The following discussion should be read in conjunction with our consolidated financial statements and notes thereto included in this Form 10-K. In connection with, and because we desire to take advantage of, the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we caution readers regarding certain forward looking statements in the following discussion and elsewhere in this report and in any other statement made by, or on our behalf, whether or not in future filings with the Securities and Exchange Commission. Forward looking statements are statements not based on historical information and which relate to future operations, strategies, financial results or other developments. Forward looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward looking statements made by, or on our behalf. We disclaim any obligation to update forward looking statements.
On January 2, 2012, USALSC was issued a Certificate of Authority to conduct life insurance business in the State of Kansas. We began third party administrative services in 2015.
Deferred tax assets are recorded based on the differences between the financial statement and tax basis of assets and liabilities at the enacted tax rates. The principal assets and liabilities giving rise to such differences are investments, insurance reserves, and deferred acquisition costs. A deferred tax asset valuation allowance is established when there is uncertainty that such assets would be realized. We have no uncertain tax positions we believe are more-likely-than-not that the benefit will not be realized.
On October 11, 2018 the Company entered into a stock purchase agreement with Great Western Insurance Company to acquire Great Western Life Insurance Company. The transaction closed on December 14, 2018. USALSC paid $500,000 to acquire all of the outstanding shares of GWLIC.
The Company is pursuing new product and distribution opportunities to increase premium production. The acquisition of DCLIC and the reinsurance agreement with ALSC are designed to increase future premiums.
Investment income, net of expenses: The components of net investment income for the years ended December 31, 2018 and 2017 are as follows:
Net investment income for the years ended December 31, 2018 was $1,477,403, compared to $817,989 in 2017, an increase of $659,414 or 81%. This increase in investment income is primarily a result of increased invested assets as a result of our premium income, the Merger with Northern Plains, and our coinsurance agreement with ALSC, and an improvement in our book yield.
Net realized gains (losses) on investments: Net realized losses on investments for the years ended December 31, 2018 were $4,499, compared to gains of $430,565 in 2017, a decrease of $435,064. The decrease in realized gains is attributable to the repositioning of an equity portfolio from a market return focus to an income focus in 2017 as well as liquidating an equity portfolio to fund the ALSC transaction in 2017. There was not a similar activity in 2018. Realized gains and losses related to the sale of securities for the years ended December 31, 2018 and 2017 are summarized as follows:
Gain on bargain purchase: The Company acquired USALSC-Montana (formerly Great Western Life Insurance Company) on December 14, 2018. The total identifiable net assets of the purchase were $1,640,996 and the Company paid $500,000 for the acquisition. This resulted in a gain on bargain purchase of $1,140,996.
Other income: Other income for the year ended December 31, 2018 was $37,608 compared to $50,057 in 2017, a decrease of $12,449. This decrease is due to the acquisition of DCLIC which resulted in third party administration income from DCLIC being eliminated during consolidation for periods after the acquisition.
Expenses. Expenses for the year ended December 31, 2018 and 2017 are summarized in the table below.
Policyholder benefits: Policyholder benefits were $3,957,090 in the year ended December 31, 2018 compared to $3,485,564 in 2017, an increase of $471,526. The primary driver of this increase is the growth of interest credited on annuities from ALSC and acquired with Dakota Capital Life.
Increase in policyholder reserves: Policyholder reserves increased $2,766,169 in the year ended December 31, 2018, compared to $5,654,476 in 2017, a decrease of $2,888,307. The decrease is driven by a one-time increase in reserves of $3.9 million in 2017 as a result of our ALSC coinsurance transaction and fully offset by the one-time assumed premium revenue associated with this transaction.
Commissions, net of deferrals: The Company pays commissions to the ceding company on a block of assumed policies as well as commissions to agents on directly written business. Commissions, net of deferrals, were $637,425 in the year ended December 31, 2018, compared to $521,155 in 2017, an increase of $116,270. This increase is due to an increase in premiums.
Amortization of deferred acquisition costs: The amortization of deferred acquisition costs was $454,906 in the year ended December 31, 2018, compared to $321,451 in 2017, an increase of $133,455. The amortization increase is attributable to the growth of our deferred acquisition cost asset related to our reinsurance transaction with ALSC.
Salaries and benefits: Salaries and benefits were $1,152,728 for the year ended December 31, 2018, compared to $990,076 in 2017, an increase of $162,652. Staffing costs increased due to additional staffing acquired with the Northern Plains Merger and the growth of our customer service team.
Other expenses: Other operating expenses were $1,967,796 in the year ended December 31, 2018, compared to $1,316,162 in 2017, an increase of $651,634. Operating costs have increased due to expenses associated with the DCLIC acquisition, including additional auditing and actuarial fees, increased information technology costs, and selling and marketing expenses. Additionally, updated interpretations of accounting guidance on leased software resulted in the full amortization of our software fixed assets.
The following graph illustrates our five-year trend of net loss per share:
Assets. Assets have increased to $44,528,989 as of December 31, 2018, an increase of $5,540,652 or 14% from December 31, 2017. This is primarily the result of the growth of our business, offset by a decrease in the market value of our fixed maturity and equity investments.
Available for sale fixed maturity securities: As of December 31, 2018, we had available for sale fixed maturity assets of $26,882,239, an increase of $3,936,539 from the December 31, 2017 balance of $22,945,700. The increase is driven by the purchase of additional assets. The increase is offset by higher interest rates, which lowers the market value of these securities. If we hold our fixed maturity securities to maturity, as we intend to do, any changes in market value is temporary. The amortized cost of our fixed maturity securities, which does not take into account market value changes, increased by $5,517,992 during 2018, an increase of 25% over the previous year end value.
Available for sale equity securities: As of December 31, 2018, we had available for sale equity assets of $10,987,539, an increase of $324,024 from the December 31, 2017 balance of $10,663,515. This growth is driven by purchases of equity securities with premium income, offset by a decrease in the market value of our equity securities due to market volatility.
Policy loans: As of December 31, 2018, our policy loans were $56,539, an increase of $22,564 from the December 31, 2017 balance of 33,975. The increase is a result of the acquisition of USALSC-Montana and normal policy loan activity.
Reinsurance related assets: As of December 31, 2018, our reinsurance related assets were $161,846 compared to $249,879 as of December 31, 2017. This decrease is the result of lower amounts due from reinsurers.
Deferred acquisition costs, net: As of December 31, 2018, our deferred acquisition costs were $2,757,404 compared to $2,963,057 as of December 31, 2017. The reduction is the result of amortization of the cost of reinsurance deferred on our coinsurance agreement with ALSC.
Other assets: As of December 31, 2018, our other assets were $406,969, an increase of $240,785 from the December 31, 2017 balance of $166,184. This increase was driven by the prepayment of our sales management tool and upgrades to insurance administrative systems.
Policy liabilities: Our total policy liabilities as of December 31, 2018 were $31,556,529 compared to $24,945,377 as of December 31, 2017, an increase of $6,611,152 or 27%. This increase is the result new policy sales and the growth of our in-force policies.
Shareholders’ Equity. Our shareholders’ equity was $12,632,666 as of December 31, 2018, a decrease of $1,303,036 from our December 31, 2017 shareholders’ equity of $13,935,702. The reduction in shareholders’ equity was driven by a reduction in other comprehensive income and our net loss during the period. Other comprehensive income consists of the unrealized gains and losses on our investment portfolio. The reduction in other comprehensive income is the result of higher interest rates which lowers the market value of our fixed maturity securities and due to market volatility which reduced the value of our equity securities. This reduction in other comprehensive income is expected to be temporary in nature and reduced shareholders equity by $2,589,867 in 2018. The reduction is partially offset by the sale of common stock during the year.
Premium income, deposits to policyholder account balances, investment income, and capital raising 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 pay 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. As a member of the Federal Home Loan Bank, USALSC has immediate access to additional cash liquidity.
Cash flow from insurance activities combines cash flow from operations with the net cash received from deposit type contracts to show the impact of our insurance operations on our cash flows. Cash flow from deposit type contracts is primarily made up of funds received into our annuity products.
The consolidated financial statements are included as part of this reporting beginning on page.