UTG has a strong philanthropic program. The Company generally allocates a portion of its GAAP net income to be used for its philanthropic efforts primarily targeted to Christ-centered organizations or organizations that help the weak or poor. The Company also encourages its staff to be involved on a personal level through monetary giving, volunteerism and use of their talents to assist those less fortunate than themselves. Through these efforts, the Company hopes to make a positive difference in the local community, state, nation and world.
Income from the equity securities investment portfolio increased approximately 69% or $1.2 million when comparing 2013 and 2012 results. During the second half of 2012, the Company purchased certain higher yielding equity securities and as a result, recognized income from these securities for a period of six months or less. During 2013, the Company recognized a full year of earnings from the higher yielding securities, which helped boost the earnings from equity securities. Also, during 2012, one of the Companies equity securities returned all of its capital to the Company. All future distributions from this security are recorded as income. The Company recognized income of approximately $1 million and $330,000 from this security during 2013 and 2012, respectively.
During the current year, the Company reported a small loss in the trading securities investment portfolio and income of $2.6 million in the prior year. The fluctuation in earnings from the trading securities portfolio is attributable to market value fluctuations of these investments and the Company significantly reducing its investment in trading security assets and liabilities. The trading securities asset balance decreased approximately 53% and the trading securities liability balance decreased approximately 95% when comparing 2013 and 2012.
Income from the discounted mortgage loan portfolio increased approximately 83% or $3.5 million when comparing 2013 and 2012 results. Income from discounted mortgage loans represented 34% of the consolidated net investment income reported by the Company during 2013. Income from the discounted mortgage loan portfolio is mainly the result of one-time events.
Discounted mortgage loans have become more difficult to purchase as the result of an increase in market competition. Management expects the discounted mortgage loan portfolio to continue to shrink as a result of the market competition and mortgage loan payoffs. While Management believes the discounted loans will continue to have favorable earnings and outcomes as they are worked through, there can be no assurance this will remain true in future periods. Changes in the current economy could have a negative impact on the loans, including the financial stability of the borrowers, the borrowers' ability to pay or refinance, the value of the property held as collateral and the ability to find purchasers at favorable prices.
Gains from the fixed maturities investment portfolio decreased 83% when comparing 2013 and 2012 results. During 2012, the Company sold a portion of its U.S. Treasury holdings to take advantage of the unusually high price spreads. Similar market opportunities were not available to the Company during the current year.
Gains from the sale of real estate decreased 90% when comparing 2013 and 2012 results. Gains from the sale of real estate are the result of one-time events and are expected to vary from year to year. During 2012, the Company recognized gains from the sale of three real estate investments. The Company sold several real estate investments during 2013. However, the gains from the sales were significantly less than the gains recognized from the 2012 real estate sales.
In recent periods, Management's focus has been directed towards 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 2013 and 2012, the Company received $2 million and $2.1 million for this work, respectively. Revenues from TPA fees are included in the line item "other income" on the Company's Consolidated Statements of Operations. 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.
In the fourth quarter of 2013, Management made the determination to not renew its largest third party administration ("TPA") contract when the contract is due for renewal in the fourth quarter of 2014. The TPA client has been notified of this decision to allow the client ample planning and transition time. This contract represents approximately 66% of the Company's total TPA revenues.
Net amortization of cost of insurance acquired decreased approximately 7% in 2013 compared to 2012. Cost of insurance acquired is established when an insurance company is acquired or when the Company acquires a block of in-force business. The Company assigns a portion of its cost to the right to receive future profits from insurance contracts existing at the date of the acquisition. 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. The interest rates may vary due to risk analysis performed at the time of acquisition on the business acquired. The Company utilizes a 12% discount rate on the remaining unamortized business. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised. Amortization of cost of insurance acquired is particularly sensitive to changes in interest rate spreads and persistency of certain blocks of insurance in-force. This expense is expected to decrease, unless the Company acquires a new block of business.
Operating expenses decreased approximately 9% in 2013 compared to 2012. The decrease in 2013 expenses, in comparison to 2012, is primarily attributable to a decrease in charitable contributions during 2013. The Company's charitable contributions decreased approximately 70% or $679,000 when comparing 2013 to 2012.
The Company's investments are generally managed to match related insurance and policyholder liabilities. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. Interest crediting rates on adjustable rate policies have been reduced to their guaranteed minimum rates, and as such, cannot be lowered any further. Policy interest crediting rate changes and expense load changes become effective on an individual policy basis on the next policy anniversary. Therefore, it takes a full year from the time the change was determined for the full impact of such change to be realized. If interest rates decline in the future, the Company will not be able to lower rates and both net investment income and net income will be impacted negatively
An additional source of liquidity to the Parent company and its subsidiaries is the line of credit facilities extended to them that allow borrowings of up to $28 million. As of December 31, 2013, the Company and its subsidiaries had available $20.9 million in line of credit facilities. As of December 31, 2012, the Company and its subsidiaries had available $21.3 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.
The Company expects to have readily available funds for 2013 and the foreseeable future to conduct its operations and to maintain target capital ratios in the insurance subsidiary through internally generated cash flow and the credit facilities. In the unlikely event that more liquidity is needed, the Company could generate additional funds through such sources as a short-term credit facility and intercompany borrowing.
During 2013, the Company's investing activities provided net cash of $6.2 million. During 2012, the Company's investing activities used net cash of $56 million. Proceeds from investments sold decreased approximately 28% or $42.2 million when comparing 2013 to 2012. Investment purchases decrease approximately 51% or $104.4 million. The net cash provided by and used in 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 outstanding debt of $19.1 million as of December 31, 2013. Approximately $2.1 million of this debt is related to the ACAP dissenters settlement that occurred during the fourth quarter of 2013. Approximately $12 million of this debt is related to a note extended to a majority owned subsidiary of UTG, HPG Acquisitions, LLC ("HPG"), during 2012. HPG borrowed money to return capital to its investors. UTG Avalon, LLC, a wholly owned subsidiary of UG, has an outstanding line of credit in the amount of $5 million. See Note 7 - Credit Arrangements in the Notes to the Consolidated Financial Statements for detailed disclosures regarding the Company's notes payable.
Shareholders' equity was $77.9 million and $79.7 million as of December 31, 2013 and 2012, respectively. Total shareholders' equity decreased approximately 2% in 2013 compared to 2012. The decrease is primarily attributable to the change in accumulated other comprehensive income. The unrealized change in fixed maturity investments available for sale was mainly responsible for the accumulated other comprehensive income decrease. The general rise in interest rates during 2013 was the main driver for lower market prices on the fixed maturity investments.
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 market value.
In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of UTG, Inc. and subsidiaries as of December 31, 2013 and 2012, and the consolidated results of their operations and their consolidated cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
Basis of Presentation - The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("GAAP"), under guidance issued by the Financial Accounting Standards Board ("FASB"). The preparation of financial statements in accordance with GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Discounted Mortgage Loans on Real Estate - Discounted mortgage loans on real estate are loans that the Company purchased at a deep discount through an auction process led by the Federal Government. In general, the discounted loans are non-performing and there is a significant amount of uncertainty surrounding the timing and amount of cash flows to be received by the Company. Accordingly, the Company records its investment in the discounted loans at its original purchase price adjusted for any principal receipts received. Management works with the borrower to reach a settlement on the loan or they foreclose on the underlying collateral which is primarily commercial real estate. For cash payments received during the work out process, the Company records these payments to interest income on a cash basis. For loan settlements reached, the Company records the amount in excess of the carrying amount of the loan as a discount accretion to investment income at the closing date. Management reviews the discount loan portfolio regularly for impairment. If an impairment is identified (after consideration of the underlying collateral), the Company records an impairment to earnings in the period the information becomes known.
Short-Term Investments - Short-term investments are reported at amortized cost, which approximates fair value.
Deferred Policy Acquisitions Costs - Commissions and other costs (salaries of certain employees involved in the underwriting and policy issue functions and medical and inspection fees) of acquiring life insurance products that vary with and are primarily related to the production of new business have been deferred. Deferred acquisition costs are amortized in a systematic manner which matches these costs with the associated revenues.
Future Policy Benefits and Expenses - The liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance subsidiary's experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. The Company makes these assumptions at the time the contract is issued or, in the case of contracts acquired by purchase, at the purchase date. Future policy benefits for individual life insurance and annuity policies are computed using interest rates ranging from 2% to 6% for life insurance and 2.5% to 9.25% for annuities. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. Current mortality rate assumptions are based on 1975-80 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or C, which are industry standard actuarial tables for forecasting assumed policy lapse rates.
Income Taxes - In July 2013, the Financial Accounting Standards Board ("FASB") issued guidance providing specific financial statement presentation requirements of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The guidance states that an unrecognized tax benefit in those circumstances should be presented as a reduction to the deferred tax asset. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.
Intangibles-Goodwill and Other - In July 2012, FASB issued guidance on the testing of indefinite-lived intangible assets for impairment, which is intended to reduce the cost and complexity of the impairment test for indefinite-lived intangible assets by providing an entity with the option to first assess qualitatively whether it is necessary to perform the impairment test that is currently in place. An entity would not be required to quantitatively calculate the fair value of an indefinite-lived intangible asset unless the entity determines that it is more likely than not that its fair value is less than its carrying value. This guidance is effective for interim and annual impairment tests beginning after September 15, 2012, with early adoption permitted. The adoption of this new guidance did not have a material impact on the Company's consolidated financial statements.
The Company held below investment grade investments with an estimated market value of $13,842,824 and $19,080,167 as of December 31, 2013 and 2012, respectively. The investments are all classified as "All other corporate bonds".
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, 2013 was $194,000 and $(353,907), respectively. The fair value of derivatives included in trading security assets and trading security liabilities as of December 31, 2012 was $6,745,528 and $(6,050,344), respectively. The derivatives held by the Company are for income generation purposes only.
During 2013 and 2012, the Company acquired $16,761,525 and $22,244,731 in mortgage loans, respectively, including both regular participation mortgage loans as well as discounted mortgage loans. FSNB services the mortgage loan portfolio of the Company. 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 amount to cover costs incurred by FSNB relating to the processing and establishment of the loan.
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 33.6 % 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, 2013 and 2012.
The following table reflects the Company's net investment income for the periods ended December 31:
The following table reflects the Company's net realized investments gains and losses for the periods ended December 31:
The other-than-temporary impairments recognized during 2013 and 2012 were taken as a result of Management's assessment and consideration of the length of time the securities have remained in an unrealized loss position and as a result of appraisal valuations. The investments were written down to better reflect their current expected market value.
The Company had investments with a fair value of $10,824,094 and $11,660,630 on deposit with various state insurance departments as of December 31, 2013 and 2012, respectively.
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 62% and 63% of UG's reinsurance reserve credit, as of December 31, 2013 and 2012, respectively.
On September 30, 1998, UG entered into a coinsurance agreement with The Independent Order of Vikings, (IOV) an Illinois fraternal benefit society. Under the terms of the agreement, UG agreed to assume, on a coinsurance basis, 25% of the reserves and liabilities arising from all in-force insurance contracts issued by the IOV to its members. At December 31, 2013, the IOV insurance in-force assumed by UG was approximately $1,551,000, with reserves being held on that amount of approximately $350,000. At December 31, 2012, the IOV insurance in-force assumed by UG was approximately $1,579,000, with reserves being held on that amount of approximately $358,000.
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 statutes of limitation for the assessments of additional tax are closed for all tax years prior to 2010. Management believes that adequate provision has been made in the consolidated financial statements for any potential assessments that may result from future tax examinations and other tax-related matters for all open tax years.
The UTG Avalon line of credit issued on January 3, 2013 carried interest at a rate of 4.0% and was payable in two semi-annual payments. This line of credit was repaid during March 2013 and replaced by the line of credit described below.
UG is a member of the Federal Home Loan Bank ("FHLB"). This membership allows the Company access to additional credit up to a maximum of 50% of the total assets of UG. To be a member of the FHLB, the Company was required to purchase shares of common stock of FHLB. Borrowing capacity is based on 50 times each dollar of stock acquired in FHLB above the "base membership" amount. The Company had no borrowings on this line of credit during 2013 or 2012.
As part of the Texas Imperial Life Insurance Company sale, the Company remained contingently liable through December 30, 2013 for certain costs pending the outcome of an ongoing race-based audit of Texas Imperial Life Insurance Company by the Texas Department of Insurance. Management had conservatively estimated the Company's exposure and other costs at $50,000 based on information provided to date from the examination team. The Company carried a contingent liability of $47,727 in its financial statements as of December 31, 2012. Upon expiration of the contingency, the Company's contingent liability was reduced to $0 at December 31, 2013.
During the third quarter 2013, the Company and the dissenters agreed, in principle, to a settlement whereby the dissenting parties would receive a total consideration of $3,000,000. The settlement agreement was executed October 24, 2013. During the third quarter 2013, the Company increased the liability related to this matter in response to the settlement agreement. At September 30, 2013, the Company held a liability of $3,000,000 for this matter. The balance was settled on October 28, 2013, using the proceeds from the Company's line of credit as further described in Note 7.
The following table represents the total funding commitments and the unfunded commitment as of December 31, 2013 related to certain investments:
During 2006, the Company committed to invest in RLF III, LLC ("RLF"), which makes land-based investment in undervalued assets. RLF makes capital calls as funds are needed for continued land purchases.
During 2010, the Company made a commitment to invest in Llano Music, LLC ("Llano"), which invests in music royalties. Llano makes capital calls to its investors as funds are needed to acquire the royalty rights.
During 2012, the Company committed to invest in Marcellus HBPI, LP, which purchases land for leasing opportunities to those looking to harvest natural resources. Marcellus HPBI, LP makes capital calls to investors as funds are needed for continued land purchases.
During 2012, the Company committed to invest in PBEX, LLC, which purchases land for leasing opportunities to those looking to harvest natural resources. PBEX, LLC makes capital calls to investors as funds are needed for continued land purchases.
During 2013, the Company committed to invest in MM-Appalachia IV, LP, which purchases land for leasing opportunities to those looking to harvest natural resources. MM-Appalachia IV, LP makes capital calls to investors as funds are needed for continued land purchases.
Stock Repurchase Program - The Board of Directors of UTG has authorized the repurchase in the open market or in privately negotiated transactions of UTG's common stock. The Board of Directors approved resolutions for a total repurchase of $6 million. Repurchased shares are available for future issuance for general corporate purposes. This program can be terminated at any time. 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 2013, the Company repurchased 25,836 shares through the stock repurchase program for $320,980. Through December 31, 2013, UTG has spent $4,932,675 in the acquisition of 588,526 shares under this program.
Director Compensation - Effective September 18, 2013, each outside Director will annually receive $8,000 as a retainer and $1,000 per meeting attended. The compensation, however, shall be paid in UTG common stock. The value will be determined annually on the close of business December 20th or the next business day should December 20th be a weekend or holiday, based on the activity of the year just ending. UTG's director compensation policy also provides that Directors who are employees of UTG or its affiliates do not receive any compensation for their services as Directors except for reimbursement for reasonable travel expenses for attending each meeting. In December 2013, the Company issued 3,162 shares of its common stock as compensation to the Directors. The shares were valued at $10.75 per share, the market value at the date of issue. During 2013, the Company record $33,992 in operating expense related to this stock issuance.
The computation of diluted earnings per share is the same as basic earnings per share for the years ending December 31, 2013 and 2012, as there were no outstanding securities, options or other offers that give the right to receive or acquire common shares of UTG.
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, 2013, substantially all of the consolidated shareholders' equity represents net assets of UTG's subsidiaries.
On February 20, 2003, UG purchased $4,000,000 of a trust preferred security offering issued by First Southern Bancorp, Inc. ("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 dividends of $264,219 and $264,943 during 2013 and 2012, respectively. On March 30, 2009, UG purchased $1,000,000 of FSBI common stock. The sale and transfer of this security is restricted by the provisions of a stock restriction and buy-sell agreement.
The Company from time to time acquires mortgage loans through participation agreements with FSNB. FSNB services the Company's mortgage loans including those covered by the participation agreements. The Company pays a 0.25% servicing fee on these loans and a one-time fee at loan origination of 0.50% of the original loan amount to cover costs incurred by FSNB relating to the processing and establishment of the loan. The Company paid $93,285 and $102,447 in servicing fees and $1,250 and $81,851 in origination fees to FSNB during 2013 and 2012, respectively.
The Company reimbursed expenses incurred by employees of FSNB relating to travel and other costs incurred on behalf of or relating to the Company. The Company paid $45,669 and $90,939 in 2013 and 2012, respectively to FSNB in reimbursement of such costs. In addition, the Company began reimbursing FSNB a portion of salaries and pension costs for Mr. Correll and Mr. Ditto. The reimbursement was approved by the UTG Board of Directors and totaled $332,029 and $462,819 in 2013 and 2012, respectively, which included salaries and other benefits.
The non-cash acquisitions of bonds and common stock resulting from the recapture of reinsurance have been excluded from the accompanying statements of cash flows.
During the first quarter of 2013, UG's wholly-owned subsidiary, UTG Avalon, LLC, entered into a noncash transaction whereby the subsidiary obtained a new line of credit in the amount of $5 million and utilized the line of credit to repay the prior line of credit. The terms of the new line of credit are consistent with the terms of the prior line of credit.