Property owned Amount % of Total Home Office $ 1,889,038 7%
Commercial property mainly consists of North Plaza, which owns for investment purposes, a shopping center in Somerset, Kentucky, approximately 14,000 acres of timberland in Kentucky, and a 50% partnership interest in an additional 11,000 acres of Kentucky timberland. The timberland is harvested and in various stages of maturity. The property is carried at $ 9,583,967.
UG is a two-thirds owner for investment purposes in a commercial office building, held in an LLC, referred to as Hampshire Plaza. The other one-third partner is Millard V. Oakley, who is a former Director of UTG. Hampshire Plaza consists of a 254,000 square foot office tower, an attached 72,000 square foot retail plaza, and an attached parking garage with approximately 350 parking spaces located in New Hampshire. The Company invested an additional $ 1,100,000 in 2003 in order to renovate and improve existing office space within the building and plans to contribute an additional $ 400,000 in the next year. The improvements have been made in order to lease the office space in the near future. During the first half of 2002 a significant portion of existing office leases expired. In 2003, the Company obtained new lease agreements whereby approximately 70% of the building would become leased. The addition of this substantial lease agreement will positively impact future cash flows on this investment. At December 31, 2003, the property was carried at $ 11,005,688.
UG purchased real estate, known as Hampshire Plaza Garage, at a cost of $ 2,220,256 from an outside third party through the formation of an LLC in which UG is a two-thirds owner. The other one-third partner is Millard V. Oakley, who is a former Director of UTG. The property consists of a parking garage with approximately 580 parking spaces located in New Hampshire.
The purpose of this section is to discuss and analyze the Company's consolidated results of operations, financial condition and liquidity and capital resources for the three years ended December 31, 2003. This analysis should be read in conjunction with the consolidated financial statements and related notes, which appear elsewhere in this Form 10-K. The Company reports financial results on a consolidated basis. The consolidated financial statements include the accounts of UTG and its subsidiaries at December 31, 2003.
DAC and Cost of Insurance Acquired Deferred acquisition costs (DAC) and cost of insurance acquired reflect our expectations about the future experience of the existing business in-force. The primary assumptions regarding future experience that can affect the carrying value of DAC and cost of insurance acquired balances include mortality, interest spreads and policy lapse rates. Significant changes in these assumptions can impact amortization of DAC and cost of insurance acquired in both the current and future periods, which is reflected in earnings.
During 2001, the Company implemented a conservation effort, which is still in place, in an attempt to improve the persistency rate of insurance company's policies. Several of the customer service representatives of the Company have become licensed insurance agents, allowing them to offer other products within the Company's portfolio to existing customers. Additionally, stronger efforts have been made in policy retention through more personal contact with the customer including telephone calls to discuss alternatives and reasons for a customer's request to surrender their policy. Previously, the Company's agency force was primarily responsible for conservation efforts. With the decline in the number of agents, their ability to reach these customers diminished, making conservation efforts difficult. The conservation efforts described above have been generally positive. Management will continue to monitor these efforts and make adjustments as seen appropriate to enhance the future success of the program. The Company has also implemented a new product referred to as "the Legacy" to be specifically used by the licensed customer service representatives as an alternative for the customer in the conservation efforts. The Company is looking at additional products to offer to further enhance conservation and home office sales.
Net investment income decreased 24% when comparing 2003 to 2002 and decreased 11% when comparing 2002 to 2001. The overall investment yields for 2003, 2002 and 2001, are 4.05%, 5.37% and 6.39%, respectively. The decline in investment yields are directly affected by the decline in the national prime rate, which has declined from 9.5% at December 31, 2000 to 4.00% at December 31, 2003. This decrease has resulted in lower earnings on short-term funds as well as on longer-term investments acquired. Should this economic climate continue, net investment income may continue to decline as the Company, along with others in the insurance industry, seeks adequate returns on investments, while staying within the conservative investment guidelines set forth by insurance regulators. Many insurance companies have suffered significant losses in their investment portfolios as a result of corporate defaults and bankruptcies in the last couple of years; however, because of the Company's conservative investment philosophy the Company has so far avoided such significant losses. The Company's corporate holdings are relatively small compared to the insurance industry. Recent periods investments acquired include a very limited amount in corporate securities. Management continues to shorten the length of the Company's portfolio which has limited investment earnings in the short run. The Company has not written off any investment losses in these turbulent economic times.
The Company's investments are generally managed to match related insurance and policyholder liabilities. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. The Company monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads, ranging from 1% to 2%. At the March 2001 Board of Directors meeting, the Boards of the insurance subsidiaries lowered crediting rates one-half percent on all products that could be lowered. With this reduction, the Company's rate-adjustable products are now at their guaranteed minimum rates, and as such, cannot be lowered any further. At the March 2002 Board of Directors meeting, the Boards of the insurance subsidiaries lowered all remaining rate-adjustable products to their guaranteed minimum rates. The guaranteed minimum crediting rates on these products range from 3% to 5.5%. These adjustments were in response to the continued declines in interest rates in the marketplace described above. Policy interest crediting rate changes and expense load changes become effective on an individual policy basis on the next policy anniversary. Therefore, it takes a full year from the time the change was determined for the full impact of such change to be realized. If interest rates continue to decline, the Company won't be able to lower rates and both net investment income and net income will be impacted negatively.
Realized investment gains, net of realized losses, were $ 485,436, $ 13,634 and $ 436,840 in 2003, 2002 and 2001, respectively. The primary source for the 2003 gain is from the sale of two investments. The Company sold one common stock holding, realizing a gain of $ 165,262 and one real estate holding, realizing a gain of $ 211,352. During 2002, the modest realized gain consisted primarily of real estate sales on residential development property the Company owned in Springfield, Illinois. During 2001, the Company sold the West Virginia properties including the former home office building of APPL, realizing a gain of $ 217,574.
On June 1, 2001, the Company began performing administrative work as a third party administrator (TPA) for an unaffiliated life insurance company. The business being administered is a closed block with approximately 250,000 policies, a majority of which are paid up. The Company receives monthly fees based on policy in force counts and certain other activity indicators such as number of premium collections performed. During the year ended 2003 and 2002, the Company received $ 473,145, and $ 521,782 for this work, respectively. These TPA revenue fees are included in the line item "other income" on the Company's consolidated statements of operations. The Company intends to pursue other TPA arrangements, and in 2002 entered into an alliance with Fiserv Life Insurance Solutions (Fiserv LIS), to provide TPA services to insurance companies seeking business process outsourcing solutions. Fiserv LIS will be responsible for the marketing and sales function for the alliance, as well as providing the datacenter operations. UTG will staff the administration effort. Management believes this alliance with Fiserv LIS positions the Company to generate additional revenues by utilizing the Company's current excess capacity and administrative services. Fiserv LIS is a unit of Fiserv, Inc. (Nasdaq: FISV) which is an independent, full-service provider of integrated data processing and information management systems to the financial industry, headquartered in Brookfield, Wisconsin. Although no additional TPA work has been added to date, management believes this area is a growing market and the Company is well positioned to serve this market.
In March 2001, the Board of UG lowered crediting rates one-half percent on all rate-adjustable products that could be lowered. With this reduction, the Company's rate-adjustable products have been lowered to their guaranteed minimum rates, and as such, cannot be lowered any further. In addition, in 2002, the Board of UG adjusted the expense loads of the Century 2000 product to the guaranteed amounts. These adjustments were in response to continued declines in interest rates in the marketplace. Policy interest crediting rate changes and expense load changes become effective on an individual policy basis on the next policy anniversary. Therefore, it takes a full year from the time the change was determined for the full impact of such change to be realized.
Commissions and amortization of deferred policy acquisition costs decreased 60% in 2003 compared to 2002 and decreased 38% in 2002 compared to 2001. The most significant factor in the continuing decrease is attributable to the Company paying fewer commissions, since the Company writes very little new business and renewal premiums on existing business continue to decline. Another factor of the decrease is attributable to normal amortization of the deferred policy acquisition costs asset. The Company reviews the recoverability of the asset based on current trends and known events compared to the assumptions used in the establishment of the original asset. No impairments were recorded in any of the three periods reported.
Operating expenses increased 29% in 2003 compared to 2002 and decreased 9% in 2002 compared to 2001. During 2003, the Company paid $ 1,950,000 in settlement of a lawsuit. In addition, the Company maintains a $ 200,000 accrual to cover expected future costs regarding this matter. During 2001, the Company transferred all remaining functions of its former insurance subsidiary APPL from Huntington, West Virginia to the Springfield, Illinois location, and sold the West Virginia property. The closing of the Huntington office resulted in an approximately $ 325,000 reduction to operating expenses in 2002. Also during 2002, the Company changed health insurance coverage on its employees. This change reduced 2002 operating expenses approximately $ 75,000, while maintaining similar coverage amounts. Additional expense reductions have been made in the normal course of business, as the Company continually monitors expenditures looking for savings opportunities. These expense reductions have been partially offset by increased operating costs of approximately $ 285,000 attributable to the Company's conversion of its existing business and TPA clients to "ID3", a software system owned by Fiserv LIS. Conversion costs to date include fees for initial licensing, consultation, and training.
The Company had a net income (loss) of $ (6,396,490), $ 1,338,795 and $ 2,308,096 in 2003, 2002 and 2001 respectively. Significant one-time charges and accruals to operating expenses, combined with an additional write-off of cost of insurance acquired and continued decline in interest rates during 2003 as previously described, were the primary differences in the 2003 to 2002 results. The decrease in net income in 2002 as compared to 2001 is primarily related to lower investment income returns and increased death claims. The Company continues to monitor and adjust those items within its control.
The following table summarizes the Company's fixed maturities distribution at December 31, 2003 and 2002 by ratings category as issued by Standard and Poor's, a leading ratings analyst.
Deferred policy acquisition costs decreased 14% in 2003 compared to 2002. Deferred policy acquisition costs, which vary with, and are primarily related to producing new business, are referred to as 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 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 $ 61,000 in policy acquisition costs deferred, $ 17,000 in interest accretion and $ 417,844 in amortization in 2003, and had $ 69,000 in policy acquisition costs deferred, $ 55,000 in interest accretion and $ 769,432 in amortization in 2002.
Cost of insurance acquired decreased 31% in 2003 compared to 2002. When an insurance company is acquired, the Company assigns a portion of its cost to the right to receive future cash flows from insurance contracts existing at the date of the acquisition. The cost of policies purchased represents the actuarially determined present value of the projected future cash flows from the acquired policies. Cost of insurance acquired is amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. In 2003 and 2002 amortization decreased the asset by $ 1,695,328 and $ 1,515,450, respectively. In 2003, the balance was reduced by an additional $ 5,000,000 as a direct charge-off of unamortized asset over the projected future profits. Also, the balance was reduced $ 8,409,722 in 2002 as a result of the valuation adjustment attributable to the acquisition of the minority positions of FCC through its merger with and into UTG.
Total liabilities decreased 1% in 2003 compared to 2002. Policy liabilities and accruals, which represented 95% and 93% of total liabilities at year end 2003 and 2002, respectively, increased slightly during the current year. The increase is attributable to a the continued aging of the in-force population and an improvement in the persistency rate on the policies.
Cash provided by (used in) operating activities was $ (933,048), $ 467,034 and $ 1,527,856 in 2003, 2002 and 2001, respectively. Reporting regulations require cash inflows and outflows from universal life insurance products to be shown as financing activities when reporting on cash flows. The net cash provided by operating activities plus policyholder contract deposits less policyholder contract withdrawals equaled $ 1,504,730 in 2003, $ 2,798,799 in 2002 and $ 3,547,366 in 2001. Management utilizes this measurement of cash flows as an indicator of the performance of the Company's insurance operations.
Cash provided by (used in) investing activities was $ (15,846,714), $ 7,833,788 and $ 714,155 for 2003, 2002 and 2001, respectively. The most significant aspect of cash provided by (used in) investing activities is the fixed maturity transactions. Fixed maturities account for 82%, 78% and 81% of the total cost of investments acquired in 2003, 2002 and 2001, respectively.
Policyholder contract deposits decreased 8% in 2003 compared to 2002, and decreased 9% in 2002 when compared to 2001. The decrease in policyholder contract deposits relates to the decline in new business production experienced in the last few years by the Company. Policyholder contract withdrawals have decreased 11% in 2003 compared to 2002, and 15% in 2002 compared to 2001. The change in policyholder contract withdrawals is not attributable to any one significant event. Factors that influence policyholder contract withdrawals are fluctuation of interest rates, competition and other economic factors.
On November 15, 2001, UTG was extended a $ 3,300,000 line of credit (LOC) from the First National Bank of the Cumberlands (FNBC) located in Livingston, Tennessee. The FNBC is owned by Millard V. Oakley, who at the time was a director of UTG. The LOC was for a one-year term from the date of issue. The Company has renewed the LOC annually. The interest rate on the LOC is variable and indexed to be the lowest of the U.S. prime rates as published in the Wall Street Journal, with any interest rate adjustments to be made monthly. At December 31, 2003, the Company had no outstanding borrowings attributable to this LOC. During 2003, the Company had no borrowings against this LOC. During 2002 the Company had total borrowings of $ 1,600,000 on this LOC, which were all repaid during the year. The draws on this LOC were used to facilitate the payments due to the former shareholders of FCC as a result of the June 12, 2002, merger of FCC with and into UTG, as further described in note 15 to the consolidated financial statements and incorporated herein by this reference.
In June 2002, the Company entered into a five-year contract with Fiserv LIS for services related to their purchase of the "ID3" software system. Under the contract, the Company is required to pay $ 12,000 per month in software maintenance costs and a monthly fee for offsite data center costs, based on the number and type of policies being administered o the ID3 software system for a five-year period from the date of the signing.
In preparation for a possible charter sale of APPL, UG and APPL entered into a 100% coinsurance agreement effective October 1, 2002, whereby UG assumed and APPL ceded all of the existing business of APPL. The coinsurance transaction had no financial impact on the consolidated financial statements or operating results of UTG. At the March 2003 Board of Directors meeting, the APPL and UG Boards reaffirmed the merger of APPL with and into UG and approved the final merger documents.
At year-end 2003, UG had five ratios outside the normal range. Three of the suspect ratios were as a result of the settlement of a lawsuit (See Note 8). The fourth ratio was slightly outside the normal range relating to net investment income while the fifth ratio was outside the normal range due to the 2002 coinsurance agreement with its then 100% owned subsidiary, APPL.
At December 31, 2003, the insurance subsidiary has a ratio that is in excess of 3, which is 300% of the authorized control level; accordingly, the insurance subsidiary meets the RBC requirements.
On July 30, 2002, President Bush signed into law the "SARBANES-OXLEY" Act of 2002 ("the Act"). This Law, enacted in response to several high-profile business failures, was developed to provide meaningful reforms that protect the public interest and restore confidence in the reporting practices of publicly traded companies. The implications of the Act to public companies, (which includes UTG) are vast, widespread, and evolving. Many of the new requirements will not take effect or full effect until after calendar-year-end companies have completed their 2003 annual reports. The Company has implemented requirements affecting the current reporting period, and is continually monitoring, evaluating, and planning implementation of requirements that will need to be taken into account in future reporting periods.
The Financial Accounting Standards Board (FASB) has issued Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. Statement 149 was issued to amend and clarify financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement 133. The provisions of Statement 149 are effective on contracts entered into or modified after June 30, 2003, with some exceptions for Statement 133 Implementation Issues and hedging relationships designated after June 30, 2003. The adoption of Statement 149 did not affect the Company's financial position or results of operations, since the Company has had no acquisitions of this nature during the reporting period.
Independent Auditors' Report for the years ended December 31, 2003, 2002, 2001..................................36
We have audited the accompanying consolidated balance sheets of UNITED TRUST GROUP, INC. (an Illinois corporation) and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
UNITED TRUST GROUP, INC. CONSOLIDATED BALANCE SHEETS As of December 31, 2003 and 2002
ASSETS 2003 (Restated) --------------- -------------- Investments: Fixed maturities held to maturity, at amortized cost (market $27,440,277 and $60,517,065) $ 26,724,507 $ 58,327,663 Investments held for sale: Fixed maturities, at market (cost $139,248,547 and $105,244,887) 139,390,382 108,704,518 Equity securities, at market (cost $7,209,443 and $4,122,887) 9,362,165 4,883,870 Mortgage loans on real estate at amortized cost 26,715,968 23,804,827 Investment real estate, at cost, net of accumulated depreciation 24,725,824 20,946,987 Policy loans 13,226,399 13,346,504 Short-term investments 34,677 377,676 --------------- -------------- 240,179,922 230,392,045
LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities and accruals: Future policy benefits $ 236,192,132 $ 234,762,656 Policy claims and benefits payable 2,541,735 1,834,952 Other policyholder funds 1,038,063 1,176,359 Dividend and endowment accumulations 12,626,515 12,628,294 Deferred income taxes 6,763,648 10,394,891 Notes payable 2,289,776 2,995,275 Other liabilities 5,557,215 5,694,121 --------------- -------------- Total liabilities 267,009,084 269,486,548 --------------- -------------- Minority interests in consolidated subsidiaries 4,851,410 3,413,845 --------------- --------------
Premiums and policy fees $ 18,121,018 $ 18,693,022 $ 20,444,514 Reinsurance premiums and policy fees (3,097,980) (2,861,445) (3,303,575) Net investment income 10,270,500 13,514,802 15,146,259 Realized investment gains, net 485,436 13,634 436,840 Other income 709,384 817,186 589,017 --------------- ---------------- ---------------- 26,488,358 30,177,199 33,313,055
Basic income (loss) per share from continuing operations and net income (loss) $ (1.67) $ 0.38 $ 0.62 =============== ================ ================
Basic weighted average shares outstanding 3,839,947 3,505,424 3,733,432 =============== ================ ================
Diluted weighted average shares outstanding 3,839,947 4,005,424 3,733,432 =============== ================ ================
UNITED TRUST GROUP, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Three Years Ended December 31, 2003 2002 2001 2003 (Restated) (Restated) --------- --------- --------------
Common stock Balance, beginning of year $ 70,726 $ 70,996 $ 83,501 Issued during year 10,331 1,177 0 Treasury shares acquired (532) (1,447) (555) Retired during year (433) 0 (11,950) Cumulative change in accounting principal (84) 0 0 ------------ ------------ ------------- Balance, end of year 80,008 $ 70,726 $ 70,996 =========== =========== =============
Additional paid-in capital Balance, beginning of year $42,976,344 $42,789,636 $ 47,730,980 Issued during year 185,574 705,514 0 Treasury shares acquired (181,817) (518,806) (172,927) Retired during year (258,361) 0 (4,768,417) Cumulative change in accounting principal (49,551) 0 0 ----------- ----------- ------------- Balance, end of year $42,672,189 $42,976,344 $ 42,789,636 =========== =========== =============
Accumulated other comprehensive income Balance, beginning of year $ 2,771,941 $ 908,744 $ 335,287 Other comprehensive income (loss) Unrealized holding gain (loss) on securities net of minority interest and reclassification adjustment (1,205,544) (1,205,544) 1,863,197 1,863,197 573,457 573,457 ----------- ------------- ----------- -------------- ------------- ----------- Comprehensive income (loss) $ (7,602,034) $ 3,201,992 $2,881,553 ============= ============== ========== Balance, end of year $ 1,566,397 $ 2,771,941 $ 908,744 =========== =========== =============
Total shareholders' equity, end of year $39,696,639 $47,593,546 $ 44,205,116 =========== =========== =============
Cash flows from investing activities: Proceeds from investments sold and matured: Fixed maturities held for sale 73,314,066 29,748,521 30,309,229 Fixed maturities matured 36,065,715 19,957,888 47,848,810 Equity securities 167,734 0 6,312,727 Mortgage loans 8,494,201 6,472,013 14,738,313 Real estate 1,096,759 1,179,931 2,135,472 Policy loans 2,619,463 3,112,687 2,912,296 Short-term 350,000 203,706 2,229,528 -------------- -------------- --------------- Total proceeds from investments sold and matured 122,107,938 60,674,746 106,486,375 Cost of investments acquired: Fixed maturities held for sale (108,410,675) (37,341,428) (84,801,095) Fixed maturities (4,283,413) (3,973,623) (1,124,925) Equity securities (7,089,857) (185,075) (4,608,649) Mortgage loans (11,405,342) (6,889,945) (5,325,569) Real estate (3,722,406) (1,575,713) (6,420,294) Policy loans (2,499,358) (2,850,735) (2,429,852) Short-term (7,001) 0 (1,124,512) -------------- -------------- --------------- Total cost of investments acquired (137,418,052) (52,816,519) (105,834,896) Purchase of property and equipment (536,600) (24,439) (138,388) Sale of property and equipment 0 0 201,064 -------------- -------------- --------------- Net cash provided by (used in) investing activities (15,846,714) 7,833,788 714,155 -------------- -------------- ---------------
Cash flows from financing activities: Policyholder contract deposits 9,505,436 10,291,519 11,361,882 Policyholder contract withdrawals (7,067,658) (7,959,754) (9,342,372) Payments of principal on notes payable (705,499) (3,405,395) (1,302,495) Proceeds from line of credit 0 2,000,000 0 Purchase of stock of affiliates 0 0 (632,131) Payments from FCC merger 0 (1,586,500) 0 Issuance of common stock 195,906 706,691 0 Purchase of treasury stock (441,144) (520,253) (1,176,653) -------------- -------------- --------------- Net cash provided by (used in) financing activities 1,487,041 (473,692) (1,091,769) -------------- -------------- ---------------
Net increase (decrease) in cash and cash equivalents (15,292,721) 7,827,130 1,150,242 Cash and cash equivalents at beginning of year 24,042,448 16,215,318 15,065,076 -------------- -------------- --------------- Cash and cash equivalents at end of year $ 8,749,727 $ 24,042,448 $ 16,215,318 ============== ============== ===============
A. ORGANIZATION - At December 31, 2003, the significant majority-owned subsidiaries of UNITED TRUST GROUP, INC., were as depicted on the following organizational chart.
B. NATURE OF OPERATIONS - United Trust Group, Inc., is an insurance holding company, which sells individual life insurance products through its subsidiary. The Company's principal market is the Midwestern United States. The Company's dominant business is individual life insurance which includes the servicing of existing insurance business in force, the solicitation of new individual life insurance and the acquisition of other companies in the insurance business.
Investments held for sale - at current market value, unrealized appreciation or depreciation is charged directly to shareholders' equity.
Real estate - investment real estate at cost less allowance for depreciation and, as appropriate, provisions for possible losses. Accumulated depreciation on investment real estate was $ 1,200,454 and $ 460,170 as of December 31, 2003 and 2002, respectively.
Cost of insurance acquired was tested for impairment as part of the regular reporting process. Due to a decline in projected future cash flows from the business and lower current investment yields, a revision of the estimated fair value of the cost of insurance acquired was considered necessary. This revision resulted in a $ 5,000,000 impairment loss. The fair value of the cost of insurance acquired was estimated using the expected present value of future cash flows. The impairment loss is included in the consolidated statements of operations under the caption of amortization of cost of insurance acquired.
L. DEFERRED POLICY ACQUISITION COSTS - Commissions and other costs (salaries of certain employees involved in the underwriting and policy issue functions and medical and inspection fees) of acquiring life insurance products that vary with and are primarily related to the production of new business have been deferred. Traditional life insurance acquisition costs are being amortized over the premium-paying period of the related policies using assumptions consistent with those used in computing policy benefit reserves.
2003 2002 2001 ---------------- ----------------- ---------------- Deferred, beginning of year $ 2,462,487 $ 3,107,919 $ 3,948,496
Acquisition costs deferred: Commissions 56,000 49,000 108,000 Other expenses 5,000 20,000 59,000 ---------------- ----------------- ---------------- Total
Interest accretion 17,000 55,000 76,000 Amortization charged to income (417,844) (769,432) (1,083,577) ---------------- ----------------- ---------------- Net amortization
Deferred, end of year $ 2,122,643 $ 2,462,487 $ 3,107,919 ================ ================= ================
2004 $ 16,000 $ 690,000 $ 674,000 2005 13,000 585,000 572,000 2006 11,000 486,000 475,000 2007 9,000 359,000 350,000 2008 8,000 296,000 288,000
M. COST IN EXCESS OF NET ASSETS PURCHASED - Cost in excess of net assets purchased is the excess of the amount paid to acquire a company over the fair value of its net assets. On January 1, 2002, the Company adopted FASB Statement No. 142, Goodwill and Intangible Assets, which required that goodwill no longer be amortized to earnings, but instead be reviewed for impairment. Accumulated amortization of cost in excess of net assets purchased was $ 1,780,146 as of December 31, 2003 and 2002, respectively. At December 31, 2003, the Company had no goodwill on its balance sheet. The goodwill balance at year end 2001 was eliminated in the purchase accounting valuations relating to the June 2002 merger of FCC.
P. EARNINGS PER SHARE - Earnings per share (EPS) are reported under Statement of Financial Accounting Standards Number 128. The objective of both basic EPS and diluted EPS is to measure the performance of an entity over the reporting period. Basic EPS is computed by dividing income available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. In addition, the numerator also is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common shares.
R. RECOGNITION OF REVENUES AND RELATED EXPENSES - Premiums for traditional life insurance products, which include those products with fixed and guaranteed premiums and benefits, consist principally of whole life insurance policies, and certain annuities with life contingencies are recognized as revenues when due. Limited payment life insurance policies defer gross premiums received in excess of net premiums, which is then recognized in income in a constant relationship with insurance in force. Accident and health insurance premiums are recognized as revenue pro rata over the terms of the policies. Benefits and related expenses associated with the premiums earned are charged to expense proportionately over the lives of the policies through a provision for future policy benefit liabilities and through deferral and amortization of deferred policy acquisition costs. For universal life and investment products, generally there is no requirement for payment of premium other than to maintain account values at a level sufficient to pay mortality and expense charges. Consequently, premiums for universal life policies and investment products are not reported as revenue, but as deposits. Policy fee revenue for universal life policies and investment products consists of charges for the cost of insurance and policy administration fees assessed during the period. Expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances.
S. PARTICIPATING INSURANCE - Participating business represents 20% and 19% of the ordinary life insurance in force at December 31, 2003 and 2002, respectively. Premium income from participating business represents 23%, 25%, and 26% of total premiums for the years ended December 31, 2003, 2002 and 2001, respectively. The amount of dividends to be paid is determined annually by the respective insurance subsidiary's Board of Directors. Earnings allocable to participating policyholders are based on legal requirements that vary by state.
T. RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform to the 2003 presentation. Such reclassifications had no effect on previously reported net income or shareholders' equity.
Ohio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 2003, UG had a statutory loss from operations of $ 1,461,177. At December 31, 2003, UG's statutory capital and surplus amounted to $ 13,008,198. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. UG paid ordinary dividends of $ 600,000 to UTG in 2003.
The Company's life insurance subsidiary has net operating loss carryforwards for federal income tax purposes expiring as follows:
2003 2002 2001 --------------- --------------- ---------------- Net income (loss) $ (6,396,490)$ 1,338,795 $ 2,308,096 Federal income tax provision 263,992 327,472 12,043 Loss (gain) of subsidiaries 6,723,981 (700,226) (2,277,990) --------------- --------------- ---------------- Taxable income $ 591,483 $ 966,041 $ 42,149 =============== =============== ================
2003 2002 ---------------- --------------- Investments $ 2,514,031 $ 2,883,414 Cost of insurance acquired 5,115,833 7,484,447 Deferred policy acquisition costs 742,925 861,870 Management/consulting fees (304,038) (321,086) Future policy benefits (1,145,126) (1,014,369) Gain on sale of subsidiary 2,312,483 2,312,483 Net operating loss carryforward (1,304,864) (364,358) Other liabilities 0 (130,594) Federal tax DAC (1,167,596) (1,316,916) ---------------- --------------- Deferred tax liability $ 6,763,648 $ 10,394,891 ================ ===============
December 31, ---------------------------------------------------------- 2003 2002 2001 --------------- ---------------- ---------------- Fixed maturities and fixed maturities held for sale $ 8,418,969 $ 10,302,735 $ 10,831,162 Equity securities 456,361 131,778 131,263 Mortgage loans 1,522,700 1,749,935 2,715,834 Real estate 2,832,171 3,261,043 567,368 Policy loans 949,770 965,227 970,142 Short-term investments 11,161 26,522 110,229 Cash 137,478 211,293 606,128 --------------- ---------------- ---------------- Total consolidated investment income 14,328,610 16,648,533 15,932,126 Investment expenses (4,058,110) (3,133,731) (785,867) ---------------- ---------------- ---------------- Consolidated net investment income $ 10,270,500 $ 13,514,802 $ 15,146,259 =============== ================ ================
At December 31, 2003, the Company had a total of $ 656,716 in investment real estate, which did not produce income during 2003.
Fixed maturities held to maturity: U.S. Government, government agencies and authorities $ 10,676,106 $ 7,480,490 State, municipalities and political subdivisions 6,342,369 8,195,248 Collateralized mortgage obligations 77,802 60,820 Public utilities 5,397,880 15,134,965 All other corporate bonds 4,230,350 27,456,140 --------------- -------------- $ 26,724,507 $ 58,327,663 =============== ==============
Fixed maturities held to maturity: U.S. Government and govt. agencies and authorities $ 10,676,106 $ 229,788 $ 0 $ 10,905,894 States, municipalities and political subdivisions 6,342,369 231,132 (12,919) 6,560,582 Collateralized mortgage obligations 77,802 875 (444) 78,233 Public utilities 5,397,880 100,056 0 5,497,936 All other corporate bonds 4,230,350 188,071 (20,789) 4,397,632 -------------- ------------- --------------- -------------- Total $ 26,724,507 $ 749,922 $ (34,152) $ 27,440,277 ============== ============= =============== ==============
Fixed maturities held to maturity: U.S. Government and govt. agencies and authorities $ 7,480,490 $ 403,473 $ (3) $ 7,883,960 States, municipalities and political subdivisions 8,195,248 406,211 (7,753) 8,593,706 Collateralized mortgage obligations 60,820 4,296 0 65,116 Public utilities 15,134,965 509,875 (96,029) 15,548,811 All other corporate bonds 27,456,140 1,058,270 (88,938) 28,425,472 -------------- ------------- --------------- -------------- Total $ 58,327,663 $ 2,382,125 $ (192,723) $ 60,517,065 ============== ============= =============== ==============
An analysis of sales, maturities and principal repayments of the Company's fixed maturities portfolio for the years ended December 31, 2003, 2002 and 2001 is as follows:
Cost or Gross Gross Proceeds Amortized Realized Realized From Year ended December 31, 2001 Cost Gains Losses Sale ------------------------------------- --------------- ------------- --------------- --------------- Scheduled principal repayments, Calls and tenders: Held for sale $ 23,583,564 $ 10,440 $ 0 $ 23,594,004 Held to maturity 47,921,354 34,690 (107,234) 47,848,810 Sales: Held for sale 6,518,181 197,044 0 6,715,225 Held to maturity 0 0 0 0 --------------- ------------- --------------- --------------- Total $ 78,023,099 $ 242,174 $ (107,234) $ 78,158,039 =============== ============= =============== ===============
The Company's insurance subsidiary is domiciled in Ohio and prepares its statutory-based financial statements in accordance with accounting practices prescribed or permitted by the Ohio insurance department. These principles differ significantly from accounting principles generally accepted in the United States of America. "Prescribed" statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, from company to company within a state, and may change in the future. The NAIC recently completed the process of codifying statutory accounting practices, the result of which is to constitute the only source of "prescribed" statutory accounting practices. The new rules promulgated by the codifying of statutory accounting practices became effective January 1, 2001. Accordingly, these uniform rules change prescribed statutory accounting practices and result in changes to the accounting practices that insurance enterprises use to prepare their statutory financial statements. Implementation of the codification rules did not have a material financial impact on the financial condition of the Company's life insurance subsidiary. UG's total statutory shareholders' equity was $ 13,008,198 and $ 16,030,200 at December 31, 2003 and 2002, respectively. The Company's life insurance subsidiary reported a statutory operating income (loss) before taxes (exclusive of intercompany dividends) of approximately $ (1,461,000), $ 2,700,000 and $ 2,913,000 for 2003, 2002 and 2001, respectively.
On September 30, 1998, UG entered into a coinsurance agreement with The Independent Order of Vikings, an Illinois fraternal organization (IOV). Under the terms of the agreement, UG agreed to assume, on a coinsurance basis, 25% of the reserves and liabilities arising from all in-force insurance contracts issued by the IOV to its members. At December 31, 2003, the IOV insurance in-force was approximately $ 1,688,000, with reserves being held on that amount of approximately $ 399,000.
On April 26, 1999, the above lawsuit was filed by David Morlan and Louis Black in the Southern District of Illinois against Universal Guaranty Life Insurance Company (UG) and United Trust Assurance Company (UTAC) (merged into UG in 1992). After the lawsuit was filed, the plaintiffs, who were former insurance salesmen, amended their complaint, dropped Louis Black as a plaintiff, and added United Security Assurance Company (USAC) (merged into UG in 1999), UTG and FCC as defendants. The plaintiffs alleged that they were employees of UG, UTAC or USAC rather than independent contractors. The plaintiffs sought class action status and asked to recover various employee benefits, costs and attorneys' fees, as well as monetary damages based on the defendants' alleged failure to withhold certain taxes.
In late June 2003, mediation was held in an attempt to bring resolution to this lawsuit. The negotiations continued in July and August, and a proposed settlement was ultimately reached. Although the Company continued to believe that it had meritorious grounds to defend this lawsuit, the legal process can be lengthy and costly, with no guarantee of success in the final resolution. Under these circumstances, management believed a settlement of the matter was in the best interests of the Company. Under the terms of the proposed settlement, the Company would pay approximately $ 1,950,000 in attorneys' fees, costs and expenses, and the Company, through its insurance subsidiary, will provide certain life insurance benefits at a discount to members of the class (or their transferees) choosing to purchase life insurance benefits.
On November 20, 2003, Hon. G. Patrick Murphy, Chief Judge for the United States District Court for the Southern District of Illinois, entered the order settling this action. On December 21, 2003 this order became final at the expiration of the appellate window and the Company paid approximately $ 1,950,000 in attorneys' fees, costs and expenses. The Company is currently awaiting the updated address information from opposing counsel in order to begin the initial mailings. At December 31, 2003, the Company maintained a $ 200,000 accrual to cover expected future costs regarding this matter.
On February 20, 2003, UG purchased $ 4,000,000 of a trust preferred security offering issued by FSBI. The security has a mandatory redemption after 30 years with a call provision after 5 years. The security pays a quarterly dividend at a fixed rate of 6.515%. The Company received $ 226,104 of dividends in 2003.
On November 6, 2003, UG purchased real estate at a cost of $ 2,220,256 from an outside third party through the formation of an LLC in which UG is a two-thirds owner. The other one-third partner is Millard V. Oakley, who is a former Director of UTG. Hampshire Plaza Garage is a 578 space parking garage located in New Hampshire.
The purchase price of shares repurchased under the stock restriction and buy-sell agreement shall be computed, on a per share basis, equal to the sum of (i) the original purchase price paid to acquire such shares from UTG and (ii) the consolidated statutory net earnings (loss) per share of such shares during the period from the end of the month next preceding the month in which such shares were acquired pursuant to the plan, to the end of the month next preceding the month in which the sale of such shares to UTG occurs. At December 31, 2003, UTG had 75,437shares outstanding that were issued under this program with a value of $ 11.63 per share pursuant to the above formula.
On November 20, 1998, FSF and affiliates acquired 929,904 shares of common stock of UTG from UTG and certain UTG shareholders. As consideration for the shares, FSF paid UTG $ 10,999,995 and certain shareholders of UTG $ 999,990 in cash. Included in the stock acquisition agreement is an earnings covenant whereby UTG warrants UTG and its subsidiaries and affiliates will have future earnings of at least $ 30,000,000 for a five-year period beginning January 1, 1998. Such earnings are computed based on statutory results excluding inter-company activities such as inter-company dividends plus realized and unrealized gains and losses on real estate, mortgage loans and unaffiliated common stocks. At the end of the covenant period, an adjustment is to be made equal to the difference between the then market value and statutory carrying value of real estate still owned that existed at the beginning of the covenant period. Should UTG not meet the covenant requirements, any shortfall will first be reduced by the actual average tax rate for UTG for the period, and then will be further reduced by one-half of the percentage, if any, representing UTG's ownership percentage of the insurance company subsidiaries. This result will then be reduced by $ 250,000. The remaining amount will be paid by UTG in the form of UTG common stock valued at $ 15.00 per share with a maximum number of shares to be issued of 500,000. However, there shall be no limit to the number of shares transferred to the extent that there are legal fees, settlements, damage payments or other losses as a result of certain legal action taken. The price and number of shares shall be adjusted for any applicable stock splits, stock dividends or other recapitalizations. For the five-year period starting January 1, 1998 and ending December 31, 2003, the Company had total earnings of $ 17,011,307 applicable to this covenant. Therefore, UTG did not meet the earnings requirements stipulated, and during 2003, UTG was required to issue 500,000 additional shares to FSF or its assigns.
At a December 17, 2001 joint meeting of the Board of Directors of UTG, FCC and their insurance subsidiaries, the Boards of Directors of the insurance subsidiaries discussed and decided to further explore and pursue a possible sale of the insurance charters of each of APPL and ABE. In the alternative to a sale of the APPL charter, the boards also discussed and decided to further explore a possible merger of APPL into UG. At the September 24, 2002 joint meeting of the Board of Directors of UTG and its insurance subsidiaries, the Boards of Directors of UG and ABE each approved the exploration of a merger transaction whereby ABE would be merged with and into UG.
On September 27, 2001, UG purchased real estate at a cost of $ 6,333,336 from an outside third party through the formation of an LLC in which UG is a two-thirds owner. The other one-third partner is Millard V. Oakley, who at the time was a Director of UTG. Mr. Oakley resigned from the Board effective March 14, 2003. Hampshire Plaza consists of a 254,000 square foot office tower, an attached 72,000 square foot retail plaza, and an attached parking garage with approximately 350 parking spaces located in New Hampshire.
UTG paid FCC $ 0 and $ 550,000 in 2002 and 2001, respectively for reimbursement of costs attributed to UTG. During 2002 through the date of the FCC merger, FCC paid $ 3,200,000 to UTG for reimbursement of costs attributed to FCC and affiliates under which FCC had management and cost sharing services arrangements.
On January 1, 1993, FCC entered an agreement with UG pursuant to which FCC provided management services necessary for UG to carry on its business. UG paid $ 2,974,088 and $ 6,156,903 to FCC in 2002 and 2001, respectively. UG paid $ 5,906,406 and $ 3,025,194 to UTG in 2003 and 2002, respectively, under this arrangement.
Since the Company's affiliation with FSF, UG has acquired mortgage loans through participation agreements with FSNB. FSNB services the loans covered by these participation agreements. UG pays a .25% servicing fee on these loans and a one-time fee at loan origination of .50% of the original loan amount to cover costs incurred by FSNB relating to the processing and establishment of the loan. UG paid $ 63,214, $ 70,140 and $ 79,730 in servicing fees and $ 13,821, $ 35,127 and $ 22,626 in origination fees to FSNB during 2003, 2002 and 2001, respectively.
The Company reimbursed expenses incurred by Mr. Jesse T. Correll and Mr. Randall L. Attkisson relating to travel and other costs incurred on behalf of or relating to the Company. The Company paid $ 20,238, $ 74,621 and $ 145,407 in 2003, 2002 and 2001, respectively to First Southern Bancorp, Inc. in reimbursement of such costs. In addition, beginning in 2001, the Company began reimbursing FSBI a portion of salaries for Mr. Correll and Mr. Attkisson. The reimbursement was approved by the UTG Board of Directors and totaled $ 151,440, $ 169,651 and $ 128,411 in 2003, 2002 and 2001, respectively, which included salaries and other benefits.
At the time of the stock acquisition above, UTG also granted, for nominal consideration, an irrevocable, exclusive option to FSF to purchase up to 1,450,000 shares of UTG common stock for a purchase price in cash equal to $ 15.00 per share, with such option to expire on July 1, 2001. UTG had a market price per share of $ 9.50 at the date of grant of the option. The option shares under this option are to be reduced by two shares for each share of UTG common stock that FSF or its affiliates purchase from UTG shareholders in private or public transactions after the execution of the option agreement. The option was additionally limited to a maximum when combined with shares owned by FSF of 51% of the issued and outstanding shares of UTG after giving effect to any shares subject to the option. The option expired unexercised on July 1, 2001.
As of December 31, 2003, no options were exercised and all options have been forfeited.
Diluted EPS Income available to common shareholders and $ assumed conversions (6,396,490) 3,839,947 $ (1.67) =============== ================== =================
Basic EPS Income available to common shareholders $ 1,338,795 3,505,424 $ 0.38 =================
Diluted EPS Income available to common shareholders and $ assumed conversions 2,308,096 3,733,432 $ 0.62 =============== ================== =================
UTG had granted stock options to FSF of 1,450,000 shares of UTG common stock which were outstanding as of year end 1998. The option shares under this option were to be reduced by two shares for each share of UTG common stock that FSF or its affiliates purchases from UTG shareholders in private or public transactions after the execution of the option agreement. The option was additionally limited to a maximum when combined with shares owned by FSF of 51% of the issued and outstanding shares of UTG after giving effect to any shares subject to the option. Due to the passage of time and the 51% limitation, all remaining stock options of 19,108 at $ 15.00 per share expired on July 1, 2001. No options were exercised during 2001. These options were not included in the computation of diluted EPS because the exercised price was greater than the average market price of the common shares for each respective year.
At December 31, 2003 and 2002, the Company had $ 2,289,776 and $ 2,995,275 in long-term debt outstanding, respectively. The debt is comprised of the following components:
2003 2002 ------------- ------------- Subordinated 20 yr. Notes $ 0 $ 0 Other notes payable 2,289,776 2,995,275 ------------- ------------- $ 2,289,776 $ 2,995,275 ============= =============
The subordinated debt was incurred June 16, 1992 as a part of the acquisition of the now dissolved CIC. These notes bore interest at the variable rate of 1% under prime per annum (paid quarterly). In May 2002 a principal payment of $ 113,112 was made on the subordinated debt. On July 9, 2002, the remaining outstanding balance of $ 401,562 on these notes was paid.
The collective scheduled principal reductions on these notes for the next five years were as follows:
On November 15, 2001, UTG was extended a $ 3,300,000 line of credit (LOC) from the First National Bank of the Cumberlands (FNBC) located in Livingston, Tennessee. The FNBC is owned by, Millard V. Oakley, who at the time was a Director of UTG. The LOC was for a one-year term from the date of issue. Upon maturity the Company renewed the LOC for an additional one-year terms. The interest rate on the LOC is variable and indexed to be the lowest of the U.S. prime rates as published in the Wall Street Journal, with any interest rate adjustments to be made monthly. During 2002 the Company had total borrowings of $ 1,600,000 on this LOC, which were all repaid during the year. The draws on this LOC were used to facilitate the payments due to the former shareholders of FCC as a result of the June 12, 2002, merger of FCC with and into UTG, as further described in note 15 to the consolidated financial statements. No borrowings were incurred during 2003.
On a cash basis, the Company paid $ 162,179, $ 263,441 and $ 333,365 in interest expense for the years 2003, 2002 and 2001, respectively. The Company paid $ 175,000, $ 60,290 and $ 92,006 in federal income tax for 2003, 2002 and 2001, respectively.
This statement was effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted Statement No. 150 in its September 30, 2003 financials and as a result, 4,178 shares of common stock no longer met the requirements to be classified as equity. The adoption of this Statement resulted in a reclassification of $ 49,635 from Shareholders' Equity to Other Liabilities.
On May 21, 2002, at a special meeting of shareholders, the shareholders of FCC, then an 82% owned subsidiary of UTG, voted on and approved that certain Agreement and Plan of Reorganization and related Plan of Merger, each dated as of June 5, 2001, between UTG, and FCC (collectively, the "Merger Agreement"), and the merger contemplated thereby in which FCC would be merged with and into UTG, with UTG being the surviving corporation of the merger. The merger became effective on June 12, 2002. Pursuant to the terms and conditions of the Merger Agreement, each share of FCC stock outstanding at the effective time of the merger (other than shares held by UTG or shares held in treasury by FCC or by any of its subsidiaries) was at such time automatically converted into the right to receive $ 250 in cash per share. This allowed UTG to acquire the remaining common shares (approximately 18%) of FCC that UTG did not own prior to the effective time of the merger.
The purchase price of the merger was comprised of the following components:
Investments $ 41,475,198 Cash and cash equivalents 2,020,960 Accrued investment income 493,609 Reinsurance receivables 6,784,813 Cost of insurance acquired (1,371,740) Property and equipment 424,217 Other assets 314,974 ------------------ Total assets 50,142,031
Policy liabilities and accruals (45,981,006) Income taxes payable - current and deferred 1,063,735 Notes payable (1,958,373) Other liabilities (786,387) ------------------ Net purchase price $ 2,480,000 ==================
December 31, December 31, 2001 -------------------- -------------------- Total revenues $ 30,064,644 $ 33,329,372 Total benefits and other expenses $ 27,927,456 $ 28,912,280 Operating income $ 2,137,188 $ 4,417,092 Net Income $ 1,394,218 $ 3,274,486 Basic earnings per share $ 0.40 $ 0.86 Diluted earnings per share $ 0.35 $ 0.86
Other comprehensive income $ 2,866,457 $ (1,003,260) $ 1,863,197 ================ ================= ===============
Other comprehensive income $ 882,242 $ $ 573,457 (308,785) ================ ================= ===============
Premiums and policy fees, net $ 3,883,003 $ 4,093,239 $ 3,686,584 $ 3,360,212 Net investment income 2,888,444 3,231,542 2,462,813 1,687,701 Total revenues 7,185,509 7,811,693 6,498,785 4,992,371 Policy benefits including dividends 5,520,920 4,931,443 5,516,224 5,102,089 Commissions and amortization of DAC and COI 544,139 441,914 513,488 5,507,726 Operating expenses 1,169,139 3,500,807 1,451,973 1,444,861 Operating income (loss) (90,406) (1,102,433) (1,023,300) (7,102,405) Net income (loss) (494,124) (669,492) (464,142) (4,768,732) Basic earnings (loss) per share (0.14) (0.17) (0.12) (1.24) Diluted earnings (loss) per share (0.12) (0.17) (0.12) (1.24)