Effective August 29, 2005, TLIC executed a lease agreement with a tenant for 2,500 square feet. The base lease period commenced on September 1, 2005 and will end on August 31, 2010. The lease will automatically renew, if not terminated on or after August 15, 2010, for another five years with a 90 day notice to terminate the lease by the lessee. The lease agreement called for minimum monthly base lease payments of $4,332 through August 31, 2010. The lease payments decreased to $3,100 per month for the period September 1, 2010 through August 31, 2015.
The future minimum lease payments to be received under non cancelable lease agreements are $241,302, $146,760, $149,652, $149,652 and $24,800 for the years 2011 through 2015, respectively.
As an insurance provider, we collect premiums in the current period to pay future benefits to our policy and contract holders. Our core operations include issuing modified premium whole life insurance with a flexible premium deferred annuity, ordinary whole life, final expense, term and annuity products to predominately middle income households in the states of Illinois, Kansas, Kentucky, Nebraska, North Dakota, Ohio, Oklahoma and Texas through independent agents.
The discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements that have been prepared in accordance with accounting principles generally accepted in the United States. Preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. We evaluate our estimates and assumptions, including those related to investments, loans from premium financing, deferred acquisition costs, value of insurance business acquired, policy liabilities, income taxes, regulatory requirements, contingencies and litigation. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following accounting policies, judgments and estimates are the most critical to the preparation of our consolidated financial statements.
Fixed maturities are comprised of bonds that are classified as available-for-sale and are carried at fair value with unrealized gains and losses, net of applicable income taxes, reported in accumulated other comprehensive income. The amortized cost of fixed maturities is adjusted for amortization of premium and accretion of discount to maturity. Interest income, as well as the related amortization of premium and accretion of discount, is included in net investment income under the effective yield method. The amortized cost of fixed maturities is written down to fair value when a decline in value is considered to be other-than-temporary.
The allowance for possible loan losses from financing casualty insurance premiums is a reserve established through a provision for possible loan losses charged to expense which represents, in management’s judgment, the known and inherent credit losses existing in the loan portfolio. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses inherent in the loan portfolio and reduces the carrying value of loans from premium financing to the estimated net realizable value on the statement of financial position.
Our liability for policyholders’ account balances represents the contract value that has accrued to the benefit of the policyholder as of the financial statement date. This liability is generally equal to the accumulated account deposits plus interest credited less policyholders’ withdrawals and other charges assessed against the account balance. Interest crediting rates for individual annuities range from 3.75% to 6.75%. Interest crediting rates for premium deposit funds range from 3% to 4%.
Our liability for future policy benefits is primarily comprised of the present value of estimated future payments to or on behalf of policyholders, where the timing and amount of payment depends on policyholder mortality or morbidity, less the present value of future net premiums. For life insurance and annuity products, expected mortality and morbidity is generally based on the Company’s historical experience or standard industry tables including a provision for the risk of adverse deviation. Interest rate assumptions are based on factors such as market conditions and expected investment returns. Although mortality and morbidity and interest rate assumptions are “locked-in” upon the issuance of new insurance with fixed and guaranteed terms, significant changes in experience or assumptions may require the Company to provide for expected future losses on a product by establishing premium deficiency reserves.
In October 2010, the FASB issued Accounting Standards Update No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts (“ASU 2010-26”). The new guidance requires that an insurance entity capitalize only the following as acquisition costs related directly to the successful acquisition of new or renewal insurance contracts:
The portion of an employee’s total compensation and payroll-related fringe benefits related directly to acquisition activities for time spent performing underwriting, policy issuance, policy processing, medical, inspection and sales force contract selling for a contract that has actually been acquired.
All other acquisition costs should be charged to expense as incurred. In addition, administrative costs, rent, depreciation, occupancy, equipment and all other general overhead costs are considered indirect costs and should be charged to expense as incurred. ASU 2010-26 is effective for interim and annual reporting periods beginning after December 15, 2011. Early adoption is permitted, but only at the beginning of an entity’s annual reporting period. The Company will likely adopt ASU 2010-26 in first quarter 2012. The Company has assessed the guidance and has determined that it will not have a significant financial impact since the Company utilizes a dynamic model whereby deferred acquisition costs on the statement of financial position only include policies currently in force. This current dynamic model results in immediate amortization of all deferred acquisition costs on the statement of operations where the policy is no longer in force. Once adopted, the above defined acquisition costs will only be capitalized directly related to the successful acquisition of new or renewal insurance contracts. After adoption, these acquisition costs will be amortized on the statement of operations when the related policies are no longer in force.
On August 6, 2009, we were made aware of potentially fraudulent loans and financial transactions made by an independent insurance agency that did business with our wholly owned subsidiary, FTCC. The fraudulent loans and financial transactions totaled $1,293,450. The independent insurance agency and its owner have assigned assets having an estimated fair value of $622,377 to cover loan losses.
Benefits and claims increased 19.6% to $5,063,553 for the year ended December 31, 2010, an increase of $829,537 from $4,234,016 for the year ended December 31, 2009. The increase is primarily due to a $544,883 increase in the change in reserves as the policies age, a $155,131 increase in the interest credited on annuities related to increased deposits in excess of withdrawals, an $83,312 increase in surrenders related to the growth in the number of policies and a $46,211 increase in death claims due to slightly increased mortality related to the growth in the number of policies.
Certain costs related to the acquisition of life insurance policies are capitalized and amortized over the premium-paying period of the policies. These costs, which are referred to as deferred policy acquisition costs, include commissions and other costs of acquiring life insurance, which vary with, and are primarily related to, the production of new insurance contracts. These capitalized acquisition costs are amortized in a systematic manner based on the related contract revenues or gross profits as appropriate.
The cost of acquiring insurance business is amortized primarily over the emerging profit of the related policies using the same assumptions that were used in computing liabilities for future policy benefits. Amortization of the value of insurance business acquired was $271,465 and $333,493 for the years ended December 31, 2010 and 2009, respectively. The decrease in the amortization of value of insurance business acquired of $62,028 reflects improving persistency in the whole life and term business reflected in the increased renewal premiums in 2010 compared to 2009.
Commissions increased 15.4% to $1,673,975 for the year ended December 31, 2010, an increase of $223,538 compared to $1,450,437 of commissions for the year ended December 31, 2009. The increase is primarily due to increased new business production of final expense business.
Net Loss and Net Loss Per Common Share Basic and Diluted
Revenues from Life and Annuity Insurance Operations increased 7.6% to $8,495,479 for the year ended December 31, 2010, an increase of $596,814 from $7,898,665 for the year ended December 31, 2009. The increase in 2010 revenue over 2009 revenue primarily relates to increased investment income, decreased realized and impairment losses and increased new business production of final expense business and increased whole life and term renewal premiums.
The income before income taxes from Life and Annuity Insurance Operations was $736,035 and $219,889 for the years ended December 31, 2010 and 2009, respectively. The $516,146 increased income for 2010 compared to 2009 is primarily due to decreased insurance and underwriting expenses, increased net investment income, increased net investment gains in excess of net investment losses and increased capitalization of deferred acquisition costs in excess of the related amortization. These items that increased income were reduced by increases in benefits, claims and commissions.
The loss before income taxes from Premium Finance Operations was $340,395 and $619,613 for the years ended December 31, 2010 and 2009, respectively. The $279,218 decreased loss is primarily attributable to a decrease in allowance for loan losses and a decrease in production of loan agreements with no significant corresponding decrease in the costs associated with Premium Finance Operations.
Revenues from corporate operations were $2,011 and $1,398 for the years ended December 31, 2010 and 2009, respectively. This $613 increase is primarily due to an increase in net investment income.
The loss before income taxes from Corporate Operations was $510,830 and $441,528 for the years ended December 31, 2010 and 2009, respectively. The $69,302 increased loss from 2009 to 2010 is primarily due to use of consultants and corporate staffing focus on preparation for the public offering of our common stock to Oklahoma residents that began on June 29, 2010.
As of December 31, 2010, our available-for-sale fixed maturity securities had a fair value of $26,623,318 and amortized cost of $23,183,633 compared to a fair value of $22,510,660 and an amortized cost of $19,772,497 at December 31, 2009. This portfolio is reported at fair value with unrealized gains and losses, net of applicable income taxes, reflected as a separate component in shareholders' equity within “Accumulated Other Comprehensive Income”. The available-for-sale fixed maturity securities portfolio is invested in a variety of companies and U. S. Government sponsored agency securities.
As of December 31, 2010, we held the following additional invested assets: mortgage loans on real estate of $1,156,812; investment real estate of $3,077,520; policy loans of $367,284 and other long-term investments of $6,886,529. As of December 31, 2009, we held the following additional invested assets: mortgage loans on real estate of $1,365,953; investment real estate of $3,146,944; policy loans of $335,022 and other long-term investments of $4,975,188. The other long-term investments are comprised of lottery prize receivables.
Total investments were $38,640,777 and $32,782,251 as of December 31, 2010 and December 31, 2009, respectively.
Deferred policy acquisition costs were $3,234,285 and $1,918,994 as of December 31, 2010 and 2009, respectively. Policy acquisition expenses related to new insurance sales were capitalized in the amount of $1,773,199 and $1,478,104 for the years ended December 31, 2010 and 2009, respectively. Amortization of deferred acquisition costs for the years ended December 31, 2010 and 2009 was $451,349 and $452,960, respectively.
As of December 31, 2010, we held the following additional assets (excluding cash and cash equivalents and certificates of deposit that are discussed below under “Liquidity and Capital Resources”): amounts recoverable from reinsurers of $977,397; accrued investment income of $385,948; accounts receivable of $357,979; property and equipment of $102,374 and other assets of $1,151,315. As of December 31, 2009, we held the following additional assets (excluding cash and cash equivalents and certificates of deposit that are discussed below under “Liquidity and Capital Resources”): amounts recoverable from reinsurers of $870,294; accrued investment income of $340,384; accounts receivable of $273,843; property and equipment of $82,349 and other assets of $837,210. Other assets include federal and state incomes taxes recoverable, prepaid expenses, notes receivable and customer account balances receivable.
The liability for deferred federal income taxes was $293,221 and $159,315 at December 31, 2010 and 2009, respectively. Other liabilities as of December 31, 2010 and 2009 were $524,125 and $331,501, respectively. Other assets include deposits on pending policy applications, accrued expenses, accounts payable and unearned investment income.
As of December 31, 2010, we had cash and cash equivalents totaling $12,985,278. The majority of our excess funds have been invested in money market mutual funds. At December 31, 2010, cash and cash equivalents of $8,897,115 of the total $12,985,278 were held by TLIC and may not be available for use by FTFC due to the required pre-approval by the Oklahoma Insurance Department of any dividend or intercompany transaction to transfer funds to FTFC. The maximum dividend, which may be paid in any twelve-month period without notification or approval, is limited to the lesser of 10% of statutory surplus as of December 31 of the preceding year or the net gain from operations of the preceding calendar year. Cash dividends may only be paid out of surplus derived from realized net profits. Based on these limitations, there is no capacity to pay a dividend in 2011 without prior approval. There were no dividends paid or a return of capital to the parent company in 2009 or in 2010. As of December 31, 2009, we had cash and cash equivalents totaling $7,080,692. At December 31, 2009, cash and cash equivalents of $5,903,258 of the total $7,080,692 were held by TLIC.
The liquidity requirements of our life insurance company are met primarily by funds provided from operations. Premium deposits and revenues, investment income and investment maturities are the primary sources of funds, while investment purchases, policy benefits, and operating expenses are the primary uses of funds. There were no liquidity issues in 2010 or 2009. Our investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs.
In addition to the measures described above, TLIC must comply with the NAIC promulgated Standard Valuation Law ("SVL") which specifies minimum reserve levels and prescribes methods for determining them, with the intent of enhancing solvency. Upon meeting certain tests, which TLIC met during 2010 and 2009, the SVL also requires the Company to perform annual cash flow testing for TLIC. This testing is designed to ensure that statutory reserve levels will maintain adequate protection in a variety of potential interest rate scenarios. The Actuarial Standards Board of the American Academy of Actuaries also requires cash flow testing as a basis for the actuarial opinion on the adequacy of the reserves which is a required part of the annual statutory reporting process.
Our marketing plan could be modified to emphasize certain product types and reduce others. New business levels could be varied in order to find the optimum level. We believe that our current liquidity, current bond portfolio maturity distribution and cash position give us substantial resources to administer our existing business and fund growth generated by direct sales. We will service other expenses and commitments by: (1) using available cash, (2) dividends from TLIC which are limited by law to the lesser of prior year net operating income or 10% of prior year-end capital and surplus unless specifically approved by the controlling insurance department, (3) dividends from FTCC and (4) corporate borrowings, if necessary.
We have used the majority of our capital provided from the public stock offerings to expand the premium finance business and to acquire a life insurance company. The operations of TLIC may require additional capital contributions to meet statutory capital and surplus requirements mandated by state insurance departments. Life insurance contract liabilities are generally long term in nature and are generally paid from future cash flows.
On March 12, 2009, we entered into a senior revolving loan with a bank to loan up to $3,000,000 to provide working capital and funds for expansion. The loan was renewed on April 30, 2009 and modified to increase the revolving loan amount to $3,600,000. The loan agreement terminated on May 31, 2010 and was not renewed at our election. On July 21, 2009, FTCC borrowed $100,000 under the loan agreement and repaid $99,999 on November 4, 2009. The remaining $1 was repaid on May 31, 2010.
We are not aware of any commitments or unusual events that could materially effect our capital resources. We are not aware of any current recommendations by any regulatory authority which, if implemented, would have a material adverse effect on our liquidity, capital resources or operations.
We have audited the accompanying consolidated statements of financial position of First Trinity Financial Corporation and Subsidiaries (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for the years then ended. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
First Trinity Financial Corporation is the parent holding company of Trinity Life Insurance Company and First Trinity Capital Corporation.
Equity securities available-for-sale are comprised of common stock and are carried at fair value. The associated unrealized gains and losses, net of applicable income taxes, are included in accumulated other comprehensive income. The cost of equity securities available-for-sale is written down to fair value when a decline in value is considered to be other-than-temporary. Dividends from these investments are recognized in net investment income when declared.
Other long term investments are comprised of lottery prize receivables and are carried at amortized cost, net of unamortized premium or discount. Interest income and the amortization of premium and accretion of discount are included in net investment income.
Commissions and other acquisition costs which vary with and are primarily related to the production of new business are deferred and amortized in a systematic manner based on the related contract revenues or gross profits as appropriate. 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.
Deferred acquisition costs related to limited-payment long-duration annuity contracts are also adjusted, net of tax, for the change in amortization that would have been recorded if the unrealized gains and (losses) from available-for-sale securities had actually been realized. This adjustment is included in the change in net unrealized appreciation (depreciation) on available-for-sale securities, a component of “Accumulated Other Comprehensive Income” in the shareholders’ equity section of the statement of financial position
As a result of the Company’s purchase of FLAC, an asset was recorded in the application of purchase accounting to recognize the value of acquired insurance in force. The Company’s value of acquired insurance in force is an intangible asset with a definite life and is amortized under Financial Accounting Standards Board (“FASB”) guidance. The value of acquired insurance in force is amortized primarily over the emerging profit of the related policies using the same assumptions that were used in computing liabilities for future policy benefits. For the amortization of the value of acquired insurance in force, the Company periodically reviews its estimates of gross profits. The most significant assumptions involved in the estimation of gross profits include interest rate spreads, future financial market performance, business surrender/lapse rates, mortality and morbidity, expenses and the impact of realized investment gains and losses. In the event actual experience differs significantly from assumptions or assumptions are significantly revised, the Company is required to record a charge or credit to amortization expense for the period in which an adjustment is made.
Net income (loss) per common share basic and diluted is calculated using the weighted average number of common shares outstanding and subscribed during the year. The weighted average outstanding and subscribed common shares basic and diluted for the years ended December 31, 2010 and 2009 were 6,235,407 and 6,095,250, respectively. These weighted average shares reflect the retrospective adjustment for the impact of the 5% stock dividend declared by the Company on January 10, 2011 and payable to holders of shares of the Company as of March 10, 2011.
Investments in fixed maturity and equity securities available-for-sale as of December 31, 2010 and December 31, 2009 are summarized as follows:
All securities in an unrealized loss position as of the financial statement dates, the estimated fair value, pre-tax gross unrealized loss and number of securities by length of time that those securities have been continuously in an unrealized loss position as of December 31, 2010 and 2009 are summarized as follows:
As of December 31, 2010, all of the above fixed maturity securities had a fair value to cost ratio equal to or greater than 94%. As of December 31, 2009, all of the above fixed maturity securities had a fair value to cost ratio equal to or greater than 86%. As of both December 31, 2010 and 2009, fixed maturity securities were 87% investment grade as rated by Standard & Poor’s.
There were no equity securities in an unrealized loss position as of December 31, 2010 and December 31, 2009.
The Company recorded two other-than-temporary impairments during 2009. During the second quarter of 2009, the Company impaired its $200,000 par value General Motors (“GM”) bond as a result of a bankruptcy filing by GM. This impairment was considered fully credit-related, resulting in a charge to the statement of operations before tax of $8,659 as of June 30, 2009. This charge represents the difference between the amortized cost basis of the security and its fair value. During the third quarter 2009, the Company recorded a second other-than-temporary impairment relative to Cit Group (“CIT”) bonds with a total par value of $710,000. These CIT bonds were written down to their fair value at September 30, 2009. The Company determined that the entire loss was credit related and recognized a realized loss of $146,705 in the statement of operations. These bonds defaulted on October 30, 2009. The Company experienced no additional other-than-temporary impairments during 2009.
Net unrealized gains included in other comprehensive income for investments classified as available-for-sale, net of the effect of deferred income taxes and deferred acquisition costs assuming that the appreciation had been realized as of December 31, 2010 and 2009 are summarized as follows:
The amortized cost and fair value of fixed maturity available-for-sale securities as of December 31, 2010, by contractual maturity, are summarized as follows:
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.
There were no loans more than 90 days past due at December 31, 2010. There were no mortgage loans in default at December 31, 2010 and there was no allowance for losses at December 31, 2010 and 2009.
The Company’s investment real estate as of December 31, 2010 and 2009 is summarized as follows:
The Company’s investment in lottery prize cash flows was $6,886,529 and $4,975,188 as of December 31, 2010 and 2009, respectively. The lottery prize cash flows are assignment of the future rights from lottery winners at a discounted price. Payments on these investments are made by state run lotteries.
The amortized cost and estimated fair value of lottery prize cash flows, by contractual maturity, at December 31, 2010 are summarized as follows:
Level 1 - Quoted prices in active markets for identical assets or liabilities. The Company’s Level 1 assets and liabilities include fixed maturity and equity securities that are traded in an active exchange market, as well as certain U.S. Treasury securities that are highly liquid and are actively traded in over-the-counter markets.
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. The Company’s Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. This category generally includes certain private equity investments and asset-backed securities where independent pricing information was not able to be obtained for a significant portion of the underlying assets.
At December 31, 2010, Level 3 financial instruments consisted of two private placement common stocks that have no active trading. At December 31, 2009, Level 3 financial instruments consisted of one private placement common stock that had no active trading. These stocks represent investments in small development stage insurance holding companies. The fair value for these securities was determined through the use of unobservable assumptions about market participants. The Company has assumed a willing market participant would purchase the securities for the same price as the Company paid until such time as the development stage company commences operations.
The change in the fair value of the Company’s Level 3 equity securities, available-for-sale for the years ended December 31, 2010 and 2009 is summarized as follows:
The estimated fair values of financial instruments, as of December 31, 2010 and 2009 are summarized as follows:
The company’s credit losses related to loans from premium financing as of December 31, 2010 and 2009 is summarized as follows:
FTCC recorded losses related to loans originated by this agency net of assets received of $344,594 that has been recognized in the December 31, 2009 financial statements. FTCC and the Company continued to investigate the facts and circumstances relating to any fraudulent loans and financial transactions in 2010 and continue to seek restitution for any losses.
There was no current federal income tax expense for the years 2010 and 2009.
Deferred taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax liabilities and assets as of December 31, 2010 and 2009 are summarized as follows:
The Company has no known uncertain tax benefits within its provision for income taxes. In addition, the Company does not believe it would be subject to any penalties or interest relative to any open tax years and, therefore, have not accrued any such amounts. The Company files U.S. federal income tax returns and income tax returns in various state jurisdictions. The 2007 through 2010 U.S. federal tax years are subject to income tax examination by tax authorities. The Company classifies any interest and penalties (if applicable) as income tax expense in the financial statements.
Reinsurance assumed and ceded amounts for TLIC for 2010 and 2009 are summarized as follows:
Property and equipment as of December 31, 2010 and 2009 is summarized as follows:
TLIC occupied approximately 7,500 square feet of its building in Topeka, Kansas until December 2009. Effective December 24, 2009, TLIC entered into a five year lease with a tenant for this space with an option to renew for five additional years. The monthly lease payments are as follows: $8,888 in 2010, $9,130 in 2011 and 2012 and $9,371 in 2013 and 2014. TLIC has leased 10,000 square feet under a lease that was renewed during 2006 to run through June 30, 2011 with a 90 day notice to terminate the lease by the lessee. The lease agreement calls for minimum monthly base lease payments of $15,757.
The future minimum lease payments to be received under the above non cancelable lease agreements are $241,302, $146,760, $149,652, $149,652 and $24,800 for the years 2011 through 2015, respectively
The statutory net loss for TLIC amounted to $449,123 and $882,176 for the years ended December 31, 2010 and 2009, respectively. The statutory surplus of TLIC was $4,316,574 and $4,327,428 as of December 31, 2010 and 2009, respectively. Old TLIC and TLIC are subject to Oklahoma laws and FLAC was subject to Kansas laws which limit the amount of dividends that insurance companies can pay to stockholders without approval of the respective Departments of Insurance. The maximum dividend, which may be paid in any twelve-month period without notification or approval, is limited to the lesser of 10% of statutory surplus as of December 31 of the preceding year or the net gain from operations of the preceding calendar year. Cash dividends may only be paid out of surplus derived from realized net profits. Based on these limitations, there is no capacity to pay a dividend in 2011 without prior approval. There were no dividends paid or a return of capital to the parent company in 2010 and 2009.