Following is a summary of fixed maturities held for investment and available for sale by rating class as of December 31, 1996.
HELD FOR INVESTMENT AVAILABLE FOR SALE ------------------- ------------------ U. S. Government $ 3,119,413 29,458,220 A or better 17,126,370 48,953,029 Baa2 or Better - 2,211,000 ------------ --------- $20,245,783 80,622,249 ------------ ----------
The Company's mortgage loan policy stipulates that the Company will loan no more than 80% of the value on residential loans and no more than 75% of the value on commercial loans. For the past five years, the Company has granted loans only to employees (excluding officers and directors), agents, agent's relatives, employees of Gold Kist and current mortgagees.
The geographic distribution of the loan portfolio as of December 31, 1996 is:
Premium income on traditional life contracts has increased 21%, 17%, and 14%. The increases came from the sales of the Company's new guaranteed issue-simplified issue and participating whole life policies.
Effective January 1, 1996, the Company and Cotton States Mutual moved its employee and agent health plans to an outside health provider. In 1996 and future years, the only group premium the Company will earn will be group life premiums received from participation in the Federal employee and servicemen pools. The Company receives no material amounts from participation in these pools.
Prior to 1996, group premiums from the Company's agents and employees were based on actual claims experience and participation in Government pools. Group premiums decreased approximately $767,000 in 1995, and $423,000 in 1994. The fluctuation in group premiums had no effect on the Company's earnings, because those premiums were based on actual claims experience plus a modest expense allowance.
Mortality and expense charges earned on universal life contracts increased 20%, 1%, and 29% in 1996, 1995 and 1994, respectively. In 1994, the Company changed its classification of reserve credits on reinsured universal life contracts. This reclassification resulted in additional mortality and expense charges earned of $328,000 and had an insignificant effect on net income. The increase for 1994 resulted from the addition of a large payroll deduction universal life case during the year, plus an increase in cost of insurance charges on all 1994 new business cases. The increase in 1996 resulted from increased sales of individual universal life sales and increased sales of payroll deduction universal life insurance.
Individual accident and health benefits as a percentage of accident and health premiums were 123%, 19% and 129% for 1996, 1995 and 1994, respectively. Even though experience on this line improved in 1995, the Company anticipates that even with rate increases, the loss ratio on this closed block of business will continue to be in the 110%-130% range.
The effective tax rates were 21% for 1996, 24% for 1995 and 25% for 1994. The effective tax rate should remain in the 20% to 25% range. The Company expects that CSMR will utilize all of its tax loss carryfowards by the fourth quarter of 1997.
Quarterly earnings fluctuated significantly during the three years ending December 31, 1996. These fluctuations are due, in the most part, to irregular claims occurrences and the timing of certain investment transactions during the year.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. COTTON STATES LIFE INSURANCE COMPANY AND SUBSIDIARIES
COTTON STATES LIFE INSURANCE COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1996, 1995, and 1994
The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP), which vary in certain respects from reporting practices prescribed or permitted by the Insurance Department of the State of Georgia. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Accounts that the Company deem to be acutely sensitive to changes in estimates include deferred policy acquisition costs and future policy benefits. In addition, the Company must determine requirements for disclosure of contingent assets and liabilities as of the date of the financial statements based upon estimates. In all instances, actual results could differ from estimates.
Credit Risk is the risk that issuers of securities owned by the Company will default, or other parties, including reinsurers which owe the Company money, will not pay. The Company minimizes this risk by adhering to a conservative investment strategy and by contracting with reinsuring companies that meet certain rating criteria and other qualifications.
Future policy benefits on traditional individual life insurance policies are computed using a net level premium method based upon conservative assumptions as to investment yields, withdrawals, morbidity, and mortality. Future policy benefits on universal life insurance policies and annuities represent the contract's accumulated account value plus credited interest.
The costs of acquiring most new individual life business are deferred and amortized with interest over the premium-paying period of the related policies. For traditional life policies, such amounts are amortized in proportion to the ratio of the annual premium income to the total anticipated premium income. Such anticipated premium income is estimated using the same assumptions as used for computing future policy benefits. For universal life policies, deferrable costs are amortized in proportion to the ratio of the contract's annual gross profits to total anticipated gross profits. First-year excess expense charges are also deferred and accreted to income in the same manner as deferrable costs are amortized. Total anticipated gross profits are based on assumptions for investment margins, surrender charges, mortality charges, and level expense loads. The principal expenses deferred are commissions and certain expenses of the product development, policy issue, underwriting, and agency departments, all of which vary with and are primarily related to the production of new business. Policy acquisition costs deferred were approximately $4,780,000 in 1996, $4,241,000 in 1995, and $3,710,000 in 1994.
The Company and CSI Brokerage Services, Inc. file a consolidated Federal income tax return. Cotton States Marketing Resources, Inc. files a separate Federal income tax return.
Earnings per share of common stock are based on the weighted average number of common shares outstanding adjusted for the October 16, 1995 five-for-four stock split effected in the form of a 25% stock dividend. The effect of unexercised stock options is not significant.
The Company accounts for its various stock-based compensation in accordance with the provisions set forth in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. In accordance with APB Opinion No. 25, compensation expense is recorded on the grant date only to the extent that the current market price of the underlying stock exceeds the exercise price on the grant date.
In November 1995, the Financial Accounting Standards Board announced that for the year ended December 31, 1995, companies that are subject to the reporting requirements of SFAS No. 115 would have a one-time opportunity to reclassify securities currently classified as held to maturity without the risk of tainting the accounting for investments on a historical basis. The Company evaluated the securities contained in this portfolio and has determined under which conditions it may dispose of such securities. In light of this review, the Company in 1995 reclassified approximately $11,197,000 of securities which were previously classified as held to maturity to the available for sale account. The result of such reclassification was to increase 1995 shareholders' equity by approximately $62,000, net of applicable deferred taxes.
The amortized cost and estimated market values of investments in debt securities as of December 31, 1996 and 1995 are as follows:
Included in investments available for sale in 1995 were certain U.S. dollar denominated U.S. government agency securities amounting to $292,500 at December 31, 1995 which were payable in foreign currency. As a result of significant foreign currency fluctuations, the Company had written these securities down to current market value in 1995 and 1994 by recognizing losses of $300,000 and $580,509, respectively. In 1996, these securities matured and a corresponding net gain of $51,200 was recognized.
Details of net investment income are as follows: 1996 1995 1994 ---- ---- ---- Investment income: Fixed maturities held for investment $ 1,395,312 1,504,117 2,095,318 Fixed maturities available for sale 5,371,791 4,627,543 3,367,984 First mortgage loans 429,312 498,084 573,008 Policy loans 480,635 434,184 424,266 Short-term investments 257,926 298,553 232,482 ---------- --------- --------- Total investment income 7,934,976 7,362,481 6,693,058 Less investment expenses 369,208 339,930 315,149 ---------- ---------- ---------- Net investment income $ 7,565,768 7,022,551 6,377,909 ========= ========= =========
Reinsurance assumed $ 696,986 655,789 668,409 ======= ====== ======= Reinsurance ceded $ 2,756,838 1,475,011 2,852,487 ========= ======== ========
Deferred income taxes reflect the net tax effects of temporary differences between the carrying values of assets and liabilities for financial reporting purposes and Federal income tax purposes. The net deferred tax liability at December 31, 1996 and 1995 is composed of the following:
Deferred tax liabilities: Fixed maturities available for sale 187,894 826,425 Deferred policy acquisition costs - financial statements 9,131,128 8,329,465 Due and unpaid premiums 70,382 66,425 Other, net 17,939 13,710 --------- ---------- Total deferred tax liabilities 9,407,343 9,236,025 --------- ---------- Net deferred tax liability $ 2,650,383 3,140,915 ========= ========= The Company has established a valuation allowance for deferred tax assets of $81,000 in 1996 and $250,000 in 1995. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.
Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS No. 109) specifically identifies certain temporary differences for which deferred tax liabilities are not recognized unless it becomes apparent that those temporary differences will reverse in the foreseeable future. The Company has not recorded a deferred tax liability for one such item entitled "policyholders' surplus" created by Federal income tax regulations in effect prior to 1984. Certain untaxed income accumulated in this special memorandum tax account will become taxable if distributions, other than stock dividends, are made in excess of certain amounts accumulated in another special memorandum tax account entitled "shareholders' surplus." The balance in the "policyholders' surplus" account at December 31, 1996 was $4,203,000. The balance in the "shareholders' surplus" account at December 31, 1996 was $30,500,000. The Company does not anticipate any of the "policyholders' surplus" account becoming taxable in the foreseeable future.
1996 1995 1994 ------- ------- ------- Federal income tax expense at statutory rate $2,143,104 1,864,609 1,537,189 Special deductions available to small life insurance companies (547,625) (610,107) (560,305) Net gains of subsidiaries not currently includable (80,552) (64,054) (30,802) Change in valuation allowance (169,000) (50,000) - Tax rate differential - 134,214 147,983 Surtax exemption (42,928) (34,481) (27,675) Other, net (12,422) 16,403 22,554 --------- -------- ------ Total Federal income taxes $1,290,577 1,256,584 1,088,944 ========= ========= =========
The Company has a plan which provides for postretirement health care and life insurance benefits for certain employees. These benefits include major medical insurance with deductible and coinsurance provisions. The Company accrues benefits on a current basis and the plan is not funded. The components of the net periodic postretirement benefit cost for the years ended December 31 are as follows: 1996 1995 1994 ------- ------- ------- Service cost $ 350 8,124 9,770 Interest cost 10,883 22,000 21,376 Amortization of unrecognized gain (9,370) (997) - -------- --------- -------- Net periodic postretirement benefit cost $ 1,863 29,127 31,146 ====== ====== ======
Unrecognized net gain 126,438 73,417 --------- -------- Accrued postretirement benefit cost $ 317,103 328,297 ======= =======
Cotton States Mutual Insurance Company, through its wholly owned subsidiary, Shield Insurance Company, controls approximately 37% of the Company's outstanding common stock. Most officers and directors of the Company hold similar positions with Cotton States Mutual.
Included in other assets are deferred software costs totaling approximately $159,000 and $464,000 in 1996 and 1995, respectively. The deferred software costs relate to various system development projects of the Company and Cotton States Mutual and are being amortized over five years. Rent, for use of the software, of approximately $448,000, $644,000, and $732,000 in 1996, 1995, and 1994, respectively, is being charged to Cotton States Mutual and Shield. The Company recorded amortization expense of approximately $342,000 in 1996 and $625,000 in 1995 and 1994.
The Company has various stock option plans for the Company's officers and key employees, as well as directors. Under the employee plan, options are granted to purchase up to 500,000 shares of the Company's stock at a per share price of not less than 100% of fair market value at date of grant. Under the directors' plan, options are granted based on the level of directors' fees at a per share price of 50% of fair market value at date of grant. The employee and directors' options have a term of 10 years and are not subject to any vesting requirements. A summary of options follows: Weighted average exercise 1996 1995 1994 Option price price ------- ------ ------- -------------- ------- Shares under option 61,382 67,912 74,740 $ 3.60-5.55 5.32 Options exercisable 61,382 67,912 74,740 3.60-5.55 5.32 Options granted 11,380 - - 3.60-4.50 4.33 Options exercised 17,910 6,828 150,280 5.55 5.55 ===== ====== =======
In addition to the stock options described above, the Company has awarded nontransferable, restricted shares of Company common stock to various key executives under key executive restricted stock bonus plans. The market value of the common stock at the date of issuance is recorded as compensation expense using the straight-line method over the vesting period of the awards. The Company awarded to current active executives, 17,586 and 19,546 shares of restricted stock under such plans during 1996 and 1995, respectively. The weighted average grant date fair value of such shares was $8.65 and $6.80, respectively. Aggregate compensation expense with respect to the foregoing restricted stock awards was approximately $106,000 and $53,000 in 1996 and 1995, respectively.
In accordance with APB Opinion No. 25, approximately $147,300 and $61,000 in compensation expense has been recorded in 1996 and 1995, respectively, for the various stock option and restricted stock awards granted in 1996 and 1995. Had the Company determined compensation cost based on the fair value at the grant date for its stock options and restricted stock awards under SFAS No. 123, the Company's net earnings and per share net earnings would have been reduced to the pro forma amounts indicated below:
Years ended December 31, 1996 1995 ------ ------- Net income: As reported $ 4,832,577 4,070,871 Pro forma 4,776,458 4,014,752 Earnings per share: As reported 1.42 1.20 Pro forma 1.40 1.18
Accounting practices used to prepare statutory financial statements for regulatory filings of stock life insurance companies differ from GAAP. Material differences resulting from these accounting practices include: deferred policy acquisition costs, deferred Federal income taxes and statutory non-admitted assets are recognized under GAAP accounting; statutory investment valuation reserves are not recognized under GAAP accounting; premiums for universal life and investment-type products are recognized as revenues for statutory purposes and as deposits to policyholders' accounts under GAAP; different assumptions are used in calculating future policyholders' benefits; and different methods are used for calculating valuation allowances for statutory and GAAP purposes.
Net earnings and stockholders' equity, as reported to regulatory authorities in conformity with statutory accounting practices for each of the years in the three-year period ended December 31, 1996 is as follows:
1996 1995 1994 ------- -------- -------- Statutory net earnings $ 2,539,179 2,147,387 748,352 ========== ========== ========= Statutory stockholders' equity $ 23,973,514 21,057,615 18,799,523 ========== ========== ==========
The Georgia Insurance Code limits dividends in any one year to the greater of statutory earnings, excluding realized capital gains, or 10% of statutory surplus, unless the expressed permission of the Georgia Insurance Department is obtained. Dividend payments to stockholders are further limited by the Georgia Insurance Code to unassigned statutory surplus, which at December 31, 1996 was approximately $20,400,000. The excess of retained earnings determined in accordance with generally accepted accounting principles over unassigned statutory surplus is not available for payment of dividends. The Company may pay a dividend amounting to $2,539,179 in 1996 without approval.
(10) Litigation The Company is a defendant in various actions incidental to the conduct of its business. While the ultimate outcome of these matters cannot be estimated with certainty, management does not believe the actions will result in any material loss to the Company.
The Board of Directors and Stockholders Cotton States Life Insurance Company:
As described in note 2, effective January 1, 1994, the Company changed its method of accounting for certain investment securities.
Management's Report to Stockholders of Cotton States Life Insurance Company and Subsidiaries
The Company's consolidated financial statements have been audited by independent auditors, KPMG Peat Marwick, LLP. Their role is to audit the consolidated financial statements in accordance with generally accepted auditing standards and render an independent and professional opinion on management's consolidated financial statements. The auditors' report on the Company's consolidated financial statements appears above.
J. Ridley Howard Gary W. Meader ------------------------------ ----------------------------- President and Chief Financial Officer Chief Executive Officer