Property owned Amount % of Total Home Office $ 2,560,242 18% Investment real estate Commercial $ 4,355,450 31% Residential development $ 5,405,282 39% Foreclosed real estate $ 1,724,544 12% $11,485,276 82%
Total investment real estate holdings represent approximately 3% of the total assets of the Company net of accumulated depreciation of $1,550,268 and $1,453,275 at year end 1997 and 1996 respectively. The Company owns an office complex in Springfield, Illinois, which houses the primary insurance operations. The office buildings contain 57,000 square feet of office and warehouse space. The properties are carried at approximately $2,649,359. In addition, an insurance subsidiary owns a home office building in Huntington, West Virginia. The building has 15,000 square feet and is carried at $165,882. The facilities occupied by the Company are adequate relative to the Company's present operations.
FINANCIAL HIGHLIGHTS (000's omitted, except per share data) 1997 1996 1995 1994 1993 Premium income net of reinsurance $ 28,639 $ 30,944 $ 33,099 $ 35,024 $ 33,097 Total revenues $ 43,354 $ 46,538 $ 48,365 $ 49,261 $ 47,185 Net loss $ (1,845) $ (3,032) $ (1,452) $ (1,775) $ (3,343) Net loss per share $ (32.65) $ (50.60) $ (24.00) $ (29.17) $ (54.93) Total assets $ 332,572 $ 336,639 $ 334,058 $ 331,410 $ 326,390 Total long term debt $ 18,242 $ 19,000 $ 20,623 $ 21,529 $ 23,535 Dividends paid per share NONE NONE NONE NONE NONE
Accounting Procedures ("GAAP") requires that premiums collected on these types of products be treated as deposit liabilities rather than revenue. Unless the Company acquires a block of in-force business or marketing changes its focus to traditional business, premium revenue will continue to decline.
Another cause for the decrease in premium revenues is related to the potential change in control of UTI over the last two years to two different parties. During September of 1996, it was announced that control of UTI would pass to an unrelated party, but the change in control did not materialize. At this writing, negotiations are progressing with a different unrelated party for the change in control of UTI. Please refer to the Notes to the Consolidated Financial Statements for additional information. The possible changes and resulting uncertainties have hurt the insurance companies' ability to recruit and maintain sales agents.
The overall investment yields for 1997, 1996 and 1995, are 7.26%, 7.33% and 7.18%, respectively. Since 1995, investment yield improved due to the fixed maturity investments. Cash generated from the sales of universal life insurance products, has been invested primarily in our fixed maturity portfolio.
Life benefits, net of reinsurance benefits and claims, decreased 20% in 1997 as compared to 1996. The decrease in premium revenues resulted in lower benefit reserve increases in 1997. In addition, policyholder benefits decreased due to a decrease in death benefit claims of $162,000.
In 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 non-standard policies had a face amount of $22,700,000 and represented 1/2 of 1% of the insurance in-force in 1994. Management's initial analysis indicated that expected death claims on the business in-force was adequate in relation to mortality assumptions inherent in the calculation of statutory reserves. Nevertheless, management determined it was in the best interest of the Company to repurchase as many of the non-standard policies as possible. Through December 31, 1996, the Company spent approximately $7,099,000 for the settlement of non-standard policies and for the legal defense of related litigation. In relation to settlement of non-standard policies the Company incurred life benefit costs of $3,307,000, and $720,000 in 1996 and 1995, respectively. The Company incurred legal costs of $906,000 and $687,000 in 1996 and 1995, respectively. All policies associated with this issue have been settled as of December 31, 1996. Therefore, expense reductions for 1997 would follow.
Commissions and amortization of deferred policy acquisition costs decreased 14% in 1997 compared to 1996. The decrease is due primarily due to a reduction in commissions paid. Commissions decreased 19% in 1997 compared to 1996. The decrease in commissions was due to the decline in new business production. There is a direct relationship between premium revenues and commission expense. First year premium production decreased 43% and first year commissions decreased 33% when comparing 1997 to 1996. Amortization of deferred policy acquisition costs decreased 7% in 1997 compared to 1996. Management would expect commissions and amortization of deferred policy acquisition costs to decrease in the future if premium revenues continue to decline.
Operating expenses decreased 20% in 1997 compared to 1996. The decrease in operating expenses is directly related to settlement of certain litigation in December of 1996. The Company incurred legal costs of $0, $906,000 and $687,000 in 1997, 1996 and 1995, respectively in relation to the settlement of the non-standard insurance policies.
Premium and policy fee revenues, net of reinsurance premium, decreased 7% when comparing 1996 to 1995. The decrease in premium income is primarily attributed to a 15% decrease in new business production. The Company changed its marketing strategy from traditional life insurance products to universal life insurance products. Universal life and interest sensitive products contribute only the risk charge to premium income, however traditional insurance products contribute all monies received to premium income. The Company changed its marketing strategy to remain competitive based on consumer demand.
A positive impact on premium income is the improvement of persistency. Persistency is a measure of insurance in force retained in relation to the previous year. The Companies' average persistency rate for all policies in force for 1996 and 1995 has been approximately 87.9% and 87.3% respectively.
Net investment income increased 3% when comparing 1996 to 1995. The overall investment yields for 1996 and 1995 are 7.33% and 7.18%, respectively. The consistent improvement in investment yield is primarily attributed to fixed maturity investments. Cash generated from the sales of universal life insurance products, has been invested primarily in our fixed investment portfolio.
Life benefits, net of reinsurance benefits and claims, increased 13% compared to 1995. The increase in life benefits is due primarily to settlement expenses discussed in the following paragraph:
In 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 non-standard policies had a face amount of $22,700,000 and represented 1/2 of 1% of the insurance in-force in 1994. Management's initial analysis indicated that expected death claims on the business in-force was adequate in relation to mortality assumptions inherent in the calculation of statutory reserves.
Nevertheless, management determined it was in the best interest of the Company to repurchase as many of the non-standard policies as possible. Through December 31, 1996, the Company spent approximately $7,099,000 for the settlement of non-standard policies and for the legal defense of related litigation. In relation to settlement of non-standard policies the Company incurred life benefits of $3,307,000 and $720,000 in 1996 and 1995, respectively. The Company incurred legal costs of $906,000 and $687,000 in 1996 and 1995, respectively. All the policies associated with this issue have been settled as of December 31, 1996. The Company has approximately $3,742,000 of insurance in-force and $1,871,000 of reserves from the issuance of paid-up life insurance policies for settlement of matters related to the original non-standard policies. Management believes the reserves are adequate in relation to expected mortality on this block of in force.
Operating expenses increased 9% in 1996 compared to 1995. The primary factor that caused the increase in operating expenses is directly related to increased legal costs and reserves established for litigation. The legal costs are due to the settlement of non-standard insurance policies as was discussed in the review of life benefits. The Company incurred legal costs of $906,000 and $687,000 in 1996 and 1995, respectively in relation to the settlement of the non-standard insurance policies.
Interest expense decreased 11% in 1996 compared to 1995. Since December 31, 1995, notes payable decreased approximately $1,623,000 that has directly attributed to the decrease in interest expense during 1996. Interest expense was also reduced, as a result of the refinancing of the senior debt under which the new interest rate is more favorable. Please refer to Note 10 "Notes Payable" of the Notes to the Consolidated Financial Statements for more information on this matter.
The Company had a net loss of $3,032,000 in 1996 compared to a net loss of $1,452,000 in 1995. The net loss in 1996 is attributed to the increase in life benefits net of reinsurance and operating expenses primarily associated with settlement and other related costs of the non-standard life insurance policies.
Fixed Maturities Rating % of Portfolio 1997 1996 Investment Grade AAA 31% 30% AA 14% 13% A 46% 46% BBB 9% 10% Below investment grade 0% 1% 100% 100%
Investment real estate and real estate acquired in satisfaction of debt decreased slightly in 1997 compared to 1996. Investment real estate holdings represent approximately 3% of the total assets of the Company. Total investment real estate is separated into three categories: Commercial 38%, Residential Development 47% and Foreclosed Properties 15%.
Cost of insurance acquired decreased 6% in 1997 compared to 1996. At December 31, 1997, cost of insurance acquired was $18,654,506 and amortization totaled $1,231,988 for the year. When an insurance company is acquired, the Company assigns a portion of its cost to the right to receive future cash flows from insurance contracts existing at the date of the acquisition. The cost of policies purchased represents the actuarially determined present value of the projected future cash flows from the acquired policies. Cost of Insurance Acquired is amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits.
Policy claims and benefits payable decreased 35% in 1997 compared to 1996. There is no single event that caused this item to decrease. Policy claims vary from year to year and therefore, fluctuations in this liability are to be expected and are not considered unusual by management.
Dividend and endowment accumulations increased 8% in 1997 compared to 1996. The increase is attributed to the significant amount of participating business the Company has in force. Over 52% of all dividends paid were put on deposit with the Company to accumulate with interest. Management expects this liability to increase in the future.Income taxes payable and deferred income taxes payable increased 9% in 1997 compared to 1996. The change in deferred income taxes payable is attributable to temporary differences between Generally Accepted Accounting Principles ("GAAP") and tax basis accounting. Federal income taxes are discussed in more detail in Note 3 of the Notes to the Consolidated Financial Statements.
The Company has three principal needs for cash - the insurance companies' contractual obligations to policyholders, the payment of operating expenses and the servicing of its long-term debt. Cash and cash equivalents as a percentage of total assets were 5% as of December 31, 1997, and 1996, respectively. Fixed maturities as a percentage of total invested assets were 82% as of December 31, 1997 and 1996.
Cash provided by (used in) operating activities was ($199,000), $2,914,000 and 720,000 in 1997, 1996 and 1995, respectively. The net cash provided by operating activities plus net policyholder contract deposits after the payment of policyholder withdrawals equaled $3,190,000 in 1997, $9,726,000 in 1996 and $9,733,000 in 1995. Management utilizes this measurement of cash flows as an indicator of 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 when reporting on cash flows.
Cash provided by (used in) investing activities was ($2,995,000), $15,808,000 and ($8,063,000), for 1997, 1996 and 1995, respectively. The most significant aspect of cash provided by (used in) investing activities are the fixed maturity transactions. Fixed maturities account for 70%, 81% and 76% of the total cost of investments acquired in 1997, 1996 and 1995, respectively. The net cash provided by investing activities in 1996, is due to the fixed maturities sold in conjunction with the coinsurance agreement with FILIC. The Company has not directed its investable funds to so-called "junk bonds" or derivative investments.
Since FCC is a holding company, funds required to meet its debt service requirements and other expenses are primarily provided by its subsidiaries. On a parent only basis, FCC's cash flow is dependent on revenues from management and cost sharing arrangements with its subsidiaries and its earnings received on invested assets and cash balances. At December 31, 1997, substantially all of the consolidated shareholders equity represents net assets of its subsidiaries. Cash requirements of FCC primarily relate to servicing its long-term debt. The Company's insurance subsidiaries have maintained adequate statutory capital and surplus and have not used surplus relief or financial reinsurance, which have come under scrutiny by many state insurance departments. The payment of cash dividends to shareholders is not legally restricted. However, insurance company dividend payments are regulated by the state insurance department where the company is domiciled. UG's dividend limitations are described.
At December 31, 1997, each of the insurance subsidiaries has a Ratio that is in excess of 3, which is 300% of the authorized control level; accordingly the insurance subsidiaries meet the RBC requirements.
Most states also have insurance holding company statutes which require registration and periodic reporting by insurance companies controlled by other corporations licensed to transact business within their respective jurisdictions. The insurance subsidiaries are subject to such legislation and registered as controlled insurers in those jurisdictions in which such registration is required. Statutes vary from state to state but typically require periodic disclosure, concerning the corporation, that controls the registered insurers and all subsidiaries of such corporation. In addition, prior notice to, or approval by, the state insurance commission of material intercorporate transfers of assets, reinsurance agreements, management agreements (see Note 9 of the Notes to the Financial Statements), and payment of dividends (see Note 2 of the Notes to the Financial Statements) in excess of specified amounts by the insurance subsidiary, within the holding company system, are required.
This statement was adopted for the 1997 Financial Statements. For all periods presented the Company reported a loss from continuing operations so any potential issuance of common shares would have an antidilutive effect on EPS. Consequently, the adoption of SFAS No. 128 did not have an impact on the Company's financial statement.
1. Prevailing interest rate levels, which may affect the ability of the company to sell its products, the market value of the company's investments and the lapse ratio of the company's policies, notwithstanding product design features intended to enhance persistency of the company's products.
Page No. FIRST COMMONWEALTH CORPORATION AND CONSOLIDATED SUBSIDIARIES Independent Auditor's Report for the Years ended December 31, 1997, 1996, 1995 32