2 Balance reflects the impact of adopting Statement of Financial Accounting Standard No. 115, "Accounting for Certain Investments in Debt and Equity Securities.
Under generally accepted accounting principles, amounts recoverable from the reinsurer for future contract benefits are reflected as assets ("investment contract benefits recoverable") and the related policy liability is presented on a gross basis. Under statutory accounting, the amounts are off-set against the related policy liabilities.
In 1991, the Delaware Department of Insurance ("Delaware") expressed concern over Investors' ratio of statutory policy liabilities to its capital and surplus. To address this concern, on October 1, 1991 Investors entered into a coinsurance agreement with Republic-Vanguard Life Insurance Company ("RVL"), a member of Winterthur Swiss Insurance Group, one of the largest Swiss insurance companies. Under the terms of this agreement 80% of all new annuity contracts written by Investors was coinsured with RVL. This agreement enabled the Company to slow the growth of its policy liabilities while at the same time adding additional capital and surplus from the profits on the coinsured portion of the business. By 1994, however, the growth of the unreinsured portion of the business had raised the ratio of statutory policy liabilities to capital and surplus to a level that brought renewed interest from Delaware. To address this concern, Investors increased the coinsurance rates for new business from 80% to 90% on October 1, 1994 and to 100% on May 1, 1995 while at the same time it developed plans to raise additional capital. Raising the coinsurance rates stopped the ratio from significantly increasing, but by late 1995 the ratio was still in excess of twenty to one, well in excess of Delaware's target of fifteen to one, and it became clear that additional capital could not be raised prior to the end of the 1995. Therefore, Investors began working on an additional reinsurance arrangement.
Normally, the Company plans to recover its acquisition cost and make its profit from the excess of investment income over interest credited and other expenses. If the policy is prematurely terminated, the Company may not fully recover its acquisition costs. However, if the risk is coinsured, premature termination will accelerate recognition of the unearned ceding commission.
Premiums and policy fees decreased $162,000, or 11.4%, to $1.3 million in 1994 from $1.4 million in 1993. This decrease is attributed to the reduction in premiums on the Medicare Supplement business following withdrawal of the product from the market.
Realized investment gains (losses) increased $1.4 million, or 414.1%, to $1.1 million in 1995 from $(0.3) million in 1994. The 1995 gains are primarily the result of the following: a). a gain of $242,000 resulting from the merger of Jupiter Tequesta National Bank ("JNB") into First United Bancorp ("FUB") in which the Company received cash and shares of FUB in exchange for the Company's shares of Jupiter TNB, b). a gain of $132,000 from the settlement of a litigation matter related to an investment that was written off several years ago, and c). gains of approximately $716,000 resulting from a program to reduce its investment in CMO type securities.
Realized investment gains (losses) decreased $2.0 million, or 120.9%, to $(0.3) million in 1994 from $1.7 million in 1993. This decrease is the combined result of the stabilization of market interest rates (which resulted in fewer security trades needed to maintain balance between the investment portfolio and the related policyholder liabilities) and recognition of a loss of $1.3 million to adjust the cost basis of an investment in the common stock of an affiliate to reflect its current market trading range. Management believes the decline in market value of this investment is other than temporary.
Current and future insurance benefits increased only $26,000, or 4.0%, to $0.68 million in 1994 from $0.65 million in 1993. The increase is attributed to benefits recorded for the Medicare supplement and accelerated benefit life products introduced and sold during 1993 and 1994.
Interest on investment contracts increased $0.5 million, or 5.8%, to $9.6 in 1995 from $9.1 million in 1994. While the weighted average crediting rate continued to decline in 1995, the weighted average policy reserve balance increased approximately 6.9% over 1994.
Underwriting, acquisition and insurance expenses decreased $0.3 million in 1995, or 6.9%, to $4.3 million in 1995 from $4.6 million in 1994. This cost reduction is primarily the result of the reduction of promotional expenses supporting the discontinued Medicare Supplemental and Accelerated Benefit Life products and the disposal cost of the remaining Medicare Supplemental policies which were incurred in 1994. Also, based on the Company's actual experience, there was some slowing of the amortization of deferred acquisitions costs in 1995.
Underwriting, acquisition and insurance expenses increased $0.9 million, or 16.1%, to $4.6 in 1994 from $5.6 million in 1993. The decrease of 15.9% in 1994 compared to 1993 is attributed to cost savings in printing and postage for agent recruiting, coupled with a significant decrease in product development expenses. The 1993 development of Medicare Supplement and Accelerated Benefit Life products generated over $630,000 of expenses which did not recur in 1994.
Other expenses decreased $0.1 million, or 9.3%, to $0.9 million in 1995 from $1.0 million in 1994. This cost reduction is primarily related to the 1994 provision of an allowance on a receivable described below.
Income taxes decreased $0.3 million, or 168.7%, to $(0.1) million in 1995 from $0.2 million in 1994. The Company maintains a 100% allowance against its net deferred tax assets until the realization of such assets is more readily determinable. Therefore, the tax expense balances shown reflect only the current tax incurred by Investors. Investors' reinsurance transaction with New Era Life Insurance Company, which was recognized in its 1995 statutory basis financial statements, created a tax loss which can be carried back to prior tax years. While the Company can consolidate its life and non-life subsidiaries in 1995, the non-life tax losses can not be used to carryback
The Company is an insurance holding company whose principal asset is the common stock of Investors. The Company's primary cash requirements are to meet debt service and to pay operating expenses. As a holding company, the Company relies on funds received from Investors in the form of commissions paid under a management and service agreement whereby the Company provides agent recruiting and administrative services. The insurance laws of the State of Delaware generally limit the ability of Investors to pay cash dividends in excess of certain amounts without prior regulatory approval and also require that certain agreements relating to the payment of fees and charges to the Company by Investors be approved by the Delaware Insurance Department. As reflected in the parent only statement of cash flows in Note 9 to the Company's financial statements, the parent company's cash flow from operations has been insufficient to meet its operating needs for several years. In prior years, IIG met this cash drain by liquidating its other investments. If this cash drain continues at the level it experienced in 1995, there is substantial doubt that IIG can continue to meet its obligations on a timely basis without an additional source of funds. While not available at this time, the Company is currently trying to develop new sources of cash (see discussion below).
On March 31, 1997, the Company will need to retire its $ 8 million note payable which is secured by its shares of IIC, Inc. which owns all the outstanding shares of Investors. This note originated as part of the purchase of IIC, Inc and its subsidiary Investors. As described more fully in Note 6 to the Company's financial statements, the Company believes the balance of the note is overstated because certain warranties made by seller were false. Subsequent to the purchase, the seller (an insurance company), attempted to transfer the non-negotiable note to another insurance company. Thereafter, both insurance companies went into rehabilitation, one in Pennsylvania and the other in Delaware. At this time, the Company cannot negotiate an appropriate adjustment to the note amount since both Pennsylvania and Delaware claim ownership. The Company plans to refinance this note or raise sufficient capital to retire it, but no assurance can be given that this will be accomplished.
The liquidity needs of Investors are met by premiums received from annuity sales, net investment income received, the proceeds from investments upon
maturity, sale or redemption and commissions received from its coinsurer on annuity contracts transferred. The primary uses of funds by Investors are the payment of surrenders, policy benefits, operating expenses and commissions, and the purchase of assets for investment purposes. No material capital expenditures are planned.
The NAIC has established risk-based capital standards to determine the capital requirements of a life insurance company based on the type and mixture of risks inherent in its operations. These standards require the computation of a risk-based capital amount which is then compared to a company's actual total adjusted capital. The computation involves applying factors to various statutory financial data to address four primary risks: asset default, adverse insurance experience, interest rate risk and external events. These standards provide for regulatory attention when the percentage of total adjusted capital to authorized control level risk-based capital is below certain levels. At December 31, 1995, Investors percentage of total adjusted capital is well in excess of the ratios which would require regulatory action.
The Company signed a definitive agreement on April 29, 1996 with AAM Capital Partners, L. P. ("AAM") for the sale of up to $7,000,000 of convertible voting preferred stock (70,000 shares). This infusion of capital will be used to recapitalize IIG's insurance subsidiary, Investors Insurance Corporation. The insurance company will then be able to retain a larger portion of its profitable annuity business that is currently being ceded to a reinsurer. AAM has in-depth expertise of insurance operations and plans to help IIG utilize its marketing expertise in a number of new and expanding markets. AAM is an equity investment fund which participates in investments in the insurance industry.
While the Company's CMO investment policy limits its investment in CMOs to low risk tranches (PACs, TACs, etc.), Delaware encouraged the Company to reduce its concentration in CMO investments. During 1995, it replaced several CMO investments and reduced the portion of CMO investment to approximately 57% of its bond portfolio as of December 31, 1995.
The Company manages its investment portfolio in part to reduce its exposure to interest rate fluctuations. In general, the market value of the Company's fixed maturity portfolio increases or decreases in inverse relationship with fluctuations in interest rates, and the Company's net investment income increases or decreases in direct relationship to interest rate changes. For example, if interest rates decline, the Company's fixed maturity investments generally will increase in market value, while net investment income will decrease as fixed income investments mature or are sold and proceeds are reinvested at the declining rates, and vice versa.
Interest rate changes significantly effect the market value of the Company's investment portfolio. Since the Company carries most of its investments at market value, these changes, net of the related effects on the amortization of deferred acquisition cost and unearned commission, and the related deferred tax accounts, directly effect total shareholders' equity.
Prevailing interest rate levels, including any continuation of the current relatively flat yield curve for short-term investments, which may affect the ability of the Company to sell its products, the market value of the Company's investments or the lapse rate of the Company's policies, notwithstanding product design features intentioned to enhance persistency of the Company's products.
Changes in the regulation of financial services, including bank sales of insurance products, which may affect the competitive environment for the Company's products.
(A) Schedule II - Condensed Financial Information of Registrant (incorporated in Note 9 of Notes to Consolidated Financial Statements)
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As described in Note 1 to the financial statements, the Company has experienced significant operating losses, has an accumulated deficit and is experiencing liquidity problems at December 31, 1995. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
The Board of Directors and Stockholders Investors Insurance Group, Inc. and Subsidiaries:
We have audited the consolidated balance sheet of Investors Insurance Group, Inc. and subsidiaries as of December 31, 1994, and the consolidated statements of operations, shareholder's equity, and cash flows for the years ended December 31, 1994 and 1993. 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 Investors Insurance Group, Inc. and subsidiaries as of December 31, 1994, and the results of their operations and their cash flows for the years ended December 31, 1994 and 1993, in conformity with generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Company adopted the provisions of the Financial Accounting Standard Board's Statement of Financial Accounting Standard No. 115 "Accounting for Certain Investments in Debt and Equity Securities." and changed its method of accounting for excess ceding commissions.
ASSETS 1995 1994 ---- ---- Investments: Fixed maturities held to maturity, at amortized cost (market $10,556 in 1995 and $8,957 in 1994) $ 9,504 $ 9,509 Securities available for sale: Fixed maturities, at market in 1995 (amortized cost $141,474 in 1995 and $144,426 in 1994) 149,231 132,025 Equity securities, at market (cost $339 in 1995 and $407 in 1994) 366 662 Short-term investments 356 312 Mortgage loans on real estate 564 648 Policy loans 598 590 -------- --------
INVESTORS INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Continued) DECEMBER 31, 1995 AND 1994 (Dollars in thousands)
Shareholders' Equity (Capital Deficit): Preferred Stock, no par, authorized 20,000,000 shares, none issued - - Common Stock, $.50 par value; authorized 30,000,000 shares; issued 2,767,782 in 1995 and 2,766,982 in 1994; outstanding 2,763,782 in 1995 and 2,766,982 in 1994 1,384 1,383 Additional paid-in capital 3,651 3,651 Net unrealized investment gains (losses) 7,083 (11,051) Accumulated deficit (10,682) (10,301) Treasury stock, at cost (4,000 shares in 1995) (8) - ------- -------
1995 1994 1993 Revenue: ---- ---- ---- Premium and policy fees $ 1,660 $ 1,263 $ 1,425 Net investment income 11,598 10,751 10,052 Realized investment gains (losses) 1,090 (347) 1,661 Commission and other income 912 786 2,130 -------- -------- --------
Benefits and Expenses: Current and future insurance benefits 915 680 654 Interest on investment contracts 9,614 9,085 8,722 Underwriting, acquisition and insurance expenses 4,326 4,645 5,623 Other expenses 922 1,016 767 ------ ------ ------
Cumulative effect to December 31, 1993 of changing to a different method of recognizing ceding commission income - (3,859) - ------ ------- -------
INVESTORS INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Continued) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Dollars in thousands, except per share data)
1995 1994 1993 ---- ---- ---- Per Share of Common Stock: Loss before cumulative effect of change in accounting principle $ (0.14) $ (1.15) $ (0.31)
Pro forma amounts assuming the new ceding commission recognition method is applied retroactively:
Net loss per share of common stock $ (1.15) $ (0.91) ======== ==========
Balance at December 31, 1994 2,766,982 1,383 3,651 (11,051) (10,301) - Treasury shares purchased - - - - - (8) Common shares issued 800 1 - - - - Change in net unrealized losses - - - 18,134 - - Net Loss - - - - (381) - --------- ------- ------- --------------- --------- -------
Balance at December 31, 1995 2,767,782 $1,384 $3,651 $ 7,083 $(10,682) $ (8) ========= ======= ======= =============== ========= =======
1995 1994 1993 ---- ---- ---- Cash flows from operating activities: Net loss $ (381) $ (7,030) $ (864) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Cumulative effect to December 31, 1994 of changing to a different method of recognizing ceding commission income - 3,859 - Net accretion of fixed maturities (594) (535) (565) Realized investment losses (gains) (1,112) 347 (1,661) Amortization of costs in excess of net assets of businesses acquired 288 140 127 Amortization of deferred acquisition costs 1,351 1,610 1,779 Amortization of unearned ceding commissions (230) (255) - Deferral of unearned ceding commission 12,420 12,776 - Deferred acquisition costs recovered upon transfer of investment contract - - 7,437 of investment contract deposits Deferral of acquisition costs (11,038) (12,724) (9,348) Change in assets and liabilities: Increase in investment contract benefits recoverable (18,899) (12,405) (8,649) Increase in insurance reserves and interest on investment contracts 30,190 21,880 18,199 Increase in other assets, net (1,595) (21) (812) Increase in other liabilities, net 3,159 1,263 661 ------- ------- ------ Net cash provided by operating activities 13,559 8,905 6,305 ------- ------- ------ Cash flows from investing activities: Investment repayments: Fixed maturities, held to maturity - - 250 Fixed maturities, available for sale - - 283 Mortgage loans 84 514 472 Policy loans, net (9) 128 110 Investments sold: Fixed maturities, available for sale 75,751 36,807 26,572 Equity securities 793 - - Investments in: Fixed maturities, held to maturity - (500) (1,510) Fixed maturities, available for sale (71,471) (60,537) (37,051) Equity securities (343) - (11) Short-term investments, net (44) 42 3,443 -------- -------- -------- Net cash provided by (used in) investing activities 4,761 (23,546) (7,442) -------- -------- --------
INVESTORS INSURANCE GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (Dollars in thousands)
1995 1994 1993 ---- ---- ---- Cash flows from financing activities: Investment contract deposits $ 107,214 $124,263 $ 96,256 Investment contract withdrawals (47,168) (27,363) (21,902) Investment contract funds transferred (99,960) (101,479) (75,048) Investment contract funds recovered 29,443 14,177 8,064 Treasury stock purchased (8) - - Common stock issued 1 - - --------- --------- --------- Net cash provided by (used in) financing activities (10,478) 9,598 7,370 ---------- --------- -------- Net increase (decrease) in cash and cash equivalents 7,842 (5,043) 6,233 Cash and cash equivalents, beginning of year 3,530 8,573 2,340 --------- -------- -------- Cash and cash equivalents, end of year $ 11,372 $ 3,530 $ 8,573 ======== ========== =======
The accompanying consolidated financial statements of Investors Insurance Group, Inc. ("IIG") and subsidiaries ("the Company") are prepared in accordance with generally accepted accounting principles ("GAAP"). All significant intercompany items have been eliminated in consolidation. IIG was incorporated under the laws of the State of Florida on May 11, 1993, and is the successor corporation of the former Gemco National, Inc. ("Gemco"), a New York corporation founded in 1966. The change in corporate identity was approved by Gemco's shareholders at the Annual Meeting of Shareholders on June 11, 1993. The actual change was accomplished by the merger of Gemco into a new Florida corporation, Investors Insurance Group, Inc., on September 1, 1993.
The Company operates predominantly in the life insurance industry, with its primary product emphasis on the sale of flexible premium deferred annuities. All of the Company's insurance operations are conducted through Investors Insurance Corporation ("Investors"), which was organized in 1957 and is licensed to sell life, annuity and health insurance in 21 states. Another subsidiary, IIC, Inc., is an insurance holding company and is the direct parent of Investors. Investors Marketing Group, Inc. ("IMG") was formed in June of 1994 to market annuities for a select group of unaffiliated life insurance companies. A former subsidiary, IICAM, Inc., was dissolved in 1993 and its operating function of providing marketing management and agent recruiting services for Investors was assumed by IIG. The dissolution of IICAM, Inc. had no significant effect on the consolidated financial statements of the Company.
The Company's financial statements are presented on the going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Delaware insurance law and regulations restrict Investors ability to pay dividends or enter into other arrangements with IIG, while at the same time the Note Payable (see Note 6) requires IIG to pay interest. In prior years, IIG met this cash drain by liquidating its other investments. If this cash drain continues at the level it experienced in 1995, there is substantial doubt that IIG can continue to meet its obligations on a timely basis without an additional source of funds. At the same time, the successful product marketing efforts of Investors have increased its need for capital which it has agreed to raise. The combined impacts of these forces require the Company to raise additional funds.
The accompanying financial statements do not include any adjustments to reflect the possible future effects that may result from the inability of the Company to continue as a going concern.
Fixed-maturity investments are securities that mature at a specified future date more than one year after being issued. Fixed-maturity securities that the Company intends to hold until maturity are classified as "held to maturity" and are carried at amortized cost. Amortized cost is based on the purchase price and is adjusted periodically in order that the carrying value will equal the face or par value at maturity.
Fixed-maturity securities which may be sold prior to maturity due to changes in interest rates, prepayment risks, liquidity needs, tax planning purposes or other similar factors, are classified as "available for sale." On January 1, 1994, the Company adopted Statement of Financial Accounting Standard ("FSAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which requires that fixed-maturity securities classified as available for sale be reported at market value. Prior to SFAS No. 115, such securities were carried at the lower of aggregate cost or market. The difference between the aggregate carrying value for fixed maturities available for sale and the aggregate amortized cost of such securities, is reported, net of the related impacts on the amortization of deferred acquisition costs, unearned ceding commission and deferred income taxes, as a separate component of shareholders' equity.
Mortgage loans on real estate and policy loans are carried at their unpaid balances. The mortgage loans are secured by the underlying real estate. Policy loans are fully collateralized by the related policy's cash value.
Net realized investment gains and losses are included in the determination of net earnings. If a decline in the market value of an individual investment is considered to be other than temporary, the difference between amortized book value and net realizable value is recorded as a realized investment loss. The cost of investments sold is determined using the specific identification basis. Cash Equivalents:
Costs which vary with and are primarily related to the acquisition of new business have been deferred to the extent that such costs are deemed recoverable through future earnings. These costs include commissions and certain expenses related to policy issuance, underwriting and marketing. For traditional life products, deferred acquisition costs ("DAC") are amortized with interest over the premium paying period in proportion to the ratio of anticipated annual premium revenue to the anticipated total premium revenue. DAC for universal life and annuity contracts is amortized in relation to the present value of expected gross profits on the products. Retrospective adjustments of these amounts are made when the Company revises its estimates of current or future gross profits to be realized from a group of policies, including both realized and unrealized investment gains and losses related to changes in market interest rates for those investments segmented against interest sensitive liabilities. Anticipated investment income is considered in the determination of recoverability of deferred acquisition costs. (see below - Change in Accounting for Ceding Commissions)
The liability for future policy benefits for traditional life insurance products has been computed based upon mortality, lapse and interest assumptions applicable to these coverages, including provision for adverse deviations. Interest rates range from 3.00% to 9.25%. Mortality, morbidity and withdrawal rate assumptions are based on the experience of the Company and are periodically reviewed against industry standards and experience.
With respect to investment contracts, the Company uses the retrospective deposit accounting method. Future policy benefits represent the premium deposits received plus accumulated interest, less mortality and administration charges. Interest credited to these contracts ranged from 4.0% to 12.0% during 1995, 4.15% to 12.0% during 1994 and 5.0% to 8.0% during 1993.
Accident & health reserves and claims represent amounts recorded to pay claims received on various accident & health policies in force and an allowance for premiums received but not yet earned on such policies.
Traditional life insurance premiums are recognized as revenue over the premium-paying period, adjusted for premiums due and advance premiums. Policy fee revenue includes surrender, mortality and administrative charges earned on annuity, universal life and other contracts.
The Company uses the asset and liability method of accounting for income tax expense prescribed by SFAS No. 109, "Accounting for Income Taxes." Under this method of accounting, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. Deferred tax assets are recorded net of the applicable valuation allowance. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Under the prior accounting method, as investment risks were ceded, the deferred acquisition costs related to the annuity contracts were reduced by the portion of the costs recovered through the ceding commission; the remaining excess ceding commission was recognized as revenue in the period the investment risks and benefits were transferred. Under the new accounting method, which was retroactively adopted effective January 1, 1994, the deferred acquisition costs related to the annuities are not reduced; the full ceding commission, including the excess ceding commissions and the recovery of the annuity acquisition costs, is treated as unearned income. This unearned ceding commission is treated as earned in direct relation to the present value of expected gross profits of the related annuity contracts, which is the same manner in which the related deferred amortization costs are amortized. Like deferred acquisition costs, the unearned ceding commission will be adjusted retrospectively when changes are made to the current or future estimated gross profits. As the ceding commission is earned, the excess ceding commission is recognized as commission income and the cost recovery portion is offset against the amortization of deferred acquisition costs.
The cumulative effect of this change in accounting practice, $3.8 million as of January 1, 1994, has been included as a adjustment to earnings for the year ended December 31, 1994.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of he financial statements and the reported amounts of revenues and expense during the reporting period. Actual results could differ from those estimates.
SFAS No. 123, "Accounting for Stock-Based Compensation" was issued by FASB in October 1995. The accounting requirements of this Statement are effective for transactions entered into in fiscal years that begin after December 15, 1995. Disclosure requirements are also effective for fiscal year beginning after December 15, 1995 although pro-forma disclosure is required for all awards granted in fiscal years beginning after December 15, 1994. Disclosures for awards granted in the first fiscal year beginning after December 15, 1994 (i.e. 1995 awards) are not required in financial statements for that fiscal year but must be represented subsequently whenever financial statements for that fiscal year are presented for comparative purposes. SFAS No. 123 encourages all entities to adopt a fair value based method of accounting for all employee stock compensation plans. Under the fair value based method, compensation cost is measured at the grant date based upon the fair value (as defined by the Statement) of the award at that date and is recognized over the service period. Companies not electing to adopt this fair value based method may continue to account for these plans using the intrinsic value based method prescribed by APB Opinion No. 25, although they must make program disclosures of net income and earnings per share as if the fair value based method had been used. The Company intends to continue to account for employee stock compensation plans using APB No. 25 and will begin providing required pro forma disclosures in 1996.
Certain amounts in the 1994 and 1993 financial statements have been reclassified to conform with the 1995 presentation.
The Company owns 188,971 shares, or 3.7%, of the capital stock of an affiliate with which it shares a common director. After closely monitoring this investment for several years, in 1994, the Company concluded the decline in market value of these shares was other than temporary. Therefore, in 1994 the cost basis of this investment was reduced to its then most recent trading range (market value of $992,098) and the Company recognized an investment loss of $1,275,555. The table below summarizes the cost and market value of this investment as of as of December 31:
The expected maturities of the Company's fixed maturity investments at December 31, 1995 were as follows (in thousands):
Amortized Cost Fair Value -------------- ---------- Due in one year or less $ 4,834 $ 5,116 Due after one year through five years 22,800 24,130 Due after five years through ten years 60,142 63,651 Due after ten years 63,202 66,890 -------- --------
This table includes mortgage-backed securities whose expected maturities are based on the forecasted cash flows from the underlying mortgages.
Realized Investment Gains (Losses) ---------------------------------- 1995 1994 1993 ---- ---- ---- Fixed maturity securities $ 730 $ 754 $ 1,611 Equity securities 360 - - Investment in Affiliate - (1,276) - Other - 175 50 ------- ------- --------
Impact of assets 6,088 (4,251) 10,339 (1,582) 121 ----- ------- ------ ------- ----
Unearned ceding commission (3,921) 5,157 (9,078) 12,527 - Deferred tax liability 2,926 1,643 1,283 (1,696) - ----- ----- ----- ------- ----
Impact on shareholder's equity $7,083 $(11,051) $18,134 $(12,413) $ 121 ===== ======= ====== ======= =====
The components of net investment income for the year ended December 31 are as follows (in thousands): 1995 1994 1993 ---- ---- ---- Fixed maturities $ 11,093 $ 10,533 $ 9,830 Mortgage and policy loans 90 111 147 Short-term investments 545 228 198 ------ ------ ------
Net investment income $ 11,598 $ 10,751 $ 10,052 ====== ====== ======
Total income tax expense (benefit) $ (136) $ 198 $ 366 ==== ==== ====
The net deferred tax assets related to unrealized gains and losses on investments for the year ended December 31 are as follows (in thousands):
1995 1994 1993 ---- ---- ---- Net deferred tax asset, beginning $2,777 $ 307 $ 308 Change during year (4,555) 2,470 (1) ------- ----- ---- Net deferred tax asset (liability), ending (1,778) 2,777 307 Valuation allowance 1,778 (2,777) (307) ----- ------- -----
Net balance $ - $ - $ - ===== ======= =====
The valuation allowance related to the deferred tax asset accounts is calculated on both an aggregate basis and for those items effecting income. The difference between these calculations is combined with the impacts of the unrealized investment gains (losses) which effect shareholder's equity directly. Therefore, while the aggregate valuation allowance is a contra- asset, the residual allowance assigned to the unrealized investment gains (losses) may be either positive or negative.
1995 1994 1993 ---- ---- ---- Computed "expected" tax expense (benefit) (34)% (34)% (34)%
Changes in the valuation allowance for deferred tax assets,allocated to income tax expense (54)% 47 % 179 % Non-deductible expenses including amortization of intangibles 21 % 2 % 9 % Small life insurance company deduction - % (8)% (83)% State income taxes, net of federal income tax benefit (1)% - 2 % Impact of tax loss carryback 38 % - - Other, net 1 % - - ----- ---- -----
The components of the deferred tax assets and liabilities at December 31 are as follows (in thousands):
Deferred tax assets: Life insurance company: Policyholder reserves and liabilities $23,241 $4,763 Unrealized losses on investments - 3,101 Investment in affiliates 366 354 Unearned ceding commission 9,516 9,189 Alternative minimum tax carryforward 185 186 Other 4 2 Non-life company: Operating loss carryforward 1,428 1,356 Other 75 185 ------ ------
Total deferred tax assets 34,815 19,136 Valuation allowance (3,319) (8,064) Net deferred tax assets 31,496 11,072 ------ ------ Deferred tax liabilities: Life insurance company: Deferred acquisition costs (10,472) (11,000) Unrealized gains on investments (1,945) - New Era reinsurance premium (19,077) - Other (1) (17) Non-life company - other (1) (55) -------- --------
The net increase (decrease) in the total valuation allowance for the years ended December 31, 1995, 1994 and 1993 was $(4,745,000), $4,486,000 and $596,000, respectively. Based on the continuing losses, the Company cannot be assured of realizing its deferred tax assets. Therefore, a 100% valuation allowance will be assigned to the net deferred tax asset until realization of this asset is considered more likely than not.
Operating Loss Capital Loss Year of expiration Carryforward Carryforward ------------------ -------------- ------------ 1996 $ - $ 45 1997 - 190 2001 3,392 - 2002 752 - 2003 248 - 2004 742 - 2005 895 - 2007 136 - 2008 397 - 2009 322 - 2010 375 - ----- ------
As a result of Delaware's continued concern over Investors' ratio of statutory policy liabilities to capital and surplus, in early 1996, Investors entered into an agreement to cede a block of annuity policies with statutory policy reserves of $76,306,929 to New Era Life Insurance Company ("New Era"). This reinsurance agreement provides for an initial coinsurance period (up to five years) followed by full assumption of the specified policies. Investors will continue to service these policies through December 31, 2000. Investors will pay New Era coinsurance allowances of 1% of the average statutory policy liability for the first 5 years. Thereafter, New Era will pay Investors 2% of the average statutory policy for the following five years. The profit related to these allowances will be deferred until its realization is assured.
Since under its terms, this agreement became effective on December 31, 1995 and, based on Delaware's approval, was reflected in Investors' 1995 statutory statement, Investors' ratio of statutory policy liabilities to capital and surplus the ratio was reduced below Delaware's target. The Company expects this to help allay Delaware's concerns (see Notes 8 and 11). (Since this transaction was closed in 1996, it will be treated as a 1996 event under generally accepted accounting principles.) (6) NOTE PAYABLE
As a result of material misrepresentations by the seller, the Company has several significant claims which, if sustained, should reduce the principal amount of the note and result in a refund of previously paid interest. However, these issues cannot be settled at this time since ownership of the note is in dispute. The seller, a Pennsylvania insurance company, allegedly transferred the non-negotiable note to a Delaware insurer. Subsequently, both companies came under orders of rehabilitation from the insurance departments of their respective states. Now, in their roles as liquidators, both states claim ownership of the note.
To avoid being subject to double liability, the Company filed a Complaint in Equity for Interpleader with the Pennsylvania Commonwealth Court in late 1995. While the parties have had numerous discussions regarding settlement, there has been no agreement to date. In connection with this action, on March 14, 1996, the Delaware Department of Insurance filed a petition for Declaratory Judgment against the Company in Delaware court. This action requests the court to declare that the note is negotiable and that the Company does not have any claim to offset the principal amount of the note and seeks indemnification from the Company. The Company is currently reviewing these filings and extensions.
Ultimately, settlement of this dispute will not result in any additional liability to the Company, but should make it possible to settle the Company's claims against the note. Since the ultimate cash flow related to this note is not determinable, calculation of its theoretical market value is not practicable.
The Company has instituted three incentive stock option plans for the benefit of employees or agents of the Company and its subsidiaries ("1982 Plan," "1992 Plan" and "Agents Plan").
Under the 1982 Plan, options for up to 147,074 shares of the Company's common stock are authorized and outstanding. These options may be exercised at a price of $.625 per share.
The 1992 Plan was approved by the shareholders in June 1992. This plan allows options on up to 500,000 shares of the Company's common stock to be granted to employees of the Company and/or its subsidiaries. During 1992, 340,000 options were granted under this plan of which 112,000 were vested at issue. The remaining 228,000 options vest over a four year period starting January 1, 1993, in amounts totaling 72,000; 72,000; 72,000 and 12,000, respectively.
During 1994 and 1993, respectively, 17,500 and 87,500, additional options were granted under this plan, all of which vested at issue. No options were granted under this plan in 1995, however, 27,500 options expired due to employee resignations and will be returned to the pool of options available
The Company makes no charges against income for these stock options since the exercise price of all options is equal to or greater than the market value of the Company's common stock at the date of each grant. Upon exercise of any of these stock options, the excess of the option price over the par value would be credited to additional paid-in capital.
-Policy Liabilities. The calculation of the liability for future policy benefits is based on different assumptions for statutory purposes than for GAAP and is reported net of reinsurance;
-Unearned Ceding Commission. Subsequent to the change in GAAP accounting described in Note 1, the GAAP profit of the ceding commission is deferred and amortized based on the expected gross profit of the related annuity contracts. Prior to this change, both statutory and GAAP profits were consistently recognized as the business was ceded.
-Interest Maintenance and Asset Valuation Reserves. These reserves are treated as liabilities for statutory purposes, but are restored to capital and surplus for GAAP;
In addition to these differences, from time-to-time, insurance companies may record transactions in different periods for regulatory purposes than under generally accepted accounting principles. The New Era reinsurance agreement (see Note 5) was recorded in 1995 for statutory accounting but in 1996 under generally accepted accounting principles.
IIG's GAAP basis shareholder's equity $ 1,428,176 $ (16,318,656) ========== ===========
At December 31, 1995, Investors' capital and surplus exceeded the $550,000 minimum required by the insurance laws of its state of domicile, which is Delaware. The Delaware Insurance Department had expressed concern over Investors' ratio of capital and surplus to policyholder liabilities. The Company stabilized this ratio by increasing the coinsurance percentage for new business to 100%, and later reduced this ratio to the level that Delaware believes is appropriate by consummating a coinsurance arrangement with New Era Life Insurance Company to reinsure a significant block of business (see Note 5).
The NAIC has established risk-based capital standards to determine the capital requirements of a life insurance company based on the type and mixture of risks inherent in its operations. These standards require the computation of a risk-based capital amount which is then compared to a company's actual total adjusted capital. The computation involves applying factors to various statutory financial data to address four primary risks: asset default, adverse insurance experience, interest rate risk and external events. These standards, effective in 1993, provide for regulatory attention when the percentage of total adjusted capital to authorized control level risk-based capital is below certain levels. At December 31, 1995, Investors percentage of total adjusted capital is in excess of ratios which would require regulatory action.
Interest rate changes significantly effect the market value of the Company's investment portfolio. Since the Company carries most of its investments at market value, these changes, net of the related effects on the amortization of deferred acquisition cost and unearned ceding commission, and the related deferred tax accounts, directly effect total shareholders' equity.
Dividends and other distributions to IIG from Investors are restricted. Investors is required to maintain minimum capital and surplus, determined in accordance with regulatory practices. Distributions are further limited by insurance regulations and may require prior approval of the regulatory insurance departments. Under the terms of a pledge agreement executed in conjunction with the issuance of the secured subordinated note payable described in Note 6, any dividend distributions from the subsidiaries to IIG will be held in an escrow account as collateral. IIG may only use the escrow account to increase the surplus of Investors in the form of a capital contribution. In the event of default, the escrow account would be available to satisfy any accrued interest and the principal balance due under the terms of the secured subordinated note payable.
December 31, -------------------- ASSETS 1995 1994 ---- ---- Cash and cash equivalents $ 272 $ 206 Equity securities, at market 16 446 Investments in affiliate and wholly-owned subsidiary 9,430 - Other assets 10 28 ----- -----
Year Ended December 31, ------------------------------- 1995 1994 1993 ---- ---- ---- Revenue: Investment income $ 7 $ 2 $ 6 Realized investment gains (losses) 382 (1,276) - Management fees 995 1,216 982 ----- ------- ------
Total expenses 1,443 1,663 1,383 ----- ------- ----- Loss before equity in net income (loss) of subsidiaries and income taxes (59) (1,721) (395) Equity in net income (loss) of subsidiaries 299 (1,450) (468) ----- ------- -----
Net cash used in financing activities (7) - - ------ ------- ------- Net increase (decrease) in cash and cash equivalents 66 (98) (326) Cash and cash equivalents, beginning of year 206 304 630 ------ ------- -------
During 1995, Delaware expressed increased concern over Investors' high ratio of statutory policy liabilities to capital and surplus. In late 1995, IIG decided to reconsider all its options, including the possible sale of Investors and reinsuring a large block of its inforce business. In December 1995, the IIG signed a definitive agreement to sell Investors to Standard Management Corporation ("SMC") in exchange for stock of SMC and relief from IIG's $8 million note. However, in the first quarter of 1996, the agreement was terminated and a controversy ensued between IIG and SMC regarding the basis of this termination. In April 1996, IIG agreed to settle all the disputes arising from this agreement and its termination by paying SMC $8,000 in cash and 72,000 restricted shares of IIG stock. The accompanying financial statements reflect the provision for this settlement.
Simultaneously with IIG's search for additional capital, Investors responded to Delaware's concern by structuring a reinsurance agreement for a significant block of its business. As described in Note 5, in the first quarter of 1996, Investors closed a reinsurance agreement with New Era. This agreement was effective December 31, 1995 and, with Delaware's approval, was recorded in Investors' statutory financial statements for 1995 (but in 1996 under generally accepted accounting principles). As a result, Investors' ratio of statutory liabilities to capital and surplus was reduced below Delaware's targeted amount. However, Delaware continues to monitor Investors closely, including reviewing and approving certain expenditures.
Under the terms of the New Era reinsurance agreement, Investors elected to transfer cash rather than securities to New Era. Therefore, in January and February of 1996 Investors sold the securities supporting this block of business and realized an investment gain of $3.7 million. Under generally accepted accounting principles, this gain accelerates the amortization of the deferred acquisition costs related to this block of business by approximately $2.1 million, leaving approximately of $1.6 million as a contribution to profits for the first quarter of 1996.
Under the terms of the agreement, which is scheduled to close on June 30, 1996, IIG's Board of Directors will expand to seven members. As separate groups, the owners of the preferred and common shares will each separately elect three directors. The remaining director will be elected by all the shareholders. Each preferred share will be convertible at any time into 100 shares of common stock or, after December 31, 2001, redeemable for $100 per share, plus accrued dividends at the option of the holder. In conjunction with this agreement, IIG will exchange 250,000 restricted shares of its common stock for all of IIG's currently outstanding warrants to purchase 1,000,000 shares of common stock. These warrants are currently held by Chester County Fund, Inc., IIG's largest shareholder.
In addition to the normal and customary contingencies, final closing of the agreement is subject to regulatory approval and the full subscription of AAM's coinvestor group.
INVESTORS INSURANCE GROUP, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED QUARTERLY FINANCIAL DATA
* Includes the cumulative affect through December 31, 1993 of retroactively applying the change in accounting for ceding commissions of $(3,858,552), or $(1.39) per share.
INVESTORS INSURANCE GROUP, INC. AND SUBSIDIARIES SCHEDULE I - SUMMARY OF INVESTMENTS DECEMBER 31, 1995 (Dollars in thousands)
Equity securities: Common stocks - banks and insurance companies 339 366 366 ------- ------- -------