The following is Management’s discussion and analysis of the financial condition and results of operations of UTG, Inc. and its subsidiaries (collectively with the Parent, the “Company”) for the years ended December 31, 2018 and 2017. This discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this report.
We have identified the accounting policies below as critical to the understanding of our results of operations and our financial condition. The application of these critical accounting policies in preparing our consolidated financial statements requires Management to use significant judgments and estimates concerning future results or other developments including the likelihood, timing or amount of one or more future transactions or amounts. Actual results may differ from these estimates under different assumptions or conditions. On an on-going basis, we evaluate our estimates, assumptions and judgments based upon historical experience and various other information that we believe to be reasonable under the circumstances. For a detailed discussion of other significant accounting policies, see Note 1 - Summary of Significant Accounting Policies in the Notes to the Consolidated Financial Statements.
Mortgage loans on real estate are carried at their unpaid principal balances, adjusted for amortization of premium or discount and valuation allowances. Valuation allowances are established for impaired loans when it is probable that contractual principal and interest will not be collected. A portion of the mortgage loan balance consists of discounted mortgage loans that were purchased at deep discounts through an auction process led by the Federal Government. In general, the discounted mortgage 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 mortgage loans at its original purchase price adjusted for any principal receipts received.
As a result of ASU No. 2016-01, Financial Instruments (Topic 825): Recognition and Measurement of Financial Assets and Financial Liabilities, changes in the fair value of equity securities are now recognized in net income rather than other comprehensive income. On January 1, 2018, cumulative net unrealized gains on equity securities of $18.3 million, net of deferred taxes of $4.9 million, were reclassified from accumulated other comprehensive income (loss) into retained earnings.
On a consolidated basis, the Company had net income attributable to common shareholders of $12.4 million and $4.8 million in 2018 and 2017, respectively. In 2018, income before income taxes was $16.5 million compared to $3.3 million in 2017. Total revenue was $41.3 million in 2018 and $28.7 million in 2017.
Premiums and policy fee revenues, net of reinsurance premiums and policy fees, were comparable for 2018 to 2017. 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 2018 and 2017 was approximately 96.1% and 96.7%, respectively. Persistency is a measure of insurance in-force retained in relation to the previous year.
Net investment income represented approximately 27% and 41% of the Company's total revenues as of December 31, 2018 and 2017, respectively. When comparing current and prior year results, net investment income was comparable in the majority of the investment categories, with the largest vairance being found in the fixed maturities and real estate investment categories.
During 2018, the Company sold a substantial bond holding. The bond holding was initially acquired during 2016 over a period of time at a deep discount, with an average cost of 25% of its par value. During the third quarter of 2018, the value of this security had recovered sufficiently enough that Management determined the time was right to sell a majority of the holding, realizing a gain of approximately $10 million. At December 31, 2018, the Company still holds $5 million of par value of this security at a cost basis of $651,000.
Benefits, claims and settlement expenses, net of reinsurance benefits, decreased approximately 8% in 2018 compared to 2017. The decrease primarily relates to changes in the Company’s death claim experience. Policy claims vary from year to year and therefore, fluctuations in mortality are to be expected and are not considered unusual by Management.
Operating expenses increased approximately 9% in 2018 as compared to 2017. When analyzing 2018 and 2017 results, the operating expenses in two of the major expense categories, salaries and charitable contributions, were higher in 2018 and driving the variance from the prior year to the current year . The increase in salary expense is the result of increased bonuses paid to employees and officers of the Company. Bonuses are not contractual or dependent upon meeting certain financial goals. They are not necessarily paid each year, and when they are paid, the amounts will vary depending on the decision of Management, the Compensation Committee, and the Board of Directors. Charitable contributions are a function of the Company’s earnings. Expenses in all of the other categories were comparable for the current and prior year.
The Company’s total investments represented 85% and 82% of the Company’s total assets as of December 31, 2018 and 2017, respectively. Fixed maturities consistently represented a substantial portion, 48% and 53%, respectively, of the total investments during 2018 and 2017. The overall investment mix, as a percentage of total investments, remained fairly consistent when comparing the investments held as of December 31, 2018 and 2017.
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 purchasing outstanding shares of UTG stock. 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, 2018 and 2017, substantially all of the consolidated shareholders’ equity represents net assets of its subsidiaries. In 2018, the Parent company received $5 million in dividends from its insurance subsidiary and $2 million in 2017. 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.
Net cash used in financing activities was approximately $1.9 million and $3.5 million during 2018 and 2017, respectively. As of December 31, 2018, the Company had no debt outstanding with third parties.
The Company had $0 debt outstanding as of December 31, 2018 and 2017.
At December 31, 2018, UG has a ratio of approximately 5.20, which is 520% of the authorized control level. Accordingly, the Company meets the RBC requirements.
The Board of Directors of UTG has authorized the repurchase in the open market or in privately negotiated transactions of UTG's common stock. At a meeting of the Board of Directors in September of 2018, the Board of Directors of UTG authorized the repurchase of up to an additional $1.5 million of UTG’s common stock, for a total repurchase of $16 million. Repurchased shares are available for future issuance for general corporate purposes. Company Management has broad authority to operate the program, including the discretion of whether to purchase shares and the ability to suspend or terminate the program. Open market purchases are made based on the last available market price but may be limited. During 2018, the Company repurchased 50,922 shares through the stock repurchase program for approximately $1,329,148. Through December 31, 2018, UTG has spent approximately $13.9 million in the acquisition of 1,140,106 shares under this program.
Shareholders’ equity was approximately $106 million and $110 million as of December 31, 2018 and 2017, respectively. Total shareholders' equity decreased approximately 3% in 2018 compared to 2017. The decrease is primarily attributable to the change in accumulated other comprehensive income and retained earnings. As of December 31, 2018 and 2017, the Company reported accumulated other comprehensive income of approximately $62,000 and $32.9 million, respectively.The decrease is the result of the adoption of ASU 2016-01 and a decline in the market value of fixed maturity securities.
At December 31, 2018, accumulated other comprehensive income was reduced by approximately $14.6 million as a result of unrealized losses on fixed maturity securities. The variance in the net unrealized gains and losses is the result of normal market fluctuations mainly related to changes in interest rates in the market place.
As a result of the TCJA, the Company has recognized a decrease to their net deferred tax liability as of December 31, 2017 of approximately $7.3 million. The Company has determined that no other changes are required to the deferred tax liability, and the current income tax expense is unaffected by this change in law. Refer to Note 1 - Summary of Significant Accounting Policies and Note 6 - Income Taxes in the Notes to the Consolidated Financial Statements for further disclosure regarding the TCJA.
We have audited the accompanying consolidated balance sheets of UTG, Inc. and subsidiaries (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of operations, comprehensive income (loss), shareholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2018, and the related notes to the consolidated financial statements (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.
This document at times will refer to the Registrant’s largest shareholder, Mr. Jesse T. Correll and certain companies controlled by Mr. Correll. Mr. Correll holds a majority ownership of First Southern Funding, LLC (“FSF”), a Kentucky corporation, and First Southern Bancorp, Inc. (“FSBI”), a financial services holding company. FSBI operates through its 100% owned subsidiary bank, First Southern National Bank (“FSNB”). Banking activities are conducted through multiple locations within south-central and western Kentucky. Mr. Correll is Chief Executive Officer and Chairman of the Board of Directors of UTG and is currently UTG’s largest shareholder through his ownership control of FSF, FSBI and affiliates. At December 31, 2018, Mr. Correll owns or controls directly and indirectly approximately 65.29% of UTG’s outstanding stock.
Basis of Presentation - The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), under guidance issued by the Financial Accounting Standards Board (“FASB”). The preparation of financial statements in accordance with GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Mortgage Loans on Real Estate - Mortgage loans on real estate are reported at their unpaid principal balances, adjusted for amortization of premium or discount and valuation allowances. Valuation allowances are established for impaired loans when it is probable that contractual principal and interest will not be collected. Included in the mortgage loans balance is discounted mortgage loans on real estate. Discounted mortgage loans on real estate are loans that the Company purchased at a deep discount through an auction process led by the Federal Government or other intermediary. 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 adjusted for any principal receipts received. Management works with the borrower to reach a settlement on the loan or they foreclose on the underlying collateral which is primarily commercial real estate. For cash payments received during the work out process, the Company records these payments to interest income on a cash basis. For loan settlements reached, the Company records the amount in excess of the carrying amount of the loan as a discount accretion to investment income at the closing date. Management reviews the discount loan portfolio regularly for impairment. If an impairment is identified (after consideration of the underlying collateral), the Company records an impairment to earnings in the period the information becomes known.
Benefit reserves for universal life insurance and interest sensitive life insurance products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims in excess of related policy account balances. Interest crediting rates for universal life and interest sensitive products range from 3.0% to 6.0% as of December 31, 2018 and 2017.
In February 2018, the FASB issued Accounting Standards Update No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220), Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income or ASU 2018-02. ASU 2018-02 was issued as a result of the enactment of the Tax Cuts and Jobs Act of 2017 (“TCJA”) on December 22, 2017. Accounting guidance required deferred tax items to be revalued based on the new tax laws (the most significant of which reduced the corporate tax rate to 21% percent from 35% percent) and to include the change in income from continuing operations. ASU 2018-02 is effective for annual and interim reporting periods beginning after December 15, 2018, with early adoption permitted. The Company adopted ASU 2018-02 for the year ended December 31, 2017.
In January 2016, the FASB issued Accounting Standards Update No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, or ASU 2016-01. The amendments in ASU 2016-01 change the accounting for non-consolidated equity investments that are not accounted for under the equity method of accounting by requiring changes in fair value to be recognized in income. Additionally, ASU 2016-01 simplifies the impairment assessment of equity investments without readily determinable fair values; requires entities to use the exit price when estimating the fair value of financial instruments; and modifies various presentation disclosure requirements for financial instruments. The Company adopted ASU 2016-01 on January 1, 2018 as a cumulative net effect adjustment and reclassified $18,277,328 of unrealized gains on equity investments, net of tax, from accumulated other comprehensive income (loss) to retained earnings on the Company's Condensed Consolidated Balance Sheet. Prior periods have not been restated to conform to current presentation. Effective January 1, 2018, the Company's results of operations include the changes in fair value of these financial instruments. During 2018, the FASB implemented ASU 2018-03, which clarifies ASU 2016-01 regarding the measurement alternative for equity securities without a readily determinable fair value as well as clarification for other presentation items. These amendments are effective for interim periods beginning after June 15, 2018.
The fair value of investments with sustained gross unrealized losses at December 31, 2018 and 2017 are as follows:
The following table reflects trading securities revenue charged to net investment income for the periods ended December 31:
During 2018 and 2017, the maximum and minimum lending rates for mortgage loans were:
Notes receivable represent collateral loans and promissory notes issued by the Company and are reported at their unpaid principal balances, adjusted for valuation allowances. Valuation allowances are established for impaired loans when it is probable that contractual principal and interest will not be collected. The valuation allowance as of December 31, 2018 and 2017 was $0. Interest accruals are analyzed based on the likelihood of repayment. The Company does not utilize a specified number of days delinquent to cause an automatic non-accrual status.
Similar to the mortgage loans, FSNB services several of the notes receivable. The Company, and the participants in the notes, share in the risk of loss associated with the terms of the note with the borrower, based upon their ownership percentage in the note. The Company has in place a monitoring system to provide Management with information regarding potential troubled loans.
(1) Effective January 1, 2018, the Company adopted ASU No. 2016-01. As a result, equity securities are no longer classified as available-for-sale with unrealized gains and losses recognized in other comprehensive income; rather, all changes in the fair value of equity securities are now recognized in net income. Prior periods have not been restated to conform to the current presentation. See Note 1.
The Company regularly reviews its investment securities for factors that may indicate that a decline in fair value of an investment is other than temporary. The factors considered by Management in its regular review to identify and recognize other-than-temporary impairment losses on fixed maturities include, but are not limited to: the length of time and extent to which the fair value has been less than cost; the Company’s intent to sell, or be required to sell, the debt security before the anticipated recovery of its remaining amortized cost basis; the financial condition and near-term prospects of the issuer; adverse changes in ratings announced by one or more rating agencies; subordinated credit support, whether the issuer of a debt security has remained current on principal and interest payments; current expected cash flows; whether the decline in fair value appears to be issuer specific or, alternatively, a reflection of general market or industry conditions, including the effect of changes in market interest rates. If the Company intends to sell a debt security, or it is more likely than not that it would be required to sell a debt security before the recovery of its amortized cost basis, the entire difference between the security’s amortized cost basis and its fair value at the balance sheet date would be recognized by a charge to other-than-temporary losses in the Condensed Consolidated Statements of Operations.
Corporate securities primarily include fixed rate corporate bonds. Inputs utilized in connection with the Company’s valuation techniques relating to this class of securities include recently executed transactions, market price quotations, benchmark yields and issuer spreads. Corporate securities are categorized in Level 2 of the fair value hierarchy.
(1) Effective January 1, 2018, the Company Adopted ASU No. 2016-01 and equity securities are no longer classified as available-for-sale. Prior periods have not been restated to conform to the current presentation. See Note 1 to the Consolidated Financial Statements for additional information.
As is customary in the insurance industry, the insurance subsidiary cedes insurance to, and assumes insurance from, other insurance companies under reinsurance agreements. Reinsurance agreements are intended to limit a life insurer's maximum loss on a large or unusually hazardous risk or to obtain a greater diversification of risk. The ceding insurance company remains primarily liable with respect to ceded insurance should any reinsurer be unable to meet the obligations assumed by it. However, it is the practice of insurers to reduce their exposure to loss to the extent that they have been reinsured with other insurance companies. The Company sets a limit on the amount of insurance retained on the life of any one person. The Company will not retain more than $125,000, including accidental death benefits, on any one life. At December 31, 2018, the Company had gross insurance in-force of $1.1 billion of which approximately $228 million was ceded to reinsurers. At December 31, 2017, the Company had gross insurance in-force of $1.2 billion of which approximately $242 million was ceded to reinsurers.
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’s ultimate parent, The Guardian Life Insurance Company of America (“Guardian”), currently holds an "A++" (Superior) rating from A.M. Best. The PALIC agreement accounts for approximately 63% of UG’s reinsurance reserve credit, as of December 31, 2018 and 2017.
On September 30, 1998, UG entered into a coinsurance agreement with The Independent Order of Vikings, (IOV) an Illinois fraternal benefit society. Under the terms of the agreement, UG agreed to assume, on a coinsurance basis, 25% of the reserves and liabilities arising from all in-force insurance contracts issued by the IOV to its members. Effective October 1, 2017, the IOV recaptured its coinsurance agreement with UG. The recapture was completed as a step in the IOV's decision to exit its insurance business.
The Company also has a deferred tax asset of $43,717 and $118,693 relating to an AMT tax carryforward as of December 31, 2018 and 2017, respectively. As a result of the changes to the Alternative Minimum Tax and corresponding credits resulting from the TCJA, Management has determined that an allowance against this asset is no longer required.
The UTG line of credit carries interest at a fixed rate of 5.125% and is payable monthly. As collateral, UTG has pledged 100% of the common voting stock of its wholly owned subsidiary, Universal Guaranty Life Insurance Company ("UG").
Stock Repurchase Program - The Board of Directors of UTG has authorized the repurchase in the open market or in privately negotiated transactions of UTG's common stock. At a meeting of the Board of Directors in September of 2018, the Board of Directors of UTG authorized the repurchase of up to an additional $1.5 million of UTG's common stock, for a total repurchase of $16 million. Company Management has broad authority to operate the program, including the discretion of whether to purchase shares and the ability to suspend or terminate the program. Open market purchases are made based on the last available market price but may be limited. During 2018, the Company repurchased 50,922 shares through the stock repurchase program for $1,329,148. Through December 31, 2018, UTG has spent $13,863,728 in the acquisition of 1,140,106 shares under this program.
Director Compensation - Effective September 18, 2013, a compensation arrangement was approved whereby each outside Director annually received $8,000 as a retainer and $1,000 per meeting attended. In September 2018 the compensation arrangement was amended, effective January 1, 2018 whereby each outside Director annually received $5,000 as a retainer and $2,500 per meeting attended. All other provisions from the September 2013 arrangement remained the same. The compensation is be paid in the form of UTG, Inc. common stock. The value is determined annually on the close of business December 20th or the next business day should December 20th be a weekend or holiday, based on the activity of the year just ending. Reasonable travel expenses are reimbursed in cash as incurred. UTG’s Director Compensation policy provides that Directors who are employees of UTG or its affiliates do not receive any compensation for their services as Directors except for reimbursement for reasonable travel expenses for attending each meeting.
UTG has a 30.10% ownership interest in an aircraft that is jointly owned with First Southern National Bank and Bandyco, LLC. Bandyco, LLC is affiliated with the Estate of Ward F. Correll. Mr. Correll is the father of Jesse Correll and a former director of the Company. The aircraft is used for business related travel by various officers and employees of the Company. For years 2018 and 2017, UTG paid $391,851 and $328,933 for costs associated with the aircraft, respectively.
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 cost to cover costs incurred by FSNB relating to the processing and establishment of the loan. The Company paid $8,393 and $11,108 in servicing fees and $0 and $0 in origination fees to FSNB during 2018 and 2017, respectively.
Because UTG serves primarily individuals located in four states, the ability of our customers to pay their insurance premiums is impacted by the economic conditions in these areas. As of December 31, 2018 and 2017, approximately 56% and 55%, respectively, of the Company’s total direct premium was collected from Illinois, Ohio, Texas and West Virginia. Thus, results of operations are heavily dependent upon the strength of these economies.