We currently lease approximately 13,007 square feet office space at 2900 South 70th Street, Suite 400, Lincoln, Nebraska 68506. This lease was executed October 17, 2013 and expires on January 31, 2024. We executed an amendment to the above lease for the additional 2,876 square feet of office space in Suite 450 on October 23, 2015, which will expire on May 31, 2017, which we do not plan to renew.
Except for certain historical information contained herein, this report contains certain statements that may be considered “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 27A of the Securities Act of 1933, as amended, and such statements are subject to the safe harbor created by those sections. All statements, other than statements of historical fact, are statements that could be deemed forward-looking statements, including without limitation: any projections of revenues, earnings, cash flows, capital expenditures, or other financial items; any statement of plans, strategies, and objectives of management for future operations; any statements concerning proposed acquisition plans, new services, or developments; any statements regarding future economic conditions or performance; and any statements of belief and any statement of assumptions underlying any of the foregoing. Words such as “believe,” “may,” “could,” “expects,” “hopes,” “estimates,” “projects,” “intends,” “anticipates,” and “likely,” and variations of these words, or similar expressions, terms, or phrases, are intended to identify such forward-looking statements. Forward-looking statements are inherently subject to risks, assumptions, and uncertainties, some of which cannot be predicted or quantified, which could cause future events and actual results to differ materially from those set forth in, contemplated by, or underlying the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Item 1A. Risk Factors,” along with any supplements in Part II below.
Our principal investments are in fixed maturities. Fixed maturities, which are classified as available for sale, are carried at their fair value in the consolidated balance sheets, with unrealized gains or losses recorded in comprehensive income (loss). We utilize external independent third-party pricing services to determine the fair values on investment securities available for sale. We have processes, and controls in place to review prices received from service providers for reasonableness and unusual fluctuations in prices. In the event that a price is not available from a third-party pricing service, we pursue external pricing from brokers. Generally, we pursue and utilize only one broker quote per security. In doing so, we solicit only brokers which have previously demonstrated knowledge and experience of the subject security.
Additionally, we have minor investments in development stage entities. These equity securities approximate carrying value and are invested in privately-held, development stage holding companies. These securities have no active trading. The fair value for these securities is determined through the use of unobservable assumptions about market participants.
The recognition of other-than-temporary impairment losses on debt securities is dependent on the facts and circumstances related to the specific security. If we intend to sell a security or it is more likely than not that we would be required to sell a security prior to recovery of the amortized cost, the difference between amortized cost and fair value is recognized in the income statement as another-than-temporary impairment. As it relates to debt securities, if we do not expect to recover the amortized basis, do not plan to sell the security and if it is not more likely than not that we would be required to sell a security before the recovery of its amortized cost, the recognition of the other-than- temporary impairment is bifurcated. We recognize the credit loss portion through earnings in the income statement and the noncredit loss portion in accumulated other comprehensive loss. The credit component of an other-than-temporary impairment is determined by comparing the net present value of projected cash flows with the amortized cost basis of the debt security. The net present value is calculated by discounting our best estimate of projected future cash flows at the effective interest rate implicit in the fixed income security at the date of acquisition. Cash flow estimates are driven by assumptions regarding probability of default, including changes in credit ratings, and estimates regarding timing and amount of recoveries associated with a default.
VOBA is also reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts. If it is determined from experience that the premium margins or gross profits are less than unamortized deferred acquisition costs, then the asset will be adjusted downward with the adjustment recorded as an expense in the current period.
The Company elected to forgo the qualitative impairment analysis and performed the first step of the goodwill quantitative analysis to determine if the fair value of the reporting unit was in excess of the carrying value. As of December 31, 2016, the fair value of the Company’s reporting unit was less than the carrying value of the net assets assigned to that unit therefore the Company was required to perform further testing for impairment. Management’s determination of the fair value of the reporting unit incorporated assumptions that market participants would make in valuing the reporting unit. Based upon our fair value analysis, the Company determined that the full amount of the goodwill should be written off as of December 31, 2016.
Amounts received as payment for annuities and/or non-traditional contracts such as interest sensitive whole life contracts, single payment endowment contracts, single payment juvenile contracts and other contracts without life contingencies are recognized as deposits to policyholder account balances and included in future insurance policy benefits. Revenues from these contracts are comprised of fees earned for administrative and contract-holder services, which are recognized over the period of the contracts, and included in revenue. Deposits are shown as a financing activity in the consolidated statement of cash flows.
Net Loss: The increase in net loss in 2016 compared to 2015 was due to the impairment of the goodwill of $1,129,824, the loss of $420,720 on the revised valuation of Midwest's equity method investment in First Wyoming mentioned below, the net loss of $185,000 as a result of the inclusion of First Wyoming Life. the decline in premium revenue, increase in interest credited, and other operating expenses. These were offset by the bargain purchase gain on the revised valuation of the Midwest and First Wyoming merger of $1,326,526. Midwest engaged a third party to prepare a valuation of Midwest and First Wyoming. The total bargain purchase gain recorded based upon the final valuation was $2,231,104. Of that amount, $904,578 was recognized in the fourth quarter of 2015 on a provisional basis, with the remainder recorded in 2016. There were also lower death benefits, decrease in reserves, and decrease in amortization of deferred acquisition costs in 2016.
Net realized gains (losses) on investments: The increase was due primarily to improved market conditions on sale of bonds.
Salaries and benefits: The increase was due to the inclusion of First Wyoming salaries and benefits of $390,000 for the full year of 2016 compared to $75,500 for only two months of 2015 and similar costs after the merger of Northstar of $225,000 in March 2016. These were offset by personnel reductions. We expect further salary and benefit reductions of approximately $166,000 in 2017 compared to 2016 and $184,000 in 2018 compared to 2017.
Other operating expenses: Other operating expenses increased due to the inclusion of First Wyoming Life expenses of $354,000 for the full year of 2016 compared to $37,000 for only two months of 2015, expenses related to Northstar and First Wyoming mergers and the redomestication and merger of our former life subsidiaries of $289,159 and an increase in travel and legal expenses due to capital raising efforts of $82,000; offset by the reimbursement for Great Plains Life 2015 regulatory examination fees of $67,000.
Increases in fixed maturity securities primarily resulted from the purchase of additional bonds from normal operating activities.
We are exposed to credit risk through counterparties and within the investment portfolio. Credit risk relates to the uncertainty associated with an obligor’s ability to make timely payments of principal and interest in accordance with the contractual terms of an instrument or contract. We manage our credit risk through diversification of investments amongst many corporations and numerous industries. Additionally our investment policy limits the size of holding in any particular issuer.
Aside from raising capital, which has funded the vast majority of our operations, premium income, deposits to policyholder account balances, and investment income are the primary sources of funds while withdrawals of policyholder account balances, investment purchases, policy benefits in the form of claims, and operating expenses are the primary uses of funds. To ensure we will be able to meet future commitments, the funds received as premium payments and deposits are invested in primarily fixed income securities. Funds are invested with the intent that the income from investments, plus proceeds from maturities, will in the future meet our ongoing cash flow needs. The approach of matching asset and liability durations and yields requires an appropriate mix of investments. Our investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs. Cash flow projections and cash flow tests under various market interest scenarios are also performed annually to assist in evaluating liquidity needs and adequacy. We currently anticipate that available liquidity sources and future cash flows will be adequate to meet our needs for funds for 2017.
Net cash used by operating activities was $927,125 for 2016, which was comprised primarily of the net loss of $3,847,922 partially offset by an increase in policy liabilities of $939,095. Net cash used in investing activities from was 907,664.. The primary source of cash was from sales of available for sale securities, the sale of an inactive subsidiary, and the acquisition of Northstar. Offsetting this source of cash was our purchases of investments in available-for-sale securities and the purchase of property and equipment. Net cash provided by financing activities was $1,303,998. The primary source of cash was net receipts on deposit-type contracts, offset by dividends paid to Class B Preferred Stock shareholders.