The Company owns an office complex in Springfield, Illinois, which houses the primary insurance operations. The office buildings in this complex contain 57,000 square feet of office and warehouse space, and are carried at $1,477,247. The facilities occupied by the Company are adequate relative to the Company's present operations.
The provision for deferred income taxes is based on the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recognized by applying enacted statutory tax rates to temporary differences between amounts reported in the Consolidated Financial Statements and the tax bases of existing assets and liabilities. A valuation allowance is recognized for the portion of deferred tax assets that, in Management's judgment, is not likely to be realized. The effect on deferred income taxes of a change in tax rates or laws is recognized in income tax expense in the period that includes the enactment date.
The Company’s primary source of new business production comes from internal conservation efforts. Several of the customer service representatives of the Company are also licensed insurance agents, allowing them to offer other products within the Company’s portfolio to existing customers. Additionally, efforts continue to be made in policy retention through more personal contact with the customer including telephone calls to discuss alternatives and reasons for a customer’s request to surrender their policy.
Net investment income decreased almost 19% when comparing 2009 to 2008. The overall gross investment yields for 2009 and 2008 are 5.58% and 6.35%, respectively. This decrease is primarily due to holding fewer fixed maturity investments and high cash balances earning low rates of interest for the majority of 2009. During 2008 and 2009, Management took steps to avoid catastrophic future losses by culling its investment portfolio. As part of this portfolio evaluation process, certain investments were subsequently sold, particularly during the third and fourth quarters of 2008 and early 2009. This resulted in a higher cash balance earning extremely low rates of interest which had an immediate impact on income. With preservation of capital being of utmost concern, Management sat on this large cash balance waiting for the dust to settle and for opportunities with margin of safety to appear. This patience has been rewarded and the Company began to deploy cash into investments deemed appropriate during the latter part of 2009. The majority of this money has been invested in fixed maturity investments and discounted mortgage loans. With the economy reeling, bankruptcies soaring and general credit drying-up, the banking industry has been under well-known pressure. As bank failures increased dramatically, their loan portfolios have been auctioned off, sometimes at deep discounts. The Company acquired approximately $35 million of these loans, primarily during the fourth quarter of 2009. With excess cash being invested, management believes the Company is well positioned and investment income should improve during 2010.
Net realized investment gains (losses) were $(629,528) and $2,362,578 in 2009 and 2008, respectively. The majority of the losses during 2009 were from bond investments. The beginning of 2009 continued with the elimination of unwanted bonds during the portfolio evaluation process. Losses on the sale of these bonds totaled approximately $3,500,000. In addition to these losses, other-than-temporary impairments of just over $2,000,000 were taken on bonds backed by trust preferred securities of banks. These losses were partially off-set from realized gains of approximately $3,800,000 from sales of mortgage backed securities at the end of 2009. Realized gains on common stocks were mainly the result of selling the remainder of CSI for a $3,000,000 gain and the sale of another common stock realizing a $1,000,000 gain. The gains were off-set by a loss of approximately $3,000,000 on exchange traded funds that moved inversely to the market. During 2008, approximately $5,353,000 in realized gains was the result of common stock sales. These gains are mostly the result of three investments. For diversification purposes, in September 2008, 28% of the Company’s investment in CSI common stock was sold for a gain of approximately $3,059,000. During 2008, amid growing global economic distress, the Company established a defensive posture in exchange traded funds. These investments resulted in gains of approximately $2,946,000. At the end of the year, SFF Production, an energy investment, was also sold resulting in realized gains of approximately $1,701,000. With 2008 experiencing one of the largest financial crises in our nation’s history, Management has refused to sit on the sidelines hoping for a recovery and spent a significant amount of time analyzing the Company’s investment holdings and reducing risk. As a result of this, certain investments that were deemed too risky, primarily those in financial institutions were sold, predominantly at losses. Those losses consisted of approximately $3,100,000 on common stocks and $3,000,000 on fixed maturity investments. Also included in these losses is an approximate $540,000 loss resulting from writing down a bond investment in Lehman Brothers to $0.
In recent periods, Management’s focus has been placed on promoting and growing TPA services to unaffiliated life insurance companies. The Company receives monthly fees based on policy in force counts and certain other activity indicators, such as number of premium collections performed, or services performed. For the years ended 2009 and 2008, the Company received $1,875,868 and $1,810,775 for this work, respectively. These TPA revenue fees are included in the line item “other income” on the Company’s consolidated statements of operations. No new TPA contracts were entered into during 2009. However, the Company intends to continue to pursue other TPA arrangements. The Company provides TPA services to insurance companies seeking business process outsourcing solutions. Management believes the Company is positioned to generate additional revenues by utilizing the Company’s current excess capacity and administrative services. During 2009, the Company renewed the contract of the largest TPA client for an additional five year period.
Benefits, claims and settlement expenses net of reinsurance benefits and claims, decreased $993,674 from 2008 to 2009. The decrease relates primarily to changes in the Company’s death claim experience. Death claims were approximately $370,000 less in 2009 as compared to 2008. There is no single event that caused the mortality variances. Policy claims vary from year to year and therefore, fluctuations in mortality are to be expected and are not considered unusual by management.
Commissions and amortization of deferred policy acquisition costs increased $1,708,239 from 2008 to 2009 mostly as a result of lower commissions offset from a reinsurance agreement in AC caused by lower profits on the block of business due to bond sales. Going forward, this line item is expected to be more in line with prior history. Most of the Company’s agent agreements contained vesting provisions, which provide for continued compensation payments to agents upon their termination subject to certain minimums and often limited to a specific period of time. Another factor is attributable to normal amortization of the deferred policy acquisition costs asset. The Company reviews the recoverability of the asset based on current trends and known events compared to the assumptions used in the establishment of the original asset. No impairments were recorded in the periods reported.
Interest expense decreased approximately $420,000, or almost by half, during 2009 compared to 2008. This decrease is the result of a lower outstanding balance of debt and paying a variable rate of interest on the majority of this balance which has gone from 4.02% at year-end 2008 to 2.06% at year-end 2009. The Company prepaid principal due in 2009 during 2008. The next required principal payment is due in December of 2010. The Company anticipates aggressively repaying the current debt.
The Company had a net income (loss) of $(4,290,247) and $653,754 in 2009 and 2008 respectively. The decrease in net income in 2009 is primarily related to realized investment losses and lower investment income as compared to 2008. With the Company’s restructured portfolio and cash deployment, Management anticipates improvement during 2010 compared with 2009.
At December 31, 2009, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in the context of consolidated assets, shareholders' equity or results from operations. 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. To provide additional flexibility and liquidity, the Company has categorized all fixed maturity investments as “investments held for sale”.
The following table summarizes the Company's fixed maturities distribution at December 31, 2009 and 2008 by ratings category as issued by Standard and Poor's, a leading ratings analyst.
During the fourth quarter of 2009, the Company began purchasing discounted commercial mortgage loans. As of December 31, 2009, the Company had acquired $118,368,661 of mortgage loans at a total cost of $35,224,022, representing an average purchase price to outstanding loan of 29.8%. As of December 31, 2009, the Company has already recorded approximately $1,000,000 in income from this loan activity. Management has extensive background and experience in the analysis and valuation of commercial real estate and believes there are significant opportunities currently available in this arena. Experienced personnel of FSNB have also been utilized in the analysis phase. This experience dates back to discounted loans during the Resolution Trust days where such loans were being sold from defunct savings and loans in the early 1990’s. The discounted loans are available through the FDIC sale of assets of closed banks and from banks wanting to reduce their loan portfolios. The loans are available on a loan by loan bid process. Prior to placing a bid, each loan is reviewed to determine interest level utilizing such information as type of collateral, location of collateral, interest rate, current loan status and available cashflows or other sources of repayment. Once it is determined interest in the loan remains, the collateral is physically inspected. Following physical inspection, if interest still remains, a bid price is determined and a bid is submitted.
Sub-prime mortgage lending has received significant attention in recent months. Default rates have risen sharply on these loans causing a negative impact in the economy in general. While the Company does not have a material direct exposure to sub-prime mortgage loans, the Company could still be negatively impacted indirectly primarily through fixed maturity holdings in financial institutions that do have sub-prime loan exposures. Declines in values relating to such entities will negatively impact the Company through unrealized investment losses, should any of these entities declare bankruptcy, the Company would then report a realized loss on its investment. Management monitors events relating to this topic.
Total investment real estate holdings represent approximately 10.5% and 9% of the total assets of the Company, net of accumulated depreciation, at year-end 2009 and 2008 respectively. The Company has made several investments in real estate in recent years. Expected returns on these investments exceed those available in fixed income securities. However, these returns may not always be as steady or predictable.
Cash and cash equivalents decreased by approximately $2,500,000 comparing 2009 to 2008. As already discussed above, Management has taken the current economic crisis very seriously refusing to sit on the sidelines and not using hope as an investment strategy. As Management put extensive efforts into evaluating each investment holding, many were sold resulting in cash balances being over $60,000,000 during 2009. Much of this cash was deployed during the fourth quarter of 2009.
Equity securities decreased approximately $17,300,000 during 2009. The decrease is attributable to Management’s ongoing portfolio evaluation process amidst the steep economic downturn and credit crisis.
Deferred policy acquisition costs decreased 20% in 2009 compared to 2008. Deferred policy acquisition costs, which vary with, and are primarily related to producing new business, are referred to as 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 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 $0 in policy acquisition costs deferred, $8,000 in interest accretion and $173,944 in amortization in 2009, and had $0 in policy acquisition costs deferred, $9,000 in interest accretion and $196,058 in amortization in 2008.
On December 30, 2009, the Company sold a 73% owned subsidiary, Texas Imperial Life Insurance Company. The transaction was entered into to further streamline operations of the affiliated group. Texas Imperial was a stipulated premium company, a unique status under Texas rules. Consolidation of this entity was not practical due to this status. The sale resulted in a decrease of approximately 4% in total assets.
The largest liability, by far, is future policy benefits. The decrease from 2008 to 2009 in this line item was approximately 8%. Excluding the sale of Texas Imperial Life Insurance Company, the decrease was approximately 1.5%. This decrease is attributable primarily to a decrease in the total future policy benefits held. As policies in force terminate, the corresponding reserve liability held for those policies is released.
Total shareholders' equity decreased approximately 9% in 2009 compared to 2008. This decrease is primarily due to the net loss of $(4,290,247) for the year.
Cash provided by investing activities was $2,904,973 and $25,952,559 for 2009 and 2008, respectively. Equity and fixed maturity investments sold increased $79,286,665 comparing 2009 to 2008, as the Company evaluated its investment portfolio. However, in total, approximately $171,000,000 was reinvested in bonds, stocks and mortgage loans as opportunities presented themselves.
On December 8, 2006, UTG borrowed funds from First Tennessee Bank National Association through execution of an $18,000,000 promissory note. The note is secured by the pledge of 100% of the common stock of UG. The promissory note carries a variable rate of interest based on the 3 month LIBOR rate plus 180 basis points. Interest is payable quarterly. Principal is payable annually beginning at the end of the second year in five installments of $3,600,000. The loan matures on December 7, 2012. During 2009, no payments were made, as the Company had prepaid the 2009 principal due during 2008. The Company made principal payments of $3,049,995 during 2008. At December 31, 2009, the outstanding principal balance on this debt was $10,491,762.
First Tennessee Bank National Association also provided UTG with a $5,000,000 revolving credit note. This note is for a one-year term and may be renewed by consent of both parties. The credit note is to provide operating liquidity for UTG and replaces a previous line of credit provided by Southwest Bank. Interest bears the same terms as the above promissory note. The collateral held on the above note also secures this credit note. UTG has no borrowings against this note at this time.
In November 2007, the Company became a member of the FHLB. This membership allows the Company access to additional credit up to a maximum of 50% of the total assets of UG. To be a member of the FHLB, the Company was required to purchase shares of common stock of FHLB. Borrowing capacity is based on 50 times each dollar of stock acquired in FHLB above the "base membership" amount. The Company's current LOC with the FHLB is $15,000,000. During 2009, the Company had borrowings of $2,000,000 and repayments of $2,000,000. During 2008, the Company had borrowings of $4,000,000 and repayments of $4,000,000. At December 31, 2009, the Company had no outstanding borrowings attributable to this LOC.
UTG is a holding company that has no day-to-day operations of its own. Funds required to meet its expenses, generally costs associated with maintaining the Company in good standing with states in which it does business, and the servicing of its debt are primarily provided by its subsidiaries. On a parent only basis, UTG's cash flow is dependent on management fees received from its insurance subsidiaries, stockholder dividends from its subsidiaries and earnings received on cash balances. On December 31, 2009, substantially all of the consolidated shareholders equity represents net assets of its subsidiaries. The Company's insurance subsidiaries have maintained adequate statutory capital and surplus. The payment of cash dividends to shareholders by UTG is not legally restricted. However, the state insurance department regulates insurance company dividend payments where the company is domiciled.
In June 2008, FASB issued amendments to ASC 260-10, Earnings Per Share, which requires unvested share based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. These amendments were effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years and require retrospective application. The adoption of these amendments did not have an impact on the Company's consolidated financial statements.
Registered Public Accounting Firm for the years ended December 31, 2009 and 2008……..…....
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework contained in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Report”).
Based on our evaluation under the framework in the COSO Report our management concluded that our internal control over financial reporting was effective as of December 31, 2009.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
We conducted our audits in accordance with generally accepted auditing standards as established by the Auditing Standards Board (United States) and in accordance with the auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of UTG, Inc. and subsidiaries as of December 31, 2009 and 2008, and the consolidated results of their operations and their consolidated cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
BUSINESS SEGMENTS - The Company has only one significant business segment - insurance.
BASIS OF PRESENTATION - The financial statements of UTG and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America.
Investments available for sale - at fair value, unrealized gains and losses deemed temporary, net of deferred income taxes, are credited or charged, as appropriate, directly to accumulated other comprehensive income or loss (a component of stockholders’ equity). Premiums and discounts on debt securities purchased at other than par value are amortized and accreted, respectively, to interest income in the Consolidated Statements of Operations, using the constant yield method over the period to maturity. Net realized gains and losses on sales of held for sale securities, and unrealized losses considered to be other than temporary, are credited or charged to net realized investment gains (losses) in the Consolidated Statements of Operations.
Policy loans - at unpaid balances including accumulated interest but not in excess of the cash surrender value of the related policy.
COST OF INSURANCE ACQUIRED - When an insurance company is acquired, the Company assigns a portion of its cost to the right to receive future cash flows from insurance contracts existing at the date of the acquisition. The cost of policies purchased represents the actuarially determined present value of the projected future profits from the acquired policies. The Company utilizes 12% discount rate on the remaining business. Cost of insurance acquired is amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. The interest rate utilized in the amortization calculation is 12%. The interest rates vary due to differences in the blocks of business. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised.
DEFERRED POLICY ACQUISITION COSTS - Commissions and other costs (salaries of certain employees involved in the underwriting and policy issue functions and medical and inspection fees) of acquiring life insurance products that vary with and are primarily related to the production of new business have been deferred. Traditional life insurance acquisition costs are being amortized over the premium-paying period of the related policies using assumptions consistent with those used in computing policy benefit reserves.
For universal life insurance and interest sensitive life insurance products, acquisition costs are being amortized generally in proportion to the present value of expected gross profits from surrender charges and investment, mortality, and expense margins. Under SFAS No. 97 (see FASB Codification 944-20-30-40-60-605-825 sections 5, 15, 25, 30, 35, 45, 50, and 50), "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments," the Company makes certain assumptions regarding the mortality, persistency, expenses, and interest rates it expects to experience in future periods. These assumptions are to be best estimates and are to be periodically updated whenever actual experience and/or expectations for the future change from initial assumptions. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised.
EARNINGS PER SHARE - Earnings per share (EPS) are reported under Statement of Financial Accounting Standards Number 128 (see FASB Codification 260-10 sections 5, 10, 15, 45, 50, 55, and 60.) The objective of both basic EPS and diluted EPS is to measure the performance of an entity over the reporting period. Basic EPS is computed by dividing net income/(loss) attributable to common shares (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. In addition, the numerator also is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common shares.
RECOGNITION OF REVENUES AND RELATED EXPENSES - Premiums for traditional life insurance products, which include those products with fixed and guaranteed premiums and benefits, consist principally of whole life insurance policies, and certain annuities with life contingencies are recognized as revenues when due. Limited payment life insurance policies defer gross premiums received in excess of net premiums, which is then recognized in income in a constant relationship with insurance in force. Accident and health insurance premiums are recognized as revenue pro rata over the terms of the policies. Benefits and related expenses associated with the premiums earned are charged to expense proportionately over the lives of the policies through a provision for future policy benefit liabilities and through deferral and amortization of deferred policy acquisition costs. For universal life and investment products, generally there is no requirement for payment of premium other than to maintain account values at a level sufficient to pay mortality and expense charges. Consequently, premiums for universal life policies and investment products are not reported as revenue, but as deposits. Policy fee revenue for universal life policies and investment products consists of charges for the cost of insurance and policy administration fees assessed during the period. Expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances.
USE OF ESTIMATES - In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The following estimates have been identified as critical in that they involve a high degree of judgment and are subject to a significant degree of variability: (i) deferred acquisition cost; (ii) reserves; (iii) reinsurance recoverable; (iv) other-than-temporary impairment; and (v) federal income taxes.
At December 31, 2009, substantially all of consolidated shareholders' equity represents net assets of UTG’s subsidiaries. The payment of cash dividends to shareholders by UTG is not legally restricted. However, the state insurance department regulates insurance company dividend payments where the company is domiciled. UG and AC’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, 2009, UG had a statutory gain from net income of $203,629. At December 31, 2009, UG's statutory capital and surplus amounted to $27,349,870. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. UG paid a dividend of $0 to UTG in 2009 and paid $3,000,000 in 2008. None of the dividends paid were considered to be an extraordinary dividend.
In June 2006, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 48, (ASC 740-10) "Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109" ("Interpretation 48"), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The recognition threshold is based on a determination of whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. Only tax positions that meet the more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized. Management believes the Company has no material uncertain income tax provisions at December 31, 2009 or 2008.
The Company’s Federal income tax returns are periodically audited by the Internal Revenue Service (“IRS”). There is no examination ongoing currently, nor is management aware of any pending examination by the IRS. The statutes of limitation for the assessments of additional tax are closed for all tax years prior to 2006. Management believes that adequate provision has been made in the consolidated financial statements for any potential assessments that may result from future tax examinations and other tax-related matters for all open tax years.
At December 31, 2009 and 2008, respectively, the Company had gross deferred tax assets of $3,971,251 and $2,352,740 net of valuation allowances of $147,521 and $529,521, and gross deferred tax liabilities of $15,921,505 and $17,046,534, resulting from temporary differences primarily related to the life insurance subsidiaries. The valuation allowance in 2009 was from UG that for tax purposes generated a net operating loss of $421,488. The Company established a deferred tax asset of $147,521 in 2009 relating to the operating loss carryforward. Also in 2009, the Company established an offsetting allowance of $147,521 for the loss. The valuation allowance in 2008 was from ACAP and its consolidated subsidiaries that for tax purposes generated a net operating loss of $1,648,710. The Company established a deferred tax asset of $529,521 in 2008 relating to the operating loss carryforward. Also in 2008, the Company established an offsetting allowance of $529,521 for the loss. The allowances were established as a result of uncertainty in the Company’s ability to utilize the loss carryforwards which is dependent on generating sufficient taxable income prior to expiration of the loss carryforward. The Company has not experienced any reductions of deferred tax assets due to the lapse of applicable statute of limitations. The 2008 net operating loss carryforwards of ACAP consolidated were utilized in their entirety with the sale of TI.
Life insurance company taxation is based primarily upon statutory results with certain special deductions and other items available only to life insurance companies. Income tax expense (benefits) consists of the following components:
The Company held five fixed maturity investments totaling $74,397,459 and one fixed maturity investment of $4,781,639 that exceeded 10% of shareholder’s equity at December 31, 2009 and 2008, respectively. The Company held two equity investments totaling $10,192,382 and $12,157,539 that exceeded 10% of shareholder’s equity at December 31, 2009 and 2008, respectively.
The fair value of investments with sustained gross unrealized losses at December 31, 2009 and 2008 are as follows:
The unrealized losses of fixed maturity investments were primarily due to financial market participants perception of increased risks associated with the current market environment, resulting in higher interest rates. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. The unrealized losses of equity investments were primarily caused by normal market fluctuations in publicly traded securities.
Securities designated as trading securities are reported at fair value, with gains or losses resulting from changes in fair value recognized in other income on the consolidated statements of operations. Trading securities include exchange traded equities and exchange traded equity options. The fair value of trading securities included in assets was $19,613,472 and $0 as of December 31, 2009 and 2008, respectively. The fair value of trading securities included in liabilities was $(11,671,911) and $0 as of December 31, 2009 and 2008, respectively. Trading securities’ unrealized gains were $570,024 and $0 as of December 31, 2009 and 2008, respectively. Unrealized losses due to trading securities were $(1,081,360) and $0 as of December 31, 2009 and 2008, respectively. Trading securities carried as liabilities are securities sold short. A gain, limited to the price at which the security was sold short, or a loss, potentially unlimited in size, will be recognized upon the termination of the short sale. Realized gains from trading securities were $525,000 and $0 as of December 31, 2009 and 2008, respectively. Trading securities are classified in cash flows from operating activities. Trading revenue charged to net income from trading securities was:
As of December 31, 2009, the Company held derivative instruments in the form of exchange-traded equity options. The Company currently does not designate derivatives as hedging instruments. Exchange traded equity options are combined with exchange traded equity securities in the Company’s trading portfolio, with the primary objective of generating a fair return while reducing risk. These derivatives are carried at fair value, with unrealized gains and losses recognized in other income. The fair value of derivatives included in trading security assets and trading security liabilities as of December 31, 2009 was $1,054,965 and $4,753,525, respectively. Realized gains due to derivatives were $525,000 and $0 December 31, 2009 and December 31, 2008 respectively. Unrealized gains included in trading security assets due to derivatives were $110,013 and $0 as of December 31, 2009 and December 31, 2008, respectively. Unrealized losses included in trading security liabilities due to derivatives were $(432,720) and $0 as of December 31, 2009 and December 31, 2008, respectively.
The following table presents the level within the hierarchy at which the Company’s financial assets and financial liabilities are measured on a recurring basis as of December 31, 2009:
The financial statements include various estimated fair value information at December 31, 2009 and 2008, as required by ASC 820. Such information, which pertains to the Company's financial instruments, is based on the requirements set forth in that guidance and does not purport to represent the aggregate net fair value of the Company.
It is not practical to estimate the fair value of policy loans as they have no stated maturity and their rates are set at a fixed spread to related policy liability rates. Policy loans are carried at the aggregate unpaid principal balances in the consolidated balance sheets, and earn interest at rates ranging from 4% to 8%. Individual policy liabilities in all cases equal or exceed outstanding policy loan balances.
The Company's insurance subsidiaries are domiciled in Ohio and Texas. The insurance subsidiaries prepare their statutory-based financial statements in accordance with accounting practices prescribed or permitted by the respective insurance department. These principles differ significantly from accounting principles generally accepted in the United States of America. "Prescribed" statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, from company to company within a state, and may change in the future. UG's total statutory shareholders' equity was approximately $27,350,000 and $27,483,000 at December 31, 2009 and 2008, respectively. UG reported a statutory net income (exclusive of inter-company dividends) of approximately $204,000 and $4,825,000 for 2009 and 2008, respectively. AC's total statutory shareholders' equity was approximately $9,781,000 and $7,346,000 at December 31, 2009 and 2008. AC reported a statutory net income (exclusive of inter-company dividends) of approximately $4,071,000 and $1,164,000 for 2009 and 2008 respectively.
As is customary in the insurance industry, the insurance subsidiaries cede insurance to, and assume insurance from, other insurance companies under reinsurance agreements. Reinsurance agreements are intended to limit a life insurer's maximum loss on a large or unusually hazardous risk or to obtain a greater diversification of risk. The ceding insurance company remains primarily liable with respect to ceded insurance should any reinsurer be unable to meet the obligations assumed by it. However, it is the practice of insurers to reduce their exposure to loss to the extent that they have been reinsured with other insurance companies. The Company sets a limit on the amount of insurance retained on the life of any one person. The Company will not retain more than $125,000, including accidental death benefits, on any one life. At December 31, 2009, the Company had gross insurance in force of $1.874 billion of which approximately $453 million was ceded to unaffiliated reinsurers.
UG entered into a coinsurance agreement with Park Avenue Life Insurance Company (PALIC) effective September 30, 1996. Under the terms of the agreement, UG ceded to PALIC substantially all of its then in-force paid-up life insurance policies. Paid-up life insurance generally refers to non-premium paying life insurance policies. PALIC and its ultimate parent, The Guardian Life Insurance Company of America (Guardian), currently hold an “A” (Excellent) and "A++" (Superior) rating, respectively, from A.M. Best. The PALIC agreement accounts for approximately 65% of UG’s reinsurance reserve credit, as of December 31, 2009.
During 1998, AC closed a coinsurance transaction with Universal Life Insurance Company (“Universal”). Pursuant to the coinsurance agreement, AC coinsured 100% of the individual life insurance policies of Universal in force at January 1, 1998. At December 31, 2009, the Universal agreement has insurance in-force of approximately $13,551,000, with reserves being held on that amount of approximately $4,848,000.
Under the insurance guaranty fund laws in most states, insurance companies doing business in a participating state can be assessed up to prescribed limits for policyholder losses incurred by insolvent or failed insurance companies. Although the Company cannot predict the amount of any future assessments, most insurance guaranty fund laws currently provide that an assessment may be excused or deferred if it would threaten an insurer's financial strength. Mandatory assessments may be partially recovered through a reduction in future premium tax in some states. The Company does not believe such assessments will be materially different from amounts already provided for in the financial statements, though the Company has no control over such assessments.
UG currently has an unresolved dispute with one of its outside reinsurers. The issue relates to reinsurance premiums. The reinsurer claims UG owes for years 2005 through 2007 in the amount of $987,000. In early 2008, the reinsurer billed UG for these amounts, providing no information or explanation. The related treaty was originally with another outside reinsurer and was acquired by the current reinsurer in a reinsurance block acquisition. The treaty is a yearly renewable term (“YRT”) cession based treaty. UG maintains it has no liability relating to the back billed premium. UG has initiated arbitration according to the treaty to bring resolution to this matter. Final resolution is not anticipated until sometime in mid 2010. UG has established a contingent liability of $500,000 relating to this matter to cover costs including legal and arbitration costs.
As part of the acquisition of ACAP on December 8, 2006, UTG loaned $3,357,000 to ACAP. ACAP used the proceeds for the repayment of existing debt with an unaffiliated financial institution and to retire all of its outstanding preferred stock. The terms of the inter-company loan mirror the interest rate and repayment requirements of the debt with First Tennessee Bank National Association. No payments were made on the loan in 2009 or 2008. At December 31, 2008, the interest due of $224,084 was added to the balance. As of December 31, 2009, the balance of the loan is $3,259,084.
During June 2003, UG entered into a lease agreement with Bandyco, LLC, an affiliated entity, for a one-sixth interest in an aircraft. Bandyco, LLC is affiliated with Ward F. Correll, who is a director of the Company. The Company is responsible for its share of annual non-operational costs, in addition to the operational costs as are billable for specific use. During 2006, UG entered into an additional lease agreement for a 27.5% interest in a second plane with Bandyco, LLC. The lease term was for a period of five years at a total cost of $166,913. In December 2009, this aircraft was sold.
On March 26, 2002, the Board of Directors of UTG adopted, and on June 11, 2002, the shareholders of UTG approved, the UTG, Inc. Employee and Director Stock Purchase Plan. This plan was terminated effective June 17, 2009 (See Note 10.A. to the consolidated financial statements).
Effective January 1, 2007, UTG entered into administrative services and cost sharing agreements with its subsidiaries, UG, AC and TI. Under these arrangements, each company pays its proportionate share of expenses of the entire group, based on an allocation formula. During 2009, UG, AC and TI paid $3,383,565, 2,827,504, and 690,028, respectively. During 2008, UG, AC and TI paid $3,717,696, $3,065,476 and $779,980, respectively.
In addition to the above promissory note, First Tennessee Bank National Association also provided UTG, Inc. with a $5,000,000 revolving credit note. This note is for a one-year term and may be renewed by consent of both parties. The credit note is to provide operating liquidity for UTG, Inc. and replaces a previous line of credit provided by Southwest Bank. Interest bears the same terms as the above promissory note. The collateral held on the above note also secures this credit note. UTG, Inc. had no borrowings against this note at December 31, 2009 and December 31, 2008.
On a cash basis, the Company paid $470,261 and $937,437 in interest expense for the years 2009 and 2008, respectively. The Company paid $301,324 and $2,094,950 in federal income tax for 2009 and 2008, respectively.
Because UTG serves primarily individuals located in four states, the ability of our customers to pay their insurance premiums is impacted by the economic conditions in these areas. As of December 31, 2009, approximately 58% of the Company’s total direct premium was collected from Illinois, Ohio, Texas and West Virginia. Thus, results of operations are heavily dependent upon the strength of these economies.
The Company reinsures that portion of insurance risk which is in excess of its retention limits. Retention limits range up to $125,000 per life. Life insurance ceded represented 23.7% of total life insurance in force at December 31, 2009. Insurance ceded represented 22.9% of premium income for 2009. The Company would be liable for the reinsured risks ceded to other companies to the extent that such reinsuring companies are unable to meet their obligations.
The Financial Accounting Standards Board (“FASB”) issued the Accounting Standards Update (“ASU”) No. 2010-10 Consolidation (Topic 810), Amendments for Certain Investment Funds. The amendments to the consolidation requirements of Topic 810 resulting from the issuance of Statement 167 are deferred for a reporting entity’s interest in an entity (1) that has all the attributes of an investment company or (2) for which it is industry practice to apply measurement principles for financial reporting purposes that are consistent with those followed by investment companies. The deferral does not apply in situations in which a reporting entity has the explicit or implicit obligation to fund losses of an entity that could potentially be significant to the entity. The deferral also does not apply to interests in securitization entities, asset-backed financing entities, or entities formerly considered qualifying special purpose entities. In addition, the deferral applies to a reporting entity’s interest in an entity that is required to comply or operate in accordance with requirements similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. An entity that qualifies for the deferral will continue to be assessed under the overall guidance on the consolidation of variable interest entities in Subtopic 810-10 (before the Statement 167 amendments) or other applicable consolidation guidance, such as the guidance for the consolidation of partnerships in Subtopic 810-20. The amendments in this Update also clarify that for entities that do not qualify for the deferral, related parties should be considered when evaluating each of the criteria in paragraph 810-10-55-37, as amended by Statement 167, for determining whether a decision maker or service provider fee represents a variable interest. In addition, the requirements for evaluating whether a decision maker’s or service provider’s fee is a variable interest are modified to clarify the Board’s intention that a quantitative calculation should not be the sole basis for this evaluation. The amendments in this update are effective as of the beginning of a reporting entity’s first annual period that begins after November 15, 2009, and for interim periods within that first annual reporting period. Management has determined that this Statement will not result in a change to current practice.
In January 2010, FASB issued ASU 2010-06, Improving Disclosures about Fair Measurements, which provides amendments to subtopic 820-10 that require separate disclosure of significant transfers in and out of Level 1 and Level 2 fair value measurements and the presentation of separate information regarding purchases, sales, issuances and settlements for Level 3 fair value measurements. Additionally, ASU 2010-06 provides amendments to subtopic 820-10 that clarify existing disclosures about the level of disaggregation and inputs and valuation techniques. ASU 2010-06 is effective for financial statements issued for interim and annual periods ending after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the rollforward of activity in Level 3 fair value measurements, which are effective for interim and annual periods ending after December 15, 2010. The Company does not expect the adoption of ASU 2010-06 to have a material impact on its consolidated financial statements.
In January 2010, FASB issued ASU 2010-02, Accounting and Reporting for Decreases in Ownership of a Subsidiary- a Scope Clarification, which addresses the accounting for noncontrolling interests and changes in ownership interests of a subsidiary. ASU 2010-02 is effective for the interim or annual reporting periods ending on or after December 15, 2009, and must be applied retrospectively to interim or annual reporting periods beginning on or after December 15, 2008. The adoption of ASU 2010-02 did not have an impact on the Company's consolidated financial statements.
In December 2009, FASB issued ASU 2009-17,Consolidations (Topic 810) Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities , which replaces the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity's economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. ASU 2009-17 also requires additional disclosures about an enterprise's involvement in variable interest entities. ASU 2009-17 is effective as of the beginning of each reporting entity's first annual reporting period that begins after November 15, 2009. The Company does not expect the adoption of ASU 2009-17 to have a material impact on its consolidated financial statements.
In December 2009, FASB issued ASU 2009-16, Transfers and Servicing, which improves financial reporting by eliminating the exceptions for qualifying special-purpose entities from the consolidation guidance and the exception that permitted sale accounting for certain mortgage securitizations when a transferor has not surrendered control over the transferred financial assets. In addition, the amendments require enhanced disclosures about the risks that a transferor continues to be exposed to because of its continuing involvement in transferred financial assets. ASU 2009-16 is effective as of the beginning of each reporting entity's first annual reporting period that begins after November 15, 2009. The Company does not expect the adoption of ASU 2009-16 to have a material impact on its consolidated financial statements.
In August 2009, FASB issued ASU 2009-05, Fair Value Measurements and Disclosures (Topic 820) Measuring Liabilities at Fair Value, which provides amendments to Subtopic 820-10, Fair Value Measurements and Disclosures-Overall, for the fair value measurement of liabilities. ASU 2009-05 clarifies that in circumstances in which a quoted price in an active market for the identical liability is not available; a reporting entity is required to measure fair value. ASU 2009-05 is effective for the first reporting (including interim periods) beginning after issuance. The adoption of ASU 2009-05 did not have a material impact on the Company's consolidated financial statements.
In April 2009, FASB issued amendments to ASC 320-10, Investments-Debt and Equity Securities, which provides greater clarity about the credit and noncredit component of an other-than-temporary impairment event and more effectively communicates when an other-than-temporary impairment event has occurred. ASC 320-10 amends the other-than-temporary impairment model for debt securities. The impairment model for equity securities was not affected. Under ASC 320-10, another-than-temporary impairment must be recognized through earnings if an investor has the intent to sell the debt security or if it is more likely than not that the investor will be required to sell the debt security before recovery of its amortized cost basis. This standard was effective for interim periods ending after June 15, 2009. The adoption of the amendments to ASC 320-10 did not have a material impact on the Company's consolidated financial statements.
The FASB also issued Statement No. 163, (See FASB Codification 944- Subtopics: 20, 40, 310, and 605) Accounting for Financial Guarantee Insurance Contracts - an interpretation of FASB Statement No. 60 Diversity exists in practice in accounting for financial guarantee insurance contracts by insurance enterprises under FASB Statement No. 60, Accounting and Reporting by Insurance Enterprises. That diversity results in inconsistencies in the recognition and measurement of claim liabilities because of differing views about when a loss has been incurred under FASB Statement No. 5, Accounting for Contingencies. This Statement requires that an insurance enterprise recognize a claim liability prior to an event of default (insured event) when there is evidence that credit deterioration has occurred in an insured financial obligation. This Statement also clarifies how Statement 60 applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities. Those clarifications will increase comparability in financial reporting of financial guarantee insurance contracts by insurance enterprises. This Statement requires expanded disclosures about financial guarantee insurance contracts. The accounting and disclosure requirements of the Statement will improve the quality of information provided to users of financial statements. This Statement is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years. The adoption did not have a material impact on its consolidated financial condition or results of operations.