The Company currently leases office space at 8101 “O” Street, Suite S111, Lincoln, Nebraska 68510. This lease was executed August 28, 2009, amended on January 21, 2011, and expires on January 31, 2014. As part of the acquisition of Old Reliance, the Company assumed a lease for the headquarters of Old Reliance in Colorado Springs, Colorado that expired on December 31, 2012. The Company also subleases office space for a satellite office in Kearney, Nebraska, which was executed on June 11, 2012 and expires on May 1, 2015. Great Plains Financial entered into a lease on May 1, 2011 for office space in Pierre, South Dakota, which expires on April 30, 2014.
As a “smaller reporting company,” the Company is not required to provide disclosure pursuant to this Item.
From our inception, we have raised approximately $17.5 million through sales of shares of voting common stock in several private placements and an intrastate public offering in the State of Nebraska.
During the third quarter of 2011, control was attained on a previous noncontrolling interest in Security Capital Corporation (Security Capital), an Arkansas corporation formerly known as Arkansas Security Capital Corporation. Security Capital is a development stage company that has not conducted operations apart from raising capital.
The Company commenced its third party administrative (“TPA”) services in 2012 as an additional revenue source. These agreements, for various levels of administrative services on behalf of each company, generate fee income for the Company. Services provided to each company vary based on their needs and can include some or all aspects of back-office accounting and policy administration. We have been able to perform our TPA services using our existing in-house resources.
During the first quarter of 2012, the Company purchased additional shares of Great Plains Financial. As a result of the increased ownership, the Company changed its method of carrying the investment from cost to equity. During the third quarter of 2012, the Company began providing TPA services to Great Plains Financial and Great Plains Financial’s wholly owned subsidiary, Great Plains Life Assurance Company (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 assigned to serve as President of the Company in addition to his role as Executive Vice President, CEO, and CFO of Great Plains Financial. During the fourth quarter of 2012, the Company purchased additional shares of Great Plains Financial, which increased our ownership to 24.5% as of December 31, 2012. As a result of the Company’s control over Great Plains Financial, the Company began consolidating Great Plains Financial during fourth quarter of 2012.
The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States of America. Preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The following is an explanation of the Company’s accounting policies and the estimates considered most significant by management. These accounting policies inherently require significant judgment and assumptions and actual operating results could differ significantly from management’s estimates determined using these policies. We believe the following accounting policies, judgments and estimates are the most critical to the understanding of the results of operations and financial position. A detailed discussion of significant accounting policies is provided in Note 1 - Nature of Operations and Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements.
The Company has a policy and process in place to identify securities that could potentially have an impairment that is other-than-temporary. The assessment of whether impairments have occurred is based on a case-by-case evaluation of underlying reasons for the decline in fair value. The Company considers severity of impairment, duration of impairment, forecasted recovery period, industry outlook, financial condition of the issuer, projected cash flows, issuer credit ratings and whether the Company intends to sell a security or it is more likely than not that the Company would be required to sell a security prior to the recovery of the amortized cost.
The Company prospectively adopted Accounting Standards Update (ASU) 2010-26 “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts,” effective January 1, 2012. Under the new guidance, incremental direct costs that result directly from and are essential to the contract acquisition transaction and would not have been incurred by the Company had the contract acquisition not occurred, are capitalized and amortized over the life of the premiums produced. The amount of acquisition costs capitalized during the year ended December 31, 2012 were $1,173,683. The amount of acquisition costs that would have been capitalized during the year ended December 31, 2012 if the Company’s previous policy had been applied during that period would have been $1,005,538. Thus, the adoption of this guidance resulted in a $168,145 increase in the amount of acquisition costs capitalized during the year.
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 Company 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.
For a reporting unit in which the qualitative impairment assessment concludes that it is more likely than not that the fair value is less than its carrying value, we perform the first step of the quantitative goodwill impairment test, which compares the fair value of the reporting unit to its carrying value. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not considered impaired and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step of the goodwill impairment test in order to determine the implied fair value of the reporting unit’s goodwill. If, during this second step, we determine that the carrying value of a reporting unit’s goodwill exceeds its implied fair value, we would record an impairment loss equal to the difference.
The Company 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, 2012, the fair value of the Company’s reporting units exceeded the carrying value of the net assets assigned to that unit and the Company was not required to perform further testing for impairment. Management's determination of the fair value of each reporting unit incorporates multiple inputs including discounted cash flow calculations, 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.
The Company assesses the recoverability of indefinite-lived intangible assets at least annually or whenever events or circumstances suggest that the carrying value of an identifiable indefinite-lived intangible asset may exceed the sum of the future discounted cash flows expected to result from its use and eventual disposition. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset.
Revenues on traditional life insurance products consist of direct and assumed premiums reported as earned when due.
Our income prior to commencing insurance operations in 2009 came from our investments, which were nominal due to the need to maintain liquidity. When American Life commenced operations in September 2009, we also 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 best 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, 2012 and 2011 are summarized in the table below.
Investment income, net of expenses: The components of net investment income for the years ended December 31, 2012 and 2011 are as follows:
Investment income, net of expenses was $480,183 in the year ended December 31, 2012 compared to $351,115 in the year ended December 31, 2011. The increase for the year ended December 31, 2012 is due to higher average invested balances as a result of investment of capital along with the acquisition of Great Plains Financial and offset by lower gains on equity method investments. Interest from mortgage loans on real estate, income from real estate investments, policy loan interest, and miscellaneous investment income is included in the “Other” line item above. A majority of the Company’s “Other” investment income results from assets such as real estate, mortgage loans, and policy loans, which were acquired in the Old Reliance acquisition that was consummated in August 2011.
Net realized gains on investments: Net realized gains on investments in the year ended December 31, 2012 was $134,120 compared to $25,628 in the year ended December 31, 2011. The Company sold these securities to reposition its available for sale portfolio and to take advantage of gains due to favorable interest rate positions.
Expenses for the years ended December 31, 2012 and 2011 are summarized in the table below.
Death and other benefits: Death and other policy benefits were $814,306 in the year ended December 31, 2012 compared to $383,899 in the year ended December 31, 2011. The increase in death and other policy benefits for the year ended December 31, 2012 is primarily attributable to a full year’s worth of expense being recognized in 2012 following the acquisition of Old Reliance, which was consummated in August 2011. Death benefits for American Life and Great Plains were nominal in 2012 and 2011.
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 the Company 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 accounting principles generally accepted in the United States of America (GAAP), these costs are capitalized and amortized over the life of the premiums produced. The amortization of such costs was $631,121 in the year ended December 31, 2012, compared to $624,650 in the year ended December 31, 2011. The increase in amortization, results from an increase in the balances of deferred acquisition costs period over period. During the first quarter of 2012, the Company recorded a one-time adjustment related to our estimated amortization period for recognizing deferred acquisition costs creating a negative amortization amount.
Salaries and benefits: Salaries and benefits were $2,344,268 in the year ended December 31, 2012 compared to $2,534,175 in the year ended December 31, 2011. This decrease in payroll for the year ending December 31, 2012 compared to the same period in 2011 results from primarily from synergies and cost sharing of payroll expenses amongst Midwest affiliates.
Loss attributable to noncontrolling interests: Midwest owns approximately 60% of the capital stock of Security Capital Corporation, approximately 24.7% of the capital stock of Hot Dot on the deconsolidation date of September 12, 2012, and approximately 24.5% of Great Plains Financial. Security Capital is consolidated on Midwest’s financial statements, Hot Dot was consolidated on Midwest’s financial statements through September 12, 2012 prior to being deconsolidated, and Great Plains Financial was consolidated on Midwest’s financial statements beginning on October 1, 2012. The loss attributable to noncontrolling interests on Midwest’s financial statements represents the allocation of pro rata portions of the net loss of Hot Dot to the other, noncontrolling shareholders of Hot Dot from January 1, 2012 through September 12, 2012 and the net loss of Great Plains Financial to the other, noncontrolling shareholders of Great Plains Financial from October 1, 2012 through December 31, 2012. Security Capital has not had any income or expense for the past two years. The loss attributable to noncontrolling interests was ($861,622) for the year ended December 31, 2012, compared to ($72,773) for the year ended December 31, 2011. The increase in loss attributable to noncontrolling interests reflects increased net losses incurred by Hot Dot and Great Plains in the periods presented. Both Security Capital and Hot Dot are development stage enterprises that have not generated significant income to offset their expenses.
The Company’s overall investment philosophy is reflected in the allocation of its investments. The Company emphasizes investment grade debt securities, with smaller holdings in equity securities, real estate, held for investment, mortgage loans on real estate, held for investment, policy loans, and other investments. The following table shows the carrying value of our investments by investment category and cash and cash equivalents, and the percentage of each to total invested assets as of December 31, 2012 and 2011.
Increases in equity method investments result from, the purchase of additional shares of First Wyoming, the deconsolidation of Hot Dot, and offset by the consolidation of Great Plains Financial. The purchases in First Wyoming increased our total investment in First Wyoming to 896,500 shares or $763,650. Our aggregate ownership percentage increased to approximately 21.45% as a result of the purchases. The deconsolidation and subsequent recording of our equity method investment in Hot Dot increased our equity securities balance approximately $500,000. The consolidation of Great Plains Financial decreased our equity method investments balance by approximately $500,000.
Decreases in mortgage loans on real estate are a primarily result of the repayment of one mortgage during the second quarter in the amount of $200,000.
The following table shows the distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value as of December 31, 2012 and 2011.
Reflecting the high quality of securities maintained by the Company, 98.2% and 99.1% of all fixed maturity securities were investment grade as of December 31, 2012 and December 31, 2011, respectively. Due to the low interest rate environment, the Company has invested in bonds with “A” or “BBB” ratings. Recently, as opportunities present themselves, lower-rated bonds have been disposed of and replaced with more-highly rated instruments.
The Company holds a diversified portfolio of investments that primarily includes cash, bonds, stocks, mortgage loans on real estate, held for investment, real estate, held for investment and notes receivable. Each of these investments is subject to market risks that can affect their return and their fair value. A majority of the investments are fixed maturity securities including debt issues of corporations, U.S. Treasury securities, or securities issued by government agencies. The primary market risks affecting the investment portfolio are interest rate risk, credit risk, and equity risk.
The Company is exposed to credit risk through counterparties and within the investment portfolio. Credit risk relates to the uncertainty associated with an obligor’s ability to make timely payments of principal and interest in accordance with the contractual terms of an instrument or contract. The Company manages its credit risk through established investment credit policies and guidelines which address the quality of creditors and counterparties, concentration limits, diversification practices and acceptable risk levels. These policies and guidelines are regularly reviewed and approved by senior management.
Equity risk is the risk that the Company will incur economic losses due to adverse fluctuations in a particular stock. As of December 31, 2012 and December 31, 2011, the fair value of our equity securities was $1,250,977 and $240,855, respectively. As of December 31, 2012 a 10% decline in the value of the equity securities would result in an unrealized loss of $125,098 as compared to an estimated unrealized loss of $24,086 as of December 31, 2011. The selection of a 10% unfavorable change in the equity markets should not be construed as a prediction by the Company of future market events, but rather as an illustration of the potential impact of such an event. A majority of the Company’s investment in equity securities are comprised of investments in affiliates and mutual funds. Additionally, our investments in affiliates constitute high-risk investments in developing businesses that have incurred significant losses and have not achieved profitability. There is no assurance as to the actual amount of financial return, if any, which may result from ownership of these securities. The entire value of these securities may be lost.