All such forward-looking statements speak only as of the date of this Form 10-K. You are cautioned not to place undue reliance on such forward-looking statements. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in the events, conditions, or circumstances on which any such statements are based.
We were formed on October 31, 2003 for the primary purpose of becoming a financial services company. We conduct our business through our sole life insurance subsidiary, American Life & Security Corp. (“American Life”). In 2009, American Life was issued a certificate of authority to conduct life insurance business in Nebraska. We have incurred losses since inception that resulted primarily from costs incurred while raising capital and establishing and operating American Life and other entities.
On June 28, 2018 we underwent a change in control as a result of the closing of a Loan, Convertible Preferred Stock and Convertible Senior Secured Note Purchase Agreement dated May 9, 2018 (the “Agreement”) with a non-affiliated third party, Xenith Holdings LLC, a Delaware limited liability company (“Xenith”). Xenith is a wholly controlled subsidiary of Vespoint LLC, a Delaware limited liability company (“Vespoint”), which is also the manager of Xenith. Vespoint is owned and managed by AMS Advisors LLC, a Delaware limited liability company, and Rendezvous Capital LLC, a New York limited liability company. Each of these three companies is a private investment company; they are controlled by A. Michael Salem and Michael Minnich, who are Co-Chief Executive Officers of Vespoint.
The terms and conditions of the Agreement are described in our Current Report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on May 14, 2018. The Agreement was filed as an exhibit to the referenced Current Report on Form 8-K.
Loans from Xenith. The Agreement also provided that Xenith could loan up to $23,500,000 to us pursuant to notes convertible into voting common stock at approximately $0.02 per share. The following table sets forth information regarding loans made to us by Xenith through December 31, 2018:
The notes are secured under a security agreement which is collateralized by all of the issued and outstanding shares of American Life. Xenith has the right to foreclose on the collateral under events of default, which include our failure to pay interest or principal on the notes when due, failure to observe any material provision of the Agreement, misrepresentations under the Agreement or bankruptcy or insolvency proceedings involving us. All interest on the notes through January 31, 2019 has been waived.
Following the closing of the Agreement, we began implementation of a new business plan whose primary purpose is to leverage technology to distribute insurance products through third party marketing organizations. Also, in 2018, American Life’s legacy business was coinsured to an unrelated third party reinsurer, for which American Life received a ceding commission of $3.5 million. A new technology stack for American Life was acquired and implemented that provides a state-of-the-art platform on which to operate. We developed a new marketing plan focused on partnering with large, independent marketing organizations (“IMOs”). We also developed a plan to seek to reinsure most of the risks of our products with third party reinsurers. Our first product is a MYGA that began to be offered through two IMOs in January 2019. We expect that additional products will be offered in the future should we perceive market demand, interested IMOs and adequate availability of reinsurers.
Additionally, management is working to expand the state license footprint of American Life beyond the 11 states in which American Life is currently licensed to sell life insurance and annuity products. During 2019, we expect to file applications for American Life to sell annuity and other life insurance products in 24 additional states.
Below is a table showing the effect on stockholders’ equity if all the preferred convertible shares and convertible notes were converted as of year ended December 31, 2018:
Our accounting and reporting policies are in accordance with generally accepted accounting principles (“GAAP”) in the United States of America. Preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The following is a summary of our significant accounting policies and estimates. These accounting policies inherently require significant judgment and assumptions and actual operating results could differ significantly from management’s estimates determined using these policies. We believe the following accounting policies, judgments and estimates are the most critical to the understanding of our results of operations and financial position. A detailed discussion of significant accounting policies is provided in this report in Note 1 - Nature of Operations and Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in this Report.
We have a policy and process in place to identify securities that could potentially have an impairment that is other-than-temporary. The assessment of whether impairments have occurred is based on a case-by-case evaluation of underlying reasons for the decline in fair value. We consider severity of impairment, duration of impairment, forecasted recovery period, industry outlook, financial condition of the issuer, issuer credit ratings and whether we intend to sell a security or it is more likely than not that we would be required to sell a security prior to the recovery of the amortized cost.
Our indefinite-lived intangible assets consist of American Life’s state licenses. We compared the carrying value to the current costs of obtaining licenses in those states. As of December 31, 2018, the sum of the fair value of those licenses exceeded the carrying value of the indefinite-lived intangible assets. The assumptions and estimates used to determine future values are complex and subjective. They can be affected by various factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our revenue forecasts.
On June 28, 2018, Midwest closed on the Agreement with Xenith as discussed above. Following the closing, we embarked upon a new business plan which includes leveraging technology to distribute insurance products through IMOs.
We also reinsured our existing legacy block of insurance business through a reinsurance agreement with a third party reinsurer in exchange for a ceding commission of $3.5 million as described below. In addition, American Life obtained an A.M. Best Rating of B++ in December 2018. We purchased and installed comprehensive new technology during the fourth quarter of 2018 and we began selling our first MYGA product in late January 2019 through the IMOs.
Insurance revenues were primarily generated from premium revenues and investment income. Insurance revenues are summarized in the table below. Unless the context requires otherwise, all references compare 2018 to 2017.
Investment income, net of expenses: The components of net investment income for 2018 and 2017 are as follows:
The decrease in investment income was primarily due to a smaller investment portfolio because of the sale of bonds for $6.9 million in the third quarter of 2017 to fund our 2017 reinsurance transaction. See Note 7 to the Notes to Consolidated Financial Statements below. The decrease was also due to the $280,544 interest paid in 2018 to the reinsurer in connection with our 2018 reinsurance transaction discussed above that was accrued from the effective date of the transaction on July 1, 2018 through the settlement date of December 10, 2018. Policy loan interest and miscellaneous investment income is included in the “Other” line item above. We expect the income from fixed maturities to grow in the future due to the premiums from our MYGA product and other future products we may develop.
Miscellaneous income: Miscellaneous income increased due to third party administrator (“TPA”) fee revenue associated with the administration of our 2018 reinsurance transactions from July 1, 2018 through December 31, 2018 of $90,796. Fees earned for other TPA administration during the year ended December 31, 2018 and 2017 were $89,240 and $71,680, respectively.
Interest credited: The decrease was due to our 2017 reinsurance agreement. The interest credited in 2018 was related to an assumed block of business which was commutated on July 31, 2018. We expect these expenses to increase significantly in 2019 upon the success of our MYGA product.
Salaries and benefits: The increase was due to the addition of wages for two officers as a result of the Xenith transaction as discussed below in Note 2 - Change in Control in the Notes to Consolidated Financial Statements in this Report. These increases were offset by the personnel reduction as a result of management’s cost-cutting initiatives.
Management does not expect a repeat of the significant technology implementation costs in 2019.
Our overall investment philosophy emphasizes investment grade debt securities, policy loans, and other investments. The following table shows the carrying value of our investments by investment category and cash and cash equivalents, and the percentage of each to total invested assets.
Decreases in fixed maturity securities primarily resulted from the sale of bonds to fund our 2017 reinsurance transaction.
Reflecting the quality of securities maintained by us, 99.2% and 97.6% of all fixed maturity securities were investment grade as of December 31, 2018 and 2017, respectively.
We are exposed to credit risk through counterparties and within the investment portfolio. Credit risk relates to the uncertainty associated with an obligor’s ability to make timely payments of principal and interest in accordance with the contractual terms of an instrument or contract. We manage our credit risk through diversification of investments amongst many corporations and numerous industries. Additionally, our investment policy limits the size of our holdings in any particular issuer.
At December 31, 2018, we had cash and cash equivalents totaling $2,832,567. We believe that our existing cash and cash equivalents will be sufficient to fund the anticipated operating expenses and capital transaction expenditures through December 31, 2019.
The National Association of Insurance Commissioners (“NAIC”) has established minimum capital requirements in the form of Risk-Based Capital (“RBC”). RBC factors the type of business written by an insurance company, the quality of its assets and various other aspects of an insurance company’s business to develop a minimum level of capital called “authorized control level risk-based capital” and compares this level to adjusted statutory capital that includes capital and surplus as reported under statutory accounting principles, plus certain investment reserves. Should the ratio of adjusted statutory capital to control level RBC fall below 200%, a series of remedial actions by the affected company would be required. On October 10, 2018 and December 7, 2018, Xenith contributed an additional $1,000,000 and $17,500,000, respectively to Midwest in the way of convertible notes. Midwest subsequently contributed all $18,500,000 to American Life. The additional funding allowed American Life to settle the Unified Life Insurance Company (“Unified”) coinsurance transaction instead of liquidating a portion of its bond portfolio. As a direct result of the capital contributions from the Xenith transaction discussed above and the ceding 100% of our remaining block of business to Unified, our RBC at December 31, 2018 was 5,480%.
Effective July 1, 2018, American Life completed the 2018 reinsurance transaction discussed above. We paid no commissions or brokerage fees relating to this transaction. While reinsurer assumed certain liabilities and obligations we are not relieved of our legal liability to the policyholders until all the policies are transferred from “indemnity” to “assumptive.” Therefore, the liabilities and obligations associated with the reinsured blocks of business remain on our Consolidated Balance Sheets under Assets and Liabilities Held for Sale. We transferred $19,311,616 of GAAP net adjusted reserves as of July 1, 2018 to the third party reinsurer for cash of $14,320,817, which was net of a ceding allowance of $3,500,000 plus the accrued interest on the transaction from July 1, 2018 until it closed on December 10, 2018. The third party reinsurer assumed all responsibilities for incurred claims, surrenders and commission from the effective date. We and the third party reinsurer expect that most of such business will be assumed by December 31, 2019.
Surplus notes American Life had issued of $300,000 and $250,000 matured on August 1, 2016 and September 1, 2016, respectively. American Life reached an agreement with the holder of the notes in late 2018 to retire the surplus notes in full, including any accrued interest, through the transfer of the 10 condominiums in Hawaii owned by American Life. This transaction received regulatory approval in December 2018. The book value at December 28, 2018 of the surplus notes was $876,400 and the book value of the 10 condominiums in Hawaii was $493,648 with an estimated market value of $830,000. We recognized a gain of $382,752 on the settlement of the transaction.
In connection with the 2017 transaction, American Life entered into an indemnity coinsurance transaction in which we paid no commissions or brokerage fees relating to the transaction and the proceeds were based upon valuations prepared by our third party actuary. Under the reinsurance agreement, the reinsurer assumed certain liabilities and obligations. As we are not relieved of our legal liability to the policyholders, the liabilities and obligations associated with the reinsured blocks of business remain on our Consolidated Balance Sheets with a corresponding reinsurance receivable from the third party reinsurer. We transferred $9,569,175 of GAAP net adjusted reserves as of September 30, 2017 to the third party reinsurer for cash of $7,078,223, which was net of a ceding allowance of $1,850,000. As a result of the transaction, in addition to the reserves, American Life ceded approximately $883,000 of annual GAAP revenues and $1,758,250 of statutory revenues. The third party reinsurer assumes all responsibilities for incurred claims, surrenders and commission from the effective date.
In 2018, net cash used by operating activities was $20,370,192, which was comprised primarily of the assets and liabilities held for sale due to 2018 reinsurance agreement discussed above, net loss of $5,065,534, and commutation of an assumption agreement of $2,544,929; partially offset by an increase in deferred ceding commission of $2,944,572. Net cash provided by investing activities was $1,862,609. The primary source of cash was from sales of available-for-sale securities for the commutation of an assumption agreement. Offsetting this source of cash was our purchases of investments in available-for-sale securities. Net cash provided by financing activities was $20,388,623 whose primary source was from capital from Xenith consisting of convertible promissory notes and preferred convertible stock of $20,438,705, net of capital raising expense.
Inflation also affects the rate of investment return on the investment portfolio with a corresponding effect on investment income.
As a smaller reporting company we are not required to provide the table of contractual obligations required pursuant to this Item.