The following table shows the distribution of real estate by type.
Real Estate Amount % of Total Home Office $ 2,759,115 16% Commercial $ 2,680,318 16% Residential development $ 6,244,142 37% Foreclosed real estate $ 5,332,413 31%
On March 9, 1995 a lawsuit was filed against Universal Guaranty Life Insurance Company on behalf of three insureds and a potential class of other insureds. The Plaintiffs allege that UG violated the insurance contract in attempting to cancel life insurance contracts. Additionally, the Plaintiffs assert violations of Illinois law alleging vexations and unreasonable insurance practices, breach of duty of good faith and fair dealing, and that Illinois consumer fraud laws have been violated. The Plaintiffs seek unspecified compensatory damages, injunctive relief, attorneys' fees, statutory damages in an amount up to $25,000, punitive damages of $1,000,000, and other equitable relief. UG filed an Answer to this lawsuit in May 1995, asserting various defenses and reserving the right to assert counterclaims. UG has also filed motions to dismiss certain allegations and claims made in the lawsuit. UG believes it has no liability to any of the plaintiffs, or other potential class members, and intends to defend the lawsuit vigorously. In June 1995, the court conditionally certified a class of non-settling insureds.
Net investment income $ 15,500 $ 14,188 $ 14,088 $14,580 $ 14,313
Net income (loss) $ (1,452) $ (1,775) $ (3,343) $(4,020) $ (448)
Net income (loss) $ (0.06) $ (0.07) $ (0.14) $ (0.21) $ (0.03)
Total long term debt $ 20,623 $ 21,529 $ 23,535 $ 26,240 $ 23,046
Cash used in investing activities was ($8,030,000), ($26,847,000) and ($23,913,000), for 1995, 1994 and 1993, respectively. The most significant aspect of investing activities is the fixed maturity transactions. Fixed maturities account for 76%, 78% and 88% of the total cost of investments acquired in 1995, 1994 and 1993, respectively. The Company has not directed its investable funds to so-called "junk bonds" or derivative investments. The cash used by investing activities in the last three years was provided by investing excess cash and cash equivalents and financing activities.
Interest credited to account balances increased 12% in 1995 compared to 1994, and decreased 14% when comparing 1994 to 1993. The increase in 1995 is due to the increase in policyholder contract deposits. The decrease in 1994 is due to a reduction in credited interest rates on the Company's insurance products in January 1994. It takes approximately one year to fully realize a change in credited rates, as such a change becomes effective on each policy's next anniversary. Insurance products that the Company is issuing are crediting 6% interest. The Company does not have any immediate plans to change product interest rates.
Net investment income increased 9% when comparing 1995 to 1994. The change reflected an increase in the amount of invested assets, which was partially offset by a lower effective yield on investments made during 1995. The overall investment yields for 1995, 1994 and 1993, are 7.10%, 7.19% and 7.40%, respectively. The Company has been able to increase its investment portfolio through financing cash flows, generated by cash received through sales of universal life insurance products. Although the Company sold no fixed maturities during the last few years, it did experience a significant turnover in the portfolio. Many companies with bond issues outstanding took advantage of the lower interest rates and retired older debt which carried higher rates. This was accomplished through early calls and accelerated pay-downs of fixed maturity investments.
Life benefits net of reinsurance benefits and claims decreased 16% compared to 1994. The decrease is related to the decrease in first year premium production. Another factor that has caused life benefits to decrease is that during 1994, the Company lowered its crediting rates on interest sensitive products in response to financial market conditions. This action will facilitate the appropriate spreads between investment returns and credited interest rates. It takes approximately one year to fully realize a change in credited rates since a change becomes effective on each policy's next anniversary. Please refer to discussion of net investment income for analysis of interest spreads.
Another factor that caused the increase in operating expenses is directly related to increased legal costs. During the third quarter of 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by Company standards. These policies had a face amount of $22,700,000 and represent 1/2 of 1% of the insurance in force of the Company. As of December 31, 1995, there remained approximately $5,738,000 of the original face amount which have not been settled. The Company will continue its efforts to repurchase as many of the policies as possible and regularly apprise the Ohio Department of Insurance regarding the status of this situation. The Company incurred legal costs of $687,000 and $229,000 in 1995 and 1994, respectively, for the legal defense of related litigation.
Interest expense decreased slightly in 1995 compared to 1994. The decrease was due to the decrease in the outstanding principal balance. The interest rate increased to 10% on March 1, 1995 compared to 7% on March 1, 1994. The Company was able to minimize the effect of the higher interest rate in 1995 by early payments of principal. The Company paid $600,000 in principal payments in 1995. The interest rate on the senior debt has decreased to 9.25% as of March 1, 1996.
Total revenue increased 4% when comparing 1994 to 1993. The termination of the Company's coinsurance agreement with Republic Vanguard contributed significantly to the increase in revenues.
Premium income, net of reinsurance premium, increased 5% when comparing 1994 to 1993. The termination of the coinsurance agreement with Republic Vanguard contributed significantly to the increase in premium, net of reinsurance premium. UG terminated the coinsurance agreement with Republic Vanguard on December 31, 1993. In UG, first year reinsurance premium was 21% of direct first year premium in 1993 compared to 3% in 1994. Coinsurance agreements provide a sharing or 50/50 relationship between the direct company and the reinsurer of the premiums, benefits and the profitability of the underlying product. Management believes that terminating the agreement was the best alternative for long term benefit of the Company.
In 1994, the Company has been very active in streamlining the product portfolio, as well as restructuring the marketing force. The Company is currently marketing three universal life products. In late 1994, the Company discontinued marketing the traditional or interest sensitive products. The current universal life products feature lower first year costs compared to the discontinued products. The marketing force is made up of three distinct groups. Business produced by the broker agency force did not meet the Company standards. Therefore, most of the agents associated with that group were terminated. The other two agency forces continued to grow in 1994. First year direct premium decreased 3% in 1994 compared to 1993. The small decrease is perceived as a positive result when considering the changes to the portfolio and marketing force.
Realized investment losses were $146,000 and $194,000 in 1994 and 1993, respectively. The Company realized losses of $513,000 and $423,000 due to permanent impairment of the value of the property located in Louisiana, in 1994 and 1993, respectively. The Company is actively pursuing a buyer for the property. The permanent impairment was due to recent appraisals and marketing analysis. The Company realized a gain of $467,000 due to the sale of an insignificant subsidiary in 1994. The Company realized a loss of $119,000 due to the sale of common stock, which was acquired through the reorganization of a fixed maturity security of Savin Corporation. The Company had other gains and losses during the period that compromised the remaining amount reported but were routine or immaterial in nature to disclose on an individual basis.
Total expenses increased 3% when comparing 1994 to 1993. Life and annuity benefits, net of reinsurance, contributed significantly to the increase in expenses. Commissions and amortization of deferred policy acquisition costs and operating expenses decreased during 1994 compared to 1993.
During 1993, and early 1994, the Company lowered its crediting rates on interest sensitive products in response to financial market conditions. This action will facilitate the appropriate spreads between investment returns and credited interest rates. The result is a reduction to the life benefits line item as the increase in policy values through credited interest is lower. The overall investment yields for 1994, 1993 and 1992, are 7.19%, 7.40% and 7.69%, respectively. The Company in conjunction with the decrease in average yield of the Company's fixed maturity portfolio has decreased the average crediting rate for the Company's insurance and investment products. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. Minimum interest spreads between earned and credited rates are 1% to 1.5%. The Company continually assesses investment yields, and when necessary takes action to reduce credited interest rates on its insurance products to preserve targeted spreads. Credited rates are established by the Board of Directors. 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 that the Company has in force and will write in the future. Management anticipates that the lowering of credited interest rates will benefit future periods.
Dividends to policyholders increased approximately 14% when comparing 1994 to 1993. USA continued to market participating policies through most of 1994. Management expects dividends to policyholders will continue to increase in the future. A portion of the Company's insurance in force is participating insurance. A significant portion of the participating business is relatively newer business. The dividend scale for participating policies increases significantly in the early years. The dividend scale is subject to approval of the Board of Directors and may be changed at their discretion. The Company no longer markets any participating policies.
The Company had a loss of $1,775,000 in 1994 compared to a loss of $3,343,000 in 1993. The establishment of a reserve of $1,250,000 liability through life benefits, claims and settlement expenses to cover cash payments to acquire the policies of certain individuals considered to be not insurable contributed significantly to the 1994 loss. The improvement in 1994 was the result of an increase in the credit provided by deferred income taxes. Deferred income taxes are affected by changes in timing differences between the financial statements and reportable for federal income tax purposes. Also, an improvement in operating expenses and commissions and amortization of deferred policy acquisition costs contributed to reducing the loss in 1994. Management anticipates that the lowering of credited interest rates on the Company's insurance and investment products will benefit future periods.
The Company's financial position at December 31, 1995, reflected an increase in assets and an increase in liabilities compared to the preceding year end. As of December 31, 1995 and 1994, cash and invested assets represented approximately 77% and 75% of consolidated assets, respectively. Cash and cash equivalents increased 7% when comparing 1995 to 1994. As of December 31, 1995 and 1994, fixed maturities represented 74% of total invested assets and cash.
By insurance statute, the majority of the Company's investment portfolio is required to be invested in investment grade securities to provide ample protection for policyholders. 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, 1995, 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.
The Company experienced moderate turnover in its fixed maturities portfolio during 1995. As previously discussed, this was the result of many companies taking advantage of lower interest rates and refinancing higher coupon rate bonds with new securities at current lower rates. This was accomplished through early calls and accelerated pay downs. During the year, the Company reinvested its funds and invested new monies from operations and from cash and short term investments primarily in investment grade corporate bonds.
Mortgage loans decreased 12% in 1995 as compared to 1994. 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 $618,000 in mortgage loans, net of a $10,000 reserve allowance, which are in default or in the process of foreclosure, this represents approximately 4% of the total portfolio.
Investment real estate and real estate acquired in satisfaction of debt decreased slightly in 1995 compared to 1994. The decrease is primarily the net result of improvements made and sales of homes and lots from the residential development. Total real estate is separated into four categories: Home Office 16%, Commercial 16%, Residential Development 37% and Foreclosed Properties 31%.
Total liabilities increased approximately 3% in 1995 compared to 1994. Future policy benefits increased 4% in 1995 and represented 83% of total liabilities at December 31, 1995. Management expects future policy benefits to increase in the future due to the aging of the volume of insurance in force and continued production by the Company's sales force.
Income taxes payable and deferred income taxes payable decreased 15% in 1995 compared to 1994. The change in deferred and current income taxes payable is attributable to temporary differences between Generally Accepted Accounting Principles ("GAAP") and tax basis. Federal income taxes are fully disclosed in Note 3 of the Notes to the Financial Statements.
The Company receives funds from its insurance subsidiaries in the form of management and cost sharing arrangements (See Note 9) and through dividends. Annual dividends in excess of maximum amounts prescribed by state statutes ("extraordinary dividends") may not be paid without the approval of the insurance commissioner in which an insurance subsidiary is domiciled. The National Association of Insurance Commissioners ("NAIC") has proposed, and certain states have adopted, legislation that lowers the threshold amount for determining what constitutes an extraordinary dividend. Such legislative changes could make it more difficult for insurance subsidiaries to pay dividends to their parents.
The NAIC has adopted Risk-Based Capital ("RBC") requirements for life/health insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching and other business factors. The RBC formula will be used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by- state basis. Regulatory compliance is determined by a ratio of the insurance company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Insurance company's below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action.
At December 31, 1995, each of the Company's insurance subsidiaries has a Ratio that is in excess of 250% of the authorized control level; accordingly the Company's subsidiaries meet the RBC requirements.
of a loan. A creditor should apply its normal loan review procedures in making that judgment. An insignificant delay or insignificant shortfall in amount of payments does not require application of this Statement. A loan is not impaired during a period of delay in payment if the creditor expects to collect all amounts due including interest accrued at the contractual interest rate for the period of delay. Thus, a demand loan or other loan with no stated maturity is not impaired if the creditor expects to collect all amounts due including interest accrued at the contractual interest rate during the period the loan is outstanding.
Consolidated Balance Sheets . . . . . . . . . . . . . . . . . . . 34
Consolidated Statements of Operations . . . . . . . . . . . . . . 35
Consolidated Statements of Shareholders' Equity . . . . . . . . . 36
Notes to Financial Statements . . . . . . . . . . . . . . . . . . 38-59