The Company, Mutual, and Shield occupy offices located at 244 Perimeter Center Parkway, Atlanta, Georgia. The building is owned by a general partnership composed of Mutual and Gold Kist Inc. (“Gold Kist”). The Company has no ownership interest in the partnership. The facility consists of a three-story office building containing approximately 260,000 square feet of space of which the Company, Mutual and Shield share approximately 90,000 square feet. The Company believes that the facility is suitable to its business. Rental expense is allocated to the Company based on its proportionate share of square footage occupied.
Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control and many of which are subject to change. These uncertainties and contingencies could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable developments. Some may be national in scope, such as general economic conditions, the possibility of war, changes in tax law and changes in interest rates. Some may be related to the insurance industry generally, such as pricing competition, regulatory developments and industry consolidation. Others may relate to the Company specifically, such as credit, volatility and other risks associated with the Company’s investment portfolio. Investors are also directed to consider other risks and uncertainties discussed in documents filed by the Company with the Securities and Exchange Commission. If the Company’s assumptions and estimates are incorrect or do not come to fruition, or if the Company does not achieve all of these key factors, then the Company’s actual performance could vary materially from the forward-looking statements made herein. The Company disclaims any obligation to update any forward-looking information.
Due to favorable market conditions caused by lower interest rates, the Company realized net gains of approximately $2,900,000, $28,000, and $406,000 in 2002, 2001, and 2000, respectively, from the sale of fixed maturity and equity securities.
Exclusive agents sell products that the Cotton States Group does not underwrite (both life and property and casualty) but are provided through the Company’s brokerage operations, and for which the Company receives override commission. Brokerage commissions for 2002 were flat as compared to 2001 due to decreased override commissions on the sale of multi-peril crop and crop hail products. This decrease in brokerage commissions was partially offset by an 11% increase in commissions on the sale of non-standard automobile policies. Brokerage commissions were flat in 2001 as compared to 2000 due to decreased override commissions on the sale of life products. Brokerage commissions increased 10% in 2000 compared to 1999 due primarily to increased sales of non-standard automobile policies.
Benefits and claims, as a percentage of premium, fluctuate within a normal range reflecting volatility in mortality, changes in mix of business, and age of policyholders. Guaranteed issue and simplified issue experience for the three year period is consistent with the Company’s future expectations for those products as the block of business matures. Individual life benefits increased in 2002 compared to 2001 due to higher traditional life reserve increases, which were the result of an overall improvement in persistency. Death benefits for 2002 were consistent with management’s expectations. Death benefits in 2001 compared to 2000 slightly exceeded management’s expectations due to an unusual increase in mortality during the first quarter of 2001.
Due to the Company’s small size, quarterly fluctuations, even when they remain within the normal range, will affect the total benefits and claims for the fiscal year. In addition, the Company’s general policy is to retain, with respect to individual life policies, generally no more than $100,000 of insurance on any one life and has also routinely purchased annual aggregate stop loss reinsurance coverage in excess of 120% of expected mortality. The Company did not experience any material impact on reinsurance costs as a result of the events of September 11, 2001.
The Company has reached partial settlement regarding $900,000 in reinsurance coverage. A lawsuit was initiated in the third quarter of 2001. To date, the Company has received $475,000 and continues to seek additional recoveries against reinsurance brokers through already existing legal channels. The remaining amount outstanding is included in reinsurance receivable on the consolidated balance sheet.
Other benefits and claims consist of participation in a Federally sponsored group life pool and benefits on a closed block of individual accident and health business.
The amortization of policy acquisition costs as a percentage of premium was 11% in 2002 compared to 15% in 2001 and 12% in 2000. Amortization for 2002 is slightly better than the Company’s expected range of 12-14% and reflects better than expected mortality in the universal life line of business and a decrease in the annual interest rate credited to policyholders. The amortization of policy acquisition costs for 2002 and 2000 reflect a favorable adjustment from updating actuarial assumptions. This adjustment represented a slow down of amortization as a result of higher estimated future profits from the improvement in mortality levels on universal life products. The after tax effect on net income for 2002 was $186,000 or $.03 per share and for 2000 was $429,000 or $.07 per share. Amortization in 2001 reflects higher lapses in the traditional lines of business which reflects increased term rate competition in the market place.
The effective tax rate for 2002 was 29% compared to 27% in 2001 and 30% in 2000. The two percentage point increase from 2001 to 2002 is the result of a decrease in the allowable small company deduction. The three percentage point decrease from 2000 to 2001 is the result of an increase in the allowable small company deduction.
Further, as described in the Notes, the Company accounts for its interest-sensitive and universal life insurance policies and annuities under the provisions of Statement of Financial Accounting Standards (SFAS) No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. SFAS No. 97 requires the remeasurement of the Company’s deferred acquisition costs each period in a manner that amortizes such deferred costs as a level percentage of actual emerged profit over the expected gross profits. Expected gross profits are primarily influenced by estimated future mortality, investment gains, and expense margins.
The Company’s insurance operations generated positive cash flows in excess of its immediate needs during 2002. Cash flows provided by operations were $17.0 million in 2002, $15.5 million in 2001, and $11.5 million in 2000. Operating cash flow is primarily used to purchase debt securities. The Company received proceeds of $14.3 million from investment maturities and repayments in 2002, adding to available cash flows. Such proceeds were $10.5 million in 2001 and $7.2 million in 2000. When market opportunities arise, the Company disposes of selected debt securities available for sale in an attempt to improve future investment yields and/or improve duration matching of our assets and liabilities. Therefore, dispositions before maturity can vary significantly from year to year. Proceeds from sales prior to maturity were $108.6 million in 2002, $50.4 million in 2001 and $3.5 million in 2000.
Other than noted above, the Company does not have any debt, lease obligations, purchase obligations, lines of credit, guarantees, off-balance sheet arrangements, trading activities involving non-exchange traded contracts accounted for at fair value or relationships with persons or entities that derive benefits from a non-independent relationship with the Company or the Company’s related parties.
Three loans representing $102,000 in principal are over 30 days delinquent. The loan-to-value ratio on delinquent loans is 21%.
that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. The adoption of SFAS No. 143 did not affect the Company’s results of operations or financial position.
On February 21, 2002, the Company filed notice of its intent to withdraw its multi-line exclusive agents from Kentucky primarily due to losses incurred by the Company’s affiliate, Cotton States Mutual Insurance Company. Without objection from the Kentucky Department of Insurance, the Company’s withdrawal plan was accepted pursuant to Kentucky insurance regulations.
Certain amounts in the accompanying financial statements have been reclassified to conform with the current period’s presentation.
The Company accounts for investments under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities.
Investments deemed to have a loss in value which is other than temporary are written down to their fair value. Unrealized gains and losses on fixed maturities available for sale are excluded from earnings and are reported within shareholders’ equity as a component of accumulated other comprehensive income, net of deferred taxes and amounts attributable to the Company’s universal life and annuity products.
The Company, CSI, and CSMR file a consolidated Federal income tax return.
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141 “Business Combinations.” SFAS No. 141 requires that the purchase method of accounting be used for all business combinations with a closing date after June 30, 2001. This statement eliminates the pooling-of-interest method of accounting for business combinations. SFAS No. 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets in a business combination. The Financial Accounting Standards Board has also issued SFAS No. 142 “Goodwill and Other Intangible Assets” which supersedes Opinion 17 “Intangible Assets,” and is effective for fiscal years beginning after December 15, 2001. SFAS No. 142 addresses how goodwill and other intangible assets should be accounted for in financial statements upon acquisition and how these items should be accounted for subsequent to acquisition. The Company’s adoption of SFAS Nos. 141 and 142 did not affect the Company’s results of operations or financial position.
The Financial Accounting Standards Board also issued SFAS No. 143 “Accounting for Asset Retirement Obligations,” which is effective for fiscal years beginning after June 15, 2002, with early adoption encouraged. SFAS No. 143 applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. The adoption of SFAS No. 143 did not affect the Company’s results of operations or financial position.
The Financial Accounting Standards Board also issued SFAS No. 145 “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections,” which is effective for financial statements issued after May 15, 2002. The adoption of SFAS No. 145 did not affect the Company’s results of operations or financial position.
In July 2002, the Financial Accounting Standards Board issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities,” which is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. The adoption of SFAS No. 146 is not expected to affect the Company’s results of operations or financial position.
Bonds with an amortized cost of $1,914,000 and $1,878,000 at December 31, 2002 and 2001, respectively, were on deposit with state insurance regulatory authorities in accordance with statutory requirements.
Realized and unrealized gains and losses on investments for the years ended December 31 were as follows:
The composition of future policy benefits, and the significant assumptions used in their development, are as follows (dollars in thousands):
Interest rates are graded to the ultimate rate in 25 years.
The Company participates in certain business assumed from Federally sponsored group pools. Further, it is the Company’s general policy to reinsure individual life insurance in excess of $100,000, group life insurance in excess of $55,000, major medical payments in excess of $85,000 annually per individual, accidental deaths, and certain disability income coverage.
In assessing the deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Management has concluded that it is more likely than not that all of its deferred tax assets are realizable. Therefore, no valuation allowance was established at December 31, 2002 and 2001.
A 1% annual increase in assumed health care cost would increase the accumulated postretirement benefit obligation at December 31, 2002 by approximately $7,500 and the service and interest cost components of the net periodic postretirement benefit cost for 2002 by $500. A 1% annual decrease in the assumed health care costs would decrease the accumulated postretirement benefit obligation at December 31, 2002 by approximately $6,900 and the service and interest components of the net periodic postretirement benefit cost by $475.
The Company also sponsors a defined contribution plan for the benefit of the Company’s employees and the employees of affiliated companies. Matching contributions by the Company vary and are determined by the Company’s prior year profitability measured by return on equity. The Company’s matching contributions were $26,664 in 2002, $38,000 in 2001 and $43,838 in 2000.
Mutual, through its wholly owned subsidiary, Shield, controls approximately 33% of the Company’s outstanding common stock. Most officers and directors of the Company hold similar positions with these affiliates.
Certain general expenses are allocated to the Company from its affiliates. These expenses, such as salaries, advertising, rents, etc., represent the Company’s share of expenses initially paid by Mutual and are allocated based on specific identification or, if undeterminable, generally on the basis of each company’s premium. Expenses allocated to the Company may not be the same as expenses incurred if the Company operated as a stand-alone entity. Expenditures allocated to the Company amounted to $3,471,048 in 2002, $3,992,556 in 2001, and $3,386,739 in 2000. At December 31, 2002 the Company was owed $42,469 from Mutual and at December 31, 2001 the Company owed Mutual $186,482.
The Company has various stock option plans for the Company’s officers and key employees, as well as directors.
In addition to the stock options described above, the Company has awarded nontransferable, restricted shares of Company common stock to various key executives under key executive restricted stock bonus plans. The market value of the common stock at the date of issuance is recorded as compensation expense using the straight-line method over the vesting period of the awards. The Company awarded 67,329, 47,439, and 63,225 shares of restricted stock under such plans during 2002, 2001, and 2000, respectively. The weighted-average grant date fair value of such shares was $9.09, $9.83, and $7.04 respectively. Aggregate compensation expense with respect to the foregoing restricted stock awards was $51,553, $424,726, and $59,146 in 2002, 2001, and 2000 respectively.
In accordance with APB Opinion No. 25, $135,000, $519,000, and $125,000 in compensation expense has been recorded in 2002, 2001, and 2000, respectively, for the various stock option and restricted stock awards granted in 2002, 2001, and 2000. Had the Company determined compensation cost based on the fair value at the grant date for its stock options and restricted stock awards under SFAS No. 123, Accounting for Stock-Based Compensation, the Company’s net income, basic net income per share, and diluted net income per share would have been reduced to the pro forma amounts indicated below:
years for options and seven years for restricted stock awarded in 2000, and three years for restricted stock awarded in 2002 and 2001; expected dividend yield of 1.67% for 2002 grants, 1.60% for 2001 grants, and 2.10% for 2000 grants; risk-free interest rate of 3.5% for 2002, 4.5% for 2001, and 5.0% for 2000; and an expected volatility of 66% for 2002 grants, 65% for 2001 grants, and 58% for 2000 grants.
Accounting practices used to prepare statutory financial statements for regulatory filings of stock life insurance companies differ from GAAP. Material differences resulting from these accounting practices include: deferred policy acquisition costs which are not recognized for statutory purposes; statutory non-admitted assets are recognized under GAAP accounting; statutory investment valuation reserves are not recognized under GAAP accounting; premiums for universal life and investment-type products are recognized as revenues for statutory purposes and as deposits to policyholders’ accounts under GAAP; different assumptions are used in calculating future policyholders’ benefits; and different methods are used for calculating valuation allowances and deferred Federal income taxes for statutory and GAAP purposes.
The Georgia Insurance Code limits dividends in any one year to the greater of statutory earnings, excluding realized capital gains, or 10% of statutory surplus, unless the express permission of the Georgia Insurance Department is obtained. Dividend payments to shareholders are further limited by the Georgia Insurance Code to unassigned statutory surplus, which at December 31, 2002 was approximately $29,000,000. The excess of retained earnings determined in accordance with GAAP over unassigned statutory surplus is not available for payment of dividends. The Company may pay a dividend amounting to approximately $2,900,000 in 2003 without prior regulatory approval.
The Company’s operations can be grouped into three major segments: (i) individual life insurance, (ii) guaranteed issue and simplified issue life insurance, and (iii) brokerage operations. These segments are differentiated primarily by their respective methods of distribution and the nature of related products, as the Company’s operations in each segment are concentrated within its southeastern states geographic market. Individual life insurance products are distributed through the Company’s multi-line exclusive agents, guaranteed issue and simplified issue products are distributed through independent agents as well as exclusive agents, and brokerage operations involve
We have audited the accompanying consolidated balance sheet of Cotton States Life Insurance Company and subsidiaries as of December 31, 2002, and the related consolidated statements of earnings, shareholders’ equity, cash flows, and comprehensive income for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
In our opinion, the 2002 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cotton States Life Insurance Company and subsidiaries at December 31, 2002, and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States.
Management’s Report to Shareholders of Cotton States Life Insurance Company and Subsidiaries
The fourth quarter results for the three years include participation in Federally sponsored group pools as follows: