The Company expects to facilitate growth through acquisitions of other life insurance companies and/or blocks of life insurance business. In the fourth quarter of 2008, the Company completed its acquisition of 100% of the outstanding stock of First Life America Corporation, included in the life insurance segment, for $2,500,000 and had additional acquisition related expenses of $195,000.
Our profitability in the life insurance segment is a function of its ability to accurately price the policies that it writes, adequately value life insurance business acquired and administer life insurance company acquisitions at an expense level that validates the acquisition cost. Profitability in the premium financing segment is dependent on the Company’s ability to compete in that sector, maintain low administrative costs and minimize losses.
Equity securities are comprised of common stock and are carried at fair value. The associated unrealized gains and losses, net of applicable income taxes, are included in accumulated other comprehensive income. The cost of equity securities is written down to fair value when a decline in value is considered to be other-than-temporary. Dividends from these investments are recognized in net investment income when declared.
Deferred acquisition costs related to limited-payment long-duration annuity contracts are also adjusted, net of tax, for the change in amortization that would have been recorded if the unrealized gains (losses) from securities had actually been realized. This adjustment is included in the change in net unrealized appreciation (depreciation) on available-for-sale securities, a component of “Accumulated Other Comprehensive Income” in the shareholders’ equity section of the statement of financial position.
As a result of our purchase of FLAC, an asset was recorded in the application of purchase accounting to recognize the value of acquired insurance in force. The Company’s value of acquired insurance in force is an intangible asset with a definite life and is amortized under Financial Accounting Standards Board (“FASB”) guidance. The value of acquired insurance in force is amortized primarily over the emerging profit of the related policies using the same assumptions that were used in computing liabilities for future policy benefits. For the amortization of the value of acquired insurance in force, the Company periodically reviews its estimates of gross profits. The most significant assumptions involved in the estimation of gross profits include interest rate spreads, future financial market performance, business surrender/lapse rates, mortality and morbidity, expenses and the impact of realized investment gains and losses. In the event actual experience differs significantly from assumptions or assumptions are significantly revised, the Company is required to record a charge or credit to amortization expense for the period in which an adjustment is made.
At December 31, 2010 and 2009 there was $604,958 and $333,493, respectively, of accumulated amortization of the value of insurance business acquired due to the purchase of FLAC that occurred at the end of 2008. We expect to amortize the value of insurance business acquired by the following amounts over the next five years: $257,729 in 2011, $211,579 in 2012, $197,041 in 2013, $184,256 in 2014 and $173,500 in 2015.
We use the liability method of accounting for income taxes. Deferred income taxes are provided for cumulative temporary differences between balances of assets and liabilities determined under GAAP and balances determined using tax bases. A valuation allowance is established for the amount of the deferred tax asset that exceeds the amount of the estimated future taxable income needed to utilize the future tax benefits.
Corporate operations, which includes the results of the parent company after the elimination of intercompany amounts.
The Company acquired FLAC as of December 23, 2008 and Old TLIC was merged into FLAC with the name of FLAC being changed to TLIC during 2009.
In addition, the independent insurance agency endorsed and deposited $326,479 of checks issued by FTCC in the agency’s bank account that were payable to other third parties for insurance premiums. FTCC recovered these funds from the banks due to improper endorsement.
FTCC and the Company continued to investigate the facts and circumstances relating to any fraudulent loans and financial transactions in 2010 and will continue to seek restitution for any losses.
Our primary sources of revenue are life insurance premium income, income from premium financing and investment income. Premium payments are classified as first-year, renewal and single. In addition, realized gains and losses on investment holdings can significantly impact revenues from period to period.
The increased net realized investment gains in excess of losses represent the recording of $155,364 of impairments during 2009 and the differences in net realized investment gains and losses during 2009 compared to 2010 (net realized investment gains of $159,300 in 2010 and net realized investment losses of $31,046 in 2009). The increased investment income primarily relates to increased total investments in the consolidated statement of financial position. The increase in premiums relates to increased new business production of final expense business and increased renewal premiums. The other income increase is primarily due to increased service fees. The decrease in income from premium financing relates to a decrease in production and fraudulent transactions in 2009 by an independent insurance agency.
Premiums increased 0.6% to $5,895,030 for the year ended December 31, 2010, an increase of $34,679 from $5,860,351 for the year ended December 31, 2009. The increase relates to increased final expense first year premium production of $282,000 and increased final expense and whole life and term renewal premium production of $173,000 and $72,000, respectively, that exceeded decreased first year whole life and term premiums of $492,000. This decrease in first year production of whole life and term premiums is due to the focus of the captive agency forces on the public stock offering that began on June 29, 2010.
Income from premium financing decreased 55.5% to $259,296 for the year ended December 31, 2010, a decrease of $323,520 from $582,816 for the year ended December 31, 2009. The decrease in income from premium financing relates to a decrease in production of loan agreements and fraudulent transactions in 2009 by an independent insurance agency.
Net investment income increased 9.8% to $2,441,334 for the year ended December 31, 2010, an increase of $218,809 from $2,222,525 for the year ended December 31, 2009. The increase in net investment income primarily relates to increased total investments in the consolidated statement of financial position. However, as investments are called or matured, the proceeds are being invested at lower effective interest rates that continue to decrease yields.
Net realized investment gains were $159,300 for the year ended December 31, 2010 compared to net realized investment losses of $186,410 for the year ended December 31, 2009, an increased net gain of $345,710. The increased net gains in excess of net losses is due to call activity and planned sales of specific securities during 2010 and 2009 combined with the 2009 losses from investment impairments. We recorded $159,300 of net realized investment gains during 2010 compared to net realized investment losses of $31,046 during 2009. In addition, we recorded $155,364 of other-than-temporary impairment losses in 2009 and none in 2010.
The investment markets were very volatile at the end of 2008 and throughout 2009 due to the credit crisis and economic downturn. There has been a recovery in the investments markets in 2010. We recorded no other-than-temporary impairments in 2010. We recorded two other-than-temporary impairments during the 2009. The Company impaired its $200,000 par value General Motors (“GM”) bond as a result of a bankruptcy filing by GM and approximately $710,000 par value investment in Cit Group (“CIT”) bonds as a result of a bankruptcy filing by CIT. Both of these impairments were considered fully credit-related, resulting in a charge to the statement of operations before taxes of $155,364 for the year ended December 31, 2009. This charge represented the difference between the amortized cost basis of the securities and fair value.
Other income was $66,346 and $63,510, respectively, for the years ended December 31, 2010 and 2009, an increase of $2,836. The increase is primarily due to a $5,000 increase in service fees in 2010 compared to 2009.
Our benefits, claims and expenses are primarily generated from benefit payments, surrenders, change in reserves, commissions and other underwriting, insurance and acquisition expenses. Benefit payments can significantly impact expenses from period to period.
Total consolidated benefits, claims and expenses decreased 4.8% to $8,936,496 for the year ended December 31, 2010, a decrease of $447,548 from $9,384,044 for the year ended December 31, 2009. The decrease is primarily attributable to a $1,141,889 decrease in other underwriting, insurance and acquisition expenses and a $358,734 increase in net deferred acquisitions costs capitalized net of the amortization of deferred acquisition costs and the amortization of value of business acquired that exceeded an $829,537 increase in benefits and claims and a $223,538 increase in commissions.
For the years ended December 31, 2010 and 2009, capitalized costs were $1,773,199 and $1,478,104, respectively. Amortization of deferred policy acquisition costs for the years ended December 31, 2010 and 2009 was $451,349 and $452,960, respectively. The $295,095 increase in the acquisition costs deferred relates to increased new business production primarily in the final expense business. The $1,611 decrease in the amortization of deferred acquisition costs primarily reflects improving persistency in the whole life and term business reflected in the increased renewal premiums in 2010 compared to 2009.
FTFC files a consolidated federal income tax return with FTCC but does not file a consolidated tax return with TLIC. TLIC is taxed as a life insurance company under the provisions of the Internal Revenue Code and must file a separate tax return until they have been a member of the consolidated filing group for five years. Certain items included in income reported for financial statements are not included in taxable income for the current period, resulting in deferred income taxes. For the year ended December 31, 2010, deferred income tax benefit was $206,526 with no current income tax expense and for the year ended December 31, 2009 deferred income tax expense was $49,139 with no current income tax expense.
The value of insurance business acquired was $2,507,258 and $2,778,723 as of December 31, 2010 and 2009, respectively. Amortization of value of insurance business acquired for the years ended December 31, 2010 and 2009 was $271,465 and $333,493, respectively.
As of December 31, 2010 and 2009, we held loans from premium financing of $1,143,977 and $2,749,830, respectively. The loan balances at December 31, 2010 and 2009, respectively, are net of unearned interest of $35,519 and $72,144 and allowance for loan losses of $443,071 and $318,826.
The progression of the Company’s loans from premium financing for the years ended December 31, 2010 and 2009 is summarized as follows:
Total liabilities as of December 31, 2010 and 2009 were $44,932,914 and $36,566,153, respectively.
Total policy liabilities as of December 31, 2010 were $44,115,568 and were composed of policyholders’ account balances of $30,261,070; future policy benefits of $13,444,284; policy claims of $367,306 and premiums paid in advance of $42,908. Total policy liabilities as of December 31, 2009 were $36,075,337 and were composed of policyholders’ account balances of $24,417,483; future policy benefits of $11,349,640; policy claims of $289,273 and premiums paid in advance of $18,941.
Since inception, our operations have been financed primarily through the private placement of equity securities and an intrastate public stock offering. Through December 31, 2010, we received $18,837,000 from the sale of our shares. Our operations have not been profitable and have generated more than $3,389,000 of losses from operations since we were incorporated in 2004 as shown in the accumulated deficit balance in the December 31, 2010 statement of financial position.
During the years ended December 31, 2010 and 2009, cash and cash equivalents increased $5,904,586 and $1,410,897, respectively. Our operating activities for the year ended December 31, 2010 provided $1,220,685 of cash compared to $324,405 of cash used in operations during the year ended December 31, 2009. The increase in cash provided by operations in 2010 is primarily due to increased net investment income and decreased underwriting, insurance and acquisition expenses that exceeded increased benefits and claims. Cash used in investing activities for the year ended December 31, 2010 was $2,809,417 and cash used by investing activities was $425,022 for the year ended December 31, 2009. Net cash provided by financing activities for the years ended December 31, 2010 and 2009 was $7,493,318 and $2,160,324, respectively. The 2010 increase in cash provided by financing activities resulted from a net increase in policy deposits for the year ended December 31, 2010 and the net proceeds from the 2010 public stock offering that commenced on June 29, 2010.
Shareholders’ equity at December 31, 2010 was $16,655,947 compared to $13,250,690 at December 31, 2009. The increase is due to an increase in fair value of fixed maturity and equity security investments, available-for-sale net of applicable income taxes and proceeds from the public stock offering that commenced on June 29, 2010 of $3,362,325 less $486,730 of offering costs. Equity per common share outstanding and subscribed increased 17.1% to $2.54 as of December 31, 2010 compared to $2.17 per share at December 31, 2009, based upon 6,565,976 common shares outstanding and subscribed as of December 31, 2010 and 6,095,250 outstanding common shares as of December 31, 2009. These weighted average shares reflect the retrospective adjustment for the impact of the 5% stock dividend declared by the Company on January 10, 2011 and payable to holders of shares of the Company as of March 10, 2011.
We are subject to various market risks. The quality of our investment portfolio and the current level of shareholders’ equity continue to provide a sound financial base as we strive to expand our marketing to offer competive products. Our investment portfolio recovered from the disruptions in the capital markets and had unrealized appreciation on available-for-sale securities of $3,621,646 and $2,836,329 as of December 31, 2010 and 2009, respectively, prior to the impact of income taxes and deferred acquisition cost adjustments.
One of the significant risks relates to the fluctuations in interest rates. Regarding interest rates, the value of our available-for-sale fixed maturity securities investment portfolio will increase or decrease in an inverse relationship with fluctuations in interest rates, while net investment income earned on newly acquired available-for-sale fixed maturity securities increases or decreases in direct relationship with interest rate changes. From an income perspective, we are exposed to rising interest rates which could be a significant risk, as TLIC's annuity business is subject to variable interest rates. The life insurance company's life insurance policy liabilities bear fixed rates. From a liquidity perspective, our fixed rate policy liabilities are relatively insensitive to interest rate fluctuations. Accordingly, we believe gradual increases in interest rates do not present a significant liquidity exposure for the life insurance policies. We maintain conservative durations in our fixed maturity portfolio. At December 31, 2010 cash and fixed-maturity investments with maturities of less than one year equaled 31.3% of total policy liabilities. If interest rates rise significantly in a short time frame, there can be no assurance that the life insurance industry, including the Company, would not experience increased levels of surrenders and reduced sales, and thereby be materially adversely affected.
On June 29, 2010, we commenced a public offering of our common stock registered with the U.S. Securities and Exchange Commission and the Oklahoma Department of Securities. The public offering is for 1,333,334 shares of our common stock for $7.50 per share. We will receive $8.5 million after reduction for offering expenses and sales commissions if all the shares are sold. We have registered an additional 133,334 shares of our common stock to cover over subscriptions if any occur. The sale of all the additional shares would provide us with an additional $850,000 after reduction for offering expenses and sales commissions. The offering will end on June 28, 2011, unless all the shares are sold before then or the offering is extended. As of December 31, 2010, the Company has received gross proceeds of $3,362,325 from the sale of 448,310 shares of our common stock in this offering and incurred $486,730 in offering costs. The proceeds were originally deposited in an escrow account that was released from escrow by the Oklahoma Department of Securities in August 2010 after the offering exceeded $1,000,000 in gross proceeds. These proceeds are now available to us. Future proceeds from the sale of shares of our common stock in this public offering will be available to us without being held in escrow.
We believe that our existing cash and cash equivalents at December 31, 2010 will be sufficient to fund our anticipated operating expenses. Loans outstanding from premium financing declined during 2009 and have continued to decline during 2010 as we have decreased production of premium financing contracts. The growth of the premium finance subsidiary is uncertain and will require additional capital if it grows. Funds will not be available to continue the expansion of the Company’s subsidiaries without borrowing funds or raising additional capital. As introduced above, we have begun a public offering to generate additional funding. We intend to use the proceeds to finance future acquisitions of life insurance companies or blocks of life insurance business, provide up to $2.0 million of capital and/or surplus to TLIC as needed to maintain adequate capital and increase working capital. We have based this estimate upon assumptions that may prove to be wrong and we could use our capital resources sooner than we currently expect.
Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and many of which are subject to change. These uncertainties and contingencies could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable factors and developments. Some of these may be national in scope, such as general economic conditions, changes in tax laws and changes in interest rates. Some may be related to the insurance industry generally, such as pricing competition, regulatory developments, industry consolidation and the effects of competition in the insurance business from other insurance companies and other financial institutions operating in our market area and elsewhere. Others may relate to the Company specifically, such as credit, volatility and other risks associated with our investment portfolio. We caution that such factors are not exclusive. We disclaim any obligation to update forward-looking information.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Trinity Financial Corporation and Subsidiaries as of December 31, 2010 and 2009, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
First Trinity Financial Corporation, (the “Company”) was incorporated in Oklahoma on April 19, 2004, for the primary purpose of organizing a life insurance subsidiary. The Company raised $1,450,000 from two private placement stock offerings during 2004. On June 22, 2005, the Company’s intrastate public stock offering filed with the Oklahoma Department of Securities for $12,750,000, which included a 10% "over-sale" provision (additional sales of $1,275,000), was declared effective. The offering was completed February 23, 2007. The Company raised $14,025,000 from this offering.
On June 29, 2010, the Company commenced a public offering of its common stock registered with the U.S. Securities and Exchange Commission and the Oklahoma Department of Securities. The public offering is for 1,333,334 shares of the Company’s common stock for $7.50 per share. If all shares are sold, the Company will receive $8.5 million after reduction for offering expenses and sales commissions. The Company has registered an additional 133,334 shares of its common stock to cover over subscriptions if any occur. The sale of all the additional shares would provide the Company with an additional $850,000 after reduction for offering expenses and sales commissions.
The offering will end on June 28, 2011, unless all the Company’s shares are sold before then or the offering is extended. As of December 31, 2010, the Company has received gross proceeds of $3,362,325 from the subscription of 448,310 shares of its common stock in this offering and incurred $486,730 in offering costs. The proceeds were originally deposited in an escrow account that was released from escrow by the Oklahoma Department of Securities in August 2010 after the offering exceeded $1,000,000 in gross proceeds. These proceeds are now available to the Company. Future proceeds from the sale of shares of the Company’s common stock in this public offering will be available to the Company without being held in escrow.
The Company purchased First Life America Corporation (“FLAC”) on December 23, 2008. On August 31, 2009, two of the Company’s subsidiaries, Trinity Life Insurance Company (“Old TLIC”) and FLAC, were merged, with FLAC being the surviving company. Immediately following the merger, FLAC changed its name to Trinity Life Insurance Company (“TLIC”). After the merger, the Company has two wholly owned subsidiaries, First Trinity Capital Corporation (“FTCC”) and TLIC, domiciled in Oklahoma. FTCC was incorporated in 2006, and began operations in January 2007 providing financing for casualty insurance premiums.
The Company’s operations, prior to the acquisition of FLAC, involved the sale of a modified premium whole life insurance policy with a flexible premium deferred annuity rider through its subsidiary Old TLIC in the state of Oklahoma. FTCC provides financing for casualty insurance premiums for individuals and companies and is licensed to conduct premium financing business in the states of Alabama, Arkansas, Louisiana, Mississippi and Oklahoma. The Company owns 100% of Southern Insurance Services, LLC, (“SIS”), a limited liability company, that operates a property and casualty insurance agency. FTCC is the sole member of SIS.
Fixed maturity securities are comprised of bonds that are classified as available-for-sale and are carried at fair value with unrealized gains and losses, net of applicable income taxes, reported in accumulated other comprehensive income. The amortized cost of fixed maturity securities available-for-sale is adjusted for amortization of premium and accretion of discount to maturity. Interest income, as well as the related amortization of premium and accretion of discount, is included in net investment income under the effective yield method. The amortized cost of fixed maturity securities available-for-sale is written down to fair value when a decline in value is considered to be other-than-temporary.
The Company evaluates the difference between the cost/amortized cost and estimated fair value of our investments to determine whether any decline in value is other-than-temporary in nature. This determination involves a degree of uncertainty. If a decline in the fair value of a security is determined to be temporary, the decline is recorded as an unrealized loss in stockholders' equity. If a decline in a security's fair value is considered to be other-than-temporary, the Company then determines the proper treatment for the other-than-temporary impairment. For fixed maturity securities available-for-sale, the amount of any other-than-temporary impairment related to a credit loss is recognized in earnings and reflected as a reduction in the cost basis of the security; and the amount of any other-than-temporary impairment related to other factors is recognized in other comprehensive income (loss) with no change to the cost basis of the security. For equity securities available-for-sale, the amount of any other-than-temporary impairment is recognized in earnings and reflected as a reduction in the cost basis of the security.
Investment real estate is carried at amortized cost. Depreciation on the office building is calculated over its estimated useful life of 39 years.
Deferred acquisition costs related to annuities that subject the Company to mortality or morbidity risk over a period that extends beyond the period or periods in which premiums are collected and that have terms that are fixed and guaranteed (i.e., limited-payment long-duration annuity contracts) are deferred to the extent deemed recoverable and amortized in relation to the present value of actual and expected gross profits on the policies. To the extent that realized gains and losses on fixed income securities result in adjustments to deferred acquisition costs related to annuities, such adjustments are reflected as a component of the amortization of deferred acquisition costs.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis.
The Company’s liability for policyholders’ account balances represents the contract value that has accrued to the benefit of the policyholder as of the financial statement date. This liability is generally equal to the accumulated account deposits plus interest credited less policyholders’ withdrawals and other charges assessed against the account balance. Interest crediting rates for individual annuities range from 3.75% to 6.75%. Interest crediting rates for premium deposit funds range from 3% to 4%.
On January 10, 2011, the Company’s Board of Directors approved a 5% share dividend by which shareholders will receive a share of Common Stock for each 20 shares of common stock of the Company they hold. The dividend is payable to the holders of shares of the Corporation as of March 10, 2011. Fractional shares will be rounded to the nearest whole number of shares. It is anticipated that approximately 324,000 shares will be issued in connection with the stock dividend that will result in accumulated deficit being charged by approximately $2,430,000 with an offsetting credit of approximately $2,430,000 to common stock and additional paid-in capital.
Revenues on traditional life insurance products consist of direct premiums reported as earned when due. Liabilities for future policy benefits are provided and acquisition costs are amortized in a systematic manner based on the related contract revenues or gross profits as appropriate. Acquisition costs for traditional life insurance contracts are deferred to the extent deemed recoverable and are amortized over the premium paying period of the related policies using assumptions consistent with those used in computing future policy benefit liabilities. Traditional life insurance products are treated as long-duration contracts since they are ordinary whole life insurance products, which generally remain in force for the lifetime of the insured.
Deferred acquisition costs related to annuities that subject us to mortality or morbidity risk over a period that extends beyond the period or periods in which premiums are collected and that have terms that are fixed and guaranteed are deferred to the extent deemed recoverable and amortized in relation to the present value of actual and expected gross profits on the policies. These annuities are treated as long-duration insurance contracts since the Company is subject to risk from policyholder mortality and morbidity over an extended period.
In addition, deferred acquisition costs related to limited-payment long-duration annuity contracts are also adjusted, net of tax, for the change in amortization that would have been recorded if the unrealized gains (losses) from available-for-sale securities had actually been realized. This adjustment is included in the change in net unrealized appreciation (depreciation) on available-for-sale securities, a component of “Accumulated Other Comprehensive Income” in the shareholders’ equity section of the statement of financial position.
Management has evaluated all events subsequent to December 31, 2010 through the date that these financial statements have been issued.
In January 2010, the FASB issued Accounting Standards Update No. 2010-06, Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). The new guidance requires entities to separately disclose information relative to transfers in and out of Levels 1 and 2 in the fair value hierarchy. In addition, ASU 2010-06 requires separate presentation of transfers in, transfers out, purchases, sales, issuances and settlements of Level 3 investments in the tabular reconciliation of Level 3 activity. ASU 2010-06 also clarifies the level of disaggregation for which fair value measurements should be disclosed and requires that information about input and valuation techniques be disclosed for Level 2 and Level 3 assets and liabilities. The Company adopted this guidance effective for the first quarter of 2010.
Based on our review, the Company experienced no other-than-temporary impairments during the year ended December 31, 2010.
Management believes that the Company will fully recover its cost basis in the securities held at December 31, 2010, and management does not have the intent to sell nor is it more likely than not that the Company will be required to sell such securities until they recover or mature. The remaining temporary impairments shown herein are primarily the result of the current interest rate environment rather than credit factors that would imply other-than-temporary impairment.
The accumulated change in net unrealized investment gains for fixed maturity and equity securities available-for-sale for the years ended December 31, 2010 and 2009 and the amount of realized investment gains (losses) on fixed maturity and equity securities for the years ended December 31, 2010 and 2009 are summarized as follows:
The Company’s mortgage loans by property type as of December 31, 2010 and 2009 are summarized as follows:
TLIC owns approximately six and one-half acres of land located in Topeka, Kansas. A 20,000 square foot office building has been constructed on approximately one-half of this land. TLIC occupied approximately 7,500 square feet of the building until it was leased to a third party effective December 24, 2009 and the remaining 12,500 square feet is leased.
The outstanding balance of lottery prize cash flows, by state lottery, as of December 31, 2010 and 2009 are summarized as follows:
Major categories of net investment income for the years ended December 31, 2010 and 2009 are summarized as follows:
Fair values for Level 1 and Level 2 assets for the Company’s fixed maturity and equity securities available-for-sale are primarily based on prices supplied by its custodian bank. The custodian bank utilizes a third party pricing service to provide quoted prices in the market which use observable inputs in developing such rates.
The Company analyzes market valuations received to verify reasonableness and to understand the key assumptions used and the sources. Since the fixed maturity securities owned by the Company do not trade on a daily basis, the custodian bank and the third party pricing service prepare estimates of fair value measurements using relevant market data, benchmark curves, sector groupings and matrix pricing. As the fair value estimates of the Company’s fixed maturity securities are based on observable market information rather than market quotes, the estimates of fair value on these fixed maturity securities are included in Level 2 of the hierarchy. The Company’s Level 2 investments include obligations of U.S. government agencies, mortgage-backed securities, corporate bonds and foreign bonds.
The Company’s equity securities are included in Level 1 except for mutual funds included in Level 2 and the private placement common stocks discussed above and included in Level 3. Level 1 for these equity securities is appropriate since they trade on a daily basis, are based on quoted market prices in active markets and based upon unadjusted prices. Level 2 for the mutual funds is appropriate since they are not actively traded as of December 31, 2010 and as such were moved from Level 1 to Level 2 during 2010. The Company’s fixed maturity and equity securities portfolio is highly liquid and allows for a high percentage of the portfolio to be priced through pricing services.
The fair value of investment real estate is based on cost, which approximates appraisal value.
The carrying value of loans from premium financing is net of unearned interest and any estimated loan losses and approximates fair value. Estimated loan losses were $443,071 and $318,826 as of December 31, 2010 and 2009, respectively.
TLIC has a $65,000 letter of credit from a bank. The letter of credit expires on December 31, 2011 and interest is accrued on the outstanding principal balance. The Company pledged a certificate of deposit with a market value of $65,000 as collateral for the letter of credit. There were no amounts borrowed against this letter of credit. The letter of credit was obtained solely to secure the issuance of standby letters of credit. The standby letters of credit are used to guarantee reserve credits taken by Optimum Re Insurance Company (“Optimum Re”).
TLIC is required to hold assets on deposit for the benefit of policyholders in accordance with statutory rules and regulations. At December 31, 2010 and 2009, these required deposits totaled $2,643,506 and $2,393,687, respectively.
Unearned interest was $35,519 and $72,144 as of December 31, 2010 and 2009, respectively. Allowances for loan losses were $443,071 and $318,826 at December 31, 2010 and 2009, respectively.
On August 6, 2009, the Company was made aware of potentially fraudulent loans and financial transactions made by an independent agency that did business with the Company’s wholly owned subsidiary, FTCC. The fraudulent loans and financial transactions totaled $1,293,450. The independent agency and its owner assigned assets having an estimated fair value of $622,377 to cover loan losses. Assets received were mortgage loan on real estate of $110,000, investment real estate of $141,483, property and equipment including an office building of $24,017, furniture and equipment of $2,000, accounts of property and casualty insurance agency of $150,000 and accounts receivable of $194,877.
The balances of and changes in deferred acquisition costs as of and for the years ended December 31, 2010 and 2009 are summarized as follows:
FTFC has net operating loss carry forwards of approximately $4,376,897 expiring in 2019 through 2025. TLIC has net operating loss carry forwards of approximately $1,510,442, expiring in 2018 through 2025. Net operating loss carry forwards of $926,226 (included in the TLIC amount above), expiring in 2018 through 2023 and capital loss carry forwards of $63,727, expiring in 2011 and 2013, remain from the acquisition of FLAC are available to offset future taxable income. The utilization of those losses is restricted by the tax laws and some or all of the losses may not be available for use.
TLIC participates in reinsurance in order to provide risk diversification, additional capacity for future growth and limit the maximum net loss potential arising from large risk. TLIC reinsures all amounts of risk on any one life in excess of $55,000 for individual life insurance with Investors Heritage Life Insurance Company, Munich American Reassurance Company, Optimum Re and Wilton Re.
To the extent that the reinsurance companies are unable to meet their obligations under the reinsurance agreements, TLIC remain primarily liable for the entire amount at risk.
The Company leased approximately 2,517 square feet of office space pursuant to a three-year lease that began July 1, 2008, leased approximately 200 square feet on a month-to-month basis during 2009 and leased 950 square feet of office space effective December 15, 2009 that terminated December 31, 2010. On June 17, 2010, the Company agreed to lease an additional 4,252 square feet of expansion office space whereby effective October 1, 2010, the Company would lease for five years a combined 6,769 square feet. Under the terms of the home office leases as amended, the monthly rent expense for the 2,517 square feet was $3,041 through June 30, 2009, $3,146 from July 1, 2009 through June 30, 2010, $3,251 from July 1, 2010 through September 30, 2010 and $7,897 from October 1, 2010 through September 30, 2015. The month to month lease was $300 per month and the 950 square feet lease was $1,225 per month. The Company incurred rent expense of $72,855 and $43,809 for the years 2010 and 2009, respectively. Future minimum lease payments to be paid under non cancelable lease agreements are $94,764 for the years 2011 through 2014 and $71,073 in 2015.
Effective August 29, 2005, TLIC executed a lease agreement with a tenant for 2,500 square feet. The base lease period commenced on September 1, 2005 and ended on August 31, 2010. The lease automatically renewed on August 15, 2010, for another five years with a 90 day notice by the lessee to terminate the lease. The lease agreement called for minimum monthly base lease payments of $4,332 through August 31, 2010. The lease payments decreased to $3,100 per month for the period September 1, 2010 through August 31, 2015.
The insurance subsidiary is domiciled in Oklahoma and prepares its statutory financial statements in accordance with statutory accounting practices prescribed or permitted by the Oklahoma Insurance Department. Prescribed statutory accounting practices include publications of the NAIC, state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. Statutory accounting practices primarily differ from GAAP by charging policy acquisition costs to expense as incurred, establishing future policy benefit liabilities using different actuarial assumptions and valuing investments, deferred taxes, and certain assets on a different basis.
Given the limited nature of each subsidiary’s operations, the Company has a life insurance segment, consisting of the operations of TLIC, and a premium financing segment, consisting of the operations of FTCC and SIS. Results for the parent company, after elimination of intercompany amounts, are allocated to the corporate segment. The Company’s three operating segments for the years ended December 31, 2010 and 2009 are summarized as follows:
The components of comprehensive income, net of related federal income taxes and adjustments to deferred acquisition costs, for the year ended December 31, 2010 and 2009 are summarized as follows:
Realized gains and losses on the sales of investments are determined based upon the specific identification method and include provisions for other-than-temporary impairments where appropriate.