From September 1989 to July 2000, the Company maintained its executive and business offices in a building located at 1200 Camp Hill By-Pass, Camp Hill, Pennsylvania. The office building contained approximately 44,000 square feet of office space (approximately 39,000 square feet of leasable space). Prior to 1994, the Company leased the entire facility at an annual rental of $421,000, plus insurance, taxes and utilities. In March of 1994, the Company exercised its option to acquire a 50% interest in its home office building for $1.75 million, which reduced the Company's annual rent on the portion of the building it did not own to $204,000. The Company's lease terminated in July 1999.
The Company now leases approximately 1,200 square feet of office space on a month-to-month basis at 1513 Cedar Cliff Drive, Camp Hill, Pennsylvania. The monthly rent for this facility is $1,300. The Company also leases approximately 1,100 square feet of warehouse space which it utilizes for the storage of its records. The monthly rent for this space is approximately $640. The warehouse lease, which terminates on May 31, 2002, is renewable for additional one-year terms at nominal increases in rent each year. Both the office space and the warehouse space are adequate for the Company's current needs.
At the Special Meeting of Shareholders held on March 24, 1998, the Company's preferred and common shareholders approved the sale of the Company's credit insurance and related products business, which was the Company's only remaining business operation. In connection with the sale of its in force credit insurance business, the Company also sold its credit insurance customer accounts and one of its life insurance subsidiaries. At the Special Meeting, the shareholders also approved a Plan of Liquidation and Dissolution (the Plan of Liquidation), pursuant to which the Company has been liquidating its remaining assets and paying or providing for all of its liabilities so that it can distribute its remaining cash to its preferred shareholders. If the Company proceeds with the Plan of Liquidation, it is unlikely that any cash will be available for distribution to the common shareholders.
net assets have reduced the estimated liquidation value of the preferred stock. During the year ended December 31, 2001, the estimated liquidation value of the preferred stock decreased by $748,000 due to an excess of benefits and expenses over revenues of $521,000 and preferred shareholder dividends of $386,000. During 2000, the estimated liquidation value of the preferred stock declined by $938,000 primarily as a result of a $432,000 increase in the amount necessary to fully fund the Company's pension plan and $391,000 in preferred shareholder dividends. In 1999, the Company's net assets in liquidation decreased from $383,000 to zero and the estimated liquidation value of the preferred stock also declined by $303,000. The $686,000 in reductions reported in 1999 were principally due to a $252,000 excess of benefits and expenses over revenues for the year, a $388,000 increase in the liability for the Company's under funded pension plan and $406,000 in preferred dividends. These reductions were partially offset by a $210,000 adjustment of certain liabilities to their estimated settlement amounts and other miscellaneous increases in net assets.
As indicated above, since the Company has no net assets available for common shareholders, all decreases in net assets must be deducted from the estimated liquidation value of the Company's preferred stock. During 2001, the estimated liquidation value of the preferred stock decreased by $748,000. As a result, at December 31, 2001, the 452,614 shares of preferred stock outstanding have an estimated liquidation value of $2,538,000.
The $748,000 reduction in the estimated liquidation value of the preferred stock for the year ended December 31, 2001 is attributable to an excess of benefits and expenses over revenues of $521,000 and preferred shareholder dividends of $386,000. The Company's total expenses in 2001 were significantly impacted by $216,000 in litigation settlement costs. The Company also incurred approximately $89,000 in legal fees in connection with the above settlements and other corporate matters, including legal fees relating to the Option Agreement. In addition, revenues for the period were adversely affected by the fact that the Company is no longer receiving any fee revenues from the sale of its credit insurance customer accounts as the result of the settlement of a dispute with the purchaser, as discussed more fully below. Fee revenues of approximately $200,000 and $373,000 were reported in 2000 and 1999, respectively. The Company's investment income also decreased from $301,000 last year to $150,000 in 2001 because of a continuing decline in investable assets (due to negative cash flows) and a significant drop in short-term interest rates. A $108,000 increase in the estimated net realizable value of the insurance licenses of the Company's subsidiary, based on the expected selling price of those licenses, partially offset the decreases discussed above.
The decrease in the liquidation value of the preferred stock in 2000 was primarily the result of a $432,000 increase in the Company's liability for its under funded pension plan and $391,000 in dividends to the preferred shareholders. An excess of expenses over revenues (excluding pension expense) also contributed to the decline in the liquidation value. Effective in March 2000, the Company terminated the pension plan as part of the Plan of Liquidation. Following the receipt of all regulatory approvals and each participant's election as to his or her form of benefit payment (lump sum or annuity), the plan's final liability was determined using a government-mandated interest rate to compute the lump sum benefits. Because the prescribed interest rate had declined from the rate used by the Company to estimate its December 31, 1999 liability to the plan, the total liability to participants, and the Company's corresponding liability to the plan, increased compared to the
estimate at the end of 1999. Consequently, the Company had to contribute $966,000 to the plan, or $432,000 more than the $534,000 which had been established at December 31, 1999 as the unfunded liability.
The agreement with the purchaser of the Company's credit insurance operations provided that the proceeds from the sale of the customer accounts were to be received as fee revenues until September 2002, based on the amount of credit insurance premiums produced by those accounts. However, as discussed in Note 12 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K, a dispute arose during 1999 between the Company and the purchaser regarding the payment of investment income on the assets which were transferred to the purchaser in connection with the sale of the in force credit insurance business. Because of the dispute, the purchaser began withholding the fee revenues from the Company to offset the investment income it believed it was due. In late 2000, the parties settled this dispute, and, pursuant to this settlement, the purchaser paid the Company $250,000 in settlement of all prior amounts withheld and in lieu of any future fee revenue payments. Since the settlement amount was $116,000 less than the amount of fee revenues due from the purchaser, the Company included a $116,000 charge off in its 2000 expenses. The Company also incurred approximately $169,000 in legal fees during 2000, principally in connection with the above-referenced dispute and other litigation matters.
During 1999, the Company's net assets in liquidation declined by $383,000 and the estimated liquidation value of the preferred stock also declined by $303,000. These decreases were principally the result of an excess of benefits and expenses over revenues of $252,000, a $388,000 increase in the liability for the Company's under funded pension plan and $406,000 in preferred stock dividends. These reductions were partially offset by a $210,000 adjustment of certain liabilities to their estimated settlement amounts. The 1999 excess of benefits and expenses over revenues was principally due to (i) higher than expected audit, actuarial and legal fees and salary expenses (in part due to the Company's inability to sell its life insurance subsidiary), (ii) delays in selling the Company's home office building, which resulted in higher than anticipated rent and maintenance costs for the year and (iii) a loss from a terminated joint venture which was expected to generate income.
The time frame for completing the liquidation is dependent upon a number of factors, the most significant of which is the timing of the proposed sale of the Company's life insurance subsidiary, since substantially all of the Company's assets are held by the subsidiary and are restricted as to their use by state insurance regulations. In January, the Company entered into an agreement to sell the subsidiary and its 25 state insurance licenses. In February 2002, the purchasers filed a Form A with the Delaware Insurance Department seeking the Department's approval of the change in control.
As a result of the foregoing, a final distribution under the Plan of Liquidation cannot be made to the preferred shareholders until (i) the life subsidiary is sold, (ii) the Company has resolved its remaining litigation matters and (iii) a determination is made regarding the amount of any contingency fund distribution which might be payable to the Company.
Based on current estimates, management believes that the Company's future expenses and other changes in net assets, including preferred stock dividends, will exceed its revenues during the remainder of the liquidation period by approximately $400,000 to $475,000. Actual revenues and expenses and other net asset changes could vary significantly from the present estimates due to the uncertainties regarding (i) when the remaining non liquid assets, particularly the stock of the life insurance subsidiary, will be liquidated, (ii) when the tender offer to the preferred shareholders occurs, (iii) the level of actual expenses which will be incurred and (iv) the ultimate resolution of all current contingencies and any contingencies which may arise in the future.
Invested assets at both December 31, 2001 and 2000 consisted of (i) U.S. Treasury Notes, owned by the Company's insurance subsidiary, which are on deposit with four state insurance departments in connection with licensing requirements, (ii) one mortgage loan, secured by commercial real estate, which is scheduled to be paid in full by June 2002 and (iii) short-term investments, principally money market funds and certificates of deposit (one certificate of deposit with a balance of $50,000 is also on deposit with a state insurance department). If the Company completes the sale of the subsidiary, as discussed above, at closing, the subsidiary will transfer to the Company all of its assets (except for the statutory deposits) and most of its liabilities, and the purchaser will pay the Company an amount equal to the fair value of the statutory deposits plus $10,000 for each of the subsidiary's 25 state insurance licenses.
We have audited the accompanying consolidated statements of net assets in liquidation of Consumers Financial Corporation and subsidiaries as of December 31, 2001 and 2000 and the related consolidated statements of changes in net assets in liquidation for each of the three years in the period ended December 31, 2001. These financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
As described in Note 4 to the financial statements, the shareholders of Consumers Financial Corporation approved a plan of liquidation on March 24, 1998, and the Company commenced liquidation shortly thereafter. As a result, the Company changed its basis of accounting for periods subsequent to March 24, 1998 from the going-concern basis to the liquidation basis. Accordingly, the carrying values of the remaining assets as of December 31, 2001 and 2000 are presented at estimated realizable values and all liabilities are presented at estimated settlement amounts.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated net assets in liquidation of Consumers Financial Corporation and subsidiaries as of December 31, 2001 and 2000 and the consolidated changes in their net assets in liquidation for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America applied on the basis described in the preceding paragraph.
The operating losses incurred by the Company from 1993 to 1997 significantly reduced its net worth and its liquidity position. As a result, in 1998, the Company sold its core credit insurance and related products business, which had been its only remaining business operation, following the sales in 1994 and 1997 of all of its universal life insurance business and the 1996 sale of its auto auction business. Since the sale of its credit insurance business, the Company's revenues, benefits and expenses have consisted principally of (i) fee revenues received from Life of the South Corporation, the Georgia-based company which acquired the Company's credit insurance business and its credit insurance accounts (LOTS), (ii) investment income on remaining assets and (iii) corporate expenses. However, see Note 12 for information concerning the discontinuation of the fee revenues.
On March 24, 1998, the Company's shareholders approved a Plan of Liquidation and Dissolution (the Plan of Liquidation) pursuant to which the Company is liquidating its remaining assets and paying or providing for all of its liabilities. If the Company proceeds with the Plan of Liquidation, all of its remaining cash will eventually be distributed to the preferred shareholders (see Note 4). As discussed more fully in Note 17, in February 2002, the Company entered into an option agreement with an investor group pursuant to which the investor group may obtain a controlling interest in the Company's common stock. If the option is exercised, the liquidation of the Company would be discontinued. Since there is no assurance at this time that the option will be exercised, the Company continues to proceed with the Plan of Liquidation.
The consolidated financial statements include the accounts of Consumers Financial Corporation and its wholly-owned subsidiaries (the Company), the most significant of which is Consumers Life Insurance Company (Consumers Life). Since December 2000, Consumers Life has been Consumers Financial Corporation's only subsidiary. Consumers Financial Corporation itself is also sometimes referred to herein as the Company. All material intercompany accounts and transactions have been eliminated.
The financial statements have been prepared on the basis of generally accepted accounting principles (GAAP) which, as to Consumers Life, vary from reporting practices prescribed or permitted by regulatory authorities. As a result of the approval of the Plan of Liquidation and Dissolution referred to above and discussed in Note 4, the Company adopted a liquidation basis of accounting for periods subsequent to March 24, 1998. Under the liquidation basis of accounting, assets are stated at their estimated net realizable values and liabilities are stated at their anticipated settlement amounts. Amounts determined in accordance with the liquidation basis of accounting do not differ significantly from the accounting policies discussed below. Certain prior year amounts have been reclassified to conform with classifications used for 2001.
Mortgage loans: The fair values for mortgage loans are estimated using discounted cash flow analyses, based on interest rates which would currently be offered for similar loans to borrowers with similar credit ratings.
Prior to the discontinuation of its insurance operations, the Company deferred the costs of acquiring new insurance business. The costs deferred consisted principally of commissions, certain sales salaries and other expenses that varied with and were primarily related to the production of new business. Deferred policy acquisition costs were expensed when such costs were deemed not to be recoverable from future earned premiums and investment income or, when applicable, from the estimated proceeds to be received from the sale of the related insurance business. At December 31, 2001, the Company had no deferred policy acquisition costs. At December 31, 2000, the Company's only unamortized policy acquisition costs related to commissions paid in connection with certain annuity business assumed during 2000 (see Note 10).
Prior to the conversion of the Company's remaining indemnity reinsurance agreements to assumption reinsurance, the liability for future policy benefits for individual life insurance was provided on a net level premium method based on estimated investment yields, withdrawals, mortality and other assumptions which were appropriate at the time the policies were issued. Such estimates were based upon industry data and past experience, as adjusted to provide for possible adverse deviation from the estimates. Benefit reserves for universal life products represented policy account balances before applicable surrender charges plus certain deferred policy initiation fees that were recognized in income over the term of the policies. At December 31, 2001, the Company had no liability for future policy benefits.
(d) Commission allowances pertaining to financing-type reinsurance agreements are not included in results of operations or changes in net assets in liquidation
Dividends and other distributions to the Company from Consumers Life are limited in that Consumers Life is required to maintain minimum capital and surplus in each of the states in which it is licensed, determined in accordance with regulatory accounting practices. The amount of minimum capital and surplus required is $8.6 million. At December 31, 2001, Consumers Life does not meet the minimum capital and surplus requirements in eight of the states in which it is licensed, and it has agreed to a temporary suspension of its insurance license in one of those states. No actions have been taken with respect to this matter by the insurance departments of the other states. Since the Company does not intend to write any new insurance business through Consumers Life and has signed an agreement to sell the subsidiary (see Note 17), a temporary suspension of any of Consumers Life's licenses will have no material adverse effect on the Company. However, if any of the licenses are revoked rather than suspended, the total consideration the Company will receive when Consumers Life is sold will be reduced.
Under Delaware insurance laws, distributions are subject to further restrictions relating to capital and surplus and operating earnings. Accordingly, under normal circumstances, at December 31, 2001, approximately $2.47 million of Consumers Life's net assets cannot be transferred to the parent company and $221,000 is available for transfer during 2002. However, because of its prior operating losses and its current capital and surplus position, the Company is not permitted to pay any dividends without prior approval from the Delaware Insurance Department. Also, any loans or advances to the Company must be reported to and approved by the Delaware Department. The Company does not have sufficient cash funds available to pay dividends to its shareholders without the amounts which may be transferred from Consumers Life. During 2001 and 2000, the Delaware Insurance Department approved the payment by Consumers Life of cash dividends totaling $212,500 and $160,000, respectively. No dividends were approved or paid in 1999.
The reported statutory capital and surplus of Consumers Life was $2.2 million at December 31, 2001 and $3.0 million at December 31, 2000. Consumers Life reported statutory net losses of $418,000 in 2001 and $316,000 in 2000.
At the Special Meeting of Shareholders held on March 24, 1998, the Company's shareholders approved the sale of the in force credit insurance
business as well as the Plan of Liquidation referred to in Note 1, pursuant to which the Company has been liquidating its remaining assets and providing for its liabilities. If the Company proceeds with the Plan of Liquidation, it will eventually distribute its remaining cash to its preferred shareholders. The Company does not expect to be able to make any payment to its common shareholders under the Plan of Liquidation.
In August 2001, the Company's Board of Directors solicited proposals for interest in acquiring control of the Company and received proposals from several investor groups that had expressed such an interest. Following a review of the proposals which were received, the Company selected one investor group with whom it entered into an option agreement in February 2002. The option agreement permits the investor group to acquire a 51% interest in the Company's common stock. The terms of the option agreement are described in Note 17. The Board of Directors considered a transaction of this type in lieu of the Plan of Liquidation because it has the potential to produce future value for the common shareholders while protecting the rights of the Company's preferred shareholders. As indicated above, the common shareholders are not expected to receive any distribution under the Plan of Liquidation. If the investor group does not exercise its option to acquire the Company, the Board of Directors intends to continue with the Plan of Liquidation.
A portion of the Company's invested assets is restricted as to use in that deposits are required with various state insurance departments in order to maintain licenses in those states (see Note 3).
During 2000 and 1999, the Company held one non-performing mortgage loan where the mortgagor had filed a voluntary petition under Chapter 11 of the Bankruptcy Code in late 1997. Interest in the amount of $39,965 was excluded from investment income in 1999 due to the non-performing status of this loan. As a result of an agreement reached with the bankruptcy trustee, from November 1999 to May 2000, the Company received approximately $32,000 in lease payments from a tenant at the mortgaged property. Such payments were applied first to legal costs incurred by the Company and then to accrued late fees and unpaid interest. The trustee sold this property in June 2000, at which time the principal balance on this loan was paid in full along with $47,000 in unpaid interest.
All debt securities held by the Company at December 31, 2001 have contractual maturities between 2003 and 2005. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company did not sell any investments in debt securities during 2001 or 2000. Proceeds from the sales of investments in debt securities during 1999 were $850,000. There were no gains or losses on those sales.
At December 31, 2001, the Company had no future policy benefits liability or unearned premiums liability as a result of the conversion of its remaining indemnity reinsurance agreements to assumption reinsurance during 2001 and the termination of three small retained policies during the year. Future policy benefits and unearned premiums at December 31, 2000 do not include any deduction for reinsurance ceded under indemnity reinsurance agreements (see Note 10). All but $39,000 of the Company's future policy benefits liability at December 31, 2000 was reinsured to other insurers pursuant to indemnity agreements. Similarly, all of the Company's unearned premiums liability at December 31, 2000 was reinsured to other insurers under indemnity-type agreements.
Life insurance in force net of reinsurance ceded was $58,000 at December 31, 2000.
Effective December 31, 2000, Consumers Life converted one of its four remaining indemnity reinsurance agreements to assumption reinsurance, thereby eliminating the contingent risk on that block of reinsured business. As of January 1, 2001, a similar conversion to assumption reinsurance was completed on another indemnity agreement. Effective October 1, 2001, Consumers Life converted its remaining two indemnity agreements to assumption reinsurance. As a result of these transactions, Consumers Life no longer has any direct policyholder obligations.
During 1999, Consumers Life was a party to a financing-type reinsurance agreement in which it assumed approximately $2 million in individual life insurance premiums and an equal amount of policy liabilities. This agreement terminated in January 2000. During 2000, the Company entered into a similar agreement with another insurer in which it assumed approximately $2.5 million of annuity premiums and policy liabilities. The effects of these financing-type agreements have been removed from the financial statements except for the cost of the financing, which amounted to $40,000 in 2001, $10,000 in 2000 and $25,000 in 1999. These costs are presented with Miscellaneous expenses on the Consolidated Statements of Changes in Net Assets in Liquidation.
In 2001, refunds (negative premiums) ceded to other companies under indemnity reinsurance agreements totaled approximately $737,000. Refunds ceded in 2000 were approximately $1.8 million, while premiums ceded in 1999 were approximately $11.9 million. The negative premiums in 2001 and 2000 are the result of the termination in late 1999 of the fronting arrangement whereby, following the sale of the credit insurance operations to LOTS in early 1998, credit insurance business continued to be written on Consumers Life's certificate forms in 1998 and most of 1999 and ceded 100% to American Republic. Once all new business ceased, the refund of unearned premiums was the only premium activity which remained.
Incurred benefits and losses reinsured under indemnity reinsurance agreements were $3.8 million in 2001 compared to $9.0 million in 2000 and $12.6 million in 1999. These amounts have been deducted in arriving at Policyholder Benefits in the Consolidated Statements of Changes in Net Assets in Liquidation. However, Future Policy Benefits and Unearned Premiums at December 31, 2000 do not include any deduction for reinsurance ceded under the indemnity reinsurance agreements. Instead, the amounts related to such reinsurance are classified as Reinsurance Recoverable and Prepaid Reinsurance Premiums (see Note 9). These asset and liability amounts have both been eliminated from the Consolidated Statements of Net Assets in Liquidation at December 31, 2001 as a result of the conversion of the indemnity reinsurance agreements to assumption reinsurance during 2001.
Effective October 1, 1999, the Company also terminated its employee stock ownership plan. In October 2000, after receiving a favorable determination letter from the Internal Revenue Service, the plan assets, consisting principally of common stock of the Company, were distributed to the participants.
The Company's remaining defined contribution plan covers all current employees and provides for annual contributions in amounts determined by the Board of Directors. Such contributions are based upon the annual compensation of each employee. Company contributions were $4,400 in 2001, $10,500 in 2000 and $11,100 in 1999.
A reconciliation of beginning and ending balances of the pension plan's assets for the year ended December 31, 2000 is as follows.
Certain claims, suits and complaints arising in the ordinary course of business have been filed or are pending against the Company or its subsidiaries. In the opinion of management, based on opinions of legal counsel, adequate reserves, if deemed necessary, have been established for these matters and their outcome will not have a significant effect on the Company's net assets in liquidation or its changes in net assets in liquidation. The Company has taken certain income tax positions in previous years that it believes are appropriate. If such positions were to be successfully challenged by the Internal Revenue Service, the Company could incur additional income taxes as well as interest and penalties. Management believes that the ultimate outcome of any such challenges will not have a material effect on the Company's financial statements.
When the Company is in arrears as to preferred dividends or sinking fund appropriations for the Preferred Stock, dividends to holders of the Company's common stock as well as purchases, redemptions or acquisitions by the Company of shares of the Company's common stock are restricted. If the Company is in default with respect to the payment of preferred dividends and the aggregate amount of the deficiency is equal to four quarterly dividends, the holders of the Preferred Stock shall be entitled, only while such arrearage exists, to elect two additional members to the then existing Board of Directors.
In connection with the potential acquisition of a controlling interest in the common stock of the Company, as discussed in Note 17, the Company intends to give all of the preferred shareholders an opportunity to tender their shares in exchange for a cash payment. If this tender offer is completed, those preferred shareholders who do not elect to tender their shares will remain shareholders of the Company and will continue to be entitled to the same rights and preferences as currently exist for the preferred stock.
(b) Distributions, other than stock dividends, are made by Consumers Life to the Company in excess of Shareholders' Surplus, as defined by prior law, or
(c) Consumers Life ceases to qualify for taxation as a life insurance company.
At December 31, 2001 and 2000, the Policyholders' Surplus Account for Consumers Life was approximately $439,000. Based on its current plans, the Company does not believe it is probable that Consumers Life will incur any additional taxes with regard to its Policyholders' Surplus Account.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. At December 31, 2001 and 2000, the Company had no material deferred tax liabilities and only one material deferred tax asset relating to net operating loss carry forwards. This deferred tax asset, which totaled $2,013,000 and $1,869,000 at the end of 2001 and 2000, respectively, has been fully offset by a valuation allowance.
The Company files a consolidated Federal income tax return with Consumers Life. At December 31, 2001, Consumers Life had available approximately $5.9 million of Federal net operating losses, which will be carried forward to future years. Of this amount, $163,000 may only be used to offset future taxable income of the life insurance company sub-group. The net operating losses will expire at various times from 2009 to 2016. However, if the planned sale of Consumers Life is completed, these loss carry forwards will no longer be available to offset any future taxable income of the Company.
that it had not obtained prior approval from the Department for certain intercompany transactions. The Department did not impose any fines or other sanctions but did require that Consumers Life obtain prior approval from the Department for all transactions with the Company and for any disbursements in excess of $10,000.
If CFC Partners exercises its option to acquire control of the Company, it has indicated that it intends to merge or otherwise combine certain existing and start-up businesses into the Company. CFC Partners has further indicated that these businesses initially will include (i) a company that will provide long distance telephone services at discounted rates, (ii) a company which provides services that enable its customers to deploy and migrate to E-business portals and E-marketplaces and (iii) a company that will offer business to business online financial services.