- MANAGEMENT'S DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Guaranteed issue and simplified issue life insurance premiums continued to show significant growth for the three year period as a result of higher production by the Company's independent agency force which increased 13% to approximately 4,400 agents under contract at December 31, 2001 compared to approximately 3,900 in 2000 and approximately 2,700 in 1999. This product is also distributed by the Company's multi-line exclusive agents and is available for purchase over the Internet at the Company's home page (www.cottonstatesinsurance.com).
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. Benefits and claims increased in 2001 primarily due to high mortality experience during the first quarter of 2001. Guaranteed issue and simplified issue experience in 2001 and 2000 is more indicative of the Company's expectations as the block of business matures. Due to the Company's small size, quarterly fluctuations, even when they remain within the normal range, do and will occur. In addition, the Company's general policy is to retain, with respects 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 $10 million. The Company did not experience any impact on reinsurance costs as a result of the events of September 11, 2001.
The Company has reached partial settlement of a $900,000 reinsurance policy law suit initiated in the third quarter of 2001. To date, the Company has received $475,000 and continues to seek additional recoveries through already existing legal channels. Costs incurred as a result of this settlement were approximately $0.03 per diluted share. 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.
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.
The Company's insurance operations generate positive cash flows in excess of its immediate needs. Cash flows provided by operations were $15.6 million in 2001, $11.8 million in 2000, and $13.4 million in 1999.
Operating cash flow is primarily used to purchase debt securities. The Company received proceeds of $10.5 million from investment maturities and repayments in 2001, adding to available cash flows. Such proceeds were $7.2 million in 2000 and $8.3 million in 1999. When market opportunities arise, the Company disposes of selected debt securities available for sale 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 $50.2 million in 2001, $3.4 million in 2000 and $8.1 million in 1999.
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.
Financial Accounting Standards Board ("FASB") SFAS No. 133, as amended, Accounting for Derivative Instruments and Hedging Activities, became effective beginning January 1, 2001. However, due to the Company's limited use of derivative financial instruments, SFAS No. 133 did not impact the Company's consolidated financial position, results of operations or cash flows in 2001.
COTTON STATES LIFE INSURANCE COMPANY AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity
COTTON STATES LIFE INSURANCE COMPANY AND SUBSIDIARIES Consolidated Statements of Comprehensive Income
Premiums on traditional life and accident and health insurance policies are recognized as income when due. Premiums on universal life policies are recognized when earned.
The costs of acquiring most new individual life business are deferred and amortized with interest over the premium-paying period of the related policies. For traditional life policies, such amounts are amortized in proportion to the ratio of the annual premium income to the total anticipated premium income. Such anticipated premium income is estimated using the same assumptions used for computing future policy benefits. For universal life policies, deferrable costs are amortized in proportion to the ratio of the contract's annual gross profits to total anticipated gross profits. First-year excess expense charges are also deferred and accreted to income in the same manner as deferrable costs are amortized. Total anticipated gross profits are based on assumptions for investment margins, surrender charges, mortality charges, and level expense loads. The principal expenses deferred are commissions and certain expenses of the product development, policy issue, underwriting, and agency departments, all of which vary with and are primarily related to the production of new business. Policy acquisition costs deferred were approximately $9,831,000 in 2001, $9,313,000 in 2000, and $8,121,000 in 1999.
The Company, CSI and CSMR file a consolidated Federal income tax return.
The FASB issued four new accounting standards in 2001. SFAS No. 141, SFAS No. 142, SFAS No. 143, and SFAS No. 144 primarily address the accounting for goodwill, business combinations, and the impairment and disposition of long-lived assets. The adoption of these standards in 2002 is not expected to have a material impact on the Company's financial position or results of operations.
The amortized cost and estimated fair values of investments in debt and equity securities as of December 31, 2001 and 2000 are as follows:
The amortized cost and estimated fair value of debt securities at December 31, 2001, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Bonds with amortized cost of $1,878,000 at December 31, 2001 were on deposit with state regulatory authorities in accordance with statutory requirements.
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.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying values of assets and liabilities for financial reporting purposes and Federal income tax purposes. The net deferred tax liability at December 31, 2001 and 2000 is composed of the tax-effected temporary differences related to the following amounts:
The following table summarizes plan assets, obligations, pension cost and assumptions of the pension plan and other postretirement benefit plan as of December 31, 2001 and 2000.
COTTON STATES LIFE INSURANCE COMPANY AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2001, 2000, and 1999
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 $38,000 in 2001, $43,838 in 2000 and $36,451 in 1999.
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 47,439, 63,225, and 29,298 shares of restricted stock under such plans during 2001, 2000, and 1999, respectively. The weighted-average grant date fair value of such shares was $9.83, $7.04, and $11.41, respectively. Aggregate compensation expense with respect to the foregoing restricted stock awards was $427,000, $57,000, and $308,000, in 2001, 2000, and, 1999, respectively.
In accordance with APB Opinion No. 25, $519,000, $125,000, and $373,000, in compensation expense has been recorded in 2001, 2000, and 1999, respectively, for the various stock option and restricted stock awards granted in 2001, 2000, and 1999. 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:
Net income and shareholders' equity, as reported to regulatory authorities in conformity with statutory accounting practices for each of the years in the three-year period ended December 31, 2001 is as follows:
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 expressed 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, 2001 was approximately $30,000,000. 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 $3,000,000 in 2002 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 third party products distributed through the Company's exclusive and independent agents.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cotton States Life Insurance Company and subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.
Note - Failure of individual quarterly income per share to total annual income per share results from the computation of weighted average number of shares on an individual quarterly basis.