The Company's short-term obligations consist primarily of operating expenses and policyholder benefits. The Company has been able to meet these funding requirements out of operating cash and cash equivalents. The Company does not anticipate that it will become necessary to sell long-term investments to meet short-term obligations.
Following is a summary of fixed maturities held for investment and available for sale by rating class:
The loan-to-value ratio on delinquent loans is 40%. Therefore, the Company does not anticipate any loss should it choose to foreclose.
All policy loans are secured by the cash surrender value of the policies.
The Company's operations can be grouped into three major segments, individual life insurance, guaranteed issue and simplified issue life insurance, and brokerage operations. These segments are differentiated primarily by their respective methods of distribution and the nature of related products, as the Company's operations in each segment are concentrated within its southeastern state geographic market. Individual life insurance products are distributed through the Company's multi-line exclusive agents, guaranteed issue and simplified issue products are distributed through independent agents as well as exclusive agents, and brokerage operations all involve third party products distributed through the Company's exclusive and independent agents.
Realized investment gains during the past three years resulted from the sale of bonds. The Company anticipates that future gains will be approximately $120,000 per year. Larger gains in 1998 resulted from the Company taking advantage of market conditions to increase its overall portfolio yield.
The effective tax rates were 30% for 1998, 26% for 1997 and 21% for 1996. The increase in effective tax rates in the last two years, was due to CSMR utilizing all of its tax loss carry forwards in the fourth quarter of 1997 and the increase in deferred acquisition costs and other temporary differences which are taxed at a rate of 34% and do not reflect the impact of the small company deduction. The Company anticipates that future tax rates will range from 30% to 33%.
The Company currently utilizes both IT and non-IT systems to conduct its business. IT systems that the Company utilizes include third party business application systems, computer hardware, and operating systems. Non-IT systems that the Company utilizes include embedded technology such as micro-controllers, which are critical in conducting its business. The Company also has several material third party relationships that must address the Year 2000 issue of their IT and non-IT systems, including the Company's related parties, reinsurers and third party administrators.
In 1995, the Company initiated a three phased project to address the business issues associated with Year 2000 and its impact on both IT and non-IT systems. The project was designed to address both internal considerations and external considerations affecting customers, business relationships, and the resulting impact on Company operations. Project progress is regularly reviewed by the Company's senior management and Board of Directors.
Phase 1: Business Applications Systems: This phase addresses the evaluation, testing, and upgrading of the Company's mission-critical business application systems, including the Life administration systems, general ledger, accounts payable, and business interfaces to and from these systems. This phase of the project was completed and fully implemented as of December 31, 1998. The costs of testing and replacing non-compliant IT systems have totaled approximately $10,000, in 1998 and have been expensed as incurred.
Phase 2: Information Technology Hardware/Operating Systems. This phase addresses the evaluation, testing and upgrading of the Company's mainframe hardware and operating systems. This phase of the project is 25% complete, with an expected completion date of September 30, 1999. The costs associated with this compliance effort have totaled $62,500 in 1998, and have been expensed as incurred. The remaining costs anticipated with this phase of the project total $33,000.
The Company does rely on several third party systems whose non-compliance could materially impact the results of operations. Certain insurance companies process override commissions for the benefit of the Company's subsidiaries, CSMR and CSI. Another significant business partner is involved in the administrative, billing, collection and reporting of financial transactions relating to the Company's payroll deduction universal life products. Non-compliance by these third parties could negatively affect the Company's revenue stream. The Company has surveyed and/or visited these companies to determine the status of their Year 2000 compliance, and has developed contingency plans in the event of Year 2000 failures with these material relationships. The Company will continue to monitor the status of these relationships as well as other significant relationships, and although the Company has not received any indication at this time that these third parties will not be Year 2000 compliant, the Company has not received nor expects to assume that the third parties will guarantee that their remediation efforts will result in Year 2000 compliance.
develop a Year 2000 operational support plan for the millennium weekend, including on-site staff and on-call support. Exposure and risk management will continue through the first quarter of 2000.
In light of its compliance efforts, the Company does not believe that the Year 2000 issue will materially adversely affect operations or results of operations, and does not expect implementation to have a material impact on the Company's financial statements. However, there can be no assurance that the Company's systems will be Year 2000 compliant prior to December 31, 1999, or that the failure of any such system will not have a material adverse effect on the Company's business, results of operations and financial condition. In addition, to the extent the Year 2000 problem has a material adverse effect on business, operations and financial condition of third parties with whom the Company has material relationships, such as customers, distributors, vendors, suppliers and financial institutions, the Year 2000 problem could have a material adverse effect on the Company's business, results of operations and financial condition.
The Company has made certain forward-looking statements in this Annual Report for the year ended December 31, 1998, and has and will make such statements in other contexts. Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, or other developments. Statements using verbs such as "expect," "anticipate," "believe" or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward- looking statements include statements which represent the Company's beliefs concerning future levels of sales and redemptions of the Company's products, investment spreads and yields, or the earnings and profitability of the Company's activities.
The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP), which vary in certain respects from reporting practices prescribed or permitted by the Insurance Department of the State of Georgia. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Accounts that the Company deems to be acutely sensitive to changes in estimates include deferred policy acquisition costs and future policy benefits. In addition, the Company must determine requirements for disclosure of contingent assets and liabilities as of the date of the financial statements based upon estimates. In all instances, actual results could differ from estimates.
CREDIT RISK is the risk that issuers of securities owned by the Company will default, or other parties, including reinsurers which owe the Company money, will not pay. The Company minimizes this risk by adhering to a conservative investment strategy and by contracting with reinsuring companies that meet certain rating criteria and other qualifications.
INTEREST RATE RISK is the risk that interest rates will change and cause a decrease in the value of an insurer's investments. The Company mitigates this risk by attempting to match the maturity schedule of its assets with the expected payout of its liabilities. To the extent that liabilities come due more quickly than assets mature, an insurer would have to sell assets prior to maturity and recognize a gain or loss.
The consolidated financial statements include the accounts of Cotton States Life Insurance Company, its wholly owned subsidiaries, CSI Brokerage Services, Inc. (CSI) and Cotton States Marketing Resources, Inc. (CSMR). All significant intercompany balances and transactions have been eliminated in consolidation.
The costs of acquiring most new individual life business are deferred and amortized with interest over the premium-paying period of the related policies. For traditional life policies, such amounts are amortized in proportion to the ratio of the annual premium income to the total anticipated premium income. Such anticipated premium income is estimated using the same assumptions as used for computing future policy benefits. For universal life policies, deferrable costs are amortized in proportion to the ratio of the contract's annual gross profits to total anticipated gross profits. First- year excess expense charges are also deferred and accreted to income in the same manner as deferrable costs are amortized. Total anticipated gross profits are based on assumptions for investment margins, surrender charges, mortality charges, and level expense loads. The principal expenses deferred are commissions and certain expenses of the product marketing, policy issue, underwriting, and agency departments, all of which vary with and are primarily related to the production of new business. Policy acquisition costs deferred were approximately $6,982,000 in 1998, $5,526,000 in 1997, and $4,780,000 in 1996.
The Company and CSI and CSMR file a consolidated Federal income tax return.
Deferred taxes are recognized for the tax consequences of "temporary differences" by applying enacted statutory rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company accounts for its various stock-based compensation in accordance with the provisions set forth in Statement of Financial Accounting Standards No. 123 ("SFAS No. 123"), Accounting for Stock- Based Compensation. SFAS No. 123 permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of the grant or alternatively, continue to apply the provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations and provide pro forma net income and pro forma earnings per share disclosures for employee stock-based grants as if the fair value-based method had been applied as defined in SFAS No. 123. In accordance with APB Opinion No. 25, compensation expense is recorded on the grant date only to the extent that the current market price of the underlying stock exceeds the exercise price on the grant date. The Company has elected to continue to apply the provisions set forth in APB Opinion No. 25 and follow the disclosure provisions of SFAS No. 123. See note 8 for further information.
Also effective January 1, 1998, the Company adopted the provisions of SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 establishes new standards for the disclosures made by public business enterprises to report information about operating segments in annual financial statements and requires those enterprises to report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The operating results for the Company's operating segments are contained on page 4 of the Form 10-K.
The amortized cost and estimated market values of investments in debt securities as of December 31, 1998 and 1997 are as follows:
Bonds with amortized cost of approximately $1,800,000 at December 31, 1998 were on deposit with state regulatory authorities in accordance with statutory requirements.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
The carrying amount of policy loans is a reasonable estimate of fair value.
(A) Interest rates are graded to the ultimate rate in 25 years.
The Company has a plan which provides for post-retirement health care and life insurance benefits for certain employees. These benefits include major medical insurance with deductible and coinsurance provisions. The Company accrues benefits on a current basis and the plan is not funded. The components of the net periodic post-retirement benefit cost for the years ended December 31 are as follows:
In addition to the stock options described above, the Company has awarded nontransferable, restricted shares of Company common stock to various key executives under key executive restricted stock bonus plans. The market value of the common stock at the date of issuance is recorded as compensation expense using the straight-line method over the vesting period of the awards. The Company awarded 23,832, 24,459, and 32,966 shares of restricted stock under such plans during 1998, 1997, and 1996, respectively. The weighted-average grant date fair value of such shares was $15.53, $7.43, and $4.50, respectively. Aggregate compensation expense with respect to the foregoing restricted stock awards was approximately $252,000, $151,000, and $106,000 in 1998, 1997, and, 1996, respectively.
In accordance with APB Opinion No. 25, approximately $320,000,$204,000 and $147,300 in compensation expense has been recorded in 1998, 1997 and 1996, respectively, for the various stock option and restricted stock awards granted in 1998, 1997 and 1996. Had the Company determined compensation cost based on the fair value at the grant date for its stock options and restricted stock awards under SFAS No. 123, the Company's net earnings and basic net earnings per share would have been reduced to the pro forma amounts indicated below:
Net earnings and shareholders' equity, as reported to regulatory authorities in conformity with statutory accounting practices for each of the years in the three-year period ended December 31, 1998 are as follows:
The Board of Directors and Shareholders Cotton States Life Insurance Company:
MANAGEMENT'S REPORT TO SHAREHOLDERS OF COTTON STATES LIFE INSURANCE COMPANY AND SUBSIDIARIES
Quarterly Results The Following is a summary of the unaudited quarterly results of operations for the three years ended December 31, 1998.
Note - Failure of individual quarterly earnings per share to total annual earnings per share results from the computation of weighted average number of shares on an individual quarterly basis.