The Company owns an office complex in Springfield, Illinois, which houses the primary insurance operations. The office buildings in this complex contain 57,000 square feet of office and warehouse space, and are carried at $1,474,424. The facilities occupied by the Company are adequate relative to the Company's present operations.
The purpose of this section is to discuss and analyze the Company's consolidated results of operations, financial condition and liquidity and capital resources for the two years ended December 31, 2010. This analysis should be read in conjunction with the consolidated financial statements and related notes, which appear elsewhere in this report. The Company reports financial results on a consolidated basis. The consolidated financial statements include the accounts of UTG and its subsidiaries at December 31, 2010.
Declines in value of securities available-for-sale that are judged to be other-than-temporary are determined based on the specific identification method and are reported in the Consolidated Statements of Operations as realized losses. The factors considered by management in determining when a decline is other-than-temporary include but are not limited to: the length of time and extent to which the fair value has been less than cost; 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, in the case of fixed maturities, the effect of changes in market interest rates); and the Company's intent and ability to hold the security for a period of time sufficient to allow for a recovery in fair value. For structured securities, such as mortgage-backed securities, an impairment loss is recognized when there has been a decrease in expected cash flows and/or a decline in the security's fair value below cost.
Premiums for traditional life insurance products, which include those products with fixed and guaranteed premiums and benefits, consist principally of whole life insurance policies, and certain annuities with life contingencies are recognized as revenues when due. Limited payment life insurance policies defer gross premiums received in excess of net premiums, which is then recognized in income in a constant relationship with insurance in force. Accident and health insurance premiums are recognized as revenue pro rata over the terms of the policies. Benefits and related expenses associated with the premiums earned are charged to expense proportionately over the lives of the policies through a provision for future policy benefit liabilities and through deferral and amortization of deferred policy acquisition costs. For universal life and investment products, generally there is no requirement for payment of premium other than to maintain account values at a level sufficient to pay mortality and expense charges. Consequently, premiums for universal life policies and investment products are not reported as revenue, but as deposits. Policy fee revenue for universal life policies and investment products consists of charges for the cost of insurance and policy administration fees assessed during the period. Expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances.
Premiums and policy fee revenues, net of reinsurance premiums and policy fees, decreased approximately 8% when comparing 2010 to 2009. The Company writes very little new business. Unless the Company acquires a block of in-force business as it did in December 2006, 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 2010 and 2009 was approximately 96.0% and 96.1%, respectively. Persistency is a measure of insurance in force retained in relation to the previous year.
In recent periods, Management’s focus has been placed on promoting and growing TPA services to unaffiliated life insurance companies. The Company receives monthly fees based on policy in force counts and certain other activity indicators, such as number of premium collections performed, or services performed. For the years ended 2010 and 2009, the Company received $1,724,880 and $1,875,868 for this work, respectively. These TPA revenue fees are included in the line item “other income” on the Company’s consolidated statements of operations. During 2010, the Company obtained an additional contract for these services, which should provide approximately $300,000 additional revenues annually. Administration for this block of business is to begin in the first quarter of 2011. The Company intends to continue to pursue other TPA arrangements as well. The Company provides TPA services to insurance companies seeking business process outsourcing solutions. Management believes the Company is positioned to generate additional revenues by utilizing the Company’s current excess capacity and administrative services. During 2009, the Company renewed the contract of the largest TPA client for an additional five year period.
Operating expenses increased approximately 14% in 2010 compared to 2009. This increase was due to increased travel expenses primarily relating to the purchase of discount mortgage loans and an increase in charitable contributions as a result of the Company’s increased earnings in 2010. Management continues to place significant emphasis on expense monitoring and cost containment. Maintaining administrative efficiencies directly impacts net income.
Interest expense decreased approximately 37% during 2010 compared to 2009. This decrease is the result of a lower outstanding balance of debt as well as the general decline in interest rates. The Company made principal payments of $3,600,351 during 2010. During 2009, no principal payments were made as the Company prepaid principal due in 2009 during 2008. The next required principal payment is due in December of 2011. The Company anticipates aggressively repaying the current debt.
At December 31, 2010, the Company held a fixed maturity security with a carrying value of $10,000 that was guaranteed by a third party. The security did not have a credit rating. The Company had no significant concentration in a guarantor either directly or indirectly as of December 31, 2010.
During the fourth quarter of 2009, the Company began purchasing discounted commercial mortgage loans. Management has extensive background and experience in the analysis and valuation of commercial real estate and believes there are significant opportunities currently available in the discounted mortgage loan arena. Experienced personnel of FSNB have also been utilized in the analysis phase. This experience dates back to discounted loans during the Resolution Trust days where such loans were being sold from defunct savings and loans in the early 1990’s. The discounted loans are available through the FDIC 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. Prior to placing a bid, each loan is reviewed to determine interest level utilizing such information as type of collateral, location of collateral, interest rate, current loan status and available cashflows or other sources of repayment. Once it is determined interest in the loan remains, the collateral is physically inspected. Following physical inspection, if interest still remains, a bid price is determined and a bid is submitted. 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 2009, the Company also contributed approximately $20,000,000 to a professionally managed trading account as another way to combat the current low rate environment. The account was established to generate a fair return while reducing risk. Securities designated as trading are reported at fair value with gains or losses resulting from changes in fair value recognized in net investment income. During 2010, approximately 21%, or $5,143,000, of investment income was due to this trading portfolio. This type of return should not be expected going forward. Volatility should be expected, as well as possible losses.
Cost of insurance acquired decreased approximately $1,324,000 in 2010 compared to $8,900,000 in 2009. 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. In 2010 and 2009, amortization decreased the asset by $1,324,731 and $4,176,539 respectively. An additional decrease of approximately $4,700,000 in 2009 was due to the sale of a subsidiary, Texas Imperial Life Insurance Company. No impairments of this asset were recorded for the periods presented.
The largest liability, by far, is future policy benefits. The decrease from 2009 to 2010 in this line item was approximately 2%. This decrease is attributable primarily to a decrease in the total future policy benefits held. As policies in force terminate, the corresponding reserve liability held for those policies is released.
The Company has three principal needs for cash - the insurance companies’ contractual obligations to policyholders, the payment of operating expenses and servicing its outstanding debt. Cash and cash equivalents as a percentage of total assets were 4% and 9% as of December 31, 2010 and 2009. Fixed maturities as a percentage of total invested assets were 45% and 47% as of December 31, 2010 and 2009, respectively.
Cash used in operating activities was $(2,986,295) and $(4,248,484) in 2010 and 2009, respectively. Sources of operating cash flows of the Company, as with most insurance entities, is comprised primarily of premiums received on life insurance products and income earned on investments. Uses of operating cash flows consist primarily of payments of benefits to policyholders and beneficiaries and operating expenses. The Company has not marketed any significant new products for several years. As such, premium revenues continue to decline. Management anticipates future cashflows from operations to remain similar to historic trends.
Cash provided by (used in) investing activities was $(11,480,532) and $2,904,973 for 2010 and 2009, respectively. During 2010, more emphasis was placed on the trading securities and discounted mortgage loans. These two investment areas accounted for 86% of investments acquired during 2010 and 79% of investments sold during 2010. In late 2009, management determined market conditions were favorable for investing in both of these arenas. The Company intends to continue this investment path as long as market conditions remain favorable in these areas and investment opportunities continue to present themselves.
Net policyholder contract deposits decreased approximately $408,000 in 2010 compared to 2009. Policyholder contract withdrawals decreased approximately $796,000 in 2010 compared to 2009. Management anticipates continued moderate declines in contract deposits and withdrawals as this block of business continues to decline. Contract withdrawals can vary from year to year based on outside influences such as changes in interest rates, competition and other economic factors.
In addition to the above promissory note, First Tennessee Bank National Association also provided UTG with a $5,000,000 revolving credit note. During 2010, Management decided that a reduction in the limit to $2,750,000 in this line of credit was more reasonable for current operations. This note is for a one-year term and may be renewed by consent of both parties. The credit note is to provide operating liquidity for UTG. The promissory note carries a variable rate of interest based on the 90-day LIBOR rate plus 2.75 percentage points, but at no time will the rate be less than 3.25%. The collateral held on the above note also secures this credit note. UTG had borrowings of $290,000 and $0 against this note during 2010 and 2009, respectively. At December 31, 2010 and 2009, the outstanding principal balance on this debt was $290,000 and $0, respectively.
In June 2002, the Company entered into a five-year contract for services related to its purchase of the “ID3” software system. The contract was amended during 2006 for a five year period ended 2011. Under the contract, the Company is required to pay $8,333 per month in software maintenance costs and a minimum charge of $14,000 per month in offsite data center costs, for a five-year period ending in 2011.
UTG is a holding company that has no day-to-day operations of its own. Funds required to meet its expenses, generally costs associated with maintaining the Company in good standing with states in which it does business, and the servicing of its debt are primarily provided by its subsidiaries. On a parent only basis, UTG's cash flow is dependent on management fees received from its insurance subsidiaries, stockholder dividends from its subsidiaries and earnings received on cash balances. On December 31, 2010, substantially all of the consolidated shareholders equity represents net assets of its subsidiaries. The Company's insurance subsidiaries have maintained adequate statutory capital and surplus. The payment of cash dividends to shareholders by UTG is not legally restricted. However, the state insurance department regulates insurance company dividend payments where the company is domiciled.
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 inter-corporate transfers of assets, reinsurance agreements, management agreements (see Note 9 to the consolidated financial statements), and payment of dividends (see Note 2 to the consolidated financial statements) in excess of specified amounts by the insurance subsidiaries, within the holding company system, are required.
At year-end 2010, UG had three ratios outside the normal range. AC had one ratio outside the normal range. Each of the ratios outside the normal range was anticipated by Management. UG’s ratios relate to the Company’s affiliated investments, percentage of real estate and mortgage loans to cash and invested assets and change in premium. The Company has made investments in real estate projects, which have been consolidated into these financial statements through limited liability companies. The limited liability companies were created to provide additional risk protection to the Company. Additionally, ACAP Corporation is a subsidiary of UG. During 2009, the Company re-evaluated its investment portfolio and began eliminating unwanted bonds. At the same time, the Company began purchasing mortgage loans at deep discounts. The Company continued to purchase discounted mortgage loans in 2010. While these investments negatively impact these ratios, the Company believes that this structure is in the best interest of the Company and these investments will have a positive long-term impact on the Company. The Company has not actively marketed life products in the past several years. Management currently placed little emphasis on new business production, believing resources could be better utilized in other ways. Current sales primarily represent sales to existing customers through additional insurance needs or conservation efforts. AC’s ratio outside the normal range relates to change in premium. AC, like UG, has not actively marketed life products in the past several years. Management currently places little emphasis on new business production, believing resources could be better utilized in other ways.
The “USA PATRIOT” Act of 2001 (“the Patriot Act”), enacted in response to the terrorist attacks of September 11, 2001, strengthens our Nation’s ability to combat terrorism and prevent and detect money-laundering activities. Under Section 352 of the Patriot Act, financial institutions (definition includes insurance companies) are required to develop an anti-money laundering program. The practices and procedures implemented under the program should reflect the risks of money laundering given the entity’s products, methods of distribution, contact with customers and forms of customer payment and deposits. In addition, Section 326 of the Patriot Act creates minimum standards for financial institutions regarding the identity of their customers in connection with the purchase of a policy or contract of insurance. The Company has instituted an anti-money laundering program to comply with Section 352, and has communicated this program throughout the organization. In addition, all new business applications are regularly screened through the Medical Information Bureau. The Company regularly updates the information provided by the Office of Foreign Asset Control, U.S. Treasury Department in order to remain in compliance with the Patriot Act and will continue to monitor this issue as changes and new proposals are made.
In December 2010, the FASB issued the ASU No. 2010-28 Intangibles-Goodwill and Other (Topic 350) When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. The amendments in this Update modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with the existing guidance and examples in paragraph 350-20-35-30, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The Company does not expect the adoption of ASU 2010-28 to have a material impact on its consolidated financial statements.
In July 2010, the FASB issued the ASU No. 2010-20 Consolidations (Topic 310) Receivables. The main objective in developing this Update is to provide financial statement users with greater transparency about an entity’s allowance for credit losses and the credit quality of its financing receivables. This Update is intended to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. Currently, a high threshold for recognition of credit impairments impedes timely recognition of losses. ASU 2010-20 is effective for annual reporting periods ending on or after December 15, 2011. The Company does not expect the adoption of ASU No 2010-20 to have a material impact on its consolidated financial statements.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and its Board of Directors regarding the preparation and fair presentation of published financial statements. However, internal control systems, no matter how well designed, cannot provide absolute assurance. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework contained in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Report”).
Based on our evaluation under the framework in the COSO Report our management concluded that our internal control over financial reporting was effective as of December 31, 2010.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
We have audited the accompanying consolidated balance sheets of UTG, Inc. (a Delaware corporation) and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
provided by (used in) operating activities net of changes in assets and liabilities
Discounted mortgage loans - during 2009 and 2010, the Company purchased non-performing 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. Management works the loans 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.
With each reporting period, management reviews its investment portfolio for securities whose value has declined below amortized cost to assess whether the decline is other than temporary. Included in the analysis are considerations of the severity and duration of the decline in fair value, the length of time expected to recover, the financial condition of the issuer, and whether the Company either plans to sell the security or it is more-likely-than-not that it will be required to sell the security before recovery of its amortized cost. If there is deemed to be an other than temporary decline in the value of any individual equity security, the Company reclassifies the associated net unrealized loss out of accumulated other comprehensive income with a corresponding charge to equity investment income. For debt securities available for sale that are determined to have an other than temporary impairment (“OTTI”), the credit component of the OTTI is recognized in earnings and the non-credit component is recognized in accumulated other comprehensive income (loss) in situations where the Company does not intend to sell the security and it is more-likely-than-not that the Company will not be required to sell the security. Prior to January 1, 2009, unrealized losses on available for sale debt securities that were deemed to be other-than-temporary were included in current period earnings.
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 4.0% to 5.5% as of December 31, 2010 and 2009.
For universal life insurance and interest sensitive life insurance products, acquisition costs are being amortized generally in proportion to the present value of expected gross profits from surrender charges and investment, mortality, and expense margins. Pursuant to Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 944, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments," the Company makes certain assumptions regarding the mortality, persistency, expenses, and interest rates it expects to experience in future periods. These assumptions are to be best estimates and are to be periodically updated whenever actual experience and/or expectations for the future change from initial assumptions. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised.
Estimated net amortization expense of deferred policy acquisition costs for the next five years is as follows:
PROPERTY AND EQUIPMENT - Company-occupied property, data processing equipment and furniture and office equipment are stated at cost less accumulated depreciation of $3,079,922 and $2,934,312 at December 31, 2010 and 2009, 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 $175,809 and $168,553 for the years ended December 31, 2010 and 2009, respectively.
INCOME TAXES - Income taxes are reported Pursuant to FASB Codification 740-10 Section 50, “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement number 109”. Deferred income taxes are recorded to reflect the tax consequences on future periods of differences between the tax bases of assets and liabilities and their financial reporting amounts at the end of each such period. The principal assets and liabilities giving rise to such differences are deferred policy acquisition costs, differences in tax basis of invested assets, cost of insurance acquired, future policy benefits, and gains on the sale of subsidiaries.
PARTICIPATING INSURANCE - Participating business represents 10% of life insurance in force at December 31, 2010 and 2009. Premium income from participating business represents 16% and 24% of total premiums for the years ended December 31, 2010 and 2009, respectively. The amount of dividends to be paid is determined annually by the insurance subsidiary's Board of Directors. Earnings allocable to participating policyholders are based on legal requirements that vary by state.
RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform to the 2010 presentation. Such reclassifications had no effect on previously reported net income or shareholders' equity.
In December 2010, the FASB issued the ASU No. 2010-29 Business Combinations (Topic 805) Disclosure of Supplementary Pro Forma Information for Business Combinations. The amendments in this Update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments in this Update also expand the supplemental pro forma disclosures under Topic 805 to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments in this Update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The Company does not expect the adoption of ASU 2010-29 to have a material impact on its consolidated financial statements.
In February 2010, the FASB issued ASU 2010-09, Subsequent Events (Topic 855) Amendments to Certain Recognition and Disclosure Requirements, which amends disclosure requirements within Subtopic 855-10. An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. This change alleviates potential conflicts between Subtopic 855-10 and the SEC's requirements. ASU 2010-09 is effective upon issuance. The adoption of ASU 2010-09 did not have a material impact on the Company's consolidated financial statements.
In January 2010, FASB issued ASU 2010-06, Improving Disclosures about Fair Value Measurements, which provides amendments to subtopic 820-10 that require separate disclosure of significant transfers in and out of Level 1 and Level 2 fair value measurements and the presentation of separate information regarding purchases, sales, issuances and settlements for Level 3 fair value measurements. Additionally, ASU 2010-06 provides amendments to subtopic 820-10 that clarify existing disclosures about the level of disaggregation and inputs and valuation techniques. ASU 2010-06 is effective for financial statements issued for interim and annual periods ending after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the rollforward of activity in Level 3 fair value measurements, which are effective for interim and annual periods ending after December 15, 2010. The Company does not expect the adoption of ASU 2010-06 to have a material impact on its consolidated financial statements.
In April 2009, the FASB replaced the guidance in the Investments - Debt and Equity Securities Topic of the FASB ASC related to OTTI. Under this new accounting guidance, an other-than-temporary impairment (“OTTI”) loss must be separated into the amount representing the decrease in cash flows expected to be collected, or “credit loss”, which is recognized in earnings, and the amount related to all other factors, or “noncredit loss”, which is recognized in other comprehensive income. In addition, the requirement for management to assert that it has the intent and ability to hold an impaired security until recovery was replaced by the requirement for management to assert if it either has the intent to sell the debt security or if it is more likely than not the entity will be required to sell the debt security before recovery of its amortized cost basis.
UG is an Ohio domiciled insurance company, which requires five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory net income or b) 10% of statutory capital and surplus. For the year ended December 31, 2010, UG had statutory net income of $4,796,439. At December 31, 2010, UG's statutory capital and surplus amounted to $30,442,880. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. UG paid dividends of $2,725,000 and $0 to UTG in 2010 and 2009, respectively. None of the dividends paid were considered to be an extraordinary dividend.
UG is required to maintain minimum statutory surplus of $2,500,000. AC is required to maintain minimum statutory surplus of $1,400,000.
The valuation allowance against deferred taxes is a sensitive accounting estimate. The Company follows the guidance of ASC 740, “Income Taxes,” which prescribes the liability method of accounting for deferred income taxes. Under the liability method, companies establish a deferred tax liability or asset for the future tax effects of temporary differences between book and tax basis of assets and liabilities.
At December 31, 2010 and 2009, respectively, the Company had gross deferred tax assets of $3,243,631 and $3,971,251 net of valuation allowances of $0 and $147,521, and gross deferred tax liabilities of $16,624,909 and $15,921,505, resulting from temporary differences primarily related to the life insurance subsidiaries. The valuation allowance in 2009 was from UG that for tax purposes generated a net operating loss of $421,488. The Company established a deferred tax asset of $147,521 in 2009 relating to the operating loss carryforward. Also in 2009, the Company established an offsetting allowance of $147,521 for the loss. The allowances were established as a result of uncertainty in the Company’s ability to utilize the loss carryforwards which is dependent on generating sufficient taxable income prior to expiration of the loss carryforward. The Company has not experienced any reductions of deferred tax assets due to the lapse of applicable statute of limitations.
The Company classifies interest and penalties on underpayment of income taxes as income tax expense. No interest or penalties were included in the reported income taxes for the years presented. Tax years 2007 to current remain subject to examination. The Company has no agreements of extension of the review period currently in effect. The Company is not aware of any potential or proposed changes to any of its tax filings.
The Company held three fixed maturity investments totaling $75,329,675 and five fixed maturity investments of $74,397,459 that exceeded 10% of shareholder’s equity at December 31, 2010 and 2009, respectively. The Company held no equity investments that exceeded 10% of shareholder’s equity at December 31, 2010 and two equity investments totaling $10,192,382 that exceeded 10% of shareholder’s equity at December 31, 2009.
As of December 31, 2010, the Company had three fixed maturity investments and two equity investments with unrealized losses less than 12 months, and five fixed maturity investments and no equity investments with unrealized losses greater than 12 months. As of December 31, 2009, the Company had eight fixed maturity investments and two equity investments with unrealized losses less than 12 months, and nine fixed maturity investments and three equity investments with unrealized losses greater than 12 months.
The Company regularly reviews its investment portfolio for factors that may indicate that a decline in fair value of an investment is other than temporary. Based on an evaluation of the issues, including, but not limited to, intentions to sell or ability to hold the fixed maturity and equity securities with unrealized losses for a period of time sufficient for them to recover; the length of time and amount of the unrealized loss; and the credit ratings of the issuers of the investments, the Company held six investments and two investments as other-than-temporarily impaired at December 31, 2010 and 2009, respectively. The other-than-temporary impairments during 2010 were due to changes in expected future cash flows of investments in stocks as well as in bonds backed by trust preferred securities of banks. In addition, the Company recognized an other-than-temporary impairment in a mortgage loan as a result of its appraisal valuation. The other-than-temporary impairments during 2009 were due to changes in expected future cash flows of investments in bonds backed by trust preferred securities of banks. The other-than-temporary impairments are detailed below:
The amortized cost and estimated market value of debt securities at December 31, 2010, by contractual maturity, is shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
INVESTMENTS ON DEPOSIT - At December 31, 2010, investments carried at approximately $6,153,000 were on deposit with various state insurance departments.
As of December 31, 2010, the Company’s discounted mortgage loan portfolio contained 131 loans with a carrying value of $47,523,860. The loans’ payment performance during the past year is shown as follows:
During 2010, the Company foreclosed on 20 discounted mortgage loans with a total carrying value of $8,939,548. Of these foreclosures, 17 loans totaling $8,411,458 were transferred to real estate while one loan is now UG’s wholly owned subsidiary, Sand Lake, LLC. Subsequent to the foreclosures, two foreclosed loans were sold with the Company realizing a gain of $51,949 upon the sale.
The Company utilized a pricing service to estimate fair value measurements for its fixed maturities and public common and preferred stocks. The pricing service utilizes market quotations for securities that have quoted market prices in active markets. Since fixed maturities other than U.S. Treasury securities generally do not trade on a daily basis, the pricing service prepares estimates of fair value measurements using relevant market data, benchmark curves, sector groupings and matrix pricing. As the fair value estimates of most fixed maturity investments are based on observable market information rather than market quotes, the estimates of fair value other than U.S. Treasury securities are included in Level 2 of the hierarchy. U.S. Treasury securities are included in the amount disclosed in Level 1 as the estimates are based on unadjusted prices. The Company’s Level 2 investments include obligations of U.S. government agencies, municipal bonds, corporate debt securities and other mortgage backed securities.
The Company's reinsured business is ceded to numerous reinsurers. The Company monitors the solvency of its reinsurers in seeking to minimize the risk of loss in the event of a failure by one of the parties. The Company is primarily liable to the insureds even if the reinsurers are unable to meet their obligations. The primary reinsurers of the Company are large, well capitalized entities.
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 and its ultimate parent, The Guardian Life Insurance Company of America (Guardian), currently hold an “A” (Excellent) and "A++" (Superior) rating, respectively, from A.M. Best. The PALIC agreement accounts for approximately 64% of UG’s reinsurance reserve credit, as of December 31, 2010.
On June 7, 2000, UG assumed an already existing coinsurance agreement, dated January 1, 1992, between Lancaster Life Reinsurance Company (LLRC), an Arizona corporation and Investors Heritage Life Insurance Company (IHL), a corporation organized under the laws of the Commonwealth of Kentucky. Under the terms of the agreement, LLRC agreed to assume from IHL a 90% quota share of new issues of credit life and accident and health policies that have been written on or after January 1, 1992 through various branches of the First Southern National Bank. The maximum amount of credit life insurance that can be assumed on any one individual’s life is $15,000. UG assumed all the rights and obligations formerly held by LLRC as the reinsurer in the agreement. LLRC liquidated its charter immediately following the transfer. At December 31, 2010, the IHL agreement has insurance in-force of approximately $836,000, with reserves being held on that amount of approximately $11,000.
At December 31, 1992, AC 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 AC representing policy loans and deferred and uncollected premiums related to the reinsured policies. AC continues to administer the reinsured policies, for which it receives an expense allowance from the reinsurer. At December 31, 2010, the Canada Life agreement has insurance in-force of approximately $57,337,000, with reserves being held on that amount of approximately $35,510,000. As of December 31, 2010, there remains $634,467 in profits to be generated under this treaty. Should future experience under the treaty match the experience of recent years, which cannot reliably be predicted to occur, it should take until late 2012 to generate the remaining profits. However, regarding the uncertainty as to when the specified level may be reached, it should be noted that the experience has been erratic from year to year and the number of policies in force that are covered by the treaty diminishes each year.
Reinsurance agreements such as the Canada Life treaty described above are often referred to as financial reinsurance arrangements and are utilized within the insurance industry as a method of borrowing funds or statutory capital for an acquisition of a block of business or company. The borrowed funds are generally in the form of an initial ceding commission received from the reinsurer. The original borrowed amount is then repaid in future periods from the profits generated by the acquired block or company. Values of the target are determined based upon an actuarial valuation and future projections. Actual results may vary from year to year based upon the performance of the business relative to the assumptions used in the projections. Under the terms of this agreement, all financial activity relating to the policies covered by the agreement are utilized to repay the remaining outstanding balance, which was $634,467 as of December 31, 2010. Results under this agreement are included in various line items of the income statement, with an overall impact to net income of approximately $21,000 and $19,000 in 2010 and 2009, respectively. The net result of the activity represents the fee paid to the reinsurer for the use of their funds or statutory capital during the duration of the agreement.
During 2010, the Company committed to invest up to $2,000,000 in Llano Music, LLC, which invests in music royalties. Llano does capital calls as funds are needed to acquire the royalty rights. At December 31, 2010, the Company has $1,821,000 committed that has not been requested by Llano.
On February 20, 2003, UG purchased $4,000,000 of a trust preferred security offering issued by FSBI. The security has a mandatory redemption after 30 years with a call provision after 5 years. The security pays a quarterly dividend at a fixed rate of 6.515%. The Company received $264,219 of dividends in 2010 and 2009. On March 30, 2009, UG purchased $1,000,000 of FSBI common stock. The sale and transfer of this security are restricted by the provisions of a stock restriction and buy-sell agreement.
On July 2, 2010, UG paid a cash dividend of $1,100,000 to UTG. On December 6, 2010, UG paid an additional dividend of $1,625,000 to UTG. UG paid no cash dividends in 2009. On May 10, 2010, AC paid a cash dividend of $728,130 to ACAP. These dividends were comprised entirely of ordinary dividends. No regulatory approvals were required prior to the payment of these dividends.
On July 20, 2009, the Company’s indirect 73% owned subsidiary AC, a Texas life insurance company, entered into a definitive stock purchase agreement for the sale of its 100% owned life insurance subsidiary, TI. The transaction was completed on December 30, 2009. TI was sold to United Funeral Directors Benefit Life Insurance Company, an unaffiliated third party. The sale price was $6,415,169 which was paid in cash. The transaction had no impact to the consolidated income statement of the Company. TI was an immaterial subsidiary acquired in 2006 as part of the acquisition of ACAP Corporation and subsidiaries. The Company has a history of acquisition and consolidation. TI is a Texas only stipulated premium insurance company. This fact made a consolidation or merger of this company with any of the other insurance companies within the group impractical.
In accordance with FASB ASC Topic 260 “Earnings per share,” the computation of diluted earnings per share is the same as basic earnings per share for the years ending December 31, 2010 and 2009, as there were no outstanding securities, options or other offers that give the right to receive or acquire common shares of UTG.
On December 8, 2006, UTG borrowed funds from First Tennessee Bank National Association through execution of an $18,000,000 promissory note. The note is secured by the pledge of 100% of the common stock of UG. The promissory note carries a variable rate of interest based on the 3 month LIBOR rate plus 180 basis points. Interest is payable quarterly. Principal is payable annually beginning at the end of the second year in five installments of $3,600,000. The loan matures on December 7, 2012. The Company made principal payments of $3,600,351 during 2010. During 2009, no payments were made, as the Company had prepaid the 2009 principal due during 2008. At December 31, 2010 and 2009, the outstanding principal balance on this debt was $6,891,411 and $10,491,762, respectively.
On February 7, 2007, HPG Acquisitions ("HPG"), a 74% owned affiliate of the Company, borrowed funds from First National Bank of Midland, through execution of a $373,862 promissory note. The note is secured by real estate owned by the HPG. The note bears interest at a fixed rate of 5%. The first payment was due January 15, 2008. There will be 119 regular payments of $3,965 followed by one irregular last payment estimated at $44,125. HPG made repayments of $34,804 during 2010 and $11,185 during 2009. At December 31, 2010 and 2009, the outstanding principal balance was $276,323 and $311,127, respectively.
On a cash basis, the Company paid $295,223 and $470,261 in interest expense for the years 2010 and 2009, respectively. The Company paid $1,888,000 and $301,324 in federal income tax for 2010 and 2009, 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, 2010, approximately 55% 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 24.5% of total life insurance in force at December 31, 2010. Insurance ceded represented 25.0% of premium income for 2010. 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.
As of December 31, 2010 and 2009, the Company established a deferred tax liability of $1,758,774 and $78,862 respectively, for the unrealized gains based on the applicable United States statutory rate of 35%.