During the first quarter of 2005 the Company entered into a lease for 20,337 square feet of office space in Austin, Texas, under an eight year, triple net lease. The base rent was $0 in the first year (June 1, 2005 to May 31, 2006), $157,612 in the second year and payments escalate to $264,384 in the final year of the lease. Leasehold improvements totaled approximately $872,000 ($203,000 funded by landlord) on the new lease space that was occupied in December 2005. Leasehold improvements are being amortized over the lease term. The $117,000 initial rent holiday and $203,000 of landlord-funded leasehold improvements will be amortized over the lease term and reduce lease expense. Deferred rent credits are included in other liabilities and were approximately $355,000 and $380,000 for 2007 and 2006, respectively.
The selected consolidated financial data presented below as of the end of and for each of the years in the five-year period ended December 31, 2007 are derived from the Company's consolidated financial statements. The consolidated financial statements as of December 31, 2007 and 2006, and for each of the years in the three-year period ended December 31, 2007 are included elsewhere in this Form 10-K.
In this section, we review the consolidated financial condition of the Company at December 31, 2007, 2006 and 2005 and the consolidated results of operations for the periods ended December 31, 2007, 2006 and 2005. Please read this discussion in conjunction with the accompanying consolidated financial statements and notes.
The following is a summary description of the Company’s methodology for estimating its claim liabilities for its insurance policies. The Company and management believe that this discussion constitutes forward-looking statements and, therefore, this discussion is given full safe-harbor.
Where the Range Estimate method is used, the management of an insurance company makes its own choice to record an amount within the range. The Company does not use the Range Estimate for any of its insurance products. Instead, for all of its insurance products, the Company uses the Single Point Estimate.
For the Company’s group and individual dental insurance, the Company’s financial personnel develop and make a Single Point Estimate for the claim liabilities which work results in the Company’s Single Point Estimate for the end of each fiscal quarter and year end. The Company’s independent consulting actuary develops and makes its separate Single Point Estimate for such liabilities. The Company’s financial personnel and independent consulting actuary compare their Single Point Estimates, reconcile any differences and agree on a Single Point Estimate for such liabilities. Annually, the Company’s independent consulting actuary gives a Single Point Estimate liability certification to the Company with the agreed amount and the Company uses such certified amount without change.
The discussion in this paragraph relates to the months where the completion factors are deemed to be fully credible which are typically the months prior to November and December. The completion factors have been relatively stable in the recent past. In the future, there could be changes in the trend of completion factors. The Company and its independent consulting actuary review the trends in the completion factors and when necessary make judgments as to the Single Point Estimate value for these items. Such estimates are based on observable trends and would also reflect any known major changes. Professional judgments are made based on the experience of the actuary and Company’s financial personnel and management. To observe the possible sensitivity of assuming 100% reliance on completion factors for claims incurred during the months for which completion factors are believed to be fully credible, if the associated claim liabilities for those months had increased by 5%, the year-end December 31, 2007, claim liabilities would have been increased by approximately $19,000.
At December 31, 2007 and 2006, respectively, the Company had gross deferred tax assets of $1,129,371 and $1,397,439 with corresponding valuation allowances of $812,466 and $1,072,825, and gross deferred tax liabilities of $346,506 and $303,614, resulting from net operating loss carryovers and temporary differences primarily related to the life insurance subsidiary. The valuation allowance is primarily due to statutory limitations on the use of net operating losses and uncertainty as to usage of AMT credit carryover. The resulting net deferred tax liability at December 31, 2007 is $29,601 compared to a deferred tax asset of $21,000 at December 31, 2006. Realization of the deferred tax asset is dependent on generating sufficient taxable income prior to expiration of the loss carry forward. Although realization is not assured, management believes it is more likely than not that all of the net deferred tax asset will be realized. However, the amount of the deferred tax asset considered realizable could be reduced in the near term if estimates of future taxable income during the carry forward period are reduced.
The Company has net operating loss carry forwards for income tax purposes at December 31, 2007 as follows:
The net cash flow for 2007 was $3,264,925 versus operating income of $4,263,002. The difference is primarily due to the purchase of $780,352 of the Company’s treasury stock and the purchase of fixed assets and leasehold improvements of $252,506.
The table below discloses the unrealized gains and losses on the "Held to Maturity" bonds.
The table below discloses the unrealized gains and losses on the bonds that are less than investment grade.
Other long term investments of $1,470,054 consists of, in part, a convertible debenture loan in the amount of $1,357,407 from the Company, to EPSI Benefits, Inc. (EBI), a Texas Corporation. The loan bears interest at an annual rate of 14%, payable monthly, with principal payments commencing September 15, 2008 and a maturity date of August 15, 2015. To protect its interest, BNLF may convert the debenture into 51% of the outstanding common stock of EBI, subject to regulatory approval. The note is one of several agreements entered into by the Company's subsidiaries which expand the business relationship with EBI and its subsidiary, Employer Plan Services, Inc. (EPSI), which provides substantially all of the A&H claims processing and adjudication for the Company's insurance subsidiary, BNLAC. In 2008 discussions began with EBI regarding a possible acquisition of a controlling interest in EBI (see Note 12 to the financial statements). BNLF receives a marketing fee from EBI under a related marketing agreement.
Other long-term investments also include an operating line of credit agreement in the amount of $112,647 and $150,402 in 2007 and 2006 respectively. The agreement provided EPSI with a $200,000 line of credit maturing August, 2011. The line of credit is at 8.00% with interest and principal payable monthly to BNLAC.
Financial Corporation for the payment of interest to the bondholders. The maximum amount of dividends, which can be paid by Arkansas domiciled insurance companies to shareholders without prior approval of the insurance commissioner, is subject to restrictions relating to statutory surplus. The Arkansas Insurance Commissioner has reviewed and approved the settlement. The Company does not expect the dividend restrictions to impact its ability to meet its cash needs. The Company has no plan to start a sinking fund for payment of the principal at maturity.
The following table reflects all long-term contractual obligations of the Company as of December 31, 2007.
In calculating the payments above, BNLAC used models of the business created for statutory asset adequacy analysis. The modeled life block was assumed to surrender for its reserve at the end of 20 years. Health blocks tested were projected using approximate means beyond 20 years. Payments on blocks not initially modeled were projected on an approximate basis. The total estimated future payments to be made relating to the Liability for Future Policy Benefits is stated as $9,731,655 which does not match the balance sheet liability total of $2,255,045 and the difference is $7,476,610. This is primarily due to the fact that the estimated future payments presented in the long term contractual obligations table for Future Policy Benefits includes consideration for future premiums, investment income and maintenance expenses and such assumptions, and perhaps other assumptions, may differ from the assumptions initially used to establish the balance sheet liability. The estimated future payments presented in the long term contractual obligations table are based on current assumptions while the balance sheet liability is based on assumptions locked in at the date the policy was approved for issue. Assumptions for estimating future payments are made regarding such items as interest earnings, mortality, morbidity, and persistency. It is likely that the actual experience will deviate from these assumptions - sometimes materially. A number of factors can have an effect such as economic conditions, changes in policyholder actions regarding premium payments and withdrawals, mortality and morbidity improvement or deterioration, and inflation. Random fluctuation in experience could also have an effect. The determination of the amount of the future payments is based upon estimates and the timing and amount of future payments is not always reasonably fixed and determinable. Because of the above considerations, the amounts and timing of future payments will likely vary from that presented in the above table.
Net investment income was $1,320,614 in 2007, $1,191,583 in 2006 and $1,003,613 in 2005, an increase of 11% in 2007, and an increase of 18% in 2006. The increase in 2007 was due to an increase in investment in fixed maturities and an increase in interest rates. The increase in 2006 was primarily due to delinquent interest received on bonds previously in default and an increase in fixed maturities investment yield. Interest rates declined in the fourth quarter of 2007, resulting in several government agency bonds called in the first quarter of 2008. The decrease in interest rates and the challenged financial markets has made it difficult to purchase investment grade bonds with yields equivalent to bonds purchased over the last few years.
The Company receives marketing fees from EBI per the marketing agreement mentioned above. The Company received marketing fees of $198,843 in 2007, $143,315 in 2006 and $115,233 in 2005. The increase in marketing fees in 2007 and 2006 was due to additional funds available at EPSI from higher profits during the year. EPSI has temporarily ceased paying the Company marketing fees in the first quarter of 2008 due to the termination of one of its largest customers.
BNLAC markets group and individual vision insurance products that are underwritten by other insurance companies, on which BNLAC does not have any exposure to underwriting (claims) losses. The Company had vision insurance income of $1,979,359, $1,603,767 and $1,051,720 in 2007, 2006 and 2005, respectively. The vision income increased by 23% and 49% in 2007 and 2006, respectively, primarily due to the addition of group voluntary vision plans that require lower participation rates.
The Company had a realized gain on debt extinguishments of $10,803 in 2007, $35,732 in 2006 and $102,067 in 2005 due to the purchase of debentures payable at less than par value. The Company purchased fewer debentures in 2007 and 2006 than it did in 2005, which resulted in less realized gain in debt extinguishments.
Increases (decreases) in liability for future policy benefits were ($213,867), ($123,066) and $308,563 in 2007, 2006 and 2005, respectively. The decrease in 2007 is primarily due to a decrease in additional contract reserves on individual dental policies and a decrease in life liabilities. The number of individual dental policies in force decreased in 2007 and the seasoned block of life business continued to decline. The decrease in future policy benefits in 2006 was primarily due to a reduction in life liabilities from an increase in surrenders on life policies and the decrease in future policy benefits liability as a result of the terminated agreement between the Company and SEMI mentioned above. As part of the termination agreement, the block of business was transferred to another company associated with SEMI and the liability for future policy benefits was reduced by $95,000. In 2005 the increase is comprised primarily of an increase in unearned premium liabilities on group and individual dental business.
Amortization of deferred policy acquisition costs was $16,060 in 2007, $26,219 in 2006 and $22,467 in 2005. Amortization of deferred policy acquisition costs are primarily costs associated with a seasoned block of business written between 1988 and 1990. The decrease in amortization expense trend should continue in subsequent years until the acquisition costs are completely amortized. Amortization expense per year may vary in relation to lapses or surrenders of the existing block of business.
Operating expenses were $9,012,950 in 2007, $8,759,605 in 2006 and $8,558,205 in 2005. The increase in expenses in 2007 was due primarily to an increase in payroll expense, executive incentive bonuses, agent recruiting bonuses and independent accounting fees. Payroll expense increased due to an increase in the variety of products available and an increase in the number of states in which we are authorized to operate. Executive incentive bonuses increased due to a 2% increase in the amount of the bonus and an increase in profit. The Company implemented agent bonus programs in 2007 to increase the number of agents marketing its products. The increase for 2006 is primarily due to an increase in payroll expense associated with the issuance of policies, customer service and information systems.
BNLAC has applied for authority to market insurance products in additional states. In 2007 we received a certificate of authority in North Carolina, Virginia, Vermont, Maine, Maryland and District of Columbia and in the first part of 2008 we were approved in Hawaii.
The information in response to this Item 8 is set forth on pages through attached to this Report which pages are hereby incorporated by reference.