FIC’s home office is located at River Place Corporate Park (previously called River Place Pointe), 6500 River Place Blvd., Building One, Austin, Texas. The Company occupies Building One of River Place Corporate Park, consisting of approximately 76,143 square feet of space. On June 1, 2005, the Company sold River Place Corporate Park to a non-affiliated party and entered into a lease with the purchaser with respect to Building One, for a five-year term at a rate of $28.00 per square foot, which is above the market rate in effect in June 2005, but was the prevailing rental rate at the time that FIC and its subsidiaries occupied the building in July 2000. The lease provides the Company with a right of cancellation at March 31, 2008. Upon the sale of Family Life in December, 2006, the Company evaluated its office space requirements. Based on this evaluation, the Company entered into sublease transactions with unrelated parties in the first quarter of 2007. Current sublease arrangements are expected to reduce the Company’s rent expense by $221,000 for the year ending December 31, 2008.
During late 2007, the Company notified the lessor of its intent to cancel the River Place Corporate Park lease as of March 31, 2008. Subsequent to this notification, the Company and the lessor entered into an amended lease agreement extending the lease term through March 31, 2009.
The Company also leases approximately 10,000 square feet in Cedar Park, Texas, to house the Company’s printing operations and warehouse storage. During 2007, the monthly base rental for the Cedar Park facility was $9,488. The original lease term ended on March 31, 2008. However, this lease has been extended to September 30, 2008 with a monthly base rental of $10,000.
In 2004, net income and earnings per share were affected by the cumulative effect of a change in accounting principle of $229,000. This amount represents the cumulative effect of changes in accounting recognition for sales inducements under Statement of Position 03-01, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts,” specifically bonus interest. The Company has certain universal life insurance products that are credited with bonus interest after applicable qualifying periods. The adoption of the new accounting principle changed the pattern of recognition of the bonus interest expense.
FIC announced that it will have a special meeting of shareholders on May 15, 2008, for the purpose of approving its proposed merger with Americo. Shareholders as of the record date of March 24, 2008, will be eligible to vote on the proposal.
Concurrently with the execution of the Merger Agreement, the directors and executive officers of FIC entered into voting agreements with Americo pursuant to which each such director or executive officer agreed, among other things, to vote all of their shares of common stock in favor of the approval and adoption of the Merger Agreement.
FIC or Americo may be required to pay a $2.5 million termination fee and/or reimbursement of expenses of up to $500,000 to the other party should certain circumstances occur that result in the termination of the Merger Agreement prior to closing.
Proceeds from the sale were used to improve FIC’s capital structure by retiring approximately $15.4 million of intercompany debt and for general corporate purposes. In addition, FIC agreed to retain the liabilities associated with Family Life’s defined benefit pension plan totaling $3.3 million, in exchange for which it received a corresponding transfer of assets from Family Life. FIC also purchased 324,320 shares of the FIC common stock owned by Family Life at a price of $6.80 per share.
Also, prior to the closing of the sale, the Family Life Pension Plan, along with its assets and liabilities, was transferred from Family Life to its upstream parent company and all current and future obligations of the Family Life Pension Plan remain the responsibility of the Company. Accordingly, pension assets, liabilities and costs were not included in discontinued operations.
Family Life owned 648,640 shares of FIC common stock prior to the sale. Such shares were reflected as treasury stock in the Company’s historical consolidated financial statements. Immediately preceding and as a condition of the sale of Family Life, 324,320 of these shares were acquired by the Company and the remaining 324,320 shares remained with Family Life at the time of the sale. Accordingly, the shares that remained with Family Life are now reflected as outstanding common stock shares as of December 31, 2006, and have been reflected as a sale of treasury stock in the accompanying consolidated financial statements.
Family Life shared certain operating costs, including personnel, premises, equipment and software, and other office and administrative expenses with FIC and its other subsidiaries through various sharing agreements. These agreements with Family Life were terminated upon its sale and Family Life (now the wholly-owned subsidiary of Manhattan Life) did not retain any employees, equipment, software or liability for leases. Accordingly, the discontinued operations of Family Life were adjusted to eliminate the estimated continuing expenses associated with these shared operating costs.
In conjunction with the sale, Family Life also entered into an administrative services agreement with the Company for a three month period following the sale. Pursuant to the agreement, the Company provided administrative services for Family Life through March 31, 2007, at which time Manhattan Life assumed all responsibilities for administering the Family Life business. The Company earned fees totaling $807,000 in the first quarter of 2007 for services performed for Family Life in accordance with the agreement. See Note 13 in the accompanying consolidated financial statements regarding litigation with Manhattan Life.
Effective with the beginning of the fourth quarter of 2007, the Company made the decision to cease sales of mortgage protection term products. A resulting impact of this decision is the accounting implications for the previously described deferred revenue liability recorded in conjunction with the Family Life coinsurance agreement. As the Company will no longer sell any mortgage term products subject to the coinsurance agreement, the Company recognized $1.3 million of the deferred revenue liability in the quarter ended September 30, 2007. This amount was reflected in other income in the accompanying consolidated statement of operations. The remaining $100,000 of the original liability balance relates to policies sold and recorded in the period from April 1, 2007 through September 30, 2007 which were subject to the coinsurance agreement. This amount will be amortized to income in future periods over the lives of these policies. Amortization of this remaining liability totaling $7,500 has been recognized through December 31, 2007.
During 2007, the equity of the shareholders of the Company (that is, the excess of the Company’s assets over its liabilities) increased $6.8 million. The change in FIC’s shareholders’ equity is primarily due to the following:
Combined net increase of $539,000 in additional paid-in capital and treasury stock as follows:
$363,000 related to the issuance of stock options during the year as described in Note 11 to the accompanying consolidated financial statements,
$171,000 for common shares issued in lieu of cash for portions of Company Board of Directors fees,
Decrease in net unrealized losses on fixed maturities available for sale of $3.7 million,
At the end of 2007, FIC had $648.7 million of assets under its direct management, exclusive of separate account assets. In broad terms, these funds were invested as follows:
The Company, working with Conning, also revised the investment policies of its insurance subsidiary in recent years. The new policies reiterate compliance with legal requirements of state insurance laws and regulations that are applicable to the Company. They also emphasize sensitivity to the way that FIC’s liabilities are likely to change over time and with changes in general interest rate levels. In practical terms, this means that the Company now focuses almost all of its investment in investment-grade securities, keeping the schedule of anticipated asset maturities in line with its projected cash needs. It also means that the Company attempts to keep the duration of its investment assets (a measure of the sensitivity of their value to changes in interest rates) in line with the duration of the Company’s liabilities. At December 31, 2007, the Company’s holdings of below investment grade securities totaled approximately 5.3% of the fixed maturity securities portfolio.
The Company’s investment portfolio does not have significant exposure to the subprime mortgage market. The portfolio holds $3.9 million par value of home-equity loan asset-backed securities. The securities have Standard & Poor’s ratings of AAA, were purchased in early 2003, and are comprised of loans originated in 2002. The performance of the underlying collateral, pools of fixed-rate mortgage loans, has been satisfactory, and the loans have paid down to under 50% of original par value. As of December 31, 2007, the aggregate unrealized loss on these bonds is approximately $12,000, which management believes can be primarily attributed to increases in market interest rates.
During 2007, net unrealized losses on fixed maturities available for sale decreased $7.0 million, prior to the effects of deferred policy acquisition costs and deferred taxes. The decrease in unrealized losses was primarily related to decreases in market interest rates. While interest rates have fluctuated rather significantly during 2007, the market interest rates at December 31, 2007 are now lower than rates at year end 2006.
Agency advances and other receivables, totaling $3.4 million and $929,000 at December 31, 2007 and 2006, respectively, consist primarily of agent balances, federal income taxes recoverable, receivables for securities, and other receivables. This increase of $2.5 million is attributed predominately to the implementation of FIN 48 as described in more detail under “Recent Adoption of Accounting Pronouncements.” Liabilities for unrecognized tax benefits, previously recorded as a reduction to current tax receivables, were reclassified and reported as other liabilities at March 31, 2007 and for subsequent periods in accordance with the new reporting requirements of FIN 48.
The costs related to acquiring new business, including certain costs of issuing policies and certain other variable selling expenses (principally commissions), are capitalized and treated as deferred policy acquisition costs (“DAC”) to be amortized over the life of the related policies. The increase in the Company’s DAC from December 31, 2006 to December 31, 2007, reflects that the capitalization of acquisition costs associated with sales of new insurance policies exceeded the amortization of such amounts capitalized in prior years. The present value of future profits of acquired business is the capitalized acquisition cost of blocks of insurance business that the Company has acquired from others in the past. This asset is amortized to expense as the profits are realized from the various blocks of acquired business and the policies in force gradually decrease. These two assets are also impacted by the net run-off in business that the Company experienced in 2007 and 2006, as shown in the following table.
For prior year comparative purposes, the changes for in-force from 2005 to 2006 for policies, traditional life insurance, universal life insurance, and annuity funds on deposit were (11.8)%, 0.0%, (6.7)%, and (15.4)%, respectively.
Investors Life had $338.7 million of separate account assets as of December 31, 2007 (not including the value of the Company’s own start-up investment in one of the accounts), as compared to $351.0 million at the end of 2006. These assets include (a) two variable annuity separate accounts that permit contractholders to allocate their contract values among a selection of third-party mutual funds and (b) $316.0 million held in custodian accounts in connection with investment annuity contracts. The investment annuity business was previously reinsured with Symetra Life Insurance Company (formerly Safeco Life Insurance Company), a third-party reinsurer, on a 90%/10% coinsurance basis, with Investors Life retaining 10% of such business. Effective June 1, 2006, Investors Life recaptured the previously reinsured investment annuity business with Symetra Life resulting in the retention of 100% of this business. This business increased other revenues by approximately $489,000 and $1.3 million during 2007 and 2006, respectively. However, as this is a closed block of business, annual revenues are expected to decrease as the policies in force decline. Investors Life is not marketing new separate account annuity contracts.
The Company’s insurance-related liabilities (future policy benefits and contractholder deposit funds) were $539.8 million at December 31, 2007, as compared to $570.8 million at December 31, 2006. The decrease in contractholder deposit funds and future policy benefits reflects the business run-off as previously described above. Contractholder fund withdrawals during 2007 were $57.0 million compared to contractholder fund deposits of $23.1 million during 2007, reflecting the primary reason for the decrease in the related liability.
In 2003, the Company borrowed $15 million through the issuance of trust preferred notes (the “2003 Notes”) which bear interest at the three-month LIBOR rate plus 4.2%, not to exceed 12.5% prior to May 2008. The 2003 Notes require the payment only of interest through May 22, 2033, when the entire $15 million must be repaid, but may be repaid without any prepayment penalty after May 2008.
Financial intermediaries such as FIC depend on their capital to absorb short-term fluctuations in asset and liability values in their financial structures. They also count on capital to support the growth of the business. One typical measure of the strength of a financial holding company such as FIC is the simple ratio of its shareholders’ equity to its total assets. For FIC this ratio was 6.8% at December 31, 2007, compared to 5.8% at December 31, 2006. If separate account assets were not included (which management believes is appropriate,) this ratio would have been higher by 3.6% and 3.0% at December 31, 2007 and 2006, respectively. The increase in the ratio in 2007 is primarily due to the net income of $3.6 million, declines in the unrealized loss on fixed maturity securities available for sale included in other comprehensive income of $3.7 million, and the decline in total managed assets of $38.6 million. Management believes that its current capital is sufficient to meet the Company’s liabilities.
The Company and its investment manager have developed asset-liability (“ALM”) models for the investment portfolio of FIC’s insurance company. These models focus on comparing the respective durations of the assets and liabilities of each company. Since duration is a direct measure of the sensitivity of an asset or liability to a change in interest rates, these ALM models are designed to allow the Company’s management to deploy investment assets in ways expected to moderate the impact of changes in interest rates on the equity of Investors Life.
Results of operations for 2007, 2006, and 2005 were net income of $3.6 million, and net losses of $24.8 million, and $165,000, respectively. However, in analyzing the Company’s results of operations, a separation of results between continuing and discontinued operations provides a more meaningful view. As previously described, the Company sold Family Life resulting in a loss from discontinued operations totaling $25.5 million in 2006, which consists of a $1.1 million loss on operations during the year and a $24.4 million loss on the sale. Losses from discontinued operations were $1.1 million in 2005.
Income from continuing operations totaled $3.6 million, $715,000 and $942,000 in 2007, 2006 and 2005, respectively.
A summary of the Company’s results of operations is as follows:
Policyholder benefits and expenses increased during 2007 by $4.1 million primarily attributable to significantly higher death benefits, along with increases in traditional policy reserve expenses resulting from the higher traditional premium production.
Amortization of deferred policy acquisition costs increased $910,000, primarily due to increased sales of traditional business by Investors Life since the third quarter of 2006 and the amortization relating to the DAC capitalized on these sales.
Gains were recognized on the sales of River Place Corporate Park of $8.5 million and other real estate of $761,000. Lease income, which is included in net real estate income, declined approximately $1.2 million in 2005, as compared to 2004, as a result of these sales.
The above described items need to be taken into consideration in drawing comparisons between the results from continuing operations in 2007 and other periods.
The declines in UL premiums and annuity deposits in 2007, 2006 and 2005, shown in the above table, reflect the net run-off of business from the Company’s existing book of business, and declining sales of new UL policies. Management has de-emphasized the sale of annuity and UL products since 2004 due primarily to the interest-rate environment and certain design features of FIC’s current annuity products. Most of the Company’s marketing efforts focused on the sale of traditional life insurance products, such as mortgage protection term insurance and final expense whole life insurance. Liabilities for contractholder deposit funds have declined from $511.4 million at December 31, 2004 to $424.9 million at December 31, 2007.
Earned insurance charges totaled $30.4 million, $31.7 million, and $32.8 million for the years ended December 31, 2007, 2006, and 2005, respectively. These revenues primarily consist of UL cost of insurance charges, but also include policy surrender charges, and policy administration charges. The decline in earned insurance charges is primarily due to reduced UL cost of insurance charges resulting from the net run-off of business.
Net investment income for the year ended December 31, 2007, was $31.0 million as compared to $29.3 million for the year ended December 31, 2006, and $25.8 million for the year ended December 31, 2005. The higher net investment income in 2007 versus 2006 was primarily due to increased dividend income earned on the Company’s investments in equity securities totaling $746,000 and improved investment yields. Dividend income earned on the equity securities totaled $941,000 for 2007 compared to $195,000 for 2006. The increase in net investment income from 2005 to 2006 of $3.5 million was primarily attributable to the reinvestment of cash and short-term investments and real estate sales proceeds into higher-yielding fixed maturity investments during the latter part of 2005 and 2006 consistent with the revised investment policies of the Company. The Company sold its investment in the River Place Corporate Park office complex in June 2005 for $103 million in cash. These proceeds were initially invested in short-term investments and subsequently reinvested into longer term fixed maturity securities resulting in increased net investment income versus real estate income. The increase in market interest rates has also had a positive impact on investment yields.
Effective with the beginning of the fourth quarter of 2007, the Company made the decision to cease sales of mortgage protection term products. A resulting impact of this decision is the accounting implications for the previously described deferred revenue liability. As the Company will no longer sell any mortgage term products subject to the coinsurance agreement, the Company recognized in income $1.3 million of the deferred revenue liability in the year ended December 31, 2007. The remaining $100,000 of the original liability balance relates to policies sold and recorded in the period from April 1, 2007 through September 30, 2007 which were subject to the coinsurance agreement. This amount will be amortized to income in future periods over the lives of these policies. Amortization of this remaining liability totaling $7,500 has been recognized through December 31, 2007.
Policyholder benefits and expenses, which consist primarily of death benefit claims, totaled $30.8 million, $26.7 million, and $29.9 million for the years ended December 31, 2007, 2006, and 2005, respectively. The increases and decreases noted during each of these years are primarily attributable to changes in death benefits. Additionally, in 2007, the increase in traditional premium revenues for 2007 also caused a corresponding increase in traditional policy reserve expenses.
Interest expense on contractholder deposit funds represents interest paid or credited to contractholders on cash values accumulated in their universal life insurance and annuity accounts. Interest expense totaled $17.2 million in 2007, $18.0 million in 2006, and $18.4 million in 2005. The decreases in interest expense noted during these years reflect the net run-off of business from the Company’s existing book of business, and, consequently, the decline in 2007 is primarily attributable to this overall reduction in the level of contractholder deposit funds. Liabilities for contractholder deposit funds have declined from $511.4 million at December 31, 2004 to $424.9 million at December 31, 2007.
The level of market interest rates can affect the interest spread which is the difference in the Company’s investment portfolio rate and the interest rates credited on policyholder contracts for universal life insurance and annuities. The Company responded to lower market rates in 2004 and 2005 by lowering many of the credited rates on its policies in these periods. However, universal life insurance and annuity policies have contractual minimum guaranteed rates and credited rates cannot be lower than such minimums. Because many of the Company’s policies have minimum guaranteed rates of 4.0%, the market interest rate environment in prior periods put pressure on the Company’s interest spread. Market rate increases in 2005 and 2006 have improved the Company’s interest spread.
Present value of future profits on acquired businesses (“PVFP”) is amortized in a similar manner as DAC, as previously described, for traditional and interest sensitive business. Amortization of PVFP totaled $988,000, $902,000, and $1.1 million for the years ended December 31, 2007, 2006, and 2005, respectively. The amortization is consistent with the run-off of the acquired blocks of business.
Operating expenses for 2007 were $20.4 million, as compared to $20.6 million in 2006 and $21.8 million in 2005. The Company has implemented cost reduction measures every year since 2004, and this continues to be a critical focus for the Company. However, audit, actuarial, accounting and other consulting, and legal fees continue to represent a significant component of operating expenses as the Company completed its delinquent SEC filings with the filing of Form 10-Q for the period ended March 31, 2007. As indicated in the table below, these fees totaled approximately $6.5 million, $6.6 million, and $5.6 million for 2007, 2006, and 2005, respectively.
Interest expense for 2007, 2006 and 2005 totaled $1.4 million, $1.4 million and $1.1 million, respectively. As previously disclosed in this Item 7, the interest expense relates to debt service on the $15 million trust preferred notes (the “2003 Notes”). The 2003 Notes bear interest quarterly at the three-month LIBOR rate plus 4.2%. Interest expense for 2007, 2006 and 2005 reflects an average annual interest rate of approximately 9.5%, 9.4% and 7.6%, respectively. The higher interest expense in 2007 and 2006 is a direct result of the increase in the LIBOR rate.
The provision for federal income taxes on income from continuing operations reflects income tax expense totaling $0.4 million, $2.9 million and $0.6 million for the years 2007, 2006 and 2005, respectively. These tax amounts equate to effective tax expense rates of 9.7%, 80.3%, and 39.7% for the years ended December 31, 2007, 2006, and 2005, respectively. The primary reason for the significant deviation from the expected statutory tax rate of 34% for the Company for the year 2007 is due to a decrease in the Company’s valuation allowance for deferred tax assets. The decrease in the valuation allowance is primarily a result of an increase in life insurance company deferred tax liabilities that have the ability to offset non-life insurance company deferred tax assets. In addition, the valuation allowance decreased due to the expiration of a tax attribute carryfoward in 2007 against which the Company previously maintained a valuation allowance. The primary reason for the significant deviation from the expected statutory tax rate of 34% for the Company for the year 2006 is due to an increase in the Company’s valuation allowance for deferred taxes resulting from the sale of Family Life. The sale of Family Life removed the source of income supporting certain deferred tax assets at the FIC consolidated level. The primary reason for the significant deviation from the expected statutory tax rate of 34% for the Company for the year 2005 is due to an increase in the Company’s valuation allowance for deferred tax assets. Under SFAS No. 109, the Company has established a valuation allowance when, based on the weight of the available evidence, it is more likely than not that some portion of its deferred tax assets will not be realized. Realization of deferred tax assets is dependent upon the Company’s generation of sufficient taxable income in the future to recover tax benefits that cannot be recovered from taxes paid in prior periods. The Company’s deferred tax assets are primarily comprised of net operating losses and pension liabilities of FIC and its non-life insurance wholly owned subsidiaries and unrealized losses and policy reserves of its life insurance subsidiary. These non-life net operating loss carry forwards totaled approximately $35.3 million at year-end 2007 and begin to expire in 2008 through 2027. The valuation allowance totaled $12.1 million at December 31, 2007. Additions and (reductions) to the allowance totaled $(0.2) million, $2.1 million and $0.4 million in 2007, 2006 and 2005, respectively. The decrease in the valuation allowance in 2007 is composed of a $931,000 increase related to the adoption of FIN 48 at January 1, 2007, offset by a $1.2 million decrease during 2007. Of the $1.2 million decrease during 2007, the amount of the decrease allocated to continuing operations and other comprehensive income is $1.1 million and $0.1 million, respectively. The additions (reductions) in 2006 include $2.0 million related to continuing operations, $0.5 million related to discontinued operations, and $(0.4) million related to other comprehensive income. The additions in 2005 include $0.1 million related to continuing operations and $0.3 million related to other comprehensive income.
Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of its business operations. FIC is an insurance holding company whose principal assets at and for the year ended December 31, 2007, consisted of its ownership interests in its insurance subsidiary, Investors Life. As a holding company, FIC’s ability to pay interest and principal on its debt, pay its expenses and pay dividends on its common stock depend substantially on its receipt of dividends or other cash flow from Investors Life.
At the holding company level, FIC’s principal current ongoing liquidity demands relate to debt service on the $15 million of 2003 Notes that it issued in May 2003. (See “Financial Condition - Liabilities” earlier in this Item 7.) These notes require quarterly interest payments at a variable interest rate of the three-month LIBOR rate plus 4.2% (which yielded an average rate of approximately 9.5% for 2007). The principal amount of the 2003 Notes must be repaid in a single payment in 2033.
In June 2004, FIC, with the approval of TDI, created FIC Insurance Services, L.P., a service company subsidiary, and transferred to it many of the administrative functions of the insurance companies. The service company charges Investors Life a monthly service fee that is calculated using a formula based on policies under management, new policies issued, managed assets, and other factors. Profits earned by the service company are paid as dividends to the holding company, providing an additional source of liquidity at the holding company level. Profits earned by the service company have decreased in 2007, as fees have declined due to the sale of Family Life on December 29, 2006. This agreement with the service company was terminated by Family Life upon the sale of Family Life to The Manhattan Life Insurance Company. Additionally, the Company amended the service agreement in October 2007 at the request of TDI. Under the revised terms of the agreement, the fees charged to Investors Life are limited to actual costs incurred. This will effectively negate the ability to generate future profits, except from non-related external sources, which will limit future dividend capabilities of the service company.
Liquidity considerations at Investors Life are different in nature than for the holding company. Sources of cash for Investors Life consist of premium payments and deposits from policyholders and annuity holders, charges on policies and contracts, investment income, and proceeds from the sale of investment assets. These funds are applied primarily to provide for the payment of claims under insurance and annuity policies, payment of policy withdrawals, surrenders and loans, operating expenses, taxes, investments in portfolio securities, and shareholder dividends.
Other policy claims and benefits represent benefit and claim liabilities for which the Company believes the amount and timing of the payment is essentially fixed and determinable. Such amounts generally relate to (1) policies or contracts where the Company is currently making payment and will continue to do so until the occurrence of a specific event and (2) incurred and reported claims.
FIC’s overall liquidity experience in recent periods is reflected in its consolidated statements of cash flows, the highlights of which are summarized in the following table for continuing operations.
For the year ended December 31, 2007, net cash used in operating activities was $9.4 million compared to net cash provided by operating activities of $24.9 million and net cash used in operating activities of $3.3 million for the years ended December 31, 2006, and 2005, respectively. The most notable change between 2007 and 2006 is a decrease in other liabilities of $14.8 million, partially offset by the Company’s net income of $3.6 million and a decrease in policy liabilities and accruals of $3.3 million. The primary changes noted between 2006 and 2005 were increases in other liabilities and deferred income taxes, and decreases in reinsurance receivables. The increase in other liabilities in 2006 is the most significant change which is primarily related to amounts due for unsettled transactions for purchased securities of $15.2 million. The settlement of these transactions in 2007 is the primary reason for the subsequent decrease in other liabilities.
Net cash used in financing activities totaled $34.2 million, $26.4 million and $32.7 million in 2007, 2006 and 2005, respectively. The most significant components of the Company’s financing activities are contractholder fund deposits and withdrawals for annuity and universal life insurance policies. For 2007, 2006, and 2005, contractholder fund withdrawals exceeded deposits by $33.8 million, $28.9 million and, $32.7 million, respectively. The change in net withdrawals in 2007 is primarily related to the decline in contractholder fund deposits of $4.5 million. The change in net withdrawals in 2006 was due to a decline in deposits in 2006 from 2005 of $2.2 million and a decline in withdrawals of $6.1 million for the same period.
Total contractholder fund withdrawals for 2007, 2006, and 2005, totaled $57.0 million, $56.5 million, and $62.6 million, respectively. Contractholder fund withdrawals are a normal part of the run-off of any company’s existing book of business.
Also included in 2006 financing activities is $2.5 million in cash provided from the sale of treasury stock. Immediately prior to the sale of Family Life to Manhattan Life, Family Life owned 324,320 shares of FIC common stock, which were reflected as treasury stock for consolidated financial statement purposes. Upon the sale of Family Life, these shares were recorded as a sale of treasury stock and are now reflected as outstanding FIC common stock shares. The $2.5 million received for the sale of these shares is an allocated portion of the total $28.0 million purchase price for Family Life.
Liquidity management is designed to ensure that adequate funds are available to meet all current and future financial obligations. The Company meets its liquidity requirements primarily by funding cash used in operations with cash flows provided by investing activities. Proper liquidity management is crucial to preserve stable, reliable, and cost-effective sources of cash to meet the future benefit payments under our various insurance and deposit contracts, pay operating expenses (including interest and income taxes), and maintain reserve requirements. In this process, we focus on our assets and liabilities, and the impact of changes in both short-term and long-term interest rates, market liquidity and other factors. We believe we have the ability to generate adequate cash flows for operations on a short-term and a long-term basis.
Projections used to determine the rate of amortization of DAC and PVFP also require assumptions about investment returns, product loads, mortality rates, persistency rates, and maintenance expense levels. DAC and PVFP for traditional type life products is reported under Statement of Financial Accounting Standards No. 60 (“SFAS 60”), pursuant to which DAC and PVFP is amortized over the premium paying period in proportion to the present value of estimated future gross premiums. The projection assumptions for SFAS 60 business are set at the time of policy issue. Under SFAS 60, these assumptions are “locked in” and are not revised for the lifetime of the policies, except where there is a premium deficiency. Variability in amortization after policy issuance is caused only by variability in premium volumes, except for premium deficiencies.
At December 31, 2007 and 2006, DAC and PVFP related to SFAS 60 products totaled $8.1 million and $5.7 million, respectively.
The following table reflects the effect on DAC and PVFP of changing each of the respective assumptions during the years ended December 31, 2007 and 2006. These changes were recorded as additional expense in the Company’s consolidated statement of operations.
At December 31, 2007 and 2006, DAC and PVFP related to SFAS 97 products totaled $13.7 million and $16.5 million, respectively.
Once established, assumptions for these traditional life insurance products are generally not changed for policies issued under those assumptions. In accordance with SFAS 60, original assumptions shall continue to be used in subsequent accounting periods to determine changes in the liability for future policy benefits (often referred to as the “lock-in concept”) unless a premium deficiency exists.
Effective January 1, 2007, the Company adopted SFAS No. 155, “Accounting for Certain Hybrid Instruments” (“SFAS No. 155”). This statement amends SFAS No. 133 and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. The provisions of SFAS No. 155 (1) permit fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, (2) clarify which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, (3) establish a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, (4) clarify that concentrations of credit risk in the form of subordination are not embedded derivatives, and (5) amend SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. The adoption of SFAS No. 155 did not have a material impact on the Company’s consolidated financial statements.
In September, 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 establishes a common definition for fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 will be applied prospectively and is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. SFAS 157 will not have a material impact on the Company’s consolidated financial statements.
In February, 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits all entities the option to measure most financial instruments and certain other items at fair value at specified election dates and to report related unrealized gains and losses in earnings. The fair value option will generally be applied on an instrument-by-instrument basis and is generally an irrevocable election. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company does not plan to adopt SFAS 159.
In December, 2007, the SEC staff issued Staff Accounting Bulletin No. 110 (“SAB 110”). SAB 110 documents the views of SEC staff regarding the use of a “simplified” method in developing an estimate of expected term of “plain vanilla” share options in accordance with FASB Statement No. 123, “Share-Based Payment.” The guidance in this release is effective January 1, 2008. SAB 110 is not expected to have a material impact on the Company’s consolidated financial statements.
Report of Deloitte & Touche LLP, Independent Registered Public Accounting Firm, dated May 30, 2007.
Consolidated Statements of Operations for the years ended December 31, 2007, 2006, and 2005.
Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006, and 2005.