FIC’s home office is located at River Place Pointe, 6500 River Place Blvd., Building One, Austin, Texas. River Place Pointe was purchased by Investors Life in October 1998. It consisted of approximately 48 acres of land in Austin, Texas. The aggregate purchase price for the undeveloped land was $8.1 million. The site development permit allowed for the construction of seven office buildings totaling 600,000 square feet, with associated parking, drives and related improvements. The Company completed construction of the first section of the project, which consists of four office buildings, an associated parking garage and related infrastructure, during 2000 and 2001. It completed the second phase of construction, which included three more office buildings, an associated parking garage and related infrastructure, in 2002. FIC and its insurance subsidiaries occupy Building One of River Place Pointe, consisting of approximately 76,143 square feet of space, and, for part of 2005, also occupied approximately 5,000 square feet of Building Four for records storage. On June 1, 2005, the Company sold River Place Pointe to a non-affiliated party, in a cash transaction for a gross purchase price of $103 million. Under the terms of the sale agreement, Investors Life entered into a lease with the purchaser with respect to all of the space in Building One, for a five-year term at a rate of $28.00 per square foot, which is above the market rate in effect in June 2005, but was the prevailing rental rate at the time that FIC and its subsidiaries occupied the building in July 2000. The lease provides Investors Life with a right of cancellation of the lease at March 31, 2008.
The Company also leases approximately 10,000 square feet in Cedar Park, Texas, to house the company’s printing operations and warehouse storage. The monthly rental for the Cedar Park facility is $9,123. The lease terms ends on February 28, 2007.
for which it received $214,099, $212,012, and $204,700 in 2004, 2003 and 2002, respectively. The lease was terminated on December 31, 2005. As described in more detail in “Note 12 - Lease Commitments” in the accompanying consolidated financial statements, at December 31, 2003, the Company accrued the estimated net loss for the continued operation of this building through the lease termination date. The estimated net loss of $2.0 million represented the annual base rental amount plus estimated operating expenses through December 2005, reduced by estimated sublease income. Actual losses incurred through the lease termination date were substantially equal to the estimated losses.
Please refer to “Forward-Looking Statements” on page 2 of this Form 10-K.
Company’s minimum pension liability. FIC’s financial condition and prospects at the end of 2004 were marked most significantly by the impact of the continuing moderate run-off of contractholder deposit funds and lower premiums during the year, cash demands, changes in the management of its investment assets, and expenses incurred and resources utilized in the internal review of the Company’s consolidated financial statements culminating in the restatements as reported herein.
Upon additional analysis of the statutory adjustments, the Company determined that the accounting errors also affected its consolidated financial statements prepared in accordance with generally accepted accounting principles as included in its previously filed 2003 Form 10-K. The Company disclosed this determination in a Form 8-K filing on April 12, 2006, along with management’s and the Board of Director’s conclusion that the Company would be required to restate its consolidated financial statements for 2003 and prior years. Subsequent to this determination, the Company continued to work on the completion of its consolidated financial statements for 2004. This work resulted in the identification of additional adjustments affecting 2003 and prior years. The details of the significant adjustments and resulting restatement are described below and in Notes 2 and 19 of the accompanying consolidated financial statements.
The Company also determined that there were errors in its process for calculating the liability for premiums received in advance related to policies processed on one of its policy administration systems. As a result, the Company developed a new program to correct the advance premium calculation process resulting in an increase to this liability of $365,000.
Reinsurance - As a result of the findings by a significant reinsurer and issues identified by the Company, the Company completed a comprehensive review of its reinsurance administrative systems. These systems generally rely on manual interface with the Company’s policy administration systems and general ledger. This manual interface, along with changes in retention policies which are based on covered individuals, resulted in errors in premiums ceded. As a result, restatement adjustments totaling $668,000 were made to appropriately cede premiums and reduce reinsurance receivables in accordance with the reinsurance agreements with various reinsurers.
Present Value of Future Profits of Acquired Businesses (PVFP) - The Company recorded a restatement adjustment totaling $56,000 for the amortization of PVFP in 2003 related to the correction of certain policy in-force data.
Excess of Net Assets Acquired Over Cost - In connection with the 2001 acquisition of ILCO, the Company allocated the purchase price to the fair value of the assets acquired and liabilities assumed in accordance with the purchase method of accounting resulting in the recognition of an excess of net assets acquired over cost, also referred to as negative goodwill. Prior to its acquisition of ILCO’s remaining outstanding common shares on May 18, 2001, the Company accounted for ILCO under the equity method of accounting. The Company owned approximately 48% of ILCO’s common shares prior to May 18, 2001. The restatement adjustments to the Company’s equity in earnings of affiliate are therefore equal to approximately 48% of the related adjustments to ILCO’s retained earnings and total shareholders’ equity prior to May 18, 2001. Certain restatement adjustments, therefore, affected the fair value of the net assets acquired from ILCO and the cost of the investment in ILCO resulting in a decrease of $2.7 million in the remaining unamortized negative goodwill, which was recognized as a cumulative effect of a change in accounting principle in 2002 in accordance with SFAS No. 141 “Business Combinations”.
Income Taxes -- Current and deferred Federal income tax provisions were recalculated to include the impact of the restatement adjustments as described herein, and to reflect the amount of taxes receivable from the IRS and the amount of deferred Federal income tax liability resulting from the utilization of the asset and liability method after consideration of the portion of the deferred tax asset that may not be realized pursuant to the requirements of SFAS No. 109, "Accounting for Income Taxes." The Company also determined that deferred taxes had not been established related to ILCO's pension assets. Adjustments made to decrease the income tax receivable and reduce the deferred tax liability totaled $1.9 million, including an increase to accumulated other comprehensive income of $280,000 primarily as a result of changes to the deferred tax valuation allowance applied to other comprehensive income and the recalculation of deferred income taxes applied to the Company's minimum pension liability.
Correct the accounting of certain manually administered policy loans, decreasing policy loans $163,000
Adjustment of duplicate claims checks included in escheat liability and vacation benefits liability, reducing other liabilities by $95,000
Correction of treasury stock, increasing additional paid-in capital by $524,000 and common treasury stock by $122,000 and reducing other liabilities by $646,000 as a result of treasury shares distributed in 2003 in conjunction with the acquisition of the New Era companies. See Note 17 in the accompanying consolidating financial statements for additional details regarding the acquisition and subsequent sale of the New Era companies.
Establishment of cash account and liability for a unrecorded premium depository account totaling $249,000
Loss from discontinued operations of the New Era companies was shown as a separate line item, with offsetting reductions in change in agency advances ($273,000), change in other assets ($4,780,000), other ($442,000), and an increase in other liabilities of $560,000.
Acquisition of subsidiary companies was adjusted to eliminate the net effects of changes in other assets and liabilities. Acquisition of subsidiary companies increased by $941,000, offset by reductions in other of $1,587,000, issuance of treasury stock of $646,000, and increases in change in other assets of $647,000 and change in other liabilities of $2,527,000.
Adjustment of proceeds from sales or maturities of fixed maturities of $458,000, with offset to other, for accretion and amortization of bond discount and premium, respectively, previously included.
Additional changes to assets and liabilities resulting in a net decrease to shareholders’ equity totaling $2.4 million:
that it concluded had significant future principal risk. While all of these securities were investment grade when purchased, six of the eight had experienced ratings downgrades since purchase. These securities were written down as other than temporary impaired securities in 2003, resulting in a net realized pre-tax loss of $5.2 million. One additional bond purchased in early 2003 was sold in late 2003 for a net pre-tax gain of $580,000. The other bonds purchased from January to September of 2003 had by December 31, 2003, resulted in an additional net unrealized loss of approximately $12.3 million; however, the Company determined that the decline in market value of this group of bonds was temporary, and retained them in the portfolio.
Mortgage-backed securities are sensitive to changes in prevailing interest rates, since interest rate levels affect the rate at which the underlying mortgage obligations are repaid. Mortgage-backed pass-through securities, sequential CMOs and support bonds, which comprised approximately 67% of the book value of FIC’s mortgage-backed securities at December 31, 2004, are sensitive to prepayment and extension risks. FIC’s insurance subsidiaries have reduced the risk of prepayment associated with mortgage-backed securities by investing in planned amortization class (“PAC”), target amortization class (“TAC”) instruments and scheduled bonds. These investments are designed to amortize in a predictable manner by shifting the risk of prepayment of the underlying collateral to other investors in other tranches (“support classes”) of the CMO. At December 31, 2004, PAC and TAC instruments and scheduled bonds represented approximately 19.8% of the book value of FIC’s mortgage-backed securities. Sequential and support classes represented approximately 23.9% of the book value of FIC’s mortgage-backed securities at December 31, 2004.
In addition to the realignment strategy as described above, with the low market interest rate environment during 2004, the Company also increased its level of cash and short-term investments from $82.4 million at December 31, 2003, to $114.6 million at December 31, 2004, in anticipation of an improved interest rate environment. It was also during this time that Conning and the Company completed more extensive asset/liability management and duration analysis which provided the information for more effective reinvestment of funds. As market interest rates began to rise subsequent to 2004, most of the cash and short-term investments were deployed in longer term debt securities during 2005 and the first quarter of 2006.
million on the sale, which includes both an immediate realized gain recognized in 2005 of $8 million and a deferred gain of $2.1 million to be recognized over the period from the sale date through March 31, 2008.
The costs related to acquiring new business, including certain costs of issuing policies and certain other variable selling expenses (principally commissions), are capitalized and treated as deferred policy acquisition costs (“DAC”) to be amortized over the life of the related policies. The decrease in the Company’s DAC from December 31, 2003, to December 31, 2004, reflects that the capitalization of acquisition costs associated with sales of new insurance policies was less than the amortization of such amounts capitalized in prior years. The present value of future profits of acquired business is the capitalized acquisition cost of blocks of insurance business that the Company has acquired from others in the past. This asset is amortized to expense as the profits are realized from the various blocks of acquired business and the policies in-force gradually decrease. The overall decline in these two assets reflects the net run-off in business that the Company experienced in 2004, as shown in the following table.
Investors Life had $359.9 million of separate account assets as of December 31, 2004 (not including the value of the Company’s own start-up investment in one of the accounts), as compared to $358.3 million at the end of 2003. These assets include (a) two variable annuity separate accounts that permit contractholders to allocate their contract values among a selection of third-party mutual funds and (b) $329.5 million held in custodian accounts in connection with investment annuity contracts. The investment annuity business is reinsured with Symetra Life Insurance Company (formerly Safeco Life Insurance Company), a third-party reinsurer, on a 90%/10% coinsurance basis, with Investors Life retaining 10% of such business. Since the reinsurance treaty is on a coinsurance basis, Investors Life is contingently liable to the policyholders in the event that the reinsurer is unable to fulfill its obligations under the treaty. Investors Life is not marketing new separate account annuity contracts.
Effective June 1, 2006, Investors Life recaptured the previously reinsured investment annuity business with Symetra Life resulting in the retention of 100% of this business. The Company expects the recapture of this previously reinsured business to increase revenues in 2006 and future years. However, as this is a closed block of business, the revenues are expected to decrease as the policies in-force decline.
Other liabilities, which totaled $29.6 million at December 31, 2004, compared to $25.3 million at December 31, 2003, consist primarily of accrued expenses, policyholder suspense liabilities, pension plan liabilities, and amounts held as agent or trustee.
A significant development in 2004 in other liabilities is the recording of an additional minimum pension liability for the ILCO pension plan as described in more detail in Note 11 of the accompanying consolidated financial statements. The additional liability resulted primarily from a decrease in the pension plan discount rate as of December 31, 2004, consistent with the decrease in overall market interest rates.
In 2003, the Company borrowed $15 million through the issuance of trust preferred notes (the “2003 Notes”) to pay for its acquisition of the New Era companies and to repay advances that it had received from one of its insurance company subsidiaries for operating expenses. The 2003 Notes bear interest at the three-month LIBOR rate plus 4.2% (approximately 9.02% at April 1, 2006), not to exceed 12.5% prior to May 2008. The 2003 Notes require the payment only of interest through May 22, 2033, when the entire $15 million must be repaid, but may be repaid without any prepayment penalty after May 2008.
In 2004, FIC’s net loss was affected by the following significant and unusual items:
$0.4 million paid to William P. Tedrow in connection with the New Era acquisition in June 2003 (see Company's Quarterly Report on Form 10-Q for the three-month period ended June 30, 2003, for a further description of this payment).
In 2002, net loss and earnings per share were affected by the cumulative effect of a change in accounting principle of $4.1 million. This amount represents the excess of fair value of net assets acquired over cost as of the beginning of 2002 related to the merger of Intercontinental Life Corporation (“ILCO”) with and into a subsidiary of FIC on May 18, 2001. The Company recorded this cumulative effect in conjunction with adopting SFAS No. 141, “Business Combinations,” in the first quarter of 2002, as required by SFAS No. 141.
The above described significant and unusual items need to be taken into consideration in drawing comparisons between the operating results in 2004 and other periods.
The Company’s revenues and net loss for years 2004, 2003, and 2002 are shown in the following table.
Setting aside the effects of the unusual events mentioned above, the Company believes that the more important factors affecting its operating results during this period include the run-off in the Company’s existing book of business, coupled with relatively low sales of new business, the decline in the prevailing interest rates, and decreases in operating expenses.
The decline in renewal premiums reflects the run-off in the Company’s existing book of business, noted above. The decrease in first-year premiums for Investors Life is attributable to the decrease in the number and value of new policies that were issued in 2004 compared to 2003 and 2002. Also, Investors Life historically has focused less on sales of traditional life insurance products, placing more emphasis on annuity and universal life insurance products. Conversely, Family Life product marketing has concentrated on sales of mortgage protection insurance which are traditional life insurance products. During 2003 and 2004, the sales organization of Family Life was extensively restructured to lower overall policy acquisition costs. Family Life also upgraded its product portfolio in 2004 to offer more competitive features and benefits. These developments were key to the increase in first year premiums in Family Life during 2004.
In accordance with GAAP, deposits received by FIC in connection with annuity contracts and premiums received for universal life (“UL”) insurance policies are reflected in FIC’s consolidated financial statements as increases in liabilities for contractholder deposit funds and not as revenues. Annual charges made against these deposits are reported as revenue. For the years 2002-2004, the table below reflects the amounts of such annuity deposits and UL premiums.
Earned insurance charges totaled $41.8 million, $40.3 million, and $41.8 million for the years ended December 31, 2004, 2003, and 2002, respectively. These revenues primarily consist of UL cost of insurance charges, but also include policy surrender charges, and policy administration charges.
Net investment income for the year ended December 31, 2004, was $30.7 million as compared to $35.3 million for the year ended December 31, 2003, and $38.2 million for the year ended December 31, 2002. The decrease in net investment income from 2003 to 2004 was primarily attributable to 1) a decline in the income received from the Company's interest-bearing investments, resulting from decreasing interest rates during 2003 and 2004 and 2) significant reinvestment of investment proceeds from sales, maturities, and mortgage-backed security prepayments in lower-yielding securities during this period. The Company's holdings of fixed maturities, trading securities, and short-term investments (including cash equivalents) are its primary interest bearing securities. Additionally, the holdings of these securities declined approximately 4.4% from 2003 to 2004 contributing to the lower net investment income. Components of net investment income by investment type are detailed below:
Real estate revenue is primarily earned from the leases on the buildings at the Company’s River Place Pointe office complex in Austin, Texas. Net real estate income (revenues from leases less associated operating expenses and depreciation) totaled $1.8 million, $2.4 million, and $2.9 million for the years ended December 31, 2004, 2003, and 2002, respectively. The decrease in income from 2002 to 2003 was primarily attributable to higher depreciation expenses in 2003 as the final phase of construction was completed during mid-year 2002, with minimal additional leasing activity. The decrease in real estate income from 2003 to 2004 was primarily due to higher depreciation, operating expenses and real estate taxes, as gross rental income was substantially the same between years. As disclosed in more detail in Note 18 of the accompanying consolidated financial statements, the Company sold the River Place Pointe property in June 2005. Accordingly, the Company will no longer have significant real estate-related income subsequent to June 2005 as the sales proceeds were reinvested primarily in fixed maturity securities.
Policyholder benefits and expenses, which consist primarily of death benefit claims, totaled $47.5 million, $47.4 million, and $53.5 million for the years ended December 31, 2004, 2003, and 2002, respectively. The decrease of $6.1 million from 2002 to 2003 was primarily attributable to lower death benefit claims and a lower level of surrenders of traditional life insurance policies. Death benefits for 2003 and 2004 were at relatively comparable levels.
Interest expense on contractholder deposit funds represents interest paid or credited to contractholders on cash values accumulated in their universal life insurance and annuity accounts. Interest expense totaled $23.2 million in 2004, $25.8 million in 2003, and $30.3 million in 2002. The decrease in interest expense in 2004 and 2003 was primarily attributable to reductions in interest rates credited to policyholders, as the Company managed its interest spread in response to the low and declining interest rates that characterized 2004 and 2003. Also contributing to the lower interest expense was a decline in universal life insurance and annuity policies in-force, as the liability for contractholder deposit funds decreased from $593.9 million at year-end 2003 to $572.1 million at year-end 2004.
The decline in market interest rates from 2001 had a negative impact on the interest spread which is the difference in the Company’s investment portfolio rate and the interest rates credited on policyholder contracts for universal life insurance and annuities. The Company responded to the lower market rates by lowering many of the credited rates on its policies during 2003 and 2004. However, universal life insurance and annuity policies have contractual minimum guaranteed rates and credited rates cannot be lower than such minimums. Because many of the Company’s policies have minimum guaranteed rates of 4.0%, the market interest rate environment in recent years has put pressure on the Company’s interest spread.
Present value of future profits on acquired businesses (PVFP) is amortized in a similar manner as DAC, as previously described, for traditional and interest sensitive business. Amortization of PVFP totaled $3.2 million, $4.5 million, and $4.2 million for the years ended December 31, 2004, 2003, and 2002, respectively. The amortization is consistent with the run-off of the acquired blocks of business. However, the amount for 2004 included reduced amortization due to assumption changes related to two acquired universal life insurance blocks of business.
Interest expense for 2004 and 2003 totaled $864,000 and $485,000, respectively. As previously disclosed in this Item 7, the interest expense relates to debt service on $15 million the Company borrowed in 2003 through issuance of trust preferred notes (the “2003 Notes”). The 2003 Notes bear interest quarterly at the three-month LIBOR rate plus 4.2%. Interest expense for 2004 and 2003 reflects an average annual interest rate of approximately 5.8% and 5.3 %, respectively.
approximately $34.6 million at year-end 2004 and begin to expire in 2008 through 2024. The valuation allowance totaled $9.8 million at December 31, 2004, with the initial establishment of the allowance in 2002 totaling $0.8 million. Additions to the allowance totaled $3.0 million and $6.0 million in 2004 and 2003, respectively. The additions in 2004 include $3.3 million related to continuing operations and a reduction of $0.3 million related to other comprehensive income. The 2003 additions include $3.6 million related to continuing operations, $2.1 million related to discontinued operations, and $0.3 million related to other comprehensive income.
Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of its business operations. FIC is an insurance holding company whose principal assets at and for the year ended December 31, 2004, consisted of its ownership interests in its insurance subsidiaries, Family Life Insurance Company and Investors Life Insurance Company. As a holding company, FIC’s ability to pay interest and principal on its debt, pay its expenses and pay dividends on its common stock depend substantially on its receipt of dividends or other cash flow from its subsidiaries.
At the holding company level, FIC’s principal current ongoing liquidity demands relate to the payment of principal and interest on its indebtedness. As of December 31, 2004, Investors Life held $15.4 million of notes receivable from FIC (the “Affiliated Notes”) that represented the remaining indebtedness related to the Family Life acquisition. Although this intercompany indebtedness is eliminated on FIC’s consolidated balance sheets, it creates a debt service requirement at the holding company level. The Affiliated Notes, through June, 2004, included the following provisions:
In June 2004, with the approval of the Texas Department of Insurance, the Affiliated Notes were amended to provide for:
Again with the approval of the Texas Department of Insurance, the loans were restructured as of March 9, 2006. As amended, the loans provide for a one year moratorium on principal payments for the period from March 12, 2006, to December 12, 2006, with principal payments to resume on March 12, 2007, with ten equal quarterly principal payments until the maturity date of June 12, 2009. These notes have been eliminated in consolidation.
Since FIC is not current in its filing of financial information with the SEC it does not have access to the public capital markets. Although FIC does not believe that it will need additional capital to fund its obligations through 2006, the unavailability of access to the public capital markets may adversely affect our ability to grow our business through acquisitions.
The ability of Family Life and Investors Life to pay dividends to FIC and meet these holding-company liquidity demands is subject to restrictions set forth in the insurance laws and regulations of Texas, its domiciliary state. Texas limits how and when Family Life and Investors Life can pay such dividends by (a) including the “greater of” standard for payment of dividends to shareholders and (b) requiring that prior notification of a proposed dividend be given to the Texas Department of Insurance. Under the “greater of” standard, an insurer may pay a dividend in an amount equal to the greater of: (i) 10% of the policyholder surplus or (ii) the insurer’s statutory net gain from operations for the previous year.
A primary liquidity consideration with respect to life insurance and annuity products is the risk of early policyholder and contractholder withdrawal. Deposit fund liabilities for universal life and annuity products as of December 31, 2004, were $572.1 million, compared to $593.9 million at December 31, 2003. Individual life insurance policies are less susceptible to withdrawal than are annuity contracts because life insurance policyholders may incur surrender charges and undergo a new underwriting process in order to obtain a new insurance policy. At December 31, 2004, the bulk of the liabilities for contractholder deposit funds on FIC’s balance sheet, $398 million, represented insurance products, as compared to only $174 million of annuity product liabilities.
There can be no assurance that future experience regarding benefits and surrenders will be similar to the historic experience on which such cash-flow testing is based, since withdrawal and surrender levels are influenced by such factors as the interest-rate environment and general economic conditions as well as the claims-paying and financial strength ratings of FIC’s insurance subsidiaries.
The following table summarizes information regarding FIC’s contractual obligations, including principal and interest where applicable, as of December 31, 2004. The amounts in the table are different than those reported in our consolidated balance sheet as of December 31, 2004 due to the consideration of interest on debt obligations. Some of the amounts included in this table are based on management’s estimates and assumptions about these obligations, including those related to duration, future mortality, and persistency. Because these estimates and assumptions are necessarily subjective, the amounts actually paid by the Company in the future may vary significantly due to the uncertainty of the timing of cash flows based on insurable events or policyholder surrenders.
Other policy claims and benefits represent benefit and claim liabilities for which the Company believes the amount and timing of the payment is essentially fixed and determinable. Such amounts generally relate to 1) policies or contracts where the Company is currently making payment and will continue to do so until the occurrence of a specific event and 2) incurred and reported claims.
FIC’s overall liquidity experience in recent periods is reflected in its consolidated statements of cash flows, the highlights of which are summarized in the following table.
Net cash used in investing activities in 2003 was primarily attributable to increased investment purchases. At December 31, 2002, the Company had holdings of short-term investments of $101,000 and cash and cash equivalents of $163.0 million for a combined total of $163.1 million. During 2003 the Company utilized $80.7 million of these funds primarily to purchase longer term fixed maturity securities. The remaining $82.4 million was held as cash and cash equivalents at December 31, 2003, and the Company had no short-term investments at year-end 2003.
Net cash used in financing activities totaled $31.2 million and $13.8 million in 2004 and 2002, respectively, while 2003 reflected net cash provided by financing activities of $10.8 million. The most significant components of the Company's financing activities are contractholder fund deposits and withdrawals for annuity and universal life insurance policies. For 2004, 2003, and 2002, contractholder fund withdrawals exceeded deposits by $31.2 million, $4.7 million, and $12.3 million, respectively. The significant change in net withdrawals in 2004 is due to a decline in deposits in 2004 from 2003 of $18.2 million and an increase in withdrawals of $8.3 million for the same period. The net withdrawals in 2003 were more than offset by funds provided by the $15.0 million notes issued in May 2003.
The decrease in contractholder fund deposits in 2004 from prior years is largely due to the Company’s decision in 2004 to temporarily discontinue the sale of fixed annuity products, as previously described. Certain design features of the Company’s annuity products, coupled with competition in the annuity market and a low interest rate market environment led to this decision. Total contractholder fund deposits for 2004, 2003, and 2002 totaled $39.3 million, $57.5 million, and $55.3 million, respectively.
Liquidity management is designed to ensure that adequate funds are available to meet all current and future financial obligations. The Company meets its liquidity requirements primarily by positive cash flows from the operations of subsidiaries, and to a lesser extent, cash flows provided by investing activities. Proper liquidity management is crucial to preserve stable, reliable, and cost-effective sources of cash to meet the future benefit payments under our various insurance and deposit contracts, pay operating expenses (including interest and income taxes), and maintain reserve requirements. In this process, we focus on our assets and liabilities, and the impact of changes in both short-term and long-term interest rates, market liquidity and other factors. We believe we have the ability to generate adequate cash flows for operations on a short-term and a long-term basis.
In accordance with accounting principles generally accepted in the United States of America (“GAAP”), universal life insurance premiums and annuity deposits received are reflected in FIC’s consolidated financial statements as increases in liabilities for contractholder deposit funds and not as revenues. Instead 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. Similarly, surrender benefits paid relating to universal life insurance policies and annuities are reflected as decreases in liabilities for contractholder deposit funds and not as expenses.
The Company’s principal investments are in fixed maturity securities and real estate; all of which are exposed to three primary sources of investment risk: credit, interest rate and liquidity. The fixed maturity securities, which are all classified as available for sale, are carried at their fair value in the Company’s balance sheet, with unrealized gains or losses recorded in accumulated other comprehensive income. The investment portfolio is monitored regularly to ensure that investments which may be other than temporarily impaired are identified in a timely fashion and properly valued, and that impairments are charged against earnings as realized investment losses. The valuation of the investment portfolio involves a variety of assumptions and estimates, especially for investments that are not actively traded. Fair values are obtained from a variety of external sources. The Company has a policy and process in place to identify securities that could potentially have an impairment that is other-than-temporary. This process involves monitoring market events that could impact issuers’ credit ratings, business climate, management changes, litigation and government actions, and other similar factors. This process also involves monitoring late payments, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues. At the end of each quarter, all securities are reviewed where fair value is less than ninety percent of amortized cost for six months or more to determine whether impairments should be recorded. The analysis focuses on each issuer’s ability to service its debts and the length of time the security has been trading below cost. This quarterly process includes an assessment of the credit quality of each investment in the entire securities portfolio. The Company considers relevant facts and circumstances in evaluating whether the impairment of a security is other-than-temporary. Relevant facts and circumstances considered include (1) the length of time the fair value has been below cost, (2) the financial position of the issuer, including the current and future impact of any specific events, and (3) the Company’s ability and intent to hold the security to maturity or until it recovers in value. To the extent the Company determines that a security is deemed to be other than temporarily impaired, the difference between amortized cost and fair value would be charged to income as a realized investment loss. There are a number of significant risks and uncertainties inherent in the process of monitoring impairments and determining if an impairment is other-than-temporary. These risks and uncertainties include (1) the risk that the Company’s assessment of an issuer’s ability to meet all of its contractual obligations will change based on changes in the credit characteristics of that issuer, (2) the risk that the economic outlook will be worse than expected or have more of an impact on the issuer than anticipated, (3) the risk that fraudulent information could be provided to the Company’s investment professionals who determine the fair value estimates and other-than-temporary impairments, and (4) the risk that new information obtained by the Company or changes in other facts and circumstances lead the Company to change its intent to hold the security to maturity or until it recovers in value. Any of these situations could result in a charge to income in a future period.
The following pronouncements have been identified as those which could have a material effect on the consolidated financial statements of the Company.
In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment.” SFAS 123(R) is a revision of SFAS 123, “Accounting for Stock-Based Compensation,” which was originally issued by the FASB in 1995. As originally issued, SFAS 123 provided companies with the option to either record expense for share-based payments under a fair value model, or to simply disclose the impact of the expense. SFAS 123(R) requires companies to measure the cost of share-based payments to employees using a fair value model, and to recognize that cost over the relevant service period. In addition, SFAS 123(R) requires that an estimate of future award forfeitures be made at the grant date, while SFAS 123 permitted recognition of forfeitures on an as incurred basis. This statement is effective for all awards granted, modified, repurchased, or cancelled after June 15, 2005, and, as a result, the Company will adopt SFAS 123(R) beginning January 1, 2006. The adoption of this statement is not expected to have a material impact on the Company’s consolidated financial statements.
In July 2003, the Accounting Standards Executive Committee (“AcSEC”) of the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) 03-01, “Accounting and Reporting by Insurance Enterprises for
The Company adopted the provisions of SOP 03-01 at January 1, 2004, resulting in an increase to income as a cumulative effect of a change in accounting principle totaling $229,000, net of taxes, as reflected in the accompanying 2004 consolidated statement of operations. The Company has certain universal life insurance products that are credited with bonus interest after applicable qualifying periods. The adoption of the new accounting principle changed the pattern of recognition of the bonus interest expense.
This Statement also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. SFAS No. 154 carries forward without change the guidance contained in APB Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. This statement is effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005, with earlier adoption permitted. As a result, and due to the restatement included within the accompanying 2003 and 2002 consolidated financial statements, the Company adopted SFAS No. 154 for the correction of errors reported after December 31, 2005.
In September, 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)”. Under this new standard, companies must recognize a net liability or asset to report the funded status of their defined benefit pension and other postretirement
Report of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm, dated July 29, 2005, except for 			the current period restatement described in Note 2 as to which the date is October 19, 2006.
Consolidated Balance Sheets as of December 31, 2004 and 2003 (Restated).
Consolidated Statements of Operations for the years ended December 31, 2004, 2003 (Restated), and 2002 (Restated).
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2004, 2003 (Restated), and 2002 (Restated).
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 (Restated), and 2002 (Restated).