Management's Discussion and Analysis of Consolidated Financial Condition and Consolidated Results of Operations
The Company's principal long-term obligations are fixed contractual obligations incurred in the sale of its life insurance products. The premiums charged for these products are based on conservative and actuarially sound assumptions as to mortality, persistency and interest. The Company believes these assumptions will produce revenues sufficient to meet its future contractual benefit obligations and operating expenses, and provide an adequate profit margin to finance future growth without a major entry into the debt or equity markets.
Results of Operations Premium Income: Premium income on traditional life contracts has increased 26 percent, 21 percent, and 17 percent for 1997, 1996, and 1995 respectively. The increases came from the sales of the Company's guaranteed issue and simplified issue whole life policies. The Company has contracted with over 1400 independent agents to market this product across the Southeast. During 1997, the Company has expanded its multi-line exclusive agency in Kentucky to 21 agents and started expansion into Tennessee with 5 agents.
Individual accident and health premiums were $174,483, $165,328 and $209,372 in 1997, 1996 and 1995 respectively. In 1988, the Company ceased writing new individual accident and health policies.
The Company anticipates that premium income from this line will remain flat.
Effective January 1, 1996, the Company and Cotton States Mutual moved its employee and agent health plans to an outside health provider. Premiums received in 1995 from these groups were $2,136,420. In 1997 and 1996 the only group premium the Company earned were group life premiums received from participation in the Federal employee and servicemen pools. The earnings effect from participation in these pools is not material.
Mortality and Expense Charges Earned: Mortality and expense charges earned on universal life contracts increased 8 percent, 20 percent and 1 percent in 1997, 1996 and 1995, respectively. Mortality and expense charges earned on the Company's payroll deduction universal life product continue to grow as new cases are added and other in force cases mature through re-enrollments. On an overall annual basis, the Company expects increases in the 8 percent and 10 percent range.
Brokerage and Other Income: CSI Brokerage Services provides the Company with commission income from brokerage agreements with property and casualty insurance carriers. These carriers supply the Company's multi-line agents with property and casualty products that the Company's affiliated property and casualty companies do not underwrite. CSI earned $1,236,114 in 1997, $561,555 in 1996 and $438,707 in 1995. In late 1996, CSI in conjunction with its property and casualty affiliate, finalized a contract to transfer management of its property and casualty affiliate's multi-peril crop and crop hail insurance to Blakely Crop Hail, a Kansas-based company. Through a ten year brokerage agreement with Blakely, CSI will receive an override commission based on premium volume generated by sales of multi-peril crop and crop hail insurance sold by its multi-line exclusive agents. During 1997, approximately $780,000 of revenue was realized under this agreement. This equates to approximately $468,000 after tax or $.07 per share diluted. CSI also received approximately $854,000 in revenue from one nonstandard auto insurance writer. Another subsidiary, Cotton States Marketing Resources, Inc. provides the Company with commission income from brokerage agreements with other life and health insurance companies. These companies supply the Company's multi-line agents with life and health products that the Company does not want to underwrite. Marketing Resources earned $305,086 in 1997, $320,148 in 1996 and $183,010 in 1995. The decline in Marketing Resources earnings in 1997 resulted from the utilization of all of its tax loss carry forwards.
Individual accident and health benefits as a percentage of accident and health premiums were 130 percent, 123 percent and 19 percent for 1997, 1996 and 1995, respectively. Even though experience on this line improved in 1995, the Company anticipates that even with rate increases, the loss ratio on this closed block of business will continue to be in the 110-130 percent range.
Operating Expenses: Operating expenses and amortization of policy acquisition costs as a percentage of total premium income, mortality and expense charges, and brokerage income were 41 percent, 45 percent and 41 percent for 1997, 1996 and 1995, respectively. The increase in 1996 was due to the elimination of $2,136,000 of group health premiums received from the Company's agents and employees in 1995. Even though the ratio increased it did not have an adverse impact on the Company's earnings.
Inflation: Prolonged inflation can adversely affect insurance operations. Expenses tend to increase while premiums are generally fixed for the life of the policy. Real and nominal interest rates have fluctuated considerably over the years, causing major swings in investments' market values and their income growth. In an effort to control these effects, management is continuing to emphasize cost control and to invest in short-term and intermediate-term investments.
COTTON STATES LIFE INSURANCE COMPANY AND SUBSIDIARIES Consolidated Statements of Cash Flows
Cash and Cash Equivalents For purposes of presenting its statements of cash flows, the Company considers all short-term investments to be cash equivalents. Short-term investments have maturity dates of less than three months.
Investments The Company accounts for investments under the provisions of Statement of Financial Accounting Standards No. 115 (SFAS No. 115), Accounting for Certain Investments in Debt and Equity Securities.
January 20, 1998 Three-for-two April 30, 1997 Five-for-four October 16, 1995 Five-for-four
The following table summarizes information relating to the calculation of basic and diluted earnings per share of common stock:
In June 1997, the FASB issued 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. SFAS No. 131 is effective for financial statements for years beginning after December 15, 1997. The Company is assessing the standards of SFAS No. 131 for disclosure in its 1998 financial statements.
(2) Investments The amortized cost and estimated market values of investments in debt securities as of December 31, 1997 and 1996 are as follows:
Held for investment: Due in one year or less $ 1,501,619 1,505,000 Due after one year through five years 9,051,249 9,390,143 Due after five years through 10 years 7,551,572 7,713,501 ---------- ---------- Total $ 18,104,440 18,608,644 ========== ==========
Available for sale: Due after one year through five years $ 20,556,256 21,084,265 Due after five years through 10 years 33,527,546 34,373,215 Due after 10 years 10,052,118 10,288,400 Mortgage-backed securities 25,402,301 26,145,391 ---------- ---------- Total $ 89,538,221 91,891,271 ========== ==========
Investment Securities For investment securities (which include fixed maturities held for investment and fixed maturities available for sale), fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Universal Life and Annuity Benefits The carrying amount of universal life and annuity benefits is a reasonable estimate of fair value since credited interest approximates current market rates.
The estimated fair values and carrying value of the Company's financial instruments at December 31, 1997 and 1996 are the same except for investment securities which are detailed in footnote 2 and mortgage loans as follows:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying values of assets and liabilities for financial reporting purposes and Federal income tax purposes. The net deferred tax liability at December 31, 1997 and 1996 is composed of the tax-effected temporary differences related to the following amounts:
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.
(6) Postretirement Benefits Other than Pensions The Company has a plan which provides for postretirement 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 postretirement benefit cost for the years ended December 31 are as follows:
Accumulated postretirement benefit obligation: Retirees $184,642 180,396 Other active participants 12,458 10,269 Accumulated postretirement benefit ------- ------- obligation in excess of plan assets 197,100 190,665
The postretirement benefit obligation was determined by application of the terms of the plan using relevant actuarial assumptions. Health care costs are projected to increase at annual rates ranging from 0 percent in 1998 up to 5 percent in 2004 and thereafter. A 1 percent annual increase in these assumed cost trend rates would increase the accumulated postretirement benefit obligation at December 31, 1997 by approximately $17,500 and the service and interest cost components of the net periodic postretirement benefit cost for 1997 by approximately $1,300. The assumed discount rate used in determining the accumulated postretirement obligation was 7.25 percent at December 31, 1997 and 7.50 percent at December 31, 1996.
The Company has various stock option plans for the Company's officers and key employees, as well as directors. Under the employee plan, options may be granted to purchase up to 937,500 shares of the Company's stock at a per share price of not less than 100 percent of fair market value at date of grant. Under the directors' plan, options are granted based on the level of directors' fees at a per share price of 50 percent of fair market value at date of grant. The employee and directors' options have a term of 10 years and are not subject to any vesting requirements. The weighted- average remaining contractual life on options outstanding at December 31, 1997 is four years. The weighted-average grant date fair value of options granted during 1997 and 1996 was $8.24 and $4.53, respectively.
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 24,459, 32,966, and 36,643 shares of restricted stock under such plans during 1997, 1996, and 1995, respectively. The weighted-average grant date fair value of such shares was $7.43, $4.50, and $3.63, respectively. Aggregate compensation expense with respect to the foregoing restricted stock awards was approximately $151,000, $106,000, and $53,000 in 1997, 1996, and, 1995, respectively.
In accordance with APB Opinion No. 25, approximately $204,000 and $147,300 in compensation expense has been recorded in 1997 and 1996, respectively, for the various stock option and restricted stock awards granted in 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:
Statutory net earnings $ 2,488,573 2,539,179 2,147,387 ========= ========= ========== Statutory shareholders' equity $ 27,393,213 23,977,514 21,057,615
The Georgia Insurance Code limits dividends in any one year to the greater of statutory earnings, excluding realized capital gains, or 10 percent of statutory surplus, unless the expressed permission of the Georgia Insurance Department is obtained. Dividend payments to shareholders are further limited by the Georgia Insurance Code to unassigned statutory surplus, which at December 31, 1997 was approximately $22,500,000. The excess of retained earnings determined in accordance with generally accepted accounting principles over unassigned statutory surplus is not available for payment of dividends. The Company may pay a dividend amounting to $2,488,573 in 1998 without approval.
We have audited the accompanying consolidated balance sheets of Cotton States Life Insurance Company and subsidiaries (the "Company") as of December 31, 1997 and 1996, and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cotton States Life Insurance Company and subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles.
Quarterly Results The Following is a summary of the quarterly results of operations for the three years ended December 31, 1997.