected in the table above have been projected utilizing assumptions based upon the Company’s historical experience and anticipated future experience.
We continue to use the original assumptions (including a provision for the risk of adverse deviation) in subsequent periods to determine the changes in the liability for future policy benefits (the “lock-in concept”) unless a premium deficiency exists. Management monitors these assumptions and has determined that a premium deficiency does not exist. Management believes that our policy liabilities and increase in future policy benefit reserves as of and for the years ended December 31, 2004, 2003 and 2002 are based upon assumptions, including a provision for the risk of adverse deviation, that do not warrant revision. The relative stability of these assumptions and management’s analysis is discussed below.
In Table II in Item 1, the ratio of lapses and surrenders to mean life insurance in force has varied between 4.9% and 8.2% over the past five years. The year 2003 was adversely impacted by the acquisition of FAIC. The 2002 ratio of 7.3% relates to surrenders caused by adverse economic conditions in several Latin American countries. In addition, the 2003 ratio of 8.2% includes FAIC surrenders and lapses of approximately $32.2 million of life insurance in force (approximately 1.2% of the total). In 2004, the ratio improved to 7.2%, the lowest amount since 2001. Improved persistency on CICA’s international business was the primary reason for the improvement.
Table IV in Item 1 above, illustrates that during the past five years the ratio of commissions, underwriting and operating expenses to insurance premiums has ranged from 42.2% to 47.7% and the ratio of commissions, underwriting and operating expenses, policy reserves increases, policyholder benefits and dividends to policyholders to insurance premiums has ranged from 114.7% to 119.2%. Table VIII also shows that the ratio of net investment income to mean amount of invested assets has varied from 4.5% to 6.8% from 2000 through 2004. The 2003 5.7% and 2004 4.5% represents the impact of the low interest environment and the liquidation of bonds to fund the acquisition of SPLIC. Additionally, the 4.5% is negatively impacted by the October acquisition of SPLIC. As set forth above in Management’s Discussion and Analysis of Financial Condition and Results of Operations, death benefits for the years ended December 31, 2004, 2003 and 2002
were $10,224,000, $6,399,000 and $6,600,000, respectively. The acquisition of SPLIC increased 2004 benefits by $3,688,000, while $712,000 of the 2002 increase in death benefits related to the acquisitions of CNLIC and $320,000 of the 2003 increase in death benefits related to the acquisitions of FAIC and MACLIC.
A recoverability test that considers among other things, actual experience and projected future experience, is performed at least annually by third party actuarial consultants. These annual recoverability tests initially calculate the available premium (gross premium less benefit net premium less percent of premium expense) for the next 30 years. The available premium per policy and the deferred policy acquisition costs per policy are then calculated. The deferred policy acquisition costs are then amortized over two methods utilizing reasonable assumptions and two other methods using pessimistic assumptions. The two methods using reasonable assumptions illustrate an early-deferred policy acquisition recoverability period. The two methods utilizing pessimistic assumptions still support early recoverability of our aggregate deferred policy acquisition costs. Based upon the analysis performed to only capitalize expenses that vary with and are directly related to the acquisition of new and renewal
insurance business, utilization of the factor method and annual recoverability testing, management believes that our deferred policy acquisition costs and related amortization as of and for the years ended December 31, 2004, 2003 and 2002 limits the amount of deferred costs to its estimated realizable value.
At December 31, 2004, investments in fixed maturity and equity securities were 94.1% and 0.2%, respectively, of total investments. Approximately 98.3% of our fixed maturities were classified as available-for-sale securities at December 31, 2004, with the remaining 1.7% classified as held-to-maturity securities based upon our intent and ability to hold these securities to maturity. All equity securities at December 31, 2004 are classified as available-for-sale securities. We have no fixed maturity or equity securities that are classified as trading securities at December 31, 2004.
Additionally, at December 31, 2004, 70.8% of our fixed maturity securities were invested in corporations backed by the implied full faith and credit of the U.S. government, U.S. Treasury securities and obligations of U.S. government corporations and agencies, including U.S. government guaranteed mortgage-backed securities. All of these securities are backed by or bear the implied full faith and credit of the U.S. government. We evaluate the carrying value of our fixed maturity and equity securities at least quarterly. A decline in the fair value of any fixed maturity or equity security below cost that is deemed other than temporary is charged to earnings resulting in the establishment of a new cost basis for the security. The new cost basis is not changed for subsequent recoveries in the fair value of the fixed maturity or equity security. With the exception of SPLIC, virtually all subsidiaries’ investments are in corporate bonds that carry the implied full faith and credit of the U.S. government, Treasuries or agencies of the U.S. government. SPLIC has significant investments in corporate and municipality bonds. Based upon our emphasis on investing in fixed maturity securities primarily composed of obligations of U.S. government sponsored corporation, U.S. Treasury securities and obligations of the U.S. government and agencies, including U.S. government guaranteed mortgage-backed securities and callable instruments issued by U.S. government agencies and our analysis whether declines in fair value below cost are temporary or other than temporary, management believes that our investments in fixed maturity and equity securities at December 31, 2004 are not impaired, and no “other than temporary losses” need to be recorded.
Gross unrealized losses on fixed maturities available-for-sale amounted to $3,857,000 as of December 2004 and $2,553,000 as of December 2003. Of this 2004 total gross unrealized loss, $2,018,000 have been in a continuous loss situation for more than 12 months and $1,839,000 have been in a continuous loss situation for less than 12 months.
The fixed maturities available-for-sale in a gross unrealized loss situation for more than 12 months are primarily investments in callable instruments issued by corporations backed by the implied full faith and credit of the U.S. government and U.S. government agencies. It is remote that unrealized losses on these instruments will result in realized losses, since the Company has the intent and believes it has the ability to hold these securities to the call date or maturity date.
The majority of the fixed maturities available-for-sale that have been in a continuous loss situation for less than 12 months are from investments owned by SPLIC. The losses are due to the coupon interest rate being less than the prevailing market interest rates at December 31, 2004. The Company has determined that there is no need to establish a new cost basis for these securities.
On January 1, 2002, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 142, “Goodwill and Other Intangible Assets.” Under the guidelines of SFAS No. 142, excess of cost over net assets acquired (goodwill) amounting to $12,402,000 and $12,939,000 and other intangible assets amounting to $2,331,000 and $3,086,000 as of December 31, 2004, and December 31, 2003, respectively, were determined to have an indefinite useful life and will no longer be amortized. Instead goodwill and other intangible assets will be subjected to annual impairment analyses under the provisions of SFAS No. 142 and SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” respectively.
In October 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 superseded and amended SFAS No. 121 and relevant portions of SFAS No. 30. SFAS No. 144 was adopted on January 1, 2002. SFAS No. 144 did not have a material effect on the financial position, results of operation or liquidity of the Company.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equities.” This statement established standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument within its scope as a liability (or an asset in some circumstances). Many of the instruments within the scope of SFAS No. 150 were previously classified as equity. Based on current operations, the Company does not anticipate that SFAS No. 150 will have a material effect on the financial position, results of operations or liquidity of the Company.
address the accounting for employee share ownership plans, which are subject to AICPA Statement of Position 93-6, “Employers’ Accounting for Employee Stock Ownership Plans.” SFAS 123 as amended is effective for interim reporting periods beginning after June 30, 2005. The Company does not anticipate the revision of SFAS No. 123 will have a material effect on the financial position, results of operations or liquidity of the Company.
In July 2003, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts. This statement provides guidance on separate account presentation and valuation, the accounting for sales inducements and the classification and valuation of long-duration contract liabilities. The Company adopted this statement on January 1, 2004. The adoption of SOP 03-1 did not have a material effect on the financial position, results of operations or liquidity of the Company.
Consolidated statements of operations - years ended December 31, 2004, 2003 and 2002