All statement, trend analyses and other information contained in this report and elsewhere (such as in filings by us with the Securities and Exchange Commission, press releases, presentations by us or our management or oral statements) relative to markets for our products and trends in our operations or financial results, as well as other statements including words such as “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend,” and other similar expressions, constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors which may cause actual results to be materially different from those contemplated by the forward-looking statements. Such factors include, among other things: (i) general economic conditions and other factors, including prevailing interest rate levels and stock and credit market performance which may affect (among other things) our ability to sell our products, our ability to access capital resources and the costs associated therewith, the market value of our investments and the lapse rate and profitability of policies; (ii) world conflict, including but not limited to the war in Iraq, which may affect consumers spending trends and priorities (iii) customer response to new products and marketing initiatives: (iv) mortality, morbidity and other factors which may affect the profitability of our products (v) changes in the federal income tax laws and regulations which may affect the relative income tax advantages of our products (vi) regulatory changes or actions, including those relating to regulation of financial services affecting (among other things) bank sales and underwriting of insurance products and regulation of the sale, underwriting and pricing of products (vii) the risk factors or uncertainties listed from time to time in our filings with the Securities and Exchange
The following is a summary description of the Company’s methodology for estimating its reserve 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.
It should be understood that there is no assurance that anything which the Company and its management have done in the past regarding its claim reserve methodology will be done in the future. The Company and its management are afforded full and complete authority and judgment in determining and implementing its claim reserve methodology which includes any and all changes which may be made from time to time.
The liability for claim reserves generally consists of the following: (1) due and unpaid claims, (2) claims in the course of settlement, and (3) claims incurred but unreported. The Company records the actual liability for all claims that are due but unpaid, Item (1). But, with regard to the last Items (2) and (3), the Company must make estimates. The estimates are based on actuarial principles. The Company’s independent consulting actuary works with Company financial personnel and management in determining the estimates and the independent consulting actuary annually gives the Company a certification as to the amounts of the reserves.
The Company calculates and maintains claim reserves for the estimated future payments on claims incurred before the statement date. These calculations are based on actuarial principles in accordance with industry standards and applicable GAAP requirements. Development of such reserves is done with Company financial personnel and management working with the Company’s independent consulting actuary. These reserves involve many considerations including but not limited to economic and social conditions, inflation, and healthcare costs. The claim reserves developed include significant estimates and assumptions based on management’s review of historical experience in consultation with its independent actuary. The extent to which future payments match the claims reserves is dependent on how well actual future experience matches the assumptions management makes regarding the future experience. The Company’s reserves are estimates that require significant judgment and, therefore, are inherently uncertain.
The Company’s financial personnel have significant experience and knowledge in developing claim reserve estimates for the Company’s insurance products. However, the Company’s financial personnel are not formally trained, certified or recognized as actuaries. The Company continually engages independent consulting actuaries. The Company makes extensive use of its independent consulting actuaries which includes the actuaries’ assistance in the development and creation of policy assumptions, the development and modification of reserve methodologies and assumptions, estimations and calculations of reserves, and the annual certification of the amount of the Company’s reserves for its products.
While claim reserves are estimated as an inherent part of the insurance industry, management of the Company believes that it follows standard industry practices in estimating claim reserves.
In implementing the completion factor approach, a review of payment history develops the completion factors. These completion factors relate what percentage of an ultimate claim is paid based upon its duration from date of service. Such completion factors are monitored over time and have been relatively stable. The completion factors are used to estimate the reserves for the months in which the claims are incurred where they are deemed to be credible.
Of all the assumptions made by the Company’s financial personnel and management and the Company’s independent consulting actuary, the loss ratio and the claims per insured per month for the most recent months are the most sensitive ones for reserve setting. If the loss ratios and claims per insured per month increase, claim reserves will likely increase by some amount. If the loss ratios and claims per insured per month decrease, claim reserves will likely decrease by some amount.
As to the consistency of the Company’s estimation of its claim reserves (the policy claims payable on the Company’s balance sheet), you may reference Notes 7 and 11 to the Company’s Financial Statements. Notes 7 and 11 present data indicating the actual claims paid in a subsequent fiscal year for a prior fiscal year; actual claims incurred in a subsequent year for a prior fiscal year; and the claim reserves for the prior fiscal year. Notes 7 and 11 are limited to the most recent fiscal year being reported, December 31, 2005, and the previous fiscal years of 2004 and 2003.
The Company determines its life insurance claim reserves by recording three items: (1) actual claims due and unpaid; (2) the claims received during the 30 day period following year end (this is done by taking an inventory of claims received during the thirty day period); and (3) estimating a liability amount for claims which have been incurred but not yet reported by the end of the thirty day period.
At December 31, 2005 and 2004, respectively, the Company had gross deferred tax assets of $1,410,226 and $1,346,704 with corresponding valuation allowances of $1,094,773 and $1,005,810, and gross deferred tax liabilities of $278,453 and $239,893, 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. The resulting net deferred tax asset is $37,000 and $101,000 at December 31, 2005 and 2004, respectively. 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.
At December 31, 2005 the Company had liquid assets of $946,272 in cash, receivable on fixed securities, money market savings accounts, and short-term certificates of deposit. All of the non-cash liquid assets can readily be converted into cash.
The major components of operating cash flows are premiums and investment income while policy benefits are the most significant cash outflow. In 2005, BNLAC collected approximately $44.4 million of premiums and annuity deposits (gross before reinsurance) and $1,003,613 of investment income. Another source of cash flow in 2005 was overwrite commissions of $1,051,720 on vision products. At the same time the Company paid $32,938,080 in policy benefits and other insurance costs.
Other long-term investments also include an operating line of credit agreement in the amount of $186,034. On October 15, 2003 BNLAC and EPSI entered into a loan agreement whereby BNLAC will provide EPSI with a $200,000 line of credit maturing October 15, 2004. The line of credit was renewed and extended with interest only payments to August 1, 2005, thereafter EPSI will pay principal and interest over 60 equal monthly installments until paid in full. The line of credit was at 6.75% at December 31, 2005, with interest and principal payable monthly to BNLAC.
The total estimated future payments to be made relating to the Supplementary Contracts liability is stated as $50,000 which does not match the balance sheet liability total of $36,981 and the difference is $13,019. This is primarily due to the fact that the estimated future payments in this long term contractual obligations table for Supplementary Contracts includes consideration of future investment income, withdrawals (if permitted) 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. The estimated future payments are based on many significant assumptions regarding future occurrences such as interest earnings, mortality, 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 withdrawals (if allowed), and mortality improvement or deterioration. Random fluctuation in experience could also have an effect. The Supplementary Contracts estimated future payments are 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 estimated future payments will likely vary from that presented in the above table.
Premium income was $44,303,827 in 2005, $42,451,319 in 2004 and $40,270,571 in 2003. The 5% increase in 2005 was due to new sales of group dental insurance and increased group and individual dental renewal premiums. The increase of 6% in 2004 was due to new sales of group and individual dental insurance and increased group and individual dental renewal premiums from a reduction in the lapse rates on existing business.
BNLAC markets group and individual vision insurance products that are underwritten by other insurance companies, and BNLAC does not have any exposure to underwriting (claims) losses. The Company had vision insurance income of $1,051,720, $695,046 and $538,765 in 2005, 2004 and 2003, respectively. The vision income increased by 51% in 2005 primarily due to the addition of voluntary plans.
The Company had a realized gain on debt extinguishments of $102,067 in 2005, $495,462 in 2004 and $424,726 in 2003 due to the purchase of debentures payable at less than par value. The Company purchased fewer debentures in 2005 which resulted in less realized gain in debt extinguishments.
Realized capital gains and (losses) on investments were $37,816 in 2005, $124,078 in and $154,628 in 2003. The realized gain in 2005 was from the sale of equity securities. The realized gain in 2004 and 2003 are primarily from the sale of U.S. Treasury bonds.
Increases in liability for future policy benefits were $308,563, $687,619 and $34,377 in 2005, 2004 and 2003, respectively. The $308,563 in 2005 is comprised primarily of an increase in unearned premium reserves on group and individual dental business. This reserve changes based on the timeliness of premium receipts. Premiums received in advance are placed in this reserve, as they are not yet earned. In 2004, a future policy benefit reserve amount of $611,410 was booked for individual dental policies then in force. This amount included additional reserves for the individual dental policies issued in 2001, 2002 and 2003, which remained in force (not terminated) in 2004 and also included reserves for individual dental policies issued in 2004. The Company began issuing individual dental policies in 2001 as a new product. The Company’s calculations indicate that in 2004 the Company recorded individual dental policy cumulative gross benefit reserves for policies issued prior to 2004 in the amount of $280,292 and the combined after-tax charge for those policies was $181,699 ($.01 per share of Common Stock) which was accounted for as a change in estimate. For the year ended December 31, 2004, the after-tax effect of recording the reserves, including the cumulative change in estimate, was calculated to have been a decrease in net income of approximately $378,000 ($.02 per share of Common Stock).
Amortization of deferred policy acquisition costs was $22,467 in 2005, $29,973 in 2004 and $30,403 in 2003. 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.
For 2005, the consolidated net income from operations before taxes was $2,830,130 compared to $3,120,686 in 2004 and $3,341,340 in 2003. The decrease in 2005 was primarily due to the decrease in realized gains from debt extinguishments. The decrease in 2004 was primarily due to the increase in additional contract reserves on the individual dental plan.
For the year ended December 31, 2005, other comprehensive income was ($79,542) compared to ($87,603) in 2004 and $56,053 or the same period in 2003. The comprehensive losses in 2005 and 2004 were due to an increase in interest rates that decreased the market value of the Company’s bond portfolio. The comprehensive income for the period ended December 31, 2003 was due to a decrease in interest rates.