UTG, Inc., a Delaware corporation, is a life insurance holding company. The Company's dominant business is individual life insurance, which includes the servicing of existing insurance policies in force, the acquisition of other companies in the life insurance business and the administration and processing of life insurance business for other entities. The Company's focus for the future includes growing the administrative portion of the business.
Future Policy Benefits - Because of the long-term nature of insurance contracts, the insurance company is liable for policy benefit payments that will be made in the future. The liability for future policy benefits is determined by standard actuarial procedures common to the life insurance industry. The accounting policies for determining this liability are disclosed in Note 1 - Summary of Significant Accounting Policies in the Notes to the Consolidated Financial Statements.
On a consolidated basis, the Company had net income attributable to common shareholders of $9.3 and $6.3 million in 2012 and 2011, respectively. In 2012, income before income taxes was $15.4 million compared to $7.8 million in 2011. The increase in income during 2012 was primarily attributable to an increase in investment income.
Total revenue was $44.8 million in 2012 and $35 million in 2011. The increase in revenues is primarily attributable to an increase in net investment income and realized gains on investments. The magnitude of realized investment gains and losses in a given year is a function of the timing of trades of investments relative to the markets themselves as well as the recognition of any impairments on investments.
Total benefits and other expenses paid in 2012 were $29.4 million compared to $27.2 million in 2011.
Premiums and policy fee revenues, net of reinsurance premiums and policy fees, decreased approximately 2% when comparing 2012 to 2011. 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 2012 and 2011 was approximately 96.2% and 95.8%, respectively. Persistency is a measure of insurance in-force retained in relation to the previous year.
Net investment income increased approximately 65% in 2012 compared to 2011. The increase in the current year net investment income, in comparison to the prior year results, is attributable to favorable results in the fixed maturities, trading securities and real estate investment portfolios.
The fixed maturity portfolio was also impacted by a reinsurance agreement that was fully recaptured during the third quarter of 2012. At the time the reinsurance was repaid, the reserves were recaptured through the elimination of reinsurance recoverable in exchange for assets received equal to the recaptured reserves. The Company received approximately $27.7 million of investment grade debt securities. See Note 12 - Other Cash Flow Disclosures in the Notes to the Consolidated Financial Statements for further information regarding the repayment of the reinsurance. The receipt of the debt securities increased the fixed maturities balance, therefore enhancing investment yields.
Income from the discounted mortgage loan portfolio decreased approximately 49% when comparing 2012 and 2011 results. Income from discounted mortgage loans represented 16% of the consolidated investment income reported by the Company during 2012. The income from the discounted mortgage loan portfolio is mainly the result of one-time events.
During 2012, income from real estate investing activities represented 32% of the consolidated investment income reported by the Company. Income from real estate investing activities increased approximately 23% when comparing 2012 to 2011 results. Income generated by HPG Acquisitions, LLC ("HPG"), a majority owned subsidiary of UG, represents 82% or approximately $6.9 million of the real estate income reported. HPG's income increased approximately 11% in comparison to the prior year. HPG owns office buildings in Midland, Texas. The increase in income is a result of increased building occupancy and an increase in rent charged.
The Company's net realized investment gains increased approximately 24% when comparing 2012 to 2011. The increase in net investment gains is mainly attributable to realized gains from fixed maturities and a decrease in other-than-temporary impairments recognized in the current year. Realized gains from fixed maturities increased approximately 6% in comparison to the prior year. The gains are mainly attributable to the Company selling a portion of its U.S. Treasury holdings to take advantage of the unusually high price spreads. The majority of the gains from the real estate portfolio are attributable to the sale of three pieces of real estate and are considered one-time events.
The Company's legal expenses increased approximately 73% or $125,000 when comparing 2012 to 2011. The increase in legal expenses is primarily attributable to the merger of American Capitol and the ACAP dissenters' lawsuit. See Note 8 - Commitments and Contingencies in the Notes to the Consolidated Financial Statements for additional information regarding the ACAP dissenters' lawsuit.
The Company's charitable contributions increased approximately 50% or $322,000 when comparing 2012 to 2011. Charitable contributions are expected to vary from year to year depending on the earnings of the Company.
The Company's information technology expenses increased approximately 33% or $283,000 when comparing 2012 to 2011. During 2012, the Company invested in new software to assist in increasing operating efficiencies and to meet regulatory requirements.
Liquidity provides the Company with the ability to meet on demand the cash commitments required by its business operations and financial obligations. The Company's liquidity is primarily derived from positive cash flows from operations, a portfolio of marketable securities and line of credit facilities. The primary cash needs of the Company are for the payment of claims and operating expenses, maintaining adequate statutory capital and surplus levels and meeting debt service requirements.
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 the servicing of its debt. 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, 2012 and 2011, substantially all of the consolidated shareholders equity represents net assets of its subsidiaries. In 2012, the Parent received $3.3 million in dividends from its insurance subsidiary and $3.5 million in 2011. The dividends were mainly used to pay debt obligations of the Parent company. 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.
An additional source of liquidity to the Parent company and its subsidiaries is the line of credit facilities extended to them that allow borrowings of up to $28 million. As of December 31, 2012, the Company and its subsidiaries had available $21.3 million in line of credit facilities. As of December 31, 2011, the Company and its subsidiaries had available $14 million in line of credit facilities. For additional information regarding the line of credit facilities, see Note 7 - Credit Arrangements in the Notes to the Consolidated Financial Statements.
The Company expects to have readily available funds for 2013 and the foreseeable future to conduct its operations and to maintain target capital ratios in the insurance subsidiary through internally generated cash flow and the credit facility. In the unlikely event that more liquidity is needed, the Company could generate additional funds through such sources as a short-term credit facility and intercompany borrowing.
Net cash provided by financing activities was $7 million during 2012 and net cash used by financing activities was $3.9 million during 2011. Proceeds from notes payable increased by approximately $8.4 million in 2012 compared to 2011. During 2012, a majority owned subsidiary of UG, HPG Acquisitions, LLC ("HPG") obtained a $12 million note, which represents a substantial portion of the proceeds from notes payable reported by the Company. Net cash provided by financing activities was further enhanced in 2012 by $2.5 million in cash received from the reinsurance recapture. See Note 12 - Other Cash Flow Disclosures in the Notes to the Consolidated Financial Statements for further information regarding the reinsurance recapture.
The Company had outstanding debt of $18.9 million as of December 31, 2012. Approximately $1.6 million of this debt is related to the acquisition of ACAP Corporation. Approximately $12.2 million of this debt is related to a note extended to a majority owned subsidiary of UTG, HPG Acquisitions, LLC ("HPG"), during 2012. HPG borrowed money to return capital to its investors. UTG Avalon, LLC, a wholly owned subsidiary of UG, has an outstanding line of credit in the amount of $5 million. See Note 7 - Credit Arrangements in the Notes to the Consolidated Financial Statements for detailed disclosures regarding the Company's notes payable.
At December 31, 2012, UG has a ratio of approximately 3.41, which is 341% of the authorized control level. Accordingly, the Company meets the RBC requirements.
The Company's investments are predominantly in fixed maturity investments such as bonds, which provide sufficient return to cover future obligations. The Company carries all of its fixed maturity holdings as available for sale which are reported in the consolidated financial statements at their market value.
During 2012, the Company received approval from the states of Ohio and Texas to merge its two insurance companies. Effective January 1, 2012, American Capitol Insurance Company was merged into Universal Guaranty Life Insurance Company.
We have audited the accompanying consolidated balance sheets of UTG, Inc. (a Delaware corporation, the "Company") and subsidiaries as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive income, shareholders' equity, and cash flows for the years then ended. These consolidated financial statements 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.
Equity Securities - Investments in equity securities, which include common and preferred stocks, are reported at fair value with unrealized gains and losses, net of deferred taxes, reflected directly in accumulated other comprehensive income.
Trading Securities - Trading security investments are reported at fair value with gains and losses resulting from changes in fair value recognized in earnings. Trading securities include bonds, exchange traded equities, exchange traded options and exchange traded futures.
Reinsurance - In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage and coinsurance contracts. The Company retains a maximum of $125,000 of coverage per individual life.
Recognition of Revenues and Related Expenses - Premiums for traditional life insurance products, which include those products with fixed and guaranteed premiums and benefits, consist principally of whole life insurance policies, and certain annuities with life contingencies are recognized as revenues when due. Limited payment life insurance policies defer gross premiums received in excess of net premiums, which is then recognized in income in a constant relationship with insurance in force. Accident and health insurance premiums are recognized as revenue pro rata over the terms of the policies. Benefits and related expenses associated with the premiums earned are charged to expense proportionately over the lives of the policies through a provision for future policy benefit liabilities and through deferral and amortization of deferred policy acquisition costs. For universal life and investment products, generally there is no requirement for payment of premium other than to maintain account values at a level sufficient to pay mortality and expense charges. Consequently, premiums for universal life policies and investment products are not reported as revenue, but as deposits. Policy fee revenue for universal life policies and investment products consists of charges for the cost of insurance and policy administration fees assessed during the period. Expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances.
The Company held, below investment grade investments with an amortized cost of $19,080,167 and $1,843,314 as of December 31, 2012 and 2011, respectively. The investments are all classified as "All other corporate bonds".
The fair value of investments with sustained gross unrealized losses at December 31, 2012 and 2011 are as follows:
The following table provides additional information regarding the number of securities that were in an unrealized loss position for greater than or less than twelve months:
Substantially all of the unrealized losses on fixed maturities available for sale at December 31, 2012 and 2011 are attributable to changes in market interest rates and general disruptions in the credit market subsequent to purchase. The unrealized losses on equity investments were primarily attributable to normal market fluctuations. The Company does not currently intend to sell nor does it expect to be required to sell any of the securities in an unrealized loss position. Based upon the Company's expected continuation of receipt of contractually required principal and interest payments and its intent and ability to retain the securities until price recovery, as well as the Company's evaluation of other relevant factors, the Company deems these securities to be temporarily impaired as of December 31, 2012 and 2011.
The Company, from time to time, acquires mortgage loans through participation agreements with FSNB. FSNB has been able to provide the Company with additional expertise and experience in underwriting commercial and residential mortgage loans, which provide more attractive yields than the traditional bond market. The Company is able to receive participations from FSNB for three primary reasons: 1) FSNB has already reached its maximum lending limit to a single borrower, but the borrower is still considered a suitable risk; 2) the interest rate on a particular loan may be fixed for a long period that is more suitable for UG given its asset-liability structure; and 3) FSNB's loan growth might at times outpace its deposit growth, resulting in FSNB participating such excess loan growth rather than turning customers away. For originated loans, the Company's Management is responsible for the final approval of such loans after evaluation. Before a new loan is issued, the applicant is subject to certain criteria set forth by Company Management to ensure quality control. These criteria include, but are not limited to, a credit report, personal financial information such as outstanding debt, sources of income, and personal equity. Once the loan is approved, the Company directly funds the loan to the borrower. The Company bears all risk of loss associated with the terms of the mortgage with the borrower.
The Company began purchasing discounted commercial mortgage loans in 2009. Management has extensive background and experience in the analysis and valuation of commercial real estate. The discounted loans are available through the FDIC's sale of assets of closed banks and from banks wanting to reduce their loan portfolios. The loans are available on a loan by loan bid process. Once a loan has been acquired, contact is made with the appropriate individuals to begin a dialog with a goal of determining the borrower's willingness to work together. There are generally three paths a discounted loan will take: the borrowers pay as required; a settlement is reached with the loan being paid off at a discounted value; or the loan is foreclosed.
During 2012 and 2011, the Company acquired $22,244,731 and $11,123,386 in mortgage loans, respectively, including both regular participation mortgage loans as well as discounted mortgage loans. FSNB services the mortgage loan portfolio of the Company. 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 amount to cover costs incurred by FSNB relating to the processing and establishment of the loan.
During 2012 and 2011, the maximum and minimum lending rates for mortgage loans were:
Management has conservatively decided to place the loans in the discounted mortgage loan portfolio on a non-accrual status, due to the instability of the borrowers. The Company additionally only recognizes any discount once the Company's entire basis in a loan has been recovered.
The following table summarizes the number loans held in the discounted mortgage loan portfolio and the carrying value of the loans as of December 31, 2012:
The Company had investments with a fair value of $11,660,630 and $10,998,036 on deposit with various state insurance departments as of December 31, 2012 and 2011, respectively.
U.S. treasury securities are based on quoted prices in active markets and are generally categorized in Level 1 of the fair value hierarchy.
Equity securities available for sale consist of common and preferred stocks mainly in private equity investments, financial institutions and insurance companies. Equity securities for which there is sufficient market data are categorized as Level 2 in the fair value hierarchy. For the equity securities in which quoted market prices are not available, the transaction price is used as the best estimate of fair value at inception. When evidence is believed to support a change to the carrying value from the transaction price, adjustments are made to reflect the expected exit values. The Company performs ongoing reviews of the underlying investments. The reviews consist of the evaluations of expected cash flows, material events and market data. These investments are included in Level 3 of the fair value hierarchy.
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, 2012.
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, 2011.
The Level 3 securities include collateralized debt obligations of trust preferred securities issued by banks and insurance companies and certain equity securities with unobservable inputs. None of the collateral is subprime or Alt-A mortgages (loans for which the typical documentation was not provided by the borrower).
Transfers into Level 3 occur when there is a lack of observable market information. The transfers occurred at December 31, 2012.
The carrying values and estimated fair values of certain of the Company's financial instruments not recorded at fair value in the Consolidated Balance Sheets are shown below. Because the fair value for all consolidated balance sheet items are not required to be disclosed, the aggregate fair value amounts presented below are not reflective of the underlying value of the Company.
The Company has been purchasing 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.
Investment real estate 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 carrying amount of short term investments in the financial statements approximates fair value.
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 and its ultimate parent, The Guardian Life Insurance Company of America ("Guardian"), currently hold an "A" (Excellent) and "A++" (Superior) rating, respectively, from A.M. Best. The PALIC agreement accounts for approximately 63% and 64% of UG's reinsurance reserve credit, as of December 31, 2012 and 2011, respectively.
The Company does not have any short-duration reinsurance contracts. The effect of the Company's long-duration reinsurance contracts on premiums earned in 2012 and 2011 were as follows:
The HPG Acquisitions promissory note issued on December 27, 2012 is secured by real estate owned by HPG. The promissory note bears interest at a fixed rate of 4%. Interest is payable monthly. Principal is payable monthly beginning in the third year of the note.
The UTG Avalon line of credit carries interest at a rate of 4.0% and is payable in two semi-annual payments. The UTG Avalon promissory note was renewed on January 3, 2013 and matures on January 3, 2014.
As part of the Texas Imperial Life Insurance Company sale, the Company remains contingently liable for certain costs pending the outcome of an ongoing race-based audit on Texas Imperial Life Insurance Company by the Texas Department of Insurance. Under the agreement, the Company is responsible for 100% of the first $50,000 of costs, 90% of the next $50,000, 75% of the third $50,000 and 50% of the costs above $150,000. Management had conservatively estimated the Company's exposure and other costs at $50,000 based on information provided to date from the examination team and has established a contingent liability of $47,727 in its financial statements. This contingency expires on December 30, 2013.
On November 9, 2011, ACAP shareholders approved a proposed merger with UTG whereby ACAP shareholders received 233 shares of UTG for each share previously held of ACAP. On November 14, 2011, the merger was completed. Certain of the ACAP shareholders dissented to the merger requesting the courts determine the value of the ACAP shares. The legal case is currently in the discovery phase. The Company has established a contingent liability of $2,550,822 as of December 31, 2012 and 2011 to cover the anticipated proceeds due to the dissenting shareholders and associated legal and other costs.
The following table represents the total funding commitments and the unfunded commitment as of December 31, 2012 related to certain investments:
During 2010, the Company made a commitment to invest in Llano Music, LLC ("Llano"), which invests in music royalties. Llano does capital calls to its investors as funds are needed to acquire the royalty rights.
During 2011, the Company committed to invest in MM-Marcellus III, LP, which purchases land for leasing opportunities to those looking to harvest natural resources. Marcellus III, LP does capital calls to its investors as funds are needed for continued land purchases.
During 2012, the Company committed to invest in MM-Marcellus HBPI, LP, which purchases land for leasing opportunities to those looking to harvest natural resources. Marcellus HPBI, LP does capital calls to investors as funds are needed for continued land purchases.
During 2012, the Company committed to invest in PBEX, LLC, which purchases land and mineral rights for leasing opportunities to those looking to harvest natural resources. PBEX, LLC does capital calls to investors as funds are needed for continued land purchases.
During 2012, the Company committed to invest in Sovereign's Capital, LP ("Sovereign's"), which invests in companies in emerging markets. Sovereign's is expected to call the remaining unfunded commitment during 2013.
Executive Compensation - In December 2012, the Company issued 16,225 shares of its common stock to certain members of management as part of year-end bonuses based on 2012 operating results. The shares were valued at $13.25 per share, the market value at the date of issue. The Company recorded $214,981 in operating expenses related to this stock issuance.
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, 2012, substantially all of the consolidated shareholders' equity represents net assets of UTG's subsidiaries.
On November 14, 2011, UTG, Inc. merged with ACAP. Shareholders of ACAP received shares of UTG in exchange for their ACAP shares. ACAP was a 73% owned subsidiary of UG. The merger reduced the corporate structure and provided certain efficiencies and economies to the Companies. All ACAP shareholders, other than UTG or UG, have the right to receive 233 shares of UTG common stock for each share of ACAP common stock they owned at closing. Under the terms of the exchange ratio, UTG issued 50,328 shares to former ACAP shareholders. An additional 129,548 UTG shares were not issued due to dissenting ACAP shareholders. See Note 8 - Commitments and Contingencies for additional information regarding the ACAP dissenting shareholders.
On September 28, 2011 UTG entered a joint ownership agreement with Bandyco, LLC and First Southern National Bank, for an 8.08% interest in an aircraft. Bandyco, LLC is affiliated with Ward F Correll, who is a director of the Company. The Company was responsible for an initial payment of $150,000 on September 30, 2011, along with a $125,000 payment on October 30, 2011. The Company pays a monthly operational fee of $25,000 starting in November 2011 and lasting through July 2016. The aircraft is issued for business related travel by various officers and employees of the Company. For years 2012 and 2011 UTG paid $573,393 and $392,227 for costs associated with the aircraft.
Effective January 1, 2007, UTG entered into administrative services and cost sharing agreements with its subsidiary. Under this arrangement, the subsidiary pays its proportionate share of expenses, based on an allocation formula. During 2012 and 2011, UG paid $8,843,596 and $7,185,037, respectively, in expenses. The Ohio Department of Insurance has approved the cost sharing agreement and it is Management's opinion that where applicable, costs have been allocated fairly and such allocations are based upon accounting principles generally accepted in the United States of America.
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 amount to cover costs incurred by FSNB relating to the processing and establishment of the loan. The Company paid $102,447 and $136,457 in servicing fees and $81,851 and $89,651 in origination fees to FSNB during 2012 and 2011, respectively.
The Company reimbursed expenses incurred by employees of FSNB relating to travel and other costs incurred on behalf of or relating to the Company. The Company paid $90,939 and $15,392 in 2012 and 2011, respectively to FSNB in reimbursement of such costs. In addition, the Company began reimbursing FSNB a portion of salaries and pension costs for Mr. Correll, Mr. Ditto and a third employee. The reimbursement was approved by the UTG Board of Directors and totaled $462,819 and $348,610 in 2012 and 2011, respectively, which included salaries and other benefits.
The Company maintains cash balances in financial institutions that at times may exceed federally insured limits. The Company maintains its primary operating cash accounts with First Southern National Bank, an affiliate of the largest shareholder of UTG, Mr. Jesse T. Correll, the Company's CEO and Chairman. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents.
The Company reinsures that portion of insurance risk which is in excess of its retention limits. Retention limits range up to $125,000 per life. Life insurance ceded represented 21% and 24% of total life insurance in force at December 31, 2012 and 2011, respectively. Insurance ceded represented 25% and 28% of premium income for 2012 and 2011, respectively. The Company would be liable for the reinsured risks ceded to other companies to the extent that such reinsuring companies are unable to meet their obligations.