Amounts are stated in thousands, except share data, or as otherwise noted.
Kansas City Life Insurance Company is a financial services company that is predominantly focused on the underwriting, sales and administration of life insurance and annuity products. The consolidated entity (the Company) primarily consists of three life insurance companies. Kansas City Life Insurance Company (Kansas City Life) is the parent company. Sunset Life Insurance Company of America (Sunset Life) and Old American Insurance Company (Old American) are wholly-owned subsidiaries.
Kansas City Life markets individual insurance products, including traditional, interest sensitive and variable products through a nationwide sales force of independent general agents and third-party marketing arrangements. Kansas City Life also markets group insurance products, which include life, dental, vision and disability products through its sales force of independent general agents, group brokers and third-party marketing arrangements. Kansas City Life operates in 48 states and the District of Columbia.
Old American sells final expense life insurance products, as well as a term product targeted to younger individuals. Old American markets its products nationwide through a general agency system, with exclusive territories, using direct response marketing to supply agents with leads. Old American’s administrative and accounting operations are part of the Company’s home office but it operates and maintains a separate marketing function and independent field force. Old American operates in 46 states and the District of Columbia.
The Company offers investment products and broker-dealer services through its subsidiary Sunset Financial Services, Inc. (SFS) for both proprietary and non-proprietary variable insurance products, mutual funds and other securities.
The Company operates in the life insurance sector of the financial services industry in the United States. This industry is highly competitive with respect to pricing, selection of products and quality of service. No single competitor or any small group of competitors dominates any of the markets in which the Company operates.
Strong sales competition, highly competitive products and a challenging economic environment present significant challenges to the Company from a new sales perspective. The Company’s primary emphasis is on expanding sales of individual life insurance products. The Company’s continued focus is on delivering competitive products for a reasonable cost, prompt customer service, excellent financial strength and effective sales and marketing support to the field force.
The Company generates cash largely through premiums collected from the sale of insurance products, deposits through the sale of universal life-type and deposit-type products and through investment activity. The principal uses of cash are for the insurance operations, including the purchase of investments, payment of insurance benefits and other withdrawals from policyholder accounts, operating expenses, premium taxes and costs related to acquiring new business. In addition, cash is used to pay income taxes and stockholder dividends, as well as to fund potential acquisition opportunities.
General economic conditions may affect future results. Market fluctuations, often extreme in nature, in recent periods have significantly impacted the financial markets and the Company’s investments and revenues. The interest rate and credit environments have presented significant challenges to the financial markets as a whole and specifically to companies invested in fixed maturity and equity securities. These conditions have improved in the most recent reporting periods, but the improvements have been uneven and the stressed economic and market environment may persist into the future. The Company is broadly diversified and has high quality investments, as 94% of all fixed maturity securities were investment grade at December 31, 2010.
The Company did not have any significant business changes in the three years ended December 31, 2010.
This report reviews the Company’s financial condition and results of operations, and historical information is presented and discussed. Where appropriate, factors that may affect future financial performance are also identified and discussed. Certain statements made in this report include “forward-looking statements” that fall within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include any statement that may predict, forecast, indicate or imply future results, performance or achievements rather than historical facts and may contain words like “believe,” “expect,” “estimate,” “project,” “forecast,” “anticipate,” “plan,” “will,” “shall” and other words, phrases or expressions with similar meaning.
Regulatory, accounting or tax changes that may affect the cost of, or the demand for, the Company’s products or services; and
The Company’s principal investments are in fixed maturity securities, mortgage loans and real estate; all of which are exposed to three primary sources of investment risk: credit, interest rate and liquidity. Credit risk is the risk that the value of the investment may decline due to deterioration in the financial strength of the issuer and that the timely or ultimate payment of principal or interest might not occur. A default by an issuer usually involves some loss of principal to the investor. Losses can be mitigated by timely sales of affected securities or by active involvement in a restructuring process. However, there can be no assurance that the efforts of an investor will lead to favorable outcomes in a bankruptcy or restructuring. Interest rate risk arises from the price sensitivity of investments to changes in interest rates. Interest and dividend income represent the greatest portion of an investment’s total return for most fixed income instruments in stable interest rate environments. The changes in the fair market price of such investments are inversely related to changes in market interest rates. As interest rates fall, the interest and dividend streams of existing fixed-rate investments become more valuable and market values rise. As interest rates rise, the opposite effect occurs. In addition, the Company is exposed to liquidity risk. Liquidity risk refers to the risk that investments cannot be converted into cash when needed or that the terms for conversion have a negative effect on the Company.
The Company monitors the various markets in which its investments are traded. The Company utilizes a primary independent third-party pricing service to determine the majority of its fair values. At December 31, 2010 the Company used a second independent third-party pricing service to validate the fair market values provided by the primary pricing service. The Company also used the second pricing service to determine the fair value of certain securities for which the primary pricing service was unable to provide. At December 31, 2010, 95% of the value of the Company’s fixed maturity and equity securities were from the primary third-party pricing service and 1% was from the second independent pricing service. The Company reviews values received from independent pricing sources for validity. In addition, the Company tests a limited number of securities from the primary pricing service each reporting period to further validate reliance on the fair values provided. When fair values are not available from external service providers, where possible, the Company utilizes quotes from brokers who are believed to have expertise in the markets in which the subject securities are traded. When the Company cannot obtain reliable broker pricing, a fair value is determined based upon an assessment of several factors appropriate for the specific issue, including but not limited to: the issuer’s industry; liquidity; cash flows; marketability, ratings and the ability of the issuer to satisfy the obligation; government intervention or regulations; fair value of comparable securities in actively traded or quoted markets; or other factors. The Company creates a matrix of factors from which to calculate an estimable value. However, all factors may not be known or publicly available from which to determine a value and, as such, the fair value used by the Company may not be truly indicative of the actual value available in an active market or an actual exit price if the Company were to sell the security in the current market.
The Company has a policy and process in place to identify securities that could potentially have an impairment that is other- than-temporary. This process involves monitoring market events and other items that could impact issuers. The evaluation includes but is not limited to such factors as the issuer’s stated intent and ability to make all principal and interest payments when due, near-term business prospects, cash flow and liquidity, credit ratings, business climate, management changes and litigation and government actions. This process also involves monitoring late payments, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts, asset quality and cash flow projections as indicators of credit issues.
At the end of each quarter, all securities are reviewed to determine whether impairments exist and whether other-than-temporary impairments should be recorded. This quarterly process includes an assessment of the credit quality of each investment in the entire securities portfolio. Additional reporting and review procedures are conducted for those securities where fair value is less than 90% of amortized cost. Further, detailed analysis is performed for each issue or issues having experienced a formal restructuring or where the security has experienced material deterioration in fair value or where the fair value is less than 80% of amortized cost for six months or more.
The current fair value of the security as compared to cost;
The tables below identify mortgage loans by geographic location and type of loan as of December 31, 2010 and December 31, 2009.
The table below identifies the commercial mortgage portfolio by current loan balance as a percentage of value at the time of origination as of years ending December 31.
At least annually, a review is performed of the models and the assumptions used to develop expected future profits, related to the profit expectations for interest sensitive and variable insurance products. This review is based upon management’s current view of future events. Management’s view primarily reflects Company experience but can also reflect emerging trends within the industry. Short-term deviations in experience affect the amortization of DAC in the period, but do not necessarily indicate that a change to the long-term assumptions of future experience is warranted. If it is determined that it is appropriate to change the assumptions of future experience, then an unlocking adjustment is recognized for the block of business being evaluated. Certain assumptions, such as interest spreads and surrender rates, may be interrelated. As such, unlocking adjustments often reflect revisions to multiple assumptions. The balance of DAC is immediately impacted by any assumption changes, with the change reflected through the income statement as an unlocking adjustment in the amount of DAC amortized. These adjustments can be positive or negative with adjustments reducing amortization limited to amounts previously deferred plus interest accrued through the date of the adjustment. The impact of unlocking adjustments from the changes in estimates for the periods reported are included in the Consolidated Results of Operations and Operating Results by Segment sections of the Management’s Discussion and Analysis of Financial Condition and Results of Operations contained within this document.
The following tables reflect the estimated pre-tax impact to DAC and VOBA on universal life, variable universal life, and fixed and variable deferred annuity products that could occur in a twelve-month period for an unlocking adjustment due to reasonably likely changes in significant assumptions. Changes in assumptions of the same magnitude in the opposite direction would have an impact of a similar magnitude but opposite direction of the examples provided.
Based on Company mortality experience. Industry experience and trends are also considered.
Based on expected future investment returns and expected future crediting rates applied to policyholder account balances; future crediting rates include constraints imposed by policy guarantees.
Reinsurance receivables include amounts related to paid benefits and estimated amounts related to unpaid policy and contract claims, future policy benefits and policyholder account balances.
The Company establishes liabilities for amounts payable under insurance policies, including traditional life insurance, annuities and accident and health insurance. Generally, amounts are payable over an extended period of time. Liabilities for future policy benefits of traditional life insurance have been computed by a net level premium method based upon estimates at the time of issue for investment yields, mortality and withdrawals. These estimates include provisions for experience less favorable than initially expected. Mortality assumptions are based on Company experience expressed as a percentage of standard mortality tables. The 2001 Valuation Basic Table and the 1975-1980 Select and Ultimate Basic Table serve as the basis for most mortality assumptions.
The Kansas City Life Cash Balance Pension Plan (the Plan) was amended effective December 31, 2010 to provide that participants’ accrued benefits will be frozen as of, and that no further benefits or accruals will be earned after, December 31, 2010. Although participants will no longer accrue additional benefits under the Plan as of December 31, 2010, participants will continue to earn years of service for vesting purposes under the Plan with respect to their benefits accrued through December 31, 2010. In addition, the cash balance account will continue to earn annual interest.
The Company measures sales in terms of new premiums and deposits. Sales of traditional life insurance, immediate annuities and accident and health products are reported as premium income for financial statement purposes. Deposits received from the sale of interest sensitive products, namely universal life insurance, fixed deferred annuities, variable universal life, variable annuities and supplementary contracts without life contingencies are reflected as deposits in the Consolidated Statements of Cash Flows.
The Company also markets an array of group products. These products include group life, dental, disability, and vision products. The primary growth strategies for these products include increased productivity of the existing group representatives, planned expansion of the group distribution system and to selectively utilize third-party marketing arrangements. Further, growth is to be supported by the addition of new products to the portfolio, particularly voluntary-type products.
Consolidated total premiums increased $10.0 million or 6% in 2009 compared to 2008, as total new premiums increased $10.0 million or 26% and total renewal premiums were flat. The increase in new premiums was driven by a $9.5 million or 75% increase in immediate annuity premiums. This improvement reflected a continuing demand for guaranteed benefit and retirement income products by consumers and an increase in sales from a third-party arrangement. In addition, new individual life insurance premiums increased $1.3 million or 10%. This increase largely resulted from a 20% increase in new premiums in the Old American segment. The increase in new premiums from the Old American segment reflected a combination of expanded distribution and improved agency productivity. New group life insurance premiums decreased $0.5 million or 23% and new group accident and health premiums decreased $0.2 million or 2%. While total renewal premiums were flat compared to 2008, a $1.4 million increase in renewal dental premiums was offset by a $1.2 million decrease in renewal individual life premiums and a $0.3 million decrease in renewal individual accident and health premiums.
Total new deposits decreased $3.2 million or 3%, following a $34.8 million or 51%, increase in 2009. The decrease in 2010 was due to an $8.9 million or 12% decrease in new fixed deferred annuity deposits. This decline can largely be contributed to the comparison with the higher sales of this product in 2009. Partially offsetting this, new universal life deposits increased $3.5 million or 35%, new variable annuity deposits increased $2.0 million or 13% and new variable universal life deposits increased $0.2 million or 19%. These improvements can be attributed to the expanded distribution from the successful recruitment of new general agents and agents in selected areas and to the improving economy. The increase in 2009 was due to a $46.2 million or 152% increase in new fixed deferred annuity deposits. This increase can be attributed to consumer preferences for fixed-rate products, resulting from the volatility of the equity markets. This volatility, along with the general effects of the recessionary environment, was also reflected in the reduction in sales of new universal life deposits, new variable universal life deposits and new variable annuities, which declined 10%, 47% and 37%, respectively.
Contract charges consist of cost of insurance, expense loads, amortization of unearned revenues and surrender charges. Certain contract charges for universal life, deposit or investment products are not recognized in income immediately but are deferred as unearned revenues and are amortized into income in a manner similar to the amortization of DAC. These contract charges, which are recorded as unearned revenues, are recognized into income in proportion to the expected future gross profits of the business. In the same manner as DAC, profit expectations are based upon assumptions of future interest spreads, mortality margins, expense margins and policy and premium persistency experience. At least annually, a review is performed of the assumptions related to profit expectations. If it is determined the assumptions should be revised, the impact is recorded as a change in the revenue reported in the current period as an unlocking adjustment.
One component of contract charges is the recognition over time of the DRL from certain universal life policies. This liability arises from front-end loads on such policies and is recognized into the income statement in concert with the future expected gross profits, as is similarly the case with amortization of DAC. In 2010, the Company completed the upgrade and enhancement of its projection modeling capabilities resulting in a refinement in methodology and in a change in estimate. The effect of the refinement on the DRL was an increase in the liability and a reduction to contract charges of $0.9 million during 2010. No refinements in methodology occurred during 2009 or 2008.
The Company uses reinsurance as a means to mitigate its risks and to reduce the earnings volatility from claims. Reinsurance ceded premiums increased $1.2 million to $55.0 million in 2010 from $53.7 million in 2009. In 2008, reinsurance ceded was $53.6 million. The increase in 2010 was largely in the Group Insurance segment, reflecting an increase in sales from a third-party arrangement that is 100% reinsured.
Gross investment income is largely composed of interest, dividends and other earnings on fixed maturity securities, equity securities, short-term investments, mortgage loans, real estate and policy loans. Gross investment income was essentially flat in 2010 compared to one year earlier. During 2010, an increase in average invested assets was offset by declines in yields earned on investments, largely due to lower interest rates and yields available in the fixed-income market. Gross investment income was flat in 2009 compared with 2008, as a decline in investment assets was mostly offset by an increase in investment yields. The decline in investment assets largely reflected declines in book value due to sales, maturities and calls. The increase in investment yields was largely due to a higher return on an alternative investment fund compared to the prior year. In 2009, this investment added gross investment income of $2.2 million. However, as a result of the significant decline in the economic environment experienced in 2008, this investment resulted in a decline in gross investment income of $4.0 million in the prior year.
Investments in mortgage loans totaled $559.2 million at December 31, 2010, an increase of $101.6 million from December 31, 2009. Mortgage loans are stated at cost, adjusted for amortization of premium and accrual of discount, less an allowance for potential future losses. A loan is considered to be impaired if it is probable that contractual amounts due will not be collected. Loans in foreclosure and loans considered to be impaired are placed on a non-accrual status. The mortgage loan allowance was $3.4 million at December 31, 2010, unchanged from December 31, 2009. The allowance for loss on mortgage loans is maintained at a level believed by management to be adequate to absorb potential future credit losses. Management’s periodic evaluation and assessment of the adequacy of the reserve is based on known and inherent risks in the portfolio, historical and industry data, current economic conditions and other relevant factors. Over the past three years, the Company has had one mortgage loan default, which occurred in the fourth quarter of 2010. The Company completed the foreclosure on this loan in the fourth quarter of 2010 with no impairment recorded due to the fair value of the equity in the property being greater than its book value. Two loans were delinquent for 30 days at December 31, 2010, payments were received and both were brought current in January 2011. No mortgage loans were restructured during 2010. No mortgage loans were restructured or delinquent for more than 90 days or foreclosed upon and transferred to real estate investments during 2009 or 2008. Mortgage loans comprised 16% of the investment portfolio at December 31, 2010, up from 14% at the end of 2009. The increase in mortgage loans during 2010 was due to the purchase of $86.5 million of commercial mortgage loans during the year. These mortgage loans purchased by the Company were seasoned performing commercial mortgages with characteristics similar to the portfolio of loans originated by the Company. The majority of all of the mortgages were commercial loans on industrial warehouses and office properties at both December 31, 2010 and 2009. Investment income from mortgage loans increased $1.9 million in 2010 and decreased $0.4 million or 1% in 2009 compared to the same periods one year earlier. The increase in 2010 was largely the result of higher mortgage loan portfolio volume in 2010 compared to 2009. The decline in 2009 was largely due to lower prepayment penalties and assumption fees, as well as lower rates earned on new loans.
Real estate investments were $119.9 million at December 31, 2010 and $114.1 million at December 31, 2009. Real estate investments consist principally of industrial warehouses, office buildings, land and investments in multi-family and single-family residential properties, including affordable housing properties. The primary monetary benefit received from investments in affordable housing properties is in the form of tax credits, which primarily serve to reduce current and future tax expense rather than increase investment revenues. The Company also invests in unimproved land for future development. Investments have been made through individual purchases, build-to-suit and speculative development, along with investments in joint ventures. The Company generally maintains its ownership interest in these properties on a direct and joint venture basis with the long-term intention of earning positive cash flow and income by leasing the properties, along with the expectation of realizing capital appreciation upon sale. The Company periodically sells certain real estate assets when management believes that the market and timing are perceived to be advantageous. Real estate investments comprised 3% of the investment portfolio at both December 31, 2010 and 2009. Investment income on real estate increased 13% in 2010, following a 9% increase in 2009. The improvement in both years primarily resulted from an increase in occupancy in certain real estate properties.
Net investment income is stated net of investment expenses. Investment expenses increased $0.6 million or 6% in 2010 compared to 2009. This increase can largely be attributed to increased real estate investment expenses. Investment expenses decreased $0.4 million or 3% in 2009 versus one year earlier. Interest expense on short-term notes payable decreased in 2009 compared to the prior year. The Company has an investment in the Federal Home Loan Bank from which it is able to borrow money at favorable interest rates, as it did during parts of 2009 and 2008. The 2009 borrowings were less than those in 2008, resulting in reduced interest expense in 2009. The Company periodically borrows and subsequently reinvests these proceeds. The Company had increased its borrowings during the first quarter of 2008 and subsequently reduced these borrowings. The Company had no notes payable outstanding at December 31, 2010 and 2009. Partially offsetting the decline in investment expenses during 2009 was an increase in real estate expenses in 2009 compared to 2008.
The following table provides asset class detail of the investment portfolio. Fixed maturity and equity securities represented 77% of the entire investment portfolio at December 31, 2010, down from 76% at December 31, 2009.
The Company recorded a net realized investment gain of $0.5 million in 2010 and net realized investment losses of $10.1 million in 2009 and $52.3 million in 2008. During 2010, investment losses of $3.8 million were due to write-downs of investment securities that were considered other-than-temporarily impaired. No investment securities were written down during the fourth quarter of 2010. These write-downs were offset by $2.5 million in gains resulting from sales of investment securities and $2.1 million in gains from securities called and other. The gain on sales of investment securities included $0.5 million realized on the sale of a security that had been previously written down due to other-than-temporary impairment. In the above table, investment securities called and other includes, but is not limited to, principal paydowns and sinking funds. During 2009, investment losses of $21.1 million were due to write-downs of investment securities and investments in affordable housing funds that were considered other-than-temporarily impaired. These were partially offset by $9.9 million in gains on the sale of investment securities, $0.7 million of investment gains realized on securities called and other, and $0.7 million of investment gains on the sale of real estate. During both 2009 and 2008, the financial markets were significantly affected by economic pressures and the residential mortgage crisis. These pressures resulted in large price dislocations that affected many securities and companies, particularly in the financial sector. These economic pressures have eased during 2010, as reflected in the reduced number and magnitude of other-than-temporary impairments recognized.
In the fourth quarter of 2009, the Company experienced impairment losses on the Company’s real estate joint ventures, specifically attributable to investments in affordable housing funds. The Company is a limited partner in several joint ventures whose underlying investments are in affordable housing properties. These properties generate federal and/or state tax credits and have a residual value in the properties that requires the funds to operate as a real estate joint venture investment. In one property fund, an impairment of $1.6 million resulted from the transfer of the residual interest in certain properties in exchange for contingent future benefits. An additional impairment of $0.3 million was recorded due to the foreclosure of certain properties in a second property fund. The Company also wrote down two affordable housing investments by $0.3 million, when it determined that there were no remaining future benefits expected from these investments.
The Company reviews and analyzes its securities on an ongoing basis to determine whether impairments exist that are other-than-temporary. Based upon these analyses, specific securities’ credit impairments may be written down through earnings as a realized investment loss if the security’s fair value is considered to be other-than-temporarily impaired. Non-credit impairments are charged to other comprehensive income (loss).
The following table summarizes securities with other-than-temporary impairments recognized in earnings during the four quarters of 2010 by asset class:
The following table provides detail regarding individual investment securities that were written down through earnings during 2010 exceeding $0.5 million.
The following table provides detail regarding individual investment securities that were written down through earnings during 2009 exceeding $0.5 million.
The following table provides detail regarding individual investment securities that were written down through earnings during 2008 exceeding $0.5 million.
Interest rate risk, relating to the market price and/or cash flow associated with changes in market yield and curves; and
The Company has not had any significant business changes in the three years ended December 31, 2010.
The Company’s fair value of fixed maturity and equity securities are derived from external pricing sources, brokers, and internal matrices and calculations. At December 31, 2010, approximately 96% of the carrying value of these investments was from external pricing services and 4% was derived from brokers, internal matrices and calculations. The investment portfolio is monitored regularly to ensure that investments which may be other-than-temporarily impaired are identified in a timely fashion and properly valued. Other-than-temporary impairments that are determined to be due to credit are charged against earnings as realized investment losses. See Note 3 - Investments for further details.
Investment income on residential mortgage-backed securities is initially based upon yield, cash flow, and prepayment assumptions at the date of purchase. Subsequent revisions in those assumptions are recorded using the retrospective method, except for adjustable rate residential mortgage-backed securities where the prospective method is used. Under the retrospective method, the amortized cost of the security is adjusted to the amount that would have existed had the revised assumptions been in place at the time of purchase. Under the prospective method, future cash flows are estimated and interest income is recognized going forward using the new effective yield to maturity. The adjustments to amortized cost under both methods are recorded as a charge or credit to net investment income. The Company bases its historical results from individual securities and internal assessments of likely future results for these securities. These results are based upon validations and comparisons to similar securities provided by third parties such as rating agency analysis.
Mortgage loans are stated at cost, adjusted for amortization of premium and accrual of discount, less an allowance for potential future losses. A loan is considered impaired if it is probable that contractual amounts due will not be collected. The allowance for loss on mortgage loans is maintained at a level believed by management to be adequate to absorb potential future credit losses. Management’s periodic evaluation and assessment of the adequacy of the reserve is based on known and inherent risks in the portfolio, historical and industry data, current economic conditions and other relevant factors. Loans in foreclosure and loans considered to be impaired are placed on a non-accrual status.
Policy loans are carried at cost, less principal payments received. Short-term investments are stated at cost, adjusted for amortization of premium and accrual of discount.
The Company’s principal investments are in fixed maturity securities, mortgage loans and real estate; all of which are exposed to three primary sources of investment risk: credit, interest rate and liquidity. The fixed maturity securities, which are all classified as available for sale, are carried at their fair value in the Company’s Consolidated Balance Sheets, with unrealized gains or losses recorded in accumulated other comprehensive income (loss). The unrealized gains or losses are recorded net of the adjustment to policyholder account balances and deferred acquisition costs to reflect what would have been earned had those gains or losses been realized and the proceeds reinvested.
The Company has a policy and process in place to identify securities that could potentially have an impairment that is other-than-temporary. This process involves monitoring market events and other items that could impact issuers’ credit ratings, business climate, management changes, litigation and government actions, and other similar factors. This process also involves monitoring late payments, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts, asset quality and cash flow projections as indicators of credit issues.
At the end of each quarter, all securities are reviewed to determine whether impairments exist and whether other-than-temporary impairments should be recorded. This quarterly process includes an assessment of the credit quality of each investment in the entire securities portfolio. Additional reporting and review procedures are conducted for those securities where fair value is less than 90% of amortized cost. The Company prepares a formal review document no less often than quarterly of all investments where fair value is less than 80% of amortized cost for six months or more and selected investments that have changed significantly from a previous period and that have a decline in fair value greater than 10% of amortized cost.
The risk that the Company’s assessment of an issuer’s ability to meet all of its contractual obligations will change based on changes in the credit characteristics of that issuer;
The discounted future cash flow calculation typically becomes the primary determinant of whether any portion and to what extent an unrealized loss is due to credit on loan-backed and similar asset-backed securities with significant indications of potential other-than-temporary impairment. Such indications typically include below investment grade ratings and significant unrealized losses for an extended period of time, among other factors. The Company identified 12 and 13 non-U.S. Agency mortgage-backed securities that had such indications as of December 31, 2010 and December 31, 2009, respectively. Discounted future cash flow analysis was performed for each of these securities to determine if any portion of the impairment was due to credit and deemed to be other-than-temporary. The discount rate used in calculating the present value of future cash flows was the investment yield at the time of purchase for each security. The initial default rates were assumed to remain constant over a 24-month time frame and grade down thereafter, reflecting the general perspective of a more stabilized residential housing environment in the future.
The Company has mortgage loans which are identified as financing receivables. Mortgage loans at December 31, 2010 totaled $559.2 million, net of the allowance for loss. Please see the mortgage loan section contained in Note 3 - Investments for further details.
Various agent commission advances and other commission receivables. Gross agent receivables in this category totaled $2.5 million, and the Company maintained an allowance for doubtful accounts of $0.6 million.
The table below identifies the Company’s financing receivables by classification amount as of December 31, 2010.
DAC is also reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts. If it is determined from emerging experience that the premium margins or expected gross profits are insufficient to amortize deferred acquisition costs, then the asset will be adjusted downward with the adjustment recorded as an expense in the current period. No impairment adjustments have been recorded in the years presented. The DAC asset is also adjusted at each reporting date to reflect the impact of unrealized gains and losses on fixed maturity and equity securities available for sale as though such gains and losses had been realized.
The Company may consider refinements in estimates due to improved capabilities resulting from administrative or actuarial system upgrades. The Company considers such enhancements to determine whether and to what extent they are associated with prior periods or simply improvements in the projection of future expected gross profits due to improved functionality. To the extent they represent such improvements, these items are applied to the appropriate financial statement line items in a manner similar to unlocking adjustments.
The amortization of DAC decreased $8.1 million or 23% in 2010 compared to one year ago. This decrease was primarily the result of a refinement in methodology (resulting in a change in estimate) and an unlocking of certain assumptions. The Company refined its estimate as a result of the implementation of an actuarial system upgrade. This upgrade allowed the Company to refine its projection of future expected gross profits on investment-type contracts which impacted the calculation of DAC amortization. The effect of the change in estimate was an increase in the DAC asset and a reduction in current period DAC amortization of $1.8 million. There was no material refinement in either 2009 or 2008.
The following table identifies the effects of the DAC change in estimate and unlocking in the Consolidated Statements of Income for the years ended December 31.
The DAC asset is adjusted to reflect the impact of unrealized gains and losses on fixed maturity securities available for sale, as described in the Investments section of Note 1. The change in DAC from unrealized losses on fixed maturity securities was $(26.5) million for year ended 2010 (2009 - $(52.1) million; 2008 - $51.2 million).
The accrual of interest for Old American VOBA was calculated at a 13.0% interest rate for the life block and a 7.0% rate for the accident and health block. In 2010, interest was accrued on the GuideOne acquisition VOBA at the rates of 4.5% on the interest sensitive life block, 4.1% on the deferred annuity block and 5.3% on the traditional life block. The VOBA on a separate acquired block of business used a 7.0% interest rate on the traditional life portion and a 5.4% interest rate on the interest sensitive portion. The interest rates used in the calculation of VOBA are based on rates appropriate at the time of acquisition. The expected amortization of VOBA each year over the next five years, 2011 through 2015, is $9,925, $7,272, $6,783, $6,136, and $5,725, respectively.
One component of contract charges is the recognition over time of the deferred revenue liability (DRL) from certain universal life policies. This liability arises from front-end loads on such policies and is recognized into the Consolidated Statements of Income in concert with the future expected gross profits, similar to the amortization of DAC. In 2010, the Company had a refinement in methodology resulting in a change in estimate. The Company refined its methodology primarily as a result of the implementation of an actuarial system upgrade. This upgrade allowed the Company to refine its calculation of the DRL liability. The effect of the refinement in estimate on the DRL was an increase in the liability and a reduction to contract charges of $0.9 million. No refinements of the DRL calculation occurred during 2009 or 2008.
At least annually, a review is performed regarding the assumptions related to profit expectations consistent with those performed for DAC and VOBA. If it is determined that the assumptions should be revised, an adjustment may be recorded to contract charge deferred revenues in the current period as an unlocking adjustment. The Company had an unlocking in the DRL in 2010. The 2010 unlocking adjustment reflects actual experience from mortality results, premium persistency, and surrender rates that have emerged. The impact of the unlocking on DRL was a decrease in the liability and a corresponding increase in the recognition of deferred revenue in the current period of $1.1 million. While there was no unlocking affecting the DRL in 2009, there was an increase in the liability of $0.8 million due to unlocking.
The following table identifies the effect of the deferred revenue change in estimate and unlocking recognized in contract charges in the Consolidated Statements of Income.
The Company has a guaranteed minimum withdrawal benefit (GMWB) rider that can be added to new or existing variable annuity contracts. The rider provides an enhanced withdrawal benefit that guarantees a stream of income payments to an owner or annuitant, regardless of the contract account value. The value of variable annuity separate accounts with the GMWB rider was $80.3 million at December 31, 2010 (2009-$57.9 million) and the guarantee liability was $(2.8) million at December 31, 2010 (2009-$(1.6) million). The value of the GMWB rider is recorded at fair value. The change in this value is included in policyholder benefits in the Consolidated Statements of Income. The value of variable annuity separate accounts with the GMWB rider is recorded in separate account liabilities and the value of the rider is included in other policyholder funds in the Consolidated Balance Sheets. The determination of fair value of the GMWB liability requires models that use actuarial and financial market assumptions, which reflect the assumptions market participants would use in pricing the contract, including adjustments for risk and issuer non-performance. The Company refined its process in 2010 to incorporate an index from an industry-recognized actuarial consulting firm that the Company believes is more consistent with the attributes of the product and better matches the volatility measure with the expected life of the underlying contracts.
The Company establishes liabilities for amounts payable under insurance policies, including traditional life insurance, immediate annuities with life contingencies, supplementary contracts with life contingencies and accident and health insurance. Generally, amounts are payable over an extended period of time. Liabilities for future policy benefits of traditional life insurance have been computed by a net level premium method based upon estimates at the time of issue for investment yields, mortality and withdrawals. These estimates include provisions for experience less favorable than initially expected. Mortality assumptions are based on Company experience expressed as a percentage of standard mortality tables. The 2001 Valuation Basic Table and the 1975-1980 Select and Ultimate Basic Table serve as the bases for most mortality assumptions.
Crediting rates for universal life insurance and fixed deferred annuity products ranged from 2.00% to 5.50% in 2010 (2009 - 3.00% to 5.50%; 2008 - 3.00% to 5.50%).
In February 2007, the FASB issued new guidance to permit an entity to measure certain financial assets and liabilities at fair value. Under this guidance, entities that elect the fair value option report unrealized gains and losses in earnings at each subsequent reporting date. The fair value option may be elected on an instrument-by-instrument basis, with a few exceptions, as long as it is applied to the instrument in its entirety. Once adopted, the fair value option election is irrevocable, unless a new election date occurs. This guidance became effective for years beginning after November 15, 2007. The Company adopted it on January 1, 2008 with no material impact to the consolidated financial statements. The Company elected to not measure financial assets and liabilities at fair value other than those already prescribed.
In March 2008, the FASB issued new guidance to require companies with derivative instruments to disclose information about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for, and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This guidance became effective for financial statements issued for fiscal years beginning after November 15, 2008. The Company adopted it on January 1, 2009 with no material impact on the consolidated financial statements.
In December 2008, the FASB issued new guidance regarding employers’ disclosures about postretirement benefit plan assets. It requires entities to provide disclosures about employer’s defined benefit plans and other post retirement plans that would help users of the financial statements understand how investment allocation decisions are made, the major categories of plan assets, the inputs and the valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs (Level 3) on changes in plan assets for the period, and significant concentrations of risk within plan assets. This guidance became effective for financial statements issued for fiscal years ending after December 15, 2009. The Company adopted this guidance on January 1, 2009 with no material impact to the consolidated financial statements.
In April 2009, the FASB issued new guidance to expand the fair value disclosures required for financial instruments for interim periods. The guidance also requires entities to disclose the methods and significant assumptions used to estimate the fair value of financial instruments in financial statements on an interim and annual basis and to highlight any changes from prior periods. This guidance became effective for financial statements issued for interim and annual periods ending after June 15, 2009. The Company elected early adoption effective for the period ended March 31, 2009 with retroactive application effective January 1, 2009 with no material impact to the consolidated financial statements.
In May 2009, the FASB issued new guidance that established general accounting standards and disclosure for events occurring subsequent to the balance sheet date but before the financial statements are issued. This guidance became effective for interim and annual accounting periods ending after June 15, 2009. The Company adopted it upon issuance, with no material impact to the consolidated financial statements.
In June 2009, the FASB issued new guidance to establish the FASB ASC as the source of authoritative accounting principles recognized by the FASB to be applied by non-governmental entities in the preparation of financial statements in conformity with GAAP. This guidance replaced previous guidance related to the same issue and became effective for interim and annual reporting periods ending after September 15, 2009. The Company adopted it upon issuance, with no material impact to the consolidated financial statements.
In July 2010, the FASB issued guidance to expand existing disclosures about the credit quality of financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. For public entities, the disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The Company adopted this new guidance on December 15, 2010 with no material impact to the consolidated financial statements.
In October 2010, the FASB issued guidance that modifies the types of costs incurred by insurance entities that can be capitalized when issuing or renewing insurance contracts. The guidance requires costs to be incremental or directly related to the successful acquisition of new or renewal contracts in order to be capitalized as a deferred acquisition cost. This guidance will be effective for interim and annual periods beginning after December 15, 2011, with either prospective or retrospective application permitted. The Company is currently evaluating this new guidance and its materiality to the consolidated financial statements.
All other new accounting standards and updates of existing standards issued during 2010 did not relate to accounting policies and procedures pertinent to the Company at this time.
The Company reviews prices received from service providers for unusual fluctuations but generally accepts the price identified from the primary pricing service. However, if the primary pricing service does not provide a price, the Company utilizes the price provided by the second pricing service if a price is available. In the event a price is not available from either third-party pricing service, the Company pursues external pricing from brokers. Generally, the Company pursues and utilizes only one broker quote per security. In doing so, the Company solicits only brokers which have previously demonstrated knowledge and experience of the subject security. If a broker price is not available, the Company determines a carrying value through various valuation techniques that may include discounted cash flows, spread-based models or similar techniques depending upon the specific security to be priced. These techniques are primarily applied to private placement securities. The Company utilizes available market information, wherever possible, to identify inputs into the fair value determination, primarily including prices and spreads on comparable securities.
The Company performs an analysis on the prices received from third-party security pricing services and independent brokers to ensure that the prices represent a reasonable estimate of the fair value. The Company corroborates and validates the primary pricing sources through a variety of procedures that include but are not limited to comparison to additional independent third-party pricing services or brokers, where possible, a review of third-party pricing service methodologies, back testing and comparison of prices to actual trades for specific securities where observable data exists. In addition, the Company analyzes the primary third-party pricing service’s methodologies and related inputs and also evaluates the various types of securities in its investment portfolio to determine an appropriate fair value hierarchy.
Investment-Type Liabilities Included in Policyholder Account Balances and Other Policyholder Funds
The Company offers a GMWB rider that can be added to new or existing variable annuity contracts. The rider provides an enhanced withdrawal benefit that guarantees a stream of income payments to an owner or annuitant, regardless of the contract account value. Fair value for GMWB rider contracts results in a Level 3 valuation, as it is based on models which utilize significant unobservable inputs. These models require actuarial and financial market assumptions, which reflect the assumptions market participants would use in pricing the contract, including adjustments for risk and issuer non-performance.
The following table presents the fair value of fixed maturities and equity securities available for sale by pricing source and fair value hierarchy level.
The changes in Level 2 assets measured at fair value on a recurring basis for the year ended December 31, 2010 are summarized below:
The following tables provide the distribution of maturities for fixed maturity securities available for sale as of December 31. Expected maturities may differ from these contractual maturities since borrowers may have the right to call or prepay obligations.
The following table provides detail concerning realized investment gains and losses by asset class for the three years ended December 31.
To the extent the Company determines that a fixed maturity security is deemed to be other-than-temporarily impaired, the portion of the impairment that is deemed to be due to credit is charged to the Consolidated Statements of Income and the cost basis of the underlying investment is reduced. The portion of the impairment that is deemed to be non-credit is charged to other comprehensive income (loss). Equity securities that are determined to be other-than-temporarily impaired are written down to fair value and the impairment is charged to the Consolidated Statements of Income.
The evaluation of loan-backed and similar asset-backed securities, particularly including residential mortgage-backed securities, with significant indications of potential other-than-temporary impairment requires considerable use of estimates and judgment. Specifically, the Company performs discounted cash flow projections on these securities to evaluate whether the value of the investment is expected to be fully realized. Projections of expected future cash flows are based upon considerations of the performance of the actual underlying assets, including historical delinquencies, defaults, severity of losses incurred, and prepayments, along with the Company’s estimates of future results for these factors. The Company’s estimates of future results are based upon actual historical performance of the underlying assets relative to historical, current and expected general economic conditions, specific conditions related to the underlying assets, industry data, and other factors that are believed to be relevant. If the present value of the projected expected future cash flows are determined to be below the Company’s carrying value, the Company recognizes an other-than-temporary impairment on the portion of the carrying value that exceeds the projected expected future cash flows. To the extent that the loan-backed or other asset-backed securities remain high quality investments and do not otherwise demonstrate characteristics of impairment, the Company performs other initial evaluations to determine whether other-than-temporary cash flow evaluations need to be performed.
The determination of any amount of impairment that is due to credit is based upon a comparison of the present value of the projected future cash flows on the security to the amortized cost. If any portion of the impairment is determined to be due to credit, based upon the present value of projected future cash flows being less than the amortized cost of the security, this amount is recognized as a realized loss in the Company’s Consolidated Statements of Income and the carrying value of the security is written down by the same amount. The portion of an impairment that is determined not to be due to credit is recorded as a component of accumulated other comprehensive income (loss) in the Consolidated Balance Sheets.
If the discounted cash flow for a collateralized security is determined to be less than the amortized cost, the difference is recorded as an other-than-temporary impairment due to credit in the Consolidated Statements of Income.
The total impairment for any security that is deemed to have an other-than-temporary impairment is recorded in the Consolidated Statements of Income as a net realized loss from investments. The portion of such impairment that is determined to be non-credit-related is deducted from net realized loss in the Consolidated Statements of Income and reflected in other comprehensive income (loss) and accumulated other comprehensive income (loss), which is a component of stockholders’ equity in the Consolidated Balance Sheets.
The following table provides information regarding fixed maturity and equity security investments available for sale with unrealized losses by length of time as of December 31, 2010.
The following table provides information regarding fixed maturity and equity security investments available for sale with unrealized losses by length of time as of December 31, 2009.
In addition, the Company also considers as part of its monitoring and evaluation process the length of time a security is below cost. At December 31, 2010, the Company had unrealized losses on its investment portfolio for fixed maturities and equity securities as follows:
18 security issues representing 10% of the issues with unrealized losses, including 56% being rated as investment grade, were below cost for one year or more and less than three years; and
39 security issues representing 21% of the issues with unrealized losses, including 49% being rated as investment grade, were below cost for three years or more.
The following tables summarize the Company’s investments in securities available for sale with unrealized losses as of December 31, 2010 and December 31, 2009.
The following table provides information regarding fixed maturity securities by asset class at December 31, 2010.
The Company held two non-income producing securities with a carrying value of $2.8 million at December 31, 2010 (2009 - one security with a carrying value of $2.7 million). These securities were previously written down due to other-than-temporary impairments and placed on non-accrual status.
The Company did not hold securities of any corporation and its affiliates that exceeded 10% of stockholders’ equity at December 31, 2010 or December 31, 2009.
The Company is exposed to risk that issuers of securities owned by the Company will default or that interest rates or credit spreads will change and cause a decrease in the value of its investments. With residential mortgage-backed securities, the Company is also exposed to prepayment and extension risks. As interest rates change, the rate at which these securities pay down principal may change. These risks are mitigated by investing in high-grade securities and managing the maturities and cash flows of investments and liabilities.
At December 31, 2010, the Company had 16% of its invested assets in mortgage loans, up from 14% at December 31, 2009. The Company originates and services fixed-rate commercial mortgage loans for its investment portfolio. New commercial loans were $146.1 million, $61.2 million and $54.4 million for 2010, 2009 and 2008, respectively. The level of new commercial mortgage loans in any year is influenced by market conditions, as the Company responds to changes in interest rates, available spreads and borrower demand. In addition to the subject collateral underlying the mortgage, the Company typically requires some amount of recourse from borrowers as another potential source of repayment. The recourse requirement is determined as part of the underwriting requirements of each loan.
The following table summarizes the amount of mortgage loans held by the Company at December 31, 2010, segregated by origination year. The 2010 amount includes the seasoned mortgage loans purchased from institutional lenders, as previously discussed.
The tables below identify mortgage loans by geographic location and property type as of December 31.
Commercial mortgage loans in California accounted for 21% of the Company’s commercial mortgage loan portfolio at December 31, 2010. The next largest concentration by state was 15% in Texas. Through this concentration in California, along with other states included in the pacific region, the Company is exposed to potential losses from a regional economic downturn and certain catastrophes, such as earthquakes and fires that may affect certain areas of the region. The Company requires borrowers to maintain fire insurance coverage to provide reimbursement for any losses due to fire. The Company diversifies its commercial mortgage loan portfolio both geographically and by property type to reduce certain catastrophe and economic exposure. However, diversification may not always sufficiently mitigate the risk of such losses. Historically, the delinquency rate of the Company’s pacific region commercial mortgage loans has been substantially below the industry average and consistent with the Company’s experience in other states. The Company does not require earthquake insurance for properties on which it makes commercial mortgage loans. However, the Company does consider the potential for earthquake loss if the property lies within areas believed by the Company to be seismically active submarkets and structural information specific to each property. The Company does not expect catastrophe or earthquake damage or economic downturn in the pacific region to have a material adverse effect on its business, financial position, results of operations or cash flows. However, the Company cannot provide assurance that such risks could not have such material adverse effects.
Under the laws of certain states, environmental contamination of a property may result in a lien on the property to secure recovery of the costs of cleanup. In some states, such a lien has priority over the lien of an existing mortgage against such property. As a commercial mortgage lender, the Company customarily conducts environmental assessments prior to making commercial mortgage loans secured by real estate and before taking title on real estate. Based on the Company’s environmental assessments, the Company believes that any compliance costs associated with environmental laws and regulations or any remediation of affected properties would not have a material adverse effect on the Company’s business, financial position, results of operations or cash flows. However, the Company cannot provide assurance that material compliance costs will not be incurred.
In December 2009, a construction-to-permanent loan in the amount of $16.0 million was executed. In the second quarter of 2010 the Company issued a second construction-to-permanent loan in the amount of $1.8 million. At December 31, 2010, $12.6 million had been disbursed for the two construction loans, with an unfunded amount of $5.2 million. Both projects are scheduled for completion by mid-2011. At completion and fulfillment of occupancy requirements, the loans will convert to long-term, fixed rate permanent loans.
The following table presents an aging schedule for delinquent payments for both principal and interest as of December 31, 2010 and December 31, 2009, by class.
As of December 31, 2010, there were two mortgage loans that were 30 days past due. Subsequently, payments were received on both of these loans and the loans were brought current in January 2011.
• Annual monitoring of each loan’s property financial statement including net operating income, debt service coverage and occupancy level;
• Analysis of the Company’s loan portfolio based on loan size concentrations, geographic concentrations, property type concentrations, maturity concentrations, origination loan-to-value concentrations and borrower concentrations;
These categories are generally monitored on an individual and aggregate basis to determine that the appropriate level of allowance is maintained. The Company’s allowance for credit losses was $3.4 million at December 31, 2010. Generally, the Company establishes the allowance for credit losses using the collectively evaluated impairment methodology. The Company has not acquired any mortgage loans with deteriorated credit quality.
• The risk that the Company’s assessment of a borrower to meet all of its contractual obligations will change based on changes in the credit characteristics of the borrower or property;
• The risk that fraudulent, inaccurate or misleading information could be provided to the Company;
• The risk that the methodology or assumptions used to develop estimates of the portion of the impairment of the loan prove over time to be inaccurate; and
• The risk that other facts and circumstances change such that it becomes more likely than not that the Company will not obtain all of it contractual payments.
Investments in real estate totaled $119.9 million at December 31, 2010 ($114.1 million at December 31, 2009). The table below provides information concerning the Company's real estate investments by major category as of December 31.
The Company had non-income producing real estate of $29.7 million, consisting of vacant properties and properties under development, at December 31, 2010 (2009 - $28.1 million).
The Company had no commitments to buy or sell real estate investments at December 31, 2010. The Company had commitments to fund affordable housing project obligations of $9.6 million at December 31, 2010 (2009 - $7.4 million).
The Company invests in certain affordable housing and real estate joint ventures which are considered to be variable interest entities (VIEs). The assets held in affordable housing real estate joint venture VIEs are primarily residential real estate properties that are restricted to provide affordable housing under federal or state programs for varying periods of time. The restrictions primarily apply to the rents that may be paid by tenants residing in the properties during the term of an agreement to remain in the affordable housing program. Investments in real estate joint ventures are equity interests in partnerships or limited liability corporations that may or may not participate in profits or residual value. In certain cases, the Company may issue fixed-rate senior mortgage loan investments secured by properties controlled by VIEs. These investments are classified as mortgage loans in the Consolidated Balance Sheets, and the income received from such investments is recorded as investment income in the Consolidated Statements of Income.
Most of the Company’s investment interests in VIEs not in the form of a fixed-rate senior mortgage debt investment are recorded using the equity method, with cash distributions from the VIE and cash contributions to the VIE recorded as decreases or increases, respectively, in the carrying value of the VIE. Certain other equity investments in VIEs, where permitted, are recorded on an amortized cost basis. The operating performance of investments in the VIE is recorded in the Consolidated Statements of Income as investment income or as a component of income tax expense, depending upon the nature and primary design of the investment. The Company evaluates the carrying value of VIEs for impairment on an ongoing basis to assess whether the carrying value is expected to be realized during the anticipated life of the investment. Fixed-rate senior mortgage debt investments secured by properties controlled by VIEs are classified as commercial mortgages, and income received from such investments is recorded as investment income.
The maximum exposure to loss relating to the real estate joint ventures and affordable housing real estate joint ventures, as shown in the table above, is equal to the carrying amounts plus any unfunded equity commitments, exposure to potential recapture of tax credits, guarantees of debt or other obligations of the VIE with recourse to the Company. Unfunded equity and loan commitments typically require financial or operating performance by other parties and have not yet become due or payable but which may become due in the future. The Company had contingent commitments to fund additional equity contributions to certain affordable housing real estate joint venture VIEs, as of December 31, 2010 and 2009 of $9.2 and $7.0 million, respectively, which could result in additional exposure to loss.
The table below provides Kansas City Life’s net gain from operations, net income (loss) and capital and surplus (stockholders' equity), on the statutory basis used to report to regulatory authorities for the years ended December 31.
Federal income taxes paid during 2010 were $4.0 million (2009 - $6.5 million; 2008 - $9.9 million).
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. In general, the Company is no longer subject to U.S. federal, state or local income tax examinations by tax authorities for years prior to 2007. The Company is not currently under examination by the Internal Revenue Service.
The Company recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense (benefit). During the years ended December 31, 2010, 2009, and 2008, the Company recognized expense (benefit) of approximately ($0.7) million, ($0.2) million, and $0.1 million in interest and penalties, respectively. The Company did not have any accrued interest and penalties at December 31, 2010 and $0.7 million for the payment of interest and penalties accrued at December 31, 2009.
The Kansas City Life Cash Balance Pension Plan (the Plan) was amended effective December 31, 2010 to provide that participants’ accrued benefits will be frozen as of, and that no further benefits or accruals will be earned after December 31, 2010. Although participants will no longer accrue additional benefits under the Plan as of December 31, 2010, participants will continue to earn years of service for vesting purposes under the Plan with respect to their benefits accrued through December 31, 2010. In addition, the cash balance account will continue to earn annual interest. Plan benefits are based on a cash balance account consisting of credits to the account based upon an employee’s years of service, compensation and interest credits on account balances calculated using the greater of the average 30-year Treasury bond rate for November of each year or 5.5%. The benefits expected to be paid in each year from 2011 through 2015 are $9.8 million, $9.9 million, $9.4 million, $10.4 million, and $10.9 million, respectively. The aggregate benefits expected to be paid in the five years from 2016 through 2020 are $51.4 million. The expected benefits to be paid are based on the same assumptions used to measure the Company’s benefit obligation at December 31, 2010 and include estimated future employee service. The 2011 contribution for the plan has not been determined.
The asset allocation of the fair value of pension plan assets at December 31 was:
Plan fiduciaries set investment policies and strategies and oversee its investment allocation, which includes selecting investment managers, commissioning periodic asset-liability studies and setting long-term strategic targets. Long-term strategic investment objectives include preserving the funded status of the plan and balancing risk and return. Target allocation ranges are guidelines, not limitations, and occasionally plan fiduciaries will approve allocations above or below a target range. The Plan does not expect to return any plan assets to the Company during 2011.
The assumed discount rates used to determine the benefit obligation for pension benefits and postretirement benefits are 5.02% and 5.59%, respectively. The discount rates were determined by reference to the Citigroup Pension Liability Yield Curve on December 31, 2010. Specifically, the spot rate curve represents the rates on zero coupon securities of the quality and type included in the pension index at various maturities. By discounting benefit cash flows at these rates, a notional amount equal to the fair value of a cash flow defeasing portfolio of bonds was determined. The discount rate for benefits was calculated as a single rate giving the same discounted value as the notional amount.
The postretirement medical plans for eligible employees, agents, and their dependents are contributory with contributions adjusted annually. The benefits expected to be paid in each year from 2011 through 2014 are $1.1 million each year and $1.2 million for 2015. The aggregate benefits expected to be paid in the five years from 2016 through 2020 are $6.6 million. The expected benefits to be paid are based on the same assumptions used to measure the Company’s benefit obligation at December 31, 2010. The 2011 contribution for the plan is estimated to be $1.1 million. The Company pays these medical costs as they become due and the plan incorporates cost-sharing features. The postretirement plan disclosures included herein do not include the potential impact from the Medicare Act (the Act) that became law in December 2003. The Act introduced a new federal subsidy to sponsors of certain retiree healthcare plans that provide a benefit that is at least actuarially equivalent to Medicare. Since the Company does not provide benefits that are actuarially equivalent to Medicare, the Act did not impact the Company’s disclosures.
The postretirement life insurance plan is non-contributory with level annual payments over the participants' expected service periods. The plan covers only those employees with at least one year of service as of December 31, 1997. The benefits in this plan are frozen, using the employees' years of service and compensation as of December 31, 1997.
No payments were made during 2010 for the three-year interval ended December 31, 2009. Also, no payments were made during 2009 for the three-year interval ended December 31, 2008. During 2008, the plan made a payment of $0.1 million to plan participants for the three-year interval ended December 31, 2007. The cost of compensation charged as an operating expense during 2010 was $0.3 million, net of tax. The change in accrual for share-based compensation that reduced operating expense during 2009 was $0.1 million, net of tax. The cost of compensation charged as an operating expense during 2008 was $0.1 million, net of tax.
Insurance revenues, as shown in the Consolidated Statements of Income, consist of premiums and contract charges, less reinsurance ceded. Insurance revenues are defined as “customer revenues” for segment reporting purposes. Other revenues consist primarily of supplementary contract considerations, policyholder dividends left with the Company to accumulate, income received on the sale of low income housing tax credits by a subsidiary of the Company, and fees charged on products and sales from the Company’s broker-dealer subsidiary. Customer revenues are added to other revenues, net investment income and realized investment gains (losses) to reconcile to the Company’s total revenues. Benefits and expenses are specifically and directly identified and recorded by segment. Certain expenses may also be allocated as necessary.
Separate investment portfolios are maintained for each of the three life insurance companies. However, investment assets and income are allocated to the Group Insurance segment based upon its cash flows and future policy benefit liabilities. Home office functions are fully integrated for all segments in order to maximize economies of scale. Therefore, operating expenses are allocated to the segments based upon internal cost studies, which are consistent with industry cost methodologies.
Old American has a coinsurance agreement that reinsures certain whole life policies issued by Old American prior to December 1, 1986. These policies had a face value of $36.8 million as of December 31, 2010 (2009 - $40.9 million). The reserve for future policy benefits ceded under this agreement at December 31, 2010 was $20.1 million at December 31, 2010 (2009 - $21.9 million).
Estimates of impairment due to credit involving collateralized securities were based upon review of projected cash flows relative to amortized cost at the time the security was determined to be other-than-temporarily impaired. The credit component of the impairment for these securities was determined to be the difference between the amortized cost of the security and the projected cash flows.
In the implementation of this guidance at March 31, 2009, the Company recorded an opening balance adjustment that increased retained earnings in the amount of $8.4 million and increased accumulated other comprehensive loss in the amount of $6.6 million. The adjustment to retained earnings consisted of an increase of $8.8 million related to non-credit impairments taken in prior periods, net of tax. This adjustment also included a $0.4 million decrease due to offsetting adjustments to DAC and VOBA, net of tax. The adjustment to accumulated other comprehensive loss consisted of a decrease of $8.8 million related to non-credit impairments taken in prior periods, net of tax. This adjustment also included a $2.2 million increase due to offsetting adjustments to DAC and VOBA, net of tax.
The Company is subject to various indemnification obligations issued in conjunction with certain transactions, primarily assumption reinsurance agreements, stock purchase agreements, mortgage servicing agreements, tax credit assignment agreements, construction and lease guarantees and borrowing agreements whose terms range in duration and often are not explicitly defined. Generally, a maximum obligation is not explicitly stated. Therefore, the overall maximum amount of the obligation under the indemnifications cannot be reasonably estimated. The Company is unable to estimate with certainty the ultimate legal and financial liability with respect to these indemnifications. The Company believes that the likelihood is remote that material payments would be required under such indemnifications and therefore such indemnifications would not result in a material adverse effect on the financial position or results of operations.
On January 24, 2011, the Kansas City Life Board of Directors declared a quarterly dividend of $ 0.27 per share, paid on February 9, 2011 to stockholders of record on February 3, 2011.
We have audited the accompanying consolidated balance sheets of Kansas City Life Insurance Company and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2010. In connection with our audits of the consolidated financial statements, we also have audited financial schedules I-V. We also have audited the Company’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements, for financial statement schedules, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Assessment of Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and financial schedules and an opinion on the Company’s internal control over financial reporting based on our audits.
As discussed in note 1 to the consolidated financial statements, effective January 1, 2009, the Company changed its method of accounting for other-than-temporary impairments of debt securities due to the adoption of Financial Accounting Standards Board Accounting Standards Codification 320.