Changes in the regulation of financial services, including bank sales and underwriting of insurance products, which may affect the competitive environment for the Company's products.
Net investment income increased approximately 75% when comparing 2010 to 2009. The overall gross investment yields for 2010 and 2009 are 9.82% and 5.58%, respectively. During 2008 and 2009, Management took steps to avoid catastrophic future losses by culling its investment portfolio. As part of this portfolio evaluation process, certain investments were subsequently sold, particularly during the third and fourth quarters of 2008 and early 2009. This resulted in a higher cash balance through most of 2009 earning extremely low rates of interest which had an immediate impact on income. With preservation of capital being of utmost concern, Management sat on this large cash balance waiting for the dust to settle and for opportunities with margin of safety to appear. This patience was rewarded and the Company began to deploy cash into investments deemed appropriate during the latter part of 2009. The majority of this money was invested in trading securities and discounted mortgage loans. With the economy reeling, bankruptcies soaring and general credit drying-up, the banking industry has been under well-known pressure. As bank failures increased dramatically, their loan portfolios have been auctioned off, sometimes at deep discounts.
A substantial amount of the Company’s 2010 earnings are directly related to strong results in investment income. The majority of the increase in investment income is from the Company’s mortgage loan portfolio. Approximately 57%, or $14,075,000, of investment income is attributable to the mortgage loan portfolio, including $7,645,000 in discount accruals. Should any of the factors change, such as the ability to acquire additional loans at such a large discount due to increased competition or insufficient supply, the ability of borrowers to settle loans mainly through refinancing, another decline in the overall economy, and other such factors, the performance of this type of investment could abruptly end, directly affecting future net income. While management believes the current portfolio would remain profitable in another downturn, with no source of new acquisitions of discounted loans, the future profit stream from this activity would be limited. Alternatively, should the Company need to look at fixed maturities for additional investment if discounted loans were no longer a viable option, the rate of return would be significantly lower given the low interest rate environment also resulting in substantially lower income.
During the fourth quarter of 2009, the Company had acquired $118,368,661 of discounted mortgage loans at a total cost of $35,224,022, representing an average purchase price to outstanding loan of 29.8%. During 2009, the Company recorded approximately $1,000,000 in income from this loan activity. During 2010, the Company acquired an additional $111,258,867 of discounted mortgage loans at a total cost of $36,283,278, representing an average purchase price to outstanding loan of 32.6%. Additionally, during 2010, the Company settled, sold or had paid off discounted mortgage loans totaling $23,607,100. During 2010, the Company recorded approximately $12,898,000 in income from the discounted mortgage loan activity, including $7,645,258 in discount accruals. The Company is currently projecting a very positive return from on-going mortgage loan payments from the discounted commercial mortgage loan portfolio.
While management believes the discounted loans will continue to have favorable earnings and outcomes as they are worked through, there can be no assurance this will remain true in future periods. Changes in the current economy such as an even greater downturn than recently experienced could have a negative impact on the loans, including the financial stability of the borrowers, the borrowers’ ability to pay or to refinance, the value of the property held as collateral and the ability to find purchasers at favorable prices. As such, management has taken a conservative approach with these investments and has classified all discounted mortgage loans held as non-accrual. In such status, the Company is recording interest income on a cash basis and is recording any accrual of discount on the loans held when realized. Discount accruals reported during 2010 were the result of the loan basis already being fully paid.
During 2009, the Company also contributed approximately $20,000,000 to professionally managed trading accounts as another way to combat the current low rate environment. The accounts were established to generate a fair return while reducing risk. Securities designated as trading are reported at fair value with gains or losses resulting from changes in fair value recognized in net investment income. During 2010, approximately 21%, or $5,143,000, of investment income was due to this trading portfolio, yielding approximately 12.8% after fees. This type of return should not be expected in future periods. Volatility should be expected, as well as possible losses. Management’s target return on these accounts is 8%.
Net realized investment losses were $(640,538) and $(629,528) in 2010 and 2009, respectively. During 2010, other-than-temporary impairments of approximately $610,000 and $740,000 were taken on bonds backed by trust preferred securities and on common stock, respectively. The other-than-temporary impairments were due to changes in expected future cash flows. Additionally, an other-than-temporary impairment of approximately $129,000 was taken on a mortgage loan as a result of its appraisal valuation. These losses were partially off-set from realized gains of approximately $811,175 on bond sales. The majority of the losses during 2009 were from bond investments. The beginning of 2009 continued with the elimination of unwanted bonds during the portfolio evaluation process. Losses on the sale of these bonds totaled approximately $3,500,000. In addition to these losses, other-than-temporary impairments of just over $2,000,000 were taken on bonds backed by trust preferred securities of banks. These losses were partially off-set from realized gains of approximately $3,800,000 from sales of mortgage backed securities at the end of 2009. Realized gains on common stocks were mainly the result of selling the remainder of CSI for a $3,000,000 gain and the sale of another common stock realizing a $1,000,000 gain. The gains were off-set by a loss of approximately $3,000,000 on exchange traded funds that moved inversely to the market.
Benefits, claims and settlement expenses net of reinsurance benefits and claims, decreased $3,546,995 from 2009 to 2010. The decrease relates primarily to changes in the Company’s death claim experience. Death claims were approximately $1,598,000 less in 2010 as compared to 2009. There is no single event that caused the mortality variances. Policy claims vary from year to year and therefore, fluctuations in mortality are to be expected and are not considered unusual by management.
Net amortization of cost of insurance acquired decreased 68% in 2010 compared to 2009. During 2009, a block of business of UG fully amortized, which accounted for the significantly lower amortization in 2010. Cost of insurance acquired is established when an insurance company is acquired. The Company assigns a portion of its cost to the right to receive future profits from insurance contracts existing at the date of the acquisition. The cost of policies purchased represents the actuarially determined present value of the projected future profits from the acquired policies. Cost of insurance acquired is comprised of individual life insurance products including whole life, interest sensitive whole life and universal life insurance products. Cost of insurance acquired is amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. The Company utilizes a 12% discount rate on the remaining unamortized business. The interest rates vary due to risk analysis performed at the time of acquisition on the business acquired. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised. Amortization of cost of insurance acquired is particularly sensitive to changes in interest rate spreads and persistency of certain blocks of insurance in-force. Persistency is a measure of insurance in force retained in relation to the previous year. The Company's average persistency rate for all policies in force for 2010 and 2009 has been approximately 96.0% and 96.1%, respectively. The Company monitors these projections to determine the adequacy of present values assigned to future profits. No impairments were recorded in the periods reported.
The Company had a net income (loss) of $7,596,575 and $(4,290,247) in 2010 and 2009, respectively. The increase in net income in 2010 is primarily related to higher investment income and lower policyholder benefits.
At December 31, 2010, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in the context of consolidated assets, shareholders' equity or results from operations. The Company has identified securities it may sell and classified them as "investments held for sale". Investments held for sale are carried at market, with changes in market value charged directly to shareholders' equity. To provide additional flexibility and liquidity, the Company has categorized all fixed maturity investments as “investments held for sale”.
The following table summarizes the Company's fixed maturities distribution at December 31, 2010 and 2009 by ratings category as issued by Standard and Poor's, a leading ratings analyst.
Mortgage loan investments represent 14% of total assets of the Company at year-end 2010 and 2009. A significant portion of the Company’s mortgage loan investments result from opportunities available through FSNB, an affiliate of Mr. Jesse T. Correll. Mr. Correll is the CEO and Chairman of the Board of Directors of UTG, and directly and indirectly through affiliates, its largest shareholder. FSNB has been able to provide the Company with additional expertise and experience in underwriting commercial and residential mortgage loans, which provide more attractive yields than the traditional bond market. FSNB services all the mortgage loans of the Company. The majority of this amount was in the form of loans purchased at a discount from failed banks. The Company pays FSNB a .25% servicing fee on these loans and a one-time fee at loan origination of .50% of the original loan amount to cover costs incurred by FSNB relating to the processing and establishment of the loan. The Company paid $190,297 and $74,153 in servicing fees and $508,283 and $558,843 in origination fees to FSNB during 2010 and 2009, respectively.
Total investment real estate holdings represent approximately 12% and 10.5% of the total assets of the Company, net of accumulated depreciation, at year-end 2010 and 2009 respectively. The Company has made several investments in real estate in recent years. Expected returns on these investments exceed those available in fixed income securities. However, these returns may not always be as steady or predictable.
Cash and cash equivalents decreased by approximately $19,000,000 comparing 2010 to 2009. This cash was redeployed into additional investments.
On December 30, 2009, the Company sold a 73% owned subsidiary, Texas Imperial Life Insurance Company. The transaction was entered into to further streamline operations of the affiliated group. Texas Imperial was a stipulated premium company, a unique status under Texas rules. Consolidation of this entity was not practical due to this status. The sale resulted in a decrease of approximately 4% in total assets in 2009.
At December 31, 2010, the Company has outstanding notes payable of $10,372,239 as compared to $14,402,889 a year ago. Approximately $6,890,000 of this debt is related to the acquisition of ACAP Corporation. The Company has two lines of credit available for operating liquidity or acquisitions of additional lines of business. The outstanding balances on these lines of credit were $2,290,000 and $0 as of December 31, 2010 and 2009, respectively. The Company's debt is discussed in more detail in Note 12 to the consolidated financial statements.
As part of the investment portfolio restructuring, a portion of the Company’s funds has been dedicated to an experienced team of market professionals with the goal of grinding out a reasonable return, primarily through cash flows, with lower overall volatility and reduced risk. The portfolio contains exchange traded equities and options which have been classified as trading securities on the balance sheet.
Each year, the NAIC calculates financial ratio results (commonly referred to as IRIS ratios) for each insurance company. These ratios compare key financial data pertaining to the statutory balance sheet and income statement. The results are then compared to pre-established normal ranges determined by the NAIC. Results outside the range typically require explanation to the domiciliary insurance department. At year-end 2010, UG had three ratios while AC had one ratio outside the normal range. All variances reported were anticipated by Management. These ratios are discussed in more detail in the Regulatory Environment discussion included in this Item 7.
The Company's investments are predominantly in fixed maturity investments such as bonds and mortgage loans, which provide sufficient return to cover future obligations. The Company carries all of its fixed maturity holdings as held for sale which are reported in the consolidated financial statements at their market value.
Net cash used in financing activities was $(4,542,564) and $(1,159,521) for 2010 and 2009, respectively. Cash used in financing activities during both years was primarily the result of debt reduction.
At December 31, 2010, UG has a ratio of approximately 3.6, which is 360% of the authorized control level. AC’s ratio is approximately 7.5, which is 750% of the authorized control level. Accordingly, both companies meet the RBC requirements.
In January 2010, FASB issued ASU 2010-02, Accounting and Reporting for Decreases in Ownership of a Subsidiary- a Scope Clarification, which addresses the accounting for non-controlling interests and changes in ownership interests of a subsidiary. ASU 2010-02 is effective for the interim or annual reporting periods ending on or after December 15, 2009, and must be applied retrospectively to interim or annual reporting periods beginning on or after December 15, 2008. The adoption of ASU 2010-02 did not have an impact on the Company's consolidated financial statements.
Listed below are the financial statements included in this Part of the Annual Report on SEC Form 10-K:
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of UTG, Inc. and subsidiaries as of December 31, 2010 and 2009, and the consolidated results of their operations and their consolidated cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
We have also audited Schedule I, II, IV and V as of December 31, 2010, and 2009 and for the years then ended, of UTG, Inc. and subsidiaries.. In our opinion, these schedules present fairly, in all material respects, the information required to be set forth therein.
Investment in unconsolidated affiliate, at fair value (cost $5,000,000 and $5,000,000)
ORGANIZATION - At December 31, 2010, the significant majority-owned subsidiaries of UTG were as depicted on the following organizational chart.
NATURE OF OPERATIONS - UTG is an insurance holding company. The Company’s dominant business is individual life insurance which includes the servicing of existing insurance business in force and the acquisition of other companies in the insurance business.
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Registrant and its wholly and majority-owned subsidiaries. All significant inter-company accounts and transactions have been eliminated.
Investments available for sale - at fair value, unrealized gains and losses deemed temporary, net of deferred income taxes, are credited or charged, as appropriate, directly to accumulated other comprehensive income or loss (a component of shareholders’ equity). Premiums and discounts on debt securities purchased at other than par value are amortized and accreted, respectively, to interest income in the Consolidated Statements of Operations, using the constant yield method over the period to maturity. Net realized gains and losses on sales of held for sale securities, and unrealized losses considered to be other-than-temporary, are credited or charged to net realized investment gains (losses) in the Consolidated Statements of Operations.
Real estate - investment real estate at lower of cost net of accumulated depreciation or fair value less cost to sell. Expenses to maintain the property are expensed as incurred.
Trading securities - at fair value, with gains or losses resulting from changes in fair value recognized in earnings. Trading securities include exchange traded equities and exchange traded equity options.
Short-term investments - at amortized cost, which approximates current market value.
Realized gains and losses include sales of investments, periodic changes in fair value, and write downs in value. If any, other-than-temporary declines in fair value are recognized in net income on the specific identification basis.
COST OF INSURANCE ACQUIRED - When an insurance company is acquired, the Company assigns a portion of its cost to the right to receive future cash flows from insurance contracts existing at the date of the acquisition. The cost of policies purchased represents the actuarially determined present value of the projected future profits from the acquired policies. The Company utilizes a 12% discount rate on the remaining unamortized business. Cost of insurance acquired is amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. The interest rate utilized in the amortization calculation is 12%. The interest rates vary due to differences in the blocks of business. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised.
EARNINGS PER SHARE - Earnings per share (EPS) are reported pursuant to FASB Codification 260-10 sections 5, 10, 15, 45, 50, 55, and 60. The objective of both basic EPS and diluted EPS is to measure the performance of an entity over the reporting period. Basic EPS is computed by dividing net income/(loss) attributable to common shares (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. In addition, the numerator also is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common shares.
IMPAIRMENT OF LONG LIVED ASSETS - The Company evaluates whether events and circumstances have occurred that indicate the remaining estimated useful life of long lived assets may warrant revision or that the remaining balance of an asset may not be recoverable. The measurement of possible impairment is based on the ability to recover the balance of assets from expected future operating cash flows on an undiscounted basis. During 2010, other-than-temporary impairments of approximately $610,000 and $215,000 were recognized on bonds backed by trust preferred securities and on common stock, respectively. The other-than-temporary impairments were due to changes in expected future cash flows. Additionally, an other-than-temporary impairment of approximately $129,000 was recognized on a mortgage loan as a result of its appraisal valuation.
In January 2011, the Financial Accounting Standards Board (“FASB”) issued the Accounting Standards Update (“ASU”) No. 2011-01 Receivables (Topic 310) Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No 2010-10. The amendments in this Update temporarily delay the effective date of the disclosures about troubled debt restructurings in Update 2010-20 for public entities. The delay is intended to allow the Board time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. Currently, that guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011. The Company does not expect the adoption of ASU 2011-01 to have a material impact on its consolidated financial statements.
At December 31, 2010, substantially all of consolidated shareholders' equity represents net assets of UTG’s subsidiaries. The payment of cash dividends to shareholders by UTG is not legally restricted. However, the state insurance department regulates insurance company dividend payments where the company is domiciled. UG and AC’s dividend limitations are described below.
FASB ASC Topic 740-10 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The recognition threshold is based on a determination of whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. Only tax positions that meet the more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized. Management believes the Company has no material uncertain income tax provisions at December 31, 2010 or 2009.
The companies of the group file separate federal income tax returns except for ACAP, AC, and Imperial Plan, which file a consolidated life/non-life federal income tax return.
The expense for income differed from the amounts computed by applying the applicable United States statutory rate of 35% before income taxes as a result of the following differences:
The Company held, at amortized cost, $138,840 and $1,459,798 in below investment grade investments as of December 31, 2010 and 2009, respectively. The investments are all classified as All Other Corporate bonds.
The fair value of investments with sustained gross unrealized losses at December 31, 2010 and 2009 are as follows:
The unrealized losses of fixed maturity investments were primarily due to financial market participants’ perception of increased risks associated with the current market environment, resulting in higher interest rates. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. The unrealized losses of equity investments were primarily caused by normal market fluctuations in publicly traded securities.
Securities designated as trading securities are reported at fair value, with gains or losses resulting from changes in fair value recognized in other income on the consolidated statements of operations. Trading securities include exchange traded equities and exchange traded equity options. The fair value of trading securities included in assets was $37,029,550 and $19,613,472 as of December 31, 2010 and 2009, respectively. The fair value of trading securities included in liabilities was $(18,429,677) and $(11,671,911) as of December 31, 2010 and 2009, respectively. Trading securities’ unrealized gains were $5,574,151 and $570,024 as of December 31, 2010 and 2009, respectively. Unrealized losses due to trading securities were $(3,770,422) and $(1,081,360) as of December 31, 2010 and 2009, respectively. Trading securities carried as liabilities are securities sold short. A gain, limited to the price at which the security was sold short, or a loss, potentially unlimited in size, will be recognized upon the termination of the short sale. Realized gains from trading securities were $184,546 and $525,000 as of December 31, 2010 and 2009, respectively. Trading securities are classified in cash flows from operating activities. Trading revenue charged to net income from trading securities was:
As of December 31, 2010, the Company held derivative instruments in the form of exchange-traded equity options. The Company currently does not designate derivatives as hedging instruments. Exchange traded equity options are matched with exchange traded equity securities in the Company’s trading portfolio, with the primary objective of generating a fair return while reducing risk. These derivatives are carried at fair value, with unrealized gains and losses recognized in other income. The fair value of derivatives included in trading security assets and trading security liabilities as of December 31, 2010 was $2,244,478 and $(17,246,957), respectively. The fair value of derivatives included in trading security assets and trading security liabilities as of December 31, 2009 was $1,054,965 and $(4,753,525), respectively. Realized gains (losses) due to derivatives were $(305,247) and $525,000 December 31, 2010 and December 31, 2009 respectively. Unrealized gains included in trading security assets due to derivatives were $1,579,071 and $110,013 as of December 31, 2010 and December 31, 2009, respectively. Unrealized losses included in trading security liabilities due to derivatives were $(3,392,010) and $(432,720) as of December 31, 2010 and December 31, 2009, respectively.
DISCOUNT MORTGAGE LOANS - During the fourth quarter of 2009, the Company began purchasing discounted commercial mortgage loans. Management has extensive background and experience in the analysis and valuation of commercial real estate and believes there are significant opportunities currently available in the discounted mortgage loan arena. Experienced personnel of FSNB have also been utilized in the analysis phase. This experience dates back to discounted loans during the Resolution Trust days where such loans were being sold from defunct savings and loans in the early 1990’s. The discounted loans are available through the FDIC sale of assets of closed banks and from banks wanting to reduce their loan portfolios. The loans are available on a loan by loan bid process. Prior to placing a bid, each loan is reviewed to determine interest level utilizing such information as type of collateral, location of collateral, interest rate, current loan status and available cashflows or other sources of repayment. Once it is determined interest in the loan remains, the collateral is physically inspected. Following physical inspection, if interest still remains, a bid price is determined and a bid is submitted. Once a loan has been acquired, contact is made with the appropriate individuals to begin a dialog with a goal of determining the borrower’s willingness to work together. There are generally three paths a discounted loan will take: the borrowers pay as required; a settlement is reached with the loan being paid off at a discounted value; or the loan is foreclosed.
At December 31, 2010, the Company holds $59,935,447 in mortgage loans in total, which represents approximately 14% of the total assets. Most mortgage loans are first position loans. Loans issued are limited to no more than 80% of the appraised value of the property with the exception of one loan whose value of the security to the loan was 100%. During 2010, the Company recognized an other-than-temporary impairment of $128,867 on this loan as a result of its appraisal valuation.
ASC 820, “Fair Value Measurements and Disclosures” established a hierarchical disclosure framework based on the priority of the inputs to the respective valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). An asset or liability’s classification within the fair value hierarchy is based on the lowest level of significant input to its valuation. ASC 820 defines the input levels as follows:
Level 1 - Unadjusted quoted prices in active markets for identical assets or liabilities. U.S. treasuries are in Level 1 and valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access. Equity securities that are actively traded on an exchange listed in the U.S. are also included in Level 1. Equity security valuation is based on unadjusted quoted prices for identical assets in active markets that the Company can access.
The following table presents the level within the hierarchy at which the Company’s financial assets and financial liabilities that are measured and recorded on a recurring basis at fair value as of December 31, 2010 and 2009:
As of December 31, 2010 and 2009, the Company held $53 million and $46 million of real estate for sale, respectively. The real estate is recorded at the lower of the net investment in the loan or the fair value of the real estate less costs to sell. The determination of fair value assessments are performed on a periodic basis by external appraisal and assessment of property values by management. Management believes these fair value assessments are classified as a Level 2 valuation technique under ASC 820, Fair Value Measurements and Disclosures as of December 31, 2010 and 2009.
The following methods and assumptions were used to estimate the fair value of each class of financial instrument required to be valued by ASC 820 for which it is practicable to estimate that value:
Securities designated as trading securities are reported at fair value using market quotes, with gains or losses resulting from changes in fair value recognized in earnings. Trading securities include exchange traded equities and exchange traded equity long and short options.
During 2009 and 2010, the Company purchased non-performing loans at a deep discount through an auction process led by the federal government. In general, the discounted loans are non-performing and there is a significant amount of uncertainty surrounding the timing and amount of cash flows to be received by the Company. Accordingly, the Company records its investment in the discounted loans at its original purchase price. Management works the loans with the borrower to reach a settlement on the loan or they foreclose on the underlying collateral which is primarily commercial real estate. For cash payments received during the work out process, the Company records these payments to interest income on a cash basis. For loan settlements reached, the Company records the amount in excess of the carrying amount of the loan as a discount accretion to investment income at the closing date. Management reviews the discount loan portfolio regularly for impairment. If an impairment is identified (after consideration of the underlying collateral), the Company records an impairment to earnings in the period the information becomes known.
For borrowings subject to floating rates of interest, carrying value is a reasonable estimate of fair value. For fixed rate borrowings fair value is determined based on the borrowing rates currently available to the Company for loans with similar terms and average maturities.
Currently, UG is utilizing reinsurance agreements with Optimum Re Insurance Company, (Optimum) and Swiss Re Life and Health America Incorporated (SWISS RE). Optimum and SWISS RE currently hold an “A-” (Excellent) and "A" (Excellent) rating, respectively, from A.M. Best, an industry rating company. The reinsurance agreements were effective December 1, 1993, and covered most new business of UG. Under the terms of the agreements, UG cedes risk amounts above its retention limit of $100,000 with a minimum cession of $25,000. Ceded amounts are shared equally between the two reinsurers on a yearly renewable term (YRT) basis, a common industry method. The treaty is self-administered; meaning the Company records the reinsurance results and reports them to the reinsurers.
In addition to the above reinsurance agreements, UG entered into reinsurance agreements with Optimum Re Insurance Company (Optimum) during 2004 to provide reinsurance on new products released for sale in 2004. The agreements are yearly renewable term (YRT) treaties where UG cedes amounts above its retention limit of $100,000 with a minimum cession of $25,000 as has been a practice for the last several years with its reinsurers. Also, Optimum is the reinsurer of 100% of the accidental death benefits (ADB) in force of UG. This coverage is renewable annually at the Company’s option. Optimum specializes in reinsurance agreements with small to mid-size carriers such as UG. Optimum currently holds an “A-” (Excellent) rating from A.M. Best.
On September 30, 1998, UG entered into a coinsurance agreement with The Independent Order of Vikings, (IOV) an Illinois fraternal benefit society. Under the terms of the agreement, UG agreed to assume, on a coinsurance basis, 25% of the reserves and liabilities arising from all in-force insurance contracts issued by the IOV to its members. At December 31, 2010, the IOV insurance in-force assumed by UG was approximately $1,612,000, with reserves being held on that amount of approximately $374,000.
The Company does not have any short-duration reinsurance contracts. The effect of the Company's long-duration reinsurance contracts on premiums earned in 2010 and 2009 were as follows:
The insurance industry has experienced a number of civil jury verdicts which have been returned against life and health insurers in the jurisdictions in which the Company does business involving the insurers' sales practices, alleged agent misconduct, failure to properly supervise agents, and other matters. Some of the lawsuits have resulted in the award of substantial judgments against the insurer, including material amounts of punitive damages. In some states, juries have substantial discretion in awarding punitive damages in these circumstances. In the normal course of business the Company is involved from time to time in various legal actions and other state and federal proceedings. Management is of the opinion that the ultimate disposition of the matters will not have a material adverse effect on the Company’s results of operations or financial position.
As part of the Texas Imperial Life Insurance Company sale, the Company remains contingently liable for certain costs pending the outcome of an ongoing race-based audit on Texas Imperial Life Insurance Company by the Texas Department of Insurance. Under the agreement, the Company is responsible for 100% of the first $50,000 of costs, $90% of the next $50,000, 75% of the third $50,000 and 50% of costs above $150,000. Management has conservatively estimated the Company’s exposure and other costs at $50,000 based on information provided to date from the examination team and has established a contingent liability in its financial statements of this amount. This contingency expires December 30, 2013.
As part of the acquisition of ACAP on December 8, 2006, UTG loaned $3,357,000 to ACAP. ACAP used the proceeds for the repayment of existing debt with an unaffiliated financial institution and to retire all of its outstanding preferred stock. The terms of the inter-company loan mirror the interest rate and repayment requirements of the debt with First Tennessee Bank National Association. A payment of $576,235 was made on the loan in 2010. No payments were made on the loan in 2009. As of December 31, 2010, the balance of the loan is $2,682,849.
During June 2003, UG entered into a lease agreement with Bandyco, LLC, an affiliated entity, for a one-sixth interest in an aircraft. Bandyco, LLC is affiliated with Ward F. Correll, who is a director of the Company. The Company is responsible for its share of annual non-operational costs, in addition to the operational costs as are billable for specific use. During 2006, UG entered into an additional lease agreement for a 27.5% interest in a second plane with Bandyco, LLC. The lease term was for a period of five years at a total cost of $166,913. In December 2009, this aircraft was sold. The aircraft is used for business related travel by various officers and employees of the company. For years 2010 and 2009 UTG paid $308,362 and $203,857 for costs associated with the aircraft.
Effective January 1, 2007, UTG entered into administrative services and cost sharing agreements with its subsidiaries, UG, AC and TI. Under these arrangements, each company pays its proportionate share of expenses of the entire group, based on an allocation formula. During 2010, UG and AC paid $3,692,434 and $3,174,724, respectively. During 2009, UG, AC and TI paid $3,383,565, $2,827,504 and $690,028, respectively.
The Company from time to time acquires mortgage loans through participation agreements with FSNB. FSNB services the Company's mortgage loans including those covered by the participation agreements. The Company pays a .25% servicing fee on these loans and a onetime fee at loan origination of .50% of the original loan amount to cover costs incurred by FSNB relating to the processing and establishment of the loan. The Company paid $190,297 and $74,153 in servicing fees and $508,283 and $558,843 in origination fees to FSNB during 2010 and 2009, respectively.
The Company reimbursed expenses incurred by employees of FSNB relating to travel and other costs incurred on behalf of or relating to the Company. The Company paid $23,763 and $22,521 in 2010 and 2009, respectively to FSNB in reimbursement of such costs. In addition, the Company began reimbursing FSNB a portion of salaries and pension costs for Mr. Correll, Mr. Ditto and a third employee. The reimbursement was approved by the UTG Board of Directors and totaled $433,340 and $332,766 in 2010 and 2009, respectively, which included salaries and other benefits.
On June 5, 2001, the Board of Directors of UTG authorized the repurchase in the open market or in privately negotiated transactions of up to $1 million of UTG's common stock. On June 16, 2004, an additional $1 million was authorized for repurchasing shares. On April 18, 2006, an additional $1 million was authorized for repurchasing shares. On June 16, 2010, an additional $500,000 was authorized for repurchasing shares at current market value. Repurchased shares are available for future issuance for general corporate purposes. This program can be terminated at any time. Open market purchases are generally limited to a maximum per share price of the most recent reported per share GAAP equity book value of the Company. Through February 15, 2011, UTG has spent $3,371,277 in the acquisition of 463,307 shares under this program.
At December 31, 2010 and 2009, the Company had $10,372,239 and $14,402,889, respectively, of debt outstanding.
In addition to the above promissory note, First Tennessee Bank National Association also provided UTG with a $5,000,000 maximum revolving credit note. During 2010, Management decided that a reduction to a maximum $2,750,000 in this line of credit was more reasonable for current operations. This note is for a one-year term and may be renewed by consent of both parties. The credit note is to provide operating liquidity for UTG. The promissory note carries a variable rate of interest based on the 90-day LIBOR rate plus 2.75 percentage points, but at no time will the rate be less than 3.25%. The collateral held on the above note also secures this credit note. UTG had borrowings of $290,000 and $0 against this note during 2010 and 2009, respectively. At December 31, 2010 and 2009, the outstanding principal balance on this debt was $290,000 and $0, respectively.
On June 1, 2005, UG was extended a $3,300,000 line of credit from the First National Bank of Tennessee. The LOC was for a one-year term from the date of issue. The interest rate on the LOC was variable and indexed to be the lowest of the U.S. prime rates as published in the Wall Street Journal, with any interest rate adjustments to be made monthly. At December 31, 2009, the Company had no outstanding borrowings attributable to this LOC. This LOC was determined to be no longer needed and was discontinued during 2009.
In November 2007, the Company became a member of the Federal Home Loan Bank (FHLB). This membership allows the Company access to additional credit up to a maximum of 50% of the total assets of UG. To be a member of the FHLB, UG was required to purchase shares of common stock of FHLB. Borrowing capacity is based on 50 times each dollar of stock acquired in FHLB above the "base membership" amount. UG's current line of credit with the FHLB is $15,000,000. During 2010, UG had borrowings of $2,000,000 against this line of credit. During 2009, UG had borrowings of $2,000,000 and repayments of $2,000,000. At December 31, 2010 and 2009, the outstanding principal balance on this debt was $2,000,000 and $0, respectively, with interest at 0.25% at December 31, 2010. The outstanding principal balance was repaid in full January 7, 2011.
In January 2007, UG became a 51% owner of the newly formed RLF Lexington Properties LLC ("Lexington"). The entity was formed to hold, for investment purposes, certain investment real estate acquired. As part of the purchase price of the real estate owned by Lexington, the seller provided financing through the issuance of five promissory notes of $1,200,000 each totaling $6,000,000. The notes bear interest at the fixed rate of 5%. The notes came due beginning on January 5, 2008, and each January 5 thereafter until 2012 when the final note is repaid. At December 31, 2010 and 2009 the outstanding principal balance was $914,505 and $3,600,000, respectively.
The Company maintains cash balances in financial institutions that at times may exceed federally insured limits. The Company maintains its primary operating cash accounts with First Southern National Bank, an affiliate of the largest shareholder of UTG, Mr. Jesse T. Correll, the Company’s CEO and Chairman. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents.