In connection with its credit insurance operations, the Company maintained branch offices in leased facilities in Philadelphia, Pennsylvania and Columbus, Ohio until December 31, 1997. The branch offices primarily provided supervision, sales and service for credit insurance agents doing business in the eastern Pennsylvania, Delaware, New Jersey and Ohio areas.
A review of the significant factors which affected the Company s net assets in liquidation at December 31, 1998, its operating results for the period from January 1, 1998 to March 24, 1998 and the changes in its net assets in liquidation for the period from March 25, 1998 to December 31, 1998 is presented below. Information relating to 1997 and 1996 is also presented for comparative purposes. This analysis should be read in conjunction with the Consolidated Financial Statements and the related Notes appearing elsewhere in this Form 10- K. OVERVIEW
As indicated above, for the period following the adoption of the liquidation basis of accounting (March 25, 1998 to December 31, 1998), the Company s expenses exceeded its revenues by $202,000. The excess expenses include $527,000 in income tax expense which resulted principally from the elimination of $472,000 in deferred tax assets. On a pre-tax basis, revenues exceeded expenses by $325,000. The Company s revenues consist primarily of investment income from its existing invested assets and fee income received from LOTS from the sale of its credit insurance customer accounts. Investment income totaled $962,000 in 1998 and $487,000 from March 25 to December 31, 1998. Investment income declined substantially compared to 1997 and 1996 because of the transfer of more than $35 million in assets to LOTS and its financial partner, American Republic Insurance Company, in May 1998 in connection with the sale of the Company s credit insurance business. That transaction also resulted in the transfer of all of the Company s credit insurance policy liabilities. For the full year of 1998, the Company s fee income from LOTS totaled $405,000, after deducting $109,000 in fees which are payable to a former joint venture partner. For the period following the adoption of the liquidation basis of accounting, fee income from LOTS, net of the partner s share, was $305,000. In addition to investment income and fee income, the Company also reported a significant increase in profits earned on a now terminated joint venture. Profits from the venture totaled $243,000 from March 25, 1998 to the end of the year. Since these profits are based on the claims experience of several blocks of insurance business, the level of profits earned in 1998 is not indicative of amounts which may be earned over the next several years.
In addition to the reduction in net assets in liquidation caused by the $202,000 excess of expenses over revenues, net assets for the period from March 25, 1998 to December 31, 1998 declined by an additional $1.1 million as a result of other factors which are discussed below under Capital Resources.
As indicated above, the liquidation of the Company is expected to continue for approximately four more years until all fee payments and other potential distributions are received from LOTS. During this period, certain corporate expenses will continue to be incurred and investment income will continue to earn on existing invested funds. The Board of Directors may determine during this period that the amount of funds available for ultimate distribution to shareholders may be increased by transferring all of the Company s remaining net assets into a liquidating trust, in which case the trustees of such trust would be responsible for liquidating all remaining assets, paying all liabilities and making any distributions to the preferred and common shareholders. Based on current estimates, which exclude the potential savings, if any, from the use of a liquidating trust, the Company believes that its future operating expenses and other costs, including preferred stock dividends, will exceed fee income and other revenues during the liquidation period by approximately $100,000 to $200,000. Actual income and expenses could vary significantly from the present estimates due to uncertainties as to when certain assets will be liquidated, when the preferred stock will be redeemed, the level of actual expenses which will be incurred and the ultimate resolution of various contingencies which may arise.
The Company s subsidiaries have historically met most of their cash requirements from funds generated from operations, while the Company has generally relied on its principal operating subsidiaries to provide it with sufficient cash funds to maintain an adequate liquidity position. As a result of the Company s decision to sell its remaining operations, liquidate all of its net assets and distribute cash to its shareholders, the Company s principal sources of cash funds are the fee income from LOTS, investment income on existing assets and proceeds from the sale of non-liquid assets. These funds must be used to settle all remaining liabilities as they become due, to pay operating expenses until the Company is dissolved and to pay dividends to preferred shareholders until the Company s preferred stock is redeemed. The adequacy of the Company s liquidity position in the future will be principally dependent on its ability to sell its real estate investments and other non- liquid assets and the timing of such sales, as well as on the level of operating expenses the Company must incur during the liquidation period.
Given its plans to liquidate and eventually dissolve, the Company has made no commitments for capital expenditures and does not intend to make any such commitments in the future. The Company s net assets in liquidation declined by $1.3 million from March 25, 1998 to December 31, 1998. The reduction is attributable to (i) the establishment of a $664,000 liability relating to the Company s under funded pension plan, (ii) the write-off of $472,000 in deferred tax assets, (iii) preferred stock dividends of $307,000 and (iv) a $175,000 charge to increase the carrying value of the preferred stock to redemption value (prior to adoption of the liquidation basis of accounting, the difference between the fair value and the redemption value of the stock was being reduced by periodic accretions which were charged to retained earnings). These decreases were partially offset by the excess of income over expenses (on a pre-tax basis). The reductions listed in (ii) and (iv) above are non-recurring, while the preferred stock dividends in (iii) are expected to continue until the preferred shares are redeemed. The amount of the ultimate pension liability, and consequently the need for any further increase or decrease in the liability, is dependent on a number of factors, the most important of which is the prescribed interest rate which is in effect at the time the plan is terminated.
Because of the Company s current plans to liquidate its assets, pay all of its liabilities, distribute any remaining cash to its shareholders and ultimately dissolve within the next four years, the effects of inflation on the Company are minimal.
Because the Company is no longer conducting any business operations and is in the process of liquidating its remaining assets, it is therefore relying, both directly and indirectly, on fewer computer systems than in the past to maintain all of its financial and other records and to file all required financial reports with state insurance departments and other regulators. In fulfilling its continuing, although limited, responsibilities, the Company directly utilizes only two computer systems, one for its general ledger accounting and one for maintenance of its shareholder records (since the Company continues to perform its own stock transfer agent functions). The Company has received written assurances from both software vendors that their respective systems have been tested and will operate problem free during and after the year 2000. The Company also receives certain computer generated information from LOTS, and has obtained a year 2000 certification from LOTS stating that all of its hardware and software systems have been tested and are year 2000 compliant. Based on the above, management does not believe that its very limited operations will be adversely impacted by year 2000 computer problems.
See notes to consolidated financial statements CONSUMERS FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
The consolidated financial statements include the accounts of Consumers Financial Corporation (the Company) and its wholly-owned subsidiaries, the most significant of which is Consumers Life Insurance Company (Consumers Life). Investors Fidelity Life Assurance Corp. (IFLAC) is a subsidiary of Consumers Life. All material intercompany accounts and transactions have been eliminated.
Fixed maturities includes bonds, notes and certificates of deposit maturing after one year. Management determines the appropriate classification of bonds and notes at the time of purchase and reevaluates such designation as of each balance sheet date. These securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. All other bonds and notes are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of income taxes, reported as a separate component of shareholders equity. The amortized cost of fixed maturity securities is adjusted for amortization of premiums and accretion of discounts to maturity. All certificates of deposits maturing after one year are deemed to be held to maturity.
Cash and short-term investments: The carrying amounts reported in the balance sheet for these instruments approximate their fair values.
Mortgage loans: The fair values for mortgage loans are estimated using discounted cash flow analyses, using interest rates currently being offered for similar loans to borrowers with similar credit ratings.
Real estate is carried at the lower of cost or fair value, less estimated selling costs. Future policy benefits
The liability for future policy benefits for individual life insurance has been provided on a net level premium method based on estimated investment yields, withdrawals, mortality and other assumptions which were appropriate at the time the policies were issued. Such estimates were based upon industry data and the Companies' past experience, as adjusted to provide for possible adverse deviation from the estimates. Benefit reserves for universal life products represent policy account balances before applicable surrender charges plus certain deferred policy initiation fees that are recognized in income over the term of the policies.
The Company and its subsidiaries provide income taxes, for financial reporting purposes, on the basis of the liability method as required by Statement of Financial Accounting Standards No. 109.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.
Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (SFAS 130), which establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. The objective of SFAS 130 is to report a measure of all changes in equity of an enterprise that result from transactions and other economic events of the period other than transactions with owners. Comprehensive income (loss) is the total of net income (loss) and all other nonowner changes in equity. Accordingly, the Company has reported comprehensive income (loss) in the Consolidated Statements of Shareholders Equity.
In 1998, the Company adopted Statement of Financial Accounting Standards No. 132, Employers Disclosures about Pensions and Other postretirement Benefits (SFAS 132). As required by SFAS 132, the Company has provided certain additional disclosures relating to the benefit obligation and the assets of its pension plan. Similar disclosures were also provided for 1997.
(a) In accordance with NAIC requirements, all bonds eligible for amortization are reported at amortized value, whereas in the accompanying financial statements, only bonds which are classified as held-to-maturity securities are stated at amortized cost, and available-for-sale securities are carried at fair value. Other securities are carried at values prescribed by or deemed acceptable to the NAIC.
(d) Deferred income taxes, if applicable, are provided as described in Note 15.
Dividends and other distributions to the Company from Consumers Life are limited in that Consumers Life is required to maintain minimum capital and surplus in each of the states in which it is licensed, determined in accordance with regulatory accounting practices. The amount of minimum capital and surplus required is $5.5 million. Under Delaware insurance laws, distributions are subject to further restrictions relating to capital and surplus and operating earnings. Accordingly, under normal circumstances, at December 31, 1998, approximately $2 million of Consumers Life's net assets cannot generally be transferred to the parent company and $682,000 is available for transfer during 1999. However, because of its prior operating losses and its current capital and surplus position, the Company is not permitted to pay any dividends without prior approval from the Delaware Insurance Department. Also, any loans or advances to the parent company of a material amount must be reported to the insurance department. The Company may have limited cash funds available to pay dividends in excess of amounts transferred from subsidiaries. In addition, separate restrictions apply to the surplus note owed to the Company by a subsidiary of Consumers Life. Payment of interest and repayment of principal on the note are permitted by the applicable state insurance department only if the subsidiary's statutory capital and surplus exceeds $3 million.
The reported statutory capital and surplus of Consumers Life was $5.0 million at December 31, 1998 and $5.7 million at December 31, 1997. Consumers Life and IFLAC reported combined statutory net income of $281,000 in 1998 and a $2.7 million combined statutory net loss in 1997.
(a) Includes renewal premiums which are 100% ceded under indemnity reinsurance agreement with third party reinsurer.
Investments, which are valued for financial statement purposes as described in Note 1, consist of the following at December 31, 1998:
At December 31, 1998 and 1997, all the Company s real estate is classified as non-investment real estate, since the Company intends to sell these properties. Accumulated depreciation on the properties at the end of 1998 and 1997 totaled $27,000 and $56,000, respectively.
All of the Company s real estate is classified as non-investment real estate since these properties are listed for sale.
The composition of future policy benefits and unearned premiums at December 31, 1998 and the assumptions pertinent thereto are as follows:
Future policy benefits reported to regulatory authorities were less than the above total by approximately $684,000 at December 31, 1998.
Life insurance in force net of reinsurance ceded was $58,000 at December 31, 1998.
Prior to the 1998 sale of its credit insurance business, as discussed in Note 4, and the sales of its individual life insurance business in 1992 through 1997, the Company routinely ceded and, in some instances, assumed reinsurance. The sale of the credit insurance business of Consumers Life was completed pursuant to an indemnity reinsurance agreement with American Republic, while IFLAC s credit insurance was ceded utilizing an assumption reinsurance agreement. Similarly, the reinsurance transactions through which the Company sold its individual life insurance business included the use of both indemnity and assumption agreements. The insurance companies remain contingently liable for insurance risks ceded under indemnity agreements, while such risks are legally transferred to the reinsurer when assumption agreements are utilized.
Historically, the insurance companies also entered into various financing- type reinsurance agreements with unaffiliated reinsurers. Such agreements, which primarily involved credit insurance, were designed to minimize the reduction of statutory capital and surplus arising at the time premiums were written. These financing-type agreements were terminated as of January 1, 1998 when the American Republic agreements became effective. During 1998, Consumers Life entered into another financing-type reinsurance agreement in which it assumed approximately $2 million in individual life insurance premiums and an equal amount of policy liabilities. The effects of all financing-type agreements have been removed from the financial statements except for the cost of the financing, which amounted to $25,000, $660,000 and $608,000 in 1998, 1997 and 1996, respectively. These costs are included with Operating Expenses on the Consolidated Statements of Operations and are presented with Miscellaneous Expenses on the Consolidated Statement of Changes in Net Assets in Liquidation.
The building lease is classified as an operating lease. The Company has no other significant leases.
Certain claims, suits and complaints arising in the ordinary course of business have been filed or are pending against the Company or its subsidiaries. In the opinion of management, based on opinions of legal counsel, adequate reserves, if deemed necessary, have been established for these matters and their outcome will not result in a significant effect on the financial condition or future operating results of the Company or its subsidiaries. The Company has taken certain income tax positions in previous years that it believes are appropriate. If such positions were to be successfully challenged by the Internal Revenue Service, the Company could incur additional income taxes as well as interest and penalties. Management believes that the ultimate outcome of any such challenges will not have a material effect on the Company s financial statements.
Prior to March 25, 1998, the difference between the fair value of the Preferred Stock at the date of issue and the mandatory redemption value was recorded through periodic accretions, using the interest method, resulting in a charge to retained earnings ($9,000 in 1998 and $36,000 in 1997 and 1996). Upon the adoption of the liquidation basis of accounting in March 1998, the unaccreted difference of $175,000 was recorded as a reduction in the Company s net assets.
In May 1982, the shareholders of the Company approved a Stock Option Plan which permitted the granting of incentive stock options (as defined in the Internal Revenue Code). The Plan provided for the granting of up to 300,000 stock options to purchase shares of the Company's common stock at at price not less than its fair market value on the date of grant. In May 1989, the shareholders of the Company approved the Stock Incentive Plan which permits the granting of any or all of the following types of awards: (1) stock options, including incentive stock options and non-qualified stock options and (2) stock appreciation rights (SAR) either in tandem with stock options or free standing. This Plan was intended to enhance the 1982 Stock Option Plan. All officers and salaried key employees of the Company and its subsidiaries and affiliates were eligible to be participants. Persons who served only as directors were not eligible. The Plan provided for the granting of up to 250,000 stock options.
As a result of the Company s operating losses over the past five years, the exercise price of the outstanding options is substantially higher than the market price of the Company s common stock, and it is therefore unlikely that any of the options, which expire in May 1999, will ever be exercised. Further, due to its planned liquidation and eventual dissolution, the Company has no intention of granting any additional options.
No options were exercised during 1998. At December 31, 1998, 133,117 shares were reserved for options which are available to be granted (although no such grants are anticipated), and all of the 132,000 outstanding options were exercisable.
Effective January 1, 1996, the Company adopted the provisions of SFAS No. 123 - Accounting for Stock-Based Compensation. As permitted by the statement, the Company has elected to continue to account for stock-based compensation using the intrinsic value method under Accounting Principles Board Opinion No. 25. Accordingly, no compensation expense has been recognized for stock options. The Company believes the computation of compensation expense based on the fair value method of accounting, as defined in SFAS No. 123, would have no material effect on the results of operations.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31, 1998 and 1997 are as follows:
The NAIC has established certain minimum capitalization requirements based on risk-based capital (RBC) formulas. The formulas are designed to identify companies which are undercapitalized and require specific regulatory action based on requirements relating to insurance, business, asset and interest rate risks. At December 31, 1998, each of the Company's two insurance subsidiaries have more than sufficient capital to meet the NAIC's RBC requirements. QUARTERLY FINANCIAL DATA (UNAUDITED)