The Company offers investment products and broker-dealer services through its subsidiary Sunset Financial Services, Inc. (SFS) for both proprietary and non-proprietary variable insurance products, mutual funds, and other securities.
The rate of morbidity, disability, and incurrence of other policyholder benefits;
During the first quarter of 2012, the Company identified an error related to the amortization period for unrecognized actuarial gains and losses for its pension plan resulting in a reduction to net periodic pension expense of $2.0 million before applicable income taxes and an after-tax increase of $1.3 million to net income and stockholders' equity. The excess amortization had been previously recorded during 2011. Please refer to Note 13 - Pensions and Other Postretirement Benefits for additional information.
Forward-looking statements are subject to known and unknown risks, uncertainties, and other factors that may cause actual results to differ materially from those contemplated by the forward-looking statements. Factors that could cause the Company’s future results to differ materially from expected results include, but are not limited to:
Fixed maturity and equity securities, which are classified as available for sale, are carried at fair value in the Company’s Consolidated Balance Sheets, with unrealized gains or losses recorded in accumulated other comprehensive income. The Company’s fair value of fixed maturity and equity securities is derived from external pricing services, brokers, and internal matrices and calculations. At December 31, 2013, approximately 97% of the carrying value of these investments was from external pricing services and 3% was derived from brokers and internal matrices or calculations.
The Company monitors the various markets in which its investments are traded. The Company uses various methodologies and techniques to determine a best-estimate of fair value of its investments. However, all factors may not be known or publicly available from which to determine a value and, as such, the fair value used by the Company may not be truly indicative of the actual value available in an active market or an actual exit price if the Company were to sell the security in the current market. See further discussion of the valuation techniques and processes identified in Notes 4 and 5 to the Consolidated Financial Statements.
judgment. Specifically, the Company performs discounted cash flow projections on these securities to evaluate whether the value of the investment is expected to be fully realized. If the present value of the expected future cash flows is determined to be below the Company’s carrying value, the Company recognizes an other-than-temporary impairment on the portion of the carrying value that exceeds the projected expected future cash flows. To the extent that the loan-backed or other asset-backed securities were high quality investments at the time of acquisition, and they remain high quality investments and do not otherwise demonstrate characteristics of impairment, the Company performs other initial evaluations to determine whether other-than-temporary cash flow evaluations need to be performed. Please see the Analysis of Investments section for additional information.
To the extent the Company's review and valuation determines a loan is impaired, that amount is charged to the allowance for loss and the loan balance is reduced. In the event that a property is foreclosed upon, the carrying value is written down to the lesser of the current fair value less costs to sell or book value of the property with a charge to the allowance for potential future losses and a corresponding reduction to the mortgage loan asset.
A 10% increase in expected surrender rates for all future years would result in a reduction in DAC and an increase in current period amortization expense of $1.6 million.
A 10 basis point reduction in future interest rate spreads would result in a reduction in DAC and an increase in current period amortization expense of $2.7 million.
A 10% increase in future maintenance expenses would result in a reduction in DAC and an increase in current period amortization expense of $1.7 million.
The following table illustrates the estimated sensitivity on a pre-tax basis to VOBA on interest sensitive products that could occur in a twelve-month period for an unlocking adjustment due to potential changes in significant assumptions. Changes in assumptions of the same magnitude in the opposite direction would have an impact of a similar magnitude but opposite direction of the examples provided. Information included in the table is intended to illustrate potential sensitivity of future expected gross profits or amortization trends.
A 10% increase in expected surrender rates for all future years would result in a reduction in VOBA and an increase in current period amortization expense of $0.6 million.
A variety of reinsurance ceded arrangements are currently in use by the Company, including individual and bulk arrangements on both coinsurance and mortality/morbidity-only basis. Reinsurance is an actively managed tool for the Company that supports several objectives, including managing statutory capital and reducing volatility and surplus strain. At the customer level, reinsurance increases the Company’s capacity, provides access to additional underwriting expertise, and generally makes it possible for the Company to offer products at competitive levels that could not otherwise be made available.
The Company remains contingently liable if the reinsurer should be unable to meet obligations under the reinsurance contract. The Company monitors the relative financial strength and viability of its reinsurance partners.
Reinsurance recoverables include amounts related to paid benefits and estimated amounts related to unpaid policy and contract claims and future policy benefits.
The measurement of pension and other postretirement benefit obligations (OPEB) and costs depends on a variety of assumptions. Changes in the valuation of pension obligations and assets supporting this obligation can significantly impact the funded status. Assumptions are made regarding the discount rate, expected long-term rate of return on plan assets, health care claim costs, heath care cost trends, retirement rates, and mortality. Generally, the discount rate, expected return on plan assets, and mortality tables have the most significant impact on the cost. See Note 13 - Pensions and Other Postretirement Benefits in the Notes to Consolidated Financial Statements for further details.
Deposits related to universal life, fixed deferred annuity contracts, and investment-type products are credited to policyholder account balances. Revenues from such contracts consist of amounts assessed against policyholder account balances for mortality, policy administration, and surrender charges, and are recognized in the period in which the benefits and services are provided as contract charges in the Consolidated Statements of Comprehensive Income. Deposits are not recorded as revenue. Instead, deposits are included as a financing activity in the Consolidated Statements of Cash Flows.
Deferred income taxes are recorded based on the differences between the tax bases of assets and liabilities and the amounts at which they are reported in the consolidated financial statements. Recorded amounts are adjusted to reflect changes in income tax rates and other tax law provisions as they become enacted. Deferred income tax assets are subject to ongoing evaluation of whether such assets will be realized. The ultimate realization of deferred income tax assets generally depends on the reversal of deferred tax liabilities and the generation of future taxable income and realized gains during the periods in which temporary differences become deductible. Deferred income taxes include future deductible differences relating to unrealized losses on investment securities. The Company evaluates the character and timing of unrealized gains and losses to determine whether available future taxable amounts are sufficient to offset future deductible amounts. A valuation allowance against deferred income tax assets may be required if future taxable income is believed to be insufficient to fully realize the assets.
The Company’s marketing plan for individual products focuses on three main aspects: providing financial security with respect to life insurance, the accumulation of long-term value, and future retirement income needs. The primary emphasis is on the growth of individual life insurance business, including new premiums for individual life products and new deposits for universal life and
variable universal life products. Consumer preferences and customer choices are very hard to predict and significantly influence life and annuity insurance purchases. The Company attempts to provide a varied portfolio of products that support consumer needs and is constantly assessing new products and opportunities.
The Company recognizes conversions of fixed deferred annuities to immediate annuities as new premiums at the time of conversion. Deferred annuity contracts typically provide for such conversions as one of several settlement options, and the volume and timing of such conversions can vary based upon the individual needs and decisions of contract owners.
The Company also markets a series of group products. These products include group life, dental, disability, and vision products. The primary growth strategies for these products include increased productivity of the existing group representatives; planned expansion of the group distribution system; and to selectively utilize third-party marketing arrangements. Further, growth is to be supported by the addition of new products to the portfolio. The Company evaluates the profitability of sales to groups and adjusts the ongoing pricing to support benefit and profit expectations.
Consolidated total premiums increased $50.6 million or 26% in 2013 compared to 2012, as total new premiums increased $47.0 million and total renewal premiums increased $3.6 million. The largest component in the increase in new premiums was a $43.4 million increase in new immediate annuity premiums. Immediate annuity receipts can have sizeable fluctuations, as receipts from policyholders largely result from one-time premiums rather than recurring premiums and the conversions from fixed deferred annuities are based upon the individual needs and decisions of contract owners. Conversions from fixed deferred annuities totaled $42.4 million during 2013. Conversions increased in 2013, reflecting an increase in eligible deferred annuities and changes in marketing and policyholder communications. In addition, new group accident and health premiums increased $2.9 million, largely in the dental line. Finally, new group life insurance premiums increased $0.5 million or 20% compared to one year earlier. These increases were primarily due to the addition of new distributors and increased sales from existing sales representatives. The increase in renewal premiums was primarily due to a $2.8 million or 3% increase in individual life insurance premiums, principally from the Old American segment. This increase was largely due to higher sales in earlier periods.
New deposits on these products are heavily influenced by the general economic conditions and interest rates available in the marketplace. In addition, the variable life and annuity products are also influenced by the fluctuations in the equity markets. Generally, low interest rate environments present significant challenges to products such as these and enable potential sizeable fluctuations in new sales.
Total new deposits decreased $2.9 million or 3% in both 2013 and 2012 compared to the same periods one year earlier. The decline in 2013 resulted from a $10.7 million decrease in new fixed annuity deposits. Partially offsetting this, new universal life deposits increased $5.2 million, new variable universal life deposits increased $0.9 million, and new variable annuity deposits increased $1.8 million.
Total renewal deposits increased $14.6 million or 10% in 2013, following a $3.6 million or 2% decline in 2012. The reinsurance transaction on variable products increased renewal deposits $20.0 million in 2013. Excluding this transaction, 2013 renewal deposits decreased $5.4 million or 4%. This reflected a $2.6 million decline in fixed annuity renewal deposits, a $1.3 million decrease in variable annuity renewal deposits, a $0.9 million decrease in universal life renewal deposits, and a $0.6 million decline in variable universal life renewal deposits. The decline in 2012 was largely attributable to a decrease in fixed deferred annuity renewal deposits.
At least annually, a review is performed regarding the assumptions related to future expected gross profits on products and policies consistent with those performed for DAC and VOBA. If it is determined that the assumptions should be revised, an adjustment may be recorded to the deferred revenue component of contract charges in the current period as an unlocking adjustment. The Company had unlocking in the DRL in both 2013 and 2012. In both years, unlocking was due to changes in the interest and mortality margins. This unlocking resulted in a decrease to the deferred revenue liability and an increase to contract charges of $1.1 million and $1.8 million in 2013 and 2012, respectively.
Investment income from real estate properties increased $1.2 million or 13% in 2013, largely due to the purchase and development of real estate over the past two years.
During 2013, the Company had one security written down through earnings that was equal to $0.5 million on a consolidated basis. This investment was a collateralized debt obligation that was written down due to an increase in projected future losses on the underlying collateral. During 2012, two securities were written down through earnings that were equal to or exceeded $0.5 million on a consolidated basis. The first was a collateralized debt obligation that was written down by $0.5 million due to an increase in projected future losses on the underlying collateral. The second was a corporate security that was written down by $0.6 million due to the expected settlement value after the issuer filed for bankruptcy. The Company did not have any individual investment securities that were written down through earnings during 2011 that exceeded $0.5 million on a consolidated basis.
Policyholder benefits consist of death benefits, immediate annuity benefits, accident and health benefits, surrenders, interest, other benefits, and the associated increase or decrease in reserves for future policy benefits. The largest component of policyholder benefits was death benefits for the periods presented. Death benefits reflect mortality results, after consideration of the impact of reinsurance. Mortality will fluctuate from period-to-period.
Policyholder benefits increased $4.4 million or 3% in 2012 compared to 2011, primarily due to an increase in benefit and contract reserves. This increase was the result of several factors, including: increased traditional life insurance sales, primarily from the Old American Segment; higher immediate annuity premiums from the Individual Insurance segment; the recapture of a block of policies in the second quarter of 2012; impacts resulting from changes and refinements that the Company made to its reserving systems in 2011, as discussed below; and, the change in the value of the guaranteed minimum withdrawal benefit (GMWB) rider liability, as discussed below. Partially offsetting the increase in reserves, the Company experienced favorable mortality, and group accident and health dental benefits decreased.
Interest is credited to policyholder account balances according to terms of the policies or contracts for universal life, fixed deferred annuities, and other investment-type products. There are minimum levels of interest crediting stipulated in certain policies or contracts, as well as allowances for adjustments to be made to reflect current market conditions in certain policies or contracts. Accordingly, the Company reviews and adjusts crediting rates as necessary and appropriate. Amounts credited are a function of account balances and current period crediting rates. As account balances fluctuate, so will the amount of interest credited to policyholder account balances. Interest credited to policyholder account balances decreased $2.7 million or 3% in 2013 and $1.4 million or 2% in 2012. The decline in 2013 reflected lower policyholder account balances and a decline in crediting rates compared to 2012. While policyholder account balances increased during 2012 compared to 2011, this increase was offset by a decline in
Total policyholder account balances decreased $31.8 million or 1%, following a $38.6 million or 2% increase in 2012. The average interest rate credited to policyholder account balances was 3.64% in 2013, 3.77% in 2012, and 3.92% in 2011. Investment yields on the assets matched to these liabilities were 5.27% in 2013, 5.51% in 2012, and 5.72% in 2011.
The primary factor in the decrease in DAC amortization in 2012 versus 2011 was the unlocking that occurred in 2011. As identified in the 2011 Form 10-K, this segment had an unlocking that included both an upgrade and refinement in the processing system, primarily related to reinsurance. In addition, increases in account values decreased the amortization of DAC for certain variable products. Partially offsetting these was the impact of an unlocking that occurred during 2012. This unlocking resulted in an increase to the DAC asset of $1.3 million and was primarily attributable to refinements in mortality, interest, and persistency assumptions.
Premiums are reported in the Consolidated Statements of Comprehensive Income net of premiums ceded under reinsurance agreements. Policyholder benefits and expenses are also reported in the Consolidated Statements of Comprehensive Income net of reinsurance ceded and equaled $53.8 million, $54.3 million, and $63.7 million for the years ended December 31, 2013, 2012 and 2011, respectively. The largest single component of the reinsurance ceded premiums is associated with reinsurance on purchased and subsequently closed blocks of business.
Future policy benefits and other related assets and liabilities are not reduced for reinsurance in the Consolidated Balance Sheet. A reinsurance recoverable is established for these items. Reinsurance related to policy and claim reserves ceded of $178.7 million and $177.1 million were included in the reinsurance recoverables at December 31, 2013 and 2012, respectively. Ceded benefits recoverable from reinsurers were $12.4 million and $13.5 million at December 31, 2013 and 2012, respectively.
The Company’s investment in affordable housing decreased tax expense in 2013, as low income housing credits earned exceeded the equity adjustment related to the affordable housing investments. The Company’s investments in affordable housing decreased tax expense in 2012, as low income housing credits earned exceeded the equity adjustment related to the affordable housing investments and the recapture of previously recognized tax credits. In 2013, tax credits earned exceeded equity adjustments by $0.8 million or 2% of income before tax. In 2012, the effect of the investments in affordable housing on the effective tax rate was a tax benefit of $0.4 million or 1% of income before tax. This was the result of $0.5 million in tax credits earned in excess of equity adjustments, partially offset by $0.1 million of recapture of previously recognized tax credits.
The following table presents financial data of the Individual Insurance business segment for the years ended December 31.
Total insurance revenues increased $57.0 million or 49% in 2013 compared to a $5.3 million or 5% increase in 2012 compared to the same periods one year earlier. In 2013, gross premiums increased 74%, contract charges increased 14%, and reinsurance ceded was essentially flat. In 2012, gross premiums increased 9%, contract charges decreased 1%, and reinsurance ceded decreased 4%.
The following table presents gross premiums by new and renewal business, less reinsurance ceded, as included in insurance revenues for the three years ended December 31. New premiums are also detailed by product.
As previously mentioned, the Company has both closed blocks and ongoing blocks of business. Total contract charges on closed blocks comprised 41% of total consolidated contract charges during 2013, compared to 35% in 2012. Total contract charges on closed blocks increased 34% from $34.8 million in 2012 to $46.6 million in 2013. This increase can be attributed to the reinsurance transaction, which is considered a closed block. Excluding this transaction, total contract charges on closed blocks equaled 30% of total consolidated contract charges during 2013 compared to 35% during 2012. This decline reflects the runoff of the business. Total contract charges on open blocks of business increased 3% in 2013 compared to 2012.
Net investment income decreased $6.1 million in 2013 and $0.9 million in 2012. These declines reflected an increase in average invested assets that was more than offset by lower yields earned.
Policyholder benefits increased $49.5 million or 57% in 2013 compared to a $4.8 million or 6% increase in 2012. This increase resulted from a $38.4 million increase in reserves, a $9.5 million or 17% increase in death benefits, net of reinsurance, and a $2.2 million or 6% increase in other benefits, net of reinsurance. Several factors contributed to the change in reserves. The largest factor was $42.4 million in new immediate annuity premiums resulting from conversions of fixed deferred annuities. Conversions increased in 2013, reflecting an increase in eligible deferred annuities and changes in marketing and policyholder communications. Policyholder reserves for immediate annuity premiums are established on an approximately equal and offsetting basis, and an increase in premiums results in an increase to reserves on a comparative basis. Also, the Company refined its reserve calculation estimate for new traditional life insurance issues in 2013 related to adjustments used for modal premiums. The refinements allow for more precise calculations of the reserve liability and resulted in a decrease to the reserve liability of $1.3 million. The refinements also resulted in a corresponding increase to the amortization of DAC, which largely offset the impact to net income. In addition, the change in the fair value of the GMWB rider resulted in a $2.7 million decrease in benefit and contract reserves. Also, the recapture of a block of previously reinsured policies in the second quarter of 2012 increased benefit and contract reserves with no corresponding increase in 2013. The increase in other benefits was primarily due to higher supplementary contract and immediate annuity payments.
Interest credited to policyholder account balances decreased $2.7 million or 3% in 2013 and $1.4 million or 2% in 2012. The decline in 2013 reflected lower policyholder account balances and a decline in crediting rates compared to 2012. In 2012, an increase in total policyholder account balances was more than offset by a decline in crediting rates.
The amortization of DAC increased $5.7 million or 39% in 2013, following a decrease of $6.9 million or 32% in 2012. The largest factor of the increase in 2013 was the amortization of the DAC asset that was established from the reinsurance transaction. This transaction added $3.6 million to amortization in 2013. Excluding this transaction, the amortization of deferred acquisition costs increased $2.1 million or 15% in 2013. This increase was primarily the result of unlocking adjustments in both 2013 and 2012. Unlocking increased DAC amortization $0.2 million in 2013, compared to an unlocking adjustment that decreased DAC amortization $1.3 million in 2012. As indicated above, the Company also had a refinement in its reserve method for new traditional life insurance issues in 2013 that impacts the amortization for each quarter. This change increased DAC amortization approximately $0.9 million in 2013. However, this change in reserve method had virtually no impact to the net income.
This segment uses direct sales representatives managed by the home office group marketing division, independent third-party distributors, and the Company's agent and general agent field force. Sales from internal producers accounted for 74% of this segment's total sales during 2013, while sales from third-party providers made up the remaining portion of sales. No one third-party provider accounts for a majority of this segment's sales.
This segment has the opportunity to consider new distribution channels, which may offer growth potential for sales. These alternative channels may offer unique or one-time opportunities from the segment's ongoing sales channels and may open new markets for the segment. These arrangements are often heavily reinsured, which reduces overall exposure to the group lines. In addition, the segment may receive administrative fee revenue on those sales.
Policyholder benefits for this segment consist of claim payments and increases or decreases in reserves for future policy benefits. Policyholder benefits increased $2.4 million or 9% in 2013 compared with the prior year. This result was largely the result of a $1.8 million increase in dental benefits and a $0.6 million increase in group life benefit payments. The increased sales in the group dental line drove the increase in benefits. This segment generally incurs higher dental benefits on new groups and generally attempts to price the products with certain benefit expectations. However, when actual results exceed expectations, price adjustments are made in subsequent renewal years. In 2012, policyholder benefits decreased $1.0 million compared with 2011. The 2012 results reflected decreased benefits in both the group dental and group life product lines, which more than offset increases in the disability product lines.
ratio for the group segment was 55% in both 2013 and 2012, and it was 56% in 2011. The group dental and group life policyholder benefit ratios decreased in both 2013 and 2012.
Operating expenses consist of commissions, fees to third-party marketing and administrative organizations, as well as expenses from the segment's operations. Operating expenses for this segment were flat in both 2013 and 2012 compared to the same periods one year earlier.
One of the key focus points for this segment is on improving profitability through enhanced technology with both its customers and sales force. This segment remains focused to find and deliver more effective electronic and automated support through interactive delivery sites and also to deliver more effective customer support to the companies that make up the group network. Further, this segment has a unique opportunity and challenge to improve performance as the Affordable Care Act (ACA) continues to unfold. The ACA law is evolving and the dental and vision lines are directly affected by these new and complex set of laws. This segment is on track to be fully ACA compliant in-time for the 2015 enrollments but the challenge to address these ever-evolving changes is difficult. The segment believes that the ACA is specifically drafted to support this segment's customer base, that being small employer groups. These small employers rely heavily on brokers to support them, especially during uncertain and challenging times.
The following table presents gross premiums by new and renewal business, less reinsurance ceded, as included in insurance revenues for the three years ended December 31.
Total new premiums were flat in 2013 compared with the same period one year earlier. However, new premiums in 2012 increased 5% versus 2011. Renewal premiums on the traditional life business totaled $61.5 million, a $2.6 million increase versus the prior year. New sales growth has slowed in 2013, due to lower agent productivity and agent turnover. However, this segment has experienced an increase in renewal premiums, which is the result of growth in new sales in prior periods. Old American continues to focus on the recruitment and development of new agencies and agents. This segment has aggressively managed territories assigned to agencies and has emphasized recruiting to improve production of new sales. This effort has also identified opportunities for this segment to expand its distribution efforts into market locations where it has either not had a presence or had a very limited presence in the recent past. Finally, Old American is also focused on maintaining and enhancing its products with the intent of keeping affordable and relevant products available to its customers.
Policyholder benefits were flat in 2013 compared with 2012. Net death benefits increased in 2013, reflecting less favorable mortality results and an increase in the overall block of business. While mortality remains within pricing assumptions, the increase in death benefits, in part, reflects the growth of sales in recent years. In addition, the Company changed its reserving methodology for new issues at the beginning of 2013. This refinement allows for more precise calculations of the reserve liability and reduced benefit and contract reserves by $2.8 million in 2013. However, this item was virtually offset by a corresponding increase in the amortization of DAC. Policyholder benefits increased $0.6 million or 1% in 2012. This increase was largely due to an increase in benefit and contract reserves, which was partially offset by a decrease in death benefits, net of reinsurance. The Company's mortality experience was favorable compared to the prior year. The increase in reserves was largely attributed to the increase in both sales and retention of business.
Operating expenses decreased $0.1 million or 1% in 2013 compared with the prior year. Operating expenses decreased 16% in 2012 versus 2011. The reduction in expenses in 2012 was due to several factors. First, VOBA from the traditional life insurance block that was established at the time of purchase became fully amortized at December 31, 2011. This resulted in a decrease of VOBA amortization in 2012 compared to 2011. In addition, there was a reduction in agent meeting costs in 2012 relative to the prior year. Partially offsetting these decreases, capitalized commissions increased $1.1 million as a result of the implementation of ASU No. 2012-26. This new accounting pronouncement impacted the way companies capitalized commission and sales related activities.
The consolidated financial statements and the accompanying notes to the Consolidated Financial Statements have been prepared on the basis of GAAP and include the accounts of Kansas City Life and its subsidiaries, principally Sunset Life and Old American. Significant intercompany transactions have been eliminated in consolidation and certain immaterial reclassifications have been made to the prior period results to conform with the current period’s presentation.
The preparation of the consolidated financial statements requires management of the Company to make estimates and assumptions relating to the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the period. These estimates are inherently subject to change and actual results could differ from these estimates. Significant estimates required in the preparation
of the consolidated financial statements include the fair value of certain invested assets, deferred acquisition costs (DAC), value of business acquired (VOBA), future policy benefits, policy and contract claim liabilities, pension and other postretirement benefits, and the valuation allowance on deferred income tax assets.
The following table provides detail about the composition of future policy benefits at December 31.
Policyholder account balances include universal life insurance, fixed deferred annuity contracts, and investment-type contracts. Liabilities for these policyholder account balances are included without reduction for potential surrender charges. These liabilities originate from new deposits and conversions from other products. These policyholder account balances are equal to cumulative deposits, less contract charges and withdrawals, plus interest credited. Deferred front-end contract charges reduce policyholder account balance liabilities and increase the other policyholder funds liability, and are amortized over the term of the policies in a manner similar to deferred acquisition costs, as discussed below. Policyholder benefits incurred in excess of related policyholder account balances are charged to policyholder benefits expense.
Crediting rates for universal life insurance and fixed deferred annuity products ranged from 1.00% to 5.50% in 2013 (2012 - 1.00% to 5.50%; 2011 - 1.50% to 5.50%).
At least annually, a review is performed of the models and the assumptions used to develop expected gross profits for interest sensitive and variable insurance products based upon management’s current view of future events. Management’s view primarily reflects Company experience but can also reflect emerging trends within the industry. Short-term deviations in experience affect the amortization of DAC, deferred revenue liability (DRL), and VOBA in the period, but do not necessarily indicate that a change to the long-term assumptions of future experience is warranted. If it is determined that it is appropriate to change the assumptions related to future experience, then an unlocking adjustment is recognized retrospectively for the block of business being evaluated. Certain assumptions, such as interest spreads and surrender rates, may be interrelated. As such, unlocking adjustments often reflect revisions to multiple assumptions. The DAC, DRL, or VOBA balance is immediately impacted by any assumption changes, with the change reflected through the income statement as an unlocking adjustment. These adjustments can be positive or negative, and adjustments increasing the DAC asset are limited to amounts previously deferred plus interest accrued through the date of the adjustment.
Reinsurance recoverables include amounts related to paid benefits and estimated amounts related to unpaid policy and contract claims, future policy benefits, and policyholder account balances. All insurance related revenues, benefits, and expenses are reported net of reinsurance ceded. Policies and contracts assumed are accounted for in a manner similar to that followed for direct business.
Deposits related to universal life, fixed deferred annuity contracts, and investment-type products are credited to policyholder account balances. Deposits are not recorded as revenue and are shown as a Financing Activity in the Consolidated Statements of Cash Flows. Revenues from such contracts consist of amounts assessed against policyholder account balances for mortality, policy administration, and surrender charges, and are recognized in the period in which the benefits and services are provided as contract charges in the Consolidated Statements of Comprehensive Income.
Contract charges consist of cost of insurance, expense loads, the amortization of unearned revenues, and surrender charges on policyholder account balances. Cost of insurance relates to charges for mortality. These charges are applied to the excess of the mortality benefit over the account value for universal life policies. Expense loads are amounts that are assessed against the policyholder balance as consideration for origination and maintenance of the contract. Surrender charges are fees on policyholder account balances upon cancellation or withdrawal of policyholder account balances consistent with policy terms.
Contract charges could be impacted by unlocking and refinements in estimates, as discussed previously.
Interest is credited to policyholder account balances according to terms of the policies or contracts. Interest sensitive life and annuity contracts provide for the payment of interest credited to policyholder account balances, subject to contractual minimum guaranteed rates. Amounts in excess of guarantees are credited at the discretion of the Company and reflect competitive, economic, investment and product considerations. Interest credited shown on the Company's financial statements reflects both the rates declared for interest sensitive products and the amount of the balances to which those rates apply. Accordingly, the Company reviews and adjusts crediting rates as necessary and appropriate. Amounts credited are a function of account balances and current period crediting rates. As account balances fluctuate, so will the amount of interest credited to policyholder account balances.
Deferred income tax assets are subject to ongoing evaluation of whether such assets will be realized. The ultimate realization of deferred income tax assets generally depends on the reversal of deferred tax liabilities and the generation of future taxable income and realized gains during the periods in which temporary differences become deductible. Deferred income taxes include future deductible differences relating to unrealized losses on investment securities. The Company evaluates the character and timing of unrealized gains and losses to determine whether future taxable amounts are sufficient to offset future deductible amounts. A valuation allowance against deferred income tax assets may be required if future taxable income of an appropriate amount and character is not expected.
Comprehensive income (loss) is comprised of net income and other comprehensive income (loss). Other comprehensive income (loss) includes the unrealized investment gains or losses on securities available for sale (net of reclassification adjustments) net of adjustments to DAC, VOBA, policyholder account balances, and future policy benefits. In addition, other comprehensive income (loss) includes the change in the liability for benefit plan obligations. Other comprehensive income (loss) reflects these items net of tax. For additional information, please see Note 16 - Comprehensive Income (Loss).
The Company has some insurance contracts where the policyholder is entitled to share in the earnings through dividends that reflect the difference between the premium charged and the actual experience. Participating business at year-end 2013 approximated 8% of statutory premiums and 14% of the life insurance in force, increasing from 3% and 4% in 2012, respectively. The increase in 2013 was the result of the reinsurance transaction. The amount of dividends to be paid is determined annually by the Company's Board of Directors. Provision has been made in the liability for future policy benefits to allocate amounts to participating policyholders on the basis of dividend scales contemplated at the time the policies were issued. Provision has been made in the liability for future policy benefits to allocate amounts to participating policyholders on the basis of dividend scales contemplated at the time the policies were issued, as well as for policyholder dividends in excess of the original scale, which have been declared by the Board of Directors.
In February 2013, the FASB issued guidance regarding the reporting of reclassifications out of accumulated other comprehensive income (AOCI). The guidance requires entities to provide information about the amounts reclassified out of AOCI by component. Significant amounts reclassified out of AOCI that are required under GAAP to be reclassified to net income in their entirety in the same reporting period must be presented either on the face of the statement, where net income is presented, or in the footnotes. For amounts that are not required under GAAP to be reclassified in their entirety to net income, entities are required to cross-reference to other disclosures that are required by GAAP that provide additional detail about those amounts. The Company adopted this new guidance as of January 1, 2013 with no material impact to the consolidated financial statements.
In February 2013, the FASB issued guidance regarding obligations resulting from joint and several liability arrangements. The guidance concerns the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date, except for obligations addressed within existing guidance in GAAP. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The Company is currently evaluating this guidance but it does not believe that there will be a material impact to the consolidated financial statements.
The Company considers relevant facts and circumstances in evaluating whether the impairment of a security is other-than-temporary. Relevant facts and circumstances considered include but are not limited to:
The risk that actions of trustees, custodians, or other parties with interests in the security may have an unforeseen adverse impact on the Company’s investments;
Once a security is determined to have met certain of the criteria for consideration as being other-than-temporarily impaired, further information is gathered and evaluated pertaining to the particular security. If the security is an unsecured obligation, the additional research is a top-down approach with particular emphasis on the likelihood of the issuer to meet the contractual terms of the obligation. If the security is secured by an asset or guaranteed by another party, the value of the underlying secured asset or the financial ability of the third-party guarantor is evaluated as a secondary source of repayment. Such research is based upon a top-down approach, narrowing to the specific estimates of value and cash flow of the underlying secured asset or guarantor. If the security is a collateralized obligation, such as a mortgage-backed or other asset-backed instrument, research is also conducted to obtain and analyze the performance of the collateral relative to expectations at the time of acquisition and with regard to projections for the future. Such analyses are based upon historical results, trends, comparisons to collateral performance of similar securities, and analyses performed by third parties. This information is used to develop projected cash flows that are compared to the amortized cost of the security.
If a determination that new asset-backed or new structured securities are other-than-temporarily impaired, an estimate is developed of the portion of such impairment that is due to credit. The estimate of the portion of impairment due to credit is based upon a comparison of ratings and maturity horizon for the security and relative historical default probabilities from one or more nationally recognized rating organizations. When appropriate for any given security, sector or period in the business cycle, the historical default probability is adjusted to reflect periods or situations of distress by adding to the default probability increments of standard deviations from mean historical results. The credit impairment analysis is supplemented by estimates of potential recovery values for the specific security, including the potential impact of the value of any secured assets, in the event of default. This information is used to determine the Company's best estimate, derived from probability-weighted cash flows.
The discounted future cash flow calculation typically becomes the primary determinant of whether any portion and to what extent an unrealized loss is due to credit on loan-backed and similar asset-backed securities with significant indications of potential other-than-temporary impairment. Such indications typically include below investment grade ratings and significant unrealized losses for an extended period of time, among other factors. The Company identified and tested 24 and 21 non-U.S. Agency mortgage-backed securities that had such indications at December 31, 2013 and December 31, 2012, respectively. The discount rate used in calculating the present value of future cash flows was the investment yield at the time of purchase for each security. The initial default rates were assumed to remain constant over a 24 month time frame and grade down thereafter, reflecting the general perspective of a more stabilized residential housing environment in the future.
Significant unrealized losses on securities can continue for extended periods of time, particularly for certain individual securities. While this can be an indication of potential credit impairments, it can also be an indication of illiquidity in a particular sector or security. In addition, the fair value of an individual security can be heavily influenced by the complexities of varying market sentiment or uncertainty regarding the prospects for an individual security. This has been the situation in several sectors in recent years, most notably in the non-U.S. Agency mortgage-backed securities market. Based upon the process described above, the Company is best able to determine if and to what extent credit impairment may exist in these securities by performing present value calculations of projected future cash flows at the conclusion of each reporting period. By reviewing the most recent data available regarding the security and other relevant industry and market factors, the Company can modify assumptions used in the cash flow projections and determine the best estimate of the portion of any impairment that is due to credit at the conclusion of each period.
In addition, the Company also considers as part of its monitoring and evaluation process the length of time the fair value of a security is below amortized cost. At December 31, 2013, the Company had 195 issues in its investment portfolio of fixed maturity and equity securities with unrealized losses. Included in this total, 173 security issues were below cost for less than one year; twelve security issues were below cost for one year or more and less than three years; and ten security issues were below cost for three years or more. At December 31, 2012, the Company had 43 issues in its investment portfolio of fixed maturity and equity securities with unrealized losses. Included in this total, 25 security issues were below cost for less than one year; three security issues were below cost for one year or more and less than three years; and 15 security issues were below cost for three years or more.
The Company held three non-income producing securities with a carrying value of $2.0 million million at December 31, 2013, compared to one security with a carrying value of $1.9 million at December 31, 2012. These securities were previously written down due to other-than-temporary impairments and placed on non-accrual status.
The Company did not hold securities of any corporation and its affiliates that exceeded 10% of stockholders' equity at December 31, 2013 or 2012.
As an additional separate consideration, the Company closely monitors its investments in securities classified as subprime. Subprime securities include all bonds or portions of bonds where the underlying collateral is made up of home equity loans or first mortgage loans to borrowers whose credit scores at the time of origination were lower than the level recognized in the market as prime. The Company’s classification of subprime does not include Alt-A or jumbo loans, unless the collateral otherwise meets the preceding definition.
The following table provides a reconciliation of credit losses recognized in earnings on fixed maturity securities held by the Company for which a portion of the other-than-temporary loss was recognized in other comprehensive income (loss) for the years ended December 31.
Additions for increases in the credit loss for which an other-than-
intent to sell the security before recovery of its amortized cost basis
Credit losses on securities held at the end of the period
The Company had 18% of its invested assets in commercial mortgage loans at both December 31, 2013 and December 31, 2012. New commercial loans, including refinanced loans, were $72.7 million and $178.7 million for 2013 and 2012, respectively. The level of new commercial mortgage loans in any year is influenced by market conditions, as the Company responds to changes in interest rates, available spreads, borrower demand, and opportunities to acquire loans that meet the Company's yield and quality thresholds.
The table below identifies mortgage loans by maturity at December 31.
The concentration in California, along with other states included in the pacific region, exposes the Company to potential losses from a regional economic downturn and certain catastrophes, such as earthquakes and fires, that may affect certain areas of the region. The Company requires borrowers to maintain fire insurance coverage to provide reimbursement for any losses due to fire. The Company diversifies its commercial mortgage loan portfolio both geographically and by property type to reduce certain catastrophic and economic exposure. However, diversification may not always sufficiently mitigate the risk of such losses. Historically, the delinquency rate of the Company's pacific region commercial mortgage loans has been substantially below the industry average and consistent with the Company's experience in other regions. The Company does not require earthquake insurance for properties on which it makes commercial mortgage loans. However, the Company does consider structural information specific to each property, as well as the potential for earthquake loss if the property lies within areas believed by the Company to be seismically active submarkets. The Company does not expect catastrophe or earthquake damage or economic downturn in the
Under the laws of certain states, environmental contamination of a property may result in a lien on the property to secure recovery of the costs of cleanup. In some states, such a lien has priority over the lien of an existing mortgage against such property. As a commercial mortgage lender, the Company customarily conducts environmental assessments prior to making commercial mortgage loans secured by real estate and before taking title on real estate. Based on the Company's environmental assessments, the Company believes that any compliance costs associated with environmental laws and regulations or any remediation of affected properties would not have a material adverse effect on the Company's business, financial position, results of operations, or cash flows. However, the Company cannot provide assurance that material compliance costs will not be incurred.
Investments in real estate totaled $142.5 million at December 31, 2013, compared to $124.7 million at December 31, 2012. The table below provides information concerning the Company's real estate investments by major category at December 31.
The Company had non-income producing real estate of $21.7 million, consisting of vacant properties and properties under development, at December 31, 2013, compared to $11.3 million at December 31, 2012.
The Company categorizes its financial assets and liabilities measured at fair value in three levels, based on the inputs and assumptions used to determine the fair value. These levels are as follows:
Level 1 - Valuations are based upon unadjusted quoted prices for identical instruments traded in active markets.
Fixed maturity and equity securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon unadjusted quoted prices, if available, except as described in the subsequent paragraphs.
The Company utilizes external third-party pricing services to determine the majority of its fair values on investment securities available for sale. At December 31, 2013, approximately 97% of the carrying value of these investments was from external pricing services, 1% was from brokers, and 2% was derived from internal matrices and calculations. In the event that the primary pricing service does not provide a price, the Company utilizes the price provided by a second pricing service. The Company reviews prices received from service providers for reasonableness and unusual fluctuations but generally accepts the price identified from the primary pricing service. In the event a price is not available from either third-party pricing service, the Company pursues external pricing from brokers. Generally, the Company pursues and utilizes only one broker quote per security. In doing so, the Company solicits only brokers which have previously demonstrated knowledge and experience of the subject security. If a broker price is not available, the Company determines a fair value through various valuation techniques that may include discounted cash flows, spread-based models, or similar techniques, depending upon the specific security to be priced. These techniques are primarily applied to private placement securities. The Company utilizes available market information, wherever possible, to identify inputs into the fair value determination, primarily including prices and spreads on comparable securities.
The Company's primary category of Level 3 fair values is fixed maturity securities, totaling $1.4 million as of December 31, 2013. These assets are valued using comparable security valuations through the unobservable input of estimated discount spreads. Specifically, the Company reviews the values and discount spreads on similar securities for which such information is observable in the market. Estimates of increased discount spreads are then determined based upon the characteristics of the securities being evaluated.
The fair value of the GMWB embedded derivative is calculated using a discounted cash flow valuation model that projects future cash flows under multiple risk neutral stochastic equity scenarios. The risk neutral scenarios are generated using the current swap curve and projected equity volatilities and correlations. The equity correlations are based on historical price observations. For policyholder behavior assumptions, expected lapse and utilization assumptions are used and updated for actual experience. The mortality assumption uses the 2000 US Annuity Basic Table Mortality Table. The present value of cash flows is determined using the discount rate curve, based upon LIBOR plus a credit spread.
The Company has financing receivables that have both a specific maturity date, either on demand or on a fixed or determinable date, and are recognized as assets in the Consolidated Balance Sheets.
The following table details the activity of the allowance for potential future losses on mortgage loans at December 31.
The following table presents an aging schedule for delinquent payments for both principal and interest at December 31, 2013 and December 31, 2012, by property type.
As of December 31, 2013, there were five mortgage loans that were 30 days or more past due, including two that were 120 days past due. The two loans that were 120 days past due are in the process of foreclosure. At December 31, 2012, there were three mortgage loans that were 30 days past due. Subsequently, payment was received on these loans and they were brought current in January 2013.
The Company did not increase the allowance for potential future losses during 2013. However, the Company reviews the portfolio's risk profile and expected ongoing performance not less often than quarterly.
The Company invests in certain affordable housing and real estate joint ventures which are considered to be variable interest entities (VIEs) and are included in Real Estate in the Consolidated Balance Sheets. The assets held in affordable housing real estate joint venture VIEs are primarily residential real estate properties that are restricted to provide affordable housing under federal or state programs for varying periods of time. The restrictions primarily apply to the rents that may be paid by tenants residing in the properties during the term of an agreement to remain in the affordable housing program. Investments in real estate joint ventures are equity interests in partnerships or limited liability corporations that may or may not participate in profits or residual value. In certain cases, the Company may issue fixed-rate senior mortgage loan investments secured by properties controlled by VIEs. These investments are classified as mortgage loans in the Consolidated Balance Sheets, and the income received from such investments is recorded as investment income in the Consolidated Statements of Comprehensive Income.
Most of the Company’s investment interests in VIEs not in the form of a fixed-rate senior mortgage debt investment are recorded using the equity method, with cash distributions from the VIE and cash contributions to the VIE recorded as decreases or increases, respectively, in the carrying value of the VIE. Certain other equity investments in VIEs, where permitted, are recorded on an amortized cost basis. The operating performance of investments in the VIE is recorded in the Consolidated Statements of Comprehensive Income as investment income or as a component of income tax expense, depending upon the nature and primary design of the investment. The Company evaluates the carrying value of VIEs for impairment on an ongoing basis to assess whether the carrying value is expected to be realized during the anticipated life of the investment.
The following table presents the carrying amount and maximum exposure to loss relating to VIEs for which the Company holds a variable interest, but is not the primary beneficiary, and which had not been consolidated at December 31, 2013 and December 31, 2012. The table includes investments in six real estate joint ventures and 25 affordable housing real estate joint ventures at both December 31, 2013 and December 31, 2012.
In addition, the maximum exposure to loss on affordable housing joint ventures at December 31, 2013 and 2012 includes $22.5 million and $14.1 million, respectively, of losses which could be realized if the tax credits received by the VIEs were recaptured. Recapture events would cause the Company to reverse some or all of the benefit previously recognized by the Company or third parties to whom the tax credit interests were transferred. A recapture event can occur at any time during a 15-year required compliance period. The principal causes of recapture include financial default and non-compliance with affordable housing program requirements by the properties controlled by the VIE. The potential exposure due to recapture may be mitigated by guarantees from the managing member or managing partner in the VIE, insurance contracts, or changes in the residual value accruing to the Company's interests in the VIEs.
Guarantees are offered under variable universal life and variable annuity contracts: a guaranteed minimum death benefit (GMDB) rider is available on certain variable universal life contracts, and GMDB are provided on all variable annuities. The GMDB rider for variable universal life contracts guarantees the death benefit for specified periods of time, regardless of investment performance, provided cumulative premium requirements are met. The GMDB rider for variable annuity contracts guarantees the death benefit for specified periods of time, regardless of investment performance.
The Company modified the presentation of information in the table above to incorporate disability reserves and has conformed prior years to be consistent with the current year presentation. The changes have no impact on amounts reported in the consolidated financial statements.
The Company had no notes payable at December 31, 2013 or December 31, 2012.
As a member of the FHLB with a capital investment of $4.8 million, the Company has the ability to borrow on a collateralized basis from the FHLB. The Company received an insignificant amount of dividends on the capital investment in 2013, 2012, and 2011.
The income tax expense is recorded in various places in the Company's financial statements, as detailed below, for the years ended December 31.
The postretirement medical plans for eligible employees, agents, and their dependents are contributory with contributions adjusted annually. The benefits expected to be paid in each year from 2014 through 2018 are $0.9 million, $1.0 million, $1.1 million, $1.1 million, and $1.2 million, respectively. The aggregate benefits expected to be paid in the five years from 2019 through 2023 are $7.3 million. The expected benefits to be paid are based on the same assumptions used to measure the Company’s benefit obligation at December 31, 2013. Contributions to the plan in 2013 were $1.1 million. The 2014 contribution for the plan is estimated to be $0.9 million. The Company pays these medical costs as they become due and the plan incorporates cost-sharing features. The postretirement plan disclosures included herein do not include the potential impact from the Medicare Act (the Act) that became law in December 2003. The Act introduced a new federal subsidy to sponsors of certain retiree healthcare plans that provide a benefit that is at least actuarially equivalent to Medicare. Since the Company does not provide benefits that are actuarially equivalent to Medicare, the Act did not impact the Company’s disclosures.
Savings plans for eligible employees and agents match employee and agent contributions up to 8% of salary and 2.5% of agents’ prior year paid commissions, respectively. Contributions to the plan in 2013 were $2.1 million (2012 - $3.2 million; 2011 - $3.3 million). The Company may contribute an additional profit sharing amount up to 4% of salary for eligible employees, depending upon corporate profits. In 2013, the Company made a contribution to the plan under the profit sharing determination of 4% of salary for eligible employees, which totaled $1.3 million. In 2012, the Company made a profit sharing contribution of $1.3 million.
The Company recognizes the funded status of its defined pension and postretirement plans, measured as the difference between plan assets at fair value and the projected benefit obligation, on the Consolidated Balance Sheets. Changes in the funded status
The following tables provide the fair value hierarchy, as described in Note 5 - Fair Value Measurements, for pension plan assets at December 31.
Total recognized in net periodic benefit cost and other comprehensive income (loss)
The following table provides the estimated net loss and prior service credit for the pension plan and other postretirement plans that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost in 2014.
For measurement purposes, the annual increase in the per capita cost of covered health care benefits was assumed to be 8.25%, decreasing gradually to 5.0% in 2027 and thereafter.
The Company has a long-term incentive plan for senior management that provides a cash award to participants for the increase in the share price of the Company's common stock through units (phantom shares) assigned by the Board of Directors. The cash award is calculated over a three-year interval on a calendar year basis. At the conclusion of each three-year interval, participants will receive a cash award based on the increase in the share price during a defined measurement period, multiplied by the number of units. The increase in the share price will be determined based on the change in the share price from the beginning to the end
bulk reinsurance agreement. At December 31, 2013, the insurance in force ceded approximated $1.0 billion (2012 - $1.1 billion) and premiums totaled $7.4 million (2012 - $7.7 million; 2011 - $8.9 million).
The maximum retention on any one life during 2013 and 2012 was five hundred thousand dollars for ordinary life plans and one hundred thousand dollars for group coverage.
The following table reflects the Company’s reinsurance partners whose reinsurance recoverable was 5% or greater of the Company's total reinsurance recoverable at December 31, 2013, along with their A. M. Best credit rating.
Kansas City Life acquired a block of traditional life and universal life products in 1997 through a 100% coinsurance and servicing arrangement. Investments equal to the statutory policy reserves are held in a trust to secure payment of the estimated liabilities relating to the policies. At December 31, 2013, the block had $1.1 billion of life insurance in force (2012 - $1.2 billion). The block generated life insurance premiums of $2.4 million in 2013 (2012 - $2.6 million; 2011 - $2.8 million).
The following table presents the pretax and the related income tax expense (benefit) components of the amounts reclassified from the Company's accumulated other comprehensive income to the Company's consolidated statement of income for the year ended December 31.
Due to the Company’s capital structure and the absence of other potentially dilutive securities, there is no difference between basic and diluted earnings per common share for any of the years reported. The average number of shares outstanding during 2013 was 11,005,799 shares (2012 - 11,095,777 shares; 2011 - 11,419,931 shares). The number of shares outstanding at year-end 2013 was 10,968,839 (2012 - 11,032,857).
The following table provides information about the Company’s customer revenues, net of reinsurance, for the years ended December 31.
1 During the third quarter of 2013, the Company identified an immaterial correction of an error in the presentation of total revenues and total benefits and expenses that resulted from the incorrect recognition of premiums related to the conversion of fixed deferred annuity contracts to immediate annuities with life contingencies. The impact of the correction was an equal and offsetting increase to both premiums and policyholder benefits, with no impact to net income or net income per common share. The Company understated revenues and policyholder benefits by $15.7 million in the first quarter of 2013 and $8.4 million in the second quarter of 2013. The numbers reported above have been corrected to reflect these adjustments. The error was insignificant to any other previous periods presented.
Net gain from operations and net income declined in 2013, driven primarily by the statutory accounting treatment of the American family transaction.
Kansas City Life recognizes its 100% ownership in Old American and Sunset Life under the equity method with subsidiary earnings recorded through surplus on a statutory accounting basis. Capital and surplus at December 31, 2013 in the above table includes capital and surplus of $21.1 million and $31.2 million for each of those entities, respectively.
The maximum stockholder dividends payable by Kansas City Life without prior approval in 2014 is $33.1 million, 10% of 2013 capital and surplus. The maximum stockholder dividends payable by Old American without prior approval in 2014 is $2.2 million,which is 10% of 2013 capital and surplus. The maximum stockholder dividends payable by Sunset Life without prior approval in 2014 is $4.8 million, the statutory net gain from operations for the preceding year. Each of the individual insurance enterprises believes that the statutory limitations impose no practical restrictions on any of its dividend payment plans.
Insurance companies are monitored and evaluated by state insurance departments as to the financial adequacy of statutory capital and surplus in relation to each company's risks. One such measure is through the risk-based capital (RBC) guidelines. RBC requirements are intended to be used by insurance regulators as an early warning tool to identify deteriorating or weakly capitalized insurance companies for the purpose of initiating regulatory action. RBC guidelines consist of target statutory surplus levels based on the relationship of statutory capital and surplus to the sum of weighted risk exposures. The RBC calculation determines both an authorized control level and a total adjusted capital prepared on the RBC basis. Generally, regulatory action is at 150% of the authorized control level. Each of the three insurance companies is expected to be within the range of 800% to 875%, well in excess of the control level at December 31, 2013.
to beneficiaries more quickly than under the current legislative and regulatory standards established for life insurance claims or may provide for additional escheatment of funds deemed abandoned under state laws. The audits could also result in administrative penalties. Given the legal and regulatory uncertainty in this area, it is also possible that life insurers, including the Company, may be subject to claims concerning their business practices. West Virginia, for example, has initiated litigation against a large number of life insurance companies, including Old American, under the abandoned property laws of that state. Based on its analysis to date, the Company believes that it has sufficiently reviewed its existing business and has adequately reserved for contingencies from a change in statute or regulation. Additional costs that cannot be reasonably estimated as of the date of this filing are possible as a result of ongoing regulatory developments and other future requirements related to this matter. Any resulting additional payments or costs could be significant and could have a material adverse effect on the Company's financial condition or results of operations.
As discussed in note 3 to the consolidated financial statements, effective January 1, 2012, the Company modified the types of costs incurred that can be capitalized when issuing or renewing insurance contracts due to the prospective adoption of Financial Accounting Standards Board Accounting Standards Update (ASU) No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts.