Property owned Amount % of Total Home Office $ 1,758,587 6%
Total investment real estate holdings represent approximately 9% of the total assets of the Company net of accumulated depreciation of $ 2,872,199 and $ 1,729,001 at year-end 2004 and 2003 respectively. The Company owns an office complex in Springfield, Illinois, which houses the primary insurance operations. The office buildings in this complex contain 57,000 square feet of office and warehouse space, and are carried at $ 1,758,587. Currently, the facilities occupied by the Company are adequate relative to the Company's present operations.
Residential development property is primarily located in Springfield, Illinois, and consists of two parcels. The Company has no current plans to further develop these parcels. The properties are located in a growing area of the community and are currently being marketed for sale.
The purpose of this section is to discuss and analyze the Company's consolidated results of operations, financial condition and liquidity and capital resources for the three years ended December 31, 2004. This analysis should be read in conjunction with the consolidated financial statements and related notes, which appear elsewhere in this Form 10-K. The Company reports financial results on a consolidated basis. The consolidated financial statements include the accounts of UTG and its subsidiaries at December 31, 2004.
We regularly monitor our investment portfolio to ensure that investments that may be other than temporarily impaired are identified in a timely manner and properly valued, and that any impairments are charged against earnings in the proper period.
Premiums and policy fee revenues, net of reinsurance premiums and policy fees, decreased 6% when comparing 2004 to 2003 and 5% from 2003 to 2002. The Company continues to write very little new business, as Management places modest emphasis on new business production. Unless the Company acquires a block of in-force business, management expects premium revenue to continue to decline at a rate consistent with prior experience. The Company's average persistency rate for all policies in force for 2004, 2003 and 2002 was approximately 94.6%, 94.9%, and 93.6%, respectively. Persistency is a measure of insurance in force retained in relation to the previous year.
Net investment income increased 1% when comparing 2004 to 2003 and decreased 24% when comparing 2003 to 2002. The overall gross investment yields for 2004, 2003 and 2002, are 6.06%, 5.73% and 6.66%, respectively. The decline in investment yield during 2003 was directly affected by the decline in the national prime rate, which was 4.00% at December 31, 2003. The national prime rate increased to 5.25% at December 31, 2004; however, the lower yield in recent years has resulted in reduced earnings on short-term funds as well as on longer-term investments acquired during the reporting period. Through this period, Management shortened the length of the Company's portfolio and maintained a conservative investment philosophy. As such, following an analysis of current holdings during the first half of 2004, the Company liquidated approximately $ 39,000,000 of its collateralized mortgage obligation and mortgage backed bond portfolio in order to limit its interest rate and extension risk. In addition, there were $ 48,000,000 in bonds that matured or were called during 2004. The result of these transactions caused an excess of cash invested in short-term money market funds during parts of 2004. The Company began reinvesting this cash during the second quarter primarily in governmental and agency bonds at current lower yields. Although this hurts investment earnings in the short run, the Company has not had to write off any investment losses due to excessive risk. Many insurance companies have suffered significant losses in their investment portfolios as a result of corporate defaults and bankruptcies in the last few years; however, because of the Company's conservative investment philosophy the Company has so far avoided such significant losses. The Company's corporate holdings are relatively small compared to the insurance industry. Recent periods investments acquired include a very limited amount in corporate securities.
The Company's investments are generally managed to match related insurance and policyholder liabilities. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. The Company monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads, ranging from 1% to 2%. In previous years, the Board of Directors lowered crediting rates to their guaranteed minimum rates, and as such, cannot lower them any further. These adjustments were in response to the continued declines in interest rates in the marketplace described above. Policy interest crediting rate changes and expense load changes become effective on an individual policy basis on the next policy anniversary. Therefore, it takes a full year from the time the change was determined for the full impact of such change to be realized. If interest rates decline in the future, the Company won't be able to lower rates and both net investment income and net income will be impacted negatively.
Realized investment gains, net of realized losses, were $ (20,648), $ 485,436 and $ 13,634 in 2004, 2003 and 2002, respectively. As previously discussed, the Company sold several of its collateralized mortgage obligation bonds during 2004 and realized a nominal net loss on these securities. The primary source for the 2003 gain is from the sale of two investments. The Company sold one common stock holding, realizing a gain of $ 165,262 and one real estate holding, realizing a gain of $ 211,352. During 2002, the modest realized gain consisted primarily of real estate sales on residential development property the Company owned in Springfield, Illinois.
Benefits, claims and settlement expenses net of reinsurance benefits and claims, decreased $ 2,307,898 from 2003 to 2004 and increased $ 1,631,372 from 2002 to 2003. The significant fluctuations between the three years relates primarily to changes in the Company's policyholder reserves, or future policy benefits. Reserves are calculated on an individual policy basis and generally increase over the life of the policy as a result of additional premium payments and acknowledgement of increased risk as the insured continues to age. Fluctuations in death claim experience from year to year also typically have a significant impact on variances in this line item. Death claims were approximately $240,000 less in 2004 as compared to 2003. Direct (prior to reinsurance) death claims were approximately $ 1,024,000 less in 2004 than in 2003. There is no single event that caused the mortality variances. Policy claims vary from year to year and therefore, fluctuations in mortality are to be expected and are not considered unusual by management. Policy surrender benefits decreased approximately $ 546,000 during the year 2004 compared to the same period in 2003 and $ 980,000 during the year 2003 compared to the same period in 2002. As discussed above, stronger efforts have been made in policy retention through more personal contact with customers including telephone calls to discuss alternatives and reasons for a request to surrender their policy. The short-term impact of such fewer policy surrenders is negligible since a reserve for future policy benefits payable is held which is, at a minimum, equal to and generally greater than the cash surrender value of a policy. Therefore, a decline in current period surrenders results in an overall increase in the policy benefits number in the current period. The benefit of fewer policy surrenders is primarily received over a longer time period through the retention of the Company's asset base.
Commissions and amortization of deferred policy acquisition costs decreased 1% in 2004 compared to 2003 and decreased 60% in 2003 compared to 2002. The most significant factor in the continuing decrease is attributable to the Company paying fewer commissions, since the Company writes very little new business and renewal premiums on existing business continue to decline. Another factor of the decrease is attributable to normal amortization of the deferred policy acquisition costs asset. The Company reviews the recoverability of the asset based on current trends and known events compared to the assumptions used in the establishment of the original asset. No impairments were recorded in any of the three periods reported.
Interest expense declined 52% comparing 2004 to 2003 and 38% comparing 2003 to 2002. The Company repaid $ 2,289,776, $ 705,499 and $ 1,405,395 in outside debt in 2004, 2003 and 2002 respectively, through operating cash flows and dividends received from its subsidiary UG. At December 31, 2004, UTG had no debt outstanding for the first time since 1992.
The Company had a net income (loss) of $ (275,617), $ (6,396,490), and $ 1,338,795 in 2004, 2003 and 2002 respectively. Significant one-time charges and accruals to operating expenses, combined with an additional write-off of cost of insurance acquired and lower interest rates during 2003 as previously described, were the primary differences in the 2004 to 2003 results. The Company continues to monitor and adjust those items within its control.
The following table summarizes the Company's fixed maturities distribution at December 31, 2004 and 2003 by ratings category as issued by Standard and Poor's, a leading ratings analyst.
Fixed Maturities Rating % of Portfolio ---------------------- 2004 2003 ---------- ---------- Investment Grade AAA 82% 82% AA 1% 1% A 13% 12% BBB 4% 4% Below investment grade 0% 1% ---------- ---------- 100% 100% ========== ==========
In previous years the Company has invested more of its funds in mortgage loans. This is the result of increased mortgage opportunities available through FSNB, an affiliate of Mr. Jesse T. Correll. Mr. Correll is the CEO and Chairman of the Board of Directors of UTG, and directly and indirectly through affiliates, its largest shareholder. FSNB has been able to provide the Company with additional expertise and experience in underwriting commercial and residential mortgage loans, which provide more attractive yields than the traditional bond market. During 2004, 2003 and 2002 the Company issued approximately $ 2,627,000, $ 11,405,000 and $ 6,920,000 respectively, in new mortgage loans. These new loans were originated through FSNB and funded by the Company through participation agreements with FSNB. FSNB services the loans covered by these participation agreements. The Company pays FSNB a .25% servicing fee on these loans and a one-time fee at loan origination of .50% of the original loan amount to cover costs incurred by FSNB relating to the processing and establishment of the loan. UG paid $ 45,468, $ 63,214 and $ 70,140 in servicing fees and $ 0, $ 13,821 and $ 35,127 in origination fees to FSNB during 2004, 2003 and 2002, respectively. The Company anticipates these opportunities to continue to be available and will pursue those investments that provide attractive yields.
Total investment real estate holdings represent approximately 9% and 8% of the total assets of the Company, net of accumulated depreciation, at year-end 2004 and 2003 respectively. Total investment real estate is separated into commercial and residential categories.
Cash provided by (used in) investing activities was $ 3,776,714, $ (15,846,714) and $ 7,833,788 for 2004, 2003 and 2002, respectively. The most significant aspect of cash provided by (used in) investing activities is the fixed maturity transactions. Fixed maturities account for 82%, 82% and 78% of the total cost of investments acquired in 2004, 2003 and 2002, respectively.
During 2002, UTG and Fiserv formed an alliance between their respective organizations to provide third party administration (TPA) services to insurance companies seeking business process outsourcing solutions. Fiserv will be responsible for the marketing and sales function for the alliance, as well as providing the operations processing service for the Company. The Company will staff the administration effort. To facilitate the alliance, the Company has converted part of its existing business and all TPA clients to "ID3", a software system owned by Fiserv to administer an array of life, health and annuity products in the insurance industry. Fiserv is a unit of Fiserv, Inc. (Nasdaq: FISV) which is an independent, full-service provider of integrated data processing and information management systems to the financial industry, headquartered in Brookfield, Wisconsin. In addition, the Company entered into a five-year contract with Fiserv for services related to their purchase of the "ID3" software system. Under the contract, the Company is required to pay $ 12,000 per month in software maintenance costs and a monthly fee for offsite data center costs, based on the number and type of policies being administered the ID3 software system for a five-year period from the date of the signing.
Management believes the overall sources of liquidity available will be sufficient to satisfy its financial obligations.
The Company's current and merged insurance subsidiaries are assessed contributions by life and health guaranty associations in almost all states to indemnify policyholders of failed companies. In several states the company may reduce premium taxes paid to recover a portion of assessments paid to the states' guaranty fund association. This right of "offset" may come under review by the various states, and the company cannot predict whether and to what extent legislative initiatives may affect this right to offset. In addition, some state guaranty associations have adjusted the basis by which they assess the cost of insolvencies to individual companies. The Company believes that its reserve for future guaranty fund assessments is sufficient to provide for assessments related to known insolvencies. This reserve is based upon management's current expectation of the availability of this right of offset, known insolvencies and state guaranty fund assessment bases. However, changes in the basis whereby assessments are charged to individual companies and changes in the availability of the right to offset assessments against premium tax payments could materially affect the company's results.
At year-end 2004, UG had four ratios outside the normal range. Each of the ratios outside the normal range was anticipated by Management, based upon the operating results of the Company. The first ratio addresses significant variations in capital of the life company. The variance from normal was the result of the contribution of capital, North Plaza of Somerset, to the insurance company from its parent. The second ratio compares net income with total income, including realized capital gains and losses. Any ratio that results in a negative value will be considered outside the normal range. As expected with the current year loss by the insurance subsidiary, this ratio was outside the normal range. The third ratio was slightly outside the normal range, as it relates to net investment income. As discussed in previous sections of this report, investment income has been hindered by declining interest rates in recent years and the average life of the investment portfolio. The fourth ratio outside the normal range relates to the current year change in premium. As previously discussed, premium revenues have declined in recent periods. In addition to this factor, the Company paid additional reinsurance premiums during the current year that were due in previous periods.
The NAIC's risk-based capital requirements require insurance companies to calculate and report information under a risk-based capital formula. The risk-based capital (RBC) formula measures the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching and other business factors. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio of the insurance company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Insurance companies below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action. The levels and ratios are as follows:
At December 31, 2004, the insurance subsidiary has a ratio that is in excess of 4, which is 400% of the authorized control level; accordingly, the insurance subsidiary meets the RBC requirements.
On July 30, 2002, President Bush signed into law the "SARBANES-OXLEY" Act of 2002 ("the Act"). This Law, enacted in response to several high-profile business failures, was developed to provide meaningful reforms that protect the public interest and restore confidence in the reporting practices of publicly traded companies. The implications of the Act to public companies, (which includes UTG) are vast, widespread, and evolving. Many of the new requirements will not take effect or full effect until after calendar-year-end companies have completed their 2004 annual reports. The Company has implemented requirements affecting the current reporting period, and is continually monitoring, evaluating, and planning implementation of requirements that will need to be taken into account in future reporting periods.
The Financial Accounting Standards Board ("FASB") has issued Statement No. 132 (revised 2003), Employers' Disclosures about Pensions and Other Postretirement Benefits (an amendment of FASB Statements 87, 88 and 106). Statement No. 132 was developed to address concerns of users of financial statements regarding their need for more information about pension plan assets, obligations, benefit payment, contributions and net benefit costs. This statement was effective at the beginning of the first interim period beginning after December 15, 2003. The adoption of Statement 132 (revised 2003) did not affect the Company's financial position or results of operations, since the Company has no such plans that meet the provisions of this statement.
The Financial Accounting Standards Board ("FASB") has issued Statement No. 151, Inventory Costs--an amendment of ARB No. 43, Chapter 4. This Statement amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of "so abnormal." In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This statement is effective for financial statements for fiscal years beginning after June 15, 2005. The adoption of Statement 151 does not currently affect the Company's financial position or results of operations, since the Company has no inventory costs that meet the provisions of this statement.
The Financial Accounting Standards Board ("FASB") has issued Statement No. 153, Exchanges of Nonmonetary Assets. Statement No. 153 amends APB Opinion No. 29, Accounting for Nonmonetary Transactions, to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. This statement is effective for financial statements for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company's will account for all future nonmonetary asset exchanges in accordance with the requirements of Statement No. 153.
Independent Auditors' Report for the years ended December 31, 2004, 2003, 2002.................................31
We have audited the accompanying consolidated balance sheets of UNITED TRUST GROUP, INC. (an Illinois corporation) and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of UNITED TRUST GROUP, INC. and subsidiaries as of December 31, 2004 and 2003, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America.
We have also audited Schedule I as of December 31, 2004, and Schedules II, IV and V as of December 31, 2004 and 2003, of UNITED TRUST GROUP, INC. and subsidiaries and Schedules II, IV and V for each of the three years in the period then ended. In our opinion, these schedules present fairly, in all material respects, the information required to be set forth therein.
2004 2003 --------------- --------------- Investments: Fixed maturities held to maturity, at amortized cost (market $12,097,708 and $27,440,277) $ 11,973,415 $ 26,724,507 Investments held for sale: Fixed maturities, at market (cost $147,217,453 and $139,248,547) 148,193,887 139,390,382 Equity securities, at market (cost $15,216,214 and $7,209,443) 24,399,172 9,362,165 Mortgage loans on real estate at amortized cost 20,722,415 26,715,968 Investment real estate, at cost, net of accumulated depreciation 28,192,081 24,725,824 Policy loans 12,844,748 13,226,399 Short-term investments 39,489 34,677 --------------- --------------- 246,365,207 240,179,922
Cash and cash equivalents 11,859,472 8,749,727 Securities of affiliate 4,000,000 4,000,000 Accrued investment income 1,678,393 1,961,552 Reinsurance receivables: Future policy benefits 32,422,529 32,789,725 Policy claims and other benefits 3,959,569 4,120,299 Cost of insurance acquired 12,747,532 14,616,667 Deferred policy acquisition costs 1,685,263 2,122,643 Property and equipment, net of accumulated depreciation 2,172,636 2,450,109 Income taxes receivable, current 181,683 212,197 Other assets 795,800 354,292 --------------- --------------- Total assets $ 317,868,084 $ 311,557,133 =============== ===============
LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities and accruals: Future policy benefits $ 235,592,973 $ 236,192,132 Policy claims and benefits payable 1,879,566 2,541,735 Other policyholder funds 1,323,668 1,038,063 Dividend and endowment accumulations 12,526,390 12,626,515 Deferred income taxes 8,561,010 6,763,648 Notes payable 0 2,289,776 Other liabilities 7,405,434 5,557,215 --------------- --------------- Total liabilities 267,289,041 267,009,084 Minority interests in consolidated subsidiaries 6,127,938 4,851,410
Shareholders' equity: Common stock - no par value, stated value $.02 per share. Authorized 7,000,000 shares - 3,965,533 and 4,004,666 shares issued and outstanding after deducting treasury shares of 227,709 and 174,136 79,315 80,008 Additional paid-in capital 42,590,820 42,672,189 Accumulated deficit (4,897,572) (4,621,955) Accumulated other comprehensive income 6,678,542 1,566,397 --------------- --------------- Total shareholders' equity 44,451,105 39,696,639 --------------- --------------- Total liabilities and shareholders' equity $ 317,868,084 $ 311,557,133 =============== ===============
Premiums and policy fees $ 17,275,708 $ 18,121,018 $ 18,693,022 Reinsurance premiums and policy fees (3,135,279) (3,097,980) (2,861,445) Net investment income 10,420,886 10,270,500 13,514,802 Realized investment gains (losses), net (20,648) 485,436 13,634 Other income 926,212 709,384 817,186 --------------- ---------------- ---------------- 25,466,879 26,488,358 30,177,199
Income (loss) before income taxes and minority interest (867,939) (9,318,544) 2,249,743 Income tax benefit (expense) 797,716 2,699,493 (479,355) Minority interest in (income) loss of consolidated subsidiaries (205,394) 222,561 (431,593) --------------- ---------------- ----------------
Basic income (loss) per share from continuing operations and net income (loss) $ (0.07) $ (1.67)$ 0.38 =============== ================ ================
Basic weighted average shares outstanding 3,986,731 3,839,947 3,505,424 =============== ================ ================
Retained earnings (accumulated deficit) Balance, beginning of year $ (4,621,955) $ 1,774,535 $ 435,740 Net income (loss) (275,617) $ (275,617) (6,396,490) $ (6,396,490) 1,338,795 $ 1,338,795 ------------ ----------- ----------- Balance, end of year $ (4,897,572) $ (4,621,955) $ 1,774,535 ============ =========== ===========
UNITED TRUST GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Three Years Ended December 31, 2004
2004 2003 2002 --------------- --------------- -------------- Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net income (loss) $ (275,617) $ (6,396,490) $ 1,338,795 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities net of changes in assets and liabilities resulting from the sales and purchases of subsidiaries: Amortization/accretion of fixed maturities 604,608 978,307 513,308 Realized investment (gains) losses, net 20,648 (485,436) (13,634) Amortization of deferred policy acquisition costs 442,380 400,844 714,432 Amortization of cost of insurance acquired 1,869,135 6,695,328 1,515,450 Depreciation 1,617,116 1,052,964 835,538 Minority interest 205,394 (222,561) 431,593 Charges for mortality and administration of universal life and annuity products (9,281,555) (9,083,778) (8,660,548) Interest credited to account balances 5,332,145 5,478,488 5,468,318 Policy acquisition costs deferred (5,000) (61,000) (69,000) Change in accrued investment income 283,159 491,288 550,020 Change in reinsurance receivables 527,926 (100,703) 1,010,146 Change in policy liabilities and accruals 1,073,108 3,163,696 (2,279,449) Change in income taxes payable (924,815) (2,877,425) 413,476 Change in other assets and liabilities, net (1,534,582) 33,430 (1,301,411) --------------- --------------- -------------- Net cash provided by (used in) operating activities (45,950) (933,048) 467,034 --------------- --------------- --------------
E. PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Registrant and its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Fixed maturities held to maturity - at cost, adjusted for amortization of premium or discount and other-than-temporary market value declines. The amortized cost of such investments differs from their market values; however, the Company has the ability and intent to hold these investments to maturity, at which time the full face value is expected to be realized.
Real estate - investment real estate at cost less allowance for depreciation and, as appropriate, provisions for possible losses. Accumulated depreciation on investment real estate was $ 2,491,205 and $ 1,200,454 as of December 31, 2004 and 2003, respectively.
I. FUTURE POLICY BENEFITS AND EXPENSES - The liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance subsidiary's experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. The Company makes these assumptions at the time the contract is issued or, in the case of contracts acquired by purchase, at the purchase date. Future policy benefits for individual life insurance and annuity policies are computed using interest rates ranging from 2% to 6% for life insurance and 3.0% to 9.25% for annuities. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. Current mortality rate assumptions are based on 1975-80 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or Linton C, which are industry standard actuarial tables for forecasting assumed policy lapse rates.
Benefit reserves for universal life insurance and interest sensitive life insurance products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims in excess of related policy account balances. Interest crediting rates for universal life and interest sensitive products range from 4.0% to 5.5% for the years ended December 31, 2004, 2003 and 2002, respectively.
2005 $ 3,875,000 $ 6,084,000 $ 2,209,000 2006 3,560,000 6,422,000 2,862,000 2007 3,145,000 5,994,000 2,849,000 2008 2,730,000 5,256,000 2,526,000 2009 2,360,000 4,482,000 2,122,000
2004 2003 2002 ---------------- ----------------- ---------------- Deferred, beginning of year $ 2,122,643 $ 2,462,487 $ 3,107,919
Deferred, end of year $ 1,685,263 $ 2,122,643 $ 2,462,487 ================ ================= ================
S. RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform to the 2004 presentation. Such reclassifications had no effect on previously reported net income or shareholders' equity.
At December 31, 2004, substantially all of consolidated shareholders' equity represents net assets of UTG's subsidiaries. The payment of cash dividends to shareholders by UTG is not legally restricted. However, the state insurance department regulates insurance company dividend payments where the company is domiciled. UG's dividend limitations are described below.
Ohio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 2004, UG had a statutory loss from operations of $ 762,152. At December 31, 2004, UG's statutory capital and surplus amounted to $ 21,860,401. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. UG paid a dividend of $ 2,275,000 to UTG in 2004, of which $ 974,180 was considered to be an extraordinary dividend.
UG ------------- 2014 965,080 2016 1,806 2017 5,078 2018 2,992,288 2019 2,101,569 ------------- TOTAL $ 6,065,821 =============
UG has a net operating loss carryforward of $ 6,065,821 at December 31, 2004. UG must average taxable income of approximately $ 404,388 over the next 15 years to fully realize its net operating loss carryforward. Management believes future earnings of UG will be sufficient to fully utilize the net operating loss carryforwards. Therefore, management has established no allowance for potential uncollectibility of its loss carryforwards in the current year.
2004 2003 2002 --------------- --------------- ---------------- Tax computed at statutory rate $ (303,779) $ (3,183,594) $ 728,618 Changes in taxes due to: Current year expense previously deducted 0 175,000 0 Tax reserve adjustment (202,225) 150,831 123,512 Benefit of prior losses 0 0 (309,710) Dividend received deduction (161,114) 0 0 Tax deferred acquisition costs (134,324) 0 0 Other 3,726 158,270 (63,065) --------------- --------------- ---------------- Income tax expense (benefit) $ (797,716) $ (2,699,493) $ 479,355 =============== =============== ================
2004 2003 ---------------- --------------- Investments $ 5,289,610 $ 2,514,031 Cost of insurance acquired 4,461,636 5,115,833 Deferred policy acquisition costs 589,842 742,925 Management/consulting fees (289,877) (304,038) Future policy benefits (646,374) (1,145,126) Gain on sale of subsidiary 2,312,483 2,312,483 Net operating loss carryforward (2,123,037) (1,304,864) Federal tax DAC (1,033,272) (1,167,596) ---------------- --------------- Deferred tax liability $ 8,561,010 $ 6,763,648 ================ ===============
December 31, ---------------------------------------------------------- 2004 2003 2002 --------------- ---------------- ---------------- Fixed maturities and fixed maturities held for sale $ 7,060,761 $ 8,418,969 $ 10,302,735 Equity securities 657,609 456,361 131,778 Mortgage loans 1,209,358 1,522,700 1,749,935 Real estate 5,335,530 2,832,171 3,261,043 Policy loans 918,562 949,770 965,227 Short-term investments 80,241 11,161 26,522 Cash 111,986 137,478 211,293 --------------- ---------------- ---------------- Total consolidated investment income 15,374,047 14,328,610 16,648,533 Investment expenses (4,953,161) (4,058,110) (3,133,731) ---------------- ---------------- ---------------- Consolidated net investment income $ 10,420,886 $ 10,270,500 $ 13,514,802 =============== ================ ================
At December 31, 2004, the Company had a total of $ 805,787 in investment real estate, which did not produce income during 2004.
Equity securities Banks, trust and insurance companies $ 19,706,511 $ 1,517,159 Industrial and miscellaneous 4,692,661 7,845,006 --------------- -------------- $ 24,399,172 $ 9,362,165 =============== ==============
Cost or Gross Gross Estimated Amortized Unrealized Unrealized Market 2004 Cost Gains Losses Value ------------------------------------ -------------- ------------- --------------- -------------- Investments held for sale: Fixed maturities U.S. Government and govt. agencies and authorities $ 41,377,077 $ 384,193 $ (128,427) $ 41,632,843 States, municipalities and political subdivisions 162,025 15,419 0 177,444 Collateralized mortgage obligations 79,634,753 459,508 (450,821) 79,643,440 Public utilities 0 0 0 0 All other corporate bonds 26,043,598 792,693 (96,131) 26,740,160 -------------- ------------- --------------- -------------- 147,217,453 1,651,813 (675,379) 148,193,887 Equity securities 15,216,214 10,214,201 (1,031,243) 24,399,172 -------------- ------------- --------------- -------------- Total $ 162,433,667 $ 11,866,014 $ (1,706,622) $ 172,593,059 ============== ============= =============== ==============
Fixed Maturities Held for Sale Estimated Amortized Market December 31, 2004 Cost Value --------------------------------------------- -------------- -------------- Due in one year or less $ 3,974,952 $ 4,016,732 Due after one year through five years 49,501,280 50,431,776 Due after five years through ten years 7,018,679 7,085,760 Due after ten years 7,087,789 7,016,180 Collateralized mortgage obligations 79,634,753 79,643,439 -------------- -------------- Total $ 147,217,453 $ 148,193,887 ============== ==============
An analysis of sales, maturities and principal repayments of the Company's fixed maturities portfolio for the years ended December 31, 2004, 2003 and 2002 is as follows:
Cost or Gross Gross Proceeds Amortized Realized Realized From Year ended December 31, 2004 Cost Gains Losses Sale ------------------------------------- --------------- ------------- --------------- --------------- Scheduled principal repayments, Calls and tenders: Held for sale $ 25,119,862 $ 8,062 $ (2,098) $ 25,125,826 Held to maturity 16,099,278 0 (801) 16,098,477 Sales: Held for sale 45,840,981 278,896 (352,551) 45,767,326 Held to maturity 0 0 0 0 --------------- ------------- --------------- --------------- Total $ 87,060,121 $ 286,958 $ (355,450) $ 86,991,629 =============== ============= =============== ===============
Cost or Gross Gross Proceeds Amortized Realized Realized From Year ended December 31, 2002 Cost Gains Losses Sale ------------------------------------- --------------- ------------- --------------- --------------- Scheduled principal repayments, Calls and tenders: Held for sale $ 29,746,832 $ 1,689 $ 0 $ 29,748,521 Held to maturity 20,071,850 7,782 (6,744) 20,072,888 Sales: Held for sale 0 0 0 0 Held to maturity 0 0 0 0 --------------- ------------- --------------- --------------- Total $ 49,818,682 $ 9,471 $ (6,744) $ 49,821,409 =============== ============= =============== ===============
Annually, the Company completes an analysis of sales of securities held to maturity to further assess the issuer's creditworthiness of fixed maturity holdings. Based on this analysis, certain issues were sold that had been classified as held to maturity. The Company considers these transactions rare and non recurring.
As is customary in the insurance industry, the insurance subsidiary of the Company cedes insurance to, and assumes insurance from, other insurance companies under reinsurance agreements. Reinsurance agreements are intended to limit a life insurer's maximum loss on a large or unusually hazardous risk or to obtain a greater diversification of risk. The ceding insurance company remains primarily liable with respect to ceded insurance should any reinsurer be unable to meet the obligations assumed by it. However, it is the practice of insurers to reduce their exposure to loss to the extent that they have been reinsured with other insurance companies. The Company sets a limit on the amount of insurance retained on the life of any one person. The Company will not retain more than $ 125,000, including accidental death benefits, on any one life. At December 31, 2004, the Company had gross insurance in force of $ 3.141 billion of which approximately $ 531 million was ceded to reinsurers.
Currently, the Company is utilizing reinsurance agreements with Generali USA Life Reassurance Company, (Generali) and Swiss Re Life and Health America Incorporated (SWISS RE). Generali and SWISS RE currenty hold an "A" (Excellent), and "A+" (Superior) rating, respectively, from A.M. Best, an industry rating company. The reinsurance agreements were effective December 1, 1993, and cover most new business of the Company. The agreements are a yearly renewable term (YRT) treaty where the Company cedes amounts above its retention limit of $ 100,000 with a minimum cession of $ 25,000.
On June 1, 2000, UG assumed an already existing coinsurance agreement, dated January 1, 1992, between Lancaster Life Reinsurance Company (LLRC), an Arizona corporation and Investors Heritage Life Insurance Company (IHL), a corporation organized under the laws of the Commonwealth of Kentucky. Under the terms of the agreement, LLRC agreed to assume from IHL a 90% quota share of new issues of credit life and accident and health policies that have been written on or after January 1, 1992 through various branches of the First Southern National Bank. The maximum amount of credit life insurance that can be assumed on any one individual's life is $ 15,000. UG assumed all the rights and obligations formerly held by LLRC as the reinsurer in the agreement. LLRC liquidated its charter immediately following the transfer. At December 31, 2004, IHL has insurance in-force of approximately $ 2,295,000, with reserves being held on that amount of approximately $ 33,000.
The insurance industry has experienced a number of civil jury verdicts which have been returned against life and health insurers in the jurisdictions in which the Company does business involving the insurers' sales practices, alleged agent misconduct, failure to properly supervise agents, and other matters. Some of the lawsuits have resulted in the award of substantial judgments against the insurer, including material amounts of punitive damages. In some states, juries have substantial discretion in awarding punitive damages in these circumstances.
On June 10, 2002 UTG and Fiserv formed an alliance between their respective organizations to provide third party administration (TPA) services to insurance companies seeking business process outsourcing solutions. Fiserv will be responsible for the marketing and sales function for the alliance, as well as providing the operations processing service for the Company. The Company will staff the administration effort. To facilitate the alliance, the Company plans to convert its existing business and TPA clients to "ID3", a software system owned by Fiserv to administer an array of life, health and annuity products in the insurance industry. Fiserv is a unit of Fiserv, Inc. (Nasdaq: FISV) which is an independent, full-service provider of integrated data processing and information management systems to the financial industry, headquartered in Brookfield, Wisconsin.
On April 25, 2003 the Company entered into an agreement with Fiserv for the conversion of the two TPA client companies to the "ID3" system. The conversion was successfully completed in December 2003 utilizing Company personnel with onsite training and guidance provided by Fiserv. During 2004, the Company began the conversion of the remaining insurance business to the "ID3" software system and successfully completed the first phase of this project. The remaining blocks of business will be completed during 2005.
In the normal course of business the Company is involved from time to time in various legal actions and other state and federal proceedings. There were no proceedings pending or threatened as of December 31, 2004.
On June 18, 2003, UG entered into a lease agreement with Bandyco, LLC, an affiliated entity, for a one-sixth interest in an aircraft. Bandyco, LLC is affiliated with Ward F. Correll, who is a director of the Company. The lease term is for a period of five years at a total cost of $ 523,831 per year. The Company is responsible for its share of annual non-operational costs, in addition to the operational costs as are billable for specific use.
On November 20, 1998, FSF and affiliates acquired 929,904 shares of common stock of UTG from UTG and certain UTG shareholders. As consideration for the shares, FSF paid UTG $ 10,999,995 and certain shareholders of UTG $ 999,990 in cash. Included in the stock acquisition agreement is an earnings covenant whereby UTG warrants UTG and its subsidiaries and affiliates will have future earnings of at least $ 30,000,000 for a five-year period beginning January 1, 1998 (See Note 10.C. to the consolidated financial statements).
ABE paid fees to FCC pursuant to a cost sharing and management fee agreement. FCC provided management services for ABE to carry on its business. The agreement required ABE to pay a percentage of the actual expenses incurred by FCC based on certain activity indicators of ABE business to the business of all the insurance company subsidiaries plus a management fee based on a percentage of the actual expenses allocated to ABE. ABE paid fees of $ 188,494 in 2002 under this agreement. ABE paid fees of $ 165,269 and $ 170,729 in 2003 and 2002, respectively, to UTG under this agreement.
APPL had a management fee agreement with FCC whereby FCC provided certain administrative duties, primarily data processing and investment advice. APPL paid fees of $ 222,000 during 2002 to FCC under this agreement. APPL paid fees of $ 222,000 and $ 222,000 to UTG during 2003 and 2002, respectively, under this agreement.
On March 26, 2002, the Board of Directors of UTG adopted, and on June 11, 2002, the shareholders of UTG approved, the United Trust Group, Inc. Employee and Director Stock Purchase Plan. The plan's purpose is to encourage ownership of UTG stock by eligible directors and employees of UTG and its subsidiaries by providing them with an opportunity to invest in shares of UTG common stock. The plan is administered by the Board of Directors of UTG. A total of 400,000 shares of common stock may be purchased under the plan, subject to appropriate adjustment for stock dividends, stock splits or similar recapitalizations resulting in a change in shares of UTG. The plan is not intended to qualify as an "employee stock purchase plan" under Section 423 of the Internal Revenue Code.
During 2004 and 2003, the Board of Directors of UTG approved offerings under the plan to qualified individuals. For the years ended December 31, 2004 and 2003, four individuals purchased 14,440 and eight individuals purchased 58,891 shares of UTG common stock, respectively. Each participant under the plan executed a "stock restriction and buy-sell agreement", which among other things provides UTG with a right of first refusal on any future sales of the shares acquired by the participant under this plan.
The purchase price of shares repurchased under the stock restriction and buy-sell agreement shall be computed, on a per share basis, equal to the sum of (i) the original purchase price paid to acquire such shares from UTG and (ii) the consolidated statutory net earnings (loss) per share of such shares during the period from the end of the month next preceding the month in which such shares were acquired pursuant to the plan, to the end of the month next preceding the month in which the sale of such shares to UTG occurs. At December 31, 2004, UTG had 89,877 shares outstanding that were issued under this program with a value of $ 11.63 per share pursuant to the above formula.
Diluted EPS Income available to common shareholders and $ assumed conversions (275,619) 3,986,731 $ (0.07) ================ ================== =================
For the year ended December 31, 2003 ------------------ --- ------------------ ---- ----------------- Income (Loss) Shares Per-Share (Numerator) (Denominator) Amount ------------------ ------------------ ----------------- Basic EPS Income available to common shareholders $ (6,396,490) 3,839,947 $ (1.67) =================
In accordance with Statement of Financial Accounting Standards No. 128, the computation of diluted earnings per share is the same as basic earnings per share for the years ending December 31, 2004 and 2003, since the Company had a loss from continuing operation for the year presented, and any assumed conversion, exercise, or contingent issuance of securities would have an antidilutive effect on earnings per share. At December 31, 2002, UTG had an obligation to issue to FSF or its assigns 500,000 shares of UTG common stock, as the result of a failed earnings covenant (See note 10.C. to the consolidated financial statements). As such, the computation of diluted earnings per share differs from basic earnings per share for the year ending December 31, 2002.
The notes payable were incurred in April 2001 to facilitate the repurchase of common stock owned primarily by two former Officers and Directors of UTG, and members of their respective families. These notes bore interest at the fixed rate of 7% per annum (paid quarterly) with payments of principal to be made in five equal installments. UTG has paid the entire principal balance on these notes.
During 2001, UTG was extended a $ 3,300,000 line of credit (LOC) from the First National Bank of the Cumberlands (FNBC) located in Livingston, Tennessee. The LOC was for a one-year term from the date of issue. Upon maturity the Company has renewed the LOC for an additional one-year term. The interest rate on the LOC is variable and indexed to be the lowest of the U.S. prime rates as published in the Wall Street Journal, with any interest rate adjustments to be made monthly. No borrowings were incurred during 2004 and 2003.
During 2002, UTG was extended a $ 5,000,000 line of credit (LOC) from Southwest Bank of St. Louis. The LOC expired one year from the date of issue and has been renewed for an additional term. As collateral for any draws under the line of credit, UTG pledged 100% of the common stock of its insurance subsidiary, UG. Borrowings under the LOC will bear interest at the rate of 0.25% in excess of Southwest Bank of St. Louis' prime rate. At December 31, 2004 and 2003, the Company had no outstanding borrowings attributable to this LOC. During 2004, UTG drew $ 2,275,000 on this LOC to repay the outstanding principal balances on the notes payable describe above. The entire draw was repaid during 2004.
On a cash basis, the Company paid $ 77,453, $ 162,179, and $ 263,441 in interest expense for the years 2004, 2003 and 2002, respectively. The Company paid $ 110,000, $ 175,000, and $ 60,290 in federal income tax for 2004, 2003 and 2002, respectively.
As of December 31, 2004, the Company has $ 450,250 that has not been disbursed to former minority shareholders of FCC in connection with FCC's merger with and into UTG. The total consideration to be paid by the Company to the former minority shareholders as a result of the merger is $ 2,480,000 (See Note 15 to the consolidated financial statements).
At December 31, 2004, the Company acquired $ 2,990,928 in fixed maturity investments for which the cash had not yet been paid. The payable for these securities is included in the line item "Other liabilities" on the consolidated balance sheet.
The Company maintains cash balances in financial institutions that at times may exceed federally insured limits. The Company maintains its primary operating cash accounts with First Southern National Bank, an affiliate of the largest shareholder of UTG, Mr. Jesse T. Correll, the Company's CEO and Chairman. In aggregate at December 31, 2004 these accounts have no balances for which there are no pledges or guarantees outside FDIC insurance limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents.
The Financial Accounting Standards Board ("FASB") has issued Statement No. 153, Exchanges of Nonmonetary Assets. Statement No. 153 amends APB Opinion No. 29, Accounting for Nonmonetary Transactions, to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. This statement is effective for financial statements for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company will account for all future nonmonetary asset exchanges in accordance with the requirements of Statement No. 153.
15. MERGER OF UNITED TRUST GROUP, INC. AND FIRST COMMONWEALTH CORPORATION
Less: reclassification adjustment for gains realized in net income (31,766) (11,118) (20,648)
---------------- ------------------- --------------- Net unrealized gains 7,864,838 (2,752,693) 5,112,145 ---------------- ------------------- --------------- Other comprehensive income $ 7,864,838 $ (2,752,693) $ 5,112,145 ================ =================== ===============
Unrealized holding gains during period $ 2,868,146 $ (1,003,851) $ 1,864,295 Less: reclassification adjustment for gains realized in net income (1,689) 591 (1,098) ---------------- ------------------- --------------- Net unrealized gains 2,866,457 (1,003,260) 1,863,197 ---------------- ------------------- --------------- Other comprehensive income $ 2,866,457 $ (1,003,260) $ 1,863,197 ================ =================== ===============
In 2004, 2003 and 2002, the Company established a deferred tax liability of $ 3,555,787, $ 803,095 and $ 1,170,197, respectively, for the unrealized gains based on the applicable United States statutory rate of 35%.
Premiums and policy fees, net $ 3,883,003 $ 4,093,239 $ 3,686,584 $ 3,360,212 Net investment income 2,888,444 3,231,542 2,462,813 1,687,701 Total revenues 7,185,509 7,811,693 6,498,785 4,992,371 Policy benefits including dividends 5,520,920 4,931,443 5,516,224 5,102,089 Commissions and amortization of DAC and COI 544,139 441,914 513,488 5,507,726 Operating expenses 1,169,139 3,500,807 1,451,973 1,444,861 Operating income (loss) (90,406) (1,102,433) (1,023,300) (7,102,405) Net income (loss) (494,124) (669,492) (464,142) (4,768,732) Basic earnings (loss) per share 0.14) (0.17) (0.12) (1.24) Diluted earnings (loss) per share (0.12) (0.17) (0.12) (1.24) -------------------- --------------------- --------------------- -------------------- 1st 2nd 3rd 4th --------------- --------------- --------------- ---------------