Death and other policyholder benefits reflect exposure to mortality risk and fluctuate from year to year on the level of claims incurred under insurance retention limits. The profitability of the Company is primarily affected by fluctuations in mortality, other policyholder benefits, expense levels, interest spreads (i.e., the difference between interest earned on investments and interest credited to policyholders) and persistency. We have the ability to mitigate adverse experience through adjustments to credited interest rates, policyholder dividends or cost of insurance charges.
The Company uses fair market values based on National Association of Insurance Commissioners (NAIC) values, versus values associated with normal marketing pricing services. The Company considers the difference to be immaterial.
Amortization of deferred policy acquisition costs for interest sensitive products is dependent upon estimates of current and future gross profits or margins on this business. Key assumptions used include the following:
Net insurance revenues increased by $339,000, or 5.0%, to $7,075,000 for fiscal year 2002 from $6,736,000 for fiscal year 2001. This increase was primarily the result of an increase in traditional life sales.
Total revenues decreased by $31,000, or .3%, to $10,603,000 for fiscal year 2001 from $10,634,000 for fiscal year 2000. Contributing to this decrease in total revenues was a $68,000 reduction in net investment income.
The Company's investment policy is to invest predominantly in fixed maturity securities, mortgage loans, and warehouse mortgage loans on a short-term basis before selling the loans to investors in accordance with the requirements and laws governing life insurance companies. Bonds owned by the Company amounted to $22,412,000 as of December 31, 2002 as compared to $24,521,000 as of December 31, 2001. This represents 45.5% and 49.8% of the total investments as of December 31, 2002 and December 31, 2001, respectively. Generally, all bonds owned by the Company are rated by the National Association of Insurance Commissioners. Under this rating system, there are nine categories used for rating bonds. At December 31, 2002, and at December 31, 2001, the Company had investments in bonds in rating categories three through nine, which are considered non-investment grade of $485,000 and $482,000, respectively.
If market conditions were to cause interest rates to change, the market value of the fixed income portfolio (approximately $24.852 million) could change by the following amounts based on the respective basis point swing (the change in market values were calculated using a modeling technique):
The Company is subject to risk based capital guidelines established by statutory regulators requiring minimum capital levels based on the perceived risk of assets, liabilities, disintermediation, and business risk. At December 31, 2002 and December 31, 2001, the Company exceeded the regulatory criteria.
Student loans are a service the Company has historically made available to the public as well as an investment. While the Company anticipates the seasonal demand for student loan funds and the subsequent sale of such loans to the Student Loan Marketing Association (SLMA), there are times when additional funds are required to meet demand for student loans until such time as the sale thereof to SLMA can be completed. In 1997 the Company renewed its $5,000,000 line of credit with SLMA until 2007 in order to meet these seasonal borrowing requirements. The Company made no draws against this line of credit through December 31, 2002.
The Company has leased approximately 80% of the available space in its principal office building and does not anticipate significant capital expenditures to the rental space.
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets". Under SFAS No. 142, amortization of goodwill is precluded; however, its recoverability must be periodically (at least annually) reviewed and tested for impairment. Goodwill must be tested at the reporting unit level for impairment in the year of adoption, including an initial test performed within six months of adoption. If the initial test indicates a potential impairment, then a more detailed analysis to determine the extent of impairment must be completed within twelve months of adoption. SFAS No. 142 also requires that useful lives for intangibles other than goodwill be reassessed and remaining amortization periods be adjusted accordingly. The adoption of SFAS No. 142 did not have a material impact on the Company's financial condition or results of operations.
Statement of Operations - years ended December 31, 2002, 2001 and 2000..................................22
Statement of Shareholders' Equity-years ended December 31, 2002, 2001 and 2000............................23
We have audited the accompanying balance sheet of Southern Security Life Insurance Company as of December 31, 2002 and 2001 and the related statements of operations, shareholders' equity, and cash flows for the three years in the period ended December 31, 2002. In connection with our audits of the financial statements, we have also audited the amounts included in the financial statement schedules as listed in the accompanying index under Item 14(a). These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
Assets 2002 2001 Investments (note 3): Fixed maturities held-to-maturity (fair value, $4,167,028 and $3,250,894 at December 31, 2002 and 2001, respectively) $3,971,539 $3,156,650 Securities available-for-sale, at fair value: Fixed maturities (cost of $17,078,241at December 31, 2002 and $20,459,833 at December 31, 2001) 18,439,961 21,364,731 Equity securities (cost, $316,293 and $316,293 at December 31, 2002 and 2001, respectively) 309,218 372,183 Mortgage loans 2,244,597 2,268,292 Policy and student loans 8,027,736 8,181,223 Short-term investments (note 11) 16,283,759 13,860,534 ----------- ----------- Total Investments 49,276,810 49,203,613 ----------- ----------- Cash and cash equivalents 3,067,284 1,969,055 Accrued investment income 473,789 613,280 Deferred policy acquisition costs (note 4) 13,391,535 12,974,390 Policyholders' account balances on deposit with reinsurer (note 7) 6,955,691 7,148,068 Reinsurance receivable (note 7) 279,090 569,163 Receivables: Agent balances, net 776,244 1,005,535 Other 614,150 722,075 Property and equipment, net, at cost (note 5) 2,430,404 2,491,062 Investment in affiliate at cost -- 783,087 ----------- ----------- Total Assets $77,264,997 $77,479,328 =========== ===========
Income tax (benefit) expense (note 10) (12,254) 16,865 38,105 --------- ----------- ----------- Net income (loss) $ (70,566) $ 70,976 $ 160,260 ========= =========== =========== Basic and diluted net income (loss) per share of common stock (note 12) $(.04) $.04 $.08 ===== ==== ====
2002 2001 2000 Cash flows provided by (used in) operating activities: Net income (loss) $(70,566) $70,976 $160,260 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 196,497 270,792 260,956 Net realized loss 1,038 -- -- Loss on disposal of property, plant & equipment -- -- 1,886 Deferred income taxes (benefit) (16,500) 22,623 (9,426) Amortization of deferred policy acquisition costs 1,969,966 2,197,399 1,797,320 Acquisition costs deferred (2,129,428) (1,898,971) (2,206,125) Change in assets and liabilities affecting cash provided by operations: Accrued investment income 139,491 (2,806) (27,566) Accounts receivable 337,216 (239,665) (78,683) Reinsurance receivable 290,073 (244,370) 48,666 Other policy claims and future benefits payable 169,791 502,866 1,356,753 Policyholders' account balances 2,107,681 2,119,312 2,080,769 Funds held under reinsurance (44,677) (37,576) (58,296) Unearned premiums (297,910) (291,269) (331,998) Dividend and endowment accumulations 14,766 (8,845) 3,101 Payable to affiliated insurance agent (109,748) 47,894 (44,096) Income taxes payable -- (57,470) (46,738) Other liabilities (132,625) 182,378 (16,125) ---------- ---------- ---------- Net cash provided by operating activities $2,425,065 $2,633,268 $2,890,658 ---------- ---------- ---------- Cash flows from (used in) investing activities: Purchase of investments: Purchase of investments held-to-maturity $ (1,784,283) $ -- $(2,606,749) Purchase of equity securities -- -- (916,815) Proceeds from maturity of held-to maturity securities 983,820 2,220,802 1,210,272 Proceeds from maturity of available-for-sale securities 3,300,000 2,814,816 1,225,522 Proceeds from sale of available- for-sale securities (equity and fixed maturity) 782,048 794,356 -- Purchase of mortgage loan -- -- (825,000) Repayment of mortgage loans 23,695 29,871 24,525 Net change in short-term investments (2,423,225) (6,045,721) 780,280 Net change in policy and student loans 153,487 39,513 238,236 Acquisition of property and equipment (68,672) (78,009) (224,129) ---------- --------- ----------- Net cash provided ( used in) investing activities $ 966,870 $(224,372)$(1,093,858) ---------- --------- -----------
2002 2001 2000 Cash flows from financing activities: Receipts from universal life and certain annuity policies credited to policyholder account balances $4,816,639 $5,037,521 $5,765,790 Return of policyholder account balances on universal life and certain annuity policies (7,110,345) (7,991,030) (9,129,406) ----------- ----------- ----------- Net cash used in financing Activities $(2,293,706)$(2,953,509) $(3,363,616) ----------- ----------- ----------- Increase (decrease) in cash and cash equivalents 1,098,229 (544,613) (1,566,816)
Effective December 17, 1998, 100% of the common stock of SSLIC Holding Company, Inc. was acquired by Security National Financial Corporation ("SNFC"). Accordingly, from December 17, 1998, the Company is a 75.0% owned, indirect subsidiary of SNFC.
Legal/regulatory risk is the risk that changes in the legal or regulatory environment in which an insurer operates will create additional expenses not anticipated by the insurer in pricing its products. That is, regulatory initiatives designed to reduce insurer profits, new legal theories or insurance company insolvencies through guaranty fund assessments may create costs for the insurer beyond those recorded in the financial statements. The Company seeks to mitigate this risk through geographic marketing of these insurance products.
(b) Basis of financial statements ----------------------------- The financial statements have been prepared on the basis of U.S. generally accepted accounting principles ("GAAP"), which vary from reporting practices prescribed or permitted by regulatory authorities.
(c) Use of estimates ---------------- In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities. Actual results could differ significantly from those estimates.
(d) Investments ----------- Investments in all debt securities and those equity securities with readily determinable market values are classified into one of three categories: held-to-maturity, trading or available-for-sale. Classification of investments is based upon management's current intent. Debt securities which management has a positive intent and ability to hold until maturity are classified as securities held-to-maturity and are carried at amortized cost. Unrealized holding gains and losses on securities held-to-maturity are not reflected in the financial statements. Debt and equity securities that are purchased for short-term resale would be classified as trading securities. Trading securities would be carried at fair value, with unrealized holding gains and losses included in earnings; the Company has no securities classified as trading securities. All other debt and equity securities not included in the above two categories are classified as securities available-for-sale. Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported in accumulated other comprehensive income which is included in shareholders' equity after adjustment for deferred income taxes and deferred acquisition costs related to universal life products.
(e) Cash and cash equivalents ------------------------- For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
(g) Property and Equipment ---------------------- Property and equipment are recorded at cost, less accumulated depreciation. Depreciation and amortization on capital leases and property and equipment are determined using the straight-line method over the estimated useful lives of the assets or terms of the lease. Expenditures for maintenance and repairs are expensed when incurred and betterments are capitalized. Gains and losses on sale of property and equipment are reflected in operations.
(h) Investment in affiliate ----------------------- Prior to 2002 the Company held investments in its parent company's common stock. This reciprocal stockholding is accounted for based on the treasury stock approach. The value of the investment is recorded at cost and will be classified as treasury stock upon consolidation with its parent company.
(k) Recognition of premium revenue and related costs ------------------------------------------------ Premiums are recognized as revenue as follows:
The computation of diluted earnings per common share is based on the weighted average number of shares outstanding during the year, plus the common stock equivalents that would arise from the exercise of stock options outstanding, using the treasury stock method and the average market price per share during the year. There were no common stock equivalents outstanding during the years ended December 31, 2002 and 2001. Common stock equivalents are not included in the diluted earnings (loss) per share calculation when their effect is antidilutive.
(p) Concentration of Credit Risk ---------------------------- The Company maintains its cash in bank deposit accounts, which at times may exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents.
Certain amounts presented in the 2001 and 2000 financial statements have been reclassified to conform to the 2002 presentation.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities", which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Action (including Certain Costs Incurred in a Restructuring)" ("Issue 94-3"). The principal difference between SFAS No. 146 and Issue 94-3 is that SFAS No. 146 requires that a for a cost associated with an exit or disposal activity be recognized when the liability is incurred, rather than at the date of an entity's commitment to an exit plan. SFAS No. 146 is effective for exit or disposal activities after December 31, 2002. Based upon a preliminary review, adoption of SFAS No. 146 would not have a material impact on the Company's financial condition or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure and Amendment to FASB No. 123", which provides three optional transition methods for entities that decide to voluntarily adopt the fair value recognition principles of SFAS No. 123, "Accounting for Stock Issued to Employees", and modifies the disclosure requirements of that Statement. Under the prospective method, stock-based compensation expense is recognized for awards granted after the beginning of the fiscal year in which the change is made. The modified prospective method recognizes stock-based compensation expense related to new and unvested awards in the year of change equal to that which would have been recognized had SFAS No. 123 been adopted as of its effective date, fiscal years beginning after December 15, 1994. The retrospective restatement method recognizes stock compensation costs for the year of change and restates financial statements for all prior periods presented as though the fair value recognition provisions of SFAS No. 123 had been adopted as of its effective date. Since the Company does not intend to voluntarily adopt the fair value provisions of FASB 123, adoption of SFAS 148 would not have a material effect on the financial condition or results of operations of the Company. However, pro forma disclosures required by SFAS 148 will be included in the Company's future interim financial statements when necessary.
Under applicable laws and regulations, the Company is required to maintain minimum surplus as to policyholders, determined in accordance with regulatory accounting practices, in the aggregate amount of approximately $1,874,000.
The Insurance Commissioner's approval is not required if the dividend is equal to or less than the greater of: (a) 10% of the Company's surplus as to policyholders' derived from realized net operating profits on its business and net realized capital gains; or (b) the Company's entire net operating profits and realized net capital gains derived during the immediately preceding calendar year, if the Company will have surplus as to policyholders equal to or exceeding 115% of the minimum required statutory surplus as to policyholders after the dividend is declared and paid. As a result of such restrictions, the maximum dividend which may be paid by the Company during 2003 without prior approval is approximately $75,000. Accordingly, GAAP excess earnings over a statutory basis are not available for dividends.
Equity securities consist of $309,218 and $372,183 of common stock at fair value at December 31, 2002 and 2001 respectively.
Unrealized appreciation of fixed maturities for years ending December 31, 2002, 2001 and 2000 is $558,067, $1,152,189, and $678,644 respectively.
Mortgage-backed securities 280,970 288,083 ---------- ----------- $3,971,539 $ 4,167,028 ========== =========== Fixed maturity securities available-for-sale:
Due in 2003 $3,854,862 $ 3,972,109 Due in 2004 through 2007 9,943,233 10,798,772 Due in 2008 through 2012 3,182,315 3,551,580 Due after 2012 97,831 117,500
2002 2001 2000 Proceeds from sale of equity securities $782,048 $ 794,356 $ -- ---------- ---------- ---------- Proceeds from sale of fixed maturities available-for-sale $3,300,000 $2,814,816 $1,225,522 ---------- ---------- ---------- Realized gains (losses) Fixed maturities: Gross realized gains $ -- $ -- $ -- Gross realized (losses) -- -- -- Equity securities: Gross realized gains -- -- -- Gross realized (losses) (1,038) -- -- ---------- --------- --------- $ (1,038) $ -- $ -- ========== ========== ==========
Investments, aggregated by issuer, in excess of 10% of shareholders' equity (before net unrealized gains and losses on available-for-sale securities) at December 31, 2002 and 2001, other than investments issued or guaranteed by the United States government are as follows:
2002 2001 2000 Interest: Fixed maturities $1,526,706 $1,790,992 $2,014,883 Policy and student loans 515,141 468,904 505,319 Short-term investments 1,235,823 1,105,434 937,077 Mortgage loans 179,193 206,212 190,068 Rental income 388,843 304,879 278,302
2002 2001 2000 Florida $1,702,867 $1,707,042 $1,708,735 Alabama 100,634 100,737 100,199 South Carolina 301,903 302,210 300,595 Georgia 252,233 252,933 250,496 Indiana 201,787 202,347 200,000 ---------- ---------- ---------- $2,559,424 $2,565,269 $2,560,025 ========== ========== ==========
Deferred policy acquisition costs at December 31, 2002, 2001, 2000 consist of the following:
At December 31, 2002 and 2001, future policy benefits, exclusive of universal life and flexible term annuities consist of the following:
For the principal non-universal life policies an interest rate beginning at 6.75% net of investment expenses was used. For universal life policies, spreads between 1.25% and 1.50% were used in developing the FAS 97 amortization schedules.
As of December 31, 2002, the Company had an unused line of credit of $5,000,000 which is secured by student loans equaling 115% of the unpaid principal balance. The facility bears interest at a variable rate per annum payable monthly and expires on April 30, 2007.
Current $ -- $ -- Deferred 1,062,802 895,437 ---------- -------- Total $1,062,802 $895,437 ========== ========
Total income taxes including taxes on the change in the value of investments for the years ended December 31, 2002, 2001, and 2000 were as follows:
2002 2001 2000 ----- ----- ------ Current: Federal $4,246 $(5,759) $40,812 State -- -- 6,719 ------ ------- ------- 4,246 (5,759) 47,531 ------- ------- ------- Deferred: Federal (14,678) 20,691 (7,073) State (1,822) 1,933 (2,353) -------- ------- ------- (16,500) 22,624 (9,426) -------- ------- ------- $(12,254) $16,865 $38,105 ======== ======= =======
Income tax expense (benefit) for the years ended December 31, 2002, 2001, 2000 differs from "expected" tax (computed by applying the U.S. federal income tax rate to pretax income) as a result of the following:
a. The Policyholders' Surplus exceeds a prescribed maximum, or; b. Distributions, other than stock dividends, are made to shareholders in excess of Shareholders' Surplus, as defined by prior law, or; c. The entity ceases to qualify for taxation as a life insurance company, or; d. the tax deferred status of the Policyholder's Surplus Account is modified by future tax legislation.
At December 31, 2002, the balance of the Policyholders' Surplus account aggregated approximately $236,000. The Company has not recorded deferred income taxes totaling approximately $80,000 relating to this amount as it has no plan to distribute the amounts in Policyholders' Surplus in the foreseeable future. The Tax Reform Act of 1986 enacted a new separate parallel tax system referred to as the Alternative Minimum Tax (AMT) system. AMT is based on a flat rate applied to a broader tax base. It is calculated separately from the regular federal income tax and the higher of the two taxes is paid. The excess of the AMT over regular tax is a tax credit, which can be carried forward indefinitely to reduce regular tax liabilities of future years. In 2002, 2001, 2000, AMT exceeded regular tax by $-0-, $-0-, and $19,854, respectively. At December 31, 2002, the AMT tax credit available to reduce future regular tax totaled $269,643.
The tax effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2002 and 2001 are presented below:
Alternative minimum tax credit carry forwards 269,643 269,643 ---------- ---------- Total gross deferred tax assets 3,795,377 3,910,970 Less valuation allowance (269,643) (269,643) ---------- ---------- Net deferred tax assets 3,525,734 3,641,327 ---------- ---------- Deferred tax liabilities: Deferred policy acquisition costs (4,544,629) (4,469,612) Other 465,440 294,104 Unrealized (appreciation) depreciation of securities (509,347) (361,256) ----------- ----------- Total gross deferred tax liabilities (4,588,536) (4,536,764) ----------- ----------- Net deferred tax (liability) $(1,062,802) $ (895,437) ========== ===========
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these deductible differences, net of the existing valuation allowances at December 31, 2002.
11. Related party transactions -------------------------- The Company's general agent, Insuradyne Corporation, is a wholly-owned subsidiary of Security National Financial Corporation. The balances due to an affiliated insurance agency reflected in the accompanying balance sheets principally represent earned commission due to Insuradyne. The Company incurred commission expense to Insuradyne aggregating $109,268, $122,787 and $180,941, in 2002, 2001, and 2000, respectively. These amounts are included as components of acquisition costs deferred and related amortization. Insuradyne incurred insurance-related expenses aggregating $206, $77, and $1,147 in 2002, 2001, 2000, respectively.
Effective December 31, 1998, the Company entered into an Administrative Services Agreement with its ultimate parent Security National Financial Corporation (Security National). Under the terms of the Administrative Services Agreement, all of the Company's employees became employees of Security National. Administrative functions previously performed by the Company are now being furnished to the Company under the Agreement. The Company pays to Security National $250,000 per month or $3 million per year for these administrative services.
The Company received for the years ended December 31, 2002 and 2001, $75,622 and $77,394 respectively, in interest income from Security National for short-term loans of which $113,707 and $344,308 were outstanding as of December 31, 2002 and 2001, respectively.
12. Earnings (loss) per share ------------------------- The following table sets forth the computation of basic and diluted earnings per share: