The Company’s home office is located at 3520 Broadway in Kansas City, Missouri. The Company owns and wholly occupies two five-story buildings consisting of approximately 236,000 square feet on an eight-acre site.
The Company offers variable life insurance and variable annuity products to the public through third-party broker-dealers. Sunset Financial Services (SFS), a wholly-owned broker-dealer, assists in the distribution and marketing of those products through those third-party entities. SFS is also responsible for servicing closed blocks of variable life insurance and variable annuity products on behalf of the Company. Prior to November 14, 2014, SFS was a full-service broker-dealer offering variable insurance products, investment products and other securities to the public. The transaction that led to the change in operations were initially made public in the Form 8-K filed by the Company on July 21, 2014.
Insurance revenues from the sale of traditional life insurance, 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 other revenues. 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. These deposits are reported as additions to the policyholders’ account balances and are reflected as deposits in Financing Activities section of the Consolidated Statements of Cash Flows. Accordingly, insurance revenues on these products are recognized over time in the form of contract charges assessed against policyholder
The Company’s profitability depends on many factors, which include but are not limited to:
The ability to maximize investment returns and manage risks such as interest rate risk, credit risk, and equity risk;
General economic conditions may affect future results. Market fluctuations, often extreme in nature, have significantly impacted the financial markets and the Company’s investments, revenues, and policyholder benefits in recent periods. The sustained low interest rate environment and volatile equity markets have presented significant challenges to the financial markets as a whole and specifically to companies invested in fixed maturity securities and other fixed income investments. These conditions may continue and the stressed economic and market environment may persist into the future, affecting the Company’s revenue, net income, and financial position.
In the last quarter of 2014, the Company completed a divestiture of certain non-proprietary agent relationships related to SFS with Securities America (SAI). Under this agreement SFS transferred the servicing of certain accounts primarily related to non-proprietary broker-dealer and registered investment advisory accounts to SAI. SFS will continue as a wholly-owned wholesale broker-dealer subsidiary of Kansas City Life to provide support for Kansas City Life's proprietary products and those variable products specifically associated with the American Family transaction. The overall impact of this change is not expected to be significant.
In April 2013, the Company acquired a block of variable universal life insurance policies and variable annuity contracts from American Family. The transfer was comprised of a 100% modified coinsurance transaction for the separate account business and a 100% coinsurance transaction for the corresponding fixed account business. Included in the transaction are ongoing servicing arrangements for this business. During 2014, this transaction contributed contract charges of $16.8 million, policyholder benefits and interest credited to policyholder account balances of $3.8 million, and amortization of deferred acquisition costs of $4.4 million. This transaction contributed contract charges of $13.0 million, policyholder benefits and interest credited to policyholder account balances of $3.1 million, and amortization of deferred acquisition costs of $3.6 million for the nine months ended December 31, 2013.
During the second quarter of 2012, the Company identified an error in the presentation of treasury stock held for the benefit of the Company's deferred compensation plans. This treasury stock was previously recorded as a component of other assets but should have been recorded in stockholders' equity as treasury stock. The Company reclassified $6.2 million (188,621 shares) from other assets to treasury stock. This error had no material impact on net income in the current or prior reporting periods.
Changes in general economic conditions, including the performance of financial markets and interest rates;
Increasing competition in the recruitment of new general agents and agents;
The preparation of the financial statements requires management to use a variety of assumptions and estimates. Actual results may differ from these estimates under different assumptions or conditions. The profitability of life insurance and annuity products is dependent on actual experience, and differences between actual experience and pricing assumptions may result in variability of net income in amounts which may be material. On an ongoing basis, the Company evaluates the estimates, assumptions, and judgments based on historical experience and other information that the Company believes to be relevant under the circumstances. A detailed discussion of significant accounting policies is provided in Note 1 - Nature of Operations and Significant Accounting Policies.
Fixed maturity and equity securities, which are classified as available for sale, are carried at fair value in the Company’s Consolidated Balance Sheets, with unrealized gains or losses recorded in accumulated other comprehensive income. The Company’s fair value of fixed maturity and equity securities is derived from external pricing services, brokers, and internal matrices and calculations.
To the extent the Company's review and valuation determines a loan is impaired, that amount is charged to the allowance for loss and the loan balance is reduced. In the event that a property is foreclosed upon, the carrying value is written down to the lesser of the current fair value or book value of the property with a charge to the allowance for loan losses and a corresponding reduction to the mortgage loan asset. See the Mortgage Loans section of Note 4 for additional information.
Historically, when a new block of business was acquired or when an insurance company was purchased, a portion of the purchase price was allocated to a separately identifiable intangible asset, called 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. The concept of VOBA is no longer applied to business combinations. Rather, under current guidance for business combinations, all amounts are reported at fair value at acquisition and an intangible asset (liability) may result due to differences between fair value and consideration paid.
Similarly, deferred revenue liabilities (DRL) represent the capitalization of revenues received from contracts as compensation for services to be provided by the Company in future periods. Such loads and charges are reported as unearned revenue in the period received and are subsequently recognized as income over the policy benefit period, using the same assumptions and factors used to amortize DAC. Like DAC, these amounts are amortized in relation to estimated gross profits for interest sensitive and variable insurance products. However, unlike DAC, the amortization of the DRL results in a recognition of revenue rather than expense.
A 2.5% increase in expected mortality experience for all future years:
A 10% increase in expected surrender rates for all future years:
The following table presents variances between the results for the two years ended December 31, 2014 and 2013. Positive amounts reflect favorable impacts to net income.
The following table presents gross premiums on new and renewal business, less reinsurance ceded, for the three years ended December 31. New premiums are also detailed by product.
The following table reconciles deposits with the Consolidated Statements of Cash Flows and provides detail by new and renewal deposits for the three years ended December 31. New deposits are also detailed by product.
Total renewal deposits decreased $2.1 million or 1% in 2014, following a $14.6 million or 10% increase in 2013. The reinsurance transaction on variable products increased renewal deposits $25.2 million in 2014 and $20.0 million for the last nine months of 2013. Excluding this transaction, renewal deposits decreased $7.3 million or 5% in 2014, reflecting a $5.5 million decline in fixed annuity renewal deposits, a $0.9 million decline in universal life renewal deposits, and a $0.5 million decline in renewal variable annuity deposits. Excluding this transaction, 2013 renewal deposits decreased $5.4 million or 4%. This reflected a $2.6 million decline in fixed annuity renewal deposits, a $1.3 million decrease in variable annuity renewal deposits, a $0.9 million decrease in universal life renewal deposits, and a $0.6 million decline in variable universal life renewal deposits.
Total contract charges increased $5.2 million or 5% in 2014 and $13.6 million or 14% in 2013, relative to the same periods one year earlier. The largest factor in the 2014 increase was the reinsurance transaction, which contributed $16.8 million to contract charges in the twelve months of 2014. This compares to a contribution of $13.0 million from this reinsurance transaction in the last nine months of 2013, as the transaction occurred in April of 2013. Excluding this transaction, total contract charges on all blocks of business increased $1.4 million or 1% in 2014. This increase was principally due to the unlocking described below. The increase in 2013 also largely resulted from the American Family reinsurance transaction, which contributed $13.0 million to contract charges. Excluding this transaction, total contract charges on all blocks of business increased $0.6 million or 1% in 2013. Reserves loads on the Company's open blocks of business increased $1.2 million or 9%. Partially offsetting the changes in reserve loads, cost of insurance charges decreased $0.8 million or 1% from the runoff of closed blocks.
Included in total contract charges are groups of policies and companies that the Company considers to be closed blocks. The closed blocks of business reflect products and entities that have been purchased but to which the Company is not actively pursuing marketing efforts to generate new sales. The Company services these policies to achieve long-term profit streams. Total contract charges on these closed blocks equaled 42% of total consolidated contract charges during 2014, compared to 41% in 2013. This increase can be attributed to the reinsurance transaction, which is considered a closed block. Excluding this transaction, total contract charges on closed blocks equaled 32% of total consolidated contract charges during 2014, down from 33% in 2013. The decline in 2014 reflects the runoff of the business.
At least annually, a review is performed of the assumptions related to profit expectations. If it is determined the assumptions should be revised, the impact is recorded as a change in the revenue reported in the current period as an unlocking adjustment. The Company had unlocking in the DRL in both 2014 and 2013. The unlocking adjustments in both years were primarily associated with mortality and interest margins. This unlocking resulted in a decrease to the deferred revenue liability and an increase to contract charges of $1.8 million and $1.1 million in 2014 and 2013, respectively.
Gross investment income is largely composed of interest, dividends, and other earnings on fixed maturity securities, equity securities, short-term investments, mortgage loans, real estate, and policy loans. Gross investment income decreased $4.0 million or 2% in 2014 and $5.8 million or 3% in 2013 compared to the same periods one year earlier. The decline in 2014 reflected lower overall yields earned and available on certain investments, which were partially offset by an increase in average assets. In addition, investment expenses increased $0.8 million as compared to prior year, largely due to expenses associated with real estate. In 2013, the return associated with an increase in the average invested assets was more than offset by the lower yields earned and available in the market at the risk level that the Company believed to be acceptable to manage policyholder liabilities.
Fixed maturity securities provided a majority of the Company’s investment income during 2014. Approximately 75% of the Company's investments were in fixed maturity securities at both December 31, 2014 and December 31, 2013. Net investment income from these investments declined $1.3 million or 1% compared to 2013, as a decline in yields earned was partially offset by an increase in average assets.
The Company recorded net realized investment gains of $3.4 million in 2014, $3.9 million in 2013, and $18.4 million in 2012. During 2014, investment losses of $1.5 million were due to write-downs of investment securities that were considered other-than-temporarily impaired. Offsetting these losses, the Company recorded a $4.5 million net gain from investment securities.
During 2013, investment losses of $1.1 million were due to write-downs of investment securities that were considered other-than-temporarily impaired. In addition, the Company recorded losses of $0.1 million on both mortgage loans and real estate investments. Offsetting these losses, the Company recorded a $5.2 million net gain from investment securities.
The following analysis covers write-downs recorded through earnings that exceeded $0.5 million on a consolidated basis. During 2014, the Company had one security written down through earnings that was equal to $0.7 million on a consolidated basis. This position is an investment in a company within the oil exploration and production sector that is challenged by the reduced oil prices and reduced demand for exploration. During 2013, the Company had one security written down through earnings that was equal to $0.5 million on a consolidated basis. This investment was a collateralized debt obligation that was written down due to an increase in projected future losses on the underlying collateral. During 2012, two securities were written down. The first was a collateralized debt obligation that was written down by $0.5 million due to an increase in projected future losses on the underlying collateral. The second was a corporate security that was written down by $0.6 million due to the expected settlement value after the issuer filed for bankruptcy.
Policyholder benefits consist of death benefits, immediate annuity benefits, accident and health benefits, surrenders, interest, other benefits, and the associated increase or decrease in reserves for future policy benefits. The largest component of policyholder benefits was death benefits for the periods presented. Death benefits reflect mortality results, after consideration of the impact of reinsurance. Mortality will fluctuate from period to period.
Policyholder benefits decreased $9.0 million or 4% in 2014 compared to 2013, predominantly the result of a decrease in benefit and contract reserves. Several factors contributed to the change in reserves. The largest factor was a decrease in immediate annuity premiums, principally due to a lower volume of conversions of fixed deferred annuities. Policyholder reserves for immediate annuity premiums are established on an approximately equal and offsetting basis, and a decrease in premiums results in a decrease to the change in reserves on a comparative basis. In addition, an increase in supplementary contract payments reduced benefit and contract reserves on a year-over-year basis. Partially offsetting these items, changes in the fair value of the GMWB rider contributed a $7.2 million increasing impact in benefit and contract reserves, as discussed further below. In addition, the Company refined its reserve calculation methodology for newly issued business beginning in 2013 such that it now uses a modal reserve methodology. This reserve refinement resulted in a $4.2 million increase in the change in reserves on a comparative basis. In addition, death benefits, net of reinsurance, decreased in 2014 compared to 2013. Partially offsetting the decreases in reserves and net death benefits were increases in supplementary contract and annuity payments and an increase in group benefit payments, largely from the group dental product.
Policyholder benefits increased $51.8 million or 32% in 2013 compared to 2012. This change resulted from increases in benefit and contract reserves, net death benefits, and other benefits, net of reinsurance. Several factors contributed to the change in reserves. The largest factor was an increase in new immediate annuity premiums resulting from conversions of fixed deferred annuities. Conversions increased in 2013, reflecting an increase in eligible deferred annuities and changes in marketing and policyholder communications. Also, the Company refined its reserve calculation estimate for new traditional life insurance issues in 2013 related to adjustments used for modal premiums. The refinements allow for more precise calculations of the reserve liability and resulted in a $4.0 million decrease to the reserve liability. In addition, the change in the fair value of the GMWB rider resulted in a $2.7 million decreasing impact in benefit and contract reserves. In addition, an increase in supplementary contract payments reduced benefit and contract reserves. Also, the recapture of a block of previously reinsured policies in 2012 increased benefit and contract reserves, with no corresponding increase in 2013. The increase in other benefits was primarily due to higher supplementary contract and immediate annuity payments and increased dental benefits.
Interest is credited to policyholder account balances according to terms of the policies or contracts for universal life, fixed deferred annuities, and other investment-type products. There are minimum levels of interest crediting stipulated in certain policies or contracts, as well as allowances for adjustments to be made to reflect current market conditions in certain policies or contracts. Accordingly, the Company reviews and adjusts crediting rates as necessary and appropriate. Amounts credited are a function of account balances and current period crediting rates. As account balances fluctuate, so will the amount of interest credited to policyholder account balances. Interest credited to policyholder account balances decreased $2.8 million or 4% in 2014 and $2.7 million or 3% in 2013. The decline in 2014 was due to lower average crediting rates, including reduced interest bonuses, as well as a decrease in policyholder account balances. The decline in 2013 reflected lower policyholder account balances and a decline in crediting rates compared to 2012. In both 2014 and 2013, the Company lowered crediting rates on in force funds at the beginning of each year and adjusted new money rates in response to changing market rates for those products not already at their minimum crediting rate.
The amortization of DAC increased $3.7 million or 10% in 2014, following a $9.2 million or 33% increase in 2013. The increase in 2014 reflected an unlocking adjustment that increased DAC amortization $1.7 million compared to an unlocking adjustment that increased DAC amortization $0.2 million in 2013. In addition, DAC amortization also increased due to the reinsurance transaction on variable products, which contributed $4.4 million to DAC amortization in 2014, compared to $3.6 million in 2013. Included in DAC amortization for the reinsurance transaction was a $0.4 million reduction from an unlocking adjustment in 2014. Excluding the reinsurance transaction, the amortization of deferred acquisition costs increased $2.8 million or 8% in 2014 compared with the prior year. Another factor was the refinement in reserve calculation estimate for new traditional life insurance issues mentioned above. These refinements in 2013 resulted in a comparative $1.9 million decrease in amortization of DAC for traditional life products in 2014.
The Company has three reportable business segments, which are defined based on the nature of the products and services offered: Individual Insurance, Group Insurance, and Old American. The Individual Insurance segment consists of individual insurance products for both Kansas City Life and Sunset Life. In addition, the reinsurance assumption transaction and acquired blocks are included with the Individual Insurance segment. The Individual Insurance segment is marketed through a nationwide sales force of independent general agents and third-party marketing arrangements. The Group Insurance segment consists of sales of group life, group disability, dental, and vision products. This segment uses internal sales representatives to market through a nationwide sales force of general agents, agents, and independent brokers, and also markets products through third party providers that market directly or through independent brokers. Old American consists of individual insurance products designed largely as final expense products. These products are marketed through a nationwide general agency sales force with exclusive territories, using direct response marketing to supply agents with leads. For more information, refer to Note 19.
The following table presents financial data of the Individual Insurance business segment for the years ended December 31. Amounts attributable to the American Family reinsurance transaction are included in the results for the years ended December 31, 2014 and 2013.
The net income for this segment in 2014 was $27.6 million, compared to $25.7 million in 2013 and $38.0 million in 2012. Factors contributing to the increase in 2014 were increases in contract charges and other revenues, along with decreases in interest credited to policyholder account balances and operating expenses. Partially offsetting these favorable items was a decrease in net investment income and an increase in the amortization of deferred acquisition costs. In addition, a $28.1 million decrease in net premiums
was partially offset by a $18.6 million decrease in policyholder benefits, in large part related to the conversion of fixed deferred annuity products. Additional information on these items is presented below.
Total insurance revenues decreased $22.9 million or 13% in 2014, following a $57.0 million or 49% increase in 2013 compared to the same periods one year earlier. In 2014, gross premiums decreased 27%, contract charges increased 5%, and reinsurance ceded increased 1%. In 2013, gross premiums increased 74%, contract charges increased 14%, and reinsurance ceded was essentially flat.
increased $5.2 million, new variable universal life deposits increased $0.9 million, and new variable annuity deposits increased $1.8 million.
Total renewal deposits decreased $2.1 million or 1% in 2014, following a $14.6 million or 10% increase in 2013. The reinsurance transaction on variable products increased renewal deposits $25.2 million in 2014 and $20.0 million in 2013, as the transaction occurred in April of 2013. Excluding this transaction, renewal deposits decreased $7.3 million or 5% in 2014, reflecting a $5.5 million decline in fixed annuity renewal deposits and a $0.9 million decline in universal life renewal deposits. Further, excluding the impact of this transaction, 2013 renewal deposits decreased $5.4 million or 4% compared to the prior year. This reflected a $2.6 million decline in fixed annuity renewal deposits, a $1.3 million decrease in variable annuity renewal deposits, a $0.9 million decrease in universal life renewal deposits, and a $0.6 million decline in variable universal life renewal deposits.
Net investment income decreased $4.6 million in 2014 and $6.1 million in 2013. The decline in 2014 reflected lower overall yields earned and available, partially offset by an increase in average assets. The decline in 2013 reflected an increase in average invested assets that was more than offset by lower yields earned.
Other revenues increased $2.4 million or 25% in 2014, following a $0.7 million or 7% increase in 2013. The increase in 2014 was primarily due to revenue resulting from the divestiture of certain non-proprietary agent relationships related to SFS described previously.
The Affordable Care Act (ACA) directly impacts this segment’s dental and vision products. Dental plans must meet federally regulated certification requirements, including purchases made outside public exchanges, to provide Essential Health Benefits to become a Qualified Health Plan. The Company has reviewed the complex and far-reaching requirements of this legislation and implemented changes to this segment’s dental and vision products to meet certification requirements in key states for 2015 enrollments. In 2014, many employers focused on addressing their medical benefits and compliance with ACA requirements and made relatively fewer changes in non-medical benefits. As a result, sales of non-medical benefits were lower in 2014. The Company believes it is well positioned for 2015 having achieved the necessary certification for the dental products.
Renewal premiums increased $3.7 million or 8% during 2014 compared with 2013. The renewal premium increase in 2014 was primarily due to a $3.4 million or 15% increase in group dental premiums and a $1.0 million or 11% increase in group life premiums. The increase in these product lines was the result of improved retention on existing business. Renewal premiums increased $1.0 million or 2% in 2013 compared with 2012. Renewal premium increases in 2013 included improvements of $0.6 million or 8% in group life and $0.7 million or 5% in the disability lines. These were partially offset by a $0.3 million or 2% decrease in the dental line.
As part of the evaluation of each group and each product's performance, this segment identifies and tracks a policyholder benefit ratio, which is derived by dividing policyholder benefits, net of reinsurance, by total revenues. This ratio allows for a measure of
Operating expenses consist of commissions, fees to third-party marketing and administrative organizations, and expenses from the segment's operations. Operating expenses for this segment increased $0.6 million or 3% in 2014, largely from increased commissions paid on new and renewal sales. Operating expenses were flat in 2013 as compared to 2012.
Net investment income decreased $0.2 million or 2% in 2014 and $0.3 million or 2% in 2013. Old American's investment portfolio is predominantly invested in fixed maturity securities and mortgage loans. While average invested assets increased in both years, the overall portfolio yields declined in both periods. The declining yields reflected the reduced rates available in the fixed income market. In addition, Old American had a small net realized investment loss in 2014 compared with a net realized investment gain of $0.3 million in 2013. These gains and losses are largely from calls and sales of certain investments.
Policyholder benefits increased $5.3 million in 2014 due to an increase in benefit and contract reserves. This increase was the result of several factors, including a larger in-force block of business, fewer policy terminations, the low interest rate environment, and the 2013 change in reserve calculation methodology. The reserve method change was a transition from a mean reserve calculation to a more refined modal reserve calculation on new policies issued beginning in 2013. For business issued in 2013 and continuing to remain in force in 2014, the reserve calculation resulted in a $3.1 million increase in the change in reserves compared to one year earlier. Total policyholder benefits were flat in 2013 compared with 2012. Net death benefits increased in 2013, reflecting less favorable mortality results and an increase in the overall block of business. While mortality remained within pricing assumptions, the increase in death benefits, in part, reflected the growth of sales in recent years. In addition, the change in reserving methodology for new policies, described above, reduced benefit and contract reserves by $2.8 million in 2013.
The Company uses the policyholder benefit ratio to measure comparability of improvement in revenue results to changes in contract benefits. This ratio is derived by dividing policyholder benefits, net of reinsurance, by total revenues excluding realized investment gains and losses. The ratio has remained relatively consistent over the years ended December 31, 2014, 2013, and 2012.
The amortization of DAC increased $0.4 million or 3% during 2014 compared to prior year. This increase reflects the growth of DAC that has resulted from increased sales in recent periods. This was partially offset by a decrease in amortization that resulted from the prior year refinement in reserve calculation estimate for new traditional life insurance issues mentioned previously. These refinements resulted in a $1.0 million decrease in amortization of DAC for traditional life products in 2014. The amortization of DAC increased $3.5 million or 26% in 2013 compared with 2012. These increases were primarily the result of the change in reserve methodology, as described above.
Operating expenses decreased $0.9 million or 6% in 2014 and $0.1 million or 1% in 2013 compared with the prior years. The decrease in 2014 was largely the result of an increase in the portion of commissions and production allowances that were capitalized and the elimination of VOBA amortization. In 2013, the Company amortized the final $0.2 million of the value of business acquired (VOBA) from the original acquisition of Old American more than 20 years earlier.
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. 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 Company also has several non-insurance subsidiaries that individually and collectively are not material. The consolidated entity (the Company) offers a diversified portfolio of individual insurance, annuity, and group products through three life insurance companies.
In 2014, the Company completed a divestiture of certain non-proprietary agent relationships related to Sunset Financial Services (SFS) with Securities America (SAI). Under this agreement SFS transferred the servicing of certain accounts primarily related to non-proprietary broker-dealer and registered investment advisory accounts to SAI. SFS will continue as a wholly-owned wholesale broker-dealer subsidiary of Kansas City Life to provide support for Kansas City Life's proprietary products and those variable products specifically associated with the American Family Insurance Company (American Family) transaction (see Reinsurance Transaction below). This transaction resulted in $3.3 million of revenue from the sale of these assets at SFS, which is reported as other revenue. This transaction does not represent a strategic shift that will have a major effect on the consolidated entity's financial results nor does the Company believe that there is any material impact to the consolidated entity's financial position.
In April 2013, the Company acquired a closed block of variable life insurance policies and variable annuity contracts through reinsurance and servicing agreements from American Family. Under the reinsurance agreement, the Company assumed 100% of the separate account liabilities on a modified coinsurance basis and 100% of the general account liabilities on a coinsurance basis. The transaction also involved an ongoing servicing arrangement for this business. This block is included as a component of the Individual Insurance segment.
The modified coinsurance portion of the transaction represented approximately $291.6 million in separate account fund balances. The Company receives fees based upon both specific transactions and the fund value of the block of policies, as provided under modified coinsurance transactions. Also, as required under modified coinsurance transaction accounting, the separate account fund balances were not recorded as separate accounts on the Company's financial statements. Rather, the Company recorded these fixed fund accounts as a separate block under its general accounts, and the Company also receives certain ongoing fees associated
The Company’s principal investments are in fixed maturity securities, mortgage loans, and real estate; all of which are exposed to at least three primary sources of investment risk, including: credit, interest rate, and liquidity. The fixed maturity and equity securities, which are all classified as available for sale, are carried at fair value in the Company’s Consolidated Balance Sheets, with unrealized gains or losses recorded in accumulated other comprehensive income. The unrealized gains or losses are recorded net of the adjustment to policyholder account balances, future policy benefits, and DAC to reflect what would have been earned had those gains or losses been realized and the proceeds reinvested. For additional information, please see Note 5.
The Company adjusts the carrying value of securities for unrealized changes in fair value. The amortized cost of a security is adjusted for declines in value that are other than temporary. Other than temporary impairment losses are reported as a component of revenues in the consolidated statements of comprehensive income, which also presents the amount of noncredit impairment losses for certain fixed maturity securities that is reported in accumulated other comprehensive income (loss). See Note 4 for additional discussion of the Company’s considerations related to other than temporary impairments.
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. Unrealized gains and losses, net of adjustments to DAC, VOBA, policyholder account balances, future policy benefits, and deferred income taxes are reported as a separate component of accumulated other comprehensive income in stockholders' equity. Unrealized gains and 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 adjustments to policyholder account balances and future policy benefits represent 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.
Liabilities for future policy benefits of traditional life insurance have been computed by a net level premium method based upon estimates at the time of issue for investment yields, mortality, and withdrawals. These estimates include provisions for experience less favorable than initially expected. Mortality assumptions are based on Company experience expressed as a percentage of standard mortality tables. The 2001 Valuation Basic Table and the 1975-1980 Select and Ultimate Basic Table serve as the bases for most mortality assumptions.
Policyholder account balances include universal life insurance, fixed deferred annuity contracts, and investment-type contracts. Liabilities for policyholder account balances are included without reduction for potential surrender charges. These liabilities originate from new deposits and conversions from other products. Policyholder account balances are equal to cumulative deposits, less contract charges and withdrawals, plus interest credited. Deferred front-end contract charges reduce policyholder account balance liabilities and increase the other policyholder funds liability, and are amortized over the term of the policies in a manner similar to deferred acquisition costs, as discussed below. Policyholder benefits incurred in excess of related policyholder account balances are charged to policyholder benefits expense.
The following table provides detail about the composition of policyholder account balances at December 31.
Policy acquisition costs that relate to interest sensitive and variable insurance products are deferred and amortized in relation to the estimated gross profits to be realized over the lives of the contracts. Estimated gross profits for interest sensitive and variable insurance products are projected using assumptions as to net interest income, net realized investment gains and losses, fees, surrender charges, expenses, and mortality gains and losses, net of reinsurance. At the issuance of policies, projections of estimated gross profits are made. These projections 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 (unlocked) using these new assumptions and any resulting adjustment is included in income in the period such an unlocking is deemed appropriate. See Unlocking and Refinements in Estimates section below.
The DAC asset is adjusted to reflect the impact of realized and unrealized gains and losses on fixed maturity securities available for sale, as described in the Investments section of Note 1.
Prior to the adoption of ASC No. 805, Business Combinations, a portion of the purchase price was allocated to a separately identifiable intangible asset, VOBA, when a new block of business was acquired or when an insurance company was purchased. 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. The assumptions regarding future experience on interest sensitive business can affect the carrying value of VOBA, similar to DAC. These assumptions include interest spreads, mortality, expense margins, and policy and premium persistency experience.
DAC and VOBA are reviewed on an ongoing basis to evaluate whether the unamortized portion exceeds the expected recoverable amounts. If it is determined from emerging experience that the premium margins or expected gross profits are insufficient to amortize DAC and VOBA, then the asset will be adjusted downward with the adjustment recorded as an expense in the current period. Similarly, if future projections of estimated gross profits indicate improvements, the amortization of DAC and VOBA may be reduced and the balance adjusted.
Separate account assets and liabilities arise from the sale of variable universal life insurance and variable annuity products. The separate account represents funds segregated for the benefit of certain policyholders who bear the investment risk. The assets are legally segregated and are not subject to claims which may arise from any other business of the Company. The separate account assets and liabilities, which are equal, are recorded at fair value based upon NAV of the underlying investment holdings as derived from closing prices on a national exchange or as provided by the issuer. Policyholder account deposits and withdrawals, investment income, and realized investment gains and losses are excluded from the amounts reported in the Consolidated Statements of Comprehensive Income. Revenues to the Company from separate accounts consist principally of contract charges, which include maintenance charges, administrative fees, and mortality and expense charges.
The Company has a GMWB rider for variable annuity contracts that is considered to be a financial derivative and, as such, is accounted for at fair value. The Company determines the fair value of the GMWB rider using a risk-neutral valuation method. The value of the riders will fluctuate depending on market conditions, but is principally impacted by stock market volatility, interest rates, and equity market returns. The change in value can have a material impact on earnings. See further discussion in Note 5.
Premiums for traditional life insurance products are reported as revenue when due. Premiums for immediate annuities with life contingencies are reported as revenue when received. Premiums on accident and health, disability, and dental insurance are reported as earned ratably over the contract period in proportion to the amount of insurance protection provided.
Contract charges, specifically the DRL, could be impacted by unlocking and refinements in estimates, as discussed previously.
In February 2013, the FASB issued guidance regarding the obligations resulting from joint and several liability arrangements. The guidance concerns the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, except for obligations addressed within existing guidance in GAAP. The Company adopted this guidance as of January 1, 2014 with no material impact to the consolidated financial statements.
In August 2014, the FASB issued guidance that requires management to evaluate whether there are concerns or events that raise substantial doubt about the entity's ability to continue as a going concern within one year after the date the financial statements are issued. Disclosures are required when certain criteria are met. This guidance is effective for annual periods ending after December 15, 2016 and for annual periods and interim periods thereafter. The Company is currently evaluating this guidance, but it does not believe that there will be a material impact to the consolidated financial statements.
On December 31, 2014, the Company elected to early adopt FASB Accounting Standards Update (ASU) No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects. ASU No. 2014-01 permits reporting entities to make an accounting policy election to use the proportional amortization method. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The ASU requires companies to use the retrospective method of adoption. As prescribed in ASC 250, comparative financial statements, footnotes, and schedules of prior years have been adjusted to apply the new method retrospectively. The Consolidated Statements of Comprehensive Income were adjusted for the year ended December 31, 2012 and for the interim periods and year ended December 31, 2013. The Consolidated Balance Sheets were adjusted as of December 31, 2013. As a result of the accounting change, retained earnings as of January 1, 2012 decreased from $780,918, as previously reported, to $776,058 under the new guidance.
The following information identifies the financial statement line items that were impacted by the adoption of the new accounting principle.
As a result of the adoption, real estate, total investments, and total assets decreased $2.8 million and $4.9 million at December 31, 2014 and 2013, respectively. Other liabilities and total liabilities decreased $0.6 million and $1.8 million at December 31, 2014 and 2013, respectively. Retained earnings and stockholders' equity decreased $2.2 million and $3.1 million at December 31, 2014 and 2013, respectively. Additionally, the adoption did not impact net cash provided by operating activities for any periods presented.
The following table provides amortized cost and fair value of securities by asset class at December 31, 2013.
No material derivative financial instruments were held at December 31, 2014, 2013, or 2012.
To the extent the Company determines that a fixed maturity security is deemed to be other-than-temporarily impaired, the portion of the impairment that is deemed to be due to credit is charged to the Consolidated Statements of Comprehensive Income and the cost basis of the underlying investment is reduced. The portion of such impairment that is determined to be non-credit-related is deducted from net realized loss in the Consolidated Statements of Comprehensive Income and is reflected in other comprehensive income (loss) and accumulated other comprehensive income.
The risk that fraudulent, inaccurate, or misleading information could be provided to the Company’s credit, investment, and accounting professionals who determine the fair value estimates and accounting treatment for securities;
Once a security is determined to have met certain of the criteria for consideration as being other-than-temporarily impaired, further information is gathered and evaluated pertaining to the particular security. If the security is an unsecured obligation, the additional research is a top-down approach with particular emphasis on the likelihood of the issuer to meet the contractual terms of the obligation. If the security is secured by an asset or guaranteed by another party, the value of the underlying secured asset or the financial ability of the third-party guarantor is evaluated as a secondary source of repayment. Such research is based upon a top-
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, 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.
Significant unrealized losses on securities can continue for extended periods of time, particularly for certain individual securities. While this can be an indication of potential credit impairments, it can also be an indication of illiquidity in a particular sector or security. In addition, the fair value of an individual security can be heavily influenced by the complexities of varying market sentiment or uncertainty regarding the prospects for an individual security. Based upon the process described above, the Company is best able to determine if and to what extent credit impairment may exist in these securities by performing present value calculations of projected future cash flows at the conclusion of each reporting period. By reviewing the most recent data available regarding the security and other relevant industry and market factors, the Company can modify assumptions used in the cash flow projections and determine the best estimate of the portion of any impairment that is due to credit at the conclusion of each period.
The following table provides information regarding fixed maturity and equity security investments available for sale with unrealized losses by length of time at December 31, 2014.
The Company does not consider these unrealized losses to be credit-related. These unrealized losses primarily relate to changes in interest rates and market spreads subsequent to purchase. A substantial portion of investment securities that have unrealized losses are either corporate debt issued with investment grade credit ratings or other investment securities for which discounted cash flow projections are performed. Refer to the Analysis of Investments in Management's Discussion and Analysis, which is incorporated by reference into these Notes to Consolidated Financial Statements, for severity of unrealized losses, credit ratings, and significant assumptions used in projecting the future cash flows of the Company's residential mortgage-backed securities, commercial mortgage-backed securities, and asset-backed securities.
As an additional separate consideration, the Company closely monitors its investments in securities classified as subprime. Subprime securities include all bonds or portions 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 as prime. The Company’s classification of subprime does not include Alt-A or jumbo loans, unless the collateral otherwise meets the preceding definition. Subprime securities represent less than 1% of the Company's total securities investments.
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 impairment loss was recognized in other comprehensive income (loss) for the years ended December 31.
Investments in mortgage loans totaled $541.2 million at December 31, 2014, compared to $629.3 million at December 31, 2013. 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 loan losses. This allowance is maintained at a level believed by management to be adequate to absorb estimated credit losses and was $1.9 million at December 31, 2014 and $3.3 million at December 31, 2013. Management's periodic evaluation and assessment of the adequacy of the allowance is based on known and inherent risks in the portfolio, historical and industry data, current economic conditions, and other relevant factors. Please see Note 6 for additional information. Three mortgage loans have been foreclosed upon and transferred to real estate investments during the past three years. One foreclosure in 2014 resulted in an impairment of $0.3 million. A second foreclosure in 2014 had no impairment, as the fair value was greater than the carrying value. There were no foreclosures in 2013. One foreclosure in 2012 resulted in the recognition of an impairment loss of $0.2 million, as the fair value was less than the carrying value. Also, there were no delinquent mortgage loans at December 31, 2014, while there were five at December 31, 2013. The Company does not hold mortgage loans to any single borrower that exceed 5% of stockholders' equity.
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 32 new loans to the portfolio during 2014, and 100% of these loans had some amount of recourse requirement. No new loans were purchased from institutional lenders during 2014. The average loan-to-value ratio for the overall portfolio was 46% at December 31, 2014, down from 50% at December 31, 2013. These ratios are based upon the current balance of loans relative to the appraisal of value at the time the loan was originated or acquired. The average loan balance was $1.5 million at December 31, 2014 and $1.6 million at December 31, 2013. The Company has certain mortgage loans that have an unamortized premium, totaling $1.0 million as of December 31, 2014, compared to $2.7 million at December 31, 2013.
The following table identifies the gross mortgage loan principal outstanding and the allowance for loan losses at December 31.
The following table summarizes the amount of mortgage loans held by the Company at December 31, 2014 and 2013, segregated by year of origination. Purchased loans are shown in the year acquired by the Company, although the individual loans may have been initially originated in prior years.
The following table identifies the concentration of mortgage loans by state greater than 5% of total at December 31.
The following table identifies mortgage loans by property type at December 31. The Other category consists principally of apartments and retail properties.
be seismically active submarkets. The Company does not expect catastrophe or earthquake damage or economic downturn in the pacific region that may occur to have a material adverse effect on its business, financial position, results of operations, or cash flows. However, the Company cannot provide assurance that such risks could not have such material adverse effects.
The Company may refinance commercial mortgage loans prior to contractual maturity as a means of originating new loans that meet the Company's underwriting and pricing parameters. The Company refinanced loans with outstanding balances of $15.8 million and $10.6 million during the years ended December 31, 2014 and December 31, 2013, respectively.
In the normal course of business, the Company commits to fund commercial mortgage loans generally up to 120 days in advance. These commitments typically 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 retains the commitment fee. For additional information, please see Note 22 - Commitments.
Investments in real estate totaled $181.1 million at December 31, 2014, compared to $137.6 million at December 31, 2013. The table below provides information concerning the Company's real estate investments by major category at December 31.
The Company had non-income producing real estate, consisting of vacant properties and properties under development, of $12.2 million at December 31, 2014, compared to $21.7 million at December 31, 2013.
Under GAAP, fair value represents the price that would be received to sell an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. It is the Company’s practice to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements.
Level 3 - Valuations are generated from techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company's assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of discounted cash flow models, spread-based models, and similar techniques, using the best information available in the circumstances.
measurement date. These liabilities are categorized as Level 3. The Company has not estimated the fair value of the liabilities under contracts that involve significant mortality or morbidity risks, as these liabilities fall within the definition of insurance contracts. Insurance contracts are excluded from financial instruments that require disclosures of fair value.
The following tables present categories reported at fair value on a recurring basis at December 31.
The Company did not exclude any realized or unrealized gains or losses on items transferred into Level 3 in any of the periods presented. Depending upon the availability of Level 1 or Level 2 pricing, specific securities may transfer into or out of Level 3. In 2013, the Company was able to identify significant assumptions or was able to corroborate observable market data for securities that had been level 3 in the previous year. These securities were transfered from Level 3 to Level 2, based upon the beginning of year values. The Company did not have any transfers between Level 1 and Level 2 at December 31, 2014 or 2013.
The Company's primary category of assets using Level 3 fair values is fixed maturity securities, totaling $0.8 million as of December 31, 2014. These assets are valued using discounted cash flow models for which the significant assumptions are not observable in the market.
The following table presents the valuation method for the financial instrument liability included in Level 3, as well as the unobservable inputs used in the valuation of those financial instruments at December 31, 2014.
The GMWB liability is sensitive to changes in observable and unobservable inputs. Observable inputs include risk-free rates, index returns, volatilities, and correlations. Increases in risk-free rates and equity returns reduce the liability, while increases in volatilities increase the liability. The Company's mortality, lapse, benefit utilization and nonperformance risk adjustment are unobservable. Increases in mortality, lapses and credit spreads used for nonperformance risk reduce the liability, while increases in benefit utilization increase the liability.
The following table details the activity of the allowance for doubtful accounts on agent receivables at December 31. Any recoveries are reflected as deductions.
Other agent receivables. Gross agent receivables in this category totaled $2.7 million, and the allowance for doubtful accounts was $1.7 million at December 31, 2014. Gross agent receivables totaled $2.8 million, and the allowance for doubtful accounts was $1.9 million at December 31, 2013.
If a mortgage loan is determined to be on non-accrual status, the Company does not accrue interest 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.
The following table presents an aging schedule for delinquent payments for both principal and interest at December 31, 2014 and December 31, 2013, by property type.
As of December 31, 2014, there were no mortgage loans that were past due or in the process of foreclosure. At December 31, 2013, there were five mortgage loans that were 30 days or more past due, including two over 90 days past due. The two loans that were over 90 days past due were in the process of foreclosure at December 31, 2013 and were foreclosed in 2014.
The allowance for loan losses is monitored and evaluated at multiple levels with a process that includes, but is not limited to, the factors presented below. Generally, the Company establishes the allowance for loan losses using the collectively evaluated impairment methodology at an overall portfolio level and then specifically identifies an allowance for loan losses on loans that contain elevated risk profiles. If the Company determines through its evaluation that a loan has an elevated specific risk profile, it then individually assesses the loan’s risk profile and assigns a specific allowance value based on many factors, including those identified below.
Analysis of the markets and sub-markets in which the Company has mortgage loans;
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 other facts and circumstances change such that it becomes more likely than not that the Company will not obtain all of the contractual payments.
Over the past three years, the Company has had three mortgage loan defaults. Two loans were foreclosed in 2014 for a total impairment loss of $0.3 million. One loan was foreclosed in 2012 for an impairment loss of $0.2 million. The Company had no troubled loans that were restructured or modified in 2014, 2013, or 2012.
using the equity method, with cash distributions from the VIE and cash contributions to the VIE recorded as decreases or increases, respectively, in the carrying value of the VIE. Certain other equity investments in VIEs, where permitted, are recorded on an amortized cost basis. The operating performance of investments in the VIE is recorded in the Consolidated Statements of Comprehensive Income as investment income or as a component of income tax expense, depending upon the nature and primary design of the investment. The Company evaluates the carrying value of VIEs for impairment on an ongoing basis to assess whether the carrying value is expected to be realized during the anticipated life of the investment. In certain cases, the Company may issue fixed-rate senior mortgage loan investments secured by properties controlled by VIEs. These investments are classified as mortgage loans in the Consolidated Balance Sheets, and the income received from such investments is recorded as investment income in the Consolidated Statements of Comprehensive Income.
The following table presents the carrying amount and maximum exposure to loss relating to VIEs for which the Company holds a variable interest, but is not the primary beneficiary, and which had not been consolidated at December 31, 2014 and December 31, 2013. The table includes investments in five real estate joint ventures and 23 affordable housing real estate joint ventures at December 31, 2014 and investments in six real estate joint ventures and 26 affordable housing real estate joint ventures at December 31, 2013.
The maximum exposure to loss relating to the real estate joint ventures and affordable housing real estate joint ventures, as shown in the table above, is equal to the carrying amounts plus any unfunded equity commitments, exposure to potential recapture of tax credits, guarantees of debt, or other obligations of the VIE with recourse to the Company. Unfunded equity and loan commitments typically require financial or operating performance by other parties and have not yet become due or payable but which may become due in the future.
At December 31, 2014, the Company had no mortgage loan or equity commitments outstanding to the real estate joint venture VIEs. At December 31, 2013, the Company had no mortgage loan commitments and $0.2 million in equity commitments. The Company also has contingent commitments to fund additional equity contributions for operating support to certain real estate joint venture VIEs, which could result in additional exposure to loss. However, the Company is not able to quantify the amount of these contingent commitments.
The total separate account assets were $406.5 million at December 31, 2014 (2013 - $393.4 million). Variable universal life and variable annuity assets comprised 28% and 72% of this amount in 2014 compared to 29% and 71% of this amount in 2013.
The Company has a guaranteed minimum withdrawal benefit (GMWB) rider that can be added to new or existing variable annuity contracts. The rider provides an enhanced withdrawal benefit that guarantees a stream of income payments to an owner or annuitant, regardless of the contract account value. The value of the separate accounts with the GMWB rider is recorded at fair value of $132.3 million at December 31, 2014 (2013 - $123.9 million). The GMWB guarantee liability was $(1.1) million at December 31, 2014 (2013 - $(4.7) million). The change in this value is included in policyholder benefits in the Consolidated Statements of Comprehensive Income. The value of variable annuity separate accounts with the GMWB rider is recorded in separate account liabilities, and the value of the rider is included in other policyholder funds in the Consolidated Balance Sheets.
In April 2013, the Company acquired a closed block of variable universal life insurance policies and variable annuity contracts from American Family as discussed in the Reinsurance Transaction section of Note 1. The Company assumed 100% of the separate account liabilities on a modified coinsurance basis and 100% of the general account liabilities on a coinsurance basis. The modified coinsurance portion of the transaction represented approximately $291.6 million in separate account fund balances at acquisition. The Company receives fees based upon both specific transactions and the fund value of the block of policies, as provided under modified coinsurance transactions. Also, as required under modified coinsurance transaction accounting, the separate account fund balances totaling $318.1 million and $319.0 million at December 31, 2014 and 2013, respectively, were not recorded as separate accounts on the Company's financial statements. Rather, the Company recorded these fixed fund accounts as a separate block under its general accounts, and the Company also receives certain ongoing fees associated with specific transactions. The coinsurance portion of the transaction represented $23.6 million in fund value and $0.6 million in future policy benefits at acquisition. The fund value and future policy benefits represented $27.2 million and $0.6 million at December 31, 2014, compared to approximately $26.0 million in fund value and $0.8 million in future policy benefits at December 31, 2013. The Company recorded these fixed fund accounts as a separate block under its general account.
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 2014 approximated 9% of statutory premiums and 13% of the life insurance in force, compared to 8% and 14% in 2013, respectively. The amount of dividends to be paid is determined annually by the Company's 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. 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, as well as for policyholder dividends in excess of the original scale, which have been declared by the Board of Directors.
The Company had no notes payable at December 31, 2014 or December 31, 2013.
The Company had unsecured revolving lines of credit of $70.0 million and $60.0 million with two major commercial banks with no balances outstanding at December 31, 2014 and 2013, respectively. The lines of credit are at variable interest rates based upon short-term indices, and they will mature in June of 2015. The Company anticipates renewing these lines as they come due.
A valuation allowance must be established for any portion of the deferred tax asset which is believed not to be realizable. Management reviews the need for a valuation allowance based on the Company’s anticipated future earnings, reversal of future taxable differences, the available carryback and carryforward periods, tax planning strategies that are prudent and feasible, and the ability and intent to hold securities until their recovery. In management’s opinion, it is more likely than not that the Company will realize the benefit of its deferred taxes.
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. In general, the Company is no longer subject to U.S. federal, state or local income tax examinations by tax authorities for years prior to 2011. The Company is not currently under examination by the Internal Revenue Service.
Tax positions are evaluated at the reporting date to determine whether an unrecognized tax benefit should be recorded. A reconciliation of the beginning and ending amounts of unrecognized tax benefits for the years ended December 31 is as follows:
The Company has pension and other postemployment benefit plans covering substantially all its employees for which the measurement date is annually on December 31.
Hedge fund investments are recorded at net asset value. The Plan's hedge funds invest primarily in other investment funds. The valuation policies of the hedge funds provide that the value of investments in other investment funds be stated at fair value based on the net asset value of the other investment funds and certain redemption restrictions may apply, including a forty-five day prior written notice to withdraw funds.
December 31, 2014. Specifically, the spot rate curve represents the rates on zero coupon securities of the quality and type included in the pension index at various maturities. By discounting benefit cash flows at these rates, a notional amount equal to the fair value of a cash flow defeasing portfolio of bonds was determined. The discount rate for benefits was calculated as a single rate giving the same discounted value as the notional amount.
The postemployment medical plans for eligible employees, agents, and their dependents are contributory with contributions adjusted annually. The benefits expected to be paid in each year from 2015 through 2019 are $1.0 million, $1.0 million, $1.1 million, $1.1 million, and $1.2 million, respectively. The aggregate benefits expected to be paid in the five years from 2020 through 2024 are $7.4 million. The expected benefits to be paid are based on the same assumptions used to measure the Company’s benefit obligation at December 31, 2014. Contributions to the plan in 2014 were $0.9 million. The 2015 contribution for the plan is estimated to be $0.9 million. The Company pays these medical costs as they become due and the plan incorporates cost-sharing features. The postemployment plan disclosures included herein do not include the potential impact from the Medicare Act (the Act) that became law in December 2003. The Act introduced a new federal subsidy to sponsors of certain retiree health care plans that provide a benefit that is at least actuarially equivalent to Medicare. Since the Company does not provide benefits that are actuarially equivalent to Medicare, the Act did not impact the Company’s disclosures.
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 2014 were $0.1 million (2013 - $0.1 million; 2012 - $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 2014 were $0.3 million (2013 - $0.3 million; 2012 - $0.5 million).
The Company recognizes the funded status of its defined pension and postemployment 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 provides the estimated net loss and prior service credit for the pension plan and other postemployment plans that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost in 2015.
Included in the Company's OPEB is a medical insurance plan for retired agents. During the second quarter of 2013, the Company notified the participants that this benefit was being terminated effective December 31, 2013. This benefit termination required a re-valuation of the plan, which was performed effective June 10, 2013 and resulted in a plan curtailment. The curtailment resulted in the immediate recognition of reduced operating expenses of $0.1 million and a reduced liability of $4.4 million.
During the first quarter of 2012, the Company identified an error related to the amortization period for unrecognized actuarial gains and losses for its pension plan. The Company determined that upon curtailment of the plan on January 1, 2011, the status of the plan participants should have changed from active to inactive. The amortization period was corrected from the average remaining service period of plan participants, approximately ten years, to the average remaining life expectancy of plan participants, approximately 26 years. The Company recognized a $2.0 million pre-tax benefit during 2012 related to the reversal of amortization recorded during 2011.
The plan made a payment of $3.8 million during 2014 for the three-year interval ended December 31, 2013. The plan made a payment of $2.4 million during 2013 for the three-year interval ended December 31, 2012. No payments were made during 2012 for the three-year interval ended December 31, 2011. The cost of compensation charged as an operating expense during 2014, 2013, and 2012 was $1.4 million, $3.5 million, and $2.2 million, net of tax, respectively.
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. In June 2012, Sunset Life recaptured approximately 9% of the outstanding bulk reinsurance agreement. At December 31, 2014, the insurance in force ceded approximated $1.0 billion (2013 - $1.0 billion) and premiums totaled $7.3 million (2013 - $7.4 million; 2012 - $7.7 million).
Reinsurance recoverables were $194.4 million at year-end 2014, consisting of reserves ceded of $181.5 million and claims ceded of $12.9 million. Reinsurance recoverables were $191.1 million at year end 2013, consisting of reserves ceded of $178.7 million and claims ceded of $12.4 million.
The maximum retention on any one life during 2014 and 2013 was $0.5 million for ordinary life plans and $0.1 million for group coverage.
The following table reflects the Company’s reinsurance partners whose reinsurance recoverable was 5% or greater of the Company's total reinsurance recoverable at December 31, 2014, along with their A.M. Best credit rating.
The Company acquired a block of variable universal life insurance policies and variable annuity contracts from American Family in 2013. The transfer was comprised of a 100% modified coinsurance transaction on the separate account business and a 100% coinsurance transaction for the corresponding fixed account business. Included in the transaction are ongoing servicing arrangements for this business. At December 31, 2014, the block consisted of $318.0 million (2013 - $319.0 million) of separate account balances, which are included in the financial statements of American Family. At December 31, 2014, the block consisted of $0.6 million (2013 - $0.8 million) of future policy benefits and $27.2 million (2013 - $26.0 million) in fixed fund balances that are included in policyholder account balances in the Company’s consolidated balance sheets.
Comprehensive income (loss) is comprised of net income and other comprehensive income (loss). Other comprehensive income (loss) includes the unrealized investment gains or losses on securities available for sale (net of reclassifications for realized investment gains or losses), net of adjustments to DAC and VOBA, future policy benefits, and policyholder account balances (including deferred revenue liability). In addition, other comprehensive income (loss) includes the change in the liability for benefit plan obligations. Other comprehensive income (loss) reflects these items net of tax.
1 The pre-tax amount includes $16.0 million for a one-time refinement in estimate and $5.6 million for the effect on the deferred revenue liability.
The Company has three reportable business segments, which are defined based on the nature of the products and services offered: Individual Insurance, Group Insurance, and Old American. The Individual Insurance segment consists of individual insurance products for both Kansas City Life and Sunset Life and the assumed reinsurance transactions. The Individual Insurance segment is marketed through a nationwide sales force of independent general agents and third-party marketing arrangements. The Group Insurance segment consists of sales of group life, dental, vision, and group disability products. This segment is marketed through a nationwide sales force of independent general agents, group brokers, and third-party marketing arrangements. The Old American segment consists of individual insurance products designed largely as final expense products. These products are marketed through a nationwide general agency sales force with exclusive territories, using direct response marketing to supply agents with leads.
The maximum stockholder dividends payable by Kansas City Life without prior approval in 2015 is $33.9 million, 10% of December 31, 2014 capital and surplus. The maximum stockholder dividends payable by Old American without prior approval in 2015 is $2.3 million, which is 10% of December 31, 2014 capital and surplus. The maximum stockholder dividends payable by Sunset Life without prior approval in 2015 is $5.4 million, the statutory net gain from operations for the preceding year. Each of the individual insurance enterprises believes that the statutory limitations impose no practical restrictions on any of its dividend payment plans.
Insurance companies are monitored and evaluated by state insurance departments as to the financial adequacy of statutory capital and surplus in relation to each company's risks. One such measure is through the risk-based capital (RBC) guidelines. RBC requirements are intended to be used by insurance regulators as an early warning tool to identify deteriorating or weakly capitalized insurance companies for the purpose of initiating regulatory action. RBC guidelines consist of target statutory surplus levels based on the relationship of statutory capital and surplus to the sum of weighted risk exposures. The RBC calculation determines both an authorized control level and a total adjusted capital prepared on the RBC basis. Generally, regulatory action is at 150% of the authorized control level. Each of the three insurance companies is within the range of approximately 750% to 900%, well in excess of the control level at December 31, 2014.
The Company's subsidiary broker-dealer/investment advisor has been involved in a business that involves a substantial risk of liability. Legal and other proceedings involving financial services firms, including the Company's subsidiary, continue to have a significant impact on the industry. Significant matters over the last few years have included registered representative activity and certain types of securities products (particularly private placements and real estate investment products).
The Company and its subsidiaries are subject to regular reviews and inspections by state and federal regulatory authorities. State insurance examiners - or independent audit firms engaged by such examiners - may, from time to time, conduct examinations or investigations into industry practices and into customer complaints. A regulatory violation discovered during a review, inspection, or investigation could result in a wide range of remedies that could include the imposition of sanctions against the Company, its subsidiaries, or its employees, any of which could have a material adverse effect on the Company's financial condition or results of operations.
Certain policies, contracts, and annuities offered by the Company and certain products offered by its broker-dealer/investment advisor subsidiary are subject to regulation under federal and state securities laws. Federal securities laws contain regulatory restrictions and criminal, administrative, and private remedial provisions. From time to time, the SEC, the Financial Industry Regulatory Authority ("FINRA"), or a state securities regulator examine or investigate the activities of broker-dealers and/or investment advisors, including the Company's affiliated broker-dealer/ investment advisor subsidiary. It is possible that the results of any examination may lead to changes in systems or procedures, payments of fines and penalties, payments to customers, or a combination thereof, any of which could have a material adverse effect on the Company's financial condition or results of operations.
Although no assurances can be given and no determinations can be made at this time, management believes that the ultimate liability, if any, with respect to these regulatory matters, legal actions, and other claims would not have a material effect on the Company's business, results of operations, or financial position.
Treasury stock, at cost (2014 - 7,671,475 shares; 2013 - 7,527,841 shares)
3 Separate investment portfolios are maintained for Kansas City Life, Sunset Life, and Old American. However, investment income is allocated to the Group Insurance segment based upon its cash flows and future policy benefit liabilities.
All other information required by this Schedule is shown in Note 16.
We have audited the accompanying consolidated balance sheets of Kansas City Life Insurance Company and subsidiaries (the Company) as of December 31, 2014 and 2013, and the related consolidated statements of comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2014. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedules I to V. We also have audited the Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).. The Company’s management is responsible for these consolidated financial statements and financial statement schedules, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Assessment of Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.
As discussed in note 3 to the consolidated financial statements, effective December 31, 2014, the Company changed its method of accounting for certain investments in qualified affordable housing projects by electing to use the proportional amortization method for such investments due to the retrospective adoption of Financial Accounting Standards Board Accounting Standards Update (ASU) No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects.