The Company owns an office complex in Springfield, Illinois, which houses a portion of the insurance operations. The office buildings in this complex contain 57,000 square feet of office and warehouse space. Effective January 1, 2020, the Company executed a one year agreement with a third party to lease approximately 2,000 square feet of the Company's office space. Excess space in Springfield, IL is currently being marketed for lease.
The Company leases space in Stanford, KY from an affiliate, FSNB, to house insurance operations. The Company rents approximately 8,000 square feet of office space and pays $2,000 per month in rent.
The following is Management’s discussion and analysis of the financial condition and results of operations of UTG, Inc. and its subsidiaries (collectively with the Parent, the “Company”) for the years ended December 31, 2019 and 2018. This discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this report.
Valuation of Securities - The Company’s investment portfolio consists of fixed maturities, equity securities, trading securities, mortgage loans and real estate to provide funding of future policy contractual obligations. The Company’s fixed maturities are classified as available-for-sale. Available-for-sale investments are carried at fair value with unrealized gains and losses reported in accumulated other comprehensive income (loss) in the Consolidated Balance Sheets.
Premiums and policy fee revenues, net of reinsurance premiums and policy fees, were comparable for 2019 to 2018. The Company writes very little new business. Unless the Company acquires a new company or a block of in-force business, Management expects premium revenue to continue to decline on the existing block of business at a rate consistent with prior experience. The Company’s average persistency rate for all policies in-force for 2019 and 2018 was approximately 96.6% and 96.1%, respectively. Persistency is a measure of insurance in-force retained in relation to the previous year.
The following table summarizes the Company's investment performance for the years ended December 31:
Net investment income represented approximately 26% and 27% of the Company's total revenues as of December 31, 2019 and 2018, respectively. When comparing current and prior year results, net investment income was comparable in the majority of the investment categories, with the largest variances being found in the fixed maturities, mortgage loans, and notes receivable investment categories.
Income from the fixed maturities investment portfolio is down approximately 20% when comparing 2019 and 2018 results. In the third quarter of 2018, the Company sold a substantial bond holding. The bond holding was initially acquired over a period of time in 2016 at a deep discount, with an average cost of 25% of its par value. At the time of sale, Management had determined the value of the security had recovered sufficiently enough and the time was right to sell a majority of the holdings, realizing a gain of approximately $10 million. A portion of the sales proceeds were used to purchase higher rated, lower yielding bonds.
Income from the notes receivable investment portfolio was up approximately 89% or $869,000 when comparing 2019 and 2018 results. During 2019, the Company acquired approximately $16 million in notes receivable as compared to approximately $11.5 million in 2018. During 2019, the Company disposed of approximately $20.3 million of notes receivable as compared to approximately $6.8 million in 2018. The turnover in the notes receivable portfolio and the associated interest rates received on the notes are the main reasons for the variance in the income reported by the notes receivable portfolio.
During 2019, the Company sold 14,000 shares of a certain common stock holding and recognized a gain of approximately $8.9 million. At December 31, 2019, the Company still owned 25,000 shares of this specific common stock and during the first quarter of 2020, sold an additional 3,000 shares of this stock; recognizing a gain of approximately $1.9 million. A substantial portion of this realized gain was previously recognized as an unrealized gain in the December 31, 2019 Consolidated Statements of Operations. Therefore, this gain will have an immaterial impact on the 2020 earnings of the Company. The realized gain will be offset by the reversal of the unrealized gain that was previously recognized by the Company at year end 2019.
During 2019, the Company sold six real estate parcels and recognized gains of approximately $3.9 million. During 2018, the Company recognized gains of approximately $1.6 million from the sale of three real estate parcels.
The 2018 gains were the result of the sale of certain fixed maturities and real estate, which were offset by the recognition of an other-than-temporary impairment on a parcel of real estate. During 2018, the Company sold a substantial bond holding. The bond holding was initially acquired during 2016 over a period of time at a deep discount, with an average cost of 25% of its par value. During the third quarter of 2018, the value of this security had recovered sufficiently enough that Management determined the time was right to sell a majority of the holding, realizing a gain of approximately $10 million. At December 31, 2018, the Company held $5 million of par value of this security at a cost basis of $651,000. During 2019, the Company recorded an other-than-temporary impairment of $650,956 on the remaining value of this security due to the deteriorating financial condition of the issuing entity.
During 2019 and 2018, realized gains were partially offset by other-than-temporary impairments of $650,956 and $300,000, respectively. The other-than-temporary impairments were taken as a result of Management’s assessment and consideration of the length of time the securities have remained in an unrealized loss position and as a result of management’s analysis and determination of value. The investments were written down to better reflect their current estimated fair value.
The Company has seen significant unrealized gains on its equity investments during 2018 and 2019. A significant portion of these gains are from two equity holdings, both in the area of oil and gas. While the Company has had very strong unrealized gains during 2018 and 2019, a pull back in the stock market, particularly in the oil and gas arena, could slow these gains or even result in future period unrealized losses. Management believes these equity investments continue to be solid investments for the Company and have further growth potential; however, changes in market conditions could cause volatility in market prices.
In summary, the Company’s basis for future revenue is expected to come from the following primary sources: Conservation of business currently in-force, the maximization of investment earnings and the acquisition of other companies or policy blocks in the life insurance business. Management has placed a significant emphasis on the development of these revenue sources to enhance these opportunities.
Benefits, claims and settlement expenses, net of reinsurance benefits, were comparable for 2018 and 2019. Policy claims vary from year to year and therefore, fluctuations in mortality are to be expected and are not considered unusual by Management.
Operating expenses decreased approximately 6% in 2019 compared to that of the same period in 2018. The variance is mainly attributable to a decrease in salary expenses. Earnings in the prior year resulted in a higher accrual for salary expense in anticipation of annual performance bonuses for both management and staff. The significant realized gains from the sale of discounted bonds in the third quarter of 2018 was the primary driver of this variation. The Compensation Committee and Management decided not to pay out all of the accrued bonus monies. The excess accrual was released during 2019.
Investments are the largest asset group of the Company. The Company's insurance subsidiary is regulated by insurance statutes and regulations as to the type of investments they are permitted to make, and the amount of funds that may be used for any one type of investment.
During 2019, the Company invested approximately $10.4 million in short-term treasury bills. The Company was holding a significant cash balance and determined it appropriate to invest in these short term treasuries to increase yield, while working to find longer-term quality investments to invest in.
UTG is a holding company that has no day-to-day operations of its own. Cash flows from UTG’s insurance subsidiary, UG, are used to pay costs associated with maintaining the Company in good standing with states in which it does business and purchasing outstanding shares of UTG stock. UTG's cash flow is dependent on management fees received from its insurance subsidiary, stockholder dividends from its subsidiary and earnings received on cash balances. As of December 31, 2019 and 2018, substantially all of the consolidated shareholders’ equity represents net assets of its subsidiaries. In 2019, the Parent company received $6 million in dividends from its insurance subsidiary and $5 million in 2018. Certain restrictions exist on the payment of dividends from the insurance subsidiary to the Parent company. For further information regarding the restrictions on the payment of dividends by the insurance subsidiary, see Note 9 - Shareholders’ Equity in the Notes to the Consolidated Financial Statements. Although these restrictions exist, dividend availability from the insurance subsidiary has historically been sufficient to meet the cash flow needs of the Parent company.
Cash used in operating activities was approximately $8.6 million and $5.1 million in 2019 and 2018, respectively. Sources of operating cash flows of the Company, as with most insurance entities, is comprised primarily of premiums received on life insurance products and income earned on investments. Uses of operating cash flows consist primarily of payments of benefits to policyholders and beneficiaries and operating expenses. The Company has not marketed any significant new products for several years. As such, premium revenues continue to decline. Management anticipates future cash flows from operations to remain similar to historic trends.
The Company had cash and cash equivalents of approximately $28.8 million and $20.2 million as of December 31, 2019 and 2018, respectively. The Company has a portfolio of marketable fixed maturities and equity securities that could be sold, if an unexpected event were to occur. These securities had a fair value of approximately $261.2 million and $240.7 million at December 31, 2019 and 2018, respectively. However, the strong cash flows from investing activities, investment maturities and the availability of the line of credit facilities make it unlikely that the Company would need to sell securities for liquidity purposes. See Note 2 - Investments in the Notes to the Consolidated Financial Statements for detailed disclosures regarding the Company’s investment portfolio.
The Company’s capital structure consists of available short-term debt, long-term debt and shareholders’ equity. A complete analysis and description of the short-term and long-term debt issues available as of December 31, 2019 and 2018 are presented in Note 7 - Credit Arrangements in the Notes to the Consolidated Financial Statements.
At December 31, 2019, UG has a ratio of approximately 5.81, which is 581% of the authorized control level. Accordingly, the Company meets the RBC requirements.
The Board of Directors of UTG has authorized the repurchase in the open market or in privately negotiated transactions of UTG's common stock. At a meeting of the Board of Directors in June of 2019, the Board of Directors of UTG authorized the repurchase of up to an additional $2.5 million of UTG’s common stock, for a total repurchase of $18.5 million. Repurchased shares are available for future issuance for general corporate purposes. Company Management has broad authority to operate the program, including the discretion of whether to purchase shares and the ability to suspend or terminate the program. Open market purchases are made based on the last available market price but may be limited. During 2019, the Company repurchased 29,252 shares through the stock repurchase program for approximately $909,368. Through December 31, 2019, UTG has spent approximately $14.8 million in the acquisition of 1,169,358 shares under this program.
Shareholders’ equity was approximately $131 million and $106.3 million as of December 31, 2019 and 2018, respectively. Total shareholders' equity increased approximately 23% in 2019 compared to 2018. The increase is primarily attributable to the change in accumulated other comprehensive income and retained earnings. As of December 31, 2019 and 2018, the Company reported accumulated other comprehensive income of approximately $9 million and $62,000, respectively.
We have audited the accompanying consolidated balance sheets of UTG, Inc. and Subsidiaries (the “Company”) as of December 31, 2019 and 2018, and the related consolidated statements of operations, comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2019, and the related notes to the consolidated financial statements (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
Equity Securities at Cost - These investments are reported at their cost basis, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. The Company adopted ASU 2016-01 during 2018 and transferred equity securities of $12,118,617, that do not have a readily determinable fair value, from equity securities at fair value to equity securities at cost on the financial statements. There was no impact to the Consolidated Statements of Operations or net Shareholders' Equity as a result of the change.
Property and Equipment - Company-occupied property, data processing equipment and furniture and office equipment are stated at cost less accumulated depreciation of $5,916,424 and $5,655,593 at December 31, 2019 and 2018, respectively. Depreciation is computed on a straight-line basis for financial reporting purposes using estimated useful lives of 3 to 30 years. Depreciation expense was $260,831 and $430,260 for the years ended December 31, 2019 and 2018, respectively.
In January of 2020, the FASB issued Accounting Standards Update No. 2020-01, Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) - Clarifying the Interactions between Topic 321, Topic 323, and Topic 815 or ASU 2020-01. ASU 2020-01 clarifies the interaction between accounting standards related to equity securities, equity method investments, and certain derivatives. The ASU is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of this guidance will have on its consolidated financial statements.
The following table provides a summary of fixed maturities by contractual maturity as of December 31, 2019. Actual maturities could differ from contractual maturities due to call or prepayment provisions:
The fair value of investments with sustained gross unrealized losses at December 31, 2019 and 2018 are as follows:
During 2019 and 2018, the Company acquired $4,367,644 and $91,954 in mortgage loans, respectively. FSNB services the majority of the Company’s mortgage loan portfolio. The Company pays FSNB a .25% servicing fee on these loans and a one-time fee at loan origination of .50% of the original loan cost to cover costs incurred by FSNB relating to the processing and establishment of the loan.
Investment real estate held for sale is reported at the lower of cost or fair value less cost to sell. Investment Real estate acquired through foreclosure, consisting of properties obtained through foreclosure proceedings or acceptance of a deed in lieu of foreclosure, is reported on an individual asset basis at the lower of cost or fair value, less disposal costs. Fair value is determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources. When properties are acquired through foreclosure, any excess of the loan balance at the time of foreclosure over the fair value of the real estate held as collateral is recognized and charged to the Consolidated Statements of Operations. Based upon Management’s evaluation of the real estate acquired through foreclosure, additional expense is recorded when necessary in an amount sufficient to reflect any declines in estimated fair value.
The Company's investment real estate portfolio includes ownerships in oil and gas royalties. As of December 31, 2019 and 2018, investments in oil and gas royalties represented 44% and 43%, respectively, of the total investment real estate portfolio.
The following table reflects the Company’s net investment income for the periods ended December 31:
The other-than-temporary impairments recognized during 2018 and 2019 were taken as a result of Management's assessment and determination of value of the investments. The investments were written down to better reflect their current expected value.
The Company had investments with a fair value of $8,371,827 and $8,317,514 on deposit with various state insurance departments as of December 31, 2019 and 2018, respectively.
Level 3 - Valuation is based upon unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities. Unobservable inputs reflect the Company’s own assumptions about the inputs that market participants would use in pricing the asset or liability.
During 2019, the Company received an offer to purchase its investments in certain music royalties held in the form of Level 3 equity investments. As a result of this event, the Company elected to change its valuation methodology from using discounted cash flow models to estimate fair value to marking the investment do the offer price to estimate the fair value. The change in methodology resulted in recording an unrealized gain on investment of approximately $2.1 million during the year ended December 31, 2019. The investments were sold during the first quarter of 2020. The Company recognized a gain of approximately $4.2 million on the sale. The 2020 net income is unaffected by the sale as the realized gain is offset by the unrealized gain reversal at the time of sale.
The following table presents the Company’s assets and liabilities measured at fair value in the consolidated balance sheet on a recurring basis as of December 31, 2019.
The Company did not transfer any assets in or out of Level 3 during 2019. The Company transferred certain cost method investments out of Level 3 during 2018. Transfers occur when there is a lack of observable market information.
Certain assets are not carried at fair value on a recurring basis, including investments such as mortgage loans and policy loans. Accordingly, such investments are only included in the fair value hierarchy disclosure when the investment is subject to re-measurement at fair value after initial recognition and the resulting re-measurement is reflected in the Consolidated Financial Statements.
A portion of the mortgage loans balance consists of discounted mortgage loans. The Company has historically purchased non-performing discounted mortgage loans at a deep discount through an auction process led by the Federal Government. In general, the discounted loans are non-performing and there is a significant amount of uncertainty surrounding the timing and amount of cash flows to be received by the Company. Accordingly, the Company records its investment in the discounted loans at its original purchase price, which Management believes approximates fair value. The inputs used to measure the fair value of our discounted mortgage loans are classified as Level 3 within the fair value hierarchy.
Investment real estate, including the Company's investment in oil and gas royalties, is recorded at the lower of the net investment in the real estate or the fair value of the real estate less costs to sell. The determination of fair value assessments are performed on a periodic, non-recurring basis by external appraisal and assessment of property values by Management. The inputs used to measure the fair value of our investment real estate are classified as Level 3 within the fair value hierarchy.
As is customary in the insurance industry, the insurance subsidiary cedes insurance to, and assumes insurance from, other insurance companies under reinsurance agreements. Reinsurance agreements are intended to limit a life insurer's maximum loss on a large or unusually hazardous risk or to obtain a greater diversification of risk. The ceding insurance company remains primarily liable with respect to ceded insurance should any reinsurer be unable to meet the obligations assumed by it. However, it is the practice of insurers to reduce their exposure to loss to the extent that they have been reinsured with other insurance companies. The Company sets a limit on the amount of insurance retained on the life of any one person. The Company will not retain more than $125,000, including accidental death benefits, on any one life. At December 31, 2019, the Company had gross insurance in-force of $1.1 billion of which approximately $214 million was ceded to reinsurers. At December 31, 2018, the Company had gross insurance in-force of $1.1 billion of which approximately $228 million was ceded to reinsurers.
UG entered into a coinsurance agreement with Park Avenue Life Insurance Company (“PALIC”) effective September 30, 1996. Under the terms of the agreement, UG ceded to PALIC substantially all of its then in-force paid-up life insurance policies. Paid-up life insurance generally refers to non-premium paying life insurance policies. Under the terms of the agreement, UG sold 100% of the future results of this block of business to PALIC through a coinsurance agreement. UG continues to administer the business for PALIC and receives a servicing fee through a commission allowance based on the remaining in-force policies each month. PALIC has the right to assumption reinsure the business, at its option, and transfer the administration. The Company is not aware of any such plans. PALIC’s ultimate parent, The Guardian Life Insurance Company of America (“Guardian”), currently holds an "A++" (Superior) rating from A.M. Best. The PALIC agreement accounts for approximately 64% and 63% of UG’s reinsurance reserve credit, as of December 31, 2019 and 2018, respectively.
At December 31, 2019 and 2018, the Company had gross deferred tax assets of $1,359,230 and $2,723,053, respectively, and gross deferred tax liabilities of $14,581,834 and $11,836,533, respectively, resulting from temporary differences primarily related to the life insurance subsidiary. A valuation allowance is to be provided when it is more likely than not that deferred tax assets will not be realized by the Company. No valuation allowance has been recorded (except as noted below) relating to the Company’s deferred tax assets since, in Management’s judgment, the Company will more likely than not have sufficient taxable income in future periods to fully realize its existing deferred tax assets.
At December 31, 2019 and 2018, the Company had the following lines of credit available:
The following table represents the total funding commitments and the unfunded commitment as of December 31, 2019 related to certain investments:
Director Compensation - Effective January 1, 2018, a compensation arrangement was approved whereby each outside Director annually received $5,000 as a retainer and $2,500 per meeting attended. All other provisions from the September 2013 arrangement remained the same. The compensation is be paid in the form of UTG, Inc. common stock. The value is determined annually on the close of business December 20th or the next business day should December 20th be a weekend or holiday, based on the activity of the year just ending. Reasonable travel expenses are reimbursed in cash as incurred. UTG’s Director Compensation policy provides that Directors who are employees of UTG or its affiliates do not receive any compensation for their services as Directors except for reimbursement for reasonable travel expenses for attending each meeting.
Other Compensation - During 2019, the Company issued 8,188 shares of stock to management and employees as compensation at a cost of $246,535. During 2018, The Company issued 10,421 shares of stock to management and employees as compensation at a cost of $263,507. These awards are determined at the discretion of the Board of Directors.
The computation of diluted earnings per share is the same as basic earnings per share for the years ending December 31, 2019 and 2018, as there were no outstanding securities, options or other offers that give the right to receive or acquire common shares of UTG.
Statutory Restrictions - Restrictions exist on the flow of funds to UTG from its insurance subsidiary. Statutory regulations require life insurance subsidiaries to maintain certain minimum amounts of capital and surplus. UG is required to maintain minimum statutory surplus of $2,500,000. At December 31, 2019, substantially all of the consolidated shareholders' equity represents net assets of UTG’s subsidiaries.
A director shall not be disqualified from-dealing with or contracting with the corporation as vendor, purchaser; employee, agent or otherwise; nor, in the absence of fraud, shall any transaction or contract or act of this corporation be void or in any way affected or invalidated by the fact that any director or any firm of which any director is a member or any corporation of which any director is a shareholder, director or officer is in any way interested in such transaction or contract or act, provided the fact that such director or such firm or such corporation so interested shall be disclosed or shall be known to the Board of Directors or such members thereof as shall be present at any meeting of the Board of Directors at which action upon any such contract or transaction or act shall be taken: nor shall any such director be accountable .or responsible to the company for or in respect to such transaction or contract or act of. this corporation or for any gains or profits realized by him by reason of the fact that he or any firm of which he is a member or any corporation of which he is a shareholder, director or officer is interested in such action or contract; and any such director may be counted in determining the existence of a quorum of any meeting of the Board of Directors of the company which shall authorize or take action in respect to any such contract or transaction or act and may vote thereat to authorize, ratify, or approve any such contract or transaction or act, with like force and effect as if he or any firm of which he is a member or any corporation of which he is a shareholder, director or officer were not interested in such transaction or contract or act.
The Company from time to time acquires mortgage loans through participation agreements with FSNB. FSNB services the Company's mortgage loans including those covered by the participation agreements. The Company pays a .25% servicing fee on these loans and a one-time fee at loan origination of .50% of the original loan cost to cover costs incurred by FSNB relating to the processing and establishment of the loan. The Company paid $15,138 and $8,393 in servicing fees and $0 and $0 in origination fees to FSNB during 2019 and 2018, respectively.
Effective July 1, 2018, the Company assumed the employees of several smaller entities associated with UTG. The purpose of this was to support the continued efforts to further streamline operations amongst associated entities. The salaries, benefits, and payroll related processing fees are 100% reimbursed by the associated entities on a monthly basis. During 2019 and 2018, the Company received reimbursements of $922,357 and $372,849, respectively.
During 2016, UG and FSF established a partnership agreement and formed a limited liability company to purchase real estate. FSF contributed $140,000 to the partnership, which gave them a 10% ownership in the LLC. The property held by this LLC was sold in January of 2019 and the funds from the sale were subsequently distributed to the members.
Because UTG serves primarily individuals located in four states, the ability of our customers to pay their insurance premiums is impacted by the economic conditions in these areas. As of December 31, 2019 and 2018, approximately 56% of the Company’s total direct premium was collected from Illinois, Ohio, Texas and West Virginia. Thus, results of operations are heavily dependent upon the strength of these economies.
The Company owns a variety of investments associated with the oil and gas industry. These investments represented approximately 25% of the Company’s total invested assets at December 31, 2019 and 2018.