The following selected historical consolidated financial data should be read in conjunction with “
We have identified the accounting policies below as critical to the understanding of our results of operations and our financial position. The application of these critical accounting policies in preparing our financial statements requires Management to use significant judgments and estimates concerning future results or other developments including the likelihood, timing or amount of one or more future transactions or amounts. Actual results may differ from these estimates under different assumptions or conditions. On an on-going basis, we evaluate our estimates, assumptions and judgments based upon historical experience and various other information that we believe to be reasonable under the circumstances. For a detailed discussion of other significant accounting policies, see Note 1 to the consolidated financial statements.
The liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance subsidiaries’ experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. The Company makes these assumptions at the time the contract is issued or, in the case of contracts acquired by purchase, at the purchase date. Future policy benefits for individual life insurance and annuity policies are computed using interest rates ranging from 2% to 6% for life insurance and 2.5% to 9.25% for annuities. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. Current mortality rate assumptions are based on 1975-80 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or Linton C, which are industry standard actuarial tables for forecasting assumed policy lapse rates.
The Company’s primary source of new business production, which has been immaterial, comes from internal conservation efforts. Several of the customer service representatives of the Company are also licensed insurance agents, allowing them to offer other products within the Company’s portfolio to existing customers. Additionally, efforts continue to be made in policy retention through more personal contact with the customer including telephone calls to discuss alternatives and reasons for a customer’s request to surrender their policy.
During the fourth quarter of 2009, the Company had acquired $118,368,661 of discounted mortgage loans at a total cost of $35,224,022, representing an average purchase price to outstanding loan of 29.8%. During 2009, the Company recorded approximately $1,000,000 in income from this loan activity. During 2010, the Company acquired an additional $111,258,867 of discounted mortgage loans at a total cost of $36,283,278, representing an average purchase price to outstanding loan of 32.6%. Additionally, during 2010, the Company settled, sold or had paid off discounted mortgage loans totaling $23,607,100. During 2010, the Company recorded approximately $12,898,000 in income from the discounted mortgage loan activity, including $7,645,258 in discount accruals. During 2011, the Company acquired an additional $17,930,217 of discounted mortgage loans at a total cost of $6,673,601, representing an average purchase price to outstanding loan of 37.2%. During 2011, the Company settled, sold or had paid off discounted mortgage loans totaling $15,032,186. While the Company reported income from the discounted loans, the majority of the income was the result of one-time events that occurred during the year. The Company does not anticipate the same return going forward from the discounted commercial mortgage loan portfolio.
With the sudden market shift, historic correlations between investments ceased to function pursuant to historical norms. For example, as U.S. Treasury yields shift, other debt securities such as corporate bonds typically follow. In this period, U.S. Treasury securities saw a dramatic and sudden shift in value, while corporate debt remained relatively unchanged. Indexes reflecting market volatility experienced historic increases over a three day period in August when U.S. Treasury debt was downgraded.
Net realized investment gains (losses) were $11,562,629 and $(640,538) in 2011 and 2010, respectively. During 2011, other-than-temporary impairments of approximately $3,360,000 and $982,354 were taken as a result of appraisal valuations and management’s analysis and determination of value on investment real estate and discounted mortgage loans, respectively. These losses were offset by realized gains of approximately $8,914,000, and $7,321,000 from bond sales and real estate, respectively. During the fourth quarter of 2011, the Company took advantage of the unusually high price spreads on U.S. Government treasury securities by selling a portion of its U.S. Treasury holdings. The gain on real estate is mainly attributable to the sale of timber from Cumberland Woodlands, which is a one-time event. During 2010, other-than-temporary impairments of approximately $610,000 and $740,000 were taken on bonds backed by trust preferred securities and on common stock, respectively. The other-than-temporary impairments were due to changes in expected future cash flows. Additionally, an other-than-temporary impairment of approximately $129,000 was taken on a mortgage loan as a result of its appraisal valuation. These losses were partially offset by realized gains of approximately $811,000 on bond sales.
In recent periods, Management’s focus has been placed on promoting and growing TPA services to unaffiliated life insurance companies. The Company receives monthly fees based on policy in force counts and certain other activity indicators, such as number of premium collections performed, or services performed. For the years ended 2011 and 2010, the Company received $2,021,348 and $1,724,880 for this work, respectively. These TPA revenue fees are included in the line item “other income” on the Company’s consolidated statements of operations. During 2010, the Company obtained an additional contract for these services, which provides approximately $300,000 additional revenues annually. Administration for this block of business began in the first quarter of 2011. The Company intends to continue to pursue other TPA arrangements as well. The Company provides TPA services to insurance companies seeking business process outsourcing solutions. Management believes the Company is positioned to generate additional revenues by utilizing the Company’s current excess capacity and administrative services.
Benefits, claims and settlement expenses net of reinsurance benefits and claims, decreased $692,178 from 2010 to 2011. The decrease relates primarily to changes in the Company’s death claim experience. Death claims were approximately $712,000 less in 2011 as compared to 2010. There is no single event that caused the mortality variances. Policy claims vary from year to year and therefore, fluctuations in mortality are to be expected and are not considered unusual by management.
Commissions and amortization of deferred policy acquisition costs decreased $116,731 from 2010 to 2011. The Company’s financial reinsurance agreement along with lower commissions makes up the decrease. The earnings on the block of business covered by the financial reinsurance agreement are utilized to re-pay the original borrowed amount. The commission allowance reported each period from this agreement represents the net earnings on the identified policies covered by the agreement in each reporting period. Results from this agreement included in this line item were approximately $(804,133) and $(674,816) for the years 2011 and 2010, respectively. As financial reinsurance, all financial results relating to this block of business are utilized to repay the outstanding borrowed amount from the reinsurer. Securities are specifically identified and segregated in a trust account relative to this arrangement. Should a gain or loss occur on one of these identified securities in the trust account, the results are included in the calculation of the current period financial results of the treaty with the reinsurer. While the agreement may result in variances in this line item, this arrangement has no material impact on net income. The overall impact to net income was $11,000 and $21,000 for the years 2011 and 2010, respectively. A liability for the original ceding commission was established at the origination of the agreement and is amortized through this line item as earnings on the block of business are realized. Management anticipates this arrangement to fully pay out during 2012. At year end 2011, $129,969 was still needed in earnings. Most of the Company’s agent agreements contained vesting provisions, which provide for continued compensation payments to agents upon their termination subject to certain minimums and often limited to a specific period of time. Another factor affecting this line item is attributable to normal amortization of the deferred policy acquisition costs asset. The Company reviews the recoverability of the asset based on current trends and known events compared to the assumptions used in the establishment of the original asset. No impairments were recorded in the periods reported.
The Company had a net income of $6,316,615 and $7,596,575 in 2011 and 2010, respectively. The decrease in net income in 2011 is primarily related to lower investment income offset by increased realized investment gains. One-time events, primarily reflected in realized gains, comprise a majority of net income of the Company during 2011. Future earnings will be significantly negatively impacted should earnings from these one-time items not be realizable in a future period. While Management believes there remain additional investments with such one-time earnings, when or if realized remains uncertain.
During the fourth quarter of 2009, the Company had acquired $118,368,661 of discounted mortgage loans at a total cost of $35,224,022, representing an average purchase price to outstanding loan of 29.8%. During 2009, the Company recorded approximately $1,000,000 in income from this loan activity. During 2010, the Company acquired an additional $111,258,867 of discounted mortgage loans at a total cost of $36,283,278, representing an average purchase price to outstanding loan of 32.6%. Additionally, during 2010, the Company settled, sold or had paid off discounted mortgage loans totaling $23,607,100. During 2010, the Company recorded approximately $12,898,000 in income from the discounted mortgage loan activity, including $7,645,258 in discount accruals. During 2011, the Company acquired an additional $17,930,217 of discounted mortgage loans at a total cost of $6,673,601, representing an average purchase price to outstanding loan of 37.2%. During 2011, the Company settled, sold or had paid off discounted mortgage loans totaling $15,032,186. The Company recorded approximately $8,232,000 in income from the discounted mortgage loan activity, including $3,940,275 in discount accruals. While the Company reported income from the discounted loans, the majority of the income was the result of one-time events that occurred during the year. The Company does not anticipate the same return going forward from the discounted commercial mortgage loan portfolio.
In mid August, the investment market took a sudden sharp decline. The U.S. debt ratings were lowered and concerns of European nations’ debt and potential defaults were in the forefront. During this time, certain of the Company’s trading securities were also negatively impacted resulting in losses of approximately $7.1 million as of year end 2011 when compared to second quarter 2011 earnings. These losses primarily resulted from holdings relating to market volatility and options relating to U.S. Treasury securities. The Company had a positive earnings track record in its trading securities accounts up until this point.
Cash and cash equivalents increased by approximately $64,000,000 comparing 2011 to 2010. This cash will be redeployed into additional investments in 2012. The Company has begun re-deploying its excess cash balances into BBB and BB rated corporate debt issues. Interest spreads on these investments are higher than historic trends and Management believes this is an opportunity to enhance yields and provide more recurring investment income.
Deferred policy acquisition costs decreased 12% in 2011 compared to 2010. Deferred policy acquisition costs, which vary with, and are primarily related to producing new business, are referred to as DAC. DAC consists primarily of commissions and certain costs of policy issuance and underwriting, net of fees charged to the policy in excess of ultimate fees charged. To the extent these costs are recoverable from future profits, the Company defers these costs and amortizes them with interest in relation to the present value of expected gross profits from the contracts, discounted using the interest rate credited by the policy. The Company had $0 in policy acquisition costs deferred, $6,000 in interest accretion and $74,345 in amortization in 2011, and had $0 in policy acquisition costs deferred, $6,000 in interest accretion and $97,029 in amortization in 2010.
The largest liability, by far, is future policy benefits. The decrease from 2010 to 2011 in this line item was approximately 2%. This decrease is attributable primarily to a decrease in the total future policy benefits held. As policies in force terminate, the corresponding reserve liability held for those policies is released. Management expects this item to continue to decline at similar rates in future periods unless an acquisition of an existing block of business occurs.
Each year, the NAIC calculates financial ratio results (commonly referred to as IRIS ratios) for each insurance company. These ratios compare key financial data pertaining to the statutory balance sheet and income statement. The results are then compared to pre-established normal ranges determined by the NAIC. Results outside the range typically require explanation to the domiciliary insurance department. At year-end 2011, UG had one ratio while AC had four ratios outside the normal range. All variances reported were anticipated by Management. These ratios are discussed in more detail in the Regulatory Environment discussion included in this Item 7.
The Company's investments are predominantly in fixed maturity investments such as bonds, which provide sufficient return to cover future obligations. The Company carries all of its fixed maturity holdings as held for sale which are reported in the consolidated financial statements at their market value.
Cash provided by (used in) investing activities was $78,850,682 and $(11,480,532) for 2011 and 2010, respectively. During 2011, fixed maturities sold made up 67% of the investments sold and matured. The Company sold ETF’s and reinvested in low interest bonds. In the fourth quarter, the Company sold the low interest bonds and is currently re-deploying the cash into BBB and BB rated corporate debt issues. During 2010, more emphasis was placed on the trading securities and discounted mortgage loans. These two investment areas accounted for 86% of investments acquired during 2010 and 79% of investments sold during 2010.
Net policyholder contract deposits decreased approximately $419,000 in 2011 compared to 2010. Policyholder contract withdrawals decreased approximately $382,000 in 2011 compared to 2010. Management anticipates continued moderate declines in contract deposits and withdrawals as this block of business continues to decline. Contract withdrawals can vary from year to year based on outside influences such as changes in interest rates, competition and other economic factors.
In addition to the above promissory note, First Tennessee Bank National Association also provided UTG with a revolving credit note. During 2011, at the renewal of the note, Management decided to increase the note amount from $2,750,000 to $5,000,000 to provide for additional operating liquidity and flexibility for current operations. This note is for a one-year term and may be renewed by consent of both parties. The credit note is to provide operating liquidity for UTG. The promissory note carries a variable rate of interest based on the 90-day LIBOR rate plus 2.75 percentage points, but at no time will the rate be less than 3.25%. The collateral held on the above note also secures this credit note. UTG had borrowings of $2,943,000 and $290,000 against this note during 2011 and 2010, respectively. At December 31, 2011 and 2010, the outstanding principal balance on this debt was $1,000,000 and $290,000, respectively.
UTG is a holding company that has no day-to-day operations of its own. Funds required to meet its expenses, generally costs associated with maintaining the Company in good standing with states in which it does business, and the servicing of its debt are primarily provided by its subsidiaries. On a parent only basis, UTG's cash flow is dependent on management fees received from its insurance subsidiaries, stockholder dividends from its subsidiaries and earnings received on cash balances. On December 31, 2011, substantially all of the consolidated shareholders equity represents net assets of its subsidiaries. The Company's insurance subsidiaries have maintained adequate statutory capital and surplus. The payment of cash dividends to shareholders by UTG is not legally restricted. However, the state insurance department regulates insurance company dividend payments where the company is domiciled.
In September 2011, FASB issued the ASU No. 2011-08 Intangibles - Goodwill and Other (Topic 350) Testing Goodwill for Impairment. Under the amendments in this Update, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit, as described in paragraph 350-20-35-4. If the carrying amount of a reporting unit exceeds its fair value, then the entity is required to perform the second step of the goodwill impairment test to measure the amount of the impairment loss, if any, as described in paragraph 350-20-35-9. Under the amendments in this Update, an entity has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test. An entity may resume performing the qualitative assessment in any subsequent period. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company does not expect the adoption of ASU 2011-08 to have a material impact on its consolidated financial statements.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2011. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework contained in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Report”).
We have audited the accompanying consolidated balance sheets of UTG, Inc. (a Delaware corporation, the “Company”) and subsidiaries as of December 31, 2011 and 2010, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the years then ended. Our audits also included the financial statement schedules I, II, IV and V. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
Unrealized holding income on securities net of noncontrolling interest and reclassification adjustment and taxes
used in operating activities net of changes in assets and liabilities
BUSINESS SEGMENTS - The Company has only one business segment - life insurance.
Investments available for sale - at fair value, unrealized gains and losses deemed temporary, net of deferred income taxes, are credited or charged, as appropriate, directly to accumulated other comprehensive income or loss (a component of shareholders’ equity). Premiums and discounts on debt securities purchased at other than par value are amortized and accreted, respectively, to interest income in the Consolidated Statements of Operations, using the constant yield method over the period to maturity. Net realized gains and losses on sales of held for sale securities, and unrealized losses considered to be other-than-temporary, are recorded to net realized investment gains (losses) in the Consolidated Statements of Operations.
Real estate - investment real estate held for sale at lower of cost or fair value less cost to sell. Expenses to maintain the property are expensed as incurred.
Realized gains and losses include sales of investments, periodic changes in fair value on trading securities, and write downs in value. If any, other-than-temporary declines in fair value are recognized in net income on the specific identification basis.
Unrealized gains and losses on investments available for sale are recognized in other comprehensive income on the specific identification basis.
FUTURE POLICY BENEFITS AND EXPENSES - The liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance subsidiaries’ experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. The Company makes these assumptions at the time the contract is issued or, in the case of contracts acquired by purchase, at the purchase date. Future policy benefits for individual life insurance and annuity policies are computed using interest rates ranging from 2% to 6% for life insurance and 2.5% to 9.3% for annuities. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. Current mortality rate assumptions are based on 1975-80 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or C, which are industry standard actuarial tables for forecasting assumed policy lapse rates.
Benefit reserves for universal life insurance and interest sensitive life insurance products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims in excess of related policy account balances. Interest crediting rates for universal life and interest sensitive products range from 4.0% to 5.5% as of December 31, 2011 and 2010.
POLICY AND CONTRACT CLAIMS - Policy and contract claims include provisions for reported claims in process of settlement, valued in accordance with the terms of the policies and contracts, as well as provisions for claims incurred and unreported based on prior experience of the Company. Incurred but not reported claims were $1,309,068 and $1,315,533 as of December 31, 2011 and 2010 respectively.
PROPERTY AND EQUIPMENT - Company-occupied property, data processing equipment and furniture and office equipment are stated at cost less accumulated depreciation of $3,235,642 and $3,079,922 at December 31, 2011 and 2010, respectively. Depreciation is computed on a straight-line basis for financial reporting purposes using estimated useful lives of three to thirty years. Depreciation expense was $162,941 and $175,809 for the years ended December 31, 2011 and 2010, respectively.
RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform to the 2011 presentation. Such reclassifications had no effect on previously reported net income or shareholders' equity.
In December 2011, Accounting Standards Board (“FASB”) issued the Accounting Standards Update (“ASU”) No 2011-12 Comprehensive Income (Topic 220) Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. In order to defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments, the paragraphs in this Update supersede certain pending paragraphs in Update 2011-05. The amendments are being made to allow the Board time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. While the Board is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company does not expect the adoption of ASU 2011-12 to have a material impact on its consolidated financial statements.
At December 31, 2011, substantially all of consolidated shareholders' equity represents net assets of UTG’s subsidiaries. The payment of cash dividends to shareholders by UTG is not legally restricted. However, the state insurance department regulates insurance company dividend payments where the company is domiciled. UG and AC’s dividend limitations are described below.
UG is an Ohio domiciled insurance company, which requires notification within five business days to the insurance commissioner following the declaration of any ordinary dividend and at least ten calendar days prior to payment of such dividend. Ordinary dividends are defined as the greater of: a) prior year statutory net income or b) 10% of statutory capital and surplus. For the year ended December 31, 2011, UG had statutory net income of $582,217. At December 31, 2011, UG's statutory capital and surplus amounted to $33,167,222. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. UG paid ordinary dividends of $2,930,000 and $2,725,000 to UTG in 2011 and 2010, respectively. No extraordinary dividends were paid during the two year period.
AC is a Texas domiciled insurance company, which requires notification within two business days to the insurance commissioner following the declaration of any ordinary dividend and at least ten calendar days prior to payment of such dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings from operations or b) 10% of statutory surplus. At December 31, 2011, AC statutory earnings from operations were $874,660. At December 31, 2011 AC, statutory surplus was $6,625,808. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. AC paid ordinary dividends of $600,000 and $728,130 during 2011 and 2010, respectively. No extraordinary dividends were paid during the two year period.
The Company held two fixed maturity investments totaling $17,258,542 and three fixed maturity investments of $75,329,675 that exceeded 10% of shareholder’s equity at December 31, 2011 and 2010, respectively. The Company held no equity investments that exceeded 10% of shareholders’ equity at December 31, 2011 and December 31, 2010.
The Company held, below investment grade investments with an amortized cost of $1,843,314 and $138,840 as of December 31, 2011 and 2010, respectively. The investments are all classified as All Other Corporate bonds.
As of December 31, 2011, the Company had five fixed maturity investments and two equity investment with unrealized losses less than 12 months, and six fixed maturity investments and one equity investments with unrealized losses greater than 12 months. As of December 31, 2010, the Company had three fixed maturity investments and two equity investments with unrealized losses less than 12 months, and five fixed maturity investments and no equity investments with unrealized losses greater than 12 months.
The unrealized losses of fixed maturity investments were primarily due to financial market participants’ perception of increased risks associated with the current market environment. The unrealized losses of equity investments were primarily caused by normal market fluctuations in publicly traded securities.
The amortized cost and estimated market value of debt securities at December 31, 2011, by contractual maturity, is shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
As of December 31, 2011, the Company held derivative instruments in the form of exchange-traded equity options and futures. The Company currently does not designate derivatives as hedging instruments. Exchange traded equity options and futures are matched with exchange traded equity securities in the Company’s trading portfolio, with the primary objective of generating a fair return while reducing risk. These derivatives are carried at fair value, with unrealized gains and losses recognized in investment income. The fair value of derivatives included in trading security assets and trading security liabilities as of December 31, 2011 was $3,217,420 and $(4,187,885), respectively. The fair value of derivatives included in trading security assets and trading security liabilities as of December 31, 2010 was $2,244,478 and $(17,246,957), respectively. Realized losses due to derivatives were $(1,343,588) and $(305,247) during 2011 and 2010, respectively. Unrealized gains included in trading security assets due to derivatives were $536,761 and $1,579,071 as of December 31, 2011 and December 31, 2010, respectively. Unrealized losses included in trading security liabilities due to derivatives were $(2,476,008) and $(3,392,010) as of December 31, 2011 and December 31, 2010, respectively.
A mortgage loan reserve is established and adjusted based on management's quarterly analysis of the portfolio and any deterioration in value of the underlying property which would reduce the net realizable value of the property below its current carrying value. The Company had no mortgage loan allowance during 2011 and 2010.
During the fourth quarter of 2009, the Company had acquired $118,368,661 of discounted mortgage loans at a total cost of $35,224,022, representing an average purchase price to outstanding loan of 29.8%. During 2009, the Company recorded approximately $1,000,000 in income from this loan activity. During 2010, the Company acquired an additional $111,258,867 of discounted mortgage loans at a total cost of $36,283,278, representing an average purchase price to outstanding loan of 32.6%. Additionally, during 2010, the Company settled, sold or had paid off discounted mortgage loans totaling $23,607,100. During 2010, the Company recorded approximately $12,898,000 in income from the discounted mortgage loan activity, including $7,645,258 in discount accruals. During 2011, the Company acquired an additional $17,930,217 of discounted mortgage loans at a total cost of $6,673,601, representing an average purchase price to outstanding loan of 10.7%. Additionally, during 2011, the Company settled, sold or had paid off mortgage loans totaling $29,916,298. During 2011, the Company recorded approximately $8,232,000 in income from the discounted mortgage loan activity, including $3,940,274 in discount accruals. While the Company reported income from the discounted loans, the majority of the income was the result of one-time events that occurred during the year. The Company does not anticipate the same return going forward from the discounted commercial mortgage loan portfolio.
At December 31, 2011, the Company holds $9,272,919 in mortgage loans, which represents approximately 2% of total assets and $27,467,920 in discounted mortgage loans, which represents 6% of total assets. Most mortgage loans are first position loans. Loans issued are generally limited to no more than 80% of the appraised value of the property. During 2011, the Company recognized an other-than-temporary impairment of $982,354 on these loans as a result of its appraisal valuation and management’s analysis and determination of value.
As of December 31, 2011, the Company’s discounted mortgage loan portfolio contained 87 loans with a carrying value of $27,467,920. The loans’ payment performance during the past year is shown as follows:
The following table summarizes discounted mortgage loan holdings of the Company:
Level 2 - Quoted prices in markets that are not active or inputs that are observable either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities other than quoted prices in Level 1; quoted prices in markets that are not active; or other inputs that are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets consist of fixed income investments valued based on quoted prices for identical or similar assets in markets that are not active.
The following table presents the level within the hierarchy at which the Company’s financial assets and financial liabilities that are measured and recorded on a recurring basis at fair value as of December 31, 2011 and 2010:
The following table presents transfers in and out of each of the valuation levels of fair value.
Transfers into Level 3 occur when there is a lack of observable market information. The transfers occurred at December 31, 2011.
Assets and liabilities measured at fair value on a nonrecurring basis are summarized below.
Certain assets are not carried at fair value on a recurring basis, including investments such as mortgage loans and policy loans. Accordingly such investments are only included in the fair value hierarchy disclosure when the investment is subject to re-measurement at fair value after initial recognition and the resulting re-measurement is reflected in the consolidated financial statements.
As of December 31, 2011 and 2010, the Company held $63 million and $53 million of investment real estate, respectively. The real estate is recorded at the lower of the net investment in the loan or the fair value of the real estate less costs to sell. The determination of fair value assessments are performed on a periodic, non-recurring basis by external appraisal and assessment of property values by management. Management believes these fair value assessments are classified as a Level 3 valuation technique under ASC 820, Fair Value Measurements and Disclosures as of December 31, 2011 and 2010.
The financial statements include various estimated fair value information at December 31, 2011 and 2010, as required by ASC 820. Such information, which pertains to the Company's financial instruments, is based on the requirements set forth in that guidance and does not purport to represent the aggregate net fair value of the Company.
The Company has been purchasing non-performing loans at a deep discount through an auction process led by the federal government. In general, the discounted loans are non-performing and there is a significant amount of uncertainty surrounding the timing and amount of cash flows to be received by the Company. Accordingly, the Company records its investment in the discounted loans at its original purchase price. Management has determined the fair value to be too difficult to calculate but believes it approximates the carrying value of these investments. Management works the loans with the borrower to reach a settlement on the loan or they foreclose on the underlying collateral which is primarily commercial real estate. For cash payments received during the work out process, the Company records these payments to interest income on a cash basis. For loan settlements reached, the Company records the amount in excess of the carrying amount of the loan as a discount accretion to investment income at the closing date. Management reviews the discount loan portfolio regularly for impairment. If an impairment is identified (after consideration of the underlying collateral), the Company records an impairment to earnings in the period the information becomes known.
Policy loans are carried at the aggregate unpaid principal balances in the consolidated balance sheets which approximates fair value, and earn interest at rates ranging from 4% to 8%. Individual policy liabilities in all cases equal or exceed outstanding policy loan balances.
The estimated fair values of the Company's financial instruments required to be valued by ASC 820 are as follows as of December 31:
The Company's insurance subsidiaries are domiciled in Ohio and Texas. The insurance subsidiaries prepare their statutory-based financial statements in accordance with accounting practices prescribed or permitted by the respective insurance department. These principles differ significantly from accounting principles generally accepted in the United States of America. "Prescribed" statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, from company to company within a state, and may change in the future. UG's total statutory shareholders' equity was approximately $33,167,000 and $30,443,000 at December 31, 2011 and 2010, respectively. UG reported a statutory net income (exclusive of inter-company dividends) of approximately $582,000 and $4,796,000 for 2011 and 2010, respectively. AC's total statutory shareholders' equity was approximately $9,126,000 and $10,934,000 at December 31, 2011 and 2010, respectively. AC reported a statutory net income/(loss) (exclusive of inter-company dividends) of approximately ($766,000) and $964,000 for 2011 and 2010, respectively.
Also, Optimum is the reinsurer of 100% of the accidental death benefits (ADB) in force of UG. This coverage is renewable annually at the Company’s option. Optimum specializes in reinsurance agreements with small to mid-size carriers such as UG.
UG entered into a coinsurance agreement with Park Avenue Life Insurance Company (PALIC) effective September 30, 1996. Under the terms of the agreement, UG ceded to PALIC substantially all of its then in-force paid-up life insurance policies. Paid-up life insurance generally refers to non-premium paying life insurance policies. Under the terms of the agreement, UG sold 100% of the future results of this block of business to PALIC through a coinsurance agreement. UG continues to administer the business for PALIC and receives a servicing fee through a commission allowance based on the remaining in-force policies each month. PALIC has the right to assumption reinsure the business, at its option, and transfer the administration. The Company is not aware of any such plans. PALIC and its ultimate parent, The Guardian Life Insurance Company of America (Guardian), currently hold an “A” (Excellent) and "A++" (Superior) rating, respectively, from A.M. Best. The PALIC agreement accounts for approximately 64% of UG’s reinsurance reserve credit, as of December 31, 2011.
At December 31, 1992, AC entered into a reinsurance agreement with Canada Life Assurance Company (“the Canada Life agreement”) that fully reinsured virtually all of its traditional life insurance policies. The reinsurer’s obligations under the Canada Life agreement were secured by assets withheld by AC representing policy loans and deferred and uncollected premiums related to the reinsured policies. AC continues to administer the reinsured policies, for which it receives an expense allowance from the reinsurer. At December 31, 2011, the Canada Life agreement has insurance in-force of approximately $52,560,000, with reserves being held on that amount of approximately $34,193,000. As of December 31, 2011, there remains $129,969 in profits to be generated under this treaty. Should future experience under the treaty match the experience of recent years, which cannot reliably be predicted to occur, it should take until mid 2012 to generate the remaining profits. However, regarding the uncertainty as to when the specified level may be reached, it should be noted that the experience has been erratic from year to year and the number of policies in force that are covered by the treaty diminishes each year.
Reinsurance agreements such as the Canada Life treaty described above are often referred to as financial reinsurance arrangements and are utilized within the insurance industry as a method of borrowing funds or statutory capital for an acquisition of a block of business or company. The borrowed funds are generally in the form of an initial ceding commission received from the reinsurer. The original borrowed amount is then repaid in future periods from the profits generated by the acquired block or company. Values of the target are determined based upon an actuarial valuation and future projections. Actual results may vary from year to year based upon the performance of the business relative to the assumptions used in the projections. Under the terms of this agreement, all financial activity relating to the policies covered by the agreement are utilized to repay the remaining outstanding balance, which was $129,969 as of December 31, 2011. Results under this agreement are included in various line items of the income statement, with an overall impact to net income of approximately $11,200 and $20,700 in 2011 and 2010, respectively. The net result of the activity represents the fee paid to the reinsurer for the use of their funds or statutory capital during the duration of the agreement.
During 1998, AC closed a coinsurance transaction with Universal Life Insurance Company (“Universal”). Pursuant to the coinsurance agreement, AC coinsured 100% of the individual life insurance policies of Universal in force at January 1, 1998. During 2010, this block of business was assumption reinsured into AC and is now considered direct business of AC. AC is now directly liable for any and all claims against these policies.
The Company does not have any short-duration reinsurance contracts. The effect of the Company's long-duration reinsurance contracts on premiums earned in 2011 and 2010 were as follows:
During 2009 Texas Imperial Life Insurance Company was sold. As part of this sale, the Company remains contingently liable for certain costs pending the outcome of an ongoing race-based audit on Texas Imperial Life Insurance Company by the Texas Department of Insurance. Under the agreement, the Company is responsible for 100% of the first $50,000 of costs, $90% of the next $50,000, 75% of the third $50,000 and 50% of costs above $150,000. Management had conservatively estimated the Company’s exposure and other costs at $50,000 based on information provided to date from the examination team. After paying costs of $2,273 during 2011, a contingent liability of $47,727 is reflected in its financial statements as of December 31, 2011. This contingency expires December 30, 2013.
Effective January 1, 2007, UTG entered into administrative services and cost sharing agreements with its subsidiaries, UG and AC. Under these arrangements, each company pays its proportionate share of expenses of the entire group, based on an allocation formula. During 2011, UG and AC paid $3,858,507 and $3,326,530, respectively. During 2010, UG and AC paid $3,692,434 and $3,174,724, respectively. Respective domiciliary insurance departments have approved the agreements of the insurance companies and it is Management's opinion that where applicable, costs have been allocated fairly and such allocations are based upon accounting principles generally accepted in the United States of America.
The Board of Directors of UTG authorized the repurchase in the open market or in privately negotiated transactions of up to $5 million of UTG's common stock. This program can be terminated at any time. Open market purchases are generally limited to a maximum per share price of the most recent reported per share GAAP equity book value of the Company. Through December 31, 2011, UTG has spent $3,682,794 in the acquisition of 490,726 shares under this program.
In accordance with FASB ASC Topic 260 “Earnings per share,” the computation of diluted earnings per share is the same as basic earnings per share for the years ending December 31, 2011 and 2010, as there were no outstanding securities, options or other offers that give the right to receive or acquire common shares of UTG.
At December 31, 2011 and 2010, the Company had $9,531,645 and $10,372,239, respectively, of debt outstanding.
In addition to the above promissory note, First Tennessee Bank National Association also provided UTG with a $5,000,000 maximum revolving credit note. During 2010, Management decided that a reduction to a maximum $2,750,000 in this line of credit was more reasonable for current operations. On July 14, 2011, the Company signed a Change in Terms Agreement increasing the line of credit back to 5,000,000. This note is for a one-year term and may be renewed by consent of both parties. The credit note is to provide operating liquidity for UTG. The promissory note carries a variable rate of interest based on the 90-day LIBOR rate plus 2.75 percentage points, but at no time will the rate be less than 3.25%. The collateral held on the above promissory note also secures this credit note. During 2011 UTG had borrowings of $2,943,000 and $2,233,000 in principal payments. During 2010, UTG had borrowings of $290,000 and made no payments. At December 31, 2011 and 2010, the outstanding principal balance on this debt was $1,000,000 and $290,000, respectively.
On April 6, 2011, UTG Avalon was extended a promissory note from First National Bank of Tennessee in the amount of $5,000,000. This note matures on January 3, 2013 and may be renewed by consent of both parties. The promissory note carries interest at a rate of 4.0%. During 2011, the Company had borrowings of $5,000,000 against this note. The funds were used to purchase a real estate investment, which serves as the collateral for the loan. At December 31, 2011 the outstanding principal balance on this debt was $5,000,000.
In November 2007, the Company became a member of the Federal Home Loan Bank (FHLB). This membership allows the Company access to additional credit up to a maximum of 50% of the total assets of UG. To be a member of the FHLB, UG was required to purchase shares of common stock of FHLB. Borrowing capacity is based on 50 times each dollar of stock acquired in FHLB above the "base membership" amount. UG's current line of credit with the FHLB is $15,000,000. During 2011, UG made payments of $2,000,000. During 2010, UG had borrowings of $2,000,000 against this line of credit. At December 31, 2011 and 2010, the outstanding principal balance on this debt was $0 and $2,000,000, respectively.
Because UTG serves primarily individuals located in four states, the ability of our customers to pay their insurance premiums is impacted by the economic conditions in these areas. As of December 31, 2011, approximately 52% of the Company’s total direct premium was collected from Illinois, Louisiana, Ohio, and Texas. Thus, results of operations are heavily dependent upon the strength of these economies.