The Company's corporate headquarters is located in a two story office building in Lake Mary, Florida, which is owned by the Company. The Company and an affiliated company occupy the second floor of the building. One hundred percent of the remaining rentable space was leased as of December 31, 2003.
The Company has primarily issued three types of insurance products: 10-Pay Whole Life with an Annuity Rider, final expense products, and universal life. The 10-Pay Whole Life with an Annuity Rider product is designed for the higher education market. The savings aspect of the Annuity Rider is marketed as a tool for parents to help fund their children's higher education. The product is offered to parents who have children under the age of 25.
Death and other policyholder benefits reflect exposure to mortality risk and fluctuate from year to year on the level of claims incurred under insurance retention limits. The profitability of the Company is primarily affected by fluctuations in mortality, other policyholder benefits, expense levels, interest spreads (i.e., the difference between interest earned on investments and interest credited to policyholders) and persistency. The Company has the ability to mitigate adverse fluctuations through adjustments to credited interest rates, policyholder dividends or cost of insurance charges.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. It is reasonably possible that actual experience could differ from the estimates and assumptions utilized which could have a material impact on the financial statements. The following is a summary of our significant accounting estimates, and critical issues that impact them:
o Yield on investments supporting the liabilities o Amount of interest or dividends credited to the policies o Amount of policy fees and charges o Amount of expenses necessary to maintain the policies, and o Amount of death and surrender benefits and the length of time the policies will stay in force.
The universal life products the Company sells have significant policy initiation fees (front-end load), which are deferred and amortized into revenues in proportion to the estimated expected gross profits from surrender charges and investment, mortality and expense margins. The same assumptions that impact deferred acquisition costs would apply to unearned revenue.
Net investment income increased by $170,000, or 4.4%, to $4,005,000 for fiscal year 2003 from $3,835,000 for fiscal year 2002. Investment yield increased to 7.59% in fiscal year 2003 from 7.41%, in 2002.
Benefits and claims increased by $255,000, or 4.8%, to $5,599,000 for fiscal year 2003 from $5,344,000 for the comparable period in 2002. The increase was primarily due to an increase in traditional life reserves and death claims.
The amortization of deferred policy acquisition costs increased by $69,000, or 3.5%, to $2,039,000 for fiscal year 2003, from $1,970,000 for the comparable period in 2002. The increase in amortization expense was in line with actuarial assumptions.
Operating expenses increased by $192,000, or 5.2%, to $3,871,000 for fiscal year 2003 from $3,679,000 for the same period in 2002. The increase was primarily due to increased marketing expenses offset by a reduction of legal expenses.
Total revenues increased by $307,000, or 2.9%, to $10,910,000 for fiscal year 2002 from $10,603,000 for fiscal year 2001. Offsetting some of the increase in total revenues was a $32,000 reduction in net investment income.
Benefits and claims increased by $861,000, or 19.2%, to $5,344,000 for fiscal year 2002 from $4,483,000 for the comparable period in 2001. The increase was primarily due to an increase in traditional life reserves and death claims.
The amortization of deferred policy acquisition costs decreased by $227,000, or 10.3%, to $1,970,000 for fiscal year 2002 from $2,197,000 for the comparable period in 2001. The decrease in amortization expense was in line with actuarial assumptions.
The Company attempts to match the duration of invested assets with its policyholder liabilities. The Company may sell investments other than those held-to-maturity in the portfolio to help in this timing; however, to date, that has not been necessary. The Company purchases short-term investments on a temporary basis to meet the expectations of short-term requirements of the Company's products. The Company's investment philosophy is intended to provide a rate of return which will persist during the expected duration of policyholder liabilities regardless of future interest rate movements.
The Company invests predominantly in fixed maturity securities, mortgage loans, and warehouse mortgage loans on a short-term basis before selling the loans to investors in accordance with the requirements and laws governing life insurance companies. Bonds owned by the Company amounted to $17,904,000 as of December 31, 2003 as compared to $22,412,000 as of December 31, 2002. This represents 38.8% and 45.5% of the total investments as of December 31, 2003 and December 31, 2002, respectively. Generally, all bonds owned by the Company are rated by the National Association of Insurance Commissioners. Under this rating system, there are nine categories used for rating bonds. At December 31, 2003, and at December 31, 2002, the Company had investments in bonds in rating categories three through six, which are considered non-investment grade of $488,000 and $485,000, respectively.
If market conditions were to cause interest rates to change, the market value of the fixed income portfolio (approximately $20.454 million) could change by the following amounts based on the respective basis point swing (the change in market values were calculated using a modeling technique):
The Company has classified certain of its fixed income securities as available for sale, with the remainder classified as held to maturity. However, in accordance with Company policy, any such securities purchased in the future will be classified as held to maturity. Business conditions, however, may develop in the future which may indicate a need for a higher level of liquidity in the investment portfolio. In that event the Company believes it could sell short-term investment grade securities before liquidating higher-yielding longer-term securities.
The Company is subject to risk based capital guidelines established by statutory regulators requiring minimum capital levels based on the perceived risk of assets, liabilities, disintermediation, and business risk. At December 31, 2003 and December 31, 2002, the Company exceeded the regulatory criteria.
Lapse rates measure the amount of insurance terminated during a particular period. The Company's lapse rate for life insurance in 2003 was 10.7% as compared to a rate of 11.9% for 2002.
Effective December 17, 1998, the Company entered into an Administrative Services Agreement with Security National Financial Corporation ("SNFC"). Under the terms of the agreement, SNFC has agreed to provide the Company with certain defined administrative and financial services, including accounting services, financial reports and statements, actuarial, policyholder services, underwriting, data processing, legal, building management, marketing advisory services and investment services. In consideration for the services provided by SNFC, the Company pays SNFC an administrative services fee of $250,000 per month, provided, however, that such fee shall be reduced to zero for so long as the capital and surplus of the Company is less than or equal to $6,000,000, unless the Company and SNFC otherwise agree in writing and such agreement is approved by the Florida Department of Insurance.
The administrative services fee may be increased, beginning on January 1, 2001, to reflect increases in the Consumer Price Index, over the index amount as of January 1, 2000. The Administrative Services Agreement shall remain in effect for an initial term expiring on December 16, 2003. The term of the agreement may be automatically extended for additional one-year terms unless either the Company or SNFC shall deliver a written notice on or before September 30, of any year stating to the other its desire not to extend the term of the agreement. However, in no event can the agreement be terminated prior to December 16, 2003.
Student loans are a service the Company has historically made available to the public as well as an investment. While the Company anticipates the seasonal demand for student loan funds and the subsequent sale of such loans to the Student Loan Marketing Association (SLMA), there are times when additional funds are required to meet demand for student loans until such time as the sale thereof to SLMA can be completed. In 1997, the Company renewed its $5,000,000 line of credit with SLMA until 2007 in order to meet these seasonal borrowing requirements. The Company made no draws against this line of credit through December 31, 2003.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 requires certain guarantees to be recorded at fair value and also requires a guarantor to make new disclosures, even when the likelihood of making payments under the guarantee is remote. In general, the interpretation applies to contracts or indemnification agreements that contingently require the guarantor to make payments to the guaranteed party based on changes in an underlying that is related to an asset, liability, or an equity security of the guaranteed party. The recognition provisions of FIN 45 are effective on a prospective basis for guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim and annual periods ending after December 15, 2002. The adoption of FIN 45 did not have a material impact on the Company's financial condition or results of operations.
Statement of Shareholders' Equity-years ended December 31, 2003, 2002 and 2001..............................23
Statement of Cash Flows - years ended December 31, 2003, 2002 and 2001....................................24
We have audited the accompanying balance sheet of Southern Security Life Insurance Company as of December 31, 2003 and 2002 and the related statements of operations, shareholders' equity, and cash flows for the three years in the period ended December 31, 2003. In connection with our audits of the financial statements, we have also audited the amounts included in the financial statement schedules as listed in the accompanying index under Item 15(a). These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
Assets 2003 2002 - ------ ---- ---- Investments (note 3): Fixed maturities held-to-maturity (fair value, $4,029,488 and $4,167,028 at December 31, 2003 and 2002, respectively) $ 3,691,064 $ 3,971,539 Securities available-for-sale, at fair value: Fixed maturities (cost of $13,157,337 at December 31, 2003 and $17,078,241 at December 31, 2002) 14,213,317 18,439,961 Equity securities (cost, $316,293 and $316,293 at December 31, 2003 and 2002, respectively) 424,165 309,218 Mortgage loans 2,211,183 2,244,597 Policy and student loans 8,131,980 8,027,736 Short-term investments (note 11) 17,497,249 16,283,759 ----------- ----------- Total Investments 46,168,958 49,276,810 ----------- -----------
Liabilities and Shareholders' Equity 2003 2002 - ------------------------------------ ---- ---- Liabilities: Future policy benefits (note 6) $ 4,279,281 $ 3,517,481 Policyholders' account balances 46,887,592 47,222,857 Unearned revenue 4,334,299 4,551,265 Other policy claims and benefits payable 798,050 701,312 Other policyholders' funds, dividend and endowment accumulations 98,071 78,811 Funds held related to reinsurance treaties (note 7) 1,294,589 1,334,963 Notes payable to related parties (note 9) 1,433,100 1,000,000 Due to affiliated insurance agency (note 11) 57,065 83,941 General expenses accrued 81,942 98,480 Unearned investment income 355,650 355,529 Other liabilities 62,798 111,786 Income taxes (note 10) 967,516 1,062,802 ----------- -----------
2003 2002 2001 ---- ---- ---- Revenues: Net insurance revenues $ 7,334,707 $ 7,075,257 $ 6,736,027 Net investment income (notes 3 and 11) 4,005,129 3,835,420 3,866,966
Prior to December 17, 1998, certain executive officers and directors of the Company were shareholders of approximately 60 percent of the shares of SSLIC Holding Company, Inc., (formerly Consolidare Enterprises, Inc.). SSLIC Holding Company, Inc. owns 77% of the Company's voting securities at December 31, 2003.
Interest rate risk is the risk that interest rates will change and cause a decrease in the value of the Company's investments. This change in rates may cause certain interest-sensitive products to become uncompetitive, may cause disintermediation, or may cause the Company to not achieve its target interest margins between interest earned on invested assets and interest required to be credited to policyholder account balances. The Company mitigates this risk by charging fees for nonconformance with certain policy provisions, by offering products that transfer this risk to the purchaser, and/or by attempting to match the maturity schedule of its assets with the expected payouts of its liabilities. To the extent that liabilities come due more quickly than assets mature, the Company would have to sell assets prior to maturity and potentially recognize a gain or loss.
The presentation of financial statements have been prepared in conformity with U.S. generally accepted accounting principles ("GAAP"), which vary from reporting practices prescribed or permitted by regulatory authorities.
Investments in all debt securities and those equity securities with readily determinable market values are classified into one of three categories: held-to-maturity, trading or available-for-sale. Classification of investments is based upon management's current intent. Debt securities which management has a positive intent and ability to hold until maturity are classified as securities held-to-maturity and are carried at amortized cost. Unrealized holding gains and losses on securities held-to-maturity are not reflected in the financial statements. Debt and equity securities that are purchased for short-term resale would be classified as trading securities. Trading securities would be carried at fair value, with unrealized holding gains and losses included in earnings; the Company has no securities classified as trading securities. All other debt and equity securities not included in the above two categories are classified as securities available-for-sale. Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported in accumulated other comprehensive income which is included in shareholders' equity after adjustment for deferred income taxes and deferred acquisition costs related to universal life products.
Insurance reserves for universal life policies are determined following the retrospective deposit method and consist of policy values that accrue to the benefit of the policyholder, unreduced by surrender charges.
The computation of diluted earnings per common share is based on the weighted average number of shares outstanding during the year, plus the common stock equivalents that would arise from the exercise of stock options outstanding, using the treasury stock method and the average market price per share during the year. There were no common stock equivalents outstanding during the years ended December 31, 2003, 2002 and 2001. Common stock equivalents are not included in the diluted earnings (loss) per share calculation when their effect is antidilutive.
The Company measures expense for stock-based employee compensation using the intrinsic value method and provides pro-forma disclosures of net income (loss) and net income (loss) per common share as if the fair value method had been applied in measuring compensation expense. For the years ended December 31, 2003, 2002, and 2001, there was no stock-based employee compensation expense or pro-forma expense.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure and Amendment to FASB No. 123", which provides three optional transition methods for entities that decide to voluntarily adopt the fair value recognition principles of SFAS No. 123, "Accounting for Stock Issued to Employees", and modifies the disclosure requirements of that Statement. Under the prospective method, stock-based compensation expense is recognized for awards granted after the beginning of the fiscal year in which the change is made. The modified prospective method recognizes stock-based compensation expense related to new and unvested awards in the year of change equal to that which would have been recognized had SFAS No. 123 been adopted as of its effective date, for fiscal years beginning after December 15, 1994. The retrospective restatement method recognizes stock compensation costs for the year of change and restates financial statements for all prior periods presented as though the fair value recognition provisions of SFAS No. 123 had been adopted as of its effective date. Since the Company does not
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 requires that certain financial instruments, which under previous guidance may have been accounted for as equity, must now be accounted for as liabilities (or an asset in some circumstances). The financial instruments affected include mandatory redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock. This Statement is effective for all such financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material effect on the Company's financial position or results of operations.
Effective December 31, 2003, the Company adopted EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments ("EITF 03-1"). EITF 03-1 provides guidance on the disclosure requirements for other-than-temporary Impairments of debt and marketable equity investments that are accounted for under Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity Securities. The adoption of EITF 03-1 requires the Company to include certain quantitative and qualitative disclosures for debt and marketable equity securities classified as available-for-sale or held-to-maturity under SFAS 115 that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The adoption of EITF 03-1 did not have a material impact on the Company's financial position or results of operations.
In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51", and subsequently issued a revision to this Interpretation in December 2003. This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. The Interpretation applies to those variable interest entities considered to be special-purpose entities no later than December 31, 2003. The Interpretation must also be applied to all other variable interest entities no later than March 31, 2004. The adoption of Interpretation No. 46 did not have a material effect on the financial position or results of operations of the Company because no variable interest entities were required to be consolidated.
j. Certain proceeds from a note payable (note 9) that are treated as shareholders' equity for statutory purposes are treated as a liability under U.S. generally accepted accounting principles.
Reinsurance assets and liabilities are reported on a gross basis rather than shown on a net basis as permitted by statutory accounting practices.
The Insurance Commissioner's approval is not required if the dividend is equal to or less than the greater of: (a) 10% of the Company's surplus as to policyholders' derived from realized net operating profits on its business and net realized capital gains; or (b) the Company's entire net operating profits and realized net capital gains derived during the immediately preceding calendar year, if the Company will have surplus as to policyholders equal to or exceeding 115% of the minimum required statutory surplus as to policyholders after the dividend is declared and paid. As a result of such restrictions, the maximum dividend, which may be paid by the Company during 2004 without prior approval, is approximately $376,000. Accordingly, GAAP excess earnings over a statutory basis are not available for dividends.
Unrealized appreciation (depreciation) of fixed maturities for years ending December 31, 2003, 2002 and 2001 is $(162,806), $558,067, and $1,152,189, respectively.
The amortized cost and estimated fair value of fixed maturities at December 31, 2003, by contractual maturity, are summarized 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.
Mortgage-backed securities -- -- ---------- ---------- $3,691,064 $4,029,488 ========== ========== Fixed maturity securities available-for-sale:
There were no realized gains and losses for fixed maturity securities classified as available-for-sale and held-to-maturity that were called during the year ended December 31, 2003, 2002 and 2001.
At December 31, 2003 and 2002, the Company owned $488,000 and $485,000, respectively, of less-than-investment grade corporate debt securities. The Company also invests in subsidized and unsubsidized student loans totaling $320,746, and $97,671 at December 31, 2003 and 2002, respectively, which are guaranteed by the U.S. government. Subsequent to December 31, 2003, all of these loans were sold at their unpaid principal balance.
2003 2002 2001 ---- ---- ---- Interest: Fixed maturities $1,429,502 $1,526,706 $1,790,992 Policy and student loans 496,142 515,141 468,904 Short-term investments 1,538,540 1,235,823 1,105,434 Mortgage loans 170,982 179,193 206,212 Rental income 376,613 388,843 304,879
Dividends on equity securities common stock, including mutual fund 691 384 -- ---------- ---------- ---------- 4,012,470 3,846,090 3,876,421 Less investment expenses 7,341 10,670 9,455 ---------- ---------- ---------- $4,005,129 $3,835,420 $3,866,966 ========== ========== ==========
Florida $1,703,992 $1,702,867 $1,707,042 Alabama 100,526 100,634 100,737 South Carolina 301,577 301,903 302,210 Georgia 251,488 252,233 252,933 Indiana 216,096 201,787 202,347 ---------- ---------- ---------- $2,573,679 $2,559,424 $2,565,269 ========== ========== ==========
Certain of these assets, totaling approximately $850,000 for each of the years ended December 31, 2003 and 2002, are restricted for the future benefit of policyholders in a particular state.
Depreciation expense for the years ended December 31, 2003, 2002, 2001 totaled $126,712, $129,330, and $129,330, respectively.
Life insurance in-force aggregated approximately $1.5 billion at December 31, 2003, and 2002. Mortality and withdrawal assumptions are based upon the Company's experience and actuarial judgment with an allowance for possible unfavorable deviations from the expected experience.
The mortality tables used in calculating benefit reserves for non universal life contracts are the 1975-1980 Basic Tables and the 1980 U.S. Population mortality table modified for company expected experience.
On December 26, 2003, the Company entered into a partially Coinsurance and a partially Modified Coinsurance Agreement (CoModco Agreement) with Security National Life Insurance Company (Security National Life) effective September 30, 2003. The Company ceded 50% of certain blocks of its universal life business to Security National Life. The total liabilities reinsured for this business on October 1, 2003 were $22,195,259. The Company received a ceding commission from Security National Life of $3,200,000 and will pay a risk charge to Security National Life of 1% of the outstanding Coinsurance per calendar quarter. The Company put into a bank trust investment grade bonds, which equal the outstanding liabilities ceded to Security National Life. Security National Life is named as a beneficiary of the trust and the terms of the trust are such that the Company will maintain investment grade bonds in the trust to equal the outstanding liabilities ceded to Security National Life. Under the CoModco Agreement the Coinsurance and the decrease in reserves are equal. Under U. S. GAAP the Coinsurance and the reserve decreases are netted since these are non-cash items, and the Company expects to recapture the Coinsurance from future profits of the reinsured business. The Company has the right to recapture the business at any time after September 30, 2004 upon 90 days advance notice. As of December 31, 2003 the outstanding Coinsurance amount was $3,075,137. The Company recorded as an expense the risk charge of $32,000 for the fourth quarter.
As of December 31, 2003, the Company had an unused line of credit of $5,000,000, which is secured by student loans equaling 115% of the unpaid principal balance. The facility bears interest at a variable rate per annum payable monthly and expires on April 30, 2007.
Current $ 18,585 -- Deferred 948,931 1,062,802 ---------- ---------- Total $ 967,516 $1,062,802 ========== ==========
Total income taxes, including taxes on the change in the value of investments for the years ended December 31, 2003, 2002, and 2001 were as follows:
Income tax expense (benefit) for the years ended December 31, 2003, 2002, 2001 is summarized as follows:
2003 2002 2001 ---- ---- ---- Computed "expected" tax expense (benefit) $(59,351) $(28,158) $ 29,866 Increase (reduction) in income taxes resulting from: Small life insurance company deduction 30,523 17,107 (7,162) Changes in the valuation allowance for deferred tax assets, allocated to income tax expense (41,929) -- (7,115) State taxes, net of federal income tax benefit (3,731) (1,203) 1,276 --------- -------- -------- $(74,488) $(12,254) $ 16,865 ======== ======== ========
a. The Policyholders' Surplus exceeds a prescribed maximum, or; b. Distributions, other than stock dividends, are made to shareholders in excess of Shareholders' Surplus, as defined by prior law, or; c. The entity ceases to qualify for taxation as a life insurance company, or; d. The tax-deferred status of the Policyholder's Surplus Account is modified by future tax legislation.
At December 31, 2003, the balance of the Policyholders' Surplus account aggregated approximately $236,000. The Company has not recorded deferred income taxes totaling approximately $80,000 relating to this amount as it has no plan to distribute the amounts in Policyholders' Surplus in the foreseeable future. The Tax Reform Act of 1986 enacted a new separate parallel tax system referred to as the Alternative Minimum Tax (AMT) system. AMT is based on a flat rate applied to a broader tax base. It is calculated separately from the regular federal income tax and the higher of the two taxes is paid. The excess of the AMT over regular tax is a tax credit, which can be carried forward indefinitely to reduce regular tax liabilities of future years. In 2003, 2002, 2001, AMT exceeded regular tax by $8,758, $-0-, and $-0-, respectively. At December 31, 2003, the AMT tax credit available to reduce future regular tax totaled $227,714.
2003 2002 ---- ---- Deferred tax assets: Unearned revenue, due to deferral of "front-end" fee $ 1,635,912 $ 1,717,492 Policy liabilities and accruals, principally due to adjustments to reserves for tax purposes 2,107,516 1,718,852 Deferred policy acquisition costs related to unrealized appreciation (depreciation) 89,609 89,390
Total gross deferred tax assets 4,060,752 3,795,377 Less valuation allowance (227,714) (269,643) ----------- -----------
The net change in the total valuation allowance for the years ended December 31, 2003 and 2002, was a (decrease) increase of $(41,929), and $-0-, respectively.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these deductible differences, net of the existing valuation allowances at December 31, 2003.
The Company received for the years ended December 31, 2003, 2002 and 2001, $167,349, $168,933, and $132,141, respectively, as rental income from Security National for a lease of office space in the Company's building under the terms of the Administrative Services Agreement.
The following table presents the carrying amounts and estimated fair values of financial instruments held at December 31, 2003 and 2002. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties.