BNLF leases approximately 1,400 square feet of office space in Sherwood, Arkansas at a rental of $19,500 per year and the lease will expire June 30, 2012. BNLAC incurs 100% of the rental expense.
In this section, we review the consolidated financial condition of the Company at December 31, 2009, 2008 and 2007 and the consolidated results of operations for the periods ended December 31, 2009, 2008 and 2007. Please read this discussion in conjunction with the accompanying consolidated financial statements and notes.
It should be understood that there is no assurance that anything which the Company and its management have done in the past regarding its claim liability methodology will be done in the future. The Company and its management are afforded full and complete authority and judgment in determining and implementing its claim liability methodology which includes any and all changes which may be made from time to time.
The liability for claims generally consists of the following: (1) due and unpaid claims, (2) claims in the course of settlement, and (3) claims incurred but unreported. The Company records the actual liability for all claims that are due but unpaid, Item (1). But, with regard to the last Items (2) and (3), the Company must make estimates. The estimates are based on actuarial principles. The Company’s independent consulting actuary works with Company financial personnel and management in determining the estimates and the independent consulting actuary annually gives the Company a certification as to the amounts of the liabilities.
For the Company’s group and individual life and annuity insurance, the Company’s financial personnel make the Single Point Estimate for each such claim liability. Annually, the Company’s consulting actuary independently reviews the Single Point Estimates. If the independent consulting actuary agrees with the Single Point Estimates, he gives a certification to the Company.
As to the consistency of the Company’s estimation of its claim liabilities (the policy claims payable on the Company’s balance sheet), you may reference Notes 7 and 11 to the Company’s Financial Statements. Notes 7 and 11 present data indicating the actual claims paid in a subsequent fiscal year for a prior fiscal year; actual claims incurred in a subsequent year for a prior fiscal year; and the claim liabilities for the prior fiscal year. Notes 7 and 11 are limited to the most recent fiscal year being reported, December 31, 2009, and the previous fiscal years of 2008 and 2007.
The Company reinsures a substantial portion of its life insurance and the associated risks and liabilities. See Item 1, Business, Reinsurance; and Note 8, Reinsurance, to the Company’s financial statements.
The discussion in this paragraph relates to the months where the completion factors are deemed to be fully credible which are typically the months prior to November and December. The completion factors have been relatively stable in the recent past. In the future, there could be changes in the trend of completion factors. The Company and its independent consulting actuary review the trends in the completion factors and when necessary make judgments as to the Single Point Estimate value for these items. Such estimates are based on observable trends and would also reflect any known major changes. Professional judgments are made based on the experience of the actuary and Company’s financial personnel and management. To observe the possible sensitivity of assuming 100% reliance on completion factors for claims incurred during the months for which completion factors are believed to be fully credible, if the associated claim liabilities for those months had increased by 5%, the year-end December 31, 2009, claim liabilities would have been increased by approximately $14,000.
At December 31, 2009 and 2008, respectively, the Company had gross deferred tax assets of $1,037,858 and $1,067,931 with corresponding valuation allowances of $683,058 and $701,414, and gross deferred tax liabilities of $248,800 and $269,517, resulting from net operating loss carryovers and temporary differences primarily related to the life insurance subsidiary. The valuation allowance is primarily due to statutory limitations on the use of net operating losses and uncertainty as to usage of AMT credit carryover. The resulting net deferred tax asset at December 31, 2009 is $106,000 compared to a deferred tax asset of $97,000 at December 31, 2008. Realization of the deferred tax asset is dependent on generating sufficient taxable income prior to expiration of the loss carry forward. Although realization is not assured, management believes it is more likely than not that all of the net deferred tax asset will be realized. However, the amount of the deferred tax asset considered realizable could be reduced in the near term if estimates of future taxable income during the carry forward period are reduced.
The reconciliation of income taxes computed at the federal statutory income tax rate to total income taxes for the years ended December 31, 2009, 2008 and 2007 is as follows:
The Company had a net increase in cash and cash equivalents of $3,100,722 in 2009 compared to an increase of $51,398 in 2008. The increase in 2009 was primarily from cash flow from operations, the sale and maturity of investments and a decrease in the amount of fixed maturity securities purchased.
Approximately $146,720 of the bond portfolio is classified as Available for Sale and carried on the Balance Sheet at market value with the unrealized gain or loss recorded in the surplus section of the Balance Sheet. The bonds are auto industry bonds. The Company may sell these bonds before they mature.
Approximately $18.4 million of the bond portfolio is classified as Held to Maturity and is carried on the Balance Sheet at amortized cost. This classification reflects management's ability and intent to hold the bonds until maturity. No adjustments to surplus are made as bond values change unless declines in market value are deemed to be other than temporary.
The table below details the unrealized gains and losses on the "Held to Maturity" bonds.
In the third quarter of 2009 the Company recognized an other-than-temporary impairment on its $100,000 Cit Group Inc. bond, for a realized loss of $42,280. Cit Group Inc. filed for chapter 11 bankruptcy on November 1, 2009. On December 8, 2009 the Company received $71,952 par value Cit Group Inc. bonds and 619 shares of Cit Group Inc. stock with a book value of $17,091, all in exchange for the $100,000 CIT Group Inc. bond.
Other long-term investments also include an operating line of credit agreement in the amount of $27,215 and $71,784 in 2009 and 2008 respectively. The agreement provided EPSI with a $200,000 line of credit maturing August, 2011. The line of credit is at 8.00% with interest and principal payable monthly to BNLAC and is current.
On November 5, 2001 the Company’s Board of Directors approved a settlement of the class action lawsuit (see "Legal Proceedings"). One term of the settlement was the issuance of Company bonds in the principal amount of $1.50 in exchange for each share of the Company’s common stock owned by the members of the class. The Arkansas Insurance Commissioner has reviewed and approved the settlement. The bonds have a 12-year term and bear interest at the rate of 6% per annum, effective December 15, 2002 payable annually from the previous fiscal year’s earnings. The total principal amount of bonds payable at December 31, 2009 is $1,323,388 compared to $1,443,282 at December 31, 2008. Bond interest expense was $82,317, and $93,536 in 2009 and 2008; respectively. BNLAC will pay dividends to BNL Financial Corporation for the payment of interest to the bondholders if permissible under Arkansas insurance laws. The maximum amount of dividends which can be paid by Arkansas domiciled insurance companies to shareholders without prior approval of the insurance commissioner is subject to restrictions relating to statutory surplus. The Company does not expect the dividend restrictions to impact its ability to meet its cash needs. The Company has no plan to start a sinking fund for payment of the principal at maturity.
In 2009, BNLAC paid dividends totaling $800,000 to BNLF for the payment of dividends to the Company’s shareholders and for other general operating funds compared to $1,300,000 dividends paid in 2008 for the payment of dividends to the Company’s shareholders and for other general operating funds.
The following table reflects all long-term contractual obligations of the Company as of December 31, 2009.
In calculating the payments above, BNLAC used models of the business created for statutory asset adequacy analysis. The modeled life block was assumed to surrender for its reserve at the end of 20 years. Health blocks tested were projected using approximate means beyond 20 years. Payments on blocks not initially modeled were projected on an approximate basis. The total estimated future payments to be made relating to the Liability for Future Policy Benefits is stated as $8,367,699 which does not match the balance sheet liability total of $2,143,273 and the difference is $6,224,426. This is primarily due to the fact that the estimated future payments presented in the long term contractual obligations table for Future Policy Benefits includes consideration for future premiums, investment income and maintenance expenses and such assumptions, and perhaps other assumptions, may differ from the assumptions initially used to establish the balance sheet liability. The estimated future payments presented in the long term contractual obligations table are based on current assumptions while the balance sheet liability is based on assumptions locked in at the date the policy was approved for issue. Assumptions for estimating future payments are made regarding such items as interest earnings, mortality, morbidity, and persistency. It is likely that the actual experience will deviate from these assumptions - sometimes materially. A number of factors can have an effect such as economic conditions, changes in policyholder actions regarding premium payments and withdrawals, mortality and morbidity improvement or deterioration, and inflation. Random fluctuation in experience could also have an effect. The determination of the amount of the future payments is based upon estimates and the timing and amount of future payments is not always reasonably fixed and determinable. Because of the above considerations, the amounts and timing of future payments will likely vary from that presented in the above table.
In calculating the payments above, BNLAC used models of the business created for statutory asset adequacy analysis. The modeled annuity block was assumed to surrender for its reserve at the end of 20 years. The total estimated future payments to be made relating to the Annuity Deposits liability is stated as $4,816,978 which does not match the balance sheet liability total of $2,505,778 and the difference is $2,311,200. The balance sheet Annuity Deposit liability represents such items as deposits, premiums, investment income, expenses, and withdrawals which have already occurred while the total estimated future payments presented in this long term contractual obligations table are estimated using assumptions for future occurrences of such factors and other factors. The estimated future payments are based on many significant assumptions regarding future occurrences such as future premium payments, interest earnings, mortality, and persistency. It is likely that the actual experience will deviate from these assumptions - sometimes materially. A number of factors can have an effect such as economic conditions, changes in policyholder actions regarding annuity deposits and withdrawals, mortality improvement or deterioration, and inflation. Random fluctuation in experience could also have an effect. The determination of the Annuity Deposit estimated future payments is based upon estimates and the timing and amount of estimated future payments is not always reasonably fixed and determinable. Because of the above considerations, the amounts and timing of estimated future payments will likely vary from that presented in the above table.
The total estimated future payments to be made relating to the Supplementary Contracts without life contingencies liability is stated as $31,347 which does not match the balance sheet liability total of $36,791 and the difference is $(5,444). This is primarily due to the fact that the estimated future payments in this long term contractual obligations table for Supplementary Contracts includes consideration of future investment income, withdrawals (if permitted) and maintenance expenses and such assumptions, and perhaps other assumptions, may differ from the assumptions initially used to establish the balance sheet liability. The estimated future payments presented in the long term contractual obligations table are based on current assumptions while the balance sheet liability is based on assumptions locked in at the date the policy was approved for issue. The estimated future payments are based on many significant assumptions regarding future occurrences such as interest earnings, mortality, and persistency. It is likely that the actual experience will deviate from these assumptions - sometimes materially. A number of factors can have an effect such as economic conditions, changes in policyholder actions regarding withdrawals (if allowed), and mortality improvement or deterioration. Random fluctuation in experience could also have an effect. The Supplementary Contracts estimated future payments are based upon estimates and the timing and amount of future payments is not always reasonably fixed and determinable. Because of the above considerations, the amounts and timing of estimated future payments will likely vary from that presented in the above table.
Premium income was $41,609,604 in 2009, $43,456,024 in 2008 and $44,564,173 in 2007. The decrease in 2009 and 2008 was due to a decrease in group and individual insurance premiums. New sales of dental insurance were down in 2009 and 2008 primarily as a result of the impact of the recession on voluntary employee benefits. This is reflected in the $790,000 decrease in first year group dental premium in 2009 and a decrease of $650,000 in 2008.
The Company receives marketing fees from EBI in accordance with a marketing agreement entered into in 2001. The Company received marketing fees of $25,000 in 2009, $0 in 2008 and $198,843 in 2007. Receipt of marketing fees resumed in 2009. By mutual agreement, EPSI ceased paying the Company marketing fees in 2008 due to the termination of one of its largest customers.
The Company has a $1,357,407 convertible debenture loan investment (“Debenture”) at 14% to EPSI Benefits, Inc. (“EBI”) that was scheduled to mature August 15, 2015. Monthly principal payments were scheduled to begin on September 15, 2008, however on July 14, 2008, the Company and EBI, amended the Debenture whereby the monthly principal payments will start on September 15, 2013 with the maturity date extended to August 15, 2020. Because of the extension of the commencement of principal payments and maturity of the Debenture, the Company was required to establish an allowance for credit losses in the amount of $204,582, which is part of the realized loss in 2008.
Policy benefits and other insurance costs decreased from $33,496,995 in 2007, to $32,978,610 in 2008 and to $31,805,555 in 2009. The decrease in 2009 was primarily due to an approximately $882,000 decrease in claims expense, $146,000 of which resulted from an overestimation of claims payable at December 31, 2008 and the decrease of policies in force. The decrease in 2008 was primarily due to an approximately $454,000 decrease in claims expense, $390,000 of which resulted from an overestimation of claims payable at December 31, 2007. The claims ratio on group dental insurance, which represents the ratio of claims incurred to premium earned, was 62.2% in 2009, 61.9% in 2008 and 61.8% in 2007.
Amortization of deferred policy acquisition costs was $30,308 in 2009, $40,564 in 2008 and $16,060 in 2007. Amortization of deferred policy acquisition costs are primarily costs associated with a seasoned block of business written between 1988 and 1990. Amortization expense per year may vary in relation to lapses or surrenders of the existing block of business.
In 2009, the consolidated income from operations before taxes was $3,415,226 compared to $2,961,311 in 2008 and $4,263,002 in 2007. The increase in 2009 was primarily due to the increase in realized gains and decrease in operating expenses. The decrease in 2008 was primarily due to the decrease in premium income and investment income and the increase in realized losses on fixed maturities.
The provision for income taxes was $597,381 in 2009, $594,839 in 2008 and $813,634 in 2007. For the periods ended December 31, 2009, 2008 and 2007, the Company had $647,381, $663,441 and $773,033 of current tax expense and $50,000 and $68,602 of deferred tax credit in 2009 and 2008 and $40,601 of deferred tax expense for 2007. Fluctuations in tax expense are primarily due to changes in taxable income, limitations on net operating losses utilized and adjustments in estimates for income taxes in prior years.