Investment real estate ---------------------- Commercial 10,050,942 65% Residential development 3,045,303 19% ---------- --- 13,096,245 84% ---------- ---
Commercial property mainly consists of North Plaza, which owns for investment purposes, a shopping center in Somerset, Kentucky, approximately 12,000 acres of timberland in Kentucky, and a 50% partnership interest in an additional 11,000 acres of Kentucky timberland. The timberland is harvested and in various stages of maturity. The property is carried at $9,362,888. Other commercial properties owned are leased to various unaffiliated companies and organizations and are being marketed for sale.
Springfield is the State Capital of Illinois. The City’s economy is service oriented with the main employers being the State of Illinois, two major area hospitals and two large insurance companies. This provides for a very stable economy not as dramatically affected by economic conditions in other parts of the United States.
2000 1999 1998 1997 1996 ---------- --------- --------- --------- ---------- Premium income net of reinsurance $ 19,490 $ 21,581 $ 26,396 $ 28,639 $ 30,944 Total revenues $ 35,747 $ 36,057 $ 40,885 $ 43,992 $ 46,976 Net income (loss)* $ (696) $ 1,076 $ (679) $ (559) $ (938) Basic income (loss) per share $ (0.17) $ 0.38 $ (0.39) $ (0.32) $ (0.50) Total assets $ 333,620 $ 339,161 $ 343,196 $ 349,300 $ 355,474 Total long-term debt $ 1,817 $ 5,918 $ 9,529 $ 21,460 $ 19,574 Dividends paid per share NONE NONE NONE NONE NONE
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 read in 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 UTG and its subsidiaries at December 31, 2000.
Prevailing interest rate levels, which may affect the ability of 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.
Changes in the federal income tax laws and regulations, which may affect the relative tax advantages of the company's products.
Changes in the regulation of financial services, including bank sales and underwriting of insurance products, which may affect the competitive environment for the company’s products.
Net investment income increased 11% when comparing 2000 to 1999 and decreased 3% when comparing 1999 to 1998. During 2000, the Company received $632,000 in investment earnings from a joint venture real estate development project that is in its latter stages. The Company expects to receive a small amount of income from this property’s final disposition. The earnings from this activity represent approximately 4% of the increase in investment income from the previous period.
The national prime rate rose in late 1999 and early 2000. This results in higher earnings on short-term funds as well as on longer-term investments acquired. In 1999, the Company began investing more of its funds in mortgage loans. This is the result of its affiliation with First Southern Funding and its affiliates (“FSF”), which includes a bank, First Southern National Bank (“FSNB”). FSNB has been able to provide the Company with additional expertise and experience in underwriting commercial and residential mortgage loans, which provide more attractive yields than the traditional bond market. During 2000, the Company issued approximately $21,863,000 in new mortgage loans. All but $80,000 of these new loans were generated through FSNB and its personnel and funded by the Company through participation agreements with FSNB. FSNB services the loans covered by these participation agreements. The Company pays FSNB a .25% servicing fee on these loans and a one-time fee at loan origination of .50% of the original loan amount to cover costs incurred by FSNB relating to the processing and establishment of the loan. The loans issued in 2000 had an average yield of approximately 9%. The Company anticipates continuing to primarily invest in mortgage loans and government agency bonds for the short period.
Realized investment losses, net of realized gains, were $260,078, $530,894 and $1,119,156 in 2000, 1999 and 1998, respectively. During late 1998 and early 1999, the Company re-evaluated its real estate holdings, especially those properties acquired through acquisitions of other companies and mortgage loan foreclosures, and determined it would be in the long term interest of the Company to dispose of certain of these parcels. Parcels targeted for sale were generally non-income or low income producing and located in parts of the country where management has little other reason to travel.
During 2000, real estate continued to account for almost all of the realized gain and loss activity. By third quarter of 2000, the Company had sold the remaining real estate properties identified for disposal in prior years. The Company recorded net realized gains of $728,000 from these sales. By fourth quarter 2000, remaining real estate consisted of the North Plaza holdings and development real estate located in Springfield, IL. In December 2000, management studied its development properties, analyzing such issues as remaining time to fully develop without over saturation, historic sales trends, management time and resources to continue development and other alternatives such as modifying current plans or discontinuing entirely. Management determined it would be in the long term best interests of the Company to discontinue development and attempt to liquidate the remaining properties. As such, a realized loss of $913,000 was recorded in December 2000 to reduce the book value of these properties to the amount management determined it would accept net of selling costs to facilitate liquidation. During the fourth quarter of 2000, the Company recorded a $170,000 loss increasing the allowance to $240,000 maintained for potential mortgage loan losses. The current allowance represents approximately 50% of the total outstanding loan balances on certain loans identified by management. Although most of these loans are currently in good standing, due to economic depression in the region these loans are located, a significant potential for future losses exists. The allowance established represents the difference in the current loan balance and management’s estimate of realizable value in today’s circumstances should foreclosure occur.
Approximately 99% of the realized loss in 1999 is from two parcels of real estate. In June 1999, the Company sold its shopping center in Gulfport, MS realizing a loss on sale of $401,000. This property was originally acquired through the foreclosure of a mortgage loan. The property was income producing, but due to the distance from the Company’s headquarters, was difficult to manage and required the use of an outside property manager. Given this circumstance and the eventual need for updates and improvements, the Company determined it was in its best long-term interest to sell the property. At year-end the Company wrote down another parcel of real estate $178,000 that it determined to attempt to and ultimately did sell during 2000. The write down was the result of Management’s determination of the amount it would be willing to accept for the property. Approximately $440,000 of realized losses in 1998 is due to the sale of real estate. The Company reduced its non-income producing investments approximately $1,610,000 during 1998, as a result of these actions. The Company incurred losses of approximately $339,000 on the foreclosure of three mortgage loans during the second quarter of 1998. The foreclosed properties were sold before the end of 1998. As a result of these foreclosures, management reassessed its remaining mortgage loan portfolio and determined an allowance of $70,000 was appropriate to cover potential future losses in the portfolio. The Company realized a loss of approximately $88,000 on the investment in John Alden Financial Corporation common stock. Under the terms of an acquisition agreement beween Fortis, Inc. and John Alden all outstanding common shares of John Alden were acquired. The Company had other gains and losses during the periods that comprised the remaining amounts reported but were immaterial on an individual basis.
(b) Expenses Benefits, claims and settlement expenses net of reinsurance benefits and claims, increased 5% in 2000 as compared to 1999 and decreased 16% in 1999 as compared to 1998. The decrease in premium revenues from normal policy terminations resulted in lower benefit reserve increases in each of the periods presented compared to the previous period. Fluctuations in death claim experience from year to year typically has a significant impact on variances in this line item. Death claims were $2,574,000 greater in 2000 than in 1999 and $202,000 greater in 1999 than 1998. There is no single event that caused the mortality variances. Policy claims vary from year to year and therefore, fluctuations in mortality are to be expected and are not considered unusual by management. Two events occurred in 1999, which differ from 1998 experience. Approximately 8% of the decrease from 1998 to 1999 is from the premium reduction on certain participating policies resulting in a lower dividend to policyholders expense than in the previous year. See discussion above in premiums and policy fee revenues for a more detailed explanation of this event. At the September 1998 Board of Directors meeting, the Boards of the insurance subsidiaries lowered crediting rates one half percent on all products crediting 5.5% or more. The change affected approximately $60,000,000 of policy reserves and will result in interest crediting reductions of $300,000 per year. At the March 1999 Board of Directors meeting, the Boards of the insurance subsidiaries again lowered crediting rates one half percent on all products that could be lowered. The change will result in interest crediting reductions of approximately $600,000 per year. These adjustments were in response to continued declines in interest rates in the marketplace. Policy interest crediting rate changes become effective on an individual policy basis on the next policy anniversary. Therefore, it will take a full year from the time the change is determined for the full impact of such change to be realized.
Commissions and amortization of deferred policy acquisition costs decreased 28% in 2000 compared to 1999 and decreased 55% in 1999 compared to 1998. At year-end 1998, the Company recorded an impairment write off of deferred policy acquisition costs of $2,983,000. The Company performs actuarial analysis of the recoverability of the asset based on current trends and known events compared to assumptions used in the establishment of the original asset. The impairment in 1998 was the result of declines in interest rates in the marketplace combined with lower than expected new policy writings which left the Company with greater per policy costs as a result of fixed costs being spread over fewer policies. No impairments were recorded in 2000 or 1999.
During the fourth quarter of 1999, the Company transferred the policy administration functions of its insurance subsidiary APPL from Huntington, WV to its Springfield, IL location. The transfer was completed to reduce operating costs. APPL policy administration was then converted to the same computer system used to administer the other insurance subsidiaries. Following the transfer and system conversion, all insurance administration is located at the Springfield, IL office and administered on the same computer system. This action resulted in cost savings of approximately $250,000 per year in administrative costs.
Deferred taxes are established to recognize future tax effects attributable to temporary differences between the financial statements and the tax return. As these differences are realized in the financial statement or tax return, the deferred income tax established on the difference is recognized in the financial statements as an income tax expense or credit. In 1998, the insurance company subsidiaries incurred taxable income for federal income tax purposes, which was offset through utilization of federal tax loss carryforwards. Since these carryforwards had an allowance established against them for deferred tax purposes, no corresponding expense was incurred in the financial statements. Additionally, the Company incurred deferred tax credits of $2,050,709 in 1998 from the deferred policy acquisition costs impairment and the notes payable discounts write-offs.
(c) Net income loss) The Company had a net income (loss) of $(696,426), $1,075,909 and $(679,492) in 2000, 1999 and 1998 respectively. Significant one time charges and accruals to operating expenses combined with an increase in death claims during 2000 were the primary differences in the 2000 to 1999 results. The additional capital received from FSF significantly enhanced the Company’s financial position and improved earnings primarily through interest expense savings from debt retirement. The 1998 results included one time charges for a deferred policy acquisition costs impairment write down and the write off of the remaining discounts associated with notes payable. The Company continues to monitor and adjust those items within its control.
The liabilities are predominantly long-term in 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, 2000, 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 changes in market value charged directly to shareholders’ equity. To provide additional flexibility and liquidity, the Company has categorized almost all fixed maturity investments acquired in 2000 as available for sale. It was determined it would be in the Company’s best financial interest to classify these new purchases as available for sale to provide additional liquidity. All of the fixed maturity acquisitions in 2000 were U.S. government and government agency securities.
The following table summarizes the Company’s fixed maturities distribution at December 31, 2000 and 1999 by ratings category as issued by Standard and Poor’s, a leading ratings analyst.
Fixed Maturities ---------------- Rating % of Portfolio ------ -------------- 2000 1999 ------ ------ Investment Grade AAA 48% 38% AA 16% 19% A 27% 35% BBB 9% 7% Below investment grade 0% 1% ------ ------ 100% 100% ====== ======
Deferred policy acquisition costs decreased 23% in 2000 compared to 1999. Deferred policy acquisition costs, which vary with, and are primarily related to producing new business, are referred to 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 in relation to the present value of expected gross profits from the contracts, discounted using the interest rate credited by the policy. The Company had $273,000 in policy acquisition costs deferred, $100,000 in interest accretion and $1,552,040 in amortization in 2000.
Cost of insurance acquired decreased 4% in 2000 compared to 1999. At December 31, 2000, cost of insurance acquired was $35,239,256 and amortization totaled $1,592,812 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 flows from the acquired policies. Cost of insurance acquired is amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits.
(b) Liabilities Total liabilities decreased 3% in 2000 compared to 1999. Policy liabilities and accruals, which represents approximately 93% of total liabilities, decreased slightly from the prior year. The decline is attributable to a shrinking policy base and declining new business production.
Notes payable decreased 69% in 2000 compared to 1999. During 2000, the Company repaid $4,100,800 of its debt. Included in this amount was $2,560,000 of convertible debt owned by First Southern that was converted to 204,800 shares of UTG common stock in July 2000. At December 31, 2000, UTG had $1,817,169 in notes payable. The remaining debt bears interest at a fixed rate of 8.5% with no principal payments due until its maturity in 2012. Management believes overall sources available are more than adequate to service this debt. These sources include current cash balances of UTG, expected future operating cashflows and repayment of affiliate receivables held by UTG. The Company’s long-term debt is discussed in more detail in Note 11 of the Notes to the Financial Statements.
Liquidity and Capital Resources The Company has three principal needs for cash - the insurance companies’ contractual obligations to policyholders, the payment of operating expenses and the servicing of its long-term debt. Cash and cash equivalents as a percentage of total assets were 5% and 6% as of December 31, 2000 and 1999, respectively. Fixed maturities as a percentage of total invested assets were 71% and 77% as of December 31, 2000 and 1999, respectively.
Future policy benefits are primarily long-term in nature and therefore, the Company’s investments are predominantly in long-term 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.
Many of the Company’s products contain surrender charges and other features which reward persistency and penalize the early withdrawal of funds. With respect to such products, surrender charges are generally sufficient to cover the Company’s unamortized deferred policy acquisition costs with respect to the policy being surrendered.
Cash provided by (used in) investing activities was $(3,940,958), $(4,928,225) and $5,555,757, for 2000, 1999 and 1998, respectively. The most significant aspect of cash provided by (used in) investing activities are the fixed maturity transactions. Fixed maturities account for 42%, 68% and 84% of the total cost of investments acquired in 2000, 1999 and 1998, respectively. The Company has not directed its investable funds to so-called “junk bonds” or derivative investments.
Policyholder contract deposits decreased 10% in 2000 compared to 1999, and decreased 8% in 1999 when compared to 1998. The decrease in policyholder contract deposits relates to the decline in new business production experienced in the last few years by the Company. Policyholder contract withdrawals have decreased 2% in 2000 compared to 1999, and decreased 10% in 1999 compared to 1998. The change in policyholder contract withdrawals is not attributable to any one significant event. Factors that influence policyholder contract withdrawals are fluctuation of interest rates, competition and other economic factors.
UTG is a holding company that has no day to day operations of its own. Funds required to meet its expenses, generally costs associated with maintaining the company in good standing with states in which it does business, are primarily provided by its subsidiaries. On a parent only basis, UTG’s cash flow is dependent on its earnings received on invested assets (primarily notes receivable from FCC) and cash balances. At December 31, 2000, substantially all of the consolidated shareholders equity represents net assets of its subsidiaries and receivables from its subsidiaries. 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 to shareholders is not legally restricted. However, the state insurance department regulates insurance company dividend payments where the company is domiciled. UTG is the ultimate parent of UG through ownership of FCC. UG can not pay a dividend directly to UTG due to the ownership structure. However, if UG paid a dividend to its direct parent, FCC, and FCC paid a dividend equal to the amount it received, UTG would receive 81% of the original dividend paid by UG. 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.
A life insurance company’s statutory capital is computed according to rules prescribed by the National Association of Insurance Commissioners (“NAIC”), as modified by the insurance company’s state of domicile. Statutory accounting rules are different from generally accepted accounting principles and are intended to reflect a more conservative view by, for example, requiring immediate expensing of policy acquisition costs. The achievement of long-term growth will require growth in the statutory capital of the Company’s insurance subsidiaries. The subsidiaries may secure additional statutory capital through various sources, such as internally generated statutory earnings or equity contributions by the Company from funds generated through debt or equity offerings.
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 capital and surplus in relation to 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 purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines 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 compliance is 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. The levels and ratios are as follows:
Ratio of Total Adjusted Capital to Authorized Control Level RBC Regulatory Event (Less Than or Equal to) ---------------- -------------------------------
At December 31, 2000, each of the insurance subsidiaries has a Ratio that is in excess of 4, which is 400% of the authorized control level; accordingly the insurance subsidiaries meet the RBC requirements.
REGULATORY ENVIRONMENT The Company’s insurance subsidiaries are assessed contributions by life and health guaranty associations in almost all states to indemnify policyholders of failed companies. In several states the company may reduce premium taxes paid to recover a portion of assessments paid to the states’ guaranty fund association. This right of “offset” may come under review by the various states, and the company cannot predict whether and to what extent legislative initiatives may affect this right to offset. Also, some state guaranty associations have adjusted the basis by which they assess the cost of insolvencies to individual companies. The Company believes that its reserve for future guaranty fund assessments is sufficient to provide for assessments related to known insolvencies. This reserve is based upon management’s current expectation of the availability of this right of offset, known insolvencies and state guaranty fund assessment bases. However, changes in the basis whereby assessments are charged to individual companies and changes in the availability of the right to offset assessments against premium tax payments could materially affect the company’s results.
Congress recently passed the Gramm-Leach-Bliley Financial Services Modernization Act, which requires financial institutions, including all insurers, to take certain steps to enhance privacy protections of nonpublic personal information for consumers. The new law is one of the most sweeping systems of privacy protection and regulation ever imposed in our nation’s history. It requires financial companies to tell consumers how their financial information is protected, and what a company’s financial information sharing practices are, both within a corporate family and with unrelated third parties. Companies must inform their customers of their privacy policies and practices at the start of their business relationship, and then at least once a year for the duration of the relationship. Companies also must disclose the types of information that are shared. The privacy protections under the act become effective November 13, 2000. Financial institutions will have until July 1, 2001, to establish and implement privacy policies. The Company has been monitoring developments regarding this new act and analyzing options and requirements to determine the best method to comply with these new requirements.
ACCOUNTING AND LEGAL DEVELOPMENTS The FASB has issued SFAS 138 entitled, Accounting for Derivative Instruments and Hedging Activities, as an amendment to SFAS 133 of the same title, SFAS 139 entitled, Rescission of FASB Statement No. 53 (Financial Reporting by Producers and Distributors of Motion Picture Films) and amendments to FASB Statements No. 63, 89, and 121, and SFAS 140 entitled, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, which is a replacement of SFAS 125 of the same title. The adoption of Statements of Financial Accounting Standards No. 138, 139 and 140, did not affect the Company’s financial position or results of operations, since the Company has no derivative or hedging type investments, and has not had any transactions relating to the above mentioned pronouncements.
In addition, First Southern Bancorp, Inc. agreed to purchase 22,500 shares of United Trust Group, Inc. common stock and 544 shares of First Commonwealth Corporation common stock pursuant to the terms of a common stock purchase agreement dated February 13, 2001 with James E. Melville and his family. Pursuant to the terms of the agreement, the United Trust Group, Inc. shares will be acquired for $8.00 per share and First Commonwealth Corporation shares will be acquired for $200.00 per share. The purchase will be in the form of a five-year promissory note. Mr. Melville has agreed to resign as a director of United Trust Group, Inc. and its subsidiaries at the closing pursuant to an agreement and release First Southern Bancorp, Inc., United Trust Group, Inc., First Commonwealth Corporation and Mr. Melville executed concurrently with the common stock purchase agreement.
Independent Auditors' Report for the Years ended December 31, 2000, 1999, 1998.......................................34
We have audited the accompanying consolidated balance sheets of UNITED TRUST GROUP, INC. (an Illinois corporation) and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
Cash and cash equivalents 15,065,076 21,027,804 Accrued investment income 3,482,036 3,459,761 Reinsurance receivables: Future policy benefits 35,083,244 36,117,010 Policy claims and other benefits 3,911,258 3,806,382 Cost of insurance acquired 35,239,256 36,832,068 Deferred policy acquisition costs 3,948,496 5,127,536 Cost in excess of net assets purchased, net of accumulated amortization 1,118,525 1,442,339 Property and equipment, net of accumulated depreciation 2,762,619 3,034,702 Income taxes receivable, current 178,335 434,427 Other assets 680,239 896,880 ------------ ------------ Total assets $ 333,620,111 $ 339,160,528 ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities and accruals: Future policy benefits $ 240,238,991 $ 244,934,013 Policy claims and benefits payable 2,639,248 2,773,309 Other policyholder funds 1,445,857 1,627,341 Dividend and endowment accumulations 13,515,427 14,431,574 Deferred income taxes 12,056,497 11,913,154 Notes payable 1,817,169 5,917,969 Other liabilities 6,292,841 5,169,128 ------------ ------------ Total liabilities 278,006,030 286,766,488 ------------ ------------ Minority interests in consolidated subsidiaries 8,899,648 9,017,368 ------------ ------------
Income (loss) before income taxes, minority interest and equity in income (loss) of investees (707,069) 1,855,553 (6,117,180) Income tax credit (expense) (228,783) (690,454) 4,624,032 Minority interest in (income) loss of consolidated subsidiaries 239,426 (142,745) 835,181 Equity in income (loss) of investees 0 53,555 (21,525) ------------- ------------- -------------
Diluted income (loss) per share from continuing operations and net income (loss) $ (0.17)$ 0.38 $ (0.39) ============= ============= =============
Accumulated deficit Balance, beginning of year $ (738,909) $ (1,814,818) $ (1,135,326) Net income (loss) (696,426) $ (696,426) 1,075,909 $ 1,075,909 (679,492) $ (679,492) ----------- ----------- ----------- Balance, end of year $ (1,435,335) $ (738,909) $ (1,814,818) =========== =========== ===========
Total shareholders' equity, end of year $ 46,714,433 $ 43,376,672 $ 25,361,311 =========== =========== ===========
2000 1999 1998 ---------- ----------- ----------- Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net income (loss) $ (696,426) $ 1,075,909 $ (679,492) Adjustments to reconcile net income (loss) to net cash provided by(used in) operating activities net of changes in assets and liabilities resulting from the sales and purchases of subsidiaries: Amortization/accretion of fixed maturities 152,917 489,491 657,863 Realized investment losses, net 260,078 530,894 1,119,156 Amortization of deferred policy acquisition costs 1,452,040 1,917,012 5,168,172 Amortization of cost of insurance acquired 1,592,812 1,847,754 2,214,928 Amortization of costs in excess of net assets purchased 90,000 90,000 90,000 Depreciation 505,221 507,771 494,364 Minority interest (239,426) 142,745 (835,181) Charges for mortality and administration of universal life and annuity products (10,151,024) (10,696,014) (10,771,795) Interest credited to account balances 6,109,491 6,300,667 7,014,683 Equity in (income) loss of investees 0 (53,555) 21,525 Policy acquisition costs deferred (273,000) (720,000) (892,000) Change in accrued investment income (22,275) 123,747 123,179 Change in reinsurance receivables 928,890 606,509 813,283 Change in policy liabilities and accruals (3,647,101) (2,218,519) 75,087 Change in income taxes payable 399,435 127,588 (4,635,447) Change in indebtedness (to) from affiliates, net 0 (1,287) 3,769 Change in other assets and liabilities, net 1,382,877 (698,651) 2,184,079 ---------- ----------- ----------- Net cash provided by (used in) operating activities (2,155,491) (627,939) 2,166,173 ---------- ----------- -----------
Cash flows from financing activities: Policyholder contract deposits 12,724,345 14,176,188 15,480,745 Policyholder contract withdrawals (10,962,425) (11,222,814) (12,402,530) Cash received in merger 0 607,508 0 Net cash transferred from coinsurance assumed 0 0 420,790 Proceeds from notes payable 0 0 500,000 Payments of principal on notes payable (1,540,800) (3,149,369) (12,420,373) Purchase of stock of affiliates (87,399) (56,053) (1,500) Purchase of treasury shares 0 (149,955) (26,527) Proceeds from issuance of common stock 0 0 10,999,995 ---------- ----------- ----------- Net cash provided by financing activities 133,721 205,505 2,550,600 ---------- ----------- -----------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. ORGANIZATION - At December 31, 2000, the parent, significant majority-owned subsidiaries and affiliates of UNITED TRUST GROUP, INC., were as depicted on the following organizational chart.
Fixed maturities -- at cost, adjusted for amortization of premium or discount and other-than-temporary market value declines. The amortized cost of such investments differs from their market values; however, the Company has the ability and intent to hold these investments to maturity, at which time the full face value is expected to be realized.
Real estate - investment real estate at cost less allowance for depreciation and, as appropriate, provisions for possible losses. Foreclosed real estate is adjusted for any impairment at the foreclosure date. Accumulated depreciation on investment real estate was $307,294 and $813,582 as of December 31, 2000 and 1999, respectively.
J. POLICY AND CONTRACT CLAIMS - Policy and contract claims include provisions for reported claims in process of settlement, valued in accordance with the terms of the policies and contracts, as well as provisions for claims incurred and unreported based on prior experience of the Company. Incurred but not reported claims were $900,114 and $831,373 as of December 31, 2000 and 1999, respectively.
K. COST OF INSURANCE ACQUIRED - 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 flows from the acquired policies. The Company utilized 9% discount rate on approximately 25% of the business and 15% discount rate on approximately 75% of the business. Cost of insurance acquired is amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. The interest rates utilized in the amortization calculation are 9% on approximately 25% of the balance and 15% on the remaining balance. The interest rates vary due to differences in the blocks of business. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised.
Acquisition costs deferred: Commissions 184,000 566,000 690,000 Other expenses 89,000 154,000 202,000 ------------- ------------- ------------- Total 273,000 720,000 892,000
Net amortization of deferred policy acquisition costs $ 1,452,040 $ 1,917,012 $ 5,168,172 Commissions 637,273 976,886 1,282,357 ---------- ----------- ------------ Total $ 2,089,313 $ 2,893,898 $ 6,450,529 ========== =========== ============
M. COST IN EXCESS OF NET ASSETS PURCHASED - Cost in excess of net assets purchased is the excess of the amount paid to acquire a company over the fair value of its net assets. Costs in excess of net assets purchased are amortized on the straight-line basis over a 40-year period. Management continually reviews the value of goodwill based on estimates of future earnings. As part of this review, management determines whether goodwill is fully recoverable from projected undiscounted net cash flows from earnings of the subsidiaries over the remaining amortization period. If management were to determine that changes in such projected cash flows no longer supported the recoverability of goodwill over the remaining amortization period, the carrying value of goodwill would be reduced with a corresponding charge to expense (no such changes have occurred). Accumulated amortization of cost in excess of net assets purchased was $1,690,146 and $1,600,146 as of December 31, 2000 and 1999, respectively.
Q. TREASURY SHARES - The Company holds 47,507 shares of common stock as treasury shares with a cost basis of $499,955 at both December 31, 2000 and 1999, respectively.
2. SHAREHOLDER DIVIDEND RESTRICTION At December 31, 2000, substantially all of consolidated shareholders’ equity represents net assets of UTG’s subsidiaries. The payment of cash dividends to shareholders by UTG is not legally restricted. However, the state insurance department regulates insurance company dividend payments where the company is domiciled. UG’s dividend limitations are described below.
Shareholders' Untaxed Company Surplus Balance ------------------- -------------- ----------- ABE $ 5,184,125 $ 1,149,693 APPL 6,603,229 1,525,367 UG 29,915,735 4,363,821
The Company has established a deferred tax asset of $1,170,398 for its operating loss carryforwards and has established an allowance of $354,981. The Company has established a deferred tax asset of $24,445 for its total unrealized losses on investments of $69,842, and has established an allowance of $24,445. The total allowances established on deferred tax assets decreased $290,147 in 2000.
2000 1999 ------------ ------------- Investments $ 1,402,431 $ 1,527,096 Cost of insurance acquired 13,427,963 14,029,379 Other assets (72,468) (72,468) Deferred policy acquisition costs 1,381,974 1,794,638 Agent balances (6,239) (20,381) Management/consulting fees (810,717) (376,556) Future policy benefits (2,485,664) (3,178,470) Gain on sale of subsidiary 2,312,483 2,312,483 Net operating loss carryforward (815,417) (1,513,912) Other liabilities (614,374) (723,940) Federal tax DAC (1,663,475) (1,864,715) ------------ ------------- Deferred tax liability $ 12,056,497 $ 11,913,154 ============ =============
Carrying Value ---------------------------------- 2000 1999 ------------- ------------ Investments held for sale: Fixed maturities U.S. Government, government agencies and authorities $ 35,444,312 $ 22,928,178 State, municipalities and political subdivisions 206,006 194,166 Collateralized mortgage obligations 5,962,594 5,578,853 Public utilities 0 0 All other corporate bonds 1,515,368 1,490,160 ------------- ------------ $ 43,128,280 $ 30,191,357 ============= ============
Fixed maturities held to maturity: U.S. Government, government agencies and authorities $ 31,350,799 $ 30,556,303 State, municipalities and political subdivisions 15,318,605 17,440,381 Collateralized mortgage obligations 3,178,210 4,892,693 Public utilities 27,287,454 35,812,281 All other corporate bonds 44,787,895 56,049,453 ------------- ------------ $ 121,922,963 $ 144,751,111 ============= ============
By insurance statute, the majority of the Company’s investment portfolio is invested in investment grade securities to provide ample protection for policyholders. The Company does not invest in so-called “junk bonds” or derivative investments.
Below Investment Grade Investments 2000 1999 1998 ------------------------- ----------- ---------- ---------- Public Utilities $ 0 $ 251,878 $ 970,311 CMO 239,165 0 0 Corporate 23,000 276,649 47,281 ----------- ---------- ---------- Total $ 262,165 $ 528,527 $1,017,592 =========== ========== ==========
Cost or Gross Gross Estimated Amortized Unrealized Unrealized Market 2000 Cost Gains Losses Value ------------------------------ ------------ ----------- ------------ ------------ Investments held for sale: U.S. Government and govt. agencies and authorities $ 35,281,562 $ 245,119 $ (82,369) $ 35,444,312 States, municipalities and political subdivisions 190,593 15,413 0 206,006 Collateralized mortgage obligations 5,919,553 58,179 (15,138) 5,962,594 Public utilities 0 0 0 0 All other corporate bonds 1,522,478 0 (7,110) 1,515,368 ------------ ----------- ------------ ------------ 42,914,186 318,711 (104,617) 43,128,280 Equity securities 5,413,507 637,191 (921,127) 5,129,571 ------------ ----------- ------------ ------------ Total $ 48,327,693 $ 955,902 $ (1,025,744) $ 48,257,851 ============ =========== ============ ============
Fixed maturities held to maturity: U.S. Government and govt. Agencies and authorities $ 30,556,303 $ 105,814 $ (1,490,965) $ 29,171,152 States, municipalities and Political subdivisions 17,440,381 85,098 (442,417) 17,083,062 Collateralized mortgage Obligations 4,892,693 78,972 (47,329) 4,924,336 Public utilities 35,812,281 268,532 (251,317) 35,829,496 All other corporate bonds 56,049,453 228,223 (610,703) 55,666,973 ------------ ----------- ------------ ------------ Total $ 144,751,111 $ 766,639 $ (2,842,731) $142,675,019 ============ =========== ============ ============
Estimated Fixed Maturities Held for Sale Amortized Market December 31, 2000 Cost Value ------------------------------------- ------------ ------------ Due in one year or less $ 6,710,854 $ 6,729,550 Due after one year through five years 27,159,052 27,344,469 Due after five years through ten years 2,969,134 2,924,188 Due after ten years 155,593 167,479 Collateralized mortgage obligations 5,919,553 5,962,594 ------------ ------------ Total $ 42,914,186 $ 43,128,280 ============ ============
An analysis of sales, maturities and principal repayments of the Company’s fixed maturities portfolio for the years ended December 31, 2000, 1999 and 1998 is as follows:
Cost or Gross Gross Proceeds Amortized Realized Realized from Year ended December 31, 2000 Cost Gains Losses Sale ------------------------------- ------------ ---------- ------------ ------------ Scheduled principal repayments, calls and tenders: Held for sale $ 5,611,476 $ 71 $ (3,847) $ 5,607,700 Held to maturity 27,047,819 59,463 (4,133) 27,103,149 Sales: Held for sale 0 0 0 0 Held to maturity 0 0 0 0 ------------ ---------- ------------ ------------ Total $ 32,659,295 $ 59,534 $ (7,980) $ 32,710,849 ============ ========== ============ ============
Cost or Gross Gross Proceeds Amortized Realized Realized from Year ended December 31, 1999 Cost Gains Losses Sale ------------------------------- ------------ ---------- ------------ ------------ Scheduled principal repayments, calls and tenders: Held for sale $ 1,430,000 $ 0 $ 0 $ 1,430,000 Held to maturity 31,037,532 16,480 (21,722) 31,032,290 Sales: Held for sale 0 0 0 0 Held to maturity 0 0 0 0 ------------ ---------- ------------ ------------ Total $ 32,467,532 $ 16,480 $ (21,722) $ 32,462,290 ============ ========== ============ ============
The fair values of mortgage loans are estimated using discounted cash flow analyses and interest rates being offered for similar loans to borrowers with similar credit ratings.
7. REINSURANCE Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies.
Currently, the Company is utilizing reinsurance agreements with Business Mens’ Assurance Company, (“BMA”) and Life Reassurance Corporation, (“LIFE RE”) for new business. BMA and LIFE RE currenty hold an “A” (Excellent), and “A++” (Superior) rating, respectively, from A.M. Best, an industry rating company. The reinsurance agreements were effective December 1, 1993, and cover all new business of the Company. The agreements are a yearly renewable term (“YRT”) treaty where the Company cedes amounts above its retention limit of $100,000 with a minimum cession of $25,000.
Shown in thousands ----------------------------------------------- 2000 1999 1998 Premiums Premiums Premiums Earned Earned Earned -------------- ------------- ------------- Direct $ 22,970 $ 25,539 $ 30,919 Assumed 76 20 20 Ceded (3,556) (3,978) (4,543) -------------- ------------- ------------- Net premiums $ 19,490 $ 21,581 $ 26,396 ============== ============= =============
Under the insurance guaranty fund laws in most states, insurance companies doing business in a participating state can be assessed up to prescribed limits for policyholder losses incurred by insolvent or failed insurance companies. Although the Company cannot predict the amount of any future assessments, most insurance guaranty fund laws currently provide that an assessment may be excused or deferred if it would threaten an insurer’s financial strength. Mandatory assessments may be partially recovered through a reduction in future premium tax in some states. The Company does not believe such assessments will be materially different from amounts already provided for in the financial statements.
On April 26, 1999, the above lawsuit was filed against Universal Guaranty Life Insurance Company on behalf of the two named individuals. The plaintiffs were former insurance salesmen of United Trust Assurance Company (merged into UG in 1992). The plaintiffs are alleging that their employment status was as an employee rather than an independent contractor and allege violation of various employment laws. The plaintiffs are seeking class action status and judgement for fair and reasonable employee benefits. Class status was certified on October 26, 2000.
UG believes it has no liability to the plaintiffs or other potential class members, has taken a meritorious position, and intends to defend the lawsuit vigorously. During the fourth quarter of 2000, the Company established a liability of $500,000 to cover estimated legal costs associated with the defense of this matter.
UTG paid FCC $750,000, $600,000 and $0 in 2000, 1999 and 1998, respectively for reimbursement of costs attributed to UTG.
On January 1, 1993, FCC entered an agreement with UG pursuant to which FCC provides management services necessary for UG to carry on its business. UG paid $6,061,515, $6,251,340 and $8,018,141 to FCC in 2000, 1999 and 1998, respectively.
ABE pays fees to FCC pursuant to a cost sharing and management fee agreement. FCC provides management services for ABE to carry on its business. The agreement requires ABE to pay a percentage of the actual expenses incurred by FCC based on certain activity indicators of ABE business to the business of all the insurance company subsidiaries plus a management fee based on a percentage of the actual expenses allocated to ABE. ABE paid fees of $371,211, $392,005 and $399,325 in 2000, 1999 and 1998, respectively under this agreement.
Following necessary regulatory approval, on December 29, 1999, UG was the survivor to a merger with its 100% owned subsidiary, USA. The merger was completed as a part of management’s efforts to reduce costs and simplify the corporate structure.
C. CONVERTIBLE NOTES On July 31, 1997, UTG issued convertible notes for cash in the amount of $2,560,000 to seven individuals, all officers or employees of UTG. The notes bear interest at a rate of 1% over prime, with interest payments due quarterly and principal due upon maturity of July 31, 2004. The conversion price of the notes are graded from $12.50 per share for the first three years, increasing to $15.00 per share for the next two years and increasing to $20.00 per share for the last two years. On March 1, 1999, First Southern Bancorp, Inc., an affiliate of First Southern Funding, LLC, acquired all the outstanding UTG convertible notes from the original holders. Pursuant to an agreement, First Southern Bancorp, Inc. converted the notes to 204,800 shares of UTG common stock on July 31, 2000.
D. SHARES ACQUIRED BY FSF AND AFFILIATES WITH OPTIONS GRANTED On November 20, 1998, First Southern Funding LLC, a Kentucky corporation, (“FSF”) and affiliates acquired 929,904 shares of common stock of UTG from UTG and certain UTG shareholders. As consideration for the shares, FSF paid UTG $10,999,995 and certain shareholders of UTG $999,990 in cash.
As of December 31, 2000, no options were exercised. At December 31, 2000, UTG common stock had a market value of $6.375 per share.
The following information applies to options outstanding at December 31, 2000:
E. EARNINGS PER SHARE CALCULATIONS The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computations as presented on the income statement.
Diluted EPS Income available to common shareholders and assumed conversions $ (696,426) 4,056,439 $ (0.17) ============= =============== =============
For the year ended December 31, 1998 ------------------------------------------------------- Income Shares Per-Share (Numerator) (Denominator) Amount ------------- --------------- ------------- Basic EPS Income available to common shareholders $ (679,492) 1,726,843 $ (0.39) =============
UTG had stock options outstanding at year end 1999 and 1998 for 451 shares of common stock at $13.07 per share, 105,000 shares of common stock at $17.50 per share that were not included in the computation of diluted EPS because the exercise price was greater than the average market price of the common shares for each respective year presented. UTG had stock options for 231 shares of common stock at $.047 per share, which were included in the calculation of diluted earnings per share for UTG for the year ended December 31, 1999, since they were assumed by UTG in the 1999 merger of UII into UTG. The stock options outstanding for 451 shares, 105,000 shares, and 231 shares all expired during the current year, ending these stock option plans.
UTG had granted stock options to FSF of 1,450,000 which were outstanding as of year end 1998. The option shares under this option are to be reduced by two shares for each share of UTG common stock that FSF or its affiliates purchases from UTG shareholders in private or public transactions after the execution of the option agreement. The option is additionally limited to a maximum when combined with shares owned by FSF of 51% of the issued and outstanding shares of UTG after giving effect to any shares subject to the option. Due to purchases made by FSF during 2000 and the 51% limitation, the number of stock options has been reduced to 19,108 at $15.00 per share. These options were not included in the computation of diluted EPS because the exercise price was greater than the average market price of the common shares for each respective year.
11. NOTES PAYABLE At December 31, 2000 and 1999, the Company had $1,817,169 and $5,917,969 in long-term debt outstanding, respectively. The debt is comprised of the following components:
The original 20-year notes bear interest at the rate of 8 1/2% per annum on $1,817,169 payable semi-annually with a lump sum principal payment due June 16, 2012. During 2000, no retirements were made on the 20-year notes.
D. CONVERTIBLE NOTES On July 31, 1997, UTG issued convertible notes for cash in the amount of $2,560,000 to seven individuals, all officers or employees of UTG. The notes were bearing interest at a rate of 1% over prime, with interest payments due quarterly. The conversion price of the notes were graded from $12.50 per share for the first three years, increasing to $15.00 per share for the next two years and increasing to $20.00 per share for the last two years. On March 1, 1999, First Southern Bancorp, Inc., an affiliate of First Southern Funding, LLC, acquired all the outstanding UTI convertible notes from the original holders. In July of 2000, First Southern Bancorp, Inc. converted the notes in the amount of $2,560,000 to 204,800 shares of UTG common stock.
12. OTHER CASH FLOW DISCLOSURES On a cash basis, the Company paid $373,988, $643,429, and $1,851,386 in interest expense for the years 2000, 1999 and 1998, respectively. The Company paid $(173,500), $557,812 and $15,805 in federal income tax for 2000, 1999 and 1998, respectively.
On December 31, 1999, UTG issued 681,818 shares of authorized but unissued common stock to acquire 100% ownership of North Plaza of Somerset, Inc. (“North Plaza”). North Plaza owns for investment purposes, a shopping center in Somerset, Kentucky, approximately 12,000 acres of timberland in Kentucky, and a 50% partnership interest in an additional 11,000 acres of Kentucky timberland. North Plaza has no debt. The net assets have been valued at $7,500,000, which equates to $11.00 per share for the new shares issued.
As partial proceeds for the acquisition of common stock of UTG during 1998, UTG issued a promissory note of $53,053 due seven years from issue.
13. CONCENTRATION OF CREDIT RISK The Company maintains cash balances in financial institutions that at times may exceed federally insured limits. The Company maintains its primary operating cash accounts with First Southern National Bank, an affiliate of First Southern Funding, LLC, the largest shareholder of UTG. In aggregate at December 31, 2000 these accounts hold approximately $3,295,000 for which there are no pledges or guarantees outside FDIC insurance limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents.
UTG owned 53% of United Trust Group, Inc., (“UTGL99”) an insurance holding company, and UII owned 47% of UTGL99. At the time the decision to merge was made, neither UTG nor UII had any other significant holdings or business dealings. The Board of Directors of each company thus concluded a merger of the two companies would be in the best interests of the shareholders. The merger will result in certain cost savings, primarily related to costs associated with maintaining a corporation in good standing in the states in which it transacts business.
Policy liabilities and accruals (74,427,627) Income taxes payable - current and deferred (2,140,155) Notes payable (3,865,344) Other liabilities (1,521,989) Minority interests (2,699,567) --------------- Net purchase price $ 10,451,455 ===============
17. SUBSEQUENT EVENT Pursuant to the terms of a common stock purchase agreement dated February 13, 2001, First Southern Bancorp, Inc. agreed to purchase 563,215 shares of United Trust Group, Inc. common stock from Larry E. Ryherd and family at a price of $8.00 per share. The purchase price will be payable in the form of $978,226 in cash and a five-year promissory note.
At the March 28, 2001 Board of Directors meeting of United Trust Group, Inc., the Board approved the assignment of First Southern Bancorp, Inc.'s position in the above agreements to UTG. Upon closing of the transactions, UTG will pay $978,226 in cash and issue notes payable totaling $3,816,294 to the sellers. The notes will bear interest at the fixed rate of 7% with principal payments due annually of $763,259 starting one year from the date of closing.
Premiums and policy fees, net $ 6,007,511 $ 5,705,270 $ 5,337,120 $ 4,531,242 Net investment income 3,640,387 3,603,212 3,628,538 3,657,400 Total revenues 9,835,111 9,136,482 8,964,360 8,121,158 Policy benefits including Dividends 6,115,079 5,569,046 4,864,370 4,740,390 Commissions and amortization of DAC and 1,366,288 1,131,407 1,070,869 1,173,088 COI Operating expenses 2,080,905 1,882,088 1,678,571 1,891,810 Operating income (loss) 74,962 392,486 1,198,404 189,701 Net income (loss) 132,461 123,481 883,271 (63,304) Basic earnings (loss) per share 0.05 0.05 0.29 (0.01) Diluted earnings (loss) per Share 0.07 0.07 0.29 (0.00)