Real Estate Amount % of Total Home Office $ 2,885,908 20% Commercial $ 2,397,475 17% Residential development $ 5,260,107 36% Foreclosed real estate $ 3,846,946 27%
FINANCIAL HIGHLIGHTS (000's omitted, except per share data) 1996 1995 1994 1993 1992
Premium income net of reinsurance $ 27,619 $ 29,998 $ 32,404 $ 31,160 $ 19,076 Total revenues $ 46,976 $ 49,869 $ 49,207 $ 48,541 $ 36,826 Net income (loss)* $ (938)$ (3,001)$ (1,624)$ (862)$ 5,661 Net income (loss) per share $ (0.05)$ (0.16)$ (0.09)$ (0.05)$ 0.30 Total assets $355,474 $356,305 $360,258 $375,755 $370,259
Consolidated operating activities of the Company produced cash flows of $2,785,000, $453,000 and $2,145,000 in 1996, 1995 and 1994, respectively. The net cash provided by operating activities plus net policyholder contract deposits after the payment of policyholder withdrawals, equalled $9,596,000 in 1996, $9,466,000 in 1995, and $10,361,000 in 1994. Management utilizes this measurement of cash flows as an indicator of the performance of the Company's insurance operations, since reporting regulations require cash inflows and outflows from universal life insurance products to be shown as financing activities.
Cash provided by (used in) investing activities was $16,163,000, ($8,030,000) and ($28,595,000), for 1996, 1995 and 1994, respectively. The most significant aspect of cash provided by (used in) investing activities is the fixed maturity transactions. Fixed maturities account for 82%, 76% and 79% of the total cost of investments acquired in 1996, 1995 and 1994, respectively. The net cash provided by investing activities in 1996, is due to the fixed maturities sold in conjunction with the coinsurance agreement with FILIC. The Company has not directed its investable funds to so-called "junk bonds" or derivative investments.
On a parent only basis, UTI's cash flow is dependent on revenues from a management agreement with UII and its earnings received on invested assets and cash balances. At December 31, 1996, substantially all of the consolidated shareholders equity represents net assets of its subsidiaries. UTI does not have significant day to day operations of its own. Cash requirements of UTI primarily relate to the payment of expenses related to maintaining the Company as a corporation in good standing with the various regulatory bodies which govern corporations in the jurisdictions where the Company does business. The payment of cash dividends to shareholders is not legally restricted. However, insurance company dividend payments are regulated by the state insurance department where the company is domiciled. UG's dividend limitations are described below.
Ohio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 1996, UG had a statutory gain from operations of $8,006,000. At December 31, 1996, UG's statutory capital and surplus amounted to $10,227,000. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation.
A life insurance company's statutory capital is computed according to rules prescribed by the National Association of Insurance Commissioners ("NAIC"), as modified by the insurance company's state of domicile. Statutory accounting rules are different from generally accepted accounting principles and are intended to reflect a more conservative view by, for example, requiring immediate expensing of policy acquisition costs. The achievement of long-term growth will require growth in the statutory capital of the Company's insurance subsidiaries. The subsidiaries may secure additional statutory capital through various sources, such as internally generated statutory earnings or equity contributions by the Company from funds generated through debt or equity offerings.
Net investment income increased 3% when comparing 1996 to 1995. The overall investment yields for 1996, 1995 and 1994, are 7.21%, 7.04% and 7.13%, respectively. The improvement in investment yield is primarily attributed to the fixed maturity portfolio. The Company has invested financing cash flows generated by cash received through sales of universal life insurance products.
Realized investment losses were $988,000 and $124,000 in 1996 and 1995, respectively. Approximately $522,000 of the realized losses in 1996 is due to the charge-off of two investments. The Company realized a loss of $207,000 from a single loan and $315,000 from an investment in First Fidelity Mortgage Company ("FFMC"). The charge- off of the loan represented the entire loan balance at the time of the charge-off. Additionally, the Company sold two foreclosed real estate properties that resulted in approximately $357,000 in realized losses in 1996. The Company had other gains and losses during the period that comprised the remaining amount reported but were immaterial in nature on an individual basis.
The Company reported a non-recurring write down of value of agency force of $0 and $8,297,000 in 1996 and 1995, respectively. The write down was directly related to the Company's change in distribution systems. The Company changed its focus from primarily a broker agency distribution system to a captive agent system. Business produced by the broker agency force in recent years did not meet Company expectations. With the change in focus of distribution systems, most of the broker agents were terminated. The termination of most of the agents involved in the broker agency force caused management to re- evaluate the value of the agency force carried on the balance sheet.
Operating expenses increased 4% in 1996 compared to 1995. The primary factor that caused the increase in operating expenses is directly related to increased legal costs and reserves established for litigation. The legal costs are due to the settlement of non-standard insurance policies as was discussed in the review of life benefits. The Company incurred legal costs of $906,000, $687,000 and $229,000 in 1996, 1995 and 1994, respectively in relation to the settlement of the non-standard insurance policies.
interest rates on its insurance products to preserve targeted spreads. Over 60% of the insurance and investment product reserves are crediting 5% or less in interest and 39% of the insurance and investment product reserves are crediting 5.25% to 6% in interest. It is expected that the monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on insurance policies the Company has in force and will write in the future.
Dividends to policyholders increased approximately 16% when comparing 1995 to 1994. USA continued to market participating policies through most of 1994. Management expects dividends to policyholders will continue to increase in the future. A significant portion of the insurance in force is participating insurance. A significant portion of the participating business is relatively newer business, and the dividend scale for participating policies increases in each duration. The dividend scale is subject to approval of the Board of Directors and may be changed at their discretion. The Company has discontinued its marketing of participating policies.
Amortization of cost of insurance acquired decreased 37% in 1995 compared to 1994. Cost of insurance acquired is amortized in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. The Company did not have any charge-offs during the periods covered by this report. The decrease in amortization during the current period is a normal fluctuation due to the expected future profits. Amortization of cost of insurance acquired is particularly sensitive to changes in persistency of certain blocks of insurance in force. The Company's average persistency rate for all policies in force for 1995 and 1994 has been approximately 87.5% and 86.3%, respectively.
Operating expenses increased 18% in 1995 compared to 1994. The increase was caused by several factors. The primary factor for the increase in operating expenses is due to the decrease in production. The decrease in production was discussed in the analysis of premium income. As such, the Company was positioned to handle significantly more first year production than was produced. First year operating expenses that were deferred and capitalized as a deferred policy acquisition costs asset was $532,000 in 1995 compared to $1,757,000 in 1994. The difference between the policy acquisition costs deferred in 1995 compared to 1994, affected the increase in operating expenses. The increase in operating expenses was offset, to a lesser extent, from a 12% reduction in staff in 1995 compared to 1994. The reduction in staff was achieved by attrition.
The liabilities are predominantly long term in nature and therefore, the Company invests in long term fixed maturity investments which are reported in the financial statements at their amortized cost. The Company has the ability and intent to hold these investments to maturity; consequently, the Company does not expect to realize any significant loss from these investments. The Company does not own any derivative investments or "junk bonds". As of December 31, 1996, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in the context of consolidated assets or shareholders' equity. The Company has identified securities it may sell and classified them as "investments held for sale". Investments held for sale are carried at market, with changes in market value charged directly to shareholders' equity.
Mortgage loans decreased 21% in 1996 as compared to 1995. The Company is not actively seeking new mortgage loans, and the decrease is due to early pay-offs from mortgagee's seeking refinancing at lower interest rates. All mortgage loans held by the Company are first position loans. The Company has $603,000 in mortgage loans, net of a $10,000 reserve allowance, which are in default or in the process of foreclosure, this represents approximately 5% of the total portfolio. The mortgage delinquency rate for the insurance industry as published by the National Association of Insurance Commissioners ("NAIC") as the "Industry Experience Factor" is 6.5%.
Deferred policy acquisition costs decreased 1% in 1996 compared to 1995. The costs, which vary with, and are primarily related to producing new business are referred to as deferred policy acquisition costs ("DAC"). DAC consists primarily of commissions and certain costs of policy issuance and underwriting, net of fees charged to the policy in excess of ultimate fees charged. To the extent that these costs are recoverable from future profits, the Company defers these costs and amortizes them with interest in relation to the present value of expected gross profits from the contracts, discounted using the interest rate credited by the policy. The Company had $1,276,000 in policy acquisition costs deferred, $408,000 in interest accretion and $1,796,000 in amortization in 1996. The Company did not recognize any impairments during the period.
Dividend and endowment accumulations increased 10% in 1996 compared to 1995. The increase is attributed to the significant amount of participating business the Company has in force. There are generally four options a policyholder can select to pay policy dividends. Over 47% of all dividends paid were put on deposit to accumulate with interest. Accordingly, management expects this liability to increase in the future.
Income taxes payable and deferred income taxes payable decreased significantly in 1996 compared to 1995. The primary reason for the decrease in deferred income taxes is due to the coinsurance agreement with FILIC. The change in deferred income taxes payable is attributable to temporary differences between Generally Accepted Accounting Principles ("GAAP") and tax basis. Federal income taxes are discussed in more detail in Note 3 of the Consolidated Notes to the Financial Statements.
Total shareholders' equity decreased 5% in 1996 compared to 1995. The decrease in shareholders' equity is primarily due to the net loss of $938,000 in 1996. The Company experienced $85,000 in unrealized depreciation of equity securities and investments held for sale in 1996.
The National Association of Insurance Commissioners ("NAIC") is an association whose membership consists of the insurance commissioners or their designees of the various states. The NAIC has no direct regulatory authority over insurance companies, however its primary purpose is to provide a more consistent method of regulation and reporting from state to state. This is accomplished through the issuance of model regulations, which can be adopted by individual states unmodified, modified to meet the state's own needs or requirements, or dismissed entirely.
At year end 1996, UG had two ratios outside the normal range. The first ratio compared commission allowances with statutory capital and surplus. The ratio was outside the norm due to the coinsurance agreement with First International Life Insurance Company ("FILIC"). Additional information about the coinsurance agreement with FILIC can be found in Note 7 of the Notes to the Consolidated Financial Statements. Management does not believe that this ratio will be outside the normal range in future periods.
The second ratio is related to the decrease in premium income. The ratio fell outside the normal range the last two years. The decrease in premium income is directly attributable to the change in distribution systems and marketing strategy. The Company changed its focus from primarily a broker agency distribution system to a captive agent system and changed its marketing strategy from traditional whole life insurance products to universal life insurance products. Management is taking a long-term approach to its recent changes to the marketing and distribution systems and believes these changes will provide long-term benefits to the Company.
The Company receives funds from its insurance subsidiaries in the form of management and cost sharing arrangements (See Note 9 of the Consolidated Notes to the Financial Statements) and through dividends. Annual dividends in excess of maximum amounts prescribed by state statutes ("extraordinary dividends") may not be paid without the prior approval of the insurance commissioner in which an insurance subsidiary is domiciled. (See Note 2 of the Consolidated Notes to the Financial Statements.)
The NAIC has recently released the Life Illustration Model Regulation. This regulation requires products which contain non-guaranteed elements, such as universal life and interest sensitive life, to comply with certain actuarially established tests. These tests are intended to target future performance and profitability of a product under various scenarios. The regulation does not prevent a company from selling a product which does not meet the various tests. The only implication is the way in which the product is marketed to the consumer. A product which does not pass the tests uses guaranteed assumptions rather than current assumptions in presenting future product performance to the consumer.
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