Midwest Holding Inc., a Nebraska corporation, (we, us, our, Midwest, the Company or the Registrant) was formed on October 31, 2003 for the primary purpose of becoming a financial services holding company. We presently conduct our business through our wholly owned subsidiary, American Life & Security Corp. (American Life). Capital Reserve Life Insurance Company of Jefferson City, Missouri (Capital Reserve) is a dormant, wholly owned subsidiary of American Life. On August 5, 2014, Great Plains Financial (Great Plains) was acquired by us. The wholly owned subsidiary, Great Plains Life Assurance Company (Great Plains Life) became a subsidiary of Midwest and then became a wholly owned subsidiary of American Life through a capital contribution from us.
On July 12, 2010, in order to provide additional capital, we commenced an offering of up to 2,000,000 additional shares of voting common stock to existing shareholders who were residents of the State of Nebraska. This offering was completed on February 28, 2011 and a total of 1,554,326 additional shares of voting common stock were sold. The gross proceeds of this sale were approximately $7.7 million. These proceeds were used to fund the acquisition of Old Reliance Insurance Company as described below, to further capitalize our insurance operations, for working capital and general corporate purposes.
On November 8, 2010, the Company entered into an agreement to acquire all of the issued and outstanding capital stock of Old Reliance. American Life merged into Old Reliance following the purchase, with the survivor changing its name to American Life & Security Corp. In the transaction, the sole shareholder of Old Reliance received: (i) approximately $1.6 million in cash, (ii) $500,000 in the form of a surplus debenture and (iii) 150,000 shares of voting common stock of the Company ($750,000 fair value). The transaction, including the merger, was consummated on August 3, 2011.
In August 2011, we acquired a controlling interest ownership of Hot Dot, Inc. (Hot Dot) for $50,000, a company organized in August 2011 to develop, manufacture, and market the Hot Dot Alert Patch. During the third quarter of 2011, Hot Dot purchased certain assets of IonX Capital Holding Inc. On September 12, 2012, Hot Dot repurchased 1,000,000 shares of Hot Dot stock from us for a purchase price of $750,000. As a result of the stock repurchase by Hot Dot, we ceased to have a controlling financial interest in Hot Dot and subsequently deconsolidated Hot Dot on the effective date of the stock repurchase. In October 2014, Hot Dot repurchased the remaining 1,500,000 shares of Hot Dot stock from us for a purchase price of $775,000. This resulted in a capital gain of $251,102.
During the first quarter of 2012, we purchased additional shares of Great Plains after earlier acquiring a small interest. As a result of the increased ownership, we changed our method of carrying the investment from cost to equity. During the third quarter of 2012, we began providing TPA services to Great Plains and Great Plains Life. At the end of the third quarter of 2012, Mark Oliver, our Chief Executive Officer and a member of our Board of Directors, was appointed to serve as President of Great Plains in addition to his role as CEO and CFO of Great Plains. During the fourth quarter of 2012, we purchased additional shares of Great Plains, which increased our ownership to 24.5% as of December 31, 2012. As a result of our ability to significantly influence the operations of Great Plains Financial, we began consolidating Great Plains during the fourth quarter of 2012. An additional purchase of shares in the first quarter of 2013 increased our ownership of Great Plains to 25.7%. Great Plains was acquired by us on August 5, 2014, through a share exchange as described below.
On February 20, 2013, we commenced a private placement offering under Regulation D of the Securities Act of 1933. Sales of voting common shares were made in Units, with each Unit consisting of fifty shares of voting common stock and one detachable warrant to purchase ten shares of voting common stock at an exercise price of $6.50 per share exercisable through December 31, 2016 for gross proceeds of $353,700. This offering ended October 31, 2013.
On November 25, 2013, we entered into a Plan and Agreement of Exchange (the “Exchange Agreement”) with Great Plains and Security Capital whereby the shareholders of Great Plains and Security Capital would receive shares of our voting common stock equal to an agreed upon value of shares currently owned in each respective company. Great Plains shareholders’ received 1.298 shares of our voting common stock for each share of Great Plains owned. Security Capital shareholders received approximately 0.162 shares of our voting common stock for each share of Security Capital common stock held by the shareholders.
The Exchange Agreement required the approval of the shareholders of both Great Plains and Security Capital. We filed a Registration Statement on Form S-4 with the Securities and Exchange Commission (SEC) pursuant to which we registered 4,120,261 shares of our voting common stock. The Exchange Agreement was approved by the shareholders of each of Great Plains and Security Capital at special shareholders’ meetings held on June 30, 2014 and July 1, 2014, respectively. The Exchange Agreement was consummated on July 21, 2014.
During the first quarter of 2014, we purchased additional shares of Pacific Northwest Capital Corporation (PNC) increasing our ownership to 22.4%. We changed our method of carrying the investment from cost to equity.
Our principal investments are in fixed maturity and equity securities. Fixed maturity and equity securities, which are classified as available for sale, are carried at their fair value in the consolidated balance sheets, with unrealized gains or losses recorded in comprehensive income (loss). We utilize external independent third-party pricing services to determine the fair values on investment securities available for sale. We have routines, processes, and controls in place to review prices received from service providers for reasonableness and unusual fluctuations. In the event that a price is not available from a third-party pricing service, we pursue external pricing from brokers. Generally, we pursue and utilize only one broker quote per security. In doing so, we solicit only brokers which have previously demonstrated knowledge and experience of the subject security.
Incremental direct costs, net of amounts ceded to reinsurers, that result directly from and are essential to the contract acquisition transaction and would not have been incurred by us had the contract acquisition not occurred, are capitalized, to the extent recoverable, and amortized over the life of the premiums produced. Recoverability of deferred acquisition costs is evaluated periodically by comparing the current estimate of the present value of expected pretax future profits to the unamortized asset balance. If this current estimate is less than the existing balance, the difference is charged to expense.
Value of business acquired (VOBA) represents the estimated value assigned to purchased companies or insurance in force of the assumed policy obligations at the date of acquisition of a block of policies. At least annually, a review is performed of the models and the assumptions used to develop expected future profits, based upon management’s current view of future events. VOBA is reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts. Management’s view primarily reflects our experience but can also reflect emerging trends within the industry. Short-term deviations in experience affect the amortization of VOBA in the period, but do not necessarily indicate that a change to the long-term assumptions of future experience is warranted. If it is determined that it is appropriate to change the assumptions related to future experience, then an unlocking adjustment is recognized for the block of business being evaluated. Certain assumptions, such as interest spreads and surrender rates, may be interrelated. As such, unlocking adjustments often reflect revisions to multiple assumptions. The VOBA balance is immediately impacted by any assumption changes, with the change reflected through the statements of comprehensive income as an unlocking adjustment in the amount of VOBA amortized. These adjustments can be positive or negative with adjustments reducing amortization limited to amounts previously deferred plus interest accrued through the date of the adjustment.
Goodwill represents the excess of the amounts paid to acquire subsidiaries and other businesses over the fair value of their net assets at the date of acquisition. Goodwill is tested for impairment at least annually in the fourth quarter or more frequently if events or circumstances change that would indicate that a triggering event has occurred.
We performed the first step of the goodwill quantitative analysis to determine if the fair value of the reporting unit was in excess of the carrying value. As of December 31, 2014, the fair value of each of our reporting units exceeded the carrying value of the net assets assigned to that unit; therefore we were not required to perform further testing for impairment. Management's determination of the fair value of each reporting unit incorporates peer company price to earnings multiples and assumptions that market participants would make in valuing the reporting unit. Other assumptions can include levels of economic capital, future business growth, and earnings projections.
When American Life commenced operations in September 2009, we began to receive premium income from the sales of life insurance. Capital Reserve, acquired in 2010, has had minimal impact on operations as it has no premium income or related expenses. Management expects the premium writings in American Life and Great Plains to increase in the next few years as the business continues to expand, and as assets and policy reserves grow, expects investment income to grow also. An evaluation of the optimal use of the assets obtained in the acquisitions of Capital Reserve and Old Reliance is ongoing.
Insurance revenues are primarily generated from premium revenues and investment income. Insurance revenues for the years ended December 31, 2014 and 2013 are summarized in the table below.
Miscellaneous income: Miscellaneous income for 2014 was $295,246 compared to $246,328 in 2013, due primarily to third-party administration fee income earned in 2014 from non-consolidated entities.
Expenses for the years ended 2014 and 2013 are summarized in the table below.
Amortization of deferred acquisition costs: Incremental direct costs that result directly from and are essential to the contract acquisition transaction and would not have been incurred by us had the contract acquisition not occurred, are capitalized and amortized over the life of the premiums produced. The majority of these acquisition expenses consist of commissions paid to agents, underwriting costs, and certain marketing expenses. In accordance with GAAP, these costs are capitalized, to the extent recoverable, and amortized over the life of the premiums produced. The amortization of such costs was $625,680 in 2014, compared to $861,840 in 2013 due to a decline in new business written.
The following table shows the distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value as of December 31, 2014 and 2013.
We attempt to mitigate our exposure to adverse interest rate movements through staggering the maturities of the fixed maturity investments and through maintaining cash and other short term investments to assure sufficient liquidity to meet its obligations and to address reinvestment risk considerations. Due to the composition of our book of insurance business, we believe it is unlikely that we would encounter large surrender activity due to an interest rate increase that would force the disposal of fixed maturities at a loss.
Aside from raising capital, which has funded the vast majority of our operations, premium income, deposits to policyholder account balances, and investment income are the primary sources of funds while withdrawals of policyholder account balances, investment purchases, policy benefits in the form of claims, and operating expenses are the primary uses of funds. To ensure we will be able to pay future commitments, the funds received as premium payments and deposits are invested in primarily fixed income securities. Funds are invested with the intent that the income from investments, plus proceeds from maturities, will in the future meet our ongoing cash flow needs. The approach of matching asset and liability durations and yields requires an appropriate mix of investments. Our investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs. Cash flow projections and cash flow tests under various market interest scenarios are also performed annually to assist in evaluating liquidity needs and adequacy. We currently anticipate that available liquidity sources and future cash flows will be adequate to meet our needs for funds for 2015.
Insurance premiums are established before the amount of losses and loss adjustment expenses, or the extent to which inflation may affect such losses and expenses, are known. We attempt, in establishing premiums, to anticipate the potential impact of inflation. If, for competitive reasons, premiums cannot be increased to anticipate inflation, this cost would be absorbed by us. Inflation also affects the rate of investment return on the investment portfolio with a corresponding effect on investment income.