As a result of the sale of all of its insurance operations and the adoption of the Plan of Liquidation, the Company occupied only a small portion of the leasable space in the office building. From 1998 to 2000, the Company subleased portions of the building to third party tenants pursuant to various short-term leases and received $14,000, $175,000 and $87,000 in 2000, 1999 and 1998, respectively, from these subleases. In August 2000, the Company and its co-owner sold the office building. The Company reported a gain of approximately $9,000 on the sale transaction and also collected approximately $56,000 in penalties from the buyer as a result of the buyer s delays in closing on the transaction.
The Company now leases approximately 1,200 square feet of office space on a month-to-month basis at 1513 Cedar Cliff Drive, Camp Hill, Pennsylvania. The monthly rent for this facility is $1,300.
A review of the significant factors which affected the Company's net assets in liquidation at December 31, 2000 and the changes in its net assets in liquidation for the year then ended is presented below. Information relating to 1999 and 1998 is also presented for comparative purposes. This analysis should be read in conjunction with the Consolidated Financial Statements and the related Notes appearing elsewhere in this Form 10-K.
For the year ended December 31, 2000, the Company reported an excess of benefits and expenses over revenues of $1,823,000, which includes pension expense of $1,554,000 (an offsetting increase in net assets of $1,122,000 is stated separately on the Statements of Changes in Net Assets in Liquidation, resulting in the net reduction of $432,000). Excluding pension expense, the excess expenses in 2000 totaled $269,000. These excess expenses are largely attributable to a decrease in fee revenues received from the sale of the credit insurance accounts and to increased legal fees, as discussed more fully below.
Due to these reductions in net assets, the Company reduced the December 31, 1999 liquidation value of its preferred stock by $303,000, from $4,635,000 ($10 per share - the redemption price) to $4,332,000 ($9.35 per share).
From January 1, 1998 to March 24, 1998, the period prior to the adoption of the liquidation basis of accounting, the Company reported net income of $24,000 (a loss of $.04 per share) as a result of a $112,000 gain from the 1997 disposal of the discontinued credit insurance business. The gain represented an adjustment to certain estimates made in 1997 when a loss on the disposal was initially reported.
Estimated Net Expenses and Other Changes in Net Assets During Liquidation Period
The time frame for completing the liquidation of the Company is dependent upon a number of factors, the most significant of which is the sale of the life insurance subsidiary, not only because most of the assets which will be available for distribution to the preferred shareholders are held by the subsidiary and are restricted as to their use by state insurance regulations, but also because of the additional shareholder value which is expected to be generated from the sale of the subsidiary s 25 state insurance licenses. In addition, the Company is a defendant in several lawsuits which must be settled or resolved in court. While management believes the plaintiffs claims are without merit, the ultimate outcome of these matters cannot be determined at this time. Furthermore, the Company may be entitled to all or a portion of the assets in a contingency fund established by the Company and the purchaser of its credit insurance business based on the claims experience of the in force credit insurance business from October 1, 1997 to September 30, 2002. However, based on the claims experience to date, as provided by the purchaser, it does not appear likely that the Company will receive any portion of the contingency fund.
Based on current estimates, management believes that the Company s future expenses and other changes in net assets, including preferred stock dividends, will exceed its revenues during the remainder of the liquidation period by approximately $1,000,000 to $1,200,000. Actual revenues and expenses and other net asset changes could vary significantly from the present estimates due to the uncertainties regarding (i) when the remaining non liquid assets, particularly the stock of the life insurance subsidiary, will be liquidated, (ii) when the distribution to the preferred shareholders occurs, (iii) the level of actual expenses which will be incurred and (iv) the ultimate resolution of all current contingencies and any contingencies which may arise in the future.
A discussion of the important elements affecting the Company's net assets in liquidation and its total invested assets at December 31, 2000 and 1999 is presented below.
Given its plans to liquidate and eventually dissolve, the Company has made no commitments for capital expenditures and does not intend to make any such commitments in the future. For the year ended December 31, 2000, the Company's cash and invested assets declined by $389,000 to $3,479,000 at the end of the year. The reduction is primarily attributable to the $966,000 payment to the Company s pension plan, in order to fully fund the plan, the payment of $391,000 in preferred stock dividends and an excess of expenses paid over revenues collected. These decreases were partially offset by a $1,150,000 increase in invested assets resulting from the sale of the Company s 50% interest in its home office building. The sale of the home office building also resulted in the payoff of a $1,176,000 mortgage granted to the co-owner of the building. The mortgage proceeds along with the proceeds from the building sale were invested in short-term securities.
For the year ended December 31, 1999, the Company's cash and invested assets decreased by approximately $754,000, from $4,622,000 at the beginning of the year to $3,868,000 at December 31, 1999. The decline is primarily attributable to the payment of $625,000 to the Company's pension plan, the payment of $406,000 in preferred dividends and an excess of expenses over revenues for the year. These decreases in invested assets were offset in part by a $520,000 income tax refund and the proceeds from the sale of non-investment real estate.
Invested assets at December 31, 2000 consisted of (i) U.S. Treasury Notes, owned by the Company's insurance subsidiary, which are on deposit with numerous state insurance departments in connection with licensing requirements, (ii) one mortgage loan secured by commercial real estate, which is scheduled to be paid in full by June 2002 and (iii) short-term investments, principally money market funds and certificates of deposit. As stated above, during 2000, the mortgage loan on the former home office building was paid in full when the office building was sold. A second loan, whose mortgagor had been in bankruptcy since 1997, was also fully repaid during 2000 as a result of a sale of the property by the bankruptcy trustee. At December 31, 1999, the Company s investments consisted of (i) U.S. Treasury Notes, (ii) three mortgage loans, including the loan granted to the co-owner of the Company's former home office building and (iii) short-term investments, principally money market funds.
The terms of the Company's 8.5% redeemable preferred stock require the Company to make annual payments to a sinking fund. The first such payment was due in July 1998. The preferred stock terms also provide that any purchase of preferred shares by the Company will reduce the sinking fund requirements by the redemption value of the shares acquired. As a result of the Company's purchases of preferred stock prior to 1998, no sinking fund payment was due in 1998, and the required payment due for 1999 was reduced from $550,000 to $414,610. The purchase of 18,000 preferred shares in 1999 and 7,400 shares in 2000 further reduced the 1999 sinking fund deficiency to $160,610. On July 1, 2000, an additional $550,000 sinking fund payment became due but was not paid. Consequently, at December 31, 2000, the total sinking fund deficiency was $710,610.
We have audited the accompanying consolidated statements of net assets in liquidation of Consumers Financial Corporation and subsidiaries as of December 31, 2000 and 1999 and the related consolidated statements of changes in net assets in liquidation for the years then ended. These financial statements and the schedules referred to below are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and the significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
We have audited the accompanying statements of operations, shareholders' equity and cash flows of Consumers Financial Corporation (a Pennsylvania corporation) and subsidiaries for the period from January 1, 1998 to March 24, 1998. In addition, we have audited the statement of changes in net assets in iquidation for the period from March 25, 1998 to December 31, 1998. These financial statements and the schedules referred to below are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audit.
As described in Note 4 to the financial statements, the shareholders of Consumers Financial Corporation approved a plan of liquidation on March 24, 1998, and the Company commenced liquidation shortly thereafter. As a result, the Company changed its basis of accounting for periods subsequent to March 24, 1998 from the going-concern basis to the liquidation basis.
CONSUMERS FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
The operating losses incurred by the Company from 1993 to 1997 significantly reduced its net worth and its liquidity position. As a result, in 1998, the Company sold its core credit insurance and related products business, which had been its only remaining business operation, following the sales in 1994 and 1997 of all of its universal life insurance business and the 1996 sale of its auto auction business. Since the sale of its credit insurance business, the Company s revenues, benefits and expenses have consisted principally of (i) fee revenues received from Life of the South Corporation, the Georgia- based company which acquired the Company s credit insurance business and its credit insurance accounts (LOTS), (ii) investment income on remaining assets and (iii) corporate expenses. However, see Note 12 for information concerning the discontinuation of the fee revenues.
Fixed maturities includes bonds, notes and certificates of deposit maturing after one year. Management determines the appropriate classification of bonds and notes at the time of purchase and reevaluates such designation as of each financial statement date. All bonds and notes are classified as available-for- sale. Available-for-sale securities are carried at fair value, with the unrealized appreciation and depreciation, net of income taxes, reported as a separate component of the changes in net assets in liquidation. All certificates of deposits maturing after one year are deemed to be held to maturity. Mortgage loans on real estate are carried at the unpaid principal balance. Short-term investments are carried at cost.
Prior to the discontinuation of its insurance operations, the Company deferred the costs of acquiring new insurance business. The costs deferred consisted principally of commissions, certain sales salaries and other expenses that varied with and were primarily related to the production of new business. Acquisition costs relating to single premium credit insurance were amortized so as to charge each year's operations in direct proportion to premiums earned. Deferred policy acquisition costs were expensed when such costs were deemed not to be recoverable from future earned premiums and investment income or, when applicable, from the estimated proceeds to be received from the sale of the related insurance business. At December 31, 2000, the Company s only unamortized policy acquisition costs relate to commissions paid in connection with certain annuity business assumed during 2000 (see Note 10).
The liability for future policy benefits for individual life insurance has been provided on a net level premium method based on estimated investment yields, withdrawals, mortality and other assumptions which were appropriate at the time the policies were issued. Such estimates were based upon industry data and past experience, as adjusted to provide for possible adverse deviation from the estimates. Benefit reserves for universal life products represent policy account balances before applicable surrender charges plus certain deferred policy initiation fees that are recognized in income over the term of the policies. Except for the liability for three retained policies and the liability for certain annuity policies assumed from another insurer, the Company s liability for future policy benefits has been permanently reinsured to other insurance companies.
For periods prior to the adoption of the liquidation basis of accounting, basic and diluted earnings per share were calculated in accordance with Statement of Financial Accounting Standards No. 128.
(a) In accordance with requirements of the National Association of Insurance Commissioners (NAIC), all bonds eligible for amortization are reported at amortized value, whereas in the accompanying financial statements, only bonds which are classified as held-to-maturity securities are stated at amortized cost, and available-for-sale securities are carried at fair value. Other securities are carried at values prescribed by or deemed acceptable to the NAIC for statutory accounting purposes.
(d) Certain assets are reported as assets in the statements of net assets in liquidation rather than being charged directly to surplus and excluded from the statutory balance sheets.
Under Delaware insurance laws, distributions are subject to further restrictions relating to capital and surplus and operating earnings. Accordingly, under normal circumstances, at December 31, 2000, approximately $3.2 million of Consumers Life's net assets cannot be transferred to the parent company and $303,000 is available for transfer during 2001. However, because of its prior operating losses and its current capital and surplus position, the Company is not permitted to pay any dividends without prior approval from the Delaware Insurance Department. Also, any loans or advances to the Company must be reported to and approved by the Delaware Department. The Company may have limited cash funds available to pay dividends in excess of amounts transferred from Consumers Life.
The amortized cost and estimated fair values of investments in debt securities at December 31, 2000 and 1999 are as follows:
All debt securities held by the Company at December 31, 2000 have contractual maturities between 2003 and 2005. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company did not sell any investments in debt securities during 2000. Proceeds from the sales of investments in debt securities during 1999 were $850,000. There were no gains or losses on those sales. Proceeds from such sales in 1998 were $3.7 million. Gross gains of $58,000 and gross losses of $6,000 were realized on those sales.
Future policy benefits reported to regulatory authorities were less than the above total by approximately $63,000 at December 31, 2000
Future policy benefits and unearned premiums do not include any deduction for reinsurance ceded to other companies. At December 31, 2000 and 1999, all but $39,000 of the Company s future policy benefits liability was reinsured to other insurers in connection with the discontinuation of the Company s insurance operations. Similarly, all of the Company s unearned premiums liability at December 31, 2000 and 1999 was reinsured to other insurers.
Future policy benefits and unearned premiums related to reinsurance ceded are classified as Reinsurance Recoverable and Prepaid Reinsurance Premiums, respectively, as shown in the following table.
Prior to the 1998 sale of its credit insurance business, as discussed in Note 4, and the sales of its individual life insurance business in 1992 through 1997, the Company routinely ceded and, in some instances, assumed reinsurance. The sale of the credit insurance business of Consumers Life was completed pursuant to an indemnity reinsurance agreement with American Republic. The reinsurance transactions through which the Company sold its individual life insurance business included the use of both indemnity and assumption agreements. The insurance companies remain contingently liable for insurance risks ceded under indemnity agreements, while such risks are legally transferred to the reinsurer when assumption agreements are utilized.
The Company s remaining defined contribution plan covers all current employees and provides for annual contributions in amounts determined by the Board of Directors. Such contributions are based upon the annual compensation of each employee. Company contributions were $10,500 in 2000 and $11,100 in 1999. No contributions were made in 1998.
The funded status of the defined benefit pension plan is as follows:
A reconciliation of beginning and ending balances of the pension plan's assets is as follows.
Rental expense in 2000, 1999 and 1998 was approximately $57,000, $138,000 and $245,000, respectively.
In November 1997, the Company and a third party reinsurer were sued by a former general agency with whom the Company had a partnership agreement. The partnership agreement provided that the agency would market universal life insurance business for the Company, pursuant to specific criteria established by the Company, and would also be entitled to a share of the profits, if any, which arose from the business produced. The claimant is seeking monetary damages to compensate it for the Company s alleged failure to share profits and for other alleged losses resulting from the Company s rejection of policy applications involving unacceptable risks. While management believes this claim is without merit and intends to vigorously defend itself in this matter, the ultimate outcome of this claim cannot be determined at this time. The Company has filed two counterclaims against this agency seeking damages for losses the Company sustained as a result of the agency s alleged breach of the partnership agreement and to recover an unpaid loan made to the agency.
Following the trial in December 2000 for the Company s claim for recovery of the unpaid loan, in January 2001, the court awarded a $90,000 judgment in favor of the Company.
During 1999, a dispute arose between the Company and the purchaser of its credit insurance business relating to the payment of investment income on the assets which were transferred to the purchaser. Subsequent to the closing of the transaction, the purchaser claimed that the Company owed it approximately $1,400,000 for investment earnings on the amount transferred for the period from October 1, 1997, the effective date of the agreement, to May 13, 1998, the date of settlement on the sale transaction. In October 1999, the purchaser informed the Company that it would begin withholding from the Company the fee revenue payments which were contractually due to the Company from the sale of the credit insurance accounts. At December 31, 1999, fee revenues totaling $176,000 had been withheld by the purchaser. The amount withheld through September 30, 2000 had increased to $421,000. In October 2000, the parties settled this dispute. Pursuant to the terms of the settlement agreement, the purchaser paid the Company $250,000 in settlement of all prior amounts withheld and in lieu of any future fee revenue payments. In addition, the Company agreed to permit the purchaser to withdraw $500,000 from a contingency fund established by the parties at the time of the sale. The total balance in the fund at the time of withdrawal was approximately $1,500,000. Although the Company may be entitled to receive all or a portion of the contingency fund in late 2002 (based on the claims experience of the in force block of business sold to the purchaser), the Company agreed to the partial withdrawal following its review of the claims experience to date, which showed that it is unlikely the Company will ultimately receive any portion of the fund.
Certain claims, suits and complaints arising in the ordinary course of business have been filed or are pending against the Company or its subsidiaries. In the opinion of management, based on opinions of legal counsel, adequate reserves, if deemed necessary, have been established for these matters and their outcome will not have a significant effect on the Company s net assets in liquidation or its changes in net assets in liquidation. The Company has taken certain income tax positions in previous years that it believes are appropriate. If such positions were to be successfully challenged by the Internal Revenue Service, the Company could incur additional income taxes as well as interest and penalties. Management believes that the ultimate outcome of any such challenges will not have a material effect on the Company s financial statements.
Annual dividends at the rate of $.85 per share are cumulative from the date of original issue and are payable quarterly on the first day of January, April, July and October. At December 31, 2000, the Company was not in arrears with respect to payment of dividends on the Preferred Stock. Except in certain limited instances, the holders of the Preferred Stock have no voting rights.
Consequently, at December 31, 2000, the total sinking fund deficiency was $710,610.
At December 31, 1998, the Company had 132,000 outstanding stock options which were exercisable at $2.25 per share. During 1999, all of these options expired. No options were exercised during the three year period ended December 31, 2000.
Under tax laws in effect prior to 1984, a portion of the gain from operations of Consumers Life was not taxed when incurred but was accumulated in a memorandum "Policyholders' Surplus Account." As a result of the Tax Reform Act of 1984, the balance in the Policyholders' Surplus Account of Consumers Life was frozen as of December 31, 1983 and additional amounts are no longer accumulated in this account. However, distributions from the account continue to be taxed, as under previous laws, if any of the following conditions occur:
At December 31, 2000 and 1999, the Policyholders' Surplus Account for Consumers Life was approximately $439,000. Based on its current plans, the Company does not believe it is probable that Consumers Life will incur any additional taxes with regard to its Policyholders Surplus Account.
The provision for federal income taxes is not proportional to pre-tax financial statement income or loss due to the exclusions and special deductions afforded life insurance companies under the Internal Revenue Code, as amended, and the exclusion of non-taxable and non-deductible items. A reconciliation between actual income tax benefits and the expected Federal income tax benefits at the applicable statutory rates for the period prior to the adoption of the liquidation basis of accounting is as follows:
The Company files a consolidated Federal income tax return. At December 31, 2000, Consumers Life has available approximately $5.5 million of Federal net operating losses. These losses will be carried forward to future years, and may only be used to offset the taxable income of the life insurance company sub-group. The net operating losses will expire at various times from 2009 to 2015.
Basic loss per common share data for the period prior to the adoption of the liquidation basis of accounting was computed based upon the weighted average number of common shares outstanding. Diluted per share information is equivalent to basic per share information because the Company had no potential common shares which were dilutive.
As discussed in Note 4, following the sale of its credit insurance business, the Company began liquidating its remaining assets and paying or providing for its liabilities. The Company intends to eventually distribute all of its remaining cash to its preferred shareholders pursuant to the Plan of Liquida- tion. The Company s revenues, benefits and expenses now consist principally of investment income on remaining assets and corporate expenses.
In August 2000, Consumers Life surrendered its certificate of authority to write insurance business in the state of Idaho because it did not meet that state s statutory deposit requirements. Since Consumers Life is no longer writing any insurance business, the surrender of the Idaho license will have no material adverse effect. However, the loss of this license may reduce the consideration the Company will receive when Consumers Life is sold.