Real Estate Amount % of Total Home Office $ 3,054,115 18% Commercial $ 2,680,318 15% Residential development $ 6,244,142 36% Foreclosed real estate $ 5,332,413 31%
insurance subsidiary owns a home office building in Huntington, West Virginia. The building has 15,000 square feet and is carried at $216,000. The facilities occupied by the Company are adequate relative to the Company's present operations.
Premium income net of reinsurance $ 29,998 $ 32,404 $ 31,160 $ 19,076 $ 9,575
Net income (loss) $ (3,001)* $ (1,624)* $ (862)* $ 5,661* $ (17)*
Consolidated operating activities of the Company produced negative cash flows of ($6,204,000), ($3,786,000) and ($7,298,000) in 1995, 1994 and 1993, respectively. The net cash provided by operating activities plus interest credited to account balances and net policyholder contract deposits after the payment of policyholder withdrawals, equalled $9,454,000 in 1995, $10,361,000 in 1994, and $10,029,000 in 1993. Management believes this measurement of cash flows more accurately indicates the performance of the Company's insurance operations, since reporting regulations require cash inflows and outflows from universal life insurance products to be shown as financing activities.
Interest credited to account balances increased 12% in 1995 compared to 1994, and decreased 14% when comparing 1994 to 1993. The increase in 1995 is due to the increase in policyholder contract deposits. The decrease in 1994 is due to a reduction in interest rates credited on the Company's insurance products in January 1994. It takes approximately one year to fully realize a change in credited rates since a change becomes effective on each policy's next anniversary. Insurance products that the Company is issuing are crediting 6% interest and the Company does not have any immediate plans to change product interest rates.
The Company's Senior Debt bears interest equal to 1% over the variable per annum rate most recently announced by the First Bank of Missouri as its "Base Rate". As of March 1, 1996, the "Base Rate" was 8.25%. The principal balance of the Company's Senior Debt is payable in installments on June 1st of each year. On December 2, 1994, the Company prepaid $2,000,000 of the $2,900,000 scheduled principal payment due June 1, 1995. On March 1, 1995, the Company prepaid the remaining $900,000 of the June 1, 1995 scheduled principal payment. On January 31, 1996, the Company prepaid $1,500,000 of the $3,900,000 scheduled principal payment due June 1, 1996.
Premium income, net of reinsurance premium, decreased 7% when comparing 1995 to 1994. The decrease is primarily attributed to the reduction in new business production and the change in products marketed. In 1995, the Company has streamlined the product portfolio, as well as restructured the marketing force. The decrease in first year premium production is directly related to the Company's change in distribution systems. The Company has changed its focus from primarily a broker agency distribution system to a captive agent system.
Business written by the broker agency force in recent years did not meet Company expectations. With the change in focus of distribution systems, most of the broker agents were terminated. (The termination of the broker agency force caused a non-recurring write-down of the value of agency force asset. See discussion of amortization of agency force for further details.)
Net investment income increased 8% when comparing 1995 to 1994. The change reflected an increase in the amount of invested assets, which was partially offset by a lower effective yield on investments made during 1995. The overall investment yields for 1995, 1994 and 1993, are 7.04%, 7.13% and 7.22%, respectively. The Company has been able to increase its investment portfolio through financing cash flows, generated by cash received through sales of universal life insurance products. Although the Company sold no fixed maturities during the last few years, it did experience a significant turnover in the portfolio. Many companies with bond issues outstanding took advantage of lower interest rates and retired older debt which carried higher rates. This was accomplished through early calls and accelerated pay-downs of fixed maturity investments.
Realized investment losses were $124,000 and $1,437,000 in 1995 and 1994, respectively. Fixed maturities and equity securities realized net investment losses of $224,000 and real estate realized net investment gains of $100,000 in 1995. The realized loss in 1995 can not be attributed to any one specific transaction. In 1994, the Company realized losses of $865,000 due to a permanent impairment of property located in Louisiana. The permanent impairment was based on recent appraisals and marketing analysis of surrounding properties.
During the third quarter of 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by Company standards. These policies had a face amount of $22,700,000 and represent 1/2 of 1% of the insurance in force. Management's analysis indicates that the expected death claims on the business in force to be adequately covered by the mortality assumptions inherent in the calculation of statutory reserves. Nevertheless, management has determined it is in the best interest of the Company to repurchase as many of the policies as possible. As of December 31, 1995, there remained approximately $5,738,000 of the original face amount which have not been settled. The Company will continue its efforts to repurchase as many of the policies as possible and regularly apprise the Ohio Department of Insurance regarding the status of this situation. Through December 31, 1995, the Company spent a total of $2,886,000 for the repurchase of these policies and for the legal defense of related litigation. In relation to the repurchase of insurance policies the Company incurred life benefits of $720,000 and $1,250,000 in 1995 and 1994, respectively. The Company incurred legal costs of $687,000 and $229,000 in 1995 and 1994, respectively.
Commissions and amortization of deferred policy acquisition costs increased 21% in 1995 compared to 1994. The increase is directly attributed to the amortization of a larger asset. The increase is also caused by the reduction in first year premium production. To a lesser extent the increase in amortization of deferred policy acquisition costs is directly related to the change in products that is currently marketed. The Company revised its portfolio of products as previously discussed in premium income. These new products pay lower first year
The Company had a net loss of $3,001,000 in 1995 compared to a net loss of $1,624,000 in 1994. The decline in 1995 is attributed to the non-recurring write down of the value of agency force and the increase in operating expenses. The write down of agency force, net of deferred income taxes and minority interest, caused $2,608,000 of the $3,001,000 net loss in 1995. The net loss was minimized by the improvement of net investment income and realized investment losses when compared to the previous year.
Premium income, net of reinsurance premium, increased 4% when comparing 1994 to 1993. The termination of the coinsurance agreement with Republic Vanguard contributed significantly to the increase in premium, net of reinsurance premium. UG terminated the coinsurance agreement with Republic Vanguard on December 31, 1993. In UG, first year reinsurance premium was 21% of direct first year premium in 1993 compared to 3% in 1994. Coinsurance agreements provide a sharing or 50/50 relationship between the direct company and the reinsurer of the premiums, benefits and the profitability of the underlying product. Management believes that terminating the agreement was the best alternative for long term benefit of the Company.
In 1994, the Company has been very active in streamlining the product portfolio, as well as restructuring the marketing force. The Company is currently marketing three universal life products. In late 1994, the Company discontinued marketing the traditional and interest sensitive products. The current universal life products feature lower first year costs compared to the discontinued products. The marketing force is made up of three distinct groups. Business produced by the broker agency force did not meet the Company standards. Therefore, most of the agents associated with that group were terminated. The other two agency forces continued to grow in 1994. First year direct premium decreased 3% in 1994 compared to 1993. The small decrease is perceived as a positive result when considering the changes to the portfolio and marketing force.
Net investment income decreased slightly when comparing 1994 to 1993. The Company's average yield on its investments declined slightly in 1994 compared to 1993. The Company has been able to increase its investment portfolio through financing cash flows and reducing its cash and short term positions. Although the Company sold no fixed maturities during 1994 or 1993, it did experience a significant turnover in the portfolio. Many companies with bond issues outstanding took advantage of the lower interest rates in the market during 1993 and early 1994 and retired older debt which carried higher rates. This was accomplished through early calls and accelerated pay-downs of fixed maturity investments. In late 1994 and early 1995, there has been a slight upward movement in general interest rates.
The Company's investments are generally managed to match related insurance and policyholder liabilities. The overall investment yields for 1994, 1993 and 1992, are 7.13%, 7.22% and 7.86%, respectively. The Company in conjunction with the decrease in average yield of the Company's fixed maturity portfolio has decreased the average crediting rate for the Company's insurance and investment products. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. Minimum interest spreads between earned and credited rates are 1% to 1.5%. The Company continually assesses
investment yields, and when necessary takes action to reduce credited interest rates on its insurance products to preserve targeted spreads. Credited rates are established by the Board of Directors. Over 60% of the insurance and investment product reserves are crediting 5% or less in interest and 39% of the insurance and investment product reserves are crediting 5.25% to 6% in interest. It is expected that the monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on insurance policies that the Company has in force and will write in the future.
Total expenses increased 4% when comparing 1994 to 1993. Life and annuity benefits, net of reinsurance, contributed significantly to the increase in expenses. Operating expenses decreased during 1994 compared to 1993.
During the third quarter of 1994, the Company became aware that certain new insurance business was being solicited by certain agents of UG and issued to individuals considered to be not insurable by Company standards. These policies had a face amount of $22,700,000 and represent less than 1/2 of 1% of the insurance in force of the Company. Management's analysis of the business in force indicates that the expected death claims on the business in force to be adequately covered by the mortality assumptions inherent in the calculation of statutory reserves. Nevertheless, management has determined it is in the best interest of the Company to attempt to acquire as many of the policies as possible.
Dividends to policyholders increased approximately 23% when comparing 1994 to 1993. USA continued to market participating policies through most of 1994. Management expects dividends to policyholders will continue to increase in the future. A portion of the Company's insurance in force is participating insurance. A significant portion of the participating business is relatively newer business. The dividend scale for participating policies increases significantly in the early years. The dividend scale is subject to approval of the Board of Directors and may be changed at their discretion. The Company no longer markets any participating policies.
Operating expenses decreased 13% in 1994 compared to 1993. The decrease is not attributable to one particular event but to the overall savings produced from the recent streamlining efforts. A reduction of operating expenses is being realized from operating fewer insurance subsidiaries. In 1992, the Company was operating eleven insurance companies, but through mergers and the sale of one insignificant subsidiary, the Company is now operating four
Interest expense decreased slightly in 1994 compared to 1993. The decrease was due to the reduction in the Company's senior debt. The Company experienced an increase in the interest rate on the Company's senior debt, which is tied to the prime rate of the lead bank. The Company was able to minimize the effect of the increase in interest rate by early payments of principal. The Company paid $2,000,000 in principal payments in 1994. The Company believes that interest rates will not change dramatically in 1995, and therefore will not significantly impact interest expense.
By insurance statute, the majority of the Company's investment portfolio is required to be invested in investment grade securities to provide ample protection to policyholders. The liabilities are predominantly long term in nature and therefore, the Company invests in long term fixed maturity investments which are reported in the financial statements at their amortized cost. The Company has the ability and intent to hold these investments to maturity; consequently, the Company does not expect to realize any significant loss from these investments. The Company does not own any derivative investments or "junk bonds". As of December 31, 1995, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in the context of consolidated assets or shareholders' equity. The Company has identified securities it may sell and classified them as "investments held for sale". Investments held for sale are carried at market.
The Company experienced moderate turnover in its fixed maturities portfolio during 1995. As previously discussed, this was the result of companies taking advantage of lower interest rates. This was accomplished through early calls and accelerated pay downs. During the year, the Company reinvested its funds and invested new monies from operations and from cash and short term investments primarily in investment grade corporate bonds.
Total liabilities increased approximately 1% in 1995 compared to 1994. Future policy benefits increased 3% in 1995 and represented 80% of total liabilities at December 31, 1995. Management expects future policy benefits to increase in the future due to the aging of the volume of insurance in force and continued production by the Company's sales force.
Dividend and endowment accumulations increased 14% in 1995 compared to 1994. The increase is attributed to the significant amount of participating business the Company has in force. There are generally four options a policyholder can select to pay policy dividends. Over 47% of all dividends paid were put on deposit to accumulate with interest. Accordingly, management expects this liability to increase in the future.
The NAIC has adopted Risk-Based Capital ("RBC") requirements for life/health insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching and other business factors. The RBC formula will be used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by- state basis. Regulatory compliance is determined by a ratio of the insurance company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Insurance company's below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action. The levels and ratios are as follows:
Consolidated Statements of Shareholders' Equity. . . . . . . 37
Consolidated Statements of Cash Flows. . . . . . . . . . . . 38
Notes to Financial Statements. . . . . . . . . . . . . . . . 39-62