During 1994, premiums increased 7% to $223,679,071 from $208,730,840 in 1993. The increase was primarily in the group division which accounted for about 99% of total premiums. Group certificates in force decreased to 102,959 in 1994 from 105,536 in 1993. Certificates issued for new group policies were 31,270 in 1994, down from 36,586 in 1993. Management believes that the health care reform bill activity in 1994 caused many policyholders to remain with their existing coverage and others not to seek new coverage. Also certain new state mandates curtailed some sales in some states, until the Company made certain adjustments to comply with those mandates. Total lapses (net of additions/decreases) in 1994 were 33,847 compared to
Net income tax expense as a percentage of pretax income was 30% in 1994 compared to 23% in 1993. The current portion of the tax, increased to $1,534,817 from $769,833 in 1993. The main reason for the increase in current taxes is the increase in pretax income. The increase in the deferred tax expense is primarily due to the increase in the valuation allowance. Since the Company's recovery rates for prior years were lower than current tax rates a higher valuation allowance is required. Also in the valuation allowance is $1,845,199 recorded directly to shareholders' equity for the net unrealized holding loss, offsetting the same amount shown as a deferred tax asset.
Net income for 1994 was $4,813,761 or $1.14 per share compared to $2,390,349 or $.57 per share in 1993. The increase is primarily due to a 21% increase in investment income, slightly lower benefit loss ratio of 69.4% compared to 69.9% in 1993 and a decrease in the ratio of operating expenses to premiums from 16.1% to 15.4%. Because group accident and health represents 97% of Central's business, investment income and a lower loss ratio from this division has a positive effect on the Company's earnings. Along with an increase in investment income in the group accident and health division, the statutory loss ratio decreased to 67.9% in 1994 from 69.5% in 1993.
In October 1994, the FASB issued SFAS 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments". This statement requires disclosure about derivative financial instruments and amends existing requirements of SFAS Nos. 105 and 107. SFAS 119 is effective for financial statements issued for fiscal years ending after December 15, 1995, for entities with less than $150 million in total assets. However, as of December 31, 1995, the Company does not own nor has it purchased any derivatives as defined in SFAS 119.
We have audited the consolidated financial statements of Central Reserve Life Corporation and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Central Reserve Life Corporation and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
Interest Rate Risk is the risk that interest rates will change and cause a decrease in the value of an insurer's investments. This change in rates may cause certain interest-sensitive products to become uncompetitive or may cause disintermediation. Central attempts to mitigate this risk by charging fees for non-conformance with certain policy provisions and/or by attempting to match the maturity schedule of
its assets with the expected payouts of its liabilities. To the extent that liabilities come due more quickly than assets mature, an insurer would have to sell assets prior to maturity and recognize a gain or loss.
Certain costs, principally commissions, which vary with and are directly related to the production of ordinary life business, have been deferred. The deferred costs are being amortized through the use of factors over the benefit period of the related policies. These factors were developed using assumptions which are consistent with those used in setting rates. Due to the nature of the business and its persistency experience, the Company does not defer acquisition costs for Central's group business. Deferred policy acquisition costs at December 31, 1995 and 1994 were $209,760 and $149,926, respectively. The net amounts amortized to income were $59,834 in 1995, $60,116 in 1994 and $16,849 in 1993.
Included in the $11.6 million for property and equipment is approximately $10 million (net of depreciation) for the home office, of which $1.4 million is for land. Depreciation for the building is primarily over 31.5 years, except for certain components which will be over 15 years. The straight-line method is used.
Liabilities for future policy benefits on ordinary life insurance have generally been provided on a net-level premium method based upon estimates of future investment yield, mortality and withdrawals using Central's
experience and actuarial judgement with an allowance for possible unfavorable deviation from the expected experience. The Company amortizes deferred costs of all ordinary life policies for Central over the benefit period. The liability for future policy benefit reserves has been computed using the following assumptions:
The Company follows SFAS No. 109, "Accounting for Income Taxes". Under the asset and liability method of SFAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The amortized cost and fair value of securities held to maturity and available for sale as of December 31, 1995 are as follows. The estimated fair value is based on quoted market prices, where available, or on values obtained from independent pricing services.
The amortized cost and estimated fair value of securities held to maturity and available for sale as of December 31, 1994 are as follows. The fair value is based on quoted market prices, where available, or on values obtained from independent pricing services.
At December 31, 1995 cash includes approximately $3.1 million held for self-funded accident and health accounts, which is restricted as to its use. A corresponding amount is included in liabilities in the accompanying consolidated financial statements.
At December 31, 1995 Central had certificates of deposit and fixed maturities on deposit with various state insurance departments, carried at $3,392,004, for the protection of policyholders.
The following table reflects the activity in the liability for Other Policy Claims and Benefits Payable, including the claims adjustment expenses (CAE) as follows:
regulatory authorities when (i) any such dividend is proposed to be paid from other than earned surplus (as defined in the applicable statute) or (ii) the value of any such dividend, together with the value of other dividends paid or distributions made within the preceding 12 months, exceeds the greater of (a) ten percent of the insurer's surplus as regards policyholders as of the 31st day of December next preceding the dividend payment, or (b) the net income of such insurer for the 12-month period ended the December 31st next preceding the dividend payment.
Shareholders' capital and surplus and net income as determined in accordance with statutory accounting practices for Central differ from GAAP. Following is a reconciliation showing those differences.
In December 1992, the National Association of Insurance Commissioners (NAIC) adopted the Life Risk-Based Capital (RBC) formula. This model act requires every life and health insurer to calculate its total adjusted capital and RBC requirement, and provides for an insurance commissioner to intervene if the insurer experiences financial difficulty. The formula includes components for asset risk, liability risk, interest rate exposure and other factors. The RBC requirement is for statutory financial statements and was effective
the proposed deficiency and management believes existing law supports the Company's position. Therefore, the Company has not recorded a liability for the difference.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1995 and 1994 are presented below:
The Company establishes a valuation allowance based on its analysis (scheduling) of future deductible amounts. A valuation allowance is currently established to the extent future deductible amounts cannot offset future taxable amounts or recover Federal income taxes paid within the statutory carryback period. Fluctuation in the valuation allowance is attributed to changes in the effect of the small life insurance company deduction and to a 100% valuation allowance on the deferred tax benefits on the net unrealized holding loss at December 31, 1994 and no valuation allowance applicable to the deferred tax expense on the net unrealized holding gain at December 31, 1995.
The Company executed a note payable, in December 1990, for $9,000,000 bearing interest at 9 1/2% per annum for 10 years. The Company received $8,500,000 of the funds in December 1990 and the remaining $500,000 in December 1991. The mortgage note is collateralized by the home office building and by an assignment of the tenant lease for the building. The Company has been required to make monthly payments, since January 1991, based on a 30 year amortization schedule, of $75,677 for 10 years. After five years, the
Company has the right to prepay the loan with a 3% prepayment fee. Principal payments due in the next five years, assuming no prepayments, are $95,291 in 1996, $104,748 in 1997, $115,145 in 1998, $126,572 in 1999 and $139,134 in 2000.
The maximum amount of exposure that Central retains on any life is $50,000 on ordinary life and $25,000 on group life on ages through 70. No retention is maintained over age 70. Maximum retention on impaired risks is $10,000. Central also has reinsurance on group accident and health claims. Effective January 1, 1995, Central's reinsurance treaty provides that all individual claims in excess of $500,000 are 100% reinsured. The overall effect of reinsurance is not material to the Company's financial condition. Reinsurance treaties in effect at December 31, 1995 were with The Cologne Life Reinsurance Company, Life ReAssurance Corporation of America and Business Men's Assurance Company.
The exercise price of options outstanding at December 31, 1995, were $2.83 and $6.75 per share and those options expire in 1997 and 1998.
The Company adopted a noncontributory pension plan in 1978. The plan is a defined contribution money purchase pension plan with an outside company, covering substantially all full-time employees of age 20 1/2 or more who have completed six months or more of service. Participants in the plan begin vesting after two years of service and are fully vested after seven years. The contribution was approximately $1,137,000 for 1995, $1,013,000 for 1994 and $1,000,000 for 1993.
In addition to the Company's defined contribution pension plan, the Company, beginning in 1995, sponsors a retiree health benefit program for certain officer-class employees who meet specified age and service criteria. The Company and, as applicable, eligible retirees, fund the payment of benefits under the program in amounts and at such times as claims are incurred. Benefits for under age 65 retirees are based on continuation of prevailing active employee health coverage, and for over age 65 retirees are based on reimbursement of expenses for Medicare Part B and a Medicare Supplement Insurance Policy. The Company and, as applicable, eligible retirees, fund the payment of benefits under the program in amounts and at such times as premium payments or reimbursement of premium payments are incurred.
The assumed annual health care cost trend rate used to measure the expected cost of benefits under the program is initially 10%, declining by approximately 1% per annum to an ultimate assumed trend rate of 5% in the year 2003.
These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Although fair value estimates are calculated using assumptions that management believes are appropriate, changes is assumptions could cause these estimates to vary materially. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in the immediate settlement of the instruments. SFAS 107 excludes certain assets and liabilities from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
INVESTMENT SECURITIES: Fair value for fixed maturity securities is based on quoted market prices, where available. For fixed maturity securities not actively traded, fair value is estimated using values obtained from independent pricing services or, in the case of private placements, is estimated by discounting expected future cash flows using a current market rate applicable to the yield, credit quality and maturity of the investments.
CASH, SHORT-TERM INVESTMENTS, PREMIUMS RECEIVABLE AND POLICY LOANS: The carrying amount reported in the balance sheets for these instruments approximate their fair value.
The following is a summary of quarterly results of operations for the years ended December 31, 1995 and 1994.