One-time events, primarily reflected in realized gains, comprise a substantial portion of the net income and revenue reported by the Company during 2015 and 2014. 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. Future earnings will be significantly negatively impacted should earnings from these one-time items not be realizable in a future period. While Management believes there remain additional investments with such one-time earnings, when or if realized remains uncertain.
Premiums and policy fee revenues, net of reinsurance premiums and policy fees, decreased approximately 5% when comparing 2015 to 2014. 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 2015 and 2014 was approximately 96.2% and 96.6%, respectively. Persistency is a measure of insurance in-force retained in relation to the previous year.
The following table reflects net investment income of the Company for the years ended December 31:
The Company's gross investment income and net investment income were down approximately 23% and 5%, respectively, when comparing the current and prior year results. Investment expenses were down approximately 58% when comparing the current and prior year results. The variance in investment income, when comparing the current and prior year results, is mainly attributable to fluctuations in the earnings of the equity securities, real estate and short term investment portfolios.
During the current year, the Company reported income of $1.7 million from equity securities portfolio, a decrease of 48% in comparison to the prior year. During 2014, the interest rate on one of the Company's preferred stocks increased substantially, according to the terms of the contractual agreement, causing the increase in income reported in the equity securities portfolio. This specific preferred stock was redeemed in subsequent quarters; therefore, no longer providing the high interest rate yield.
The Company's real estate investment portfolio produced income of approximately $1.5 million and $8.4 million during 2015 and 2014, respectively. During 2014, one of the Company's consolidated subsidiaries sold all of the real estate it owned. Historically, this real estate generated annual rental income of approximately $6.7 million. As a result of the sale, the Company no longer recognizes rental income from this real estate.
Income from the short term investment portfolio increased approximately $630,000 in comparison to the prior year. During 2016, the Company financed a short-term note receivable. The note was fully repaid during the fourth quarter of 2015 and the Company recognized income of approximately $443,000 at the time of payoff.
The gain reported in the equity securities portfolio during 2015 and 2014 is mainly the result of the redemption of a certain preferred stock owned by the Company. During 2014, the Company recognized gains totaling approximately $1.9 million from the redemption of a portion of this preferred stock. In 2015, the remaining portion of this preferred stock was redeemed, producing a gain of approximately $972,000.
The Company reported total benefits and other expenses of $28.5 million and $32.5 million for the twelve-month period ended December 31, 2015 and 2014, respectively. Benefits, claims and settlement expenses represented approximately 66% and 60% of the Company's total expenses for 2015 and 2014, respectively. The other major expense category of the Company is operating expenses, which represented 31% and 33% of the Company's total expenses for 2015 and 2014, respectively.
Benefits, claims and settlement expenses, net of reinsurance benefits, decreased approximately 4% in 2015 compared to 2014. 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.
In early 2013, the Company began a proactive analysis of its in-force business to try to reconnect with lost customers and verify its customers are not deceased. In some instances, the Company found that the customer was indeed deceased, but no notification or claim was presented to the Company. During 2014, the Company paid approximately $1.2 million in death claim benefits as a result of this action. This project was completed during the second quarter of 2014 and contributed to higher benefit expenses in 2014, compared to 2015.
Changes in policyholder reserves, or future policy benefits, also impact this line item. Reserves are calculated on an individual policy basis and generally increase over the life of the policy as a result of additional premium payments and acknowledgement of increased risk as the insured continues to age.
Charitable contributions decreased approximately 63% when comparing current and prior year expenditures. As mentioned above in the Overview section of the Management Discussion and Analysis, UTG has a strong philanthropic program. The Company generally allocates a portion of its earnings to be used for its philanthropic efforts primarily targeted to Christ-centered organizations or organizations that help the weak or poor. Charitable contributions made by the Company are expected to vary from year to year depending on the earnings of the Company.
Management has been working on a plan and has made the determination it is in the Company's best long term interest to relocate its main operations from Springfield, Illinois to Stanford, Kentucky. The Company's majority shareholder, Jess Correll, headquarters his other operating entities in Stanford, Kentucky. Management believes this move will provide the Company with significant synergies, improve efficiencies and reduce overall operating expenses. The relocation is anticipated to occur during the third quarter of 2016. Significant time and planning has been put into this relocation to help ensure as smooth a transition as possible.
The Company's total investments represented 85% and 84% of the Company's total assets as of December 31, 2015 and 2014, respectively. Fixed maturities consistently represented a substantial portion, 49%, of the total investments during 2014 and 2015. The overall investment mix, as percentage of total investments, remained fairly consistent when comparing the investments held as of December 31, 2015 and 2014.
As of December 31, 2015, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in the context of consolidated assets, shareholders' equity or results from operations. To provide additional flexibility and liquidity, the Company has identified all fixed maturity securities as "investments available for sale". Investments available for sale are carried at market, with changes in market value charged directly to shareholders' equity. Changes in the market value of available for sale securities resulted in net unrealized losses of approximately $(7.2) million during 2015 and net unrealized gains of approximately $4.2 million during 2014. The variance in the net unrealized gains and losses is the result of normal market fluctuations mainly related to higher interest rates.
During 2015, the trading securities asset balance decreased while the equity securities balance increased. As disclosed in Note 2 - Investment of the Consolidated Financial Statements, as of June 30, 2015, the Company reclassified its remaining exchange-traded equity trading security to the available for sale category. The fair value of the security at the time of the reclassification was $3,224,000. Trading securities are purchased and held primarily for purposes of selling them in the near term and reflect active and frequent buying and selling. Management analyzed the recent buying and selling activity related to the exchange-traded equity and deems the available for sale category to better reflect Management's intent for this security going forward. Through June 30, 2015, unrealized gains and losses from this exchange-traded equity were recorded as a component of earnings. Future unrealized gains/losses will be reported as a component of comprehensive income.
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, 2015 and 2014, substantially all of the consolidated shareholders' equity represents net assets of its subsidiaries. In 2015, the Parent company received $4 million in dividends from its insurance subsidiary and $4.8 million in 2014. 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. As of December 31, 2015, the Company and its subsidiaries had available $18 million in line of credit facilities. As of December 31, 2014, the Company and its subsidiaries had available $8 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.
During 2015, the Company's investing activities provided net cash of approximately $13.6 million. During 2014, the Company's investing activities provided net cash of approximately $34.3 million. Proceeds from investments sold decreased approximately 39% or $50 million when comparing 2015 to 2014. Investment purchases decreased approximately 30% or $27.3 million. The net cash provided by investing activities is expected to vary from year to year depending on market conditions and management's ability to find and negotiate favorable investment contracts.
The Company had no outstanding debt as of December 31, 2015 and $4.4 million of outstanding debt as of December 31, 2014. The 2014 outstanding debt belonged to UTG Avalon, LLC, a wholly owned subsidiary of UG. 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, 2015, UG has a ratio of approximately 4.74, which is 474% 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 on June 3, 2015, the Board of Directors of UTG authorized the repurchase of up to an additional $1,000,000 of UTG's common stock, for a total repurchase of $8,000,000. Repurchased shares are available for future issuance for general corporate purposes. This program can be suspended or terminated at any time without further notice. Open market purchases are made based on the last available market price and are generally limited to a maximum per share price of the most recent reported per share GAAP equity book value of the Company. During 2015, the Company repurchased 25,919 shares through the stock repurchase program for $375,207. Through December 31, 2015, UTG has spent $6.5 million in the acquisition of 688,617 shares under this program.
Shareholders' equity was approximately $77 million and $83.6 million as of December 31, 2015 and 2014, respectively. Total shareholders' equity decreased approximately 8% in 2015 compared to 2014. The decrease is primarily attributable to the change in accumulated other comprehensive income (loss). As of December 31, 2015, the Company reported an accumulated other comprehensive loss of approximately $(1.2) million and accumulated other comprehensive income of approximately $6.9 million as of December 31, 2014. The change in accumulated other comprehensive income (loss) is mainly attributable to the net unrealized holding losses of approximately $(7.2) million during 2015 compared to net unrealized holding gains of $4.2 million reported during 2014. As previously discussed in the above in the Financial Condition - Investment Information section of the MD&A, the variance in the net unrealized gains and losses is the result of normal market fluctuations mainly related to higher interest rates.
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 fair value.
In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of UTG, Inc. and subsidiaries as of December 31, 2015 and 2014, and the consolidated results of their operations and their consolidated cash flows for each of the years in the two-year period ended December 31, 2015, 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 100.00 %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, 2015, Mr. Correll owns or controls directly and indirectly approximately 57.61 % of UTG's outstanding stock.
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 (loss).
Property and Equipment - Company-occupied property, data processing equipment and furniture and office equipment are stated at cost less accumulated depreciation of $3,323,718 and $3,868,331 at December 31, 2015 and 2014, respectively. Depreciation is computed on a straight-line basis for financial reporting purposes using estimated useful lives of three to thirty years. Depreciation expense was $139,218 and $309,279 for the years ended December 31, 2015 and 2014, respectively.
Reclassifications - Certain reclassifications have been made to the 2014 consolidated financial statements to make them comparable to the current year consolidated financial statements.
The following table provides a summary of fixed maturities by contractual maturity as of December 31, 2015. Actual maturities could differ from contractual maturities due to call or prepayment provisions:
The Company held below investment grade investments with an estimated market value of $13,352,934 and $9,142,063 as of December 31, 2015 and 2014, respectively. The investments are all classified as "All other corporate bonds".
The fair value of investments with sustained gross unrealized losses at December 31, 2015 and 2014 are as follows:
Securities designated as trading securities are reported at fair value, with gains or losses resulting from changes in fair value recognized in net investment income on the Consolidated Statements of Operations. Trading securities include exchange-traded equities and exchange-traded options. Trading securities carried as liabilities are securities sold short. A gain, limited to the price at which the security was sold short, or a loss, potentially unlimited in size, will be recognized upon the termination of the short sale. The fair value of derivatives included in trading security assets and trading security liabilities as of December 31, 2015 was $0 and $(28,609), respectively. The fair value of derivatives included in trading security assets and trading security liabilities as of December 31, 2014 was $6,250 and $(23,853), respectively. Earnings from trading securities are classified in cash flows from operating activities. The derivatives held by the Company are for income generation purposes only.
As of June 30, 2015, the Company reclassified its remaining exchange-traded equity trading security to the available for sale category. The fair value of the security at the time of the reclassification was $3,224,000. Trading securities are purchased and held primarily for purposes of selling them in the near term and reflect active and frequent buying and selling. Management analyzed the recent buying and selling activity related to the exchange-traded equity and deems the available for sale category to better reflect Management's intent for this security going forward. Through June 30, 2015, unrealized gains and losses from this exchange-traded equity were recorded as a component of earnings. Subsequent unrealized gains/losses are reported as a component of comprehensive income.
Approximately 30% and 39% of the mortgage loan portfolio consists of discounted commercial mortgage loans as of December 31, 2015 and 2014, respectively. 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 2015 and 2014, the Company acquired $13,774,698 and $2,348,890 in mortgage loans, respectively, including both regular participation mortgage loans as well as discounted mortgage loans. FSNB services the majority of the Company's mortgage loan portfolio. 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 cost to cover costs incurred by FSNB relating to the processing and establishment of the loan.
The Company has in place a monitoring system to provide Management with information regarding potential troubled loans. Letters are sent to each mortgagee when the loan becomes 30 days or more delinquent. Management is provided with a monthly listing of loans that are 60 days or more past due along with a brief description of what steps are being taken to resolve the delinquency. All loans 90 days or more past due are placed on a non-performing status and classified as delinquent loans. Quarterly, coinciding with external financial reporting, the Company reviews each delinquent loan and determines how each delinquent loan should be classified. Management believes the current internal controls surrounding the mortgage loan selection process provide a quality portfolio with minimal risk of foreclosure and/or negative financial impact.
A mortgage loan reserve is established and adjusted based on Management's quarterly analysis of the portfolio and any deterioration in value of the underlying property which would reduce the net realizable value of the property below its current carrying value. The Company acquired the discounted mortgage loans at below contract value, and believes that it will fully recover its carrying value upon disposal, therefore no reserve for delinquent loans is deemed necessary. Those not currently paying are being vigorously worked by Management. The current discounted commercial mortgage loan portfolio has an average price of 39.0 % of face value and Management has determined that this deep discount provides a financial cushion or built in allowance for any of the loans that are not currently performing within the portfolio of loans purchased. The mortgage loan reserve was $0 at December 31, 2015 and 2014.
The following table summarizes the number of loans held in the discounted mortgage loan portfolio and the carrying value of the loans as of December 31, 2015:
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, 2015 and 2014 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.
Level 3 - Valuation is based upon unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities. Unobservable inputs reflect the Company's own assumptions about the inputs that market participants would use in pricing the asset or liability.
The inputs used in the valuation techniques employed by the Company are provided by nationally recognized pricing services, external investment managers and internal resources. To assess these inputs, the Company's review process includes, but is not limited to, quantitative analysis including benchmarking, initial and ongoing evaluations of methodologies used by external parties to calculate fair value, and ongoing evaluations of fair value estimates based on the Company's knowledge and monitoring of market conditions.
Securities designated as trading securities consist of exchange-traded equities and exchange-traded options. These securities are primarily valued at quoted active market prices, and are therefore categorized as Level 1 in the fair value hierarchy.
There were no transfers in or out of Level 3 as of December 31, 2015. Transfers occur when there is a lack of observable market information.
Certain assets are not carried at fair value on a recurring basis, including investments such as mortgage loans and policy loans. Accordingly such investments are only included in the fair value hierarchy disclosure when the investment is subject to re-measurement at fair value after initial recognition and the resulting re-measurement is reflected in the Consolidated Financial Statements.
A portion of the mortgage loans balance consists of discounted mortgage loans. 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. The inputs used to measure the fair value of our discounted mortgage loans are classified as Level 3 within the fair value hierarchy.
The carrying amount of short term investments in the Consolidated Balance Sheets approximates fair value. The inputs used to measure the fair value of our short term investments are classified as Level 3 within the fair value hierarchy.
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, 2015, the Company had gross insurance in-force of $1.3 billion of which approximately $272 million was ceded to reinsurers. At December 31, 2014, the Company had gross insurance in-force of $1.4 billion of which approximately $287 million was ceded to reinsurers.
Also, Optimum is the reinsurer of 100% of the accidental death benefits ("ADB") in force of UG. This coverage is renewable annually at the Company's option. Optimum specializes in reinsurance agreements with small to mid-size carriers such as UG.
At December 31, 1992, UG (formerly American Capitol) entered into a reinsurance agreement with Canada Life Assurance Company ("the Canada Life agreement") that fully reinsured virtually all of its traditional life insurance policies. The reinsurer's obligations under the Canada Life agreement were secured by assets withheld by UG representing policy loans and deferred and uncollected premiums related to the reinsured policies. UG continues to administer the reinsured policies. At December 31, 2013, the Canada Life agreement had insurance in-force of approximately $6,815,000, with no reserve credit being taken on that amount. The Canada Life agreement was fully repaid in August 2012. With the reinsurance recaptured by the Company, a 15 % profit share will continue to be paid to the reinsurer going forward relative to the block of business. Effective July 1, 2014, the Company acquired the 15% profit share on this block of business from Canada Life for $300,000. This payment effectively settled any future obligations of the Company to the reinsurer under this agreement.
As of December 31, 2015 and 2014, the Company had a deferred tax asset of $35,094 and $17,401, respectively, relating to a net operating loss carryforward. The Company established an allowance of $35,094 and $17,401 against this deferred tax asset as of December 31, 2015 and 2014, respectively. The Company also has a deferred tax asset of $118,693 and $0 relating to an AMT tax carryforward as of December 31, 2015 and 2014, respectively. The Company established an allowance of $118,693 against this deferred tax asset as of December 31, 2015. The allowances were established based on Management's assessment of the recoverability of these deferred assets.
The Company's Federal income tax returns are periodically audited by the Internal Revenue Service ("IRS"). In February 2011, the IRS audited UTG's 2009 federal income tax return. The examination was closed with no adjustments to the return. There are currently no examinations in process, nor is Management aware of any pending examination by the IRS. The Company follows the accounting guidance for uncertainty in income taxes using the provisions of Financial Accounting Standards Board ("FASB") ASC 740, Income Taxes. Using that guidance, tax positions initially need to be recognized in the financial statements when it is more-likely-than-not the position will be sustained upon examination by the tax authorities. Such tax positions initially and subsequently need to be measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and relevant facts. The Company has evaluated its tax positions, expiring statutes of limitations, changes in tax law and new authoritative rulings and believes that no disclosure relative to a provision of income taxes is necessary, at this time, to cover any uncertain tax positions.
At December 31, 2015 and 2014, the Company had the following outstanding debt:
During 2014, the Company committed to invest in UGLIC, LLC, which purchases real estate tax receivables. UGLIC, LLC makes capital calls as funds are needed for additional purchases.
On July 20, 2015 the Board of Directors of UTG also clarified and amended the terms on which UTG may repurchase shares in the program and gave Company Management broad authority to operate the program, including the discretion of whether to purchase shares and the ability to suspend or terminate the program. The program may be suspended or terminated at any time without further notice.
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, 2015, substantially all of the consolidated shareholders' equity represents net assets of UTG's subsidiaries.
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 paid a monthly operational fee of $25,000 through July of 2014 when the aircraft was sold. During July of 2014, the Company acquired a different aircraft. UTG paid $1,600,000 in the acquisition of the aircraft, increasing the Company's ownership interest to 30.10 %. The aircraft is used for business related travel by various officers and employees of the Company. For years 2015 and 2014, UTG paid $255,920 and $879,453 for costs associated with the aircraft, respectively.
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 2015 and 2014, UG paid $6,867,882 and $8,902,568, 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.
On a cash basis, the Company paid the following expenses for the periods ended December 31:
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, 2015 and 2014, approximately 54% 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.
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% of total life insurance in force at December 31, 2015 and 2014. Insurance ceded represented 31% and 29% of premium income for 2015 and 2014, 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.