Global Preferred is in the process of winding up its business and affairs, selling its remaining assets and discharging its known liabilities.
On December 30, 2004, we entered into the Reorganization Agreement with AEGON and GAC to transfer to GAC all of the outstanding shares of Global Preferred Re. On May 10, 2005, our stockholders authorized: (1) the sale of Global Preferred Re to GAC and (2) the subsequent liquidation and dissolution of Global Preferred pursuant to the Dissolution Plan. On May 25, 2005, the transactions contemplated by the Reorganization Agreement were consummated whereby Global Preferred received 4,503,274 AEGON common shares in exchange for all of the outstanding shares of Global Preferred Re.
The Reorganization Agreement provides that, no more than twelve months after closing of the transaction with AEGON, we must dissolve and distribute all remaining AEGON common shares received pursuant to the Reorganization Agreement and any of our other remaining assets to our stockholders, after making adequate provision for our liabilities in accordance with Delaware law. Since the sale of substantially all of our assets on May 25, 2005, our operations have been limited to winding up our business and affairs, selling our remaining assets and discharging our known liabilities.
On June 1, 2005, we filed a certificate of dissolution with the Delaware Secretary of State. Once a corporation is dissolved under Delaware law, its existence is automatically continued for a term of three years, or for such longer period as the Delaware Court of Chancery directs, but solely for the purpose of winding up its business. The process of winding up includes: (1) the prosecution and defense of lawsuits, if any; (2) the settling and closing of any business; (3) the disposition and conveyance of any assets and property; (4) the discharge of any liabilities; and (5) the distribution of any remaining assets to the stockholders.
The accompanying consolidated statements of income and cash flows for the 145 day period ended May 25, 2005 have been presented on a going concern basis consistent with prior periods, which assumes the realization of assets and the satisfaction of liabilities in the normal course of business. Effective May 26, 2005, we adopted the liquidation basis of accounting.
Under the liquidation basis of accounting, assets are recorded at their estimated net realizable values and liabilities are recorded at their estimated settlement amounts and include estimates for future operating costs and settlement reserves during the liquidation period. The valuation of assets and liabilities requires many estimates and assumptions by management and there may be substantial uncertainties in carrying out the provisions of the Dissolution Plan. In all instances, actual results could vary from those estimates. Information included elsewhere herein, including Note 2 of the Financial Statements, includes a summary of the critical accounting policies used in the preparation of our liquidation basis financials. It is anticipated that distributions ultimately made to stockholders upon liquidation will differ from the “net assets in liquidation” recorded in the accompanying statement of net assets in liquidation as a result of the actual proceeds received from the realization of assets and the ultimate settlement amount of our liabilities and obligations.
The distribution of the AEGON common shares was recorded in the liquidation basis financial statements during the third quarter of 2005 at a value of $12.87 per share which was equal to the market value per share as of June 30, 2005. As of December 31, 2005, Global Preferred had 911 AEGON common shares which were being held on behalf of stockholders who had not claimed their ownership. Those shares were recorded as dividends payable in the liquidation basis financial statements as of December 31, 2005 at $16.32 per share, the market value as of that date, along with the cash dividends received from AEGON for those remaining shares. These remaining shares and cash aggregating approximately $15,000 were distributed in January 2006.
Prior to the sale of Global Preferred Re, Global Preferred, through its subsidiaries, provided profit sharing solutions for the life insurance and annuity industry. While we no longer have active business operations, the following description of our business operations prior to the asset sale is provided to aid our readers’ understanding of our historical financial statements.
Under a typical reinsurance agreement, like the ones we entered into with the various insurance companies for which we reinsured policies, the economic consequences of certain insurance risks are transferred from the ceding life company to the reinsurer. Depending upon the type of reinsurance agreement, these risks included mortality, persistency, investment and expense. The ceding life companies retain responsibility for the payment of all claims, surrender values, commissions, and expenses involved in issuing and maintaining the policies reinsured. In addition, generally the ceding life companies administer the reinsurance contracts and, on a periodic basis, provide the reinsurer with information regarding premiums, reserves and benefits and the amounts owed to the ceding life company for claims and settlement expenses on the policies reinsured.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions regarding uncertainties that affect certain amounts in the consolidated financial statements on a going concern basis. Accounts that we deemed to be sensitive to changes in estimates for those amounts reported through May 25, 2005 included reinsurance settlements, deferred acquisition costs and future policy benefits. In all instances, actual results could have differed from estimates. A summary of significant accounting policies is included in Note 2 to the Financial Statements.
Net Income. Our profitability, in part, depended on the volume of policies reinsured and the experience of the reinsured policies. Factors that affected the experience of the policies included reinsured policy persistency, death claims and investment performance of the separate account balances. While death claims were reasonably predictable over a period of years, claims become less predictable over shorter periods, and were subject to fluctuation from quarter to quarter and year to year. Similarly, separate account investment returns, upon which a significant portion of our revenues depended, may have had relatively stable returns over a period of years but could be volatile over shorter periods.
Deferred Acquisition Costs. We capitalized and deferred costs that varied with and were primarily related to the acquisition of the reinsured policies. These expenses were deferred to the extent that such costs were deemed recoverable from future policy revenues and were recorded as deferred acquisition costs on the balance sheet. Such costs included reinsurance expense allowances paid to ceding life companies, and may have included other underwriting costs such as actuarial, legal and accounting fees.
Future Policy Benefits. Liabilities for future benefits on life insurance policies were established in an amount we estimated were adequate to meet the estimated future obligations on the policies in effect. Policy reserves were included in “future policy benefits” on the consolidated balance sheet.
Liabilities for future policy benefits under the renewable term agreements included provisions for expected future claims. The liability was estimated using assumptions such as estimates of expected investment yields, mortality, persistency and expenses applicable at the time the reinsurance contracts were executed.
Liabilities for future policy benefits reflected in the consolidated financial statements were based on information provided to us by the ceding life companies. Reserves established by us with respect to individual risks or classes of business may not have been the same as those established by ceding life companies due to differing risks and assumptions regarding mortality, persistency, investment and expenses.
Other Financial Assets and Liabilities. The carrying value of cash and cash equivalents, reinsurance receivables and payables, short-term debt, accrued expenses and accounts payable approximated their fair values due to the short-term nature of these accounts. The carrying value of future policy benefits approximated its fair value as credited interest approximates current market rates.
The life insurance and annuity policies that we reinsured were underwritten and issued by Western Reserve, American Skandia, Kemper and Pacific Life. The following table indicates the percentage of our reinsurance revenues derived from these ceding life companies:
On May 25, 2005, Global Preferred completed its sale of Global Preferred Re, which comprised substantially all of its assets, to AEGON for 4,503,274 shares of AEGON common stock. As a result, our operations and substantially all operating cash flows, except for investment income and wind-up expenses have ceased. Effective May 26, 2005, Global Preferred adopted the liquidation basis of accounting as opposed to preparing our financial statements on a going concern basis under accounting principles generally accepted in the United States of America. The asset sale resulted in no further premium or reinsured policy revenues after May 25, 2005. Additionally, no benefits, claims and expenses, change in future policy benefits, reinsurance expense allowances, or amortization of deferred acquisition costs were incurred after May 25, 2005. Accordingly, results of operations for the 145 day period ended May 25, 2005 are not comparable to the years ended December 31, 2003 and 2004 due to the shortened reporting periods. Results of operations do not reflect adjustments recorded upon the change to the liquidation basis of accounting adopted on May 26, 2005.
The results of operations for the 145 day period ended May 25, 2005, were compared with the six month period ended June 30, 2004, in Global Preferred’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005. Due to the conversion of Global Preferred’s financial accounting to liquidation basis accounting beginning on May 26, 2005, and the fundamentally different nature of Global Preferred’s operations following that date, a comparison of the results of operations for the period ended May 25, 2005 to the year ended December 31, 2004 would not be meaningful.
During the period May 26 through December 31, 2005, our operations were limited to collecting investment income on our assets, paying operating expenses and costs of liquidation, and making distributions to our stockholders.
Reinsured Policy Revenues. Reinsured policy revenues decreased $264,000, or 2%, from $12.8 million for the year ended December 31, 2003 to $12.5 million for the same period in 2004. This decrease was primarily attributable to the effect of policy surrender activity for our variable annuity business, which is partially offset by an increase in mortality and expense charges and asset-based fees resulting from an increase in average reinsured policy account balances in 2004.
the purchase of $16.8 million of fixed maturity and equity securities during 2003, most of which occurred in the latter half of the year, and $6.8 million of fixed maturity securities purchased during 2004.
Net Unrealized Gain on Investments. For the year ended December 31, 2004, we had $549,000 of other equity investments classified as trading securities, which resulted in an unrealized gain on investments of $49,000. There were no other equity investments classified as trading securities for the year ended December 31, 2003, thus no unrealized gains or losses were recognized in income during such period.
Reinsurance Expense Allowances, Net. Net reinsurance expense allowances decreased $450,000, or 6%, from $8.1 million for the year ended December 31, 2003 to $7.7 million for the same period in 2004. This decrease was primarily attributable to a decrease in business in force, partially offset by an increase in reinsurance expense allowances associated with an increase in policy account balances. Policy account balances increased primarily because of positive separate account fund yields and premiums and deposits, which were partially offset by policy surrender activity.
Amortization of Deferred Acquisition Costs. Amortization of deferred acquisition costs increased $672,000 or 12%, from $5.5 million for the year ended December 31, 2003 to $6.2 million for the same period in 2004. The increase in amortization primarily resulted from higher gross profits in 2004 primarily due to lower death claims, and increases in rates of amortization since policy account balances remained below our long-term expectations.
Operating Expenses. Operating expenses decreased $60,000, or 2%, from $3.4 million for the year ended December 31, 2003 to $3.3 million for the same period in 2004. These expenses include salaries and benefits, professional fees for legal, actuarial and accounting fees and other operating expenses. The decline resulted from an overall decrease in operating expenses resulting from increased operating efficiency, partially offset by increased consulting and legal fees relating to the Reorganization Agreement.
the amount of current taxable income. Based upon our taxable income in 2004, we estimated our effective tax rate to be 28% for 2004, as compared to 34% in 2003. The tax rate in 2004 reflected a $315,000 benefit from the small life insurance company deduction. In 2003, our taxable income was not sufficient to take advantage of the small life insurance company deduction.
In accordance with Statements of Financial Accounting Standards (“SFAS”) No. 109, Accounting for Income Taxes, we have $1.3 million of net operating loss carry-forwards, which would have begun to expire in 2018. These net operating loss carry-forwards at a 34% effective tax rate had been included as an offset to the deferred tax liability. With the sale of Global Preferred Re, these assets were transferred to AEGON.
Historically, our operations and related revenues and operating results varied substantially from quarter to quarter. A high percentage of our operating expenses, particularly personnel, marketing and rent were relatively fixed in advance of any particular quarter.
Due to the sale of Global Preferred Re and the dissolution of Global Preferred, during the third quarter of 2005, we restructured our investment portfolio to invest in higher quality and shorter duration investments over the remaining dissolution period. We sold our remaining fixed maturity securities for $2.4 million and used the proceeds to purchase United States treasury notes. Additionally, cash of $2.1 million was used to purchase $2.1 million of United States treasury bills, which are classified as cash equivalents.
As of December 31, 2005, the fixed maturity portion of our invested asset portfolio has an average Moody’s quality rating of Aaa, an average duration of less than 2 years and an average yield to maturity of 3.7% before investment expenses.
Prior to the sale of Global Preferred Re, we had defined our reportable segments based on the nature of our reinsurance agreements and the accounting treatment used for the various reinsurance agreements. For definitions of these segments and associated financial information, refer to Note 14 of the Financial Statements.
As of December 31, 2005, our primary sources of liquidity are $2.4 million in fixed maturity securities held for sale and $1.8 million in cash and cash equivalents. The effective duration of our fixed maturity portfolio is less than 2 years with 100% of the fixed maturity securities having an effective maturity of less than 3 years. Our fixed maturity portfolio represents 57% of our total invested assets, and has an average Moody’s quality rating of Aaa.
Cash flows provided by operations in 2003 related to new policies reinsured under coinsurance and modified coinsurance reflected net payments of $156,000 to Western Reserve to reinsure policies issued in 2003, and cash flows provided by operations for policies previously in force under coinsurance and modified coinsurance and by all policies reinsured under renewable term reinsurance of $12.0 million. Other cash flows used in operating activities of $1.0 million in 2003 were the result of cash payments for operating expenses and interest expenses.
Investment Cash Flows. Net cash flows (used in) provided by investing activities were ($15.0 million) and ($3.2 million) for the years ended December 31, 2003 and 2004, respectively, and $1.3 million for the 145 day period ended May 25, 2005. The cash flows provided by investing activities in the shortened period in 2005 primarily related to the sale and call of $1.5 million of fixed maturity securities offset by the decrease in reinsured policy loans of $205,000. The cash flows used in investing activities of $3.2 million in 2004 primarily related to our purchase of $6.8 million of fixed maturity securities, which was partially offset by the sale of $1.0 million of fixed maturity securities and $2.0 million of equity securities and the maturities and principal payments of $700,000 on fixed maturity securities. The cash flows used in investing activities of $15.0 million in 2003 primarily related to our purchase of $14.3 million of fixed maturity securities and $2.5 million of equity securities. We incurred no significant capital expenditures during 2005.
Financing Cash Flows. Financing cash flows related primarily to activities associated with our capital position. Net cash flows used in financing activities were zero and $5.0 million for the years ended December 31, 2003 and 2004, respectively and $11 for the 145 day period ended May 25, 2005. Cash flows used in financing activities in 2004 related to the principal payment due to Money Services for the five-year term note. There were no cash flows provided by or used in financing operations in 2003.
Restrictions. Prior to the sale of Global Preferred Re, Global Preferred relied primarily on funds retained at the holding company level, management service fees from its subsidiaries and potential dividends from Global Preferred Re to meet ongoing cash requirements. The ability of Global Preferred Re to pay dividends to Global Preferred was subject to, among other things, regulatory restrictions under the insurance laws of Bermuda, which are discussed in Note 10 to the Financial Statements. In addition, the Reorganization Agreement specified that while the agreement was in effect, Global Preferred Re could not pay Global Preferred cumulative dividends in excess of $6,384 per day and cumulative management fees in excess of $8,000 per day. As of March 31, 2005, Global Preferred Re had estimated total statutory capital and surplus of approximately $28.4 million, which included an estimated $13.1 million available for distribution as dividends without seeking regulatory approval. During the year ended December 31, 2005, Global Preferred Re paid $932,064 in dividends to Global Preferred.
Prior to the sale of Global Preferred Re on May 25, 2005, we had written all of our reinsurance business in U.S. dollars.
Changes in economic conditions, including interest rate and equity market conditions, which could affect our investment portfolio.
Statement of Net Assets in Liquidation as of December 31, 2005
Consolidated Statement of Changes in Net Assets in Liquidation for the Period May 26, 2005 to December 31, 2005
Consolidated Statements of Income (Going Concern Basis) for the Years Ended December 31, 2003 and 2004 and for the Period January 1, 2005 to May 25, 2005
Consolidated Statements of Cash Flows (Going Concern Basis) for the Years Ended December 31, 2003 and 2004 and for the Period January 1, 2005 to May 25, 2005