The Company owns an office complex in Springfield, Illinois, which houses the primary insurance operations. The office buildings in this complex contain 57,000 square feet of office and warehouse space.
The following is Management's discussion and analysis of the financial condition and results of operations of UTG, Inc. and its subsidiaries (collectively with the Parent, the "Company") for the years ended December 31, 2015 and 2014. This discussion should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this report.
UTG, Inc., a Delaware corporation, is a life insurance holding company. The Company's dominant business is individual life insurance, which includes the servicing of existing insurance policies in-force, the acquisition of other companies in the life insurance business, the acquisition of blocks of business and the administration and processing of life insurance business for other entities.
Valuation of Securities - The Company's investment portfolio consists of fixed maturities, equity securities, trading securities, mortgage loans and real estate to provide funding of future policy contractual obligations. The Company's fixed maturities and equity securities are classified as available-for-sale. Available-for-sale investments are carried at fair value with unrealized gains and losses reported in accumulated other comprehensive income (loss) in the Consolidated Balance Sheets.
The Company's trading securities are carried at fair value with unrealized gains and losses reported in income in the Consolidated Statements of Operations. Fair value is the price that the Company would expect to receive upon sale of the asset in an orderly transaction.
Total benefits and other expenses paid in 2015 were $28.5 million compared to $32.5 million in 2014.
The Company's investment expenses decreased approximately 58% or $5 million when comparing the 2015 and 2014 results. Investment expenses are expected to vary from year to year depending on the resources utilized by the Company to maintain and work the investment portfolio. As mentioned above, during 2014, one of the Company's consolidated subsidiaries sold the real estate it owned. This real estate generated investment expenses related to its operations of approximately $4.7 million during 2014. As a result of the sale, the Company did not incur similar expenses during 2015.
The Company's net realized investment gains were approximately $12.6 million lower when comparing the current and prior year results and is primarily attributable to the Company recognizing fewer gains in the equity and real estate investments portfolios during the current year. Furthermore, the Company recognized significantly more other than temporary impairments (OTTI) in the current year as compared to the prior year.
Other income, which mainly consists of fees charged for third party administration ("TPA") services, decreased approximately $1 million when comparing the 2015 and 2014 results reported by the Company. The Company receives monthly fees based on policy in-force counts and certain other activity indicators, such as number of premium collections performed, or services performed. The Company provides TPA services to insurance companies seeking business process outsourcing solutions.
During the fourth quarter of 2014, Management did not renew its largest third party administration contract as a result of thin profit margins associated with this contract coupled with its labor intensity. The non-renewal of this contract did not have a material financial impact as the Company has recognized operating expense reductions similar to the lost revenues.
In summary, the Company's basis for future revenue growth is expected to come from the following primary sources: conservation of business currently in-force, the maximization of investment earnings and the acquisition of other companies or policy blocks in the life insurance business. Management has placed a significant emphasis on the development of these revenue sources to enhance these opportunities.
The short-term impact of policy surrenders is negligible since a reserve for future policy benefits payable is held which is, at a minimum, equal to and generally greater than the cash surrender value of a policy. The benefit of fewer policy surrenders is primarily received over a longer time period through the retention of the Company's asset base.
Operating expenses decreased approximately 17% in 2015 compared to 2014. When analyzing 2014 and 2015 operating expenses, expenses were down slightly in the majority of the categories, and significantly in two categories, information technology and charitable contributions. As previously mentioned in the Results of Operations - Other Income section of the MD&A, the Company did not renew its largest third party administration contract. The non-renewal of this contract allowed the Company to recognize cost saving measures therefore reducing operating expenses incurred by the Company during 2015.
Information technology expenses decreased approximately 29% compared to the prior year. Information technology expenses were higher in the prior year as a result of additional expenses incurred in relation to the conversion to a new administrative system. Following an extensive analysis of administrative systems available in the market place, early in 2014 the Company determined it would change its administrative system. The Company will be fully converted to the new system during the first quarter of 2016. Management believes this system change will better position the Company for the future by providing a more modern and flexible operating system while reducing ongoing operating costs.
Net amortization of cost of insurance acquired decreased approximately 8% when comparing current and prior year activity. Cost of insurance acquired is established when an insurance company is acquired or when the Company acquires a block of in-force business. 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. 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 rates may vary due to risk analysis performed at the time of acquisition on the business acquired. The Company utilizes a 12% discount rate on the remaining unamortized business. 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. This expense is expected to decrease, unless the Company acquires a new block of business.
Sources of cash flows for the insurance subsidiary primarily consist of premium and investment income. Cash outflows from operations include policy benefit payments, commissions, administrative expenses, taxes and dividends to the Parent company.
Net cash used in financing activities was approximately $(4.6) million and $(26.5) million during 2015 and 2014, respectively. During 2015, the Company made principal payments on its outstanding debt of approximately $4.4 million and as of December 31, 2015 the Company had no debt outstanding with third parties. During 2014, the Company made principal payments on its outstanding debt of approximately $16.3 million. As a result of the 2014 principal payments made, UTG, as well as one of its subsidiaries, HPG Acquisitions, LLC, fully repaid their outstanding debt.
The Company had cash and cash equivalents of approximately $11.8 million and $14 million as of December 31, 2015 and 2014, respectively. The Company has a portfolio of marketable fixed and equity securities that are available for sale, if an unexpected event were to occur. These securities had a fair value of approximately $231 million and $238 million at December 31, 2015 and 2014, respectively. However, the strong cash flows from investing activities, investment maturities and the availability of the line of credit facilities make it unlikely that the Company would need to sell securities for liquidity purposes. See Note 2 - Investments in the Notes to the Consolidated Financial Statements for detailed disclosures regarding the Company's investment portfolio.
The Company's capital structure consists of short-term debt, long-term debt and shareholders' equity. A complete analysis and description of the short-term and long-term debt issues outstanding as of December 31, 2015 and 2014 are presented in Note 7 - Credit Arrangements in the Notes to the Consolidated Financial Statements.
As a smaller reporting company, as defined by Rule 12b-2 of the Exchange Act and Item 10(f)(1) of Regulation S-K, the Company has elected to comply with certain scaled disclosure reporting obligations, and therefore does not have to provide the information required by this item.
Policy Loans - Policy loans are reported at their unpaid balances, including accumulated interest, but not in excess of the cash surrender value of the related policy.
Cash Equivalents - The Company considers certificates of deposit and other short-term instruments with an original purchased maturity of three months or less to be cash equivalents.
Cash - Cash consists of balances on hand and on deposit in banks and financial institutions.
Future Policy Benefits and Expenses - The liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance subsidiary's experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. The Company makes these assumptions at the time the contract is issued or, in the case of contracts acquired by purchase, at the purchase date. Future policy benefits for individual life insurance and annuity policies are computed using interest rates ranging from 2% to 6% for life insurance and 2.5% to 7.50% for annuities. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. The mortality rate assumptions for policies currently issued by the Company are based on 2001 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or C, which are industry standard actuarial tables for forecasting assumed policy lapse rates.
Benefit reserves for universal life insurance and interest sensitive life insurance products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims in excess of related policy account balances. Interest crediting rates for universal life and interest sensitive products range from 4.0% to 5.5% as of December 31, 2015 and 2014.
Earnings Per Share - The objective of both basic earnings per share ("EPS") and diluted EPS is to measure the performance of an entity over the reporting period. The Company presents basic and diluted EPS on the face of the Consolidated Statements of Operations. Basic EPS is computed by dividing income available to common shareholders by the weighted average common shares outstanding for the period. Diluted EPS is calculated by adding to shares outstanding the additional net effect of potentially dilutive securities or contracts, such as stock options, which could be exercised or converted into common shares.
Accounting Standards Update (ASU) 2015-17, Income Taxes: Balance Sheet Classification of Deferred Taxes - ASU 2015-17 simplifies the presentation of deferred income taxes to require that deferred tax assets and liabilities be classified as non-current in a classified balance sheet. Current U.S. GAAP requires an entity to separate deferred income tax assets and liabilities into current and non-current amounts in a classified balance sheet. The current requirement that deferred tax assets and liabilities of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments of this Update. For public companies, the guidance is ASC 2015-17 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Earlier adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.
Accounting Standards Update (ASU) 2015-01, Income Statement - Extraordinary and Unusual Items - ASU 2015-01 removes the concept of extraordinary items from U.S. GAAP. Under the existing guidance, an entity is required to separately disclose extraordinary items, net of tax, in the income statement after income from continuing operations if an event or transaction is unusual and occurs infrequently. This separate, net-of-tax presentation will no longer be allowed. The existing requirement to separately disclose events or transactions that are unusual or occur infrequently on a pre-tax basis within continuing operations in the income statement has been retained. The new guidance requires similar separate presentation of items that are both unusual and infrequent. The new standard is effective for periods beginning after December 15, 2015. Early adoption is permitted, but only as of the beginning of the fiscal year of adoption. Upon adoption, the Company will present transactions that are both unusual and infrequent, if any, on a pre-tax basis within continuing operations in the Consolidated Statements of Operations.
The following tables provide a summary of fixed maturities available for sale and equity securities by original or amortized cost and estimated fair value:
Substantially all of the unrealized losses on fixed maturities available for sale at December 31, 2015 and 2014 are attributable to changes in market interest rates and general disruptions in the credit market subsequent to purchase. The unrealized losses on equity investments were primarily attributable to normal market fluctuations. The Company does not currently intend to sell nor does it expect to be required to sell any of the securities in an unrealized loss position. Based upon the Company's expected continuation of receipt of contractually required principal and interest payments and its intent and ability to retain the securities until price recovery, as well as the Company's evaluation of other relevant factors, the Company deems these securities to be temporarily impaired as of December 31, 2015 and 2014
Most mortgage loans are first position loans. Loans issued are generally limited to no more than 80% of the appraised value of the property.
Changes in the current economy 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. Given the uncertainty of the current market, Management has taken a conservative approach with the discounted mortgage loans and has classified all discounted mortgage loans held as non-accrual. In such status, the Company is not recording any accrued interest income nor is it recording any accrual of discount on the loans held. The Company records repayments on loans as discount accrual when the loan basis has been paid in full.
The Company had investments with a fair value of $8,932,241 and $10,635,716 on deposit with various state insurance departments as of December 31, 2015 and 2014, respectively.
The following table presents the Company's assets and liabilities measured at fair value in the consolidated balance sheet on a recurring basis as of December 31, 2015.
The following table presents the Company's assets and liabilities measured at fair value in the consolidated balance sheet on a recurring basis as of December 31, 2014.
UG entered into a coinsurance agreement with Park Avenue Life Insurance Company ("PALIC") effective September 30, 1996. Under the terms of the agreement, UG ceded to PALIC substantially all of its then in-force paid-up life insurance policies. Paid-up life insurance generally refers to non-premium paying life insurance policies. Under the terms of the agreement, UG sold 100 % of the future results of this block of business to PALIC through a coinsurance agreement. UG continues to administer the business for PALIC and receives a servicing fee through a commission allowance based on the remaining in-force policies each month. PALIC has the right to assumption reinsure the business, at its option, and transfer the administration. The Company is not aware of any such plans. PALIC's ultimate parent, The Guardian Life Insurance Company of America ("Guardian"), currently holds an "A++" (Superior) rating from A.M. Best. The PALIC agreement accounts for approximately 63 % of UG's reinsurance reserve credit, as of December 31, 2015 and 2014.
The Company does not have any short-duration reinsurance contracts. The effect of the Company's long-duration reinsurance contracts on premiums earned in 2015 and 2014 were as follows:
At December 31, 2015 and 2014, the Company had gross deferred tax assets of $4,896,464 and $2,405,249, respectively, and gross deferred tax liabilities of $8,301,931 and $11,819,043, respectively, resulting from temporary differences primarily related to the life insurance subsidiary. A valuation allowance is to be provided when it is more likely than not that deferred tax assets will not be realized by the Company. No valuation allowance has been recorded (except as noted below) relating to the Company's deferred tax assets since, in Management's judgment, the Company will more likely than not have sufficient taxable income in future periods to fully realize its existing deferred tax assets.
The UTG Avalon promissory note issued on December 29, 2014 carried interest at a rate of 3.50 % with interest payable quarterly beginning in July of 2015. The interest is a variable rate that is equal to the lowest of the U.S. Prime Rates as published in the money section of the Wall Street Journal. The interest rate is subject to change monthly and any change in interest rate is effective the first day of the month following the rate change. Principal is due upon maturity of the note. This note was fully repaid during the third quarter of 2015. The principal payments were paid by UTG and as a result of the payments; intercompany promissory notes receivable/payable were established.
The UTG line of credit carries interest at a fixed rate of 3.75 % and is payable monthly. As collateral, UTG has pledged 100% of the common voting stock of its wholly owned subsidiary, Universal Guaranty Life Insurance Company ("UG").
During June of 2015, the Federal Home Loan Bank approved UG's Cash Management Advance Application ("CMA"). The CMA gives the Company the option of selecting a variable rate of interest for up to 90 days or a fixed rate for a maximum of 30 days. The variable rate CMA is prepayable at any time without a fee, while the fixed CMA is not prepayable prior to maturity.
Within the Company's trading accounts, certain trading securities carried as liabilities represent 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.
The following table represents the total funding commitments and the unfunded commitment as of December 31, 2015 related to certain investments:
During 2015, the Company committed to invest in Sovereign's Capital, LP Fund II ("Sovereign's II"), which invests in companies in emerging markets. Sovereign's II makes capital calls to investors as funds are needed.
Stock Repurchase Program - The Board of Directors of UTG has authorized the repurchase in the open market or in privately negotiated transactions of UTG's common stock. At a meeting of the Board of Directors on June 3, 2015, the Board of Directors of UTG authorized the repurchase of up to an additional $1,000,000 of UTG's common stock, for a total, repurchase of $8,000,000. Repurchased shares are available for future issuance for general corporate purposes. This program can be suspended or terminated at any time without further notice. Open market purchases are made based on the last available market price and are generally limited to a maximum per share price of the most recent reported per share GAAP equity book value of the Company. During 2015, the Company repurchased 25,919 shares through the stock repurchase program for $375,207. Through December 31, 2015, UTG has spent $6.5 million in the acquisition of 688,617 shares under this program.
Director Compensation - Effective September 18, 2013, each outside Director will annually receive $8,000 as a retainer and $1,000 per meeting attended. The compensation, however, shall be paid in UTG common stock. The value will be determined annually on the close of business December 20th or the next business day should December 20th be a weekend or holiday, based on the activity of the year just ending. UTG's director compensation policy also provides that Directors who are employees of UTG or its affiliates do not receive any compensation for their services as Directors except for reimbursement for reasonable travel expenses for attending each meeting. In December of 2015, the Company issued 4,245 shares of its common stock as compensation to the Directors. The shares were valued at $14.36 per share, the market value at the date of issue. During 2015, the Company recorded $60,958 in operating expense related to the stock issuance. In December of 2014, the Company issued 4,755 shares of its common stock as compensation to the Directors. The shares were valued at $14.50 per share, the market value at the date of issue. During 2014, the Company recorded $68,948 in operating expense related to the stock issuance.
The computation of diluted earnings per share is the same as basic earnings per share for the years ending December 31, 2015 and 2014, as there were no outstanding securities, options or other offers that give the right to receive or acquire common shares of UTG.
UG is domiciled in the state of Ohio. Ohio requires notification within five business days to the insurance commissioner following the declaration of any ordinary dividend and at least ten calendar days prior to payment of such dividend. Ordinary dividends are defined as the greater of: a) prior year statutory net income or b) 10 % of statutory capital and surplus. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. UG paid ordinary dividends of $4,000,000 and $4,800,000 to UTG in 2015 and 2014,respectively. No extraordinary dividends were paid during the two year period. UTG used the dividends received during 2014 and 2015 to purchase outstanding shares of UTG stockand for general operations of the Company.
On February 20, 2003, UG purchased $4,000,000 of a trust preferred security offering issued by First Southern Bancorp, Inc. ("FSBI"). The security has a mandatory redemption after 30 years with a call provision after 5 years. The security pays a quarterly dividend at a fixed rate of 6.515 %. The Company received dividends of $264,219 during 2015 and 2014. On March 30, 2009, UG purchased $1,000,000 of FSBI common stock. The sale and transfer of this security is restricted by the provisions of a stock restriction and buy-sell agreement.
The Company reimbursed expenses incurred by employees of FSNB relating to salaries, travel and other costs incurred on behalf of or relating to the Company. The Company paid $324,918 and $325,479 in 2015 and 2014, respectively to FSNB in reimbursement of such costs. In addition, the Company reimburses FSNB a portion of salaries and pension costs for Mr. Correll and Mr. Ditto. The reimbursement was approved by the UTG Board of Directors and totaled $349,351 and $332,725 in 2015 and 2014, respectively, which included salaries and other benefits.
As previously disclosed in the Notes Receivable section of Note 2 - Investments, several of the Company's notes have participation agreements in place with third parties. Certain participation agreements are with FSF, a related party. The participation agreements are sold without recourse and assigned to the participant based on their pro-rata share of the principal, interest and collateral as specified in the participation agreements. The undivided participations in the notes receivable range from 20% - 50%. The total amount of loans participated to FSF were $3,170,000 and $0 as of December 31, 2015 and 2014, respectively. One of the participated notes receivable was fully repaid during the first quarter of 2016 reducing the outstanding participating notes receivable balance with FSF to $670,000.
During the fourth quarter of 2014, UG's wholly-owned subsidiary, UTG Avalon, LLC, entered into a noncash transaction whereby the subsidiary obtained a promissory note in the amount of $4.4 million and utilized the note to repay a prior line of credit.