The Company leases approximately 6,100 square feet located at 2285 Executive Drive, Lexington, Kentucky. At December 31, 1998, the Company leased approximately 5,400 square feet pursuant to a lease agreement which would expire on March 31, 1999. In February of 1999, the Company extended the 5,400 square foot lease agreement until January 31, 2001. Additionally, in February of 1999 the Company entered into a lease agreement for an additional 700 square feet at the same location. The lease on this additional space expires on January 31, 2001. Annual rent expense for the year ended December 31, 1998 totaled $77,633.
The statements contained in the following "Management's Discussion and Analysis of Financial Condition and Results of Operations," statements contained in future filings with the Securities and Exchange Commission and publicly disseminated press releases, and statements which may be made from time to time in the future by management of the Company in presentations to shareholders, prospective investors, and others interested in the business and financial affairs of the Company, which are not historical facts, are forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statements. Any projections of financial performances or statements concerning expectations as to future developments should not be construed in any manner as a guarantee that such results or developments will, in fact, occur. There can be no assurance that any forward-looking statement will be realized or that actual results will not be significantly different from that set forth in such forward-looking statement. In addition to the risks and uncertainties of ordinary business operations, the forward-looking statements of the Company referred to above are also subject to risks and uncertainties.
The following discussion should be read in conjunction with the consolidated financial statements and the notes thereto beginning on page.
Life insurance companies typically reinsure a portion of the death benefit on individual lives. Reinsurance is a method of transferring risk to another life insurance company to guard against an adverse effect on capital. In return for assuming this risk, a premium is charged by the reinsurance company. FAIC has a reinsurance agreement for its primary product with Businessmen's Assurance Company of Kansas City, Missouri. Under the terms of the agreement, FAIC is not required to make first year premium payments. However, Generally Accepted Accounting Principles require the amount of premium not paid in the first year be recorded as a liability and amortized over the duration of the associated policies. Reinsurance premiums totaled $89,240, $58,279 and $42,427 for 1998, 1997 and 1996 respectively. These reinsurance premiums are a direct reduction of premium income.
During 1998, net investment income increased $90,781 over 1997 results. This increase is primarily due to a larger investment base from FAIC's operations and investment earnings on cash made available from the redemption of the U.S. Star preferred stock investment. The U.S. Star investment contained a provision which allowed the Company to redeem its entire preferred stock investment for the full purchase price at the end of an eighteen month period which ended September 30, 1998. During this period, the Company did not receive any interest income on the investment. Accordingly, 1997 results reflect the loss of interest on $1,000,000. The decrease in investment income in 1997 compared to 1996 can also be attributed to the interest loss on the U.S. Star investment. Investment income in 1996 totaled $585,244.
Realized investment gains during 1998 totaled $6,529. During 1997, realized investment losses included a write-off of a $31,000 credit line balance of LGP, Inc., a valuation allowance of $75,000 on notes receivable offset by a $8,000 gain on the sale of Medical Acceptance Corporation. During 1998, realized investment gains included $6,529 of investment gains on the sale of bonds. In 1996, realized investment losses totaled $4,368 which were related to the loss on sale of bond investments.
Other income totaled $88,628 in 1998 which represents a $48,873 increase over 1997 results of $39,755. The Company provides accounting support to Mid-American Alliance Corporation and First American Capital Corporation during their public stock offerings. Fees related to these accounting services increased $1,000 per month ($12,000 annually) during 1998.
Life insurance policy reserves totaled $731,958 in 1998 and $381,888 in 1997. Life insurance reserves are established to provide for the payment of policyholder benefits. Factors such as premiums, interest, mortality and life expectancy are considered in the calculation of reserve factors developed by an actuary. Typically, these factors increase as a policy reaches another anniversary creating a larger reserve. During 1998, reserves were recorded on the new insurance sales and reserves on existing policies increased. This accounted for the increase of $350,070 in 1998 as compared to 1997. During 1996, life insurance reserves totaled $354,648.
During 1997, the Company granted stock options. Compensation expense was recorded based on the difference between the exercise price of the options and the fair market value of the stock on the date of grant. This compensation expense totaled $159,743 in 1997. There were no options granted during 1998 and accordingly, no compensation cost related to stock options is recorded.
Changes in the consolidated balance sheet of 1998 compared to 1997 reflect the operations of the Company and capital transactions discussed below.
Total assets in 1998 increased by $1,934,661 from 1997 to $15,233,025. At December 31, 1998 and 1997, invested assets totaled $6,362,765 and $10,393,617, respectively. This decrease of $4,030,852 is the result of maturing investments held in cash and cash provided from insurance operations. Additionally, the investment in preferred stock was redeemed and held in cash equivalents at December 31, 1998. Cash and cash equivalents totaled $6,587,264 at December 31, 1998 which consisted primarily of U.S. Treasury Bills and money market mutual funds.
Deferred policy acquisition costs increased $773,935 net of amortization of $426,476 during 1998. Policy acquisition expenses related to new insurance sales totaled $1,200,411 and were capitalized during 1998. Advances to agents increased $34,425 during 1998 due to money provided to agents for living expenses and advances on new business submitted.
A growing concern is the ability of computer systems to accurately process date calculations in the year 2000 and beyond. The problem arises from the initial design of date values which only recognize a two digit year value. As a result, a computer may interpret a date entered for the year 2000 as the year 1900. Any computer system that performs date comparisons and calculations is exposed to such a problem. These systems are typically referred to as information technology systems ("ITS") or computer based systems. Another concern is microchips which may also be encoded with a two digit date value. These microchips are typically found in such office equipment as facsimile machines and telephone systems. These systems are referred to as non-information technology systems ("NITS").
The Company's primary exposure to any business interruption would be the result of an ITS failure. The life insurance industry relies heavily on date sensitive calculations in daily operations. The inability to process transactions could be detrimental to the Company's ability to continue operations. The Company out-sources its primary computer processing system through Navisys, Inc. of Saint Louis, Missouri. Navisys has assured the Company that its hardware and software systems have been modified to eliminate any potential year 2000 problems. Testing is scheduled to be completed by mid year 1999. Evaluation of internal hardware and software is being performed. However, management does not believe that a failure of these internal systems would cause an interruption of business. Additionally, a NITS failure would not substantially disrupt operations.
The Company is in the process of developing contingency plans to address any system failure related to the year 2000. These plans are expected to be completed during the fall of 1999.