The Company owns its home office building, located at 17800 Royalton Road, Strongsville, Ohio. The building, which consists of 121,625 square feet of gross floor area, was occupied in late 1990 by the Company and all the subsidiaries. Central, the principal operating subsidiary, entered into a 15 year triple net lease agreement with the Company for 100% of the space. All operations are conducted in this building.
Liquidity is the ability of an enterprise to generate adequate amounts of cash to meet its financial commitments. The major needs for cash for the Company are Central Reserve Life Insurance Company's (Central) ability to pay claims and expenses as they come due. Central's primary sources of cash are premiums and investment income. Central's payments consist of current claim payments to insureds, managed care expenses, operating expenses such as salaries, employee benefits, commissions, taxes, etc., and shareholder dividends payable to the Company. By statute, the state regulatory authorities set minimum liquidity standards to protect both policyholders and shareholders and limit the dividends payable by Central to the Company. See Item 5.
the primary investment of the Company and were $80,878,265 or 97% of total investments at December 31, 1994. The Company is carrying fixed maturities of $13,468,956 at amortized cost (held to maturity) and fixed maturities of $67,409,309 at fair value (available for sale) at December 31, 1994. The Company does not hold any so-called "junk" bonds or what are generally considered high-yield type securities, and 99% of the bonds are of investment grade quality. In accordance with SFAS 115, the Company recorded a reduction in investments of $5,427,055 to reflect the reporting of investments classified as available for sale at fair value (estimated market value) which was lower than amortized cost. Management believes the Company's positive cash flow from investment income and operations will enable the Company to operate without having to sell the investments that have the unrealized holding loss of $5,427,055. The charge is reflected in shareholders' equity as a "net unrealized holding loss". In addition to the fixed maturities, the Company also had $4.2 million in unrestricted cash and $2.2 million in short term investments at December 31, 1994. Central also has an unused $1 million line of credit with a major bank. During 1994, total assets increased about $9.3 million, before the net unrealized holding loss of $5,427,055 or 9% to $113,219,213, mainly due to a positive cash flow from operations during the year from premiums and investment income.
Liabilities accrued for future policy benefits and policy claims payable increased 12%, or about $6.6 million to $62,716,877 primarily because of a strengthening of reserves and increased premiums. Shareholders' equity decreased $2,326,164 after paying dividends of $1,772,615 and a reduction of $5,427,055 for a net unrealized holding loss.
The only long-term debt the Company has at December 31, 1994, is $8,685,754, which is the principal amount payable under a loan secured by a mortgage on the Company's home office building. The Company entered into the loan agreement in 1990 for $9 million for a term of 10 years bearing interest at 9 1/2% per annum with a 30 year amortization period payment schedule. At the same time, the Company also entered into a 15 year lease agreement with Central for 100% of the space. The Company will use the monthly rental payments to pay, among other expenses, the required mortgage loan payments. No major capital expenditures occurred in 1994 nor are any anticipated for 1995.
Not included in premiums, for generally accepted accounting principles (GAAP) purposes, are annuity considerations in the amounts of $3,492,402 and $8,728,902 for 1994 and 1993. The decrease in annuity considerations was primarily due to increasing interest rates available in other investments.
Benefits and claims incurred expenses increased 6% in 1994 to $155,257,560 from $146,017,738 in 1993. This compares to a 28% in 1993 over 1992. The incurred loss ratio was 69.4% in 1994 and 69.9% in 1993. The improvement can be attributed to managed care cost controls, certain rate adjustments, reduction in large claims and an overall moderation in the medical inflation rate for 1994.
The Federal income tax returns for the Company and its subsidiaries have been examined by the Internal Revenue Service (IRS) for 1991 and 1992. During the third quarter of 1994, the IRS issued a proposal for adjustments to the Company's returns for 1991 and 1992. The proposed deficiencies are approximately $2.4 million of which $215,303, pertaining to some non deductible expenses and certain assets expensed and not capitalized, was agreed to and paid in 1994. The balance primarily deals with whether or not the Company's subsidiary, Central, qualified as a life company, for tax purposes. The Company intends to vigorously protest the proposed deficiency and management believes existing law supports the Company's position. Therefore, the Company has not recorded a liability for the difference.
If the IRS were to pursue litigation and prevail in its position that Central no longer qualifies as a life company for tax purposes, Federal income taxes would increase in the future. Presently, as a small life company, Central is permitted, among other things, a deduction from the first $3 million of income of 60% or $1.8 million. As Central's income increases above $3 million, the special deduction is reduced proportionately. Besides relying on favorable existing case law, Central may have, under certain circumstances, the ability to change and market policies that could insure its qualification as a life company for tax purposes in the future, if the need arises.
During 1993, premiums increased 21% to $208,730,840 from $172,010,014 in 1992. The increase was primarily in the group division which accounted for about 99% of total premiums. Group certificates in force increased to 105,536 in 1993 from 96,175 in 1992. Certificates issued for new group policies were 36,586 in 1993 and 36,834 in 1992. Total lapses (net of additions/decreases) in 1993 were 27,225 compared to 19,534 in 1992. Management attributes the increase in lapses to a product sold through an association which appears to be used as a short term policy. Also, decreases in certificates in existing groups exceeded additions during the year, indicating reductions in employment in many companies.
Commissions increased 20% in 1993 over 1992 and were 15.4% of premiums in 1993, down slightly from 15.6% in 1992. The decrease in the ratio to premiums was primarily due to the increase in renewal premiums which carry a lower commission rate than new, first year premiums. Expenses increased 3% in 1993 over 1992 compared to a 32% increase in 1992 over 1991 and were 16.1% of premiums in 1993 compared to 18.9% for 1992. Major reasons for the 3% increase were increases in premium taxes.
SFAS 115 was effective for fiscal years beginning after December 15, 1993 and the Company adopted it as required January 1, 1994. The Company has identified various securities as available for sale. Effective January 1, 1994, the Company started to carry these fixed maturities at fair value and accordingly recorded a net unrealized holding loss of $5,427,055 at December 31, 1994 as a separate component of shareholders'
As discussed in note 1 to the consolidated financial statements, the Company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities, in 1994.
The consolidated financial statements include the accounts of Central Reserve Life Corporation (Company) and its wholly-owned subsidiaries, Central Reserve Life Insurance Company (Central), Western Reserve Administrative Services, Inc. (Western) and CRL Asset Management Corporation (AMC). All significant intercompany accounts and transactions have been eliminated in consolidation.
It now appears that no major federal health care reform will take place in 1995. However, incremental changes are more probable than major changes and it is more likely this will be on the state level than federal. The federal government has already enacted a series of health care mandates which has resulted in cost shifting from the federal government to state government and the private sector. The Company cannot predict the ultimate timing or effect of such legislative efforts, and no assurance can be given that any such efforts will not have a material adverse effect on the Company's business and results of operations.
Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 (SFAS 115) "Accounting for Certain Investments in Debt and Equity Securities". SFAS 115 requires that investments in all debt securities and those equity securities with readily determinable market values be classified into one of three categories: held to maturity, trading or available for sale. Classification of investments is based upon management's current intent. Debt securities which management has a positive intent and ability to hold until maturity are classified as securities held to maturity and are carried at amortized cost. Unrealized holding gains and losses on securities held to maturity are not reflected in the consolidated financial statements. Debt and equity securities that are purchased for short-term resale are classified as trading securities. Trading securities are carried at market value, with unrealized holding gains and losses included in earnings. All other debt and equity securities not included in the above two categories are classified as securities available for sale. Securities available for sale are carried at market value, with unrealized holding gains and losses reported as a separate component of shareholders' equity, net of tax. At December 31, 1994 the Company did not have any investments classified as trading securities.
Prior to January 1, 1994, the Company classified fixed maturities in accordance with the then existing accounting standards, and, accordingly, those fixed maturities intended to be held to maturity were reported at amortized cost and those considered available for sale were reported at the lower of aggregate amortized cost or market.
Other property and equipment, primarily furniture, fixtures and data processing equipment, is carried at cost less allowances for depreciation and amortization. Depreciation is computed on the straight-line method over the estimated useful lives of the equipment, principally five and seven years.
(1) The guaranteed interest rate on policies currently being issued is 5.2%.
The liabilities for unpaid accident and health and death claims are estimated principally based upon past experience for pending, incurred but not reported and reopened claims. The liability includes a provision for the estimated cost of investigating and settling the claim liability. The liability is particularly sensitive to recent claims frequency and severity experience of Central. Management believes the liabilities for unpaid claims are adequate. A consulting actuary is retained by Central to assist in the estimation process and to certify to the statutory reserves.
differences are expected to be recovered or settled. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
At December 31, 1994 Central had certificates of deposit and fixed maturities on deposit with various state insurance departments, carried at $3,380,448, for the protection of policyholders.
subsidiary available for transfer to the parent company are limited to the amounts by which the insurance subsidiary's net assets, as determined in accordance with statutory accounting practices, exceed minimum statutory requirements. In addition, payments of such amounts as dividends are subject to approval by regulatory authorities when (i) any such dividend is proposed to be paid from other than earned surplus (as defined in the applicable statute) or (ii) the value of any such dividend, together with the value of other dividends paid or distributions made within the preceding 12 months, exceeds the greater of (a) ten percent of the insurer's surplus as regards policyholders as of the 31st day of December next preceding the dividend payment, or (b) the net income of such insurer for the 12-month period ended the December 31st next preceding the dividend payment.
In December 1992, the National Association of Insurance Commissioners (NAIC) adopted the Life Risk-Based Capital (RBC) formula. This model act requires every life and health insurer to calculate its total adjusted capital and RBC requirement, and provides for an insurance commissioner to intervene if the insurer
million of which $215,303, pertaining to some nondeductible expenses and certain assets expensed and not capitalized, was agreed to and paid in 1994. The balance primarily deals with whether or not the Company's subsidiary, Central, qualified as a life company, for tax purposes. The Company intends to vigorously protest the proposed deficiency and management believes existing law supports the Company's position. Therefore, the Company has not recorded a liability for the difference.
The Company establishes a valuation allowance based on its analysis (scheduling) of future deductible amounts. A valuation allowance is currently established to the extent future deductible amounts cannot offset future taxable amounts or recover federal income taxes paid within the statutory carryback period. Fluctuation in the valuation allowance is attributed to changes in the effect of the small life insurance company deduction and to a 100% valuation allowance on the net unrealized holding loss at December 31, 1994.
The Company's employment agreement with its Chief Executive Officer was entered into in 1982 and amended in 1983. The agreement expires December 31, 2001 and calls for annual increases of 11% per year through 1996. The 1994 compensation under the agreement was $784,834. The agreement has a change of control provision, which if exercised, upon such a change would require a lump sum payment for the unexpired term.
The exercise price of options outstanding at December 31, 1994, ranged from $2.83 to $6.75 per share and those options expire in 1997 and 1998.
The Company adopted a noncontributory pension plan in 1978. The plan is a defined contribution money purchase pension plan with an outside company, covering substantially all full-time employees of age 20 1/2 or more who have completed six months or more of service. Participants in the plan begin vesting after two years of service and are fully vested after seven years. The contribution was approximately $1,013,000 for 1994, $1,000,000 for 1993 and $949,000 for 1992.