On September 1, 2009, American Life was issued a certificate of authority to conduct life insurance business in the State of Nebraska. Initial capital and surplus contributed to American Life was approximately $3.5 million, which was increased to approximately $5.5 million on September 1, 2009. In its first four months of operation, between September 1, 2009 and December 31, 2009, American Life generated $354,352 in premium revenue. In 2011 and 2010, American Life generated $2.5 million and $1.9 million in premium revenue, respectively.
In January 2011, we completed the private sale of 74,159 shares of our Series A Preferred Stock to certain qualified investors in Latin America. The net proceeds of this sale, after expenses, were approximately $415,750. These proceeds were used to further capitalize our insurance operations, for working capital and for other general corporate purposes.
$1.6 million in cash, (ii) $500,000 in the form of a surplus debenture and (iii) 150,000 shares of voting common stock of the Company ($750,000 fair value). On November 8, 2010, prior to signing the stock purchase agreement with American Life, Old Reliance had assets of approximately $19 million and for the period from January 1, 2010 through November 8, 2010, income of approximately $1.4 million, and expenses of approximately $1.7 million. The transaction, including the merger, was consummated on August 3, 2011.
The Company was a development stage company until American Life commenced insurance operations in 2009. We have incurred significant net losses since inception totaling approximately $10.5 million through December 31, 2011. These losses have resulted primarily from costs incurred while raising capital and establishing American Life. We expect to continue to incur operating losses until we achieve a volume of in-force life insurance policies that provides premiums that are sufficient to cover our operating expenses.
In August 2011, the Company acquired a controlling interest ownership of Hot Dot, Inc., a company organized to develop, manufacture, and market the Alert Patch. The Alert Patch is an adhesive-backed cloth patch that is used to detect increases in body temperature that pose a risk of heat exhaustion or heat stroke. Hot Dot had no operating revenues and operating expenses of $115,147 for the year ended December 31, 2011. Hot Dot is a development stage company that has not conducted operations apart from raising capital.
The accounting and reporting policies of the Company are in accordance with U.S. generally accepted accounting principles. Preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The following is an explanation of the Company’s accounting policies and the estimates considered most significant by management. These accounting policies inherently require significant judgment and assumptions and actual operating results could differ significantly from management’s estimates determined using these policies. We believe the following accounting policies, judgments and estimates are the most critical to the understanding of the results of operations and financial position. A detailed discussion of significant accounting policies is provided in Note 1 - Nature of Operations and Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements.
The Company has a policy and process in place to identify securities that could potentially have an impairment that is other-than-temporary. The assessment of whether impairments have occurred is based on a case-by-case evaluation of underlying reasons for the decline in fair value. We consider severity of impairment, duration of impairment, forecasted recovery period, industry outlook, financial condition of the issuer, projected cash flows, issuer credit ratings and the intent and ability of the Company to hold the investment until the recovery of the cost.
VOBA is also reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts. If it is determined from emerging experience that the premium margins or gross profits are insufficient to amortize deferred acquisition costs, then the asset will be adjusted downward with the adjustment recorded as an expense in the current period.
In September 2011, the FASB issued ASU 2011-08 which amends the rules for testing goodwill for impairment. Under the new rules, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. We early adopted ASU 2011-08 for our December 31, 2011 annual goodwill impairment test.
In assessing the qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we assess relevant events and circumstances that may impact the fair value and the carrying amount of the reporting unit. The identification of relevant events and circumstances and how these may impact a reporting units’ fair value or carrying amount involve significant judgments and assumptions. The judgment and assumptions include the identification of macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, specific events and share price trends and making the assessment on whether each relevant factor will impact the impairment test positively or negatively and the magnitude of any such impact.
Our income prior to commencing insurance operations in 2009 came from our investments, which were nominal due to the need to maintain liquidity. When American Life commenced operations in September 2009, we also began to receive premium income from the sales of life insurance. Capital Reserve, acquired in 2010, had little impact on 2010 operations as it had no premium income or related expenses. Management expects the premium writings in American Life to increase substantially in the next few years, and as assets and policy reserves grow, expects investment income to grow also. An evaluation of the best use of the assets obtained in the acquisitions of Capital Reserve and Old Reliance is ongoing.
Investment income, net of expenses was $268,287 in the 2011 period compared to $167,613 in the 2010 period. This increase is primarily a result of higher average invested balances as a result of investment of capital along with the acquisition of investments from Old Reliance.
Miscellaneous income: Miscellaneous income was $223,711 for the year ended December 31, 2011 compared to $24,138 in the year ended December 31, 2010, which was largely due to the gain recognized from writing up the Company’s previously held interest in Security Capital.
Other expenses: Other expenses (general administrative expenses, licenses and fees, and other expenses) were $2,745,737 in 2011 compared to $1,961,631 in 2010. This increase is mainly the result of the continued growth of our business. We expect most of these expenses to continue to increase in the future as a result of an increased administrative expenses necessary for the management of the anticipated growth of our life insurance business, although management intends to pursue opportunities to forge partnerships with other companies of similar size in order to achieve better economies of scale.
Net Loss: Net loss attributable to Midwest Holding Inc. was ($3,777,945) for the year ended December 31, 2011, compared to a net loss of ($2,223,205) for the year ended December 31, 2010. The increase in the net loss was primarily attributable to the fact that the overall increase in recurring expenses described above more than offset the overall increase in recurring revenue. We expect our losses to continue and increase in the future as we incur increased cost to grow our life insurance business.
Increases in fixed maturity securities, equity securities, mortgage loans on real estate, held for investment, real estate, held for investment, and policy loans are primarily a result of the Old Reliance acquisition.
Increases in private placement common stock are a result from the acquisition of Security Capital Corporation during the third quarter of 2011. Security Capital Corporation’s primary asset was its investment in equity securities, which added $434,000 to the consolidated balance sheet.
Increases in notes receivable are a result of short-term financing arrangements made with affiliated companies to cover operating expenses during developmental stage activities. As of December 31, 2011, the company had short-term financing arrangements with Rocky Mountain Capital Corporation and Northstar Financial Corp. in the amounts of $105,000 and $115,000, respectively. The Northstar note was repaid in full on January 11, 2012 and management anticipates the repayment of the Rocky Mountain note during 2012.
The Company acquired approximately $1.7 million of fixed maturity securities rated AAA and U.S. Government during the year as part of the Old Reliance acquisition. However, this was offset by sales of similarly rated securities during the year and to a lesser extent, downgrades of similarly rated securities. The increase in fixed maturity securities rated AA and BBB is primarily related to additional purchases of securities during the year and to a lesser extent, bonds acquired from Old Reliance. The increase in fixed maturity securities rated A is primarily related to bonds acquired from Old Reliance.
The Company acquired approximately $700K of mortgage loans on real estate, held for investment during the year as part of the Old Reliance acquisition. As part of the Old Reliance purchase agreement, the seller guaranteed the performance of the mortgage loans. Additionally, the Company transferred $200K from notes receivable to mortgage loans on real estate, held for investment during the year as the note receivable was restructured as a mortgage loan.
We hold a diversified portfolio of investments that primarily includes cash, bonds, stocks, mortgage loans on real estate, held for investment, real estate, held for investment and notes receivable. Each of these investments is subject to market risks that can affect their return and their fair value. A majority of our investments are fixed maturity securities including debt issues of corporations, U.S. Treasury securities, or securities issued by government agencies. The primary market risks affecting our investment portfolio are interest rate risk, credit risk, and equity risk.
We attempt to mitigate our exposure to adverse interest rate movements through staggering the maturities of our fixed maturity investments and through maintaining cash and other short term investments to assure sufficient liquidity to meet our obligations and to address reinvestment risk considerations. Due to the composition of our book of insurance business, we believe it is unlikely that we would encounter large surrender activity due to an interest rate increase that would force the disposal of fixed maturities at a loss.
Equity risk is the risk that the Company will incur economic losses due to adverse fluctuations in a particular stock. As of December 31, 2011 and 2010, the fair value of our equity securities was $1,820,205 and $1,110,725, respectively. As of December 31, 2011 a 10% decline in the value of the equity securities would result in an unrealized loss of $182,021 as compared to an estimated unrealized loss of $111,073 as of December 31, 2010. The selection of a 10% unfavorable change in the equity markets should not be construed as a prediction by the Company of future market events, but rather as an illustration of the potential impact of such an event.
Premium income, deposits to policyholder account balances, and investment income are the primary sources of funds while withdrawals of policyholder account balances, investment purchases, policy benefits in the form of claims, and operating expenses are the primary uses of funds. To ensure we will be able to pay future commitments, the funds received as premium payments and deposits are invested in primarily fixed income securities. Funds are invested with the intent that the income from investments, plus proceeds from maturities, will meet the ongoing cash flow needs of the Company. The approach of matching asset and liability durations and yields requires an appropriate mix of investments. Additionally, the Company’s investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs.
In the year ended December 31, 2011, net cash used in operating activities was ($3,832,432) compared to cash provided by operating activities of $667,993 for the year ended December 31, 2010. The cash provided by operating activities in 2010 was largely due to the effects of the non-recurring transaction with Security National, and the net cash used in operating activities in the 2011 period largely reflects our operating losses. In the 2011 period, net cash used in investing activities was ($3,702,400) compared to ($2,501,251) in the 2010 period. The increase in cash flow used in investing activities is a primarily a result of the Company’s acquisition of Old Reliance offset by a decrease in purchases of available for sale securities. In the 2011 period, net cash provided by financing activities was $4,754,089 compared to $5,599,612 in the 2010 period. The decrease in positive cash flow from financing activities can be attributed to the decrease in proceeds from the sale of shares of voting common stock to existing shareholders in Nebraska in the first half of 2011 and partially offset by proceeds from issuing equity instruments and transfers from noncontrolling interests both in relation capital raising efforts through a private placement by the Company’s less than wholly owned subsidiary, Hot Dot.
The consolidated financial statements are included as a part of this report beginning on page.