During the first quarter of 2005 the Company entered into a lease for 20,337 square feet of office space in Austin, Texas, under an eight year, triple net lease. The base rent is $0 in the first year (June 1, 2005 to May 31, 2006), $157,612 in the second year and payments escalate to $264,384 in the final year of the lease. Leasehold improvements totaled approximately $872,000 ($203,000 funded by landlord) on the new lease space that was occupied in December 2005. Leasehold improvements are being amortized over the lease term. The $117,000 initial rent holiday and $203,000 of landlord funded leasehold improvements will be amortized over the lease term and reduce lease expense. Deferred rent credits are included in other liabilities and were approximately $380,000 and $320,000 for 2006 and 2005, respectively.
BNLAC leases 288 square feet of office space in Des Moines, IA at a rental of $7,476 per year. The rent includes the services of a secretary that is shared with other tenants of the building.
In this section, we review the consolidated financial condition of the Company at December 31, 2006, 2005 and 2004 and the consolidated results of operations for the periods ended December 31, 2006, 2005 and 2004. Please read this discussion in conjunction with the accompanying consolidated financial statements and notes.
The Company’s financial personnel have significant experience and knowledge in developing claim estimates for the Company’s insurance products. However, the Company’s financial personnel are not formally trained, certified or recognized as actuaries. The Company continually engages independent consulting actuaries. The Company makes extensive use of its independent consulting actuaries which includes the actuaries’ assistance in the development and creation of policy assumptions, the development and modification of reserve and claim liability methodologies and assumptions, estimations and calculations of reserves and claim liabilities, and the annual certification of the amount of the Company’s liabilities for its products.
Management reviews trends in loss ratios and claims per insured per month in determining its estimate for the most recent months. Generally, while fluctuations do occur, the Company’s loss ratio and claims per insured per month are stable. In estimating claim liabilities (the policy claims payable on the Company’s balance sheet), the Company consistently uses the
assumptions of loss ratio and claims per insured per month which are based on actual, historical data. See, the discussion in the section herein entitled “Trends in Completion Factors, Loss Ratio, and Claims Per Insured Per Month”.
As to the consistency of the Company’s estimation of its claim liabilities (the policy claims payable on the Company’s balance sheet), you may reference Notes 7 and 11 to the Company’s Financial Statements. Notes 7 and 11 present data indicating the actual claims paid in a subsequent fiscal year for a prior fiscal year; actual claims incurred in a subsequent year for a prior fiscal year; and the claim liabilities for the prior fiscal year. Notes 7 and 11 are limited to the most recent fiscal year being reported, December 31, 2006, and the previous fiscal years of 2005 and 2004.
The Company determines its life insurance claim liabilities by recording three items: (1) actual claims due and unpaid; (2) the claims received during the day period following year end (this is done by taking an inventory of claims received during the thirty day period); and (3) estimating a liability amount for claims which have been incurred but not yet reported by the end of the thirty day period.
The discussion in this paragraph relates to the months where the completion factors are deemed to be fully credible which are typically the months prior to November and December. The completion factors have been relatively stable in the recent past. In the future, there could be changes in the trend of completion factors. The Company and its independent consulting actuary review the trends in the completion factors and when necessary make judgments as to the Single Point Estimate value for these items. Such estimates are based on observable trends and would also reflect any known major changes. Professional judgments are made based on the experience of the actuary and Company’s financial personnel and management. To observe the possible sensitivity of assuming 100% reliance on completion factors for claims incurred during the months for which completion factors are believed to be fully credible, if the associated claim liabilities for those months had increased by 5%, the year end December 31, 2006, claim liabilities would have been increased by approximately $22,000.
The reconciliation of income taxes computed at the federal statutory income tax rate to total income taxes for the years ended December 31, 2006, 2005 and 2004 is as follows:
The Company has net operating loss carry forwards for income tax purposes at December 31, 2005 as follows:
Approximately $19.1 million of the bond portfolio is classified as Held to Maturity and is carried on the Balance Sheet at amortized cost. This classification reflects management's ability and intent to hold the bonds until maturity. No adjustments to surplus are made as bond values change.
The Company’s investments are primarily in U.S. Government and Government Agencies ($15,819,988 amortized book value), other investment grade bonds ($2,886,306 amortized book value) and less than investment grade ($422,343 amortized book value).
Other long term investments of $1,507,809 consists of, in part, a convertible debenture loan in the amount of $1,357,407 from the Company, to EPSI Benefits, Inc. (EBI), a Texas Corporation. The loan bears interest at an annual rate of 14%, payable monthly, with principal payments commencing September 15, 2008 and a maturity date of August 15, 2015. To protect its interest, BNLF may convert the debenture into 51% of the outstanding common stock of EBI, subject to regulatory approval. The note is one of several agreements entered into by the Company's subsidiaries which expand the business relationship with EBI and its subsidiary, Employer Plan Services, Inc. (EPSI), which provides substantially all of the A&H claims processing and adjudication for the Company's insurance subsidiary, BNLAC. BNLF receives a marketing fee from EBI under a related marketing agreement.
Other long-term investments also include an operating line of credit agreement in the amount of $150,402 and $186,034 in 2006 and 2005 respectively. On October 15, 2003 BNLAC and EPSI entered into a loan agreement whereby BNLAC provided EPSI with a $200,000 line of credit maturing October 15, 2004. The line of credit was renewed and extended with interest only payments to August 1, 2005, at which time EPSI began paying principal and interest payments amortized over five years. The line of credit is at 8.00% with interest and principal payable monthly to BNLAC.
On November 5, 2001 the Company’s Board of Directors approved a settlement of the class action lawsuit (see "Legal Proceedings"). One term of the settlement was the issuance of Company bonds in the principal amount of $1.50 in exchange for each share of the Company’s common stock owned by the members of the class. The bonds have a 12-year term and bear interest at the rate of 6% per annum, effective December 15, 2002 payable annually from the previous fiscal year’s earnings. The total principal amount of bonds payable at December 31, 2006 is $1,639,984 compared to $1,747,178 at December 31, 2005. Bond interest expense was $86,700, and $116,920 in 2006 and 2005; respectively. BNLAC will pay dividends to BNL Financial Corporation for the payment of interest to the bondholders. The maximum amount of dividends, which can be paid by Arkansas domiciled insurance companies to shareholders without prior approval of the insurance commissioner, is subject to restrictions relating to statutory surplus. The Arkansas Insurance Commissioner has reviewed and approved the settlement. The Company does not expect the dividend restrictions to impact its ability to meet its cash needs. The Company has no plan to start a sinking fund for payment of the principal at maturity.
In 2006, BNLAC paid dividends totaling $1,450,000 to BNLF for the purchase of Company stock and bonds and for other general operating funds compared to $2,950,000 dividends paid in 2005. In 2005, the Company negotiated with Universal Guaranty Life Insurance Company to purchase 2,216,776 shares of BNL Financial Corporation’s common stock for $2,300,000.
The following table reflects all long-term contractual obligations of the Company as of December 31, 2006.
Future payments related to short duration contracts such as group dental are not included in the above table in the line item Liabilities for Future Policy Benefits.
The total estimated future payments to be made relating to the Supplementary Contracts without life contingencies liability is stated as $33,000 which does not match the balance sheet liability total of $17,241 and the difference is $15,759. This is primarily due to the fact that the estimated future payments in this long term contractual obligations table for Supplementary Contracts includes consideration of future investment income, withdrawals (if permitted) and maintenance expenses and such assumptions, and perhaps other assumptions, may differ from the assumptions initially used to establish the balance sheet liability. The estimated future payments presented in the long term contractual obligations table are based on current assumptions while the balance sheet liability is based on assumptions locked in at the date the policy was approved for issue. The estimated future payments are based on many significant assumptions regarding future occurrences such as interest earnings, mortality, and persistency. It is likely that the actual experience will deviate from these assumptions - sometimes materially. A number of factors can have an effect such as economic conditions, changes in policyholder actions regarding withdrawals (if allowed), and mortality improvement or deterioration. Random fluctuation in experience could also have an effect. The Supplementary Contracts estimated future payments are based upon estimates and the timing and amount of future payments is not always reasonably fixed and determinable. Because of the above considerations, the amounts and timing of estimated future payments will likely vary from that presented in the above table.
Policy benefits and other insurance costs increased from $31,766,217 in 2004, to $33,317,136 in 2005 and increased to $34,374,507 in 2006. The increase in 2005 was primarily due to an increase in claims ($1.3 million) resulting from an increase in group and individual dental business. The increase in 2006 was due to an increase in claims of approximately $740,000 and a $344,000 increase in commissions resulting from the increase in group dental premium collected. The claims ratio on group dental insurance, which represents the ratio of claims incurred to premium earned, was 64.1% in 2006, 63.1% in 2005 and 62.3% in 2004. The claims ratio has increased over the last three years primarily due to increased utilization by policyholders. Management closely monitors claims ratios on group and individual dental business
Amortization of deferred policy acquisition costs was $26,219 in 2006, $22,467 in 2005 and $29,973 in 2004. Amortization of deferred policy acquisition costs are primarily costs associated with a seasoned block of business written between 1988 and 1990. The decrease in amortization expense trend should continue in subsequent years until the acquisition costs are completely amortized. Amortization expense per year may vary in relation to lapses or surrenders of the existing block of business.
Taxes other than on income were $1,526,427 in 2006, $1,577,775 in 2005 and $1,344,723 for 2004. The decrease for 2006 is due to an over accrual in 2005 for state taxes. The increase in 2005 was due to an increase in premium taxes on additional premiums collected and from prior year accrual adjustments.
$79,001 and $113,000 of deferred tax expense; respectively. Fluctuations in tax expense are primarily due to changes in taxable income, limitations on net operating losses utilized and adjustments in estimates for income taxes in prior years.