We were formed on October 31, 2003 for the primary purpose of becoming a financial services company. We operate our business primarily through three subsidiaries, American Life, 1505 Capital, and Seneca Re. American Life is licensed to sell, underwrite, and market life insurance and annuity products in 21 states and the District of Columbia and has pending applications in additional states. We also provide insurance company administrative services through a division known as “m.pas” that was formed in 2019. 1505 Capital provides investment advisory and related asset management services. Seneca Re reinsures various types of the life insurance risks through one or more single purposes entities or “cells.”
In 2018, we began implementation of a new business plan with the purpose of leveraging technology and reinsurance to distribute insurance products through IMOs as described elsewhere in this Form 10-K.
American Life’s sales force continues to grow, with eight third-party IMOs presently offering our products. American Life obtained an A.M. Best Rating of B++ in December 2018 that was affirmed in 2020. A. M. Best also upgraded American Life's long-term issuer credit rating to bbb+ from bbb in December 2020.
Beginning in mid-2019, American Life began ceding portions of its MYGA and FIA annuity business to third-party insurance companies and Seneca Re that we refer to us as “quota shares.” For detailed information see “Note 8 - Reinsurance” to our Consolidated Financial Statements included in this Form 10-K.
Effective March 12, 2020, we formed Seneca Re for the purpose of reinsuring various types of risks through one or more single purpose entitles, or “protected cells.” On March 30, 2020, Seneca Re received its certificate of authority to transact business as a captive insurance company. On May 12, 2020, we contributed $300,000 to Seneca Re for a 100% ownership interest. Seneca Re has one protected cell, cell 2020-01 (“SRC1”) as of December 31, 2020. We contributed a total of $15.0 million through December 31, 2020 to capitalize SRC1, which is consolidated in our financial statements.
Effective on April 24, 2020, we raised capital of $5,227,000 from various third-party investors and issued 231,655 shares of voting common stock at $22.50 per share. Also, on April 24, 2020, we signed a securities purchase agreement with Crestline for additional capital of $10.0 million and issued 444,444 shares of our voting common stock to Crestline at $22.50 per share.
American Life has agreements with several third-party reinsurers that have funds withheld (“FW”) and modified coinsurance (“Modco”) coinsurance provisions under which the assets related to the reinsured business are maintained by American Life as collateral; however, ownership of the assets and the total return on the asset portfolios belong to the third-party reinsurers. Under GAAP, this arrangement is considered an embedded derivative as discussed in “Note 5 - Derivative Instruments” to our Consolidated Financial Statements. As a result of price increases in 2020, assets carried as investments on American Life’s financial statements for the third-party reinsurers contained unrealized gains of approximately $2.9 million as of December 31, 2020. The terms of the contracts with the third-party reinsurers provide that unrealized gains on the portfolios accrue to the third-party reinsurers. We account for these unrealized gains by recording equivalent realized losses on our income statement. Accordingly, the unrealized gains on the assets held by American Life on behalf of the third-party reinsurers were offset by recording an embedded derivative loss of $2.9 million. If prices of investments recover, the unrealized losses of the third-party reinsurers may be reduced; therefore, the associated embedded derivative gain recognized by us for 2020, would be reduced accordingly.
The type and amount of investments that can be made by a life insurance company are specifically controlled by applicable state statutes and rules and regulations of the respective state departments of insurance. American Life has adopted investment policies in compliance with the insurance laws of the State of Nebraska. We have a significant amount of investments on our balance sheets that are held as collateral for our reinsurers.
Our investment portfolio expanded in 2019 to include a broader class of fixed maturities (including collateralized loan obligations, corporate, asset-backed and mortgage-backed securities), mortgage loans, derivatives and other investments including assets we hold as collateral for reinsurance entitles. Fixed maturities, which are classified as available-for-sale, are carried at their fair value in the consolidated balance sheets, with unrealized gains or losses recorded in accumulated other comprehensive income (loss). Mortgage loans are carried at unpaid principle which is also used for their fair value in the consolidated balance sheets. Derivatives are carried at fair market value with the realized gains or losses recorded in realized gains (losses) on the comprehensive income statement. We utilize external independent third-party pricing services to determine the fair values on investment securities available-for-sale. We have processes and controls in place to review prices received from service providers and unusual fluctuations in prices. In the event that a price is not available from a third-party pricing service, we pursue external pricing from brokers. Generally, we pursue and utilize only one broker quote per security. In doing so, we solicit only brokers that have previously demonstrated knowledge and experience of the subject security. Trades are cleared through independent brokers after competitive prices are solicited.
We frequently review our investment portfolio for declines in fair value. Our process for identifying declines in the fair value of investments that are other-than-temporary involves consideration of several factors including (a) the time or period and extent to which the fair value has been less than the amortized cost basis, (b) adverse conditions specifically related to a security, industry or geographic area, (c) the historical and implied volatility of the fair value of a security, (d) payment structure of a security, (e) failure of issuer of a security to make interest payments, (f) changes to the rating of a security, and (g) possible recoveries or additional declines in the fair value after the balance sheet date. The recognition of other-than-temporary impairment losses on debt securities is dependent on the facts and circumstances related to a specific security. If we intend to sell a security or it is more likely than not that we would be required to sell a security prior to recovery of the amortized cost, the difference between amortized cost and fair value is recognized in the income statement as an other-than-temporary impairment. As it relates to debt securities, if we do not expect to recover the amortized basis, do not plan to sell the security and if it is not more likely than not that we would be required to sell a security before the recovery of its amortized cost, the recognition of the other-than-temporary impairment is bifurcated. We recognize the credit loss portion through earnings in the income statement and the noncredit loss portion in accumulated other comprehensive loss. The credit component of an other-than-temporary impairment is determined by comparing the net present value of projected cash flows with the amortized cost basis of the debt security. The net present value is calculated by discounting our best estimate of projected future cash flows at the effective interest rate implicit in the fixed income security at the date of acquisition. Cash flow estimates are derived using assumptions regarding probability of default, including changes in credit ratings, and estimates regarding timing and amount of recoveries associated with a default.
Our indefinite-lived intangible assets consist of American Life’s state licenses. We compared the carrying value to the current costs of obtaining licenses in those states. As of December 31, 2020, the sum of the fair value of those licenses exceeded the carrying value of the indefinite-lived intangible assets.
In a typical reinsurance transaction, we receive a ceding commission and reimbursement of certain expenses at the time liabilities are reinsured, plus ongoing fees for the administration of the business ceded. Our reinsurers are typically not “accredited” or qualified as reinsurers under Nebraska law. In order to receive credit for reinsurance for transactions with these reinsurers and to reduce potential credit risk, we usually hold collateral from the reinsurer on a funds withheld basis or require the reinsurer to maintain a trust that holds assets backing up its obligation to pay claims on the business it assumes. In some cases, the reinsurer may appoint an investment manager to manage these assets pursuant to guidelines approved by us that are consistent with state investment statutes and regulations relating to reinsurance. Our investment advisor subsidiary, 1505 Capital, is appointed to manage these assets and we receive additional ongoing asset management fees via 1505 Capital.
We establish liabilities for amounts payable under our policies, including annuities. Generally, amounts are payable over an extended period of time. Under GAAP, our annuities are treated as deposit liabilities, where we use account value in lieu of future policy reserves. Our FIA reserves are calculated by an independent consulting actuary and our MYGA reserves equal the account value from our policy administration system. We currently do not offer traditional life insurance products
Deferred tax assets are recorded based on the differences between the financial statement and tax basis of assets and liabilities at the applicable tax rates. The principal assets and liabilities giving rise to such differences are investments, insurance reserves, and deferred acquisition costs. A deferred tax asset valuation allowance is established when there is uncertainty that such tax assets would be realized. We have no uncertain tax positions that we believe are more-likely-than not that the benefit will not be realized.
Net loss increased in 2020 compared to 2019 primarily due to the following:
1. Our salaries increased approximately $3.6 million due to the increase in personnel during 2020 to support our new business growth.
a. The FIA product has embedded derivatives included in the account value that are market driven. Our third-party reinsurers of our FIA products pay American Life an option allowance to purchase derivatives. As of December 31, 2020, the mark-to-market on those embedded derivatives was in a positive position. Due to the terms of the agreement with the third-party reinsurers, American Life has to mark the option allowance paid by the reinsurers to market to cover their obligations to the policyholders. The mark-up of those options resulted in a $2.3 million expense on American Life’s books and payable to the reinsurers.
b. The remaining increase in other operating expenses of $1.3 million included legal and stock related fees related to the reverse stock split, the formation of the Vermont captive Seneca Re, and incurred audit and consultant fees.
3. On November 30, 2018, American Life entered into an Assumption and Indemnity Reinsurance Agreement with Unified Life Insurance Company (“Unified”), a Texas domiciled stock insurance company. The Reinsurance Agreement provided that American Life cede and Unified agreed to reinsure, on an indemnity reinsurance basis, 100% of the liabilities and obligations under substantially all of American Life’s life, annuity and health policies. The increase in the net loss year over year was due to the indemnity coinsurance converting to assumptive for approximately of 11%, or $305,600, compared to 79% or $2.6 million for the years ended December 31, 2020 and 2019, respectively. This is recorded as amortization of deferred gain on reinsurance.
Consolidated Results of Operations - Years Ended December 31, 2020 and 2019
Premium revenue: The introduction of our MYGA and FIA products discussed above generated a large volume of new business; however, these products are defined as investment contracts and U.S. GAAP requires that premiums be deferred as deposit-type liabilities on our balance sheet. American Life expects to introduce additional versions of these products in 2021 primarily in the annuity business. The table below shows premium issued under statutory accounting principles (“SAP”) on our two annuity products:
(1) Under SAP, the MYGA and FIA premiums are treated as premium revenue. Under GAAP these products are defined as deposit-type contracts; therefore, the premium revenue that is recognized under SAP is accounted for under GAAP as deposit-type liabilities on our balance sheet and is not recognized on our income statement.
The increase in investment income for 2020 over 2019 was due to the investment income earned on the bonds and mortgage loans purchased with the sales of our MYGA and FIA products that were not ceded to reinsurers during the period. Our investment portfolio grew to $518,194,579 as of December 31, 2020 compared to $138,602,143 as of December 31, 2019, as a result proceeds from our MYGA and FIA product sales. American Life ceded $228.1 million of premiums to reinsurers and transferred approximately $7.7 million of investment income related to the ceded premiums as required by the terms of its reinsurance agreements.
The embedded derivative is a total return swap related to coinsurance agreements with our reinsurers. American Life has treaties with several reinsurers that have funds withheld coinsurance provisions, under which the assets backing the treaties are maintained by American Life as collateral but the assets and total return on the asset portfolios belong to the reinsurers. Under GAAP this arrangement is considered an embedded derivative as discussed in Note 5 - Derivative Instruments to our Consolidated Financial Statements. The total return swap is included in net realized gains on investments. As a result of price increases in 2020, assets carried as investments on American Life’s financial statements for the third party reinsurers contained unrealized gains of approximately $2.9 million as of December 31, 2020. The terms of the contracts with the third party reinsurers provide that unrealized gains or losses on the portfolios accrue to the third party reinsurers. We account for these unrealized gains by recording equivalent realized losses on our income statement. Accordingly, the unrealized gains on the assets held by American Life on behalf of the third party reinsurers were offset by recording an embedded derivative loss of $2.9 million.
Service fee revenue, net of expenses: For financial statement purposes, 1505 Capital, our investment adviser subsidiary became consolidated into Midwest as of April 2, 2019. The increase in 2020 was due primarily to the increase in services provided to our third-party reinsurers and purchasing the remaining 49% interest in 1505 Capital in June of 2020.
Other revenue: The increase in third-party administration (“TPA”) fees earned was due to us providing other administrative services to clients.
Death and other benefits: Death benefits decreased due to the reduction of the amount of our estimate during 2020 related to the escheatment of aged death claims.
Increase in benefit reserves: The change in benefit reserves was due to the annuity products that were classified on the balance sheet under deposit-type contracts.
Amortization of deferred acquisition costs: The increase was due to the deferred acquisition costs (”DAC”) deferred on the sale of American Life’s MYGA and FIA products retained that were not ceded to third-party reinsurers.
Salaries and benefits: The increase was due to the addition of personnel to service our new business growth. We are hiring more in-house expertise to service our growth initiatives.
Other operating expenses: Other operating expenses were approximately $4.2 million higher than prior year. The primary items of this increase are:
● Our FIA product has embedded derivatives included in the account value. Those derivatives are market driven. The reinsurers that reinsure the FIA products pay an option allowance to American Life to purchase derivatives. As of December 31, 2020, the mark-to-market on those allowances were in a positive position so American Life incurred a $2.3 million expense and payable to the reinsurers for that mark-up.
● Due to the valuation completed on the preferred stock on Midwest’s investment in Ironbound Reinsurance Company Limited, an unaffiliated reinsurance company organized under the laws of Barbados (“Ironbound”), it was determined that a impairment should be recorded for the full value of the preferred stock with by setting up an expense impairment of $500,000.
● Travel decreased by approximately $125,000 primarily due to impact of COVID-19.
The investment guidelines typically include U.S. government bonds, corporate bonds, commercial mortgages, asset backed securities, municipal bonds, and collateral loans. The duration of our investments is 5 to 10 years in line with that of our liabilities. We do allow non-U.S. dollar denominated investments where the foreign exchange risk is hedged back to U.S. dollars.
The following table shows the distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value as of December 31, 2020 and 2019.
The primary market risks affecting the investment portfolio are interest rate risk, credit risk and liquidity risk. With respect to investments that we hold on our balance sheet as collateral, our reinsurers bear the market risks related to these investments, while we bear the market risks on any net retained investments.
We are exposed to liquidity risk when liabilities come due. In order to pay a policyholder, we may need to liquidate assets. If our assets are illiquid assets, we might be unable to convert an asset into cash without giving up capital and income due to a lack of buyers or an inefficient market. We seek to mitigate this risk by keeping a portion of our investment portfolio in liquid investments.
Our primary insurance subsidiary, American Life, is required to prepare statutory financial statements in accordance with SAP prescribed by the NDOI. SAP primarily differs from GAAP by charging policy acquisition costs to expense as incurred, establishing future benefit liabilities using actuarial assumptions as well as valuing investments and certain assets and accounting for deferred taxes on a different basis. For further discussion regarding SAP as well as net income (loss) of American Life under SAP, see Note 16 to our
State insurance laws and regulations govern the operations of all insurers and reinsurers such as our insurance and reinsurance company subsidiaries. These various laws and regulations require that insurance companies maintain minimum amounts of statutory surplus as regards policyholders and risk-based capital and determine the dividends that insurers can pay without prior approval from regulators. The statutory net income of American Life is one of the primary sources of additions to our statutory surplus as regards policyholders, in addition to capital contributions from us.
We have reported our insurance subsidiaries’ assets, liabilities and results of operations in accordance with GAAP, which varies from SAP. The following items are principal differences between SAP and GAAP:
• requires that we exclude certain assets, called non-admitted assets, from the balance sheet.
• requires us to expense policy acquisition costs when incurred, while GAAP allows us to defer and amortize policy acquisition costs over the estimated life of the policies.
• allows ceding commission income to be recognized when written if the cost of acquiring and renewing the associated business exceeds the ceding commissions, but under GAAP such income is deferred and recognized over the coverage period.
• requires that unearned premiums and loss reserves are presented net of related reinsurance rather than on a gross basis under GAAP.
• requires that we record reserves liabilities and expense, while we record all transactions related to the annuity products under GAAP as a deposit-type contract liability.
• requires a provision for reinsurance liability be established for reinsurance recoverable on paid losses aged over 90 days and for unsecured amounts recoverable from unauthorized reinsurers. Under GAAP there is no charge for uncollateralized amounts ceded to a company not licensed in the insurance affiliate’s domiciliary state and a reserve for uncollectable reinsurance is charged through earnings rather than surplus or equity.
• requires an additional admissibility test outlined in Statements on Statutory Accounting Principles, No. 101 and the change in deferred income tax is reported directly in capital and surplus, rather than being reported as a component of income tax expense under GAAP. Our insurance subsidiaries must file with the insurance regulatory authorities an “Annual Statement” which reports, among other items, net income (loss) and surplus as regards policyholders, which is called stockholders’ equity under GAAP.
• review and assess the operating performance of our management team;
• analyze and evaluate financial and strategic planning decisions regarding future operations; and
Annuity premiums, also referred to as sales or direct written premiums, do not correspond to revenues under GAAP, but are relevant metrics to understand our business performance. Under statutory accounting practices or SAP, our annuity premiums received are treated as premium revenue. Our premium metrics include all sums paid into an individual annuity in a given period. We typically transfer all or a substantial portion of the premium and policy obligations to reinsurers. Ceded premium represents the premium we transfer to reinsurers in a given period. Retained premium represents the portion of premium received a given period that was not ceded to reinsurers and will either be reinsured in a subsequent period or retained by us. We typically retain premiums prior to transferring them to reinsurers to facilitate block and other reinsurance transactions involving portfolios of annuity premiums.
The following table sets forth premiums received under SAP. Under GAAP these products are defined as deposit-type contracts; therefore, the premium revenue is accounted under GAAP as deposit-type liabilities on our balance sheet and is not recognized in our income statement.
Under GAAP, ceding commissions are deferred on our balance sheet as a deferred gain on coinsurance transactions and are subsequently amortized through amortization of deferred gain on reinsurance on the income statement over the period of the policy contracts.
Adjusted net income (loss) is management’s evaluation of the impact of revenue we receive and retain taking into account the reinsurance transactions we complete. Under these provisions with third party reinsurers, the assets backing the treaties are maintained by American Life as collateral and are carried on the balance sheet for American Life, but the assets are owned by the third party reinsurer; thus, the total return on the asset portfolio belongs to the third party reinsurers. Under GAAP this is considered an embedded derivative but is not designated as a hedge. We make an income statement adjustment for net realized losses on investments related to the embedded derivative. The net realized losses on investments related to the embedded derivative is included in GAAP net loss but is reversed dollar for dollar in the calculation of GAAP other comprehensive income through a reclassification adjustment for net realized gains on investments. We define adjusted net income (loss) as net income (loss) including the impact of reinsurance transactions completed during the period and excluding the total return on the asset portfolios that are owned by reinsurers and held by us. These items have no direct expense and the tax effect of these adjustments is already included in our tax basis, which is similar to our Adjusted Net Income. Our management uses adjusted net income (loss) as an internal measure of our underlying business performance and because it provides useful insights into our results of operations.
At December 31, 2020, we had cash and cash equivalents totaling $151,679,274. Approximately $15,227,000 of the increase in cash was due to the completion of private sales of our voting common stock in April 2020 and approximately $65,000,000 was due to the completion of a public offering completed on December 21, 2020. We believe that our existing cash and cash equivalents will be sufficient to fund our anticipated operating expenses and capital transaction expenditures for the foreseeable future.
The following table summarizes our cash flows from operational, investing and financing activities for the periods indicated. See the Consolidated Statements of Cash Flow in our Consolidated Financial Statements for more detailed information.
Net cash used for investing activities for 2020 was $367,481,662. The primary source of cash used was from our purchase of investments from sales of the MYGA and FIA products of $530,786,864. Offsetting this use of cash was our sale of investments of $163,314,094.
Net cash provided by financing activities in 2020 was $491,688,618. The primary source of cash was net receipts on the MYGA and FIA products of $413,052,257 and capital raises, net of related expenses, of $79,311,805.
The Company’s audited consolidated financial statements are included as a part of this report beginning on page.