Midwest was formed on October 31, 2003 for the primary purpose of becoming a financial services holding company. We presently conduct our business through our wholly owned subsidiary, American Life & Security Corp. Capital Reserve Life Insurance Company of Jefferson City, Missouri is a dormant, wholly owned subsidiary of American Life. Security Capital Corporation is a 60% owned subsidiary of Midwest. Great Plains Financial Corporation is a 24.5% owned subsidiary of Midwest. Great Plains Life Assurance Company is a wholly owned subsidiary of Great Plains Financial.
On June 20, 2010, American Life acquired Capital Reserve in exchange for a cash payment of approximately $1.9 million. This transaction added approximately a like amount of assets to American Life. Further, with the insurance charters acquired from Capital Reserve, we obtained access to additional markets in Missouri and Kansas. Capital and surplus of Capital Reserve as of December 31, 2012 and 2011 was $1,396,147 and $1,206,355, respectively. Capital Reserve generated a $66,813 and $112,327 net loss for the years ended December 31, 2012 and 2011, respectively.
The Company was a development stage company until American Life commenced insurance operations in 2009. We have incurred significant net losses since inception in 2003 totaling approximately $12.2 million through December 31, 2012. These losses have resulted primarily from costs incurred while raising capital and establishing American Life. We expect to continue to incur operating losses until we achieve a volume of in-force life insurance policies that provides premiums that are sufficient to cover our operating expenses.
Additionally, the Company has investments in development stage entities. These equity securities approximate carrying value and are invested in privately-held life insurance companies. These securities have no active trading. The fair value for these securities is determined through the use of unobservable assumptions about market participants. These companies are regularly bringing new investors into their entities at or above the prices paid by the Company. Accordingly, the Company has asserted that a willing market participant would purchase the security for the same price as the Company paid until such time as the development stage company commences operations.
The recognition of other-than-temporary impairment losses on debt securities is dependent on the facts and circumstances related to the specific security. If the Company intends to sell a security or it is more likely than not that the Company would be required to sell a security prior to recovery of the amortized cost, the difference between amortized cost and fair value is recognized in the income statement as an other-than-temporary impairment. If the Company does not expect to recover the amortized basis, does not plan to sell the security and if it is not more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, the recognition of the other-than-temporary impairment is bifurcated. The Company recognizes the credit loss portion in the statements of comprehensive income and the noncredit loss portion in accumulated other comprehensive loss. The credit component of an other-than-temporary impairment is determined by comparing the net present value of projected cash flows with the amortized cost basis of the debt security. The net present value is calculated by discounting the Company’s best estimate of projected future cash flows at the effective interest rate implicit in the fixed income security at the date of acquisition. Cash flow estimates are driven by assumptions regarding probability of default, including changes in credit ratings, and estimates regarding timing and amount of recoveries associated with a default.
Incremental direct costs that result directly from and are essential to the contract acquisition transaction and would not have been incurred by the Company had the contract acquisition not occurred, are capitalized and amortized over the life of the premiums produced. Recoverability of deferred acquisition costs is evaluated periodically by comparing the current estimate of the present value of expected pretax future profits to the unamortized asset balance. If this current estimate is less than the existing balance, the difference is charged to expense.
In the normal course of business, the Company seeks to limit aggregate and single exposure to losses on large risks by purchasing reinsurance. The amounts reported in the consolidated balance sheets as reinsurance recoverable include amounts billed to reinsurers on losses paid as well as estimates of amounts expected to be recovered from reinsurers on insurance liabilities that have not yet been paid. Reinsurance recoverable on unpaid losses are estimated based upon assumptions consistent with those used in establishing the liabilities related to the underlying reinsured contracts. Insurance liabilities are reported gross of reinsurance recoverable. Management believes the recoverables are appropriately established. The Company generally strives to diversify its credit risks related to reinsurance ceded. Reinsurance premiums are generally reflected in income in a manner consistent with the recognition of premiums on the reinsured contracts. Reinsurance does not extinguish the Company’s primary liability under the policies written. Therefore, the Company regularly evaluates the financial condition of its reinsurers including their activities with respect to claim settlement practices and commutations, and establishes allowances for uncollectible reinsurance recoverable as appropriate.
The Company establishes liabilities for amounts payable under insurance policies, including traditional life insurance and annuities. Generally, amounts are payable over an extended period of time. Liabilities for future policy benefits of traditional life insurance have been computed by a net level premium method based upon estimates at the time of issue for investment yields, mortality and withdrawals. These estimates include provisions for experience less favorable than initially expected. Mortality assumptions are based on industry experience expressed as a percentage of standard mortality tables.
Premium revenue: Premium revenue in the year ended December 31, 2012 was $4,208,659 compared to $3,119,457 in the year ended December 31, 2011. The increase in premium revenue is primarily attributable to the acquisition of Great Plains Financial. 100% of payments received for first year premiums are traditional life insurance premiums and recognized as earned when due. In subsequent years, 50% of the payments received are applied toward the traditional life insurance premium. The other 50% of the payments received are applied towards the annuity premium which is recognized as deposits to policyholder account balances and included in future insurance policy benefits. The change in distribution contributes to an apparent lower level of persistency than that actually experienced. Were annuities included, premium income would be $5,606,044 and $3,937,460, respectively. Management is pursuing the development of new products, which it expects to release during 2013.
Realized gain on initial consolidation of Great Plains Financial: The realized gain on the initial consolidation of Great Plains Financial for the year ended December 31, 2012 was $118,612. The gain was a result of the excess of the acquisition date fair value of the Company’s previously held equity interest in Great Plains Financial over its carrying value on the acquisition date.
Increase in benefit reserves: The increase in benefit reserves was $993,103 in the year ended December 31, 2012 compared to $1,199,340 in the year ended December 31, 2011. The increase in benefit reserves declined for the year ended December 31, 2012 compared to the same period in 2011 primarily because of a decrease in life reserves held on assumed business as part of the Security National agreement.
Other expenses: Other expenses (general administrative expenses, licenses and fees, and other expenses) were $3,059,773, in the year ended December 31, 2012 compared to $2,745,737 in the year ended December 31, 2011. The Company’s other operating expenses during the year ended December 31, 2012 increased compared to the same period in 2011 due to an increase in other expenses incurred by the Company’s subsidiary, Hot Dot, which were not incurred during 2011 along with an increase in legal and consulting expenses of approximately $274,000 incurred by the Company during the first quarter of 2012 related to its Form 10 filing as it became a public company, offset by decreases in third-party administration fees and merger and acquisition expenses.
Net Loss: Net loss was ($2,519,309) for the year ended December 31, 2012, compared to a net loss of ($3,767,890) for the year ended December 31, 2011. The decrease in net loss was primarily attributable to the fact that the overall increase in recurring revenues described above was more than the overall increase in expenses. Additionally, a significant portion of the increased expenses relate to consolidated subsidiaries that are not wholly owned by Midwest. As such, a substantial portion of the increased net loss is attributable to other noncontrolling owners, as described below.
Net loss attributable to Midwest Holding Inc.: Net loss attributable to Midwest Holding Inc. was ($1,657,687) for the year ended December 31, 2012 compared to a net loss of ($3,695,117) for the year ended December 31, 2011. The decrease in the net loss for the year ended December 31, 2012 compared to same period in 2011 was primarily attributable to an increase in premiums of $1,089,202 resulting from the acquisition of Old Reliance and Great Plains Financial and the Company’s own continued growth offset by increases in death and other benefits and benefit reserves of $224,170. Further, salaries and benefits and other operating expenses, after excluding the results of Hot Dot, decreased $873,037, which was largely due to the termination of the contract with the Company’s third-party administrator, non-recurring acquisition expenses as part of the Old Reliance acquisition, and synergies and cost sharing of payroll expenses amongst Midwest affiliates. During the year ended December 31, 2011, the Company paid its third-party administrator approximately $340,000 compared to $59,000 during the same period of 2012. During the year ended December 31, 2011, the Company paid $387,945 in fees related to the acquisition of Old Reliance. These savings were offset by increases in legal and consulting expenses of approximately $274,000 incurred by the Company during the first quarter of 2012 related to its Form 10 filing as it became a public company. We expect our losses to continue in the future as we incur costs to grow our life insurance business.
Increases in fixed maturity securities, common corporate stock, equity securities carried at cost, cash, and short-term investments result from the consolidation of Great Plains Financial during the fourth quarter of 2012 and organic growth in the Company’s portfolio.
Decreases in notes receivable are a result of payments of short-term financing arrangements made with affiliated companies to cover operating expenses during developmental stage activities. The short-term financing arrangements with Rocky Mountain Capital Corporation and Northstar Financial Corp. in the amounts of $105,000 and $115,000, respectively, were both repaid with interest during the first quarter of 2012.
Net cash used in operating activities was ($2,700,672) for the year ended December 31, 2012. The primary sources of cash from operating activities were from premium receipts, collection amounts due from reinsurers and net investment income. The primary uses of cash from operating activities were from payments of commissions to agents and settlement of policy liabilities. Net cash provided by investing activities was $331,716. The primary sources of cash were from sales of available for sale securities, the net change in short-term investments, and the acquisition of Great Plains Financial. Offsetting these sources of cash were the Company’s investments in available for sale securities and the removal Hot Dot’s cash balances as a result of the deconsolidation. Net cash provided by financing activities was $4,245,786. The primary sources of cash were the net proceeds from the issuance of stock by Hot Dot prior to its deconsolidation and receipts on deposit type contracts. These were offset by payments made by the Company on its surplus notes.
At December 31, 2012, the Company had cash and cash equivalents totaling $4,346,555. The Company believes that its existing cash and cash equivalents will be sufficient to fund the anticipated operating expenses and capital expenditures for at least twelve months. The Company has based this estimate upon assumptions that may prove to be wrong and the Company could use its capital resources sooner than they currently expect. The growth of our insurance subsidiaries is uncertain and will require additional capital if they continue to grow.
Insurance premiums are established before the amount of losses and loss adjustment expenses, or the extent to which inflation may affect such losses and expenses, are known. The Company attempts, in establishing premiums, to anticipate the potential impact of inflation. If, for competitive reasons, premiums cannot be increased to anticipate inflation, this cost would be absorbed by us. Inflation also affects the rate of investment return on the investment portfolio with a corresponding effect on investment income.
As a “smaller reporting company” the Company is not required to provide the table of contractual obligations required pursuant to this Item.