FINANCIAL HIGHLIGHTS (000's omitted, except per share data) 1997 1996 1995 1994 1993 Premium income net of reinsurance $ 28,639 $ 30,944 $ 33,099 $ 35,145 $ 33,530 Total revenues $ 43,992 $ 46,976 $ 49,869 $ 49,207 $ 48,541 Net loss* $ (559) $ (938) $ (3,001) $ (1,624) $ (862) Net loss per share $ (0.32) $ (0.50) $ (1.61) $ (0.90) $ (0.50) Total assets $349,300 $355,474 $356,305 $360,258 $375,755 Total long-term debt $ 21,460 $ 19,574 $ 21,447 $ 22,053 $ 24,359 Dividends paid per share NONE NONE NONE NONE NONE
The purpose of this section is to discuss and analyze the Company's consolidated results of operations, financial condition and liquidity and capital resources. This analysis should be readin conjunction with the consolidated financial statements and related notes which appear elsewhere in this report. The Company reports financial results on a consolidated basis. The consolidated financial statements include the accounts of UTI and its subsidiaries at December 31, 1997.
Premiums and policy fee revenues, net of reinsurance premiums and policy fees, decreased 7% when comparing 1997 to 1996. The Company currently writes little new traditional business, consequently, traditional premiums will decrease as the amount of traditional business in-force decreases. Collected premiums on universal life and interest sensitive products is not reflected in premiums and policy revenues because Generally Accepted Accounting Procedures ("GAAP") requires that premiumscollected on these types of products be treated as deposit liabilities rather than revenue. Unless the Company acquires a block of inforce business or marketing changes its focus totraditional business, premium revenue will continue to decline.
Another cause for the decrease in premium revenues is relatedto the potential change in control of UTI over the last two years to two different parties. During September of 1996, it was announced that control of UTI would pass to an unrelated party, butthe change in control did not materialize. At this writing, negotiations are progressing with a different unrelated party for the change in control of UTI. Please refer to the Notes to the Consolidated FinancialStatements for additional information. The possible changes and resulting uncertainties have hurt the insurance companies' ability to recruit and maintain sales agents.
New business production decreased significantly over the last two years. New business production decreased 43% or $3,935,000 when comparing 1997 to 1996. In recent years, the insurance industry asawholehas experienced a decline in the total number of agents who sell insurance products, therefore competition has intensified for top producing sales agents. The relatively small size of our companies, and the resulting limitations, have made it challenging to compete in this area.
The Company's investments are generally managed to match related insurance and policyholder liabilities. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. The minimum interest spread between earned and credited rates is 1% on the "Century 2000" universal life insurance product, which currentlyis the Company's primary sales product. The Company monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads. It is expectedthat monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on the insurance policies the Company currently has in force and will write in the future.
Commissions and amortization of deferred policy acquisition costs decreased 14% in 1997 compared to 1996. The decrease is due primarily due to a reduction in commissions paid. Commissions decreased 19%in 1997 compared to 1996. The decrease in commissions was due to the decline in new business production. There is a direct relationship between premium revenues and commission expense. First year premium production decreased43% and first year commissions decreased 33% when comparing 1997to 1996. Amortization of deferred policy acquisition costs decreased6% in 1997 compared to 1996. Management would expect commissions and amortization of deferred policy acquisition costs to decrease in the future if premium revenues continue to decline.
Interestexpense increased 5% in 1997 compared to 1996. Since December 31, 1996,notes payable increased approximately $1,886,000. Average outstanding indebtedness was $20,517,000 with an average cost of 8.9% in 1997 compared to average outstanding indebtedness of 20,510,000 with an average cost of 8.5% in1996. The increase in outstanding indebtedness was due to the issuance of convertible notes to seven individuals, all officers or employees of UTI. In March 1997, the baseinterest rate for most of the notes payable increased a quarter of a point.The base rate is defined as the floating daily, variable rateofinterest determined and announced by First of America Bank. Please referto Note 12 "Notes Payable" in the Consolidated Notes to the Financial Statements for more information.
Premium and policy fee revenues, net of reinsurance premium, decreased 7% whencomparing 1996 to 1995.The decrease in premium income is primarily attributed to a 15% decrease in new business production. The Company changed its marketing strategy from traditional life insurance products to universal life insurance products. Universal life and interest sensitive products contribute only the risk charge to premium income, however traditional insurance products contribute all monies received to premium income. The Company changed its marketing strategy to remain competitive based on consumer demand.
A positive impact on premium income is the improvement of persistency. Persistency is a measure of insurance in force retained in relationto the previous year. The Companies' average persistency rate for all policies in force for 1996 and 1995 has been approximately 87.9% and 87.3%, respectively.
Net investment income increased 3% when comparing 1996 to1995. The overallinvestment yields for 1996 and 1995 are 7.29% and 7.12%, respectively. The improvement in investment yield is primarily attributed to fixed maturity investments. Cash generated fromthe sales of universal life insurance products, has been invested primarily in our fixed investment portfolio.
The Company's investments are generally managed to match related insurance and policyholder liabilities. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread.The minimum interest spread between earned and credited rates is 1% on the "Century 2000" universal life insurance product, which currently is the Company's primary sales product. The Company monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads. It is expected that monitoring of the interest spreads by management will providethenecessary margin to adequately provide for associated costs on the insurance policies the Company currently has in force and will write in the future.
Realized investment losses were $988,000 and $124,000 in 1996 and 1995, respectively. Approximately $522,000 of realized losses in 1996 are due to the charge-off of two specific investments. The Company realized a loss of $207,000 from a single loan and $315,000 from an investment in First Fidelity Mortgage Company ("FFMC"). The charge-off of the loan represented the entire loan balance at the time of the charge-off. Additionally, the Company sold two foreclosed real estate properties that resulted in approximately $357,000 in realized losses in 1996. The Company had other gains and losses during the period that comprised the remaining amount reported but were immaterial in nature on an individual basis.
In 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by Company standards. These nonstandard policieshad a face amount of $22,700,000 and represented1/2 of 1% of the insurance in-force in 1994. Management's initial analysis indicated that expected death claims on the business in-force was adequate in relation to mortality assumptions inherent in the calculation of statutory reserves. Nevertheless, management determined it was in the best interest of the Company to repurchase as many of the non-standard policies as possible. Through December 31, 1996, the Company spent approximately $7,099,000 for the settlement of non-standard policies and for the legal defense of related litigation. In relation to settlement of non-standard policies the Company incurred life benefits of $3,307,000 and $720,000 in 1996 and 1995, respectively. The Company incurred legal costs of $906,000 and $687,000 in 1996 and 1995, respectively. All the policies associated with this issue have been settled as of December 31, 1996. The Company has approximately $3,742,000 of insurance inforce and $1,871,000 of reserves from the issuance of paid-up life insurance policies for settlement of matters related to the original non-standard policies. Management believes the reserves are adequate in relation to expected mortality on this block of in-force.
The Company reported a non-recurring write down of value of agency force of $0 and $8,297,000 in 1996 and 1995, respectively. The write down was directly related to the Company's change in distribution systems. The Companychanged its focus from primarily a broker agency distribution system to a captive agent system. Business produced by the broker agency force inrecent years did notmeet Company expectations.With the change in focus of distribution systems, most of the broker agents were terminated. The termination of most of the agents involved in the broker agency force caused management tore- evaluateandwrite-off the value of the agency force carried onthe balance sheet.
Interest expense decreased 12% in 1996 compared to 1995. Since December 31, 1995, notes payable decreased approximately $1,873,000 that has directly attributed to the decrease in interest expense during 1996. Interest expense was also reduced, as a result of the refinancing of the senior debt under which the new interest rate is more favorable. Please refer to Note 11 "Notes Payable" of the Consolidated Notes to the Financial Statements for more information on this matter.
The Company had a net loss of $938,000 in 1996 compared to a net loss of $3,001,000 in1995. The net loss in 1996 is attributed to the increase in life benefits net of reinsurance and operating expenses primarily associated with settlement and other related costs of the non-standard life insurance policies.
The liabilities are predominantly long-termin nature and therefore, the Company invests in long-term fixed maturity investments that are reported in the financial statements at their amortized cost. The Company has the ability and intent to hold these investments to maturity; consequently, the Company does not expect to realize any significant loss from these investments. The Company does not own any derivative investments or "junk bonds". As of December 31, 1997, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in the context of consolidated assets or shareholders' equity. The Company has identified securities it may sell and classified them as "investments held for sale". Investments held for sale are carried at market, with changesin market value charged directly to shareholders' equity.
The following table summarizes the Company's fixed maturities distribution at December 31, 1997 and 1996 by ratings category as issued by Standard and Poor's, a leading ratings analyst.
Mortgage loans decreased 14% in 1997 as compared to 1996. The Company isnot actively seeking new mortgage loans, and the decrease is due toearly pay-offs from mortgagee's seeking refinancing at lower interest rates. All mortgage loans held by theCompany are first position loans. The Company has $298,227 in mortgage loans, net of a $10,000 reserve allowance, which are in default and in the process of foreclosure, this represents approximately 3% of the total portfolio.
Deferred policy acquisition costs decreased 6% in 1997 compared to 1996. Deferred policy acquisition costs, which vary with, and are primarily related to producing new business, are referredto as ("DAC").DAC consists primarily of commissions and certain costs of policy issuance and underwriting, net of fees charged to the policy in excess of ultimate fees charged. To the extent these costs are recoverable from future profits, the Company defers these costs and amortizes them with interest inrelation to the present value of expected gross profits from the contracts,discounted using the interest ratecredited by the policy. The Company had $586,000 in policy acquisition costs deferred, $425,000 in interest accretion and $1,735,636 in amortization in 1997. The Company did not recognize any impairment during the period.
Cost of insurance acquired decreased 5% in 1997 compared to 1996. At December 31, 1997, cost of insurance acquired was $41,523,000and amortizationtotaled $2,394,000 for the year. When an insurance company is acquired, the Company assigns a portion of its cost to the right to receive future cash flows from insurance contracts existing at the date of the acquisition. The cost of policies purchased represents the actuarially determined present value of the projected future cash flowsfromthe acquired policies. Cost of Insurance Acquired is amortized with interest in relation to expected future profits, including direct chargeoffs for any excess of the unamortized asset over the projected future profits.
Other policyholder funds decreased 12% in 1997 compared to 1996. The decrease can be attributed to a decrease in premium deposit funds. Premium deposit funds are funds deposited by the policyholder with the insurance company to accumulate interest and pay futurepolicy premiums. The change in marketing from traditional insurance products touniversal life insurance products is the primary reason for the decrease. Universal life insurance products do nothave premium deposit funds. All premiums received from universal life insurance policyholders are credited to the life insurance policy and are reflected in future policy benefits.
Dividend and endowment accumulations increased 7% in 1997 compared to 1996. The increase is attributed to the significant amount of participating business the Company has in force. Over 47% of all dividends paid were put on deposit with the Company to accumulate with interest. Management expects this liability to increase in the future.
The remaining proceeds of approximately $1,500,000, of the original $2,560,000, will be used to reduce the outstanding debt of the Company.
Future policy benefits are primarily long-term in nature and therefore, the Company's investments are predominantly in longterm fixed maturity investments such as bonds and mortgage loans which provide sufficient return to cover these obligations. The Company has the ability and intent to hold these investments to maturity; consequently, the Company's investment in long-term fixed maturities is reported in the financial statements at their amortized cost.
Cash provided by operating activities was $23,000, $3,140,000 and 486,000 in 1997, 1996 and 1995, respectively.The net cash provided by operating activities plus net policyholder contract deposits after the paymentof policyholder withdrawals equaled $3,412,000 in 1997, $9,952,000 in 1996 and $9,499,000 in1995. Management utilizes this measurementof cash flows as an indicator of the performance of theCompany's insurance operations, since reporting regulations require cash inflows and outflows fromuniversal life insurance products to be shownas financing activities when reporting on cash flows.
Cash provided by (used in) investing activities was ($2,989,000), $15,808,000 and ($8,063,000), for 1997, 1996 and 1995, respectively. The most significant aspect of cash provided by (used in) investing activities are the fixed maturity transactions. Fixed maturities account for 70%, 81% and 76% of the total cost of investments acquired in 1997, 1996 and 1995, respectively. The net cash provided by investing activities in 1996, is due to the fixed maturities sold in conjunction with the coinsurance agreement with FILIC. The Company has not directed its investable funds to so-called "junk bonds" or derivative investments.
Policyholder contract deposits decreased 20% in 1997 compared to 1996, and decreased 11% in 1996 when compared to 1995. Policyholder contract withdrawals has decreased 6% in 1997 compared to 1996, and decreased 4% in 1996 compared to 1995. The change inpolicyholder contract withdrawals is not attributable to any one significant event. Factorsthat influence policyholder contract withdrawals are fluctuation of interest rates, competition and other economic factors.
Since UTI is a holding company, funds required to meet its debt service requirements and other expenses are primarily providedbyits subsidiaries. On a parent only basis, UTI's cash flow is dependent on revenues from a management agreement with UII and its earnings received on invested assets and cash balances. At December31, 1997, substantially all of the consolidated shareholders equity represents net assets of its subsidiaries. Cash requirements of UTI primarily relate to servicing its longterm debt.The Company's insurance subsidiaries have maintained adequate statutory capital and surplus and have not used surplus relief or financial reinsurance, which have come under scrutiny by many state insurance departments. The payment of cash dividends toshareholders is not legally restricted.However, insurance company dividend payments are regulated by the state insurance department where the company is domiciled. UTI is the ultimate parent of UG through ownership of several intermediary holding companies. UG can not pay a dividend directly to UTI due to the ownership structure. Please refer to Note 1 of the Notes to the Consolidated Financial Statements. UG's dividend limitations are described below without effect of the ownership structure.
The NAIC's risk-based capital requirements require insurance companies to calculate and report information under a risk-based capital formula. The risk-based capital formula measures the adequacy of statutory capitaland surplus in relationto investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching and other business factors. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purposeof initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formuladefines new minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory complianceis determined by a ratio of the insurance company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Insurance companies below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action.
Ratio of Total Adjusted Capital to Authorized Control Level RBC Regulatory Event (Less Than or Equal to) Company action level 2* Regulatory action level 1.5 Authorized control level 1 Mandatory control level 0.7
At December 31, 1997, each of the insurance subsidiaries has a Ratio thatis in excess of 3, which is 300% of the authorized control level; accordingly the insurance subsidiaries meet the RBC requirements.
At year-end 1997, the insurance companies had one ratio outside the normalrange. The ratio is related to the decreasein premium income. The ratio fell outside the normal range the last three years. A primary cause for the decrease in premium revenues is related to the potential change in control of UTI over the last two years to two different parties. During September of 1996, it was announced that control ofUTI would passto an unrelated party, but the transaction did not materialize. At this writing, negotiations are progressing with a different unrelated party for the change in control of UTI. . Please refer to the Notes to the Consolidated Financial Statements for additional information. The possible changes and resulting uncertainties have hurt the insurance companies' ability to recruit and maintain sales agents. The industry has experienced a downward trend in the total number of agents who sell insurance products, and competition for the top sales producers has intensified. As this trend appears to continue, the recruiting focus of the Company has been on introducing quality individuals to the insurance industry through an extensive internal training program. The Company feels this approach is conducive to the mutual success of our new recruits and the Company as these recruits market our products in a professional, company structured manner.
The NAIC,in conjunction with state regulators, has been reviewing existing insurance laws and regulations. A committee of the NAIC proposed changes in the regulations governing insurance company investments and holding company investments in subsidiaries and affiliates which were adopted by the NAIC as model laws in 1996. The Company does not presently anticipate any material adverse change in its business as a result of these changes.
The NAIC adopted the Life Illustration Model Regulation. Many states have adopted the regulation effective January 1, 1997. This regulation requires products which contain non-guaranteed elements, such as universal life and interest sensitive life, to comply with certain actuarially established tests. These tests are intended to target future performance and profitability of a product under various scenarios.The regulation does not prevent a company from selling a product that does not meet the various tests. The only implication is the way in which the product is marketed to the consumer. A product that does not pass the tests uses guaranteed assumptions rather than current assumptions in presenting futureproduct performance to the consumer. The Company conducts an ongoing thorough review of its sales and marketing processand continues to emphasize its compliance efforts.
The Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards (SFAS) No. 128 entitled Earnings per share, which is effective for financial statements for fiscal years beginning after December 15, 1997. SFAS No. 128 specifiesthe computation, presentation, and disclosure requirements for earnings per share (EPS) for entities with publicly held common stock or potential common stock. The Statement's objective is to simplify the computation of earnings per share, and to make the U.S. standard for computing EPS more compatible with the EPS standards of other countries.
This statement was adopted for the 1997 Financial Statements. Forall periods presented the Company reported a loss from continuing operations so any potential issuance of common shares would havean antidilutive effect on EPS. Consequently, the adoption of SFAS No. 128 did not have an impact on the Company's financial statement.
SFAS No.130 defines how to report and display comprehensive income and its components in a full set of financial statements. The purposeof reporting comprehensive income is to report a measure of all changes in equity of an enterprise that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners.
SFAS No.132 addresses disclosure requirements for postretirement benefits.The statement does not change postretirement measurement or recognition issues.
The Company is not aware of any litigation that will have a material adverse effect on the financial position of the Company. In addition, the Company does not believe that the regulatory initiatives currently under consideration by various regulatory agencies will have a material adverse impact on the Company. The Company is not aware of any material pending orthreatened regulatory action with respect to the Company or any ofits subsidiaries. The Company does not believe that any insurance guaranty fund assessments will be materially different from amounts already provided for in the financial statements.
The "Year 2000 Issue" is the inability of computers and computing technology to recognize correctly the Year 2000 date change. The problem results from a long-standing practice by programmers to save memory space by denoting Years using just two digits instead of four digits. Thus, systems that are not Year 2000 compliant may be unable to read dates correctly after the Year 1999 and can return incorrect or unpredictable results.This couldhave a significant effect on the Company's business/financial systems as well as products and services, if not corrected.
On March 25, 1997, the Board of Directors of UTI and UII voted to recommend tothe shareholders a merger of the two companies. Under the Plan of Merger, UTI would be the surviving entity with UTI issuing one share of its stock for each share held by UII shareholders.
1. Prevailing interest rate levels which may affect the abilityof the company to sell its products, the market value of the company's investments and the lapse ratio of the company's policies, notwithstanding product design features intended to enhance persistency of the company's products.
Independent Auditor's Report for the Years ended December 31, 1997, 1996, 1995 33