The Company earns revenues primarily from premiums received from the sale of life, immediate annuity and accident and health policies, from earnings on its investment portfolio and from the sale of investment assets. Revenues from the sale of traditional life insurance and immediate annuity products and accident and health products are reported as premium income for financial statement purposes. Considerations for supplementary contracts with life contingencies are reported as part of other revenues. However, deposits received from the sale of interest sensitive products, namely universal life insurance products, fixed deferred annuities, variable universal life, variable annuities and supplementary contracts without life contingencies, are not reported as premium revenues, but are instead reported as additions to the policyholders’ account balances and are reflected as deposits in the Consolidated Statements of Cash Flows. Accordingly, revenues on these products are recognized over time in the form of contract charges assessed against policyholder account balances, charges assessed on the early surrender of policyholder account balances and other charges deducted from policyholders’ balances.
The rate of morbidity, disability and incurrence of other policyholder benefits;
The ability to maximize other investment returns and minimize risks such as interest rate risk, credit risk and equity risk;
Increasing competition in the recruiting of new agents and agent practices;
Fixed maturity securities, which are classified as available for sale, are carried at their fair value in the Company’s Consolidated Balance Sheets, with unrealized gains or losses recorded in accumulated other comprehensive income (loss). The unrealized gains or losses are recorded net of the adjustment to policyholder account balances and deferred acquisition costs to reflect what would have been earned had those gains or losses been realized and the proceeds reinvested. The Company’s fair value of fixed maturity and equity securities are derived from external pricing services, brokers, and internal matrices and calculations. At December 31, 2010, approximately 96% of the carrying value of these investments was from external pricing services and 4% was derived from brokers and internal matrices or calculations. The investment portfolio is monitored regularly to ensure that investments which may be other-than-temporarily impaired are identified in a timely fashion and properly valued. Other-than-temporary impairments that are determined to be due to credit are charged against earnings as realized investment losses. The valuation of the investment portfolio involves a variety of assumptions and estimates.
Investments in mortgage loans totaled $559.2 million at December 31, 2010 ($457.6 million - December 31, 2009). The Company’s mortgage loans are mostly secured by commercial real estate and are carried net of an allowance for loss of $3.4 million ($3.4 million - 2009). The allowance for loss on mortgage loans is maintained at a level believed by management to be adequate to absorb potential future credit losses. Management’s periodic evaluation and assessment of the adequacy of the reserve is based on known and inherent risks in the portfolio, historical and industry data, current economic conditions and other relevant factors. Over the past three years, the Company has had one mortgage loan default, which occurred in the fourth quarter of 2010. The Company completed the foreclosure on this loan in the fourth quarter of 2010 with no impairment recorded due to the fair value of the equity in the property being greater than its book value. Two loans were delinquent for 30 days at December 31, 2010, but payments were received and both loans were brought current in January 2011. No loans were restructured during 2010. No mortgage loans were restructured or delinquent for more than 90 days or foreclosed upon and transferred to real estate investments during 2009.
At December 31, 2010, the Company had 16% of its invested assets in mortgage loans, up from 14% at December 31, 2009. In addition to the subject collateral underlying the mortgage, the Company typically requires some amount of recourse from borrowers as another potential source of repayment. The recourse requirement is determined as part of the underwriting requirements of each loan. The Company added 69 new loans to the portfolio during 2010, and 54 or 78% of these loans had some amount of recourse requirement. The Company added $84.6 million in purchased mortgage loans from another institutional lender during 2010. These purchased loans are seasoned performing loans having characteristics of property type, geographical diversification, term, underwriting and cash flows that are similar to the Company’s portfolio of originated loans. In addition, the Company purchased one $1.9 million loan during the fourth quarter of 2010 from a separate originator. At December 31, 2010, 15% of the Company’s commercial mortgage portfolio was acquired and not originated by the Company. During 2009, the Company added 26 new loans and 100% of these loans included some amount of recourse. The average loan to value ratio for the overall portfolio was 49% at both December 31, 2010 and December 31, 2009, based upon the underwriting and appraisal of value at the time the loan was originated or acquired.
The table below identifies mortgage loans by maturity as of December 31, 2010 and December 31, 2009.
The table below identifies the commercial mortgage portfolio by current loan balance as of years ending December 31.
Deferred acquisition costs (DAC), principally agent commissions and other selling, selection and issue costs, which vary with and are directly related to the production of new business, are capitalized as incurred. At least annually, the Company reviews its DAC capitalization policy and the specific items which are capitalized with existing guidance. These deferred costs for life insurance products are generally deferred and amortized over the premium paying period. Policy acquisition costs that relate to interest sensitive and variable insurance products are deferred and amortized with interest in relation to the estimated gross profits to be realized over the lives of the contracts. DAC is reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts.
When a new block of business is acquired or when an insurance company is purchased, a portion of the purchase price is allocated to a separately identifiable intangible asset, called the value of business acquired (VOBA). VOBA is established as the actuarially determined present value of future gross profits of the business acquired and is amortized with interest in proportion to future premium revenues or the expected future profits, depending on the type of business acquired. Similar to DAC, the assumptions regarding future experience can affect the carrying value of VOBA, including interest spreads, mortality, expense margins and policy and premium persistency experience. Significant changes in these assumptions can impact the carrying balance of VOBA and produce changes that are reflected in the current period’s income as an unlocking adjustment to the amortization of the VOBA amortization. VOBA amortization is included in operating expenses in the Consolidated Statements of Income. VOBA is reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts.
Profit expectations are based upon assumptions of future interest spreads, mortality margins, expense margins and policy and premium persistency experience. Mortality relates to the occurrence of death. Interest spreads are the difference between the investment returns earned and the crediting rates of interest applied to policyholder account balances. Surrender rates relate to the relative volume of policy terminations. Expense margins involve the expenses incurred for maintaining and servicing in force policies. These assumptions involve judgment and are compared to actual experience on an ongoing basis. If it is determined that the assumptions related to the profit expectations for interest sensitive and variable insurance products should be revised, the impact of the change is reported in the current period’s income as an unlocking adjustment. The Company considers the following assumptions to be of significance when evaluating the amortization of VOBA: expected mortality, interest spreads, surrender rates and expense margins.
At least annually, a review is performed of the models and the assumptions used to develop expected future profits, based upon management’s current view of future events. Management’s view primarily reflects Company experience but can also reflect emerging trends within the industry. Short-term deviations in experience affect the amortization of VOBA in the period, but do not necessarily indicate that a change to the long-term assumptions of future experience is warranted. If it is determined that it is appropriate to change the assumptions of future experience, then an unlocking adjustment is recognized for the block of business being evaluated. Certain assumptions, such as interest spreads and surrender rates, may be interrelated. As such, unlocking adjustments often reflect revisions to multiple assumptions. The balance of VOBA is immediately impacted by any assumption changes, with the change reflected through the income statement as an unlocking adjustment in the amount of VOBA amortized. These adjustments can be positive or negative with adjustments reducing amortization limited to amounts previously deferred plus interest accrued through the date of the adjustment. The impact of unlocking adjustments from the changes in estimates for the periods reported are included in the Consolidated Results of Operations and Operating Results by Segment sections of the Management’s Discussion and Analysis of Financial Condition and Results of Operations contained within this document.
A 2.5% increase in expected mortality experience for all future years would result in a reduction in DAC and an increase in current period amortization expense of $2.9 million.
Based on Company surrender experience. Industry experience and trends are also considered.
A 10% increase in expected surrender rates for all future years would result in a reduction in DAC and an increase in current period amortization expense of $1.3 million.
A 10 basis point reduction in future interest rate spreads would result in a reduction in DAC and an increase in current period amortization expense of $2.9 million.
A 10% increase in future maintenance expenses would result in a reduction in DAC and an increase in current period amortization expense of $2.0 million.
A 2.5% increase in expected mortality experience for all future years would result in a reduction in VOBA and an increase in current period amortization expense of $1.1 million.
A 10% increase in expected surrender rates for all future years would result in a reduction in VOBA and an increase in current period amortization expense of $0.9 million.
A 10% increase in future maintenance expenses would result in a reduction in VOBA and an increase in current period amortization expense of $0.2 million.
A variety of reinsurance vehicles are currently in use, including individual and bulk arrangements on both coinsurance and mortality/morbidity-only basis. Reinsurance supports a multitude of corporate objectives, including managing statutory capital, reducing volatility and surplus strain and is an actively managed tool for the Company. At the customer level, reinsurance increases the Company’s capacity, provides access to additional underwriting expertise, and generally makes it possible for the Company to offer products at competitive levels that could not otherwise be made available.
Policyholder account balances include universal life insurance, fixed deferred annuity contracts and investment-type contracts. Liabilities for these policyholder account balances are included without reduction for potential surrender charges and deferred front-end contract charges. The account balances for universal life contracts are equal to cumulative deposits, less contract charges and withdrawals, plus interest credited. The account balances for fixed deferred annuities and investment-type contracts are equal to the cumulative deposits, less any applicable contract charges and withdrawals, plus interest credited. Front-end contract charges are deferred and amortized over the term of the policies. Policyholder benefits incurred in excess of related policyholder account balances are charged to policyholder benefits expense. Interest on policyholder account balances is credited as earned.
The measurement of pension and other postretirement benefit obligations and costs depends on a variety of assumptions. Assumptions are made regarding the discount rate, expected long-term rate of return on plan assets, employee turnover, expected compensation increases, health care claim costs, heath care cost trends, retirement rates and mortality. The discount rate and the expected return on plan assets have the most significant impact on the level of cost. See Note 9 - Pensions and Other Postretirement Benefits in the Notes to Consolidated Financial Statements for further details.
In addition, the Company recognizes the funded status of its defined benefit pension and postretirement plans, measured as the difference between plan assets at fair value and the benefit obligation, on the balance sheet. Changes in the funded status that arise during the period but are not recognized as components of net periodic benefit cost are recognized within other comprehensive income (loss), net of income taxes.
Deposits related to universal life, fixed deferred annuity contracts and investment-type products are credited to policyholder account balances. Revenues from such contracts consist of amounts assessed against policyholder account balances for mortality, policy administration and surrender charges, and are recognized in the period in which the benefits and services are provided in contract charges in the Consolidated Statements of Income. The cash flows from deposits are credited to policyholder account balances. Deposits are not recorded as revenue. Deposits are shown as a Financing Activity in the Consolidated Statements of Cash Flows.
The Company measures its sales or new business production with two components: new premiums recorded and new deposits received and then by general product type. New premiums and new deposits are considered to be first year and single receipts. Premiums and deposits are subdivided into two categories: new and renewal. New premiums and deposits are measures of sales or new business production. Renewal premiums and deposits occur as continuing business from existing customers.
Deferred income taxes are recorded on the differences between the tax bases of assets and liabilities and the amounts at which they are reported in the consolidated financial statements. Recorded amounts are adjusted to reflect changes in income tax rates and other tax law provisions as they become enacted. Deferred income tax assets are subject to ongoing evaluation of whether such assets will be realized. The ultimate realization of deferred income tax assets generally depends on the reversal of deferred tax liabilities and the generation of future taxable income and realized gains during the periods in which temporary differences become deductible. Deferred income taxes include future deductible differences relating to unrealized losses on investment securities. The Company evaluates the character and timing of unrealized gains and losses to determine whether sufficient future taxable amounts are sufficient to offset future deductible amounts. A valuation allowance against deferred income tax assets may be required if future taxable income of the correct character is not expected.
The Company’s marketing plan for individual products focuses on providing financial security with respect to life insurance, accumulation and retirement income needs. The primary emphasis is on the growth of individual life insurance business, including new premiums for individual life products and new deposits for universal life and variable universal life products.
Sales are primarily made through the Company’s existing sales force. The Company is emphasizing growth of the sales force with the addition of new general agents and agents. The Company believes that increasing both the number and productivity of general agents and agents is essential to increasing new sales. The Company has also placed an emphasis on training and direct support within the field. As alternative sales opportunities arise, the Company selectively utilizes third-party marketing arrangements to enhance its sales objectives. The marketing plan allows the Company the flexibility to identify niches or pursue unique avenues in the existing market environment and to react quickly to be able to take advantage of short-term opportunities when they occur.
Consolidated total premiums increased $4.0 million or 2% in 2010 compared to 2009, as total new premiums increased $5.2 million or 11% and total renewal premiums decreased $1.2 million or 1%. The two largest contributors to the increase in new premiums were a $2.3 million or 16% increase in new individual life insurance premiums and a $2.0 million or 18% increase in new group accident and health insurance premiums. The increase in new individual life premiums was largely the result of a $2.6 million or 29% increase in new individual life premiums in the Old American segment. The increase in new group accident and health premiums reflected increases in disability and dental premiums. In addition, new group life insurance premiums increased $0.7 million or 43% compared to one year earlier. The decrease in renewal premiums was largely due to a 10% decrease in group life premiums and a 1% decrease in group accident and health premiums, primarily in the dental product line. These were partially offset by a 1% increase in renewal individual life premiums.
Renewal deposits increased $1.8 million or 1% in 2010 compared to a $4.3 million or 3% increase in 2009. The increase during 2010 was due to a $5.7 million or 21% increase in renewal fixed deferred annuity deposits, largely resulting from the increased sales experienced during 2009. This was partially offset by a $1.8 million decline in renewal universal life deposits, a $1.5 million or 11% decrease in variable universal life deposits and a $0.6 million or 6% decline in variable annuity deposits. The increase in 2009 resulted from higher fixed deferred annuity deposits, which increased $9.3 million or 54% compared to one year ago. This increase was partially offset by declines in the following products: $2.9 million or 3% in universal life deposits, $1.2 million or 8% in variable universal life deposits and $0.8 million or 8% in variable annuity deposits.
Insurance revenues consist of premiums and contract charges less reinsurance ceded. Insurance revenues increased $3.0 million or 1% to $245.8 million in 2010, compared to a $6.6 million or 3% increase in 2009. The improvement in 2010 was largely due to a $4.0 million or 2% increase in premiums, largely due to increased premiums in the Old American segment. Total life premiums increased $2.5 million or 2%, and total accident and health premiums increased $1.3 million or 3%. These were partially offset by a $1.2 million or 2% increase in reinsurance ceded. The improvement in 2009 resulted from a $10.0 million or 6% increase in premiums. Total annuity premiums increased $9.5 million or 75%, and total accident and health premiums increased $1.0 million or 2%. The improvement in premiums was partially offset by a $3.3 million or 3% decrease in contract charges.
Insurance revenues are affected by the level of new sales, the type of products sold, the persistency of policies, general economic conditions and competitive forces. The Company strives to provide a portfolio of products with safety and competitive return objectives. The Company offers a broad range of products, including variable insurance products, which allow policyholders to participate in both the equity and fixed income markets. Interest sensitive and traditional insurance products combine safety of principal with competitive interest returns.
Contract charges were essentially flat in 2010 versus one year earlier, compared to a 3% decrease in 2009. The results in 2010 reflected a decrease in cost of insurance charges, largely due to the runoff of closed blocks, and a decrease in surrender charges resulting from lower surrenders of variable and universal life products. Offsetting these changes, expense loads increased due to higher account values of variable annuities from the sale of universal life products. In addition, deferred revenue increased, largely due to unlocking that occurred during 2010, as discussed below. The decline in 2009 can largely be attributed to three factors: lower account balances on variable contracts, lower surrender charges due to a decline in policy surrenders on certain products and the runoff of closed blocks. Included in total contract charges are blocks of policies and companies that the Company has purchased with the intent of servicing these blocks to achieve long-term purchased profit streams but without additional marketing for further new sales. Total contract charges on these closed blocks equaled 36% of total consolidated contract charges during 2010, compared to 37% in 2009. Total contract charges on closed blocks declined 4% in 2010 compared to 2009, reflecting the runoff of this business. Total contract charges on open blocks of business increased 3% in 2010 compared to 2009, reflecting the growing blocks of new and existing products.
At least annually, a review is performed regarding the assumptions related to profit expectations. If it is determined that the assumptions should be revised, an adjustment may be recorded to contract charge deferred revenues in the current period as an unlocking adjustment. The Company had an unlocking in the DRL in 2010 related to changes in assumptions. The impact of the unlocking on DRL was a decrease in the liability and a corresponding increase in the recognition of deferred revenue in 2010 in the amount of $1.1 million. No unlocking adjustments were identified on the DRL during 2009. Unlocking that occurred during 2008 resulted in an increase to the deferred revenue liability and a corresponding decrease in the recognition of deferred revenue in the amount of $0.8 million.
Net investment income decreased 1% in 2010 compared to 2009 and was flat in 2009 versus 2008. Net investment income was $175.9 million in 2010 compared to $177.4 million in both 2009 and 2008. While average invested assets increased during 2010, this was offset by a decline in yields earned on investments. Net investment income results in 2009 were impacted by a decline in the Company’s invested asset base and a slight improvement in yields from the portfolio. In addition, expenses associated with investment income increased during 2010 compared to a decline in 2009.
Short-term investments totaled $15.7 million at December 31, 2010, down from $138.7 million at December 31, 2009. Short-term invested assets consist primarily of money-market funds. The holdings of short-term investments at year-end 2009 reflected proceeds from sales and renewals of life and annuity products, along with sales and maturities of long-term investments which had not been reinvested. The decrease during 2010 reflected the reinvestment of those funds. Income from short-term investments declined $0.1 million or 30% in 2010 and $0.7 million or 73% in 2009. The decline in 2010 was due to reduced short-term investments due to reinvestment and lower short-term yields. The decline experienced in 2009 was primarily the result of a decline in yields.
The Company offers policy loans as a benefit to its policyholders. These loans are payable at the policyholder’s discretion but are secured by the cash value of the policy. Policy loans totaled $84.3 million at December 31, 2010, down $1.3 million from December 31, 2009. Investment income from policy loans declined 1% in 2010 and 5% in 2009. The declines in both years were largely due to reduced balances of policy loans outstanding.
The following table summarizes securities with other-than-temporary impairments recognized in earnings during the four quarters of 2009 by asset class:
The Company seeks to protect policyholders’ benefits and achieve a desired level of organizational profitability by optimizing risk and return on an ongoing basis through managing asset and liability cash flows, monitoring credit risk, avoiding high levels of investments that may be redeemed by the issuer, maintaining sufficiently liquid investments and avoiding undue asset concentrations through diversification, among other things. The Company has three primary sources of investment risk:
Kansas City Life Insurance Company is a Missouri domiciled stock life insurance company which, with its subsidiaries, is licensed to sell insurance products in 49 states and the District of Columbia. The Company offers a diversified portfolio of individual insurance, annuity and group products through three life insurance companies. The consolidated entity (the Company) primarily consists of three life insurance companies. Kansas City Life Insurance Company (Kansas City Life) is the parent company. Sunset Life Insurance Company of America (Sunset Life) and Old American Insurance Company (Old American) are wholly-owned subsidiaries.
The accompanying consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America (GAAP) and include the accounts of Kansas City Life and its subsidiaries, principally Sunset Life and Old American. Significant intercompany transactions have been eliminated in consolidation and certain immaterial reclassifications have been made to the prior period results to conform with the current period’s presentation.
Investment income is recognized when earned. Premiums and discounts on fixed maturity securities are amortized over the life of the related security as an adjustment to yield using the effective interest method. Realized gains and losses on the sale of investments are determined on the basis of specific security identification recorded on the trade date. Securities available for sale are stated at fair value. Unrealized gains and losses, net of adjustments to deferred acquisition costs (DAC), value of business acquired (VOBA), policyholder account balances and deferred income taxes, are reported as a separate component of accumulated other comprehensive income (loss) in stockholders’ equity. Unrealized losses represent the difference between amortized cost and fair value on the valuation date. The adjustments to DAC and VOBA represent changes in the amortization of DAC and VOBA that would have been required as a charge or credit to income had such unrealized amounts been realized. The adjustment to policyholder account balances represents the increase from using a discount rate that would have been required if such unrealized gains or losses had been realized and the proceeds reinvested at current market interest rates, which were lower than the then-current effective portfolio rate.
Real estate consists of directly owned investments and real estate joint ventures. Real estate that is directly owned is carried at depreciated cost. Real estate joint ventures consist primarily of office buildings, industrial warehouses, unimproved land for future development and low income housing tax credit (LIHTC) investments. Real estate joint ventures are consolidated when required or are valued at cost, adjusted for the Company’s equity in earnings.
The Company monitors the various markets in which its investments are traded. The Company utilizes a primary independent third-party pricing service to determine the majority of its fair values. The Company uses a second third-party pricing service to validate the fair market values provided by the primary pricing service. The Company also uses the second pricing service to determine the fair value of certain securities for which the primary pricing service was unable to provide. The Company reviews values received from independent pricing sources for unusual fluctuations. In addition, the Company tests a limited number of securities from the primary independent pricing service each reporting period to further validate reliance on the fair values provided. When fair values are not available from external service providers, where possible, the Company pursues external pricing from brokers. Generally, the Company pursues and utilizes only one broker quote per security. In doing so, the Company solicits only brokers which have previously demonstrated knowledge and experience of the subject security. When the Company cannot obtain reliable broker pricing, a fair value is determined based upon an assessment of several factors appropriate for the specific issue, including but not limited to: the issuer’s industry; liquidity; cash flows; marketability, ratings and the ability of the issuer to satisfy the obligation; government intervention or regulations; fair value of comparable securities in actively traded or quoted markets; or other factors. The Company creates a matrix of factors from which to calculate an estimable value. However, all factors may not be known or publicly available from which to determine a value and, as such, the fair value used by the Company may not be truly indicative of the actual value available in an active market or an actual exit price if the Company were to sell the security in the current market.
The current fair value of the security as compared to amortized cost;
The Company may selectively determine that it no longer intends to hold a specific issue to its maturity. If the Company makes this determination and the fair value is less than the cost basis, an analysis of the fair value of the investment is performed and the investment is written down to the fair value and an other-than-temporary impairment is recorded on this particular position. Subsequently, the Company seeks to obtain the best possible outcome available for this specific issue and records an investment gain or loss at the disposal date.
The Company has exposure to the municipal bond market. The Company’s investments in municipal bonds present unique considerations in evaluating other-than-temporary impairments. Judgments regarding whether a municipal debt security is other-than-temporarily impaired include analyzing a number of rather unique characteristics pertaining to the issuer. Municipalities possess unique powers, along with special legal standing and protections. These powers include the sovereign power to tax, access to one-time revenue sources, capacity to issue or restructure debt and the ability to shift spending to other authorities. In addition, state governments often provide secondary support to local governments in times of financial stress and the federal government has also provided assistance to state governments as well.
The Company has financing receivables as defined in the newly issued and adopted guidance Accounting Standards Update No. 2010-20 “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.”
The Company has several categories of receivables, not all of which meet the definition of a financing receivable as defined under the guidance. The Company has both long-term receivables and short-term receivables which might otherwise meet the definition, except that short-term receivables are specifically excluded under the guidance. To qualify as a financing receivable, a receivable must have both a specific maturity date, either on demand or on a fixed or determinable date, and it must be recognized as an asset in the Company’s statement of financial position. In addition, certain investments in mortgage loans and policy loans were also be evaluated to determine whether they meet the definition of a financing receivable. The Company’s financing receivables are defined as follows:
The Company has agent receivables which are classified as financing receivables and which are reduced by an allowance for doubtful accounts. These receivables are long-term in nature, are trade receivables with the Company’s sales force, contain specifically agreed contracts and are specifically assessed as to the collectability of each receivable. The Company’s gross agent receivables totaled $2.8 million at December 31, 2010 and the Company maintained an allowance for doubtful accounts totaling $0.6 million. The Company has two types of agent receivables included in this category as follows:
Agent specific loans. These loans totaled $0.3 million with a minimal allowance for doubtful accounts.
For interest sensitive and variable insurance products, estimated gross profits are composed of net interest income, net realized investment gains and losses, fees, surrender charges, expenses, and mortality gains and losses. At the issuance of policies, projections of estimated gross profits are made which are then replaced by actual gross profits over the lives of the policies. In addition to other factors, emerging experience may lead to a revised outlook for the remaining estimated gross profits. Accordingly, DAC may be recalculated using these new assumptions and any resulting adjustment is included in income. The Company considers the following assumptions to be of significance when evaluating future estimated gross profits: mortality, interest rates and spreads, surrender and withdrawal rates and expense margins.
The other factor impacting the amortization of DAC was an unlocking that occurred in 2010. The unlocking primarily related to a change in the estimated future gross profits associated with the mortality assumption for certain universal life and variable universal life products. This unlocking adjustment reflects actual experience from mortality results that have emerged and which have been better than assumed in expected future profits previously established. The unlocking of the mortality assumption on the variable universal life product included a change to a more recent mortality table. This table is also currently used by the Company in the mortality assumption for universal life and allows the Company enhanced consistency with mortality assumptions on other interest-sensitive products. In addition, the Company also unlocked an interest rate assumption on selected fixed deferred annuity products. The impact of unlocking was an increase in the DAC asset and a corresponding decrease in the amortization of DAC of $5.8 million. While no material DAC unlocking or change in estimate occurred in 2009, DAC amortization was reduced by $3.0 million due to unlocking during 2008.
When a new block of business is acquired or when an insurance company is purchased, a portion of the purchase price is allocated to a separately identifiable intangible asset, called the value of business acquired (VOBA). VOBA is established as the actuarially determined present value of future gross profits of the business acquired and is amortized with interest in proportion to future premium revenues or the expected future profits, depending on the type of business acquired. VOBA is reported as a component of other assets with related amortization included in operating expenses. Amortization of VOBA occurs with interest over the anticipated lives of the underlying business to which it relates, initially 15 to 30 years. Similar to DAC, the assumptions regarding future experience can affect the carrying value of VOBA, including interest spreads, mortality, expense margins and policy and premium persistency experience. Significant changes in these assumptions can impact the carrying balance of VOBA and produce changes that are reflected in the current period’s income as an unlocking adjustment. Profit expectations are based upon assumptions of future interest spreads, mortality margins, expense margins and policy and premium persistency experience. Mortality relates to the occurrence of death. Interest spreads are the difference between the investment returns earned and the crediting rates of interest applied to policyholder account balances. Surrender rates relate to the relative volume of policy terminations. Expense margins involve the expenses incurred for maintaining and servicing in force policies. These assumptions involve judgment and are compared to actual experience on an ongoing basis. If it is determined that the assumptions related to the profit expectations for interest sensitive and variable insurance products should be revised, the impact of the change is reported in the current period’s income as an unlocking adjustment.
At least annually, a review is performed of the models and the assumptions used to develop expected future profits, based upon management’s current view of future events. VOBA is reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts. Management’s view primarily reflects Company experience but can also reflect emerging trends within the industry. Short-term deviations in experience affect the amortization of VOBA in the period, but do not necessarily indicate that a change to the long-term assumptions of future experience is warranted. If it is determined that it is appropriate to change the assumptions related to future experience, then an unlocking adjustment is recognized for the block of business being evaluated. Certain assumptions, such as interest spreads and surrender rates, may be interrelated. As such, unlocking adjustments often reflect revisions to multiple assumptions. The VOBA balance is immediately impacted by any assumption changes, with the change reflected through the income statement as an unlocking adjustment in the amount of VOBA amortized. These adjustments can be positive or negative with adjustments reducing amortization limited to amounts previously deferred plus interest accrued through the date of the adjustment.
VOBA is also reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts. If it is determined from emerging experience that the premium margins or gross profits are insufficient to amortize deferred acquisition costs, then the asset will be adjusted downward with the adjustment recorded as an expense in the current period. No impairment adjustments have been recorded in the years presented.
The amortization of VOBA increased $2.2 million in 2010 compared to the same period in the prior year. This increase was due primarily to two factors, both which occurred in the prior year. First, in 2009, the Company refined its method for calculating VOBA from a premium-based method to a volume-based method for certain traditional life products. Since the Company’s establishment of VOBA, it had used the measure of premium in force which had been inconsistent from period to period due to the way the premium in force was identified and captured. This resulted in a corresponding volatile amortization of VOBA that was inconsistent when related to the actual run off of the in force policies. Accordingly, the Company refined its method of estimating VOBA to the use of volume in force. This refinement in estimate reduced VOBA amortization $2.5 million in 2009. Second, the Company had an unlocking adjustment on interest-sensitive products, which decreased VOBA amortization $0.2 million in 2009. There was no unlocking or refinement in methodology in 2010 (2008 - increased amortization $0.2 million).
The following table identifies the effects of the VOBA change in estimate and unlocking in the Consolidated Statements of Income for the years ended December 31.
The VOBA asset is adjusted to reflect the impact of unrealized gains and losses on fixed maturity securities available for sale, as described in the Investments section of Note 1. The change in VOBA asset from unrealized losses on fixed maturity securities in 2010 was $(10.1) million (2009 - $(12.4) million; 2008 - $15.2 million).
Contract charges consist of cost of insurance, expense loads, the amortization of unearned revenues and surrender charges. Cost of insurance relates to charges for mortality. These charges are applied to the excess of the mortality benefit over the account value for universal life policies. Expense loads are amounts that are assessed against the policyholder balance as consideration for origination and maintenance of the contract. Surrender charges are fees imposed on policyholders upon cancellation of a policy.
Unlocking or other events may also have an impact on products and policies. If it is determined that it is appropriate to change the assumptions of future experience, then an unlocking adjustment is recognized for the block of business being evaluated. Certain assumptions, such as interest spreads and surrender rates, may be interrelated. As such, unlocking adjustments often reflect revisions to multiple assumptions. In addition, the Company may also consider refinements in estimates for other unusual or one-time occurrences for events such as administrative or actuarial system upgrades. These items are applied to the appropriate financial statement line items similar to unlocking adjustments.
Consistent with the general practice of the life insurance industry, the Company enters into traditional agreements of indemnity reinsurance with other insurance companies to support sales of new products and the in force business. The reinsurance arrangements have taken various forms over the years. The Company has reinsurance in force on all of the following bases: automatic and facultative; yearly renewable term (YRT) and coinsurance; and excess and quota share basis. For additional information pertaining to the Company’s significant reinsurers, along with additional information pertaining to reinsurance, please see Note 13 - Reinsurance in the Notes to Consolidated Financial Statements.
Currently, new sales of traditional life and universal life products are reinsured on a YRT basis in excess of the Company’s retention limits while sales of certain term life insurance products are reinsured on a quota share (a portion of each policy is reinsured), coinsurance basis. Sales of group disability income products are reinsured on a quota share coinsurance basis. New sales of group life are reinsured on an excess of retention basis with the accidental death and dismemberment benefits being 100% reinsured. The Company’s maximum retention limit on individual life insurance products is three hundred fifty thousand dollars and on group life business is one hundred thousand dollars.
As of December 31, 2010, separate account balances for variable annuity contracts were $240.6 million. The total reserve held for variable annuity GMDB was $0.3 million. Additional information related to the GMDB and related separate account balances and net amount at risk (the amount by which the GMDB exceeds the account balance) as of December 31, 2010 and 2009 is provided below:
Deferred income tax assets are subject to ongoing evaluation of whether such assets will be realized. The ultimate realization of deferred income tax assets generally depends on the reversal of deferred tax liabilities and the generation of future taxable income and realized gains during the periods in which temporary differences become deductible. Deferred income taxes include future deductible differences relating to unrealized losses on investment securities. The Company evaluates the character and timing of unrealized gains and losses to determine whether sufficient future taxable amounts are sufficient to offset future deductible amounts. A valuation allowance against deferred income tax assets may be required if future taxable income of the correct character is not expected.
Due to the Company’s capital structure and the absence of other potentially dilutive securities, there is no difference between basic and diluted earnings per common share for any of the years reported. The average number of shares outstanding during 2010 was 11,486,306 shares (2009 - 11,550,016 shares; 2008 - 11,568,635 shares). The number of shares outstanding at year-end 2010 was 11,467,105 (2009 - 11,565,091).
The Company has some insurance contracts where the policyholder is entitled to share in the earnings through dividends that reflect the difference between the premium charged and the actual experience. Participating business at year-end 2010 approximated 4% of statutory premiums and 5% of the life insurance in force. The amount of dividends to be paid is determined annually by the Board of Directors. Provision has been made in the liability for future policy benefits to allocate amounts to participating policyholders on the basis of dividend scales contemplated at the time the policies were issued. Additional provisions have been made for policyholder dividends in excess of the original scale, which have been declared by the Board of Directors.
In October 2008, the FASB issued new guidance to clarify the application of fair value accounting in a market that is not active and to provide an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. The Company adopted this guidance upon issuance, with no material impact to the consolidated financial statements.
In April 2009, the FASB issued new guidance regarding other-than-temporary impairment of debt securities and changes in the recognition and presentation of debt securities determined to be other-than-temporarily impaired. The guidance requires an enterprise to bifurcate any other-than-temporary impairment between credit and non-credit impairments and then establish accounting treatment for each aspect, in current and subsequent periods. Retroactive application became required to other-than-temporary impairments recorded in prior periods by making a cumulative-effect adjustment to the opening balance of retained earnings and accumulated other comprehensive income (loss) in the period of adoption. This guidance became effective for financial statements issued for interim and annual periods ending after June 15, 2009. The Company elected early adoption effective for the period ended March 31, 2009 with retroactive application effective January 1, 2009. For additional information pertaining to this guidance, please see Note 15 - Accumulated Effect of Change in Accounting Principle.
In June 2009, the FASB issued new guidance to improve the information that a reporting entity provides in its financial reports related to a transfer of financial assets. It addresses the effects of a transfer on financial position, financial performance, cash flows and a transferor’s continuing involvement in transferred financial assets. In addition, this guidance also eliminates the concept of a qualifying special-purpose entity. This guidance became effective for interim and annual accounting periods beginning after November 15, 2009. The Company adopted it on January 1, 2010 with no material impact to the consolidated financial statements.
In January 2010, the FASB issued new guidance to improve disclosures about fair value measurements. This guidance requires new disclosures and clarification of existing disclosures regarding Levels 1, 2 and 3 in the fair value hierarchy. The majority of this guidance became effective for interim and annual reporting periods beginning after December 15, 2009. However, disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements will become effective for fiscal years beginning after December 15, 2010 and for interim periods within those years. The Company adopted the guidance on January 1, 2010 with no material impact to the consolidated financial statements.
The Company has assessed, based upon the information available, the Affordable Care Act, as passed in the first quarter of 2010. The Company has considered its medical and dental plans provided for employees, agents and retirees. While the Company will incur additional costs associated with the implementation of this Act, it does not believe these costs or ongoing costs associated with this Act will have a material impact to the consolidated financial statements. The Company does not provide a separate prescription drug plan to its retirees. In addition, the Company does not sell any medical insurance or prescription drug coverage. However, the Company does sell dental and vision insurance but believes that the impact of this Act is immaterial to these products. The Company will continue to assess the information contained in this Act as additional guidance becomes available and as additional implications are understood or clarified.
The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in July of 2010. This Act focuses on financial reform, specifically changes to derivatives regulation, regulatory framework for executive pay, corporate governance, investor protection, clawback provisions, mortgage reform, and numerous other issues. The Company will continue to assess the information contained in this Bill as additional guidance becomes available and as additional implications are clarified. The Company expects that additional disclosures will become required and additional costs may be associated with this Act. However, the Company does not believe they will have a material impact to the consolidated financial statements.
The Company groups its financial assets and liabilities measured at fair value in three levels, based on the inputs and assumptions used to determine the fair value. These levels are as follows:
Under U.S. GAAP, fair value represents the price that would be received to sell an asset (exit price) or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is the Company’s policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. Accordingly, the Company utilizes a primary independent third-party pricing service to determine the majority of its fair values on investment securities available for sale. At December 31, 2010, the Company used a second independent third-party pricing service to validate the fair market values provided by the primary pricing service. The Company also used the second pricing service to determine the fair value of certain securities for which the primary pricing service was unable to provide.
Fair values of mortgage loans on real estate properties are calculated by discounting contractual cash flows, using discount rates based on current industry pricing or the Company’s estimate of an appropriate risk-adjusted discount rate for loans of similar size, type, remaining maturity, likelihood of prepayment, and repricing characteristics.
The Company had no borrowings at December 31, 2010 or December 31, 2009.
The Company had $18.6 million transfers into Level 3 and $13.0 million transfers out of Level 3 for the year ended December 31, 2010. The Company did not exclude any realized or unrealized gains or losses on items transferred into Level 3. Depending upon the availability of Level 1 or Level 2 pricing, specific securities may transfer into or out of Level 3.
The table below is a summary of fair value estimates as of December 31, 2010 and December 31, 2009 for financial instruments. The Company has not included assets and liabilities that are not financial instruments in this disclosure. The total of the fair value calculations presented do not represent, and should not be construed to represent, the underlying value of the Company.
The following table provides amortized cost and fair value of securities by asset class at December 31, 2010.
The following table provides amortized cost and fair value for securities by asset class at December 31, 2009.
The Company reviews all security investments, with particular attention given to those having unrealized losses. Further, the Company specifically assesses all investments with greater than 10% declines in fair value and, in general, monitors all security investments as to ongoing risk. These risks are fundamentally evaluated through both a qualitative and quantitative analysis of the issuer. The Company also prepares a formal review document no less often than quarterly of all investments where fair value is less than 80% of amortized cost for six months or more and selected investments that have changed significantly from a previous period and that have a decline in fair value greater than 10% of amortized cost.
The Company has a policy and process in place to identify securities that could potentially have an impairment that is other-than-temporary. This process involves monitoring market events and other items that could impact issuers. The evaluation includes but is not limited to such factors as the issuer’s stated intent and ability to make all principal and interest payments when due, near-term business prospects, cash flow and liquidity, credit ratings, business climate, management changes and litigation and government actions. This process also involves monitoring several factors, including late payments, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts, asset quality and cash flow projections, as indicators of credit issues.
The Company considers relevant facts and circumstances in evaluating whether the impairment of a security is other-than-temporary. Relevant facts and circumstances considered are described in the Valuation of Investments section of Note 1 - Nature of Operations and Significant Accounting Policies.
There are a number of significant risks and uncertainties inherent in the process of monitoring impairments, determining if an impairment is other-than-temporary and determining the portion of an other-than-temporary impairment that is due to credit. These risks and uncertainties are described in the Valuation of Investments Section of Note 1.
The following table provides the change in the net unrealized gains (losses) reported in other comprehensive income (loss), net of tax.
As of December 31, 2010, the Company had gross unrealized losses of $41.6 million on investment securities, including fixed maturity and equity securities, that had a fair value of $589.1 million. As of December 31, 2009, the Company had gross unrealized losses of $93.2 million on investment securities, including fixed maturity and equity securities that had a fair value of $814.4 million. The decrease in unrealized losses was primarily attributable to the improved economy and financial markets, along with a decline in interest rates during the twelve months ended December 31, 2010. These changes affected the broad financial markets and resulted in price improvements in virtually every sector. At December 31, 2010, approximately 25% of the gross unrealized losses were attributable to securities having gross unrealized losses of less than 12 months. This compares to approximately 8% at December 31, 2009. At December 31, 2010, unrealized losses on investments available for sale were primarily due to $16.8 million in unrealized losses on corporate private-labeled residential mortgage-backed securities. In addition, unrealized losses on corporate securities totaled $12.8 million. Based, in part, on the Company’s assessment of the performance of the underlying collateral compared to the credit enhancement, the Company concluded that these securities were not other-than-temporarily impaired at December 31, 2010.
130 security issues representing 69% of the issues with unrealized losses, including 94% being rated as investment grade, were below cost for less than one year;
At December 31, 2009, the Company had unrealized losses on its investment portfolio for fixed maturities and equity securities as follows:
84 security issues representing 36% of the issues with unrealized losses, including 93% being rated as investment grade, were below cost for less than one year;
96 security issues representing 41% of the issues with unrealized losses, including 80% being rated as investment grade, were below cost for one year or more and less than three years; and
The following tables provide the distribution of maturities for fixed maturity securities available for sale with unrealized losses as of December 31, 2010 and December 31, 2009. Expected maturities may differ from these contractual maturities since borrowers may have the right to call or prepay obligations.
Subprime securities include all bonds or portion of bonds where the underlying collateral is made up of home equity loans or first mortgage loans to borrowers whose credit scores at the time of origination were lower than the level recognized in the market at prime. The Company’s classification of subprime does not include Alt-A or jumbo loans, unless the collateral otherwise meets the preceding definition. At December 31, 2010, the Company had investments with subprime residential mortgage exposure of $19.6 million and a related $4.9 million unrealized loss. At December 31, 2009, the Company had investments with subprime residential mortgage exposure of $20.9 million and a related $8.0 million unrealized loss. This exposure amounted to less than 1% of the Company’s invested assets at both December 31, 2010 and 2009.
The following table provides a reconciliation of credit losses recognized in earnings on fixed maturity securities held by the Company for which a portion of the other-than-temporary loss was recognized in other comprehensive income (loss).
The table below provides sales of investment securities available for sale, excluding maturities and calls, for the three years ended December 31.
Investments in mortgage loans totaled $559.2 million at December 31, 2010 ($457.6 million - December 31, 2009). The Company’s mortgage loans are mostly secured by commercial real estate and are stated at cost, adjusted for amortization of premium and accrual of discount, less an allowance for potential future losses. The allowance for mortgage loans is maintained at a level believed by management to be adequate to absorb estimated credit losses and was $3.4 million as of December 31, 2010 and 2009. Management’s periodic evaluation and assessment of the adequacy of the allowance is based on known and inherent risks in the portfolio, historical experience, industry data, current economic conditions and other relevant factors. One mortgage loan has been foreclosed upon and transferred to real estate investments during the past three years. Also, there were two delinquent mortgage loans at December 31, 2010 (none in 2009), although payments were subsequently received in January 2011 to bring these loans current. The Company does not hold mortgage loans of any single borrower that exceeds 5% of stockholders’ equity.
The Company added 69 new loans to the portfolio during 2010 of which 54 or 78% of these loans had some amount of recourse requirement. A total of 38 new loans or $86.5 million were purchased from institutional lenders during 2010 and 15% of the Company’s commercial mortgage portfolio having been acquired rather than originated by the Company. The purchased loans are seasoned performing loans having characteristics of property type, geographical diversification, term, underwriting and cash flows that are similar to the Company’s portfolio of originated loans. The average loan to value ratio for the overall portfolio was 49% at December 31, 2010 and 2009, based upon the appraisal of value at the time the loan was originated or acquired. The average loan balance was approximately $1.5 million at December 31, 2010.
The following table identifies the concentration of mortgage loans by state greater than 5% as of December 31.
The table below identifies mortgage loans by maturity as of December 31.
In the normal course of business, the Company commits to fund commercial mortgage loans generally up to 120 days in advance. The Company had commitments to originate mortgage loans of $6.6 million at December 31, 2010 with fixed interest rates ranging from 5.25% to 6.25%. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, the Company will retain the commitment fee. The commitments in place at December 31, 2010 were funded in January and February 2011, $5.3 million and $1.3 million, respectively.
The Company considers its mortgage loan portfolio to be long-term financing receivables. Mortgage loans are stated at cost net of allowance for potential future losses. Mortgage loan interest income is recognized on an accrual basis with any premium or discount amortized over the life of the loan. Prepayment and late fees are recorded on the date of collection. Loans in foreclosure, loans considered impaired or loans past due 90 days or more are placed on a non-accrual status.
If a mortgage loan is determined to be on non-accrual status, the mortgage loan does not accrue any revenue into the Consolidated Statements of Income. The loan is independently monitored and evaluated as to potential impairment or foreclosure. This evaluation includes assessing the probability of receiving future cash flows, along with consideration of many of the factors described below. If delinquent payments are made and the loan is brought current, then the Company returns the loan to active status and accrues income accordingly.
Generally, the Company considers its mortgage loans to be a portfolio segment. The Company considers its primary class to be property type. The Company primarily uses loan-to-value as its credit risk quality indicator but also monitors additional secondary risk factors, such as geographic distribution both on a regional and specific state basis. The mortgage loan portfolio segment is presented by property-type in a table in this section. In addition, geographic distribution for both regional and significant state concentrations are also presented. These measures are also supplemented with various other analytics targeted to provide specific additional information concerning a mortgage loan and supports management’s assessment of each financing receivable.
The allowance for losses on mortgage loans is maintained at a level believed by management to be adequate to absorb estimated credit losses. Management’s periodic evaluation and assessment of the adequacy of the reserve is based on known and inherent risks in the portfolio, historical and industry data, current economic conditions and other relevant factors. A loan is considered impaired if it is probable that contractual amounts due will not be collected.
The allowance for loss is monitored and evaluated with a process that includes, but is not limited to, the following factors:
• Analysis of the Company’s own historical loss experiences over the last several years;
• Analysis of current industry conditions that are affecting the market, including rental and vacancy rates;
• Analysis of the markets and sub markets in which the Company has mortgage loans; and
There are a number of significant risks and uncertainties inherent in the process of monitoring impairments on loans, determining if impairment is other-than-temporary and determining the amount of an other-than-temporary impairment. These risks include but are not limited to:
• The risk that the economic outlook will be worse than expected or have more of an impact on the borrower than anticipated;
• The risk that the performance of the underlying property could deteriorate in the future;
To the extent the Company determines a loan is impaired, that amount will be charged to the allowance for loss and the loan balance will be reduced. In the event the property is foreclosed upon, the carrying value will be written down to the lesser of the current fair value less costs to sell, or book value of the property with a charge to the allowance for loss and a corresponding reduction to the mortgage loan asset.
The following chart details the activity of the collectively evaluated allowance for loss as of December 31.
The Company purchased $84.6 million of seasoned mortgage loans in 2010. These purchases resulted in an addition to the Company’s mortgage loan portfolio with a weighted average net yield of 6.6%. These loans were all performing loans which met or exceeded all of the Company’s normal underwriting criteria. Additionally in 2010, the Company purchased one $1.9 million loan in December 2010 from a separate originator.
Investment real estate is depreciated on a straight-line basis over periods ranging from 3 to 60 years.
Investments in the affordable housing real estate joint ventures and real estate joint ventures are interests that will absorb portions of the VIE’s expected losses or receive portions of expected residual returns of the VIE’s net assets exclusive of variable interests. The Company makes an initial assessment of whether it is the primary beneficiary of a VIE at the time of the initial investment and on an ongoing basis thereafter. The Company considers many factors when making this determination based upon a review of the underlying investment agreement and other information related to the specific investment. The first factor is whether the Company has the ability to direct the activities of a VIE that most significantly impact the VIE’s economic performance. The power to direct the activities of the VIE is generally vested in the managing general partner or managing member of the VIE, which is not the position held by the Company in these investments. Other factors include the entity’s equity investment at risk, decision-making abilities, obligations to absorb economic risks and the right to receive economic rewards of the entity; and the extent to which the Company shares in the VIE’s expected losses and residual returns.
The Company had no notes payable at December 31, 2010 or December 31, 2009.
The Company has unsecured revolving lines of credit of $60.0 million with two major commercial banks with no balances outstanding and which are at variable interest rates based upon short-term indices. These lines of credit will expire in June of 2011. The Company anticipates renewing these lines as they come due.
Interest paid on all borrowings was less than $0.1 million in 2010 (2009 - less than $0.1 million; 2008 - $1.1 million).
Stockholder dividends may not exceed statutory unassigned surplus. Additionally, under Missouri law, the Company must have the prior approval of the Missouri Director of Insurance in order to pay dividends in any consecutive twelve-month period exceeding the greater of statutory net gain from operations for the preceding year or 10% of statutory stockholders' equity at the end of the preceding year. The maximum stockholder dividends payable in 2011 without prior approval is $32.2 million, 10% of 2010 capital and surplus. The Company believes these statutory limitations impose no practical restrictions on its dividend payment plans.
The Company is required to deposit a defined amount of assets with state regulatory authorities. Such assets had a statutory carrying value of $12.0 million at December 31, 2010 (2009 - $11.6 million; 2008 - $12.1 million).
A reconciliation of the beginning and ending amounts of unrecognized tax benefits for the years ended December 31 is as follows:
The total amount of unrecognized tax benefits, if recognized, that would impact the effective tax rate was $0.6 million as of December 31, 2009. The decrease in unrecognized tax benefits in 2010 is primarily attributable to an accounting method change that was approved by the IRS during 2010.
Certain of the Company’s pension plan assets consist of investments in pooled separate accounts offered by the Plan. Net asset value (NAV) of the separate accounts is calculated in a manner consistent with U.S. GAAP for investments companies and is determinative of their fair value. Several of the separate accounts invest in publicly quoted mutual funds or actively managed stocks. The fair value of the underlying mutual funds or stock is used to determine the NAV of the separate account, which is not publicly quoted. Some of the separate accounts also invest in fixed income securities. The fair value of the underlying securities is based on quoted prices of similar assets and used to determine the NAV of the separate account. Sale of plan assets may be at values less than NAV and certain redemption restrictions may apply.
The current assumption for the expected long-term rate of return on plan assets is 8.0%. This assumption is determined by analyzing: 1) historical average returns, 2) historical data on the volatility of returns, 3) current yields available in the marketplace, 4) actual returns on plan assets, and 5) current and anticipated future allocation among asset classes. The asset classes used for this analysis are domestic and international equities, investment grade corporate bonds, alternative assets, and cash. The overall rate is derived as a weighted average of the estimated long-term returns on the asset classes represented in the investment portfolio of the plan.
Non-contributory defined contribution retirement plans for eligible general agents and sales agents provide supplemental payments based upon earned agency first year individual life and annuity commissions. Contributions to these plans in 2010 were $0.1 million (2009 - $0.1 million; 2008 - $0.1 million). Non-contributory deferred compensation plans for eligible agents based upon earned first year commissions are also offered. Contributions to these plans in 2010 were $0.3 million (2009 - $0.3 million; 2008 - $0.4 million).
Savings plans for eligible employees and agents match employee and agent contributions up to 6% of salary and 2.5% of agents’ prior year paid commissions, respectively. Contributions to the plan in 2010 were $1.2 million (2009 - $1.3 million; 2008 - $1.8 million). Effective January 1, 2011 the plan was amended, increasing the employer match from 6% to 8%. The Company may contribute an additional profit sharing amount up to 4% of salary for eligible employees, depending upon corporate profits. The Company made no profit sharing contribution in 2010 or in the prior two years.
The Company recognizes the funded status of its defined pension and postretirement plans, measured as the difference between plan assets at fair value and the projected benefit obligation, on the Consolidated Balance Sheets. Changes in the funded status that arise during the period, but are not recognized as components of net periodic benefit cost, are recognized within other comprehensive income (loss) net of taxes.
The following table discloses the level within the fair value hierarchy in which the pension plan and other postretirement assets fall.
The following table provides the estimated net loss and prior service cost for the pension plan and other postretirement plans that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost in 2011.
For measurement purposes a 10.0% annual increase in the per capita cost of covered health care benefits was assumed to decrease gradually to 6.0% in 2018 and thereafter.
The following table provides information about the outstanding three-year intervals as of December 31, 2010.
Kansas City Life acquired a block of traditional life and universal life products in 1997. As of December 31, 2010, the block had $1.4 billion of life insurance in force (2009 - $1.5 billion). The block generated life insurance premiums of $3.0 million in 2010 (2009 - $3.2 million; 2008 - $3.4 million) and had reinsurance ceded of $0.8 million in 2010 (2009 - $1.0 million; 2008 - $1.0 million).
Sunset Life entered into a yearly renewable term reinsurance agreement January 1, 2002, whereby it ceded 80% of its retained mortality risk on traditional and universal life policies. As of December 31, 2010, the insurance in force ceded approximated $1.4 billion (2009 - $1.7 billion) and premiums totaled $8.9 million (2009 - $8.9 million; 2008 - $8.9 million).
The maximum retention on any one life is three hundred fifty thousand dollars for ordinary life plans and one hundred thousand dollars for group coverage. A contingent liability exists with respect to reinsurance, which may become a liability of the Company in the unlikely event that the reinsurers should be unable to meet obligations assumed under reinsurance contracts. The solvency of reinsurers is reviewed annually.
The following table reflects the Company’s significant reinsurance partners along with their A. M. Best credit rating and the amount of reinsurance recoverable and their related percent of recoverable at December 31, 2010.
The Company monitors several factors that it considers relevant to satisfy itself as to the ongoing ability of a reinsurer to meet all obligations of the reinsurance agreements. These factors include the credit rating of the reinsurer, the financial strength of the reinsurer, significant changes or events of the reinsurer, and any other relevant factors. If the Company believes that any reinsurer would not be able to satisfy its obligations with the Company, a separate contingency reserve may be established. As of year-end 2010 and 2009, no reinsurer met these conditions.
The reinsurance recoverable is composed of reinsurance ceded receipts due from policyholder benefit payments of $17.0 million and reserves for life and accident and health business of $170.1 million at December 31, 2010.
Effective for the period ended March 31, 2009, the Company adopted FASB guidance related to the recognition and presentation of other-than-temporary impairments. Pursuant to this guidance, the Company reviewed all previously-recorded other-than-temporary impairments of securities and developed an estimate of the portion of such impairments using a methodology consistent with that applied to the current period other-than-temporary bifurcation of credit and non-credit as of January 1, 2009. As a result, the Company determined that $13.5 million in previously recorded other-than-temporary impairments had been due to non-credit impairments as of January 1, 2009.
The process used by the Company in estimating the portion of previously recorded other-than-temporary impairments due to credit as of January 1, 2009 was consistent with the methodology currently employed for those securities determined to be other-than-temporarily impaired. Specifically, if the security is unsecured, secured by an asset or includes a guaranty of payment by a third-party, the estimate of the portion of impairment due to credit was based upon a comparison of ratings and maturity horizon for the security relative to historical default probabilities from one or more nationally recognized rating organizations. When appropriate for any given security, sector or period in the business cycle, the historical default probability was adjusted to reflect periods or situations of distress by adding to the default probability increments of standard deviations from mean historical results. The credit impairment analysis was supplemented by estimates of potential recovery values for the specific security, including the potential impact of the value of any secured assets, in the event of default. This information was used to determine the Company’s best estimate, derived from probability-weighted cash flows.
The unaudited quarterly results of operations for the years ended December 31, 2010 and 2009 are summarized in the table below.
In the normal course of business, the Company has open purchase and sale commitments. At December 31, 2010, the Company had purchase commitments to fund mortgage loans and affordable housing projects of $16.2 million. At December 31, 2010, the Company also had commitments to fund two construction-to-permanent loans of $5.2 million that are subject to the borrower’s performance.
Subsequent to December 31, 2010, the company entered into commitments to fund additional mortgage loans of $14.4 million and real estate and joint venture investments of $1.1 million and to sell real estate investments for $0.4 million. The Company has funded $2.4 million of the commitments on the two construction-to-permanent loans that were outstanding at December 31, 2010 as well as funded $1.1 million of the affordable housing purchases. In addition, the Company also has entered into a commitment to fund another construction-to-permanent loan of $2.8 million that is subject to the borrower’s performance.
The life insurance industry, including the Company, has been subject to an increase in litigation in recent years. Such litigation has been pursued on behalf of purported classes of policyholders and other claims and legal actions in jurisdictions where juries often award punitive damages, which may be grossly disproportionate to actual damages.
All other information required by this Schedule is shown in Note 13 - Reinsurance in the Notes to Consolidated Financial Statements.