The Company's 2002 net loss was $2,572,000 compared a net loss of $6,206,000 in 2001 and net income of $238,000 in 2000. Comprehensive losses (which combine net losses and net unrealized gains and losses) were $2,105,000, $2,875,000, and $4,658,000 for 2002, 2001, and 2000, respectively. During 2002, the Company continued to be adversely affected by declining equity markets along with declining interest yields on its fixed income investment portfolio. The majority of the 2001 and 2000 declines in net income and the comprehensive losses were attributable to adverse securities markets during those years, including the effects of declines in the telecommunications and technology sectors, a general economic recession and terrorist events.
On July 7, 2000, the Company acquired, through an assumption reinsurance agreement, 100% of the inforce business of National Affiliated Investors Life Insurance Company ("NAIL") for a net cash purchase price of approximately $355,000 (the "NAIL Acquisition"). The acquisition was coordinated through the National Organization of Life and Health Guaranty Associations. The acquired business consists primarily of individual life insurance business with policy reserves and annual premium of approximately $3,500,000 and $300,000, respectively.
On October 14, 1999, the Company acquired 100% of the stock of Citizens Insurance (formerly Kentucky Insurance Company) from an unaffiliated insurance holding company (the "Citizens Insurance Acquisition"). Citizens Insurance is licensed as a property and casualty insurance company in six states and has approximately $3.6 million of statutory capital and surplus; however, it currently has no insurance operations. The aggregate purchase price for the
Citizens Insurance Acquisition was approximately $3,550,000 (including net costs associated with the transaction of approximately $50,000).
Standard & Poor's Corporation Rating Amortized Cost 1 Fair Value 2 -------------------------------------- ----------------- --------------- Investment grade: AAA to A- $ 80,102,193 $ 83,103,323 BBB+ to BBB- 15,852,485 16,054,042 -------------------------------------- ----------------- --------------- Total investment grade 95,954,678 99,157,365 Non-investment grade: BB+ to BB- 2,651,515 2,589,976 B+ to B- 1,431,094 1,282,473 CCC+ to C 658,941 461,650 CI to not rated 464,946 462,351 -------------------------------------- ----------------- --------------- Total non-investment grade 5,206,496 4,796,450 -------------------------------------- ----------------- --------------- Total fixed maturities $101,161,174 $103,953,815 -------------------------------------- ----------------- ---------------
Non-Investment Grade December 31, 2002 Amortized Cost Fair Value ------------------------------- ------------------- ------------------ Largest $507,176 $525,000 Second largest 449,643 267,486 Third largest 408,411 390,000 Fourth largest 387,727 385,084 ------------------------------- ------------------- ------------------ Total $1,752,957 $1,567,570 ------------------------------- ------------------- ------------------
The Company reviews its marketable investments each quarter to determine if there have been declines in their value that in management's opinion are other-than-temporary. These reviews can involve qualitative and quantitative information relating to an individual company or industry and general factors impacting the economy. However, due to wide market fluctuations occurring during the past two years, determining whether declines are temporary has become much more complex and judgmental. These reviews resulted in the recognition of impairment losses on equity securities totaling $754,000 during 2002 ($141,000, $315,000, $250,000 and $48,000 for the first through fourth quarters, respectively). In addition, $501,000 of impairment losses were recognized on fixed maturities during 2002 ($133,000, $88,000, and $280,000 during the second, third, and fourth quarters, respectively). During 2002, equity securities were sold which contained impairment writedowns of $1,531,000.
Citizens Security owns the building in which the Company and its subsidiaries maintain their home offices. They occupy approximately 31% of the building with the balance leased to third-party tenants. Market conditions for this property are generally favorable. An updated appraisal obtained during 2002 indicates the market value of the property is approximately $2,500,000 higher than its carrying value.
At December 31, 2002 the Company has recorded $756,000 of goodwill and $13,533,000 of other intangible assets for deferred policy acquisition costs and value of insurance acquired. As noted in the above discussion of critical accounting policies and estimates, these intangibles, and the recorded value of policy liabilities, are based on many assumptions that require substantial estimates and judgment. In connection with adoption of SFAS No. 142, the Company reassessed the assumptions supporting these values. Although no impairment was considered necessary, a continued historically low interest rate environment could require adjustment of these recorded values.
Home Service Life sales have been favorable in recent years, with net growth in policy liabilities of 4.2% and 3.4% in 2002 and 2001, respectively, through a combination of attracting new producers and continuing to focus on meeting the needs of existing customers and agents. The Broker Life segment's 2002 policy liability net increase of $640,000 resulted primarily from normal aging of existing reserves. A significant portion of the $217,000 decrease in Broker Life policy liabilities during 2001 relates to expiration of a withdrawal waiting period for the NAIL business acquired during 2000. During 2002 and 2001, the Company increased Preneed Life production through arrangements with several third party marketing groups and its internal marketing organization, with significant growth occurring in Ohio, Pennsylvania, Kentucky, Indiana, and North Carolina. A significant portion of this growth consists of single premium policies whereby individuals are fully funding their funeral costs. Due to the lower interest rate environment, the Company has reduced the rate of annual increases in benefit amounts and is in the process of reducing some agent commission schedules. Accordingly, depending on competitor responses, future business growth could be adversely impacted. The Company's Dental products are annual term coverages; accordingly, policy liabilities for this segment are not significant. The Other Health segment business is not a significant marketing focus.
Shown below is a progression of the Company's policyholder deposit activity for the year ended December 31, 2002.
As indicated above, total policyholder deposits decreased by a net $174,000 during 2002. The Company is not devoting significant marketing effort towards Annuity, Universal Life and other deposit products and has elected not to aggressively compete in crediting excess interest on such products.
Year Ended December 31 2002 2001 2000 ------------------------- ---------------- --------------- --------------- Home Service Life $7,334,030 $7,152,242 $6,906,473 Broker Life 3,621,053 3,812,841 3,664,072 Preneed Life 17,993,645 8,397,911 3,982,948 Dental 8,182,483 7,988,620 7,892,356 Other Health 1,347,939 1,392,762 1,376,575 ------------------------- ---------------- --------------- --------------- Total $ 38,479,150 $ 28,744,376 $ 23,822,424 ------------------------- ---------------- --------------- ---------------
Home Service Life premium increased 2.5% and 3.6% during 2002 and 2001, respectively. New sales levels continue to be favorable, at levels which more than exceed normal policy lapses. The Company continues to attract a number of successful, experienced Home Service agents without subsidizing inexperienced agents. In addition, the Company's program to automate and streamline agent field accounting continues to expand with favorable reaction among the agency force. During early 2003 the Company terminated a small Home Service marketing joint venture in two southern states with a much larger property and casualty insurance carrier. To mitigate effects of the lower interest rate environment, during the second quarter of 2003 the Company will be introducing premium rate increases on its Home Service products.
The 5% decrease in Broker Life premium during 2002 resulted from reduction of business provided by certain larger brokers during 2002 and continuing pressure from the overall economic slowdown on middle and lower-income consumers. The
The 2.4% growth in Dental premium during 2002 resulted primarily from normal inflationary increases, while the 1.2% growth during 2001 was impacted by loss of a large group case. During the past two years, new business production has become increasingly competitive as larger providers expand their marketing initiatives. However, the Company has historically maintained strong customer and agent loyalty by continuing to improve customer service, including sales and administrative support functions.
Investments. The Company monitors its available-for-sale fixed maturities and equity securities to assure they are strategically positioned within the current market environment. This practice has historically resulted in holding significant equity security positions, which tend to dampen current income yields in favor of an overall total return focus. The Company's equity securities comprised 6.5% and 8.6% of its total investment portfolios at December 31, 2002 and 2001, respectively. The Company's investment income yields were 4.8%, 5.6%, and 4.9% for 2002, 2001, and 2000, respectively. The 2002 yield decline resulted primarily from substantially lower interest rates on new investments and the Company's 33% net addition to its fixed maturity portfolio during the year, much of which is attributable to additional Preneed Life business. The 2001 yield increase resulted primarily from carrying significantly lower levels of equity securities and higher levels of fixed maturity investments. Although the Company's total return on investments has historically been very favorable, returns for the past three years have been severely impacted by declines in the telecommunications and technology sectors, a general economic recession and the effect of terrorist events on the securities markets. As detailed below, net realized and unrealized investment losses totaled approximately $(11,953,000) for the three years ended December 31, 2002, while net realized and unrealized gains totaled approximately $14,200,000 for the two years ended December 31, 1999. The Company does not anticipate continued severe deterioration in the securities markets, although some additional losses on fixed income securities may occur if the overall economic slowdown continues. At December 31, 2002, the Company's investment portfolios are somewhat more conservatively positioned compared to prior years, and they contain a net unrealized gain outstanding of $3,446,000. Below is an approximate calculation of investment income yields and total return rates for the five years ending December 31, 2002.
During 2002, the Company's investment income yield declined approximately 73 basis points. Accordingly, since the Company allocates investment income to each business segment based on average net policy reserves, each of the three life insurance segments were adversely impacted by investment yields during 2002. In addition, the 2002 Home Service Life profit was adversely impacted by increased mortality, partially offset by lower expenses, while 2001 profit benefited from sales growth and improved mortality results. The 2002 Broker Life earnings decrease resulted primarily from the lower investment yield while the 2001 decrease resulted primarily from increased mortality and expenses. The 2002 Preneed Life loss resulted from lower investment yields, unfavorable mortality,
Statutory Insurance Information. For insurance regulatory and rating purposes, the Insurance Subsidiaries report on the basis of statutory accounting principles ("SAP"). As described in Note 8 of the Notes to Consolidated Financial Statements, effective January 1, 2001 portions of SAP were revised by a process called "Codification". In recent years, various state insurance departments and the NAIC have expressed concern, essentially about the "rate of return" earned by holders of small face amount life policies, potentially including Preneed policies. Although the Company does not believe calculating a simple "rate of return" or premium "pay-back" measure is meaningful for traditional life insurance products, certain state insurance regulators are considering actions that could alter the profitability of existing contracts or eliminate small face amount policies as a viable product offering. During 2002, A.M. Best Company ("Best") affirmed Citizens Security's B- rating. This rating was previously lowered from a B in 2001. United Liberty's rating has remained at B- by Best since it was acquired in 1998, and Citizens Insurance, due to its lack of insurance operations, is not rated.
1 Asset Valuation Reserves are statutory liabilities that act as contingency reserves in the event of extraordinary losses on invested assets and as a buffer for policyholders' surplus to reduce the impact of realized and unrealized investment losses. The 1998 through 2002 amounts also include United Liberty's asset valuation reserves. 2 Represents Statutory Capital and Surplus plus Asset Valuation Reserves divided by invested assets plus cash.
During 2002, statutory capital and surplus and asset valuation reserves increased approximately $101,000. This increase resulted primarily from the $2,000,000 issuance of preferred stock described above, net of the $1,184,000 net loss for the year and $950,000 of unrealized losses. During 2001, statutory capital and surplus and asset valuation reserves increased approximately $760,000. This increase resulted primarily from the Citizens Insurance capital contribution noted above, plus $1,082,000 of unrealized gains offsetting the $3,498,000 net loss and a $572,000 increase in nonadmitted assets. During 2000, statutory capital and surplus and asset reserves decreased by approximately $7,413,000. This decrease resulted primarily from $1,869,000 of statutory net income offset by $7,875,000 of unrealized losses and a $1,200,000 redemption of Citizens Security's preferred capital stock. During 1999, statutory capital and surplus and asset reserves increased by approximately $2,443,000. This increase resulted primarily from $4,946,000 of statutory net income offset by a $1,200,000 redemption of preferred capital stock, and a $1,000,000 shareholder dividend paid. During 1998, statutory capital and surplus and asset reserves increased by approximately $2,454,000. This increase resulted primarily from $3,662,000 of statutory net income offset by a $1,500,000 redemption of preferred capital stock, along with unrealized investment gains.
In addition to the statutory totals shown above, Citizens Insurance generated statutory net income of approximately $63,000, $76,000, and $93,000 during, 2002, 2001, and 2000, respectively without remitting any dividends to its parent.
value of the Company's equity portfolio was approximately $7,762,000 and $8,117,000 at December 31, 2002 and 2001, respectively. Accordingly, a 10% decline in equity prices would have reduced the fair value of the Company's equity portfolio by $776,200 and $811,700 at December 31, 2002 and 2001, respectively. The average cost value of the Company's equity portfolio was $6,967,000 and $9,737,000 during 2002 and 2001, respectively.
Regarding interest rate risk, the value of the Company's fixed-maturity investment portfolio will increase or decrease in an inverse relationship with fluctuations in interest rates while net investment income earned on newly-acquired fixed-maturities increases or decreases in direct relationship with interest rate changes. Management estimates that a 100 basis point increase in interest rates ("rate shock") would have decreased the fair value of its $104.0 million fixed maturity portfolio by approximately 3.2% or $3.3 million at December 31. 2002 and 2.8% or $2.2 million at December 31, 2001. From an income perspective, the Company does not believe rising interest rates present a significant risk, as essentially all of the Company's policy liabilities bear fixed rates. However, approximately 45% of policy liabilities contain provisions permitting interest or benefit adjustments at the discretion of the Boards of Directors of the Insurance Subsidiaries. The Company's cash flow testing (described below) indicates that overall profitability will generally be enhanced in rising interest rate scenarios. From a liquidity perspective, the Company's fixed rate policy liabilities have been relatively insensitive to interest rate fluctuations. Accordingly, the Company believes gradual increases in interest rates do not present a significant liquidity exposure. The Company monitors economic conditions on a regular basis and manages this interest rate risk primarily by adjusting the duration of its fixed-maturity portfolio. Historically, the Company has maintained conservative durations in its fixed-maturity portfolio. At December 31, 2002 cash and fixed-maturity investments with maturities of less than five years equaled approximately 60% of total policy liabilities. Notwithstanding the foregoing, if interest rates rise significantly in a short timeframe, there can be no assurance that the life insurance industry, including the Company, would not experience increased levels of surrenders and reduced sales, and thereby be materially adversely affected.
The Life Insurance Subsidiaries' most recent cash flow testing, which was completed in February 2003, involved a review of two basic measures. The first was the value of free market surplus, which is defined as the difference between the projected market value of assets and liabilities at the end of the analysis period (typically 10-20 years). Deficits could indicate the need for corrective action depending upon the severity and the number of scenarios in which a deficit appeared. A second measure involved distributable earnings. Negative earnings for extended durations might impair the ability of the Life Insurance Subsidiaries to continue without exhausting surplus. Again, depending upon severity and frequency, corrective measures might be needed. Based on results of the testing, no corrective measures were indicated at the current time. However, such testing is ongoing and dynamic in nature and future events in the interest and equity markets or a significant change in the composition of Life Insurance Subsidiaries' business could negatively impact testing results and require the initiation of corrective measures.
Initially balanced durations do not guarantee positive future results. Asset type, quality, and yield will vary depending upon the economic scenario tested. Liabilities will be similarly affected. Projected reinvestment yields may cause overall yields to fall below those required to support projected liabilities. In that event, portfolio realignment might involve the type, quality and yield of investments rather than duration. Alternatively, additional reserve amounts could be allocated to cover any future shortfalls.
All statements, trend analyses and other information contained in this report relative to markets for the Company's products and trends in the Company's operations or financial results, as well as other statements including words such as "anticipate", "believe", "plan", "estimate", "expect", "intend", and other similar expressions, constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors which may cause actual results to be materially different from those contemplated by the forward-looking statements. Such factors include, among other things:
Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000 ............................27
Consolidated Statements of Financial Condition at December 31, 2002 and 2001................................................28
Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000..............................31
Schedule I - Summary of Investments - Other than Investments In Related Parties......................................47
The Life Insurance Subsidiaries market their portfolio of products through the personal producing general agent distribution system and presently have approximately 3,500 sales representatives. Many of these also represent other insurance carriers. Approximately 600 of the agents specialize in the home service market while approximately 800 are Preneed representatives who market through funeral homes. These markets consist primarily of individuals who desire whole life policies with policy limits typically below $10,000.
Investments. The Company classifies fixed maturities and equity securities as "available-for-sale". Available-for-sale securities are carried at fair value, with unrealized gains and losses included in accumulated other comprehensive income (loss), net of applicable deferred taxes and adjustments to related deferred policy acquisition costs. Mark-to-market accounting is used for equity options embedded in convertible bonds and all other derivatives. Changes in the fair value of derivatives are reported currently as realized gains or losses.
For purposes of computing realized gains and losses on fixed maturities and equity securities sold, the carrying value is determined using the specific-identification method. Mortgage loans and policy loans are carried at unpaid balances. Investment real estate is carried at depreciated cost. Short-term investments, which consist of certificates of deposit and treasury bills, are carried at cost which approximates fair value. Cash and cash equivalents consist of highly liquid investments with maturities of three months or less at the date of purchase and are also carried at cost which approximates fair value.
Property and Equipment. Property and equipment, including the home office building, are carried at cost less accumulated depreciation, using principally the straight-line method of depreciation. Accumulated depreciation at December 31, 2002 was $2,361,180 ($2,333,330 at December 31, 2001).
Goodwill and Value of Insurance Acquired. Goodwill represents the excess of purchase price of purchased subsidiaries, over amounts assigned (based on estimated fair values at the date of acquisition) to the identifiable net assets acquired. Effective January 1, 2002, the Company discontinued amortizing goodwill and began testing for potential impairment of goodwill on an annual basis. Prior to 2002, the Company amortized goodwill over 10 to 20 years using the straight-line method. At December 31, 2002 and 2001, accumulated amortization was $412,861.
Reserves on insurance policies acquired by purchase are based on assumptions considered appropriate as of the date of purchase. Assumed investment yields for such acquired policies range from 5.5% to 9.0%.
Premiums, Benefits and Expenses. Premiums for traditional individual life (including Preneed) and accident and health policies are reported as earned when due. Benefit claims (including an estimated provision for claims incurred but not reported), benefit reserve changes and expenses (except those deferred) are charged to expense as incurred. Deferred policy acquisition costs related to traditional life and accident and health policies are charged to expense over the life of the policy using methods and assumptions consistent with those used in estimating liabilities for future policy benefits. In determining whether a premium deficiency exists on short-duration policies, management does not give consideration to investment income.
On October 14, 1999, the Company acquired 100% of the stock of Citizens Insurance (formerly Kentucky Insurance Company) from an unaffiliated insurance holding company (the "Citizens Insurance Acquisition"). Citizens Insurance is licensed as a property and casualty insurance company in four states and has approximately $3.6 million of statutory capital and surplus; however, it currently has no insurance operations. The aggregate purchase price for the Citizens Insurance Acquisition was approximately $3,550,000 (including net costs associated with the acquisition of approximately $50,000).
The fair values for investments in fixed maturities and equity securities are based on quoted market prices, where available. For investments in fixed maturities and equity securities not actively traded, fair values are estimated using values obtained from independent pricing services.
December 31, 2002 Amortized Cost Fair Value - ------------------------------------------ ------------------ ------------------ Due in one year or less $ 14,753,468 $ 14,881,072 Due after one year through five years 49,355,130 50,889,915 Due after five years through ten years 17,894,409 18,475,601 Due after ten years 9,087,082 9,270,613 - ------------------------------------------ ------------------ ------------------ Subtotal 91,090,089 93,517,201 Mortgage-backed securities 10,071,085 10,436,614 - ------------------------------------------ ------------------ ------------------ Total $ 101,161,174 $ 103,953,815 - ------------------------------------------ ------------------ ------------------
Gross gains of $555,169, $463,679, and $2,268,554 and gross losses of $819,705, $1,778,519, and $1,127,299 were realized on the sale of available-for-sale fixed maturities during 2002, 2001, and 2000, respectively. Included in gross realized losses during 2002, 2001, and 2000 are net adjustments to the carrying value of available-for-sale fixed maturities of $501,399, $739,000, and $912,000 respectively, relating to declines in value which were considered by management to be other than temporary. Net realized gains from the sale of fixed maturities have been increased (decreased) by $35,826, $63,492, and $(80,166) in 2002, 2001, and 2000 respectively, due to amortization of deferred policy acquisition costs. In addition, net realized gains from the sale of fixed maturities have been reduced by $8,744 in 2001 for incentive fees earned by the portfolio manager.
Gross gains of $1,814,053, $1,378,585, and $16,764,844 and gross losses of $4,093,424, $8,245,943, and $16,740,314 were realized on the sale of available-for-sale equity securities during 2002, 2001 and 2000. Included in gross realized losses during 2002, 2001, and 2000 are adjustments to the carrying value of available-for-sale equity securities of $753,953, $1,533,000, and $5,733,000 respectively, relating to declines in value which were considered by management to be other than temporary. Net realized gains from the sale of equity securities have been increased by $47,936, $252,534, and $302,629 in 2002, 2001, and 2000 respectively, due to amortization of deferred policy acquisition costs. In addition, net realized gains from the sale of available-for-sale equity securities have been reduced by $9,623, $36,913, and $207,369 in 2002, 2001, and 2000, respectively, for incentive and management fees earned by the portfolio manager.
The Company limits credit risk by diversifying its investment portfolio among government and corporate fixed maturities and common and preferred equity securities. It further diversifies these investment portfolios within industry sectors. As a result, management believes that significant concentrations of credit risk do not exist. The following are the only investments (other than the U.S. Governments) comprising more than ten percent of shareholders' equity at December 31, 2002: Clear Channel Communications ($2,977,500), JP Morgan ($2,235,973), and Preferred Term Securities III, Ltd. ($1,952,556). At December 31, 2002, the Company had no investments which had not been income producing for a period of at least twelve months prior to year-end and had approximately $170,000 of fixed maturity securities on non-accrual status at December 31, 2002.
As an income generation strategy, the Company takes certain option positions, generally on equity securities or related market indices and on equity options embedded in convertible bonds. Although such positions may be covered by actual securities owned or offsetting options, hedge accounting is not used. Accordingly, all such positions are marked to market and changes in value reported as realized gains or losses. During 2002, option purchases totaled approximately $822,000 and related net realized gains totaled approximately $63,000. At December 31, 2002 net option positions outstanding had a market value of $60,000, with an associated 2002 realized loss recorded of $36,000. Approximately $7,000 of these positions contain market risk of loss beyond the recorded value.
The Company owns the building and land which it currently occupies. At December 31, 2002 and 2001, the Company occupied approximately 31% and 29% respectively, of the building with the remaining space leased or available for lease to third-party tenants. The accompanying financial statements reflect the proportionate Company occupied share of the building and related operating expense as property and equipment and general expense, respectively. The remaining portion is reflected as investment real estate and as a reduction of investment income, respectively. Accumulated depreciation at December 31, 2002 and 2001 on the investment real estate portion of the building was $1,153,634 and $1,041,432, respectively.
The Company leases office space to third-party tenants under noncancellable lease agreements. Future minimum rental income is $527,000, $373,000, $287,000, $64,000 and $6,000 for years 2003 through 2007, respectively.
Year Ended December 31 2002 2001 2000 - --------------------------------------- ------------ ------------- ------------- Balance at beginning of year $4,177,907 $4,884,680 $5,295,818 Business acquired --- --- 355,360 Accretion of interest 253,996 296,964 312,002 Amortization (814,301) (1,003,737) (1,078,500) - --------------------------------------- ------------- ------------ ------------- Balance at end of year $3,617,602 $4,177,907 $4,884,680 - --------------------------------------- ------------- ------------ -------------
Amortization of the value of insurance acquired (net of interest accretion) in each of the following five years will be approximately: 2003 - $480,000; 2004 - $423,000; 2005 - $382,000; 2006 - $338,000, and 2007 - $298,000.
During 2002, the Company borrowed $2,000,000 from its Chairman. These funds were used to purchase redeemable preferred stock of the Company's subsidiary, Citizens Security, thereby strengthening the statutory capital and surplus of Citizens Security. Interest on the debt is payable quarterly by the Company at an annual rate equal to the greater of 6.00% or the prime lending rate plus 1%. The outstanding principal is callable upon 90 days notice or otherwise due on June 30, 2005, except however, under terms of a subordination agreement between the Chairman and the Company's commercial bank, repayment is prohibited until all outstanding commercial bank borrowings are repaid.
Significant components of the Company's deferred tax liabilities and assets as of December 31, 2002 and 2001 are as follows:
December 31 2002 2001 2000 - --------------------------- ----------------- ---------------- ----------------- Net Income (Loss) $ (1,663,236) $ (3,762,603) $ 1,961,792 Capital and Surplus $ 9,903,639 $ 9,687,289 $ 11,694,494
income as required for GAAP; e) assets and liabilities of acquired companies are adjusted to their fair values at acquisition with the excess purchase price over such fair values recorded as goodwill under GAAP; f) available-for-sale fixed maturity investments are reported at fair value with unrealized gain and losses reported as a separate component of shareholders' equity for GAAP; and g) statutory asset valuation reserves and interest maintenance reserves are not required for GAAP.
Statutory restrictions limit the amount of dividends which the insurance companies may pay. Generally, dividends during any year may not be paid, without prior regulatory approval, in excess of the lesser of (a) 10% of statutory shareholder's surplus as of the preceding December 31, or (b) statutory net operating income for the preceding year. During 2002, the Company purchased $2,000,000 of redeemable preferred stock from Citizens Security, as further described in Note 5. During 2001, the Company contributed the stock of Citizens Insurance and $150,000 to Citizens Security. The statutory value of the contributed Citizens Insurance stock was $3,540,555. Citizens Security contributed the $150,000 received from the Company to Citizens Insurance. During 2000, with appropriate prior regulatory approval, Citizens Security redeemed $1,200,000 of its outstanding preferred stock from the Company. United Liberty paid dividends to Citizens Security of $214,000, $292,000 and $200,000 during 2002, 2001, and 2000 respectively. The Insurance Subsidiaries must each maintain $1,250,000 of capital and surplus, the minimum required for insurance companies domiciled in Kentucky. The KDI imposes minimum risk-based capital ("RBC") requirements on insurance enterprises that were developed by the NAIC. The formulas for determining the amount of RBC specify various weighting factors that are applied to financial balances and various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio (the "Ratio") of the enterprise's regulatory total adjusted capital, as defined by the NAIC, to its required authorized control level RBC, as defined by the NAIC. Enterprises below specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. Based on RBC computations as of December 31, 2002, the Insurance Subsidiaries each have statutory capital which is well in excess minimum regulatory requirements.
Segment information as of December 31, 2002, 2001 and 2000, and for the years then ended is as follows:
Year Ended December 31 2002 2001 2000 - ------------------------------------- -------------- ------------- ------------- Net Investment Income: Home Service Life $ 1,790,949 $ 2,053,995 $ 2,028,680 Broker Life 2,178,667 2,579,117 2,538,610 Preneed Life 1,592,356 1,514,638 1,298,434 Dental 24,896 35,312 39,289 Other Health 78,728 91,081 88,349 - ------------------------------------- -------------- ------------- ------------- Segment Totals $ 5,665,596 $ 6,274,143 $ 5,993,362 - ------------------------------------- -------------- ------------- -------------
December 31 2002 2001 2000 - ---------------------------------- -------------- -------------- -------------- Assets: Home Service Life $ 45,219,971 $ 44,818,038 $ 45,577,255 Broker Life 53,874,949 54,954,194 57,721,008 Preneed Life 46,739,831 34,138,535 29,421,677 Dental 660,334 726,728 799,496 Other Health 1,946,447 1,959,588 2,018,570 - ---------------------------------- -------------- -------------- -------------- Total Assets $148,441,532 $136,597,083 $135,538,006 - ---------------------------------- -------------- -------------- --------------
* Net Loss for the quarters ended March 31, June 30, and September 30, 2001 has been restated from amounts previously reported in the Company's Form 10-Qs. The restated amounts reflect correction of policy benefit reserves and related deferred acquisition costs for the Preneed Life segment. In addition, corresponding income taxes have been revised for the Preneed Life change and to reflect the actual effective tax rate applicable for the year. The effect of the restatement for the first three quarters of 2001 was to increase earnings and per share amounts (i.e. decrease Net Loss) as follows:
The Company currently follows the general practice of reinsuring that portion of risk on the life of any individual which is in excess of $40,000 for individual policies (under yearly renewable term and coinsurance agreements) and $15,000 for group policies (under a group yearly renewable term agreement). Graded death benefit and simplified issue coverages above $4,000 are generally 50% reinsured, with the Life Insurance Subsidiaries maintaining a maximum $10,000 risk on any one policyholder. Individual and group accidental death coverage and a minor portion of cancer coverage are 100% reinsured. To the extent that reinsuring companies are unable to meet obligations under reinsurance agreements, the Company would remain liable. Reinsurance premiums, expenses, recoveries and reserves related to reinsured business are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts.
United Liberty, which the Company acquired in 1998, is defending an action in an Ohio state court brought by two policyholders. The Complaint refers to a particular class of life insurance policies that United Liberty issued over a period of years ending around 1971. It alleges that United Liberty's dividend payments on these policies from 1993 through 1999 were less than the required amount. It does not specify the amount of the alleged underpayment but implies a maximum of about $850,000. The plaintiffs also allege that United Liberty is liable to pay punitive damages, also in an unspecified amount, for breach of an implied covenant of good faith and fair dealing to the plaintiffs in relation to the dividends. The action has been certified as a class action on behalf of all policyholders who were Ohio residents and whose policies were still in force in 1993. United Liberty has denied the material allegations of the Complaint and is defending the action vigorously. Pre-trial discovery is continuing. United Liberty has filed a motion for summary judgment to which the plaintiffs have not yet responded. At United Liberty's request, an initial mediation session has been completed and negotiations are continuing. As a pre-requisite for the mediation, United Liberty offered to settle the matter for payments over time, which would include attorneys' fees, and which would be contingent upon an exchange or reformation of the insurance policies currently owned by the members of the class. At this stage of the litigation, the Company is unable to determine whether an unfavorable outcome of the action is likely to occur or, alternatively, whether the chance of such an outcome is remote. Therefore, at this time, management has no basis for estimating potential losses, if any. In addition, the Company is party to other lawsuits in the normal course of business. Management believes that recorded claims liabilities are adequate to ensure that these other suits will be resolved without material financial impact to the Company.
Cash and Cash Equivalents: The carrying amount of cash and cash equivalents approximates their fair value. At December 31, 2002 and 2001, the fair value of cash and cash equivalents was $6,699,171 and $18,433,626, respectively.
Policy Loans: The carrying amount of policy loans approximates their fair value. At December 31, 2002 and 2001, the fair value of policy loans was $4,239,128 and $4,136,649, respectively.
Investment Contracts: The carrying amount of investment-type fixed annuity contracts approximates their fair value. At December 31, 2002 and 2001, the fair value of investment-type fixed annuity contracts was $9,805,082 and $9,907,941, respectively.
The Company has various transactions with its President and Chairman of the Board (the "Chairman") or entities he controls. The Chairman provides investment portfolio management for the Company and its subsidiaries through SMC Advisors, Inc. (of which the Chairman is the principal officer, a director, and the sole shareholder). The investment portfolio management contracts provide for total annual fixed fees of $45,000 and incentive compensation equal to five percent (5%) of the sum of the net realized and unrealized capital gains in the fixed maturities and equity securities portfolios of the Company during each contract year. Any excess of net realized and unrealized capital losses over net realized and unrealized capital gains at the end of a contract year is not carried forward to the next contract year. Fixed fees totaled $45,000, $45,000, and $48,000 in 2002, 2001, and 2000, respectively. Incentive fees of $0, $48,168, and $207,369 were incurred and paid for 2002, 2001, and 2000, respectively. The Company also maintains a portion of its investments under a Trust Agreement with a bank controlled by the Chairman. Fees to the bank are based on assets held. Such fees were $100,675, $94,199, and $94,660 in 2002, 2001, and 2000, respectively. The Company also manages certain commercial real estate affiliated with its Chairman. The Company charges the real estate projects management and leasing fees at market rates, which totaled $213,070, $174,746, and $150,672 during 2002, 2001, and 2000, respectively. In December 2002, the Company borrowed $2,000,000 from its Chairman with interest payable quarterly at the greater of 6% per year or the commercial bank prime lending rate plus 1%.
In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, "Business Combinations", and No. 142, "Goodwill and Other Intangible Assets", effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill will no longer be amortized but is subject to annual impairment tests in accordance with the Statements. Other intangible assets will continue to be amortized over their useful lives. The Company applied the new rules on accounting for goodwill and other intangible assets beginning in the first quarter of 2002. Application of the nonamortization provisions of the Statement decreased the 2002 net loss approximately $96,000 ($0.06 per share). During 2002, the Company performed an impairment test of goodwill and concluded that no impairment adjustment was necessary.
Total goodwill outstanding at December 31, 2002 is $756,000 with $304,000 allocable to Broker Life, $270,000 to Home Service Life and $182,000 to Preneed Life.
1 Adjusted for declines in value believed to be other than temporary, totaling $1,569,399 for fixed maturity securities and $1,544,505 for equity securities and, as to fixed maturities, reduced by repayments and adjusted for amortization of premium and accrual of discounts.