Real Estate Amount % of Total Home Office $ 2,610,908 19% Commercial $ 2,318,514 17% Residential development $ 5,341,858 37% Foreclosed real estate $ 3,846,946 27%
Net cash provided by (used in) financing activities was ($13,900,000), $8,108,000 and $6,211,000 for 1996, 1995 and 1994, respectively. The change between 1996 and 1995 is due to a coinsurance agreement with First International Life Insurance Company as of September 30, 1996. At closing of the transaction, UG received a reinsurance credit of $28,318,000 for policy liabilities covered under the agreement. UG transferred assets equal to the credit received. This transfer included policy loans of $2,855,000 associated with policies under the agreement and a net cash transfer of $19,088,000 after deducting the ceding commission due UG of $6,375,000.
On May 8, 1996, FCC refinanced its senior debt of $8,900,000. The refinancing was completed through First of America Bank - NA and is subject to a credit agreement. The refinanced debt bears interest to a rate equal to the "base rate" plus nine-sixteenths of one percent. The Base rate is defined as the floating daily, variable rate of interest determined and announced by First of America Bank from time to time as its "base lending rate". The base rate at issuance of the loan was 8.25%, and has remained unchanged through March 1, 1997. Interest is paid quarterly and principal payments of $1,000,000 are due in May of each year beginning in 1997, with a final payment due May 8, 2005. On November 8, 1996, the Company prepaid $500,000 of the May 8, 1997 principal payment.
On a parent only basis, FCC's cash flow is dependent on revenues from its life insurance subsidiaries from management and cost sharing arrangements and through dividends. At December 31, 1996, substantially all of the consolidated shareholders equity represents net assets of its subsidiaries. Cash requirements of FCC primarily relate to servicing its long-term debt. The payment of cash dividends to shareholders is not legally restricted. However, insurance company dividend payments are regulated by the state insurance department where the company is domiciled. UG's dividend limitations are described below.
The Company changed its focus from primarily a broker agency distribution system to a captive agent system. Business written by the broker agency force, in recent years, did not meet Company expectations. With the change in focus of distribution systems, most of the broker agents were terminated. (The termination of the broker agency force caused a non- recurring write down of the value of agency force asset in 1995. See discussion of amortization of agency force for further details.)
One factor that has had a positive impact on premium income is the improvement of persistency. Persistency is a measure of insurance in force retained in relation to the previous year. The Company's average persistency rate for all policies in force for 1996 and 1995 has been 87.9% and 87.5%, respectively.
Other considerations net of reinsurance increased 7% compared to one year ago. Other considerations consists of administrative charges on universal life and interest sensitive life insurance products. The insurance in force relating to these types of products continues to increase as marketing efforts are focused on universal life insurance products.
Net investment income increased 3% when comparing 1996 to 1995. The overall investment yields for 1996, 1995 and 1994, are 7.21%, 7.10% and 7.19%, respectively. The improvement in investment yield is primarily attributed to the fixed maturity portfolio. The Company has invested financing cash flows generated by cash received through sales of universal life insurance products.
Realized investment losses were $411,000 and $349,000 in 1996 and 1995, respectively. The Company sold two foreclosed real estate properties that resulted in approximately $357,000 in realized losses in 1996. The Company had other gains and losses during the period that comprised the remaining amount reported but were immaterial in nature on an individual basis.
Life benefits net of reinsurance benefits and claims increased 13% compared to 1995. The increase in life benefits is due primarily to settlement expenses discussed in the following paragraph:
In 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by Company standards. These non-standard policies had a face amount of $22,700,000 and represented 1/2 of 1% of the insurance in-force in 1994. Management's initial analysis indicated that expected death claims on the business in-force was adequate in relation to mortality assumptions inherent in the calculation of statutory reserves. Nevertheless, management determined it was in the best interest of the Company to repurchase as many of the non-standard policies as possible. Through December 31, 1996, the Company spent approximately $7,099,000 for the settlement of non-standard policies and for the legal defense of related litigation. In relation to settlement of non-standard policies the Company incurred life benefits of $3,307,000, $720,000 and $1,250,000 in 1996, 1995 and 1994, respectively. The Company incurred legal costs of $906,000, $687,000 and $229,000 in 1996, 1995 and 1994, respectively. All the policies associated with this issue have been settled as of December 31, 1996. The Company has approximately $3,742,000 of insurance in-force and $1,871,000 of reserves from the issuance of paid-up life insurance policies for settlement of matters related to the original non-standard policies. Management believes the reserves are adequate in relation to expected mortality on this block of in force.
Other considerations net of reinsurance increased 13% compared to one year ago. Other considerations consists of administrative charges on universal life and interest sensitive life insurance products. The insurance in force relating to these types of products continues to increase as marketing efforts are focused on universal life insurance products.
Commissions and amortization of deferred policy acquisition costs increased 23% in 1995 compared to 1994. The increase is directly attributed to the amortization of a larger asset. The increase is also caused by the reduction in first year premium production. To a lesser extent the increase in amortization of deferred policy acquisition costs is directly related to the change in products that is currently marketed. The Company revised its portfolio of products as previously discussed in premium income. These new products pay lower first year commissions than the products sold in prior periods. The asset increased due to first year premium production by the agency force. The Company did benefit from improved persistency.
Policy loans decreased 15% in 1996 compared to 1995. Policy loans decreased approximately $2,787,000 due to the coinsurance agreement with FILIC. Industry experience for policy loans indicates few policy loans are ever repaid by the policyholder other than through termination of the policy. Policy loans are systematically reviewed to ensure that no individual policy loan exceeds the underlying cash value of the policy. Policy loans will generally increase due to new loans and interest compounding on existing policy loans.
Deferred policy acquisition costs decreased 5% in 1996 compared to 1995. The costs, which vary with, and are primarily related to producing new business are referred to as deferred policy acquisition costs ("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 that 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 $1,276,000 in policy acquisition costs deferred, $854,000 in interest accretion and $3,010,000 in amortization in 1996. The Company did not recognize any impairments during the period.
Cost of insurance acquired decreased significantly during 1996. The decrease is primarily attributed to the coinsurance agreement with FILIC.
Policy claims and benefits payable increased 3% in 1996 compared to 1995. There is no single event that caused this item to increase. Policy claims vary from year to year and therefore, fluctuations in this liability are to be expected and are not considered unusual by management.
Dividend and endowment accumulations increased 11% in 1996 compared to 1995. The increase is attributed to the significant amount of participating business the Company has in force. There are generally four options a policyholder can select to pay policy dividends. Over 47% of all dividends paid were put on deposit to accumulate with interest. Accordingly, management expects this liability to increase in the future.
Income taxes payable and deferred income taxes payable decreased significantly in 1996 compared to 1995. The primary reason for the decrease in deferred income taxes is due to the coinsurance agreement with FILIC. The change in deferred income taxes payable is attributable to temporary differences between Generally Accepted Accounting Principles ("GAAP") and tax basis. Federal income taxes are discussed in more detail in Note 3 of the Notes to the Consolidated Financial Statements.
Notes payable decreased approximately $1,623,000 in 1996 compared to 1995. On May 8, 1996, FCC refinanced its senior debt of $8,900,000. The refinancing was completed through First of America Bank - NA. The refinanced debt bears interest to a rate equal to the "base rate" plus nine-sixteenths of one percent. The Base rate is defined as the floating daily, variable rate of interest determined and announced by First of America Bank from time to time as its "base lending rate". The base rate at issuance of the loan was 8.25%, and has remained unchanged through March 1, 1997. Interest is paid quarterly. Principal payments of $1,000,000 are due in May of each year beginning in 1997, with a final payment due May 8, 2005. On November 8, 1996, the Company prepaid $500,000 of the May 8, 1997 principal payment. The Company's long term debt is discussed in more detail in Note 10 of the Notes to the Financial Statements.
Total shareholders' equity decreased 8% in 1996 compared to 1995. The decrease in shareholders' equity is primarily due to the net loss of $3,032,000 in 1996. The Company experienced $175,000 in unrealized depreciation of equity securities and investments held for sale in 1996.
The Company's insurance subsidiaries are subject to government regulation in each of the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including the power to: (i) grant and revoke licenses to transact business; (ii) regulate and supervise trade practices and market conduct; (iii) establish guaranty associations; (iv) license agents; (v) approve policy forms; (vi) approve premium rates for some lines of business; (vii) establish reserve requirements; (viii) prescribe the form and content of required financial statements and reports; (ix) determine the reasonableness and adequacy of statutory capital and surplus; and (x) regulate the type and amount of permitted investments. Insurance regulation is concerned primarily with the protection of policyholders. The Company cannot predict the form of any future proposals or regulation. The Company's insurance subsidiaries, USA, UG, APPL and ALIC are domiciled in the states of Ohio, Ohio, West Virginia and Illinois, respectively.
The Company receives funds from its insurance subsidiaries in the form of management and cost sharing arrangements (See Note 9 of the Notes to the Consolidated Financial Statements) and through dividends. Annual dividends in excess of maximum amounts prescribed by state statutes ("extraordinary dividends") may not be paid without the prior approval of the insurance commissioner in which an insurance subsidiary is domiciled. (See Note 2 of the Notes to the Consolidated Financial Statements.)
RATIO OF TOTAL ADJUSTED CAPITAL TO AUTHORIZED CONTROL LEVEL RBC REGULATORY EVENT (LESS THAN OR EQUAL TO)
No new accounting standards became effective or were adopted by the Company during the year which resulted in a material impact on the Company's financial statements.
Independent Auditor's Report for the Years ended December 31, 1996, 1995, 1994 . . . . . . . . . . 30
Consolidated Balance Sheets . . . . . . . . . . . . . . . . . 31
Consolidated Statements of Operations . . . . . . . . . . . . 32
Consolidated Statements of Cash Flows . . . . . . . . . . . . 34
Notes to Consolidated Financial Statements . . . . . . . . 35-54