The Company’s home office is located at 3520 Broadway in Kansas City, Missouri. The Company owns and wholly occupies two five-story buildings on an eight-acre site.
Kansas City Life Insurance Company (the Company) is a financial services company. The Company primarily consists of three life insurance companies: Kansas City Life Insurance Company (Kansas City Life) the parent company, and wholly owned subsidiaries Sunset Life Insurance Company of America (Sunset Life) and Old American Insurance Company (Old American).
The Company offers investment products and broker dealer services through its subsidiary Sunset Financial Services, Inc. (SFS) for both proprietary and non-proprietary variable insurance products and mutual funds.
In 2006, the Company entered into a Master General Agent and Marketing Agreement with American Republic Insurance Company (American Republic) under which American Republic agents market Kansas City Life’s insurance products. For segment reporting purposes, sales under this agreement are reflected in the Individual Insurance segment.
The accounting policies below have been identified as critical to the understanding of the results of operations and financial position. The application of these critical accounting policies in preparing the financial statements requires management to use a variety of assumptions and estimates, in particular expectations of current and future mortality, morbidity, persistency, expenses, interest rates and equity market performance. Actual results may differ from these estimates under different assumptions or conditions. The profitability of life insurance and annuity products is dependent on actual experience and differences between actual experience and pricing assumptions may result in variability of net income in amounts which may be material. On an ongoing basis, estimates, assumptions and judgments are evaluated based on historical experience and various other information believed to be reasonable under the circumstances. For a detailed discussion of other significant accounting policies, see Note 1 - Nature of Operations and Significant Accounting Policies in the Notes to Consolidated Financial Statements.
Deposits relate to insurance products that include universal life, variable life, variable annuities, fixed deferred annuities and deposit products without life contingencies. The cash flows from deposits are credited to policyholder account balances. Deposits are not recorded as revenue, but revenues from such contracts consist of amounts assessed against policyholder account balances for mortality, policy administration and surrender charges, and are recognized in the period in which the benefits and services are provided. Deposits are shown as a Financing Activity in the Consolidated Statements of Cash Flows.
amounts related to paid benefits and estimated amounts related to unpaid policy and contract claims, future policy benefits and policyholder account balances.
At least annually, a review is performed of the models and the assumptions used to develop expected future profits, based upon management’s current view of future events. Management’s view primarily reflects Company experience but can also reflect emerging trends within the industry. Short-term deviations in experience affect the amortization of DAC and VOBA in the period, but do not necessarily indicate that a change to the long-term assumptions of future experience is warranted. If it is determined that it is appropriate to change the long-term assumptions of future experience, then an unlocking adjustment is recognized for the block of business being evaluated. Certain assumptions, such as interest spreads and surrender rates, may be interrelated. As such, unlocking adjustments often reflect revisions to multiple assumptions. The balances of DAC and VOBA are immediately impacted by any assumption changes, with the change reflected through the income statement as an unlocking adjustment in the amount of DAC or VOBA amortized. These adjustments can be positive or negative. The impact of unlocking adjustments from the changes in estimates for the periods reported are included in the sections Consolidated Results of Operations and Operating Results by Segment.
A 10% increase in expected surrender rates for all future years would result in a reduction in DAC and VOBA, and an increase in current period amortization expense of $2.4 million.
A 10 basis point reduction in future interest rate spreads would result in a reduction in DAC and VOBA, and an increase in current period amortization expense of $4.1 million.
At the end of each quarter, all securities are reviewed to determine whether impairments should be recorded. For those securities where fair value is less than ninety percent of amortized cost for six consecutive months or more, a detailed analysis is prepared which focuses on each issuer’s ability to service its debts and the length of time and extent the security has been valued below cost. This quarterly process includes an assessment of the credit quality of each investment in the entire securities portfolio.
The measurement of pension and other postretirement benefit obligations and costs depends on a variety of assumptions. Assumptions are made regarding the discount rate, expected long-term rate of return on plan assets, employee turnover, expected compensation increases, health care claim costs, heath care cost trends, retirement rates and mortality. The discount rate and the expected return on plan assets have the most significant impact on the level of cost. See Note 7 - Pensions and Other Postretirement Benefits in the Notes to Consolidated Financial Statements for further details.
Total premiums declined 2% in 2006 following a 5% decline in 2005. The decline in 2006 from 2005 was primarily due to lower sales of immediate annuities, and the decline in 2005 from 2004 was primarily due to reduced immediate annuity and group accident and health sales and renewal premiums. New individual life premiums declined 6% in 2006 and 2% in 2005, while new immediate annuity premiums declined 41% in 2006 and 14% in 2005. The Company’s marketing plan has been to focus its primary growth strategies on its individual life business and to grow the business through its existing field force, including the addition of new agents and general agents. As a result of the emphasis on individual life insurance sales, a decline in annuity sales has occurred. The decline in individual life sales in 2006 was primarily the result of lower sales through third-party marketing arrangements, specifically GuideOne Insurance agents. This was primarily due to a change in marketing emphasis by GuideOne Insurance to increase sales of property casualty policies. In addition, sales within the Old American business segment have declined due to increased competition. As identified earlier, the Company has entered into a marketing agreement with American Republic Insurance Company whereby American Republic will market Kansas City Life’s life insurance products. This agreement makes available
Total group premiums grew 6% in 2006 but declined 5% in 2005. The increase in 2006 was largely the result of a 17% increase in new group accident and health sales, primarily from the group dental product line. New group life insurance declined 23% in 2006 and 12% in 2005.
Insurance revenues consist of premiums and contract charges, less reinsurance ceded. Insurance revenues decreased $3.3 million or 1% to $235.2 million in 2006 versus a decrease of $11.6 million or 5% to $238.5 million in 2005. The decline in 2006 was largely the result of a $5.0 million decrease in immediate annuity premiums and a $1.5 million decrease in individual life premiums. These changes were partially offset by a $2.8 million increase in accident and health premiums, which was largely the result of increased group dental sales. The decline in 2005 premiums was primarily due to decreased sales of immediate annuities and group accident and health insurance.
Contract charges were flat in 2006 versus a decline of 1% in 2005, which occurred as a result of a $1.0 million decrease from an unlocking adjustment.
assumptions related to profit expectations. If it is determined the assumptions should be revised, the impact is recorded as a change in the revenue reported in the current period as an unlocking adjustment.
Investments in mortgage loans increased $13.4 million during 2006, but investment income from mortgage loans decreased $1.1 million or 3% for the year. Despite a $28.0 million increase in mortgage loan assets in 2005, mortgage loan investment income declined $0.5 million or 1%. The reduced income in both years reflects a decline in available yields on new mortgages and the impact of the prepayment of loans with rates higher than those of new loans.
Real estate investments increased $28.9 million in 2006 compared with 2005, but many of these new investments were development properties where the income stream is less than those of mature properties. As such, investment income from real estate investments declined 5% in 2006 compared with 2005. In 2005, following the sale of a substantial real estate holding in Arizona in late 2004, real estate income declined $5.2 million or 40%.
The Company loans money to its policyholders, secured by the cash value of the policy. Investment income from policy loans declined by $0.5 million in 2006 and $0.6 million in 2005 from a total of $7.8 million in 2004. The decline in investment income from policy loans is directly related to the decline in the amount of loans outstanding.
The Company realizes investment gains and losses from several other sources. Many securities purchased by the Company contain call provisions, which allow the issuer to redeem the securities at a particular price. Depending upon the terms of the call provision and price at which the security was purchased, a realized gain or loss may be realized. Sales and calls of investments in securities resulted in net realized gains of $2.9 million in 2006, a realized loss of $1.6 million in 2005 and a realized gain of $1.1 million in 2004. Other sources of realized investment gains and losses include write-downs of investment securities, changes in the Company’s valuation reserve for losses in the commercial mortgage portfolio and other miscellaneous investment gains and losses.
The Company has a long history of investing in real estate. Real estate investments were $110.8 million at December 31, 2006 and $81.9 million at December 31, 2005. Real estate investments consist principally of office buildings and industrial warehouses that are both in use and under development, and investments in multi-family and single-family residential properties, including affordable housing. The Company also invests in unimproved land for future development. Properties have been acquired through individual purchases, build-to-suit and speculative development, and acquisition of other life insurance company investment portfolios. The Company generally maintains its ownership interest in these properties with the long-term intention of earning positive cash flow and income by leasing the properties along with the expectation of realizing capital appreciation upon sale, as evidenced by realized investment gains from sales illustrated in the table above. The Company periodically sells certain real estate assets when management believes that the market and timing are perceived to be advantageous.
The following table provides asset class detail of the investment portfolio. Fixed maturity and equity securities represented 80% of the entire investment portfolio at December 31, 2006 and 2005.
The securities portfolio had unrealized gains before taxes of $2.7 million at year-end 2006 compared with $35.2 million at year-end 2005. The portfolio was broadly diversified across sectors. A variety of measures have been employed to manage the portfolio’s credit and interest rate risks, as discussed later in this document in
In 2006, the Company entered into a Master General Agent and Marketing Agreement with American Republic Insurance Company (American Republic) under which American Republic agents market Kansas City Life’s insurance products. For segment reporting purposes, sales under this agreement will be reflected in the Individual Insurance segment.
Short-term investments are stated at cost, adjusted for amortization of premium and accrual of discount. Securities available for sale are stated at fair value. Unrealized gains and losses, net of adjustments to deferred acquisition costs (DAC), value of business acquired (VOBA), policyholder account balances and deferred income taxes, are reported as a separate component of accumulated other comprehensive loss in stockholders' equity. The adjustments to DAC and VOBA represent changes in the amortization of DAC and VOBA that would have been required as a charge or credit to income had such unrealized amounts been realized. The adjustment to policyholder account balances represents the increase from using a discount rate that would have been required if such unrealized gains had been realized and the proceeds reinvested at current market interest rates, which were lower than the then current effective portfolio rate.
Policy loans are carried at cost, less principal payments received. Investment income is recognized when earned. Realized gains and losses on the sale of investments are determined on the basis of specific security identification recorded on the trade date.
present value of future gross profits of the business acquired and is amortized in proportion to future premium revenues or the expected future profits, depending on the type of business acquired. Amortization of VOBA occurs with interest over the anticipated lives of the underlying business to which it relates, initially 15 to 30 years. Similar to DAC, the assumptions regarding future experience can affect the carrying value of VOBA, including interest spreads, mortality, expense margins and policy and premium persistency experience. Significant changes in these assumptions can impact the carrying balance of VOBA and produce changes that are reflected in the current period’s income as an unlocking adjustment. There were no VOBA unlocking adjustments in any of the years presented.
As of December 31, 2006, separate account balances for variable annuity contracts were $283.9 million. The total reserve held for variable annuity guaranteed minimum death benefits was $0.1 million. Additional information related to the guaranteed minimum death benefits and related separate account balances and net amount at risk (the amount by which the guaranteed minimum death benefit exceeds the account balance) as of December 31, 2006 is provided below:
Return of the greater of the highest anniversary contract value or net deposits
Liabilities for future policy benefits of traditional life insurance have been computed by a net level premium method based upon estimates at the time of issue for investment yields, mortality and withdrawals. These estimates include
provisions for experience less favorable than actually expected. Mortality assumptions are based on Company experience expressed as a percentage of standard mortality tables. The 1975-1980 Select and Ultimate Basic Table is used for new business.
Liabilities for universal life and fixed deferred annuity products are included in policyholder account balances, without reduction for potential surrender charges and deferred front-end contract charges. Front-end contract charges are amortized over the term of the policies. Policyholder benefits incurred in excess of related policyholder account balances are charged to policyholder benefits expense. Interest on policyholder account balances is credited as earned.
Due to the Company's capital structure and the absence of other potentially dilutive securities, there is no difference between basic and diluted earnings per common share for any of the years or periods reported. The weighted average number of shares outstanding during the year was 11,883,830 shares (2005 - 11,923,831 shares; 2004 - 11,932,109 shares). The number of shares outstanding at year-end was 11,855,497 (2005 - 11,918,634).
Comprehensive income is comprised of net income and other comprehensive income (loss). Other comprehensive income (loss) includes the unrealized investment gains or losses on securities available for sale (net of reclassification adjustments for realized investment gains or losses) net of adjustments to DAC, VOBA and policyholder account balances. In addition, other comprehensive income (loss) includes the change in the additional minimum pension liability, and the adjustment to adopt SFAS 158 - described below under New Accounting Pronouncements. The adjustment to adopt SFAS 158 consists of pension and postretirement net losses and prior service costs. Other comprehensive income (loss) also includes deferred income taxes on these items.
In August 2006, the Securities and Exchange Commission (SEC) adopted SEC Release No. 33-8732A, “Executive Compensation and Related Person Disclosure” which amends the disclosure requirements for executive and director compensation, related person transactions, director independence and other corporate governance matters and security ownership of officers and directors. The release expands the currently required tabular disclosures and adds a narrative Compensation Discussion & Analysis (CD&A) which must describe the Company’s compensation policies and decisions. The amendments in the release apply to disclosures included in proxy and information statements, periodic and current reports, as well as other filings under the Securities Exchange Act of 1934 and to registration statements under the Exchange Act and the Securities Act of 1933. For financial statement purposes, this release is effective for years ending on or after December 15, 2006. The Company has adopted this release and will include the required disclosures in the appropriate filings.
The following table provides information regarding unrealized losses on investments available for sale, as of December 31, 2006.
The following table provides information regarding unrealized losses on investments available for sale, as of December 31, 2005.
Securities with unrealized losses for less than twelve consecutive months included 116 issues with a carrying value of $355,824 and unrealized losses of $4,659. Of this portfolio, 98.6% were investment grade (rated AAA through BBB-) at December 31, 2006, with associated unrealized losses of $4,358. The unrealized losses on these securities were due to changes in market interest rates and credit spreads since the securities were acquired.
The table below summarizes the fixed maturity securities with unrealized losses as of December 31, 2006.
The Company held no non-income producing securities at December 31, 2006 (2005 - $760).
The following table provides the distribution of maturities for fixed maturity investment securities available for sale as of December 31, 2006. Expected maturities may differ from these contractual maturities since borrowers may have the right to call or prepay obligations.
Investment real estate, other than foreclosed properties, is depreciated on a straight-line basis over periods ranging from 10 to 60 years.
The Company had non-income producing real estate of $17,386, consisting of properties under development at December 31, 2006 (2005 - $21,142).
The Company had commitments to sell real estate investments of $6.2 million at December 31, 2006. These commitments expire in 2007.
One real estate loan with an interest rate of 7.50% paid off in
As a member of the FHLB with a capital investment of $5.9 million, the Company has the ability to borrow on a collateralized basis from the FHLB. The Company earned a 3.81% average rate on the capital investment in the FHLB for 2006.
The Company has unsecured revolving lines of credit of $60.0 million with two major commercial banks with no balances outstanding, and which are at variable interest rates - currently at 6.075%. Both lines of credit will expire during 2007, and it is expected that the Company will renew these facilities.
Stockholder dividends may not exceed statutory unassigned surplus. Additionally, under Missouri law, the Company must have the prior approval of the Missouri Director of Insurance in order to pay dividends in any consecutive twelve-month period exceeding the greater of statutory net gain from operations for the preceding year or 10% of statutory stockholders' equity at the end of the preceding year. The maximum payable in 2007 without prior approval is $46.8 million, the statutory net gain from operations in 2006. The Company believes these statutory limitations impose no practical restrictions on its dividend payment plans.
A valuation allowance must be established for any portion of the deferred tax asset which is believed not to be realizable. Based predominately upon review of our anticipated future earnings and reversal of future taxable differences, in management's opinion, it is more likely than not that the Company will realize the benefit of its deferred tax asset.
The Kansas City Life Pension Plan was amended and restated effective January 1, 1998 as the Kansas City Life Cash Balance Pension Plan. Plan benefits are based on a cash balance account consisting of credits to the account based upon an employee’s years of service, compensation and interest credits on account balances calculated using the greater of the average 30-year Treasury bond rate for November of each year or 5.5%. The benefits expected to be paid in each year from 2007 through 2011 are $7,900, $9,000, $11,100, $9,500, and $12,400, respectively. The aggregate benefits expected to be paid in the five years from 2012 through 2016 are $62,200. The expected benefits to be paid are based on the same assumptions used to measure the Company’s benefit obligation at December 31, 2006 and include estimated future employee service. The 2007 contribution for the plan cannot be reasonably estimated at this time. The asset allocation of the fair value of pension plan assets at December 31 was:
flows at these rates, a notional amount equal to the market value of a cash flow defeasing a portfolio of AA finance corporate bonds was determined. The discount rate for benefits was calculated as a single rate giving the same discounted value as the notional amount.
The incremental effect of applying SFAS 158 on individual line items in the Consolidated Balance Sheet as of December 31, 2006, was as follows.
For measurement purposes a 12.0% annual increase in the per capita cost of covered health care benefits was assumed to decrease gradually to 6% in 2018 and thereafter.
The estimated net loss and prior service cost for the other postretirement plans that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year is $119 and ($378), respectively.
Old American has a coinsurance agreement that reinsures certain whole life policies issued by Old American prior to December 1, 1986. These policies had a face value of $56.6 million as of this year-end. The reserve for future policy benefits ceded under this agreement was $28,424 (2005 - $30,682).
Kansas City Life acquired a block of traditional life and universal life products in 1997. As of this year-end, the block had $1.8 billion of life insurance in force (2005 - $2.0 billion). The block generated life insurance premiums of $2,716 net of reinsurance (2005 - $2,882).
Sunset Life entered into a yearly renewable term reinsurance agreement January 1, 2002, whereby it ceded 80% of its retained mortality risk on traditional and universal life policies. As of this year-end, the insurance in force ceded approximates $2.1 billion (2005 - $2.3 billion) and premiums totaled $8,785.
At year-end 2006, all of the Company’s notes payable had a carrying value which approximated their fair value. The Company’s other liabilities are generally short-term in nature and their carrying value approximates their fair value.
The unaudited quarterly results of operations for the years ended December 31, 2006 and 2005 are summarized in the table below.
On January 29, 2007, the Board of Directors declared two dividends, including a quarterly dividend of $0.27 per share, unchanged from the prior year, and a special one-time dividend of $2.00 per share. Both dividends, totaling $26.9 million, were paid on February 13, 2007 to shareholders of record as of February 8, 2007.
We have audited the accompanying consolidated balance sheets of Kansas City Life Insurance Company and subsidiaries (the Company) as of December 31, 2006 and December 31, 2005, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedules I-V. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
As discussed in note 1 to the consolidated financial statements, the Company adopted Statement of Financial Standards No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, effective December 31, 2006.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.