Property owned Amount % of Total Home Office $ 2,029,272 10%
Total investment real estate holdings represent approximately 6% of the total assets of the Company net of accumulated depreciation of $460,170 and $169,281 at year-end 2002 and 2001 respectively. The Company owns an office complex in Springfield, Illinois, which houses the primary insurance operations. The office buildings in this complex contain 57,000 square feet of office and warehouse space, and are carried at $2,029,272. Currently, the facilities occupied by the Company are adequate relative to the Company's present operations.
Premiums and policy fee revenues, net of reinsurance premiums and policy fees, decreased 7% when comparing 2002 to 2001 and 11% from 2001 to 2000. The Company currently writes little new business. A majority of the new business currently written is universal life insurance. Collected premiums on universal life and interest sensitive products is not reflected in premiums and policy revenues because accounting principles generally accepted in the United States of America require that premiums collected on these types of products be treated as deposit liabilities rather than revenue. Unless the Company acquires a block of in-force business or marketing significantly increases on traditional business, management expects premium revenue to continue to decline at a rate consistent with prior experience. The Companies' average persistency rate for all policies in force for 2002, 2001 and 2000 was approximately 93.6%, 91.6%, and 89.8%, respectively. Persistency is a measure of insurance in force retained in relation to the previous year.
During 2001, the Company implemented a conservation effort, which is still in place, in an attempt to improve the persistency rate of Company policies. Several of the customer service representatives of the Company have become licensed insurance agents, allowing them to offer other products within the Company's portfolio to existing customers. Additionally, stronger efforts have been made in policy retention through more personal contact with the customer including telephone calls to discuss alternatives and reasons for a customer's request to surrender their policy. Previously, the Company's agency force was primarily responsible for conservation efforts. With the decline in the number of agents, their ability to reach these customers diminished, making conservation efforts difficult. The conservation efforts described above are relatively new, but early results are generally positive. Management will continue to monitor these efforts and make adjustments as seen appropriate to enhance the future success of the program. The Company is currently implementing a new product referred to as "the Legacy" to be specifically used by the licensed customer service representatives as an alternative for the customer in the conservation efforts. The new product has been developed but has yet to be marketed as of December 31, 2002. The Company hopes to start marketing the product by the end of the first quarter of 2003.
The Company has considered the feasibility of a marketing opportunity with First Southern National Bank ("FSNB") an affiliate of UTG's largest shareholder, Chariman and CEO, Jesse T. Correll. Management has considered various products including annuity type products, mortgage protection products and existing insurance products, as potential products that could be marketed to banking customers. This marketing opportunity has potential and is believed to be a viable niche. The Company has recently designed the "Horizon" annuity product as well as the "Legacy" life product which are both to be used in marketing efforts by FSNB. The introduction of these new products is currently not expected to produce significant premium writings.
Net investment income decreased 11% when comparing 2002 to 2001 and decreased 6% when comparing 2001 to 2000. The national prime rate has declined from 9.5% at December 31, 2000 to 4.25% at December 31, 2002. This has resulted in lower earnings on short-term funds as well as on longer-term investments acquired. Should this economic climate continue, net investment income may continue to decline as the Company, along with others in the insurance industry, seeks adequate returns on investments, while staying within the conservative investment guidelines set forth by insurance regulators. Many insurance companies have suffered significant losses in their investment portfolios in the last couple of years, however, because of the Company's conservative investment philosophy the Company has so far avoided such significant losses. Management shortened the length of the Company's portfolio which hurt investment earnings in the short run, but the Company has not had to write off any losses in these turbulent economic times. During 2000, the Company received $632,000 in investment earnings from a joint venture real estate development project that was in its latter stages. The earnings from this activity represent approximately 4% of the 2000 investment income.
During the fourth quarter of 2000, Mr. Jesse T. Correll as Board Chairman, requested the resignation of James E. Melville as President of UTG and its subsidiaries. A special joint meeting of the Boards of Directors of United Trust Group, Inc. and its subsidiaries was held January 8, 2001, at which the termination of the employment agreement between First Commonwealth Corporation and James E. Melville, and the termination of James E. Melville as an officer or agent of United Trust Group, Inc. and all of its subsidiaries were approved by the Boards of Directors of each of the companies. An accrual of $562,000 was established through a charge to general expenses at year-end 2000 for the remaining payments required pursuant to the terms of Mr. Melville's employment contract and other settlement costs. A $500,000 accrual was also established at year-end 2000 for estimated legal costs associated with the defense of a legal matter. During the third quarter 2000, the Company settled a legal matter for $550,000 and incurred an additional $150,000 in legal fees. At the March 27, 2000 Board of Directors meeting, United Trust Group, Inc. and each of its affiliates accepted the resignation of Larry E. Ryherd as Chairman of the Board of Directors and Chief Executive Officer. Mr. Ryherd had 28 months remaining on an employment contract with the Company at the end of March 2000. As such, a charge of $933,000 was incurred in first quarter 2000 for the remainder of this contract. Exclusive of the above accruals, operating expenses declined 13% in 2001 compared to 2000.
The Company had a net income (loss) of $1,499,618, $2,439,573 and $(696,426) in 2002, 2001 and 2000 respectively. The decrease in net income in 2002 as compared to 2001 is primarily related to lower investment income returns and increased death claims. Significant one-time charges and accruals to operating expenses combined with an increase in death claims during 2000 as further described above were the primary differences in the 2001 to 2000 results. The Company continues to monitor and adjust those items within its control.
At December 31, 2002, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in the context of consolidated assets or shareholders' equity. The Company has identified securities it may sell and classified them as "investments held for sale". Investments held for sale are carried at market, with changes in market value charged directly to shareholders' equity. To provide additional flexibility and liquidity, the Company has categorized almost all fixed maturity investments acquired in 2002 and 2001 as available for sale. It was determined it would be in the Company's best financial interest to classify these new purchases as available for sale to provide additional liquidity and flexibility.
The following table summarizes the Company's fixed maturities distribution at December 31, 2002 and 2001 by ratings category as issued by Standard and Poor's, a leading ratings analyst.
Fixed Maturities Rating % of Portfolio ---------------------- 2002 2001 ---------- ---------- Investment Grade AAA 65% 61% AA 3% 6% A 24% 24% BBB 6% 8% Below investment grade 2% 1% ---------- ---------- 100% 100% ========== ==========
In the past few years the Company has invested more of its funds in mortgage loans. This is the result of increased mortgage opportunities available through FSNB, an affiliate of Jesse Correll. Mr. Correll is the CEO and Chairman of the board of directors of UTG, and directly and indirectly through affiliates, its largest shareholder. FSNB has been able to provide the Company with additional expertise and experience in underwriting commercial and residential mortgage loans, which provide more attractive yields than the traditional bond market. During 2002, 2001 and 2000 the Company issued approximately $6,920,000, $4,535,000 and $21,863,000 respectively, in new mortgage loans. These new loans were originated through FSNB and funded by the Company through participation agreements with FSNB. FSNB services the loans covered by these participation agreements. The Company pays FSNB a .25% servicing fee on these loans and a one-time fee at loan origination of .50% of the original loan amount to cover costs incurred by FSNB relating to the processing and establishment of the loan. UG paid $70,140, $79,730 and $34,721 in servicing fees and $35,127, $22,626 and $91,392 in origination fees to FSNB during 2002, 2001 and 2000, respectively.
Total investment real estate holdings represent approximately 6% of the total assets of the Company, net of accumulated depreciation, at year-end 2002 and 2001 respectively. Total investment real estate is separated into two categories: Commercial 92% and Residential Development 8%.
Policy loans remained consistent for the periods presented. Industry experience for policy loans indicates that few policy loans are ever repaid by the policyholder, other than through termination of the policy. Policy loans are systematically reviewed to ensure that no individual policy loan exceeds the underlying cash value of the policy.
Notes payable decreased 32% in 2002 compared to 2001. At December 31, 2001, UTG had $4,400,670 in notes payable. During 2002, the Company repaid $1,405,395 of its debt through operating cashflows and dividends received from its subsidiary UG. At December 31, 2002, UTG had $2,995,275 in notes payable, all remaining debt is owed to two former officers and directors of the Company and their respective families as a result of an April 2001 stock purchase transaction. These notes bear interest at the fixed rate of 7% per annum (paid quarterly), with three remaining principal payments of $763,259 due annually. The next principal payment due date is in April of 2004. Management believes overall sources of liquidity available are more than adequate to service this debt. These sources include current cash balances of UTG, expected future operating cashflows and payment of dividends from the Company's life subsidiaries. The Company's long-term debt is discussed in more detail in Note 11 to the consolidated financial statements, which is incorporated herein by this reference.
On November 15, 2001, UTG was extended a $3,300,000 line of credit ("LOC") from the First National Bank of the Cumberlands ("FNBC") located in Livingston, Tennessee. The FNBC is owned by Millard V. Oakley, who is a director of UTG. The LOC was for a one-year term from the date of issue. Upon maturity the Company renewed the LOC for an additional one-year term. The interest rate on the LOC is variable and indexed to be the lowest of the U.S. prime rates as published in the Wall Street Journal, with any interest rate adjustments to be made monthly. At December 31, 2002, the Company had no outstanding borrowings attributable to this LOC. During 2002 the Company had total borrowings of $1,600,000 on this LOC, which were all repaid during the year. The draws on this LOC were used to facilitate the payments due to the former shareholders of FCC as a result of the June 12, 2002, merger of FCC with and into UTG, as further described in note 15 to the consolidated financial statements and incorporated herein by this reference.
The Company is currently evaluating its alternatives to converting its existing business to "ID3". Currently, the Company believes the conversion costs could range from $500,000 to $1,700,000. Alternatives include completing the conversion with the existing staff of the Company, to outsourcing the entire conversion to Fiserve LIS. Management expects to make a decision shortly.
The Company has been attempting to sell the Charter (state licenses) of APPL. To accommodate such a sale, APPL entered into a 100% coinsurance agreement effective October 1, 2002, whereby APPL ceded and UG assumed all policies in force of APPL as of the effective date of the agreement. The agreement was approved by the Ohio Department of Insurance pursuant to regulatory requirements. Under the coinsurance agreement, UG has primary responsibility for the policies, but APPL remains contingently liable for the policies. Currently, a sale of the Charter appears to be remote. As an alternative, a merger proposal is being considered whereby APPL would be merged with and into UG. A decision regarding the merger is likely to be approved at the Board meeting in March 2003.
As a result of the 100% coinsurance agreement, the ownership of ABE was transferred from APPL to UG, as part of the coinsurance asset transfer. Prior to the coinsurance transaction, in September 2002, the boards of ABE and UG approved the exploration of a merger transaction whereby ABE would be merged with and into UG. The UG and ABE Boards are expected to approve the merger transaction at the March 2003 meeting. The merger will require the approval of the insurance departments of the States of Ohio and Illinois prior to completion. The merger is expected to be completed in mid 2003.
On November 20, 1998, FSF and affiliates acquired 929,904 shares of common stock of UTG from UTG and certain UTG shareholders. As consideration for the shares, FSF paid UTG $10,999,995 and certain shareholders of UTG $999,990 in cash. Included in the stock acquisition agreement is an earnings covenant whereby UTG warrants UTG and its subsidiaries and affiliates will have future earnings of at least $30,000,000 for a five-year period beginning January 1, 1998. Such earnings are computed based on statutory results excluding inter-company activities such as inter-company dividends plus realized and unrealized gains and losses on real estate, mortgage loans and unaffiliated common stocks. At the end of the covenant period, an adjustment is to be made equal to the difference between the then market value and statutory carrying value of real estate still owned that existed at the beginning of the covenant period. Should UTG not meet the covenant requirements, any shortfall will first be reduced by the actual average tax rate for UTG for the period, then will be further reduced by one-half of the percentage, if any, representing UTG's ownership percentage of the insurance company subsidiaries. This result will then be reduced by $250,000. The remaining amount will be paid by UTG in the form of UTG common stock valued at $15.00 per share with a maximum number of shares to be issued of 500,000. However, there shall be no limit to the number of shares transferred to the extent that there are legal fees, settlements, damage payments or other losses as a result of certain legal action taken. The price and number of shares shall be adjusted for any applicable stock splits, stock dividends or other recapitalizations. For the five-year period starting January 1, 1998 and ending December 31, 2002, the Company had total earnings of $17,011,307 applicable to this covenant. Therefore, UTG did not meet the earnings requirements stipulated, and UTG believes it will be required to issue 500,000 additional shares to FSF or its assigns. Pursuant to the covenant, a final accounting and issuance of any shares due are to occur by April 30, 2003.
Currently, the Company's insurance subsidiaries are subject to government regulation in each of the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including the power to: (i) grant and revoke licenses to transact business; (ii) regulate and supervise trade practices and market conduct; (iii) establish guaranty associations; (iv) license agents; (v) approve policy forms; (vi) approve premium rates for some lines of business; (vii) establish reserve requirements; (viii) prescribe the form and content of required financial statements and reports; (ix) determine the reasonableness and adequacy of statutory capital and surplus; and (x) regulate the type and amount of permitted investments. Insurance regulation is concerned primarily with the protection of policyholders. The Company cannot predict the impact of any future proposals, regulations or market conduct investigations. The Company's insurance subsidiaries, UG and APPL, are domiciled in the state of Ohio, while ABE is domiciled in the state of Illinois.
At year-end 2002, UG had two ratios outside the normal range, and APPL had three ratios outside the normal range. All five ratios resulted from a 100% coinsurance agreement between UG and APPL, which became effective on October 1, 2002. Under the terms of the agreement, APPL ceded and UG assumed all policies in force of APPL as of the effective date of the agreement. The agreement was approved by the Ohio Department of Insurance.
A task force of the NAIC undertook a project to codify a comprehensive set of statutory insurance accounting rules and regulations. Project results were approved by the NAIC with an implementation date of January 1, 2001. Many states in which the Company does business implemented these new rules with the same effective date as proposed by the NAIC. The Company implemented these new regulations effective January 1, 2001 as required. Implementation of these new rules to date has not had a material financial impact on the insurance subsidiaries financial position or results of operations. The NAIC continues to modify and amend issue papers regarding codification. The Company will continue to monitor this issue as changes and new proposals are made.
On October 26, 2001, President Bush signed into law the "USA PATRIOT" Act of 2001 ("the Patriot Act"). This Law, enacted in response to the terrorist attacks of September 11, 2001, strengthens our Nation's ability to combat terrorism and prevent and detect money-laundering activities. Under Section 352 of the Patriot Act, financial institutions (definition includes insurance companies) are required to develop an anti-money laundering program. The practices and procedures implemented under the program should reflect the risks of money laundering given the entity's products, methods of distribution, contact with customers and forms of customer payment and deposits. In addition, Section 326 of the Patriot Act creates minimum standards for financial institutions regarding the identity of their customers in connection with the purchase of a policy or contract of insurance. Final regulations regarding the aforementioned Patriot Act, are to be issued by the Department of the Treasury sometime this spring. In anticipation of the final regulations, the Company has instituted an anti-money laundering program to comply with Section 352, and has communicated this program throughout the organization. The Company is currently working on a database program to facilitate compliance with Section 326. The Company will monitor the release of the final regulations and make any adjustments needed for continued compliance at that time.
On July 30, 2002, President Bush signed into law the "SARBANES-OXLEY" Act of 2002 ("the Act"). This Law, enacted in response to several high-profile business failures, was developed to provide meaningful reforms that protect the public interest and restore confidence in the reporting practices of publicly traded companies. The implications of the Act to public companies, (which includes UTG) are vast, widespread, and evolving. Many of the new requirements will not take effect or full effect until after calendar-year-end companies have completed their 2002 annual reports. The Company has implemented requirements affecting the current reporting period, and is continually monitoring, evaluating, and planning implementation of requirements that will need to be taken into account in future reporting periods.
Statement 146 was issued to address the accounting and reporting for costs associated with exit or disposal activities because entities increasingly are engaging in such activities and certain costs associated with those activities were recognized as liabilities at a plan (commitment) date that did not meet the definition of a liability as outlined in FASB Concepts Statement No. 6. Statement 146 improves financial reporting for cost associated with exit or disposal activities, by requiring that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The accounting for similar events and circumstances will be the same, thereby improving the comparability and representational faithfulness of reported financial information. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The adoption of Statement 146 did not affect the Company's financial position or results of operations, since the Company has had no such exit or disposal activities during the reporting period.
Statement 148 was issued to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2002. The adoption of Statement 148 will not affect the Company's financial position or results of operations, since the Company has no forms of stock-based employee compensation.
We have also audited Schedule I as of December 31, 2002, and Schedules II, IV and V as of December 31, 2002 and 2001, of UNITED TRUST GROUP, INC. and subsidiaries and Schedules II, IV and V for each of the three years in the period then ended. In our opinion, these schedules present fairly, in all material respects, the information required to be set forth therein.
UNITED TRUST GROUP, INC. CONSOLIDATED BALANCE SHEETS As of December 31, 2002 and 2001
Shareholders' equity: Common stock - no par value, stated value $.02 per share. Authorized 7,000,000 shares - 3,536,311 and 3,549,791 shares issued and outstanding after deducting treasury shares of 147,607 and 75,236 70,726 70,996 Additional paid-in capital 42,976,344 42,789,636 Retained earnings 2,503,856 1,004,238 Accumulated other comprehensive income 2,771,941 908,744 --------------- -------------- Total shareholders' equity 48,322,867 44,773,614 --------------- -------------- Total liabilities and shareholders' equity $ 318,902,970 $ 328,938,671 =============== ==============
Income (loss) before income taxes and minority interest 2,242,588 4,192,162 (707,069) Income tax expense (479,355) (1,181,133) (228,783) Minority interest in (income) loss of consolidated subsidiaries (263,615) (571,456) 239,426 --------------- ---------------- ----------------
Basic income (loss) per share from continuing operations and net income (loss) $ 0.43 $ 0.65 $ (0.17) =============== ================ ================
Diluted income (loss) per share from continuing operations and net income (loss) $ 0.37 $ 0.65 $ (0.17) =============== ================ ================
UNITED TRUST GROUP, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Three Years Ended December 31, 2002
UNITED TRUST GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Three Years Ended December 31, 2002
2002 2001 2000 -------------- ------------- -------------- Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net income (loss) $ 1,499,618 $ 2,439,573 $ (696,426) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities net of changes in assets and liabilities resulting from the sales and purchases of subsidiaries: Amortization/accretion of fixed maturities 513,308 150,579 152,917 Realized investment (gains) losses, net (13,634) (436,840) 260,078 Amortization of deferred policy acquisition costs 714,432 1,007,577 1,452,040 Amortization of cost of insurance acquired 1,515,450 1,572,920 1,592,812 Amortization of costs in excess of net assets purchased 0 90,000 90,000 Depreciation 571,037 436,216 505,221 Minority interest 263,615 571,456 (239,426) Charges for mortality and administration of universal life and annuity products (8,660,548) (9,344,711) (10,151,024) Interest credited to account balances 5,468,318 5,749,098 6,109,491 Policy acquisition costs deferred (69,000) (141,000) (273,000) Change in accrued investment income 550,020 479,176 (22,275) Change in reinsurance receivables 1,010,146 1,175,305 928,890 Change in policy liabilities and accruals (2,279,449) (2,721,245) (3,647,101) Change in income taxes payable 413,476 1,090,064 399,435 Change in other assets and liabilities, net (1,458,143) (753,121) 1,382,877 -------------- ------------- -------------- Net cash provided by (used in) operating activities 38,646 1,365,047 (2,155,491) -------------- ------------- --------------
Net increase (decrease) in cash and cash equivalents 8,573,137 412,272 (5,962,728) Cash and cash equivalents at beginning of year 15,477,348 15,065,076 21,027,804 -------------- ------------- -------------- Cash and cash equivalents at end of year $ 24,050,485 $ 15,477,348 $ 15,065,076 ============== ============= ==============
Real estate - investment real estate at cost less allowance for depreciation and, as appropriate, provisions for possible losses. Accumulated depreciation on investment real estate was $460,170 and $169,281 as of December 31, 2002 and 2001, respectively.
H. REINSURANCE - In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage and coinsurance contracts. The Company retains a maximum of $125,000 of coverage per individual life.
2002 2001 2000 -------------- --------------- -------------- Cost of insurance acquired, beginning of year $ 33,081,336 $ 34,654,256 $ 36,247,068 Interest accretion 4,570,678 4,777,576 5,032,790 Amortization (6,086,128) (6,350,496) (6,625,602) -------------- --------------- -------------- Net amortization (1,515,450) (1,572,920) (1,592,812) Revaluation adjustment from UTG/FCC merger (8,409,722) 0 0 -------------- --------------- -------------- Cost of insurance acquired, end of year $ 23,156,164 $ 33,081,336 $ 34,654,256 ============== =============== ==============
2002 2001 2000 -------------- --------------- -------------- Deferred, beginning of year $ 3,107,919 $ 3,948,496 $ 5,127,536
Acquisition costs deferred: Commissions 49,000 108,000 184,000 Other expenses 20,000 59,000 89,000 -------------- --------------- -------------- Total
N. PROPERTY AND EQUIPMENT - Company-occupied property, data processing equipment and furniture and office equipment are stated at cost less accumulated depreciation of $5,748,321 and $5,560,547 at December 31, 2002 and 2001, respectively. Depreciation is computed on a straight-line basis for financial reporting purposes using estimated useful lives of three to thirty years. Depreciation expense was $280,148, $316,900, and $372,313 for the years ended December 31, 2002, 2001, and 2000, respectively.
Q. TREASURY SHARES - The Company holds 147,607 and 75,236 shares of common stock as treasury shares with a cost basis of $1,193,690 and $673,437 at December 31, 2002 and 2001, respectively.
T. RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform to the 2002 presentation. Such reclassifications had no effect on previously reported net income or shareholders' equity.
At December 31, 2002, substantially all of consolidated shareholders' equity represents net assets of UTG's subsidiaries. The payment of cash dividends to shareholders by UTG is not legally restricted. However, the state insurance department regulates insurance company dividend payments where the company is domiciled. UG's dividend limitations are described below.
Ohio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 2002, UG had a statutory gain from operations of $2,062,744. At December 31, 2002, UG's statutory capital and surplus amounted to $16,030,200. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. UG paid ordinary dividends of $800,000 to the former FCC in 2002, and $1,400,000 to UTG in 2002.
The following table summarizes the companies with this situation and the maximum amount of income that has not been taxed in each.
Shareholders' Untaxed Company Surplus Balance ---------------------- ----------------- -------------- ABE $ 5,286,670 $ 1,149,693 APPL 6,452,554 1,525,367 UG 28,019,005 4,363,821
The life insurance company subsidiaries file a consolidated federal income tax return. The non-insurance companies of the group file separate returns.
The Companies have net operating loss carryforwards for federal income tax purposes expiring as follows:
UTG UG ------------- ------------- 2019 0 863,986 2021 177,037 0 ------------- ------------- TOTAL $ 177,037 $ 863,986 ============= =============
UTG has a net operating loss carryforward of $177,037 at December 31, 2002. UTG has averaged approximately $536,000 in taxable income over the past three years and must average taxable income of approximately $10,000 over the next 19 years to fully realize its net operating loss carryforward, as UTG's operating loss carryforward does not expire until the year 2021. UG has a net operating loss carryforward of $863,986 at December 31, 2002. UG must average taxable income of approximately $50,000 over the next 17 years to fully realize its net operating loss carryforward, as UG's operating loss carryforward does not expire until the year 2019. Management believes future earnings of both UTG and UG will be sufficient to fully utilize their respective net operating loss carryforwards. Therefore, management has established no allowance for potential uncollectibility of its loss carryforwards in the current year.
2002 2001 2000 ------------- ------------- -------------- Tax computed at statutory rate $ 784,906 $ 1,467,257 (247,474) Changes in taxes due to: Cost in excess of net assets purchased 0 31,500 31,500 Current year loss for which no benefit realized 0 0 546,231 Benefit of prior losses (309,710) (159,456) (139,061) Other 4,159 (158,168) 37,587 ------------- ------------- -------------- Income tax expense $ 479,355 $ 1,181,133 228,783 ============= ============= ==============
2002 2001 ---------------- --------------- Investments $ 2,883,414 $ 1,820,177 Cost of insurance acquired 9,328,616 12,835,481 Deferred policy acquisition costs 861,870 1,087,772 Management/consulting fees (321,086) (508,101) Future policy benefits (1,014,369) (1,531,687) Gain on sale of subsidiary 2,312,483 2,312,483 Net operating loss carryforward (364,358) (564,303) Other liabilities (130,594) (372,303) Federal tax DAC (1,316,916) (1,509,996) ---------------- --------------- Deferred tax liability $ 12,239,060 $ 13,569,523 ================ ===============
December 31, ------------------------------------------------------ 2002 2001 2000 -------------- --------------- --------------- Fixed maturities and fixed maturities held for sale $ 10,302,735 $ 10,831,162 $ 11,775,706 Equity securities 131,778 131,263 116,327 Mortgage loans 1,749,935 2,715,834 1,777,374 Real estate 730,501 488,168 611,494 Policy loans 965,227 970,142 997,381 Other long-term investments 0 0 655,418 Short-term investments 26,522 110,229 158,378 Cash 211,293 606,128 936,433 -------------- --------------- --------------- Total consolidated investment income 14,117,991 15,852,926 17,028,511 Investment expenses (771,167) (785,867) (942,678) -------------- --------------- --------------- Consolidated net investment income $ 13,346,824 $ 15,067,059 $ 16,085,833 ============== =============== ===============
The following table summarizes the Company's fixed maturity holdings and investments held for sale by major classifications:
By insurance statute, the majority of the Company's investment portfolio is invested in investment grade securities to provide ample protection for policyholders.
The amortized cost and estimated market value of debt securities at December 31, 2002, by contractual maturity, is shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Fixed Maturities Held for Sale Estimated Amortized Market December 31, 2002 Cost Value ----------------------------------------- -------------- -------------- Due in one year or less $ 1,027,197 $ 1,062,985 Due after one year through five years 31,766,665 33,309,128 Due after five years through ten years 6,688,465 7,334,766 Due after ten years 158,619 176,890 Collateralized mortgage obligations 65,603,941 66,820,749 -------------- -------------- Total $ 105,244,887 $ 108,704,518 ============== ==============
Estimated Fixed Maturities Held to Maturity Amortized Market December 31, 2002 Cost Value ----------------------------------------- -------------- -------------- Due in one year or less $ 27,179,794 $ 27,550,341 Due after one year through five years 26,921,769 28,509,885 Due after five years through ten years 1,858,205 2,070,897 Due after ten years 2,307,075 2,320,826 Collateralized mortgage obligations 60,820 65,116 -------------- -------------- Total $ 58,327,663 $ 60,517,065 ============== ==============
An analysis of sales, maturities and principal repayments of the Company's fixed maturities portfolio for the years ended December 31, 2002, 2001 and 2000 is as follows:
Cost or Gross Gross Proceeds Amortized Realized Realized From Year ended December 31, 2002 Cost Gains Losses Sale --------------------------------- ------------- ----------- ------------- ------------- Scheduled principal repayments, Calls and tenders: Held for sale $ 29,746,832 $ 1,689 $ 0 $ 29,748,521 Held to maturity 20,071,850 7,782 (6,744) 20,072,888 Sales: Held for sale 0 0 0 0 Held to maturity 0 0 0 0 ------------- ----------- ------------- ------------- Total $ 49,818,682 $ 9,471 $ (6,744) $ 49,821,409 ============= =========== ============= =============
Cost or Gross Gross Proceeds Amortized Realized Realized From Year ended December 31, 2001 Cost Gains Losses Sale --------------------------------- ------------- ----------- ------------- ------------- Scheduled principal repayments, Calls and tenders: Held for sale $ 23,583,564 $ 10,440 $ 0 $ 23,594,004 Held to maturity 47,921,354 34,690 (107,234) 47,848,810 Sales: Held for sale 6,518,181 197,044 0 6,715,225 Held to maturity 0 0 0 0 ------------ ----------- ------------- ------------- Total $ 78,023,099 $ 242,174 $ (107,234) $ 78,158,039 ============= =========== ============= =============
C. INVESTMENTS ON DEPOSIT - At December 31, 2002, investments carried at approximately $12,386,000 were on deposit with various state insurance departments.
The Company's insurance subsidiaries are domiciled in Ohio and Illinois and prepare their statutory-based financial statements in accordance with accounting practices prescribed or permitted by the respective insurance department. These principles differ significantly from accounting principles generally accepted in the United States of America. "Prescribed" statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners ("NAIC"). "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, from company to company within a state, and may change in the future. The NAIC recently completed the process of codifying statutory accounting practices, the result of which is to constitute the only source of "prescribed" statutory accounting practices. The new rules promulgated by the codifying of statutory accounting practices became effective January 1, 2001. Accordingly, these uniform rules change prescribed statutory accounting practices and result in changes to the accounting practices that insurance enterprises use to prepare their statutory financial statements. Implementation of the codification rules did not have a material financial impact on the financial condition of the Company's life insurance subsidiaries. UG's total statutory shareholders' equity was $16,030,200 and $16,105,265 at December 31, 2002 and 2001, respectively. The Company's life insurance subsidiaries reported combined statutory operating income before taxes (exclusive of intercompany dividends) of approximately $2,700,000, $2,913,000 and $2,091,000 for 2002, 2001 and 2000, respectively.
On June 1, 2000, UG assumed an already existing coinsurance agreement, dated January 1, 1992, between Lancaster Life Reinsurance Company, an Arizona corporation ("LLRC") and Investors Heritage Life Insurance Company, a corporation organized under the laws of the Commonwealth of Kentucky ("IHL"). Under the terms of the agreement, LLRC agreed to assume from IHL a 90% quota share of new issues of credit life and accident and health policies that have been written on or after January 1, 1992 through various branches of the First Southern National Bank. The maximum amount of credit life insurance that can be assumed on any one individual's life is $15,000. UG assumed all the rights and obligations formerly held by LLRC as the reinsurer in the agreement. LLRC liquidated its charter immediately following the transfer. At December 31, 2002, IHL has insurance inforce of approximately $3,700,000, with reserves being held on that amount of approximately $45,000.
In June 2002, the Company entered into a five-year contract with Fiserv LIS for services related to their purchase of the "ID3" software system. Under the contract, the Company is required to pay $12,000 per month in software maintenance costs and $5,000 per month in offsite data center costs for a five-year period from the date of the signing.
On April 26, 1999, the above lawsuit was filed by David Morlan and Louis Black in the Southern District of Illinois against Universal Guaranty Life Insurance Company ("UG") and United Trust Assurance Company ("UTAC") (merged into UG in 1992). After the lawsuit was filed, the plaintiffs, who were former insurance salesmen, amended their complaint, dropped Louis Black as a plaintiff, and added United Security Assurance Company ("USAC") (merged into UG in 1999) and UTG as defendants. The plaintiffs are alleging that they were employees of UG, UTAC or USAC rather than independent contractors. The plaintiffs are seeking class action status and have asked to recover various employee benefits, costs and attorneys' fees, as well as monetary damages based on the defendants' alleged failure to withhold certain taxes. A trial date has been currently set for August 26, 2003.
The Company continues to believe that it has meritorious grounds to defend this lawsuit, and it intends to defend the case vigorously. The Company believes that the defense and ultimate resolution of the lawsuit should not have a material adverse effect upon the business, results of operations or financial condition of the Company. Nevertheless, if the lawsuit were to be successful, it is likely that such resolution would have a material adverse effect on the Company's business, results of operations and financial condition. At December 31, 2002, the Company maintains a liability of $250,000 to cover estimated legal costs associated with the defense of this matter.
UTG and its subsidiaries are named as defendants in a number of legal actions arising as a part of the ordinary course of business relating primarily to claims made under insurance policies. Those actions have been considered in establishing the Company's liabilities. Management is of the opinion that the settlement of those actions will not have a material adverse effect on the Company's financial position or results of operations.
On May 21, 2002, at a special meeting of shareholders, the shareholders of FCC, then an 82% owned subsidiary of UTG, voted on and approved that certain Agreement and Plan of Reorganization and related Plan of Merger, each dated as of June 5, 2001, between UTG, and FCC (collectively, the "Merger Agreement"), and the merger contemplated thereby in which FCC would be merged with and into UTG, with UTG being the surviving corporation of the merger. The merger became effective on June 12, 2002. Pursuant to the terms and conditions of the Merger Agreement, each share of FCC stock outstanding at the effective time of the merger (other than shares held by UTG or shares held in treasury by FCC or by any of its subsidiaries) was at such time automatically converted into the right to receive $250 in cash per share ($2,480,000 in the aggregate).
On September 27, 2001, UG purchased real estate at a cost of $6,333,336 from an outside third party through the formation of an LLC in which UG is a two-thirds owner. The other one-third partner is Millard V. Oakley, who is a Director of UTG. Hampshire Plaza, LLC consists of a twenty story, 254,000 square foot office tower, an attached 72,000 square foot retail plaza, and an attached parking garage with approximately 350 parking spaces located in Manchester, New Hampshire.
On October 26, 2001, APPL effected a reverse stock split, as a result of which (i) it became a wholly-owned subsidiary of UG, and an indirect wholly-owned subsidiary of UTG, and (ii) its minority shareholders received an aggregate of $1,055,295 in respect of their shares. Prior to the reverse stock split, UG owned 88% of the outstanding shares of APPL.
On April 12, 2001, UTG completed the purchase of 22,500 shares of UTG common stock and 544 shares of FCC common stock from James E. Melville and family pursuant to the Melville Purchase Agreement in exchange for five year promissory notes of UTG in the aggregate principal amount of $288,800. On April 12, 2001, UTG also completed the purchase from another family member of Mr. Melville of an additional 100 shares of UTG for a total cash payment of $800. The purchase for cash by UTG of an additional 39 shares of FCC common stock owned by Mr. Melville at a purchase price of $200.00 per share was consummated on June 27, 2001. Mr. Melville was a former director of UTG, FCC and the three insurance subsidiaries of UTG; he resigned from those boards on February 13, 2001.
During 2000 and 2001, FCC paid a majority of the general operating expenses of the affiliated group. FCC then received management, service fees and reimbursements from the various affiliates. Beginning in January 2002, and in anticipation of the merger of FCC, UTG began paying a majority of the general operating expenses of the affiliated group. Following the FCC merger in June 2002, UTG also assumed the rights and obligations of the management and service fees agreements with the various affiliates originally held by FCC.
UTG paid FCC $0, $550,000 and $750,000 in 2002, 2001 and 2000, respectively for reimbursement of costs attributed to UTG. During 2002 through the date of the FCC merger, FCC paid $3,200,000 to UTG for reimbursement of costs attributed to FCC and affiliates under which FCC had management and cost sharing services arrangements.
On January 1, 1993, FCC entered an agreement with UG pursuant to which FCC provided management services necessary for UG to carry on its business. UG paid $2,974,088, $6,156,903 and $6,061,515 to FCC in 2002, 2001 and 2000, respectively. UG paid $3,025,194 to UTG in 2002 under this arrangement.
APPL had a management fee agreement with FCC whereby FCC provided certain administrative duties, primarily data processing and investment advice. APPL paid fees of $222,000, $444,000 and $444,000 in 2002, 2001 and 2000, respectively under this agreement. APPL paid fees of $222,000 to UTG during 2002 under this agreement.
The Company reimbursed expenses incurred by Mr. Correll and Mr. Attkisson relating to travel and other costs incurred on behalf of or relating to the Company. The Company paid $74,621, $145,407 and $96,599 in 2002, 2001 and 2000, respectively to First Southern Bancorp, Inc. in reimbursement of such costs. In addition, beginning in 2001, the Company began reimbursing FSBI a portion of salaries for Mr. Correll and Mr. Attkisson. The reimbursement was approved by the UTG board of directors and totaled $169,651 and $128,411 in 2002 and 2001, respectively, which included salaries and other benefits.
A total of 400,000 shares of common stock may be purchased under the plan, subject to appropriate adjustment for stock dividends, stock splits or similar recapitalizations resulting in a change in shares of UTG. The plan is not intended to qualify as an "employee stock purchase plan" under Section 423 of the Internal Revenue Code. At its September 2002 meeting, the Board of Directors of UTG approved initial offerings under the plan to qualified individuals totaling 367,000 shares, subject to the registration or qualification of the shares for sale under Federal or applicable state securities laws. These initial offers were made November 1, 2002, at which time each offeree had 30 days to accept the offer, execute the appropriate documents and pay for the shares to be acquired. At the end of the 30-day period, the offers expired. This initial offering was at a purchase price of $12.00 per share. Eight individuals acquired stock under the plan from this initial offering with a total of 58,891 shares of UTG common stock issued. Each participant under the plan executed a "stock restriction and buy-sell agreement", which among other things provides UTG with a right of first refusal on any future sales of the shares acquired by the participant under this plan.
On June 5, 2001, the board of directors of UTG authorized the repurchase from time to time in the open market or in privately negotiated transactions of up to $1 million of UTG's common stock. Repurchased shares will be available for future issuance for general corporate purposes. Through February 28, 2003, UTG has spent $682,237 in the acquisition of 97,115 shares under this program.
As of December 31, 2002, no options were exercised and all options have been forfeited.
For the year ended December 31, 2002 --------------- ------ ------------------ ---- ----------------- Income Shares Per-Share (Numerator) (Denominator) Amount --------------- ------------------ ----------------- Basic EPS Income available to common shareholders $ 1,499,618 3,505,424 $ 0.43 =================
For the year ended December 31, 2001 --------------- ------ ------------------ ---- ----------------- Income Shares Per-Share (Numerator) (Denominator) Amount --------------- ------------------ ----------------- Basic EPS Income available to common shareholders $ 2,439,573 3,733,432 $ 0.65 =================
Effect of Dilutive Securities Convertible notes 0 0 Options 0 0 --------------- ------------------
Diluted EPS Income available to common shareholders and $ assumed conversions 2,439,573 3,733,432 $ 0.65 =============== ================== =================
For the year ended December 31, 2000 --------------- ------ ------------------ ---- ----------------- Income Shares Per-Share (Numerator) (Denominator) Amount --------------- ------------------ ----------------- Basic EPS Income available to common shareholders $ (696,426) 4,056,439 $ (0.17) =================
Effect of Dilutive Securities Convertible notes 0 0 Options 0 0
2002 2001 ------------- ------------- Subordinated 20 yr. Notes $ 0 $ 514,674 Other notes payable 2,995,275 3,885,996 ------------- ------------- $ 2,995,275 $ 4,400,670 ============= =============
The other notes payable were incurred in April 2001 to facilitate the repurchase of common stock owned primarily by James E. Melville and Larry E. Ryherd, two former officers and directors of UTG, and members of their respective families. These notes bear interest at the fixed rate of 7% per annum (paid quarterly) with payments of principal to be made in five equal installments, the first principal payment in the amount of $777,199, was made on March 31, 2002. In December 2002 an advance principal payment of $113,522 was made on these notes. Subsequent to the current reporting period, in January 2003, UTG paid the 2003 principal reduction of $705,499.
On November 15, 2001, UTG was extended a $3,300,000 line of credit ("LOC") from the First National Bank of the Cumberlands ("FNBC") located in Livingston, Tennessee. The FNBC is owned by, Millard V. Oakley, who is a director of UTG. The LOC was for a one-year term from the date of issue. Upon maturity the Company renewed the LOC for an additional one-year term. The interest rate on the LOC is variable and indexed to be the lowest of the U.S. prime rates as published in the Wall Street Journal, with any interest rate adjustments to be made monthly. At December 31, 2002, the Company had no outstanding borrowings attributable to this LOC. During 2002 the Company had total borrowings of $1,600,000 on this LOC, which were all repaid during the year. The draws on this LOC were used to facilitate the payments due to the former shareholders of FCC as a result of the June 12, 2002, merger of FCC with and into UTG, as further described in note 15 to the consolidated financial statements.
On a cash basis, the Company paid $263,441, $333,365, and $373,988 in interest expense for the years 2002, 2001 and 2000, respectively. The Company paid $60,290, $92,006 and $(173,500) in federal income tax for 2002, 2001 and 2000, respectively.
Under Statement 4, all gains and losses from extinguishment of debt were required to be aggregated, and, if material, classified as an extraordinary item, net of related income tax effect. Statement 145 eliminates Statement 4 and as a result, gains and losses from extinguishment of debt should be classified as extraordinary items only if they meet certain criteria as outlined in Opinion 30. Applying the provisions of Opinion 30 will distinguish transactions that are part of an entity's recurring operations from those that are unusual or infrequent or that meet the criteria for classification as an extraordinary item. Statement 64 amended Statement 4 and is no longer necessary because Statement 4 has been rescinded. Statement 44 was issued to establish accounting requirements for the effects of transition to the provisions of the Motor Carrier Act of 1980. Those transitions are completed; therefore, Statement 44 is no longer necessary. Statement 145 also amends Statement 13 to require sale-leaseback accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. Statement 145 also makes various technical corrections to existing pronouncements, none of which are substantive in nature. Statement 145 is required for fiscal years beginning after May 15, 2002, with early application encouraged. The adoption of Statement 145 did not affect the Company's financial position or results of operations since the Company has had no transactions of the aforementioned kind, during the reporting period.
Statement 146 was issued to address the accounting and reporting for costs associated with exit or disposal activities because entities increasingly are engaging in exit and disposal activities and certain costs associated with those activities were recognized as liabilities at a plan (commitment) date that did not meet the definition of a liability as outlined in FASB Concepts Statement No. 6. Statement 146 improves financial reporting for cost associated with exit or disposal activities, by requiring that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The accounting for similar events and circumstances will be the same, thereby improving the comparability and representational faithfulness of reported financial information. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The adoption of Statement 146 did not affect the Company's financial position or results of operations, since the Company has had no such exit or disposal activities during the reporting period.
On May 21, 2002, at a special meeting of shareholders, the shareholders of FCC, then an 82% owned subsidiary of UTG, voted on and approved that certain Agreement and Plan of Reorganization and related Plan of Merger, each dated as of June 5, 2001, between UTG, and FCC (collectively, the "Merger Agreement"), and the merger contemplated thereby in which FCC would be merged with and into UTG, with UTG being the surviving corporation of the merger. The merger became effective on June 12, 2002. Pursuant to the terms and conditions of the Merger Agreement, each share of FCC stock outstanding at the effective time of the merger (other than shares held by UTG or shares held in treasury by FCC or by any of its subsidiaries) was at such time automatically converted into the right to receive $250 in cash per share.
The purchase price in the merger is comprised of the following components:
The following table summarizes certain unaudited operating results of UTG as though the merger transaction had taken place at the beginning of the reporting periods ending on December 31, 2002 and December 31, 2001, respectively.
December 31, December 31, 2001 ------------------ ------------------ Total revenues $ 30,064,644 $ 33,329,372 Total benefits and other expenses $ 27,927,456 $ 28,912,280 Operating income $ 2,137,188 $ 4,417,092 Net Income $ 1,394,218 $ 3,274,486 Basic earnings per share $ 0.40 $ 0.86 Diluted earnings per share $ 0.35 $ 0.86
Less: reclassification adjustment for gains realized in net income (1,689) 591 (1,098) ---------------- ----------------- --------------- Net unrealized gains 2,866,457 (1,003,260) 1,863,197 ---------------- ----------------- --------------- Other comprehensive income $ 2,866,457 $ (1,003,260) $ 1,863,197 ================ ================= ===============
Tax Before-Tax (Expense) Net of Tax 2000 Amount or Benefit Amount ---------------------------------------------- ---------------- ----------------- ---------------
Unrealized holding losses during period $ 1,513,673 $ $ 1,513,673 Less: reclassification adjustment for losses realized in net income (39,486) (39,486) ---------------- ----------------- --------------- Net unrealized losses 1,474,187 1,474,187 ---------------- ----------------- --------------- Other comprehensive deficit $ 1,474,187 $ $ 1,474,187 ================ ================= ===============
Premiums and policy fees, net $ 4,554,451 $ 4,768,808 $ 4,137,361 $ 3,811,796 Net investment income 4,014,425 3,931,677 3,557,702 3,563,255 Total revenues 8,428,235 9,005,351 7,963,274 7,968,472 Policy benefits including dividends 4,937,725 5,193,310 4,586,257 4,807,794 Commissions and amortization of DAC and COI 929,415 621,810 511,470 773,199 Operating expenses 1,514,115 1,768,758 1,573,817 1,629,001 Operating income 1,008,366 1,323,667 1,183,712 676,417 Net income 343,858 975,292 645,873 474,550 Basic earnings per share 0.08 0.27 0.13 0.18 Diluted earnings per share 0.08 0.27 0.13 0.18 -------------------- --------------------- --------------------- -------------------- 1st 2nd 3rd 4th --------------- --------------- --------------- ---------------