Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to provide in narrative form the perspective of the management of Kansas City Life Insurance Company (the Company) on its financial condition, results of operations, liquidity and certain other factors that may affect its future results for the three years ended December 31, 2009. This discussion should be read in conjunction with the consolidated financial statements and accompanying notes included in this document.
Old American sells final expense life insurance 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 and independent field force. Old American operates in 46 states and the District of Columbia.
The rate of mortality, lapse and surrenders of future policy benefits and policyholder account balances;
The Company generates cash largely through premiums collected through the sale of insurance products, and 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.
Starting in 2007 and continuing into 2009, extreme fluctuations in market conditions significantly impacted the financial markets and the Company’s investments and revenues. The interest rate and credit environments have presented a significant challenge to the markets as a whole and specifically to companies invested in fixed maturity and equity securities. These conditions may persist into the future as the credit and equity markets continue to be challenged, particularly in the financial services sector. The Company is broadly diversified and has high quality investments, as 94% of all fixed maturity securities were investment grade at December 31, 2009. However, as a result of the consolidations occurring in the financial services sector, diversification in this sector will be a challenge until greater market stabilization occurs. In addition, the entrance of the U.S. Government into private company arrangements and specific guarantees may add further complications to a variety of issues, which are yet to be fully determined.
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. Coupon 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 coupon 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. This risk increased in the recent economic downturn.
Whether the Company intends to sell a debt security and whether it is not more likely than not that the Company will be required to sell a debt security before recovery of the amortized cost basis; and
The Company considers the following assumptions to be of significance when evaluating the amortization of DAC and VOBA: expected mortality, interest spreads, surrender rates and expense margins. Mortality relates to the occurrence of death. Interest spreads are the difference between the investment returns earned and the crediting rates of interest applied to policyholder account balances. Surrender rates relate to the relative volume of policy terminations. Expense margins involve the expenses incurred for maintaining and servicing in-force policies.
The following table reflects 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.
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 VBT and the 1975-1980 Select and Ultimate Basic Table serve as the basis for most mortality assumptions.
Deposits related to universal life, fixed deferred annuity contracts and investment-type products are credited to policyholder account balances. Revenues from such contracts consist of amounts assessed against policyholder account balances for mortality, policy administration and surrender charges, and are recognized in the period in which the benefits and services are provided. The cash flows from deposits are credited to policyholder account balances. Deposits are not recorded as revenue. Deposits are shown as a Financing Activity in the Consolidated Statements of Cash Flows.
The Company earned net income of $10.7 million in 2009 compared to a net loss of $17.1 million in 2008 and net income of $35.7 million in 2007. Net income per share was $0.93 in 2009 versus a net loss of $1.47 per share in 2008 and net income of $3.01 per share in 2007. The increase in 2009 net income was largely attributed to a reduction in realized investment losses and higher insurance revenues, which were partially offset by an increase in operating expenses. The decline in net income in 2008 largely resulted from increased realized investment losses, reduced net investment income, and increases in policyholder benefits and operating expenses. These were partially offset by an increase in insurance revenues and a decrease in interest credited to policyholder account balances.
The Company’s marketing plan is to focus its primary growth strategies on individual life insurance business in both the Individual Insurance and Old American segments. This growth strategy includes new premiums for individual life products and new deposits for universal life and variable universal life products. The Company’s growth strategy encourages a product mix that includes both life and annuity products. The marketing plan includes strategies to grow the business through the Company’s existing sales force and with the addition of new general agents and agents. The Company believes that increasing both the number and productivity of general agents and agents is essential to this strategy. Accordingly, the Company has been successful in recruiting new general agents and agents nationwide and has placed an emphasis on training and direct support within the field. The Company also utilizes third-party marketing arrangements to enhance its sales objectives. In addition, the Company’s marketing and product strategy allows the Company the flexibility to identify niches in the existing market environment and to react quickly to be able to take advantage of short-term opportunities when they occur.
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 reflects 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 reflects 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.
Consolidated total premiums increased $5.3 million or 3% in 2008 versus 2007, as total new premiums increased $6.5 million or 20% and total renewal premiums decreased $1.2 million or 1%. The largest contributor to the increase in new premiums was a $4.5 million or 55% increase in immediate annuity premiums. This increase largely reflects changes in consumer preferences. New group life insurance premiums increased $0.6 million or 37% and new group accident and health premiums increased $0.9 million or 9%, reflecting an increase in dental premiums. The improvements in both new group life and new group accident and health premiums reflect an increase in the number of sales representatives and the realignment of sales territories. In addition, enhanced product features within the dental product line contributed to the increase in new group accident and health premiums. The Company exited the stop loss market during 2006 but continued to process
existing business until the stop loss contracts expired in 2007. Excluding this product line from 2007, the result would be a 4% increase in total premiums, a 26% increase in total new premiums and a 27% increase in new group accident and health premiums in 2008. New individual life premiums increased $0.6 million or 5%, which includes an 11% increase in new premiums in the Old American segment. The increase in new premiums at the Old American segment reflects a combination of enhancements to products, compensation and distribution expansion. The slight decline in total renewal premiums was largely the result of a 1% decline in total individual life renewal premiums.
Renewal deposits increased $4.3 million or 3% in 2009 versus a $4.9 million or 4% decline in 2008. The increase in 2009 resulted from higher fixed deferred annuity deposits, which increased $9.3 million or 54% compared to one year ago. This increase was partially offset by declines in the following products: $2.9 million or 3% in universal life deposits, $1.2 million or 8% in variable universal life deposits and $0.8 million or 8% in variable annuity deposits. The decline in 2008 was largely due to a $4.5 million or 30% decline in variable annuity deposits and a $2.1 million or 2% decline in universal life deposits. These declines were partially offset by a $2.3 million or 16% increase in fixed deferred annuity deposits.
Insurance revenues are affected by the level of new sales, the type of products sold, the persistency of policies, general economic conditions, and competitive forces. The Company strives to provide a portfolio of products with safety and competitive return objectives. The Company offers a broad range of products, including variable insurance products, which allow policyholders to participate in both the equity and fixed income markets. Interest sensitive and traditional insurance products combine safety of principal with competitive interest returns.
Contract charges consist of cost of insurance, expense loads, amortization of unearned revenues and surrender charges. Certain contract charges for universal life insurance 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.
Investments in mortgage loans totaled $457.6 million at December 31, 2009, an increase of $12.2 million from December 31, 2008. Mortgage loans are stated at cost, adjusted for amortization of premium and accrual of discount, less a reserve for probable losses. A loan is considered 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 reserve was $3.4 million at December 31, 2009, unchanged from December 31, 2008. The reserve for mortgage loans is maintained at a level believed by management to be adequate to absorb estimated 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. No mortgage loans were restructured or delinquent for more than 90 days or foreclosed upon and transferred to real estate investments during the last three years. The Company does not hold mortgage loans of any borrower that exceed 5% of stockholders’ equity. Mortgage loans comprised 14% of the investment portfolio at December 31, 2009, down slightly from 15% at the end of 2008. Almost all of the mortgages were commercial loans on industrial warehouses and office properties at both December 31, 2009 and 2008. Investment income from mortgage loans decreased $0.4 million or 1% in 2009 and $1.6 million or 5% in 2008 compared to the same periods one year earlier. The decline in 2009 was largely due to lower prepayment penalties and assumption fees, as well as lower rates earned on new loans. The decline in 2008 was due to reduced mortgage loan balances, as a result of fewer new mortgage loans, lower rates earned on new loans and lower fee income earned.
The Company offers policy loans as a benefit to its policyholders. These loans are secured by the cash value of the policy. Policy loans totaled $85.6 million at December 31, 2009, down $2.7 million from December 31, 2008. Investment income from policy loans declined 5% in 2009 and was flat in 2008. The decline in 2009 was largely due to the reduced balances of policy loans outstanding. In 2008, the decline in the balance of policy loans was offset by an increase in yields.
Net investment income is stated net of investment expenses, and investment expenses decreased $0.4 million or 3% versus one year earlier. Interest expense on short-term notes payable decreased in 2009 compared to last year. The Company has an investment in the Federal Home Loan Bank from which it is able to borrow money at favorable interest rates. 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, 2009. Partially offsetting this decline was an increase in real estate expenses in 2009 compared to 2008. Investment expenses decreased $0.7 million or 6% in 2008 compared to 2007. This was primarily due to a decrease in real estate investment expenses and interest expense. The largest factor contributing to the decrease was reduced tenant improvement costs on buildings held for investment. The decrease in interest expense related to borrowings from the Federal Home Loan Bank.
The Company realized investment gains and losses from several sources, including write-downs of investments and sales of investment securities and real estate. Many securities purchased by the Company contain call provisions, which allow the
The following table provides detail concerning realized investment gains and losses over the three years ended December 31.
In the fourth quarter of 2009, the Company experienced $1.9 million of net 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’s analysis of securities for the quarter ended June 30, 2009 resulted in the determination that six fixed-maturity issuers (seven securities) had other-than-temporary impairments and were written down by a combined $4.0 million due to credit impairments. The aggregate impairment for these securities was $4.4 million, and $0.4 million of this amount was determined to be non-credit and was recognized in other comprehensive income (loss).
Following is a description of the securities that were written down during the second quarter of 2009:
downgrades, combined with the issuer’s need to raise additional capital to meet future payments contributed to the other-than-temporary impairment.
One security was from a trucking company that was written down $1.6 million. As the trucking industry is highly correlated with the general economy, this company had experienced a reduction in shipping volume as a result of the recession. This company renegotiated its credit facilities in the first quarter of 2009, but new covenants placed significant requirements on the issuer. These restrictions, combined with the need to retire longer-term debt, placed additional stress on cash resources and led to indications of continued weakening performance that the Company believed to be other-than-temporary.
One security was from a company that develops, manufactures and markets imaging products that was written down $1.2 million. This company’s past emphasis was in traditional film, which has been largely surpassed by digital photography. The decline in the economy had negatively affected sales, as the consumer photography industry is a discretionary item. The company’s declining revenues and liquidity position led to the other-than-temporary impairment.
One security was written down $1.0 million as the Company accepted a tender offer on the Company’s holdings from an issuer during the second quarter of 2009.
Following is a description of the securities that were written down during the fourth quarter of 2008:
Two securities were written down by $3.1 million, primarily as a result of declines in price and rating agency downgrades on debt issues from issuers that completed leveraged buyout transactions during 2008. One of these securities was subsequently sold during the fourth quarter of 2008.
One security was written down $1.1 million as continued price deterioration occurred on this security that was previously written down. This issuer is primarily in the radio and advertising business.
Three of the securities were written down by a total of $3.3 million, primarily as a result of declines in price and rating agency downgrades on debt issues from issuers that had recently completed leveraged buyout (LBO) transactions. These LBO transactions greatly increased the debt level of each issuer. One of these securities had been written down previously, and the other two securities were below cost by 20% or more for at least six consecutive months.
No other-than-temporary impairments were identified during the first quarter of 2008.
The Company’s analysis of fixed maturity securities for the quarter ended December 31, 2007 resulted in the determination that two securities had other-than-temporary declines which were written down by $4.0 million.
Following is a description of the securities that were written down during the fourth quarter of 2007:
One security was below cost by 20% or more for more than six consecutive months and was the subject of a recent leveraged buyout that was finalized during the fourth quarter of 2007, which greatly increased the debt level of the company. Accordingly, the Company wrote down this security $3.3 million at year-end 2007.
Credit risk, relating to the uncertainty associated with the continued ability of a given obligor to make timely payments of principal and interest;
The Company’s ability to manage these risks is essential to the success of the organization. In particular, the Company devotes considerable resources to the credit analysis of each new investment and the ongoing credit positions. The majority of the Company’s investments are exposed to varying degrees of credit risk. 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. Credit risk is managed primarily through industry, issuer, structure and asset diversification.
The following table provides information regarding fixed maturity securities by asset class as of December 31, 2009.
The following table provides information regarding fixed maturity securities by asset class as of December 31, 2008.
The following table identifies fixed maturity securities available for sale by rating.
Reflecting the high quality of securities maintained by the Company, 94% and 96% of all fixed maturity securities were investment grade as of December 31, 2009 and December 31, 2008, respectively. Changes in the mix of investment grade
Intent and ability to make all principal and interest payments when due;
All securities are reviewed to determine whether impairments should be recorded. This 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 risk that the facts and circumstances change such that it becomes more likely than not that the Company will be required to sell the investment before recovery of the amortized cost basis; and
Identified below are tables that divide these investment types among vintage and credit ratings as of December 31, 2009.
The following table provides information regarding investment securities with unrealized losses on fixed maturity and equity security investments available for sale, as of December 31, 2009.
At December 31, 2009, gross unrealized losses on fixed maturity and equity security investments attributable to securities having gross unrealized losses of 12 months or longer decreased from $128.2 million at December 31, 2008 to $86.0 million at December 31, 2009. The largest component of this decrease was from the corporate obligations category, which decreased $44.9 million during 2009. Further, $7.2 million or 8% of the gross unrealized losses on fixed maturity and equity security investments was attributable to securities having gross unrealized losses of less than 12 months. This compares to $103.7 million or 45% at December 31, 2008. The corporate obligations category of securities accounted for the largest portion of the decrease that occurred during 2009. In addition, all of the Company’s equity securities at both December 31, 2009 and 2008 were in the financial sector.
security issues representing 41% of the issues with unrealized losses, including 80% being rated as investment grade, were below cost for one year or more and less than three years; and
The total number of fixed maturities and equity securities with unrealized losses decreased from 483 at December 31, 2008 to 232 at December 31, 2009. These results were primarily due to three factors. First, the Company has and continues to purchase high quality investments. Second, the economic downturn has improved since last year-end, but continues to affect securities that the Company owns. Third, the Company has written down or sold certain securities that had previously been in an unrealized loss position.
The following tables summarize the Company’s investments in securities available for sale with unrealized losses as of December 31, 2009 and December 31, 2008.
Total unrealized losses on the Company’s investments in securities available for sale at December 31, 2009 were $93.2 million. The Company segments these unrealized losses into those on which other-than-temporary impairments have been recorded and those that have not been previously written down.
including less than six months, six months or more and less than twelve months, and twelve months or greater. The Company had investment grade securities with unrealized losses of greater than 20% that totaled $3.3 million and $5.8 million for less than six months and six or more and less than twelve-month periods, respectively, at December 31, 2009. The Company had investment grade securities with unrealized losses of greater than 20% for twelve months or greater that totaled $12.7 million. The Company had below investment grade securities with unrealized losses of greater than 20% for six months or more and less than twelve months that totaled $1.7 million at December 31, 2009. Below investment grade securities with unrealized losses greater than 20% for twelve months or greater totaled $4.0 million.
Following is a discussion regarding those securities with unrealized losses on which other-than-temporary impairments have been recorded as of December 31, 2009. Total unrealized losses of 20% or less and greater than 10% were $1.9 million or 7% of the total unrealized losses on securities with other-than-temporary impairments. Total unrealized losses greater than 20% were $23.4 million or 92% of the total securities with other-than-temporary impairments.
Following is a discussion regarding those securities with unrealized losses on which other-than-temporary impairments had been recorded as of December 31, 2008. The Company had investment grade securities with unrealized losses of greater than 20% that totaled $1.8 million for less than six months at December 31, 2008. The Company also had below investment grade securities with unrealized losses of greater than 20% that totaled $0.1 million for less than six months. The Company had no securities with unrealized losses of greater than 20% for six months or greater at December 31, 2008.
The following table provides information on fixed maturity securities with gross unrealized losses by rating as of December 31, 2009.
Following is a discussion of securities whose fair value had been less than 80% of amortized cost for at least six months at December 31, 2009. The Company has evaluated 13 fixed maturity securities in this category, and prepared detailed analyses
One security is a senior tranche of an asset-backed security structure backed primarily by subprime mortgages on residential properties. This security has also been affected by the price depreciation in the current market but continues to perform within its contractual obligations.
One security is from an international banking institution that has been negatively impacted by the effects of both the global credit deterioration and the U.S. housing and mortgage credit crisis. This institution is being supported by the UK Government’s Asset Protection Scheme. This security continues to perform within its contractual obligations.
One security is a CDO that has been impacted by the rapid rise in delinquencies and foreclosures in the sub-prime and Alt-A mortgage markets, along with a decline in the fair value of securities issued by financial institutions. Ongoing CDO liquidations and investor selling have caused extreme declines in market valuations, regardless of individual security performance. This security continues to perform within its contractual obligations.
The Company has written down certain investments in previous periods. Securities written down and still owned at December 31, 2009 had a fair value of $40.7 million with a net unrealized loss of $17.2 million, including the impact of the cumulative effect of change in accounting principle. Comparatively, securities written down and still owned at December 31, 2008 had a carrying value of $29.2 million and a net unrealized loss of $2.2 million.
The Company evaluated the current status of all previously written-down investments to determine whether the Company continues to believe that these investments were still credit-impaired to the extent previously recorded. The Company’s evaluation process is similar to its impairment evaluation process. However, if evidence exists that the Company believes that it will receive all or a materially greater portion of its contractual maturities from securities previously written down, the accretion of income is adjusted. Accordingly, the Company changed its evaluation of two investments during 2009. The Company believes that it will receive all contractual maturities due on these investments. During the second quarter, the Company changed its evaluation of one security that matures in less than one year and is from an issuer that designs, manufactures and services cars and trucks and provides vehicle-related financing, leasing and insurance. In the fourth quarter of 2009, the Company changed the evaluation of one investment that matures in nine years and is from an issuer that operates a television network, several cable channels, radio and television stations and outdoor advertising.
The Company does not have a material amount of direct or indirect guarantees for the securities in its investment portfolio. The Company did not have any direct exposure to financial guarantors at December 31, 2009. The Company’s indirect exposure to financial guarantors totaled $47.2 million, which was less than 2% of the Company’s investment assets at December 31, 2009. Total unrealized losses on these investments totaled $5.8 million at December 31, 2009.
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 (LIHTC) by a subsidiary of the Company and fees charged on products and sales from the Company’s broker-dealer subsidiary. Other revenues decreased $2.4 million or 19% in 2009 versus 2008. This decrease was largely due to a reduction in income from reduced volumes of sales of LIHTC investments and broker-dealer transactions. Also, revenue from supplementary contract considerations increased, but was offset by a reduction in dividends left to accumulate. Other revenues increased $1.5 million or 13% in 2008 compared to 2007. This increase was largely due to additional sales of LIHTC credits.
Policyholder benefits consist of death benefits (mortality), immediate annuity benefits, accident and health benefits, surrenders and the associated increase or decrease in reserves for future policy benefits. The largest component of policyholder benefits was death benefits for the periods presented. Death benefits reflect mortality results. Mortality will fluctuate from period-to-period but has remained within pricing expectations for the periods presented.
Policyholder benefits increased $0.2 million or less than 1% in 2009 compared to 2008. Benefit and contract reserves increased due to higher annuity sales, as reserves are established virtually on a one-for-one basis with premiums. Partially offsetting this was a decrease in benefit and contract reserves for the GMWB. This rider is considered to be a financial derivative and is accounted for at fair value. The Company determines the fair value of the GMWB rider using a risk-neutral valuation method. This method is a probability measure that results when the current value of all financial assets is assumed to equal the expected value of the future payoff of the asset discounted at the risk-free rate. The value of the riders will fluctuate depending on market conditions. These annuity riders had a decrease in value of $2.4 million during 2009, largely due to favorable returns in the capital markets, decreases in market volatility, increases in risk-free (swap) rates and changes in the reference spread used for issuer discount. In addition, the Company has a guaranteed minimum death benefit (GMDB) on certain products. The benefit reserve for GMDB declined from $0.5 million at December 31, 2008 to $0.3 million at December 31, 2009. The increase in benefit and contract reserves was mostly offset by decreases in death benefits and other benefits. The decline in death benefits reflects favorable mortality and the decline in other benefits largely reflects lower accumulated dividends and interest thereon. Policyholder benefits increased $12.3 million or 7% in 2008 compared to 2007. The increase in 2008 was due to several factors. Death benefits increased $4.4 million or 4% compared to the prior year, reflecting adverse mortality. Higher dental benefits reflected the increase in new dental business during 2008 over the prior year. Benefit and contract reserves increased due to higher annuity sales.
Policyholder benefits for the group accident and health product line increased $0.2 million or 1% in 2009 and $3.0 million or 13% in 2008. These increases were largely the result of increases in group dental benefits, which increased $0.2 million or 1% and $3.5 million or 17% in 2009 and 2008, respectively.
Interest is credited to policyholder account balances according to terms of the policies or contracts. Interest is credited to policyholder account balances for universal life, fixed deferred annuities and other investment-type products. There are minimum levels of interest crediting assumed in certain policies or contracts, as well as allowances for adjustments to be made to reflect current market conditions in certain policies or contracts. Accordingly, the Company reviews and adjusts crediting rates as necessary and appropriate. Interest credited to policyholder account balances decreased $0.2 million or less than 1% in 2009 and $4.3 million or 5% in 2008. Amounts credited are a function of account balances and current period crediting rates. As account balances fluctuate, so will the amount of interest credited to policyholder account balances. Total policyholder account balances increased $18.2 million or 1% during 2009, following a $56.8 million or 3% decline during 2008. The average interest rate credited to policyholder account balances was 4.26% in 2009, 4.28% in 2008 and 4.30% in 2007.
The amortization of DAC was $35.1 million in 2009, compared with $35.0 million in 2008 and $31.1 million in 2007. While total DAC amortization did not fluctuate significantly between 2009 and 2008, two components of the balances did change considerably. While no unlocking adjustment was made during 2009, DAC amortization was reduced by $3.0 million due to unlocking during the second quarter of 2008. This was mostly offset by a decline in amortization resulting from lower actual gross profits on the variable universal life and annuity products during 2009. The increase in 2008 was due to several factors. First, DAC amortization increased on variable products due to increased surrenders and a decline in the market value of the account balances. Second, Old American increased commission schedules in 2007. Accordingly, as policies terminated in 2008, an increase in DAC amortization resulted from the increased commission costs that had been deferred. In addition, DAC amortization was reduced $3.0 million in the second quarter of 2008 due to unlocking, primarily related to interest margins and mortality experience on selected products. The unlocking adjustment for 2007 totaled $3.4 million, and was primarily related to adjustments for interest spreads. Partially offsetting these, the amortization of DAC decreased in 2008 compared to 2007 due to a large number of policy surrenders that occurred in 2007, resulting in additional DAC amortization in 2007.
VOBA is amortized in concert with each purchased block of business. Generally, as policies run off, the amortization will decline over time. The amortization of VOBA was $4.5 million in 2009, $7.1 million in 2008 and $9.2 million in 2007. The decrease in 2009 was largely due to two factors. First, the Company refined its method for calculating VOBA from a premium-based method to a volume-based method for certain traditional life products during the second quarter of 2009. Since the establishment of the VOBA, the measure of premium in force has fluctuated from period to period. This has resulted in a corresponding volatile amortization of the VOBA unrelated to the actual run off of the in force policies. Second, the unlocking adjustment on interest-sensitive products in the second quarter of 2009 decreased VOBA amortization by $0.2 million, whereas the unlocking adjustment in the second quarter of 2008 increased VOBA amortization by $0.2 million. The unlocking adjustment in 2009 was related to improvements in the ultimate earned rates for certain products. The unlocking adjustment in 2008 was related to a change in the policy surrender assumptions. The unlocking adjustment totaled $1.1 million in 2007 and was primarily related to a reduction in the mortality assumptions.
Premiums are reported on a gross basis, with separate reporting for premiums ceded under reinsurance agreements. Policyholder benefits and expenses are reported net of reinsurance ceded and equaled $67.9 million, $68.1 million and $61.1 million for the years ended December 31, 2009, 2008 and 2007, respectively.
Future policy benefits and other related assets and liabilities are not reduced for reinsurance in the balance sheet. A reinsurance receivable is established for such balance sheet items. Reinsurance related to policy and claim reserves ceded of $166.5 million and $154.1 million were included in the reinsurance receivables as of December 31, 2009 and 2008, respectively. Ceded benefits recoverable from reinsurers were $13.9 million and $14.4 million as of December 31, 2009 and 2008, respectively.
The Company’s overall reinsurance strategy has not changed during the periods addressed in this report. However, in 2008 the Company implemented changes to its reinsurance on new products by reducing the amount of coverage that is reinsured. These changes have been made primarily due to the increased cost of reinsurance currently available in the market.
The Company recorded income tax expense of $5.7 million or 35% of income before tax in 2009, compared to an income tax benefit of $9.2 million or 35% of income before tax in 2008. The increase in tax expense in 2009 versus 2008 was impacted by higher income before tax, a decrease in low income housing tax credit benefits, and a decrease in the provision to tax return adjustments. In 2007, the Company recorded an income tax expense of $17.3 million or 33% of income before tax. The decrease in tax expense in 2008 versus 2007 was due to lower income before tax and a decrease in the provision to tax return adjustments, offset by a decrease in low income housing tax credits earned. Income taxes will fluctuate depending upon items such as net income, realized investment gains and losses, and affordable housing tax credits.
The Company establishes contingent tax assets or liabilities, when appropriate, to provide for potential challenges by taxing jurisdictions. In 2009, the Company’s income tax expense was reduced $0.1 million, due to a net decrease in contingent tax liabilities relating to the 2006 through 2009 tax years. The Company’s income tax expense was increased $0.1 million in 2008 and reduced $0.1 million in 2007 due to the net change in contingent tax liabilities.
The following table presents financial data for the Individual Insurance business segment for the years ended December 31.
The net income for this segment in 2009 was $11.3 million, compared to a $15.9 million net loss in 2008 and $34.8 million of net income in 2007. The two largest factors in the increase in income in 2009 versus 2008 were a $41.8 million reduction in realized investment losses and a $2.9 million reduction in amortization of DAC and VOBA. Partially offsetting these improvements, operating expenses increased $4.9 million and contract charges declined $3.3 million. Although premiums increased significantly in 2009, the growth was primarily in immediate annuities. These new premiums are largely offset by increased reserves in policyholder benefits, having little impact on net income in the current period. The largest contributor to the loss for 2008 was $50.0 million in net realized investment losses. Also contributing to the loss in 2008 was a $12.4 million decrease in net investment income, an $8.1 million increase in policyholder benefits and a $5.7 million increase in operating expenses. Partially offsetting these changes, premiums increased $4.8 million, other revenues increased $1.5 million and interest credited to policyholder account balances decreased $4.3 million in 2008.
This segment’s direct insurance revenues (total insurance revenues excluding reinsurance ceded) are primarily derived from premiums on traditional insurance products and contract charges. Traditional insurance products principally include whole life, term life and immediate annuities. Contract charges are collected from interest sensitive insurance products, including universal life, fixed deferred annuities and variable life and annuities. In 2009, this segment received 39% of its direct insurance revenues from premiums on traditional products, compared to 36% in 2008 and 33% in 2007.
Total insurance revenues increased 4% in 2009 and 2% in 2008. The increase in 2009 was due to a 15% increase in premiums, as immediate annuity sales increased 75% compared to 2008. This was partially offset by a 3% decline in contract charges, resulting from lower account balances on variable contracts, lower surrender charges due to a decline in policy surrenders on certain products, and the runoff of closed blocks. The increase in 2008 reflected a 9% increase in premiums. The premium growth reflected a 55% increase in immediate annuity sales, reflecting changes in consumer
Total new deposits increased $34.8 million or 51% in 2009 compared to a 1% decrease in 2008. The increase in 2009 was due to a $46.2 million or 152% increase in new fixed deferred annuity deposits. This improvement was partially offset by declines in the following products: $1.0 million or 10% in new universal life deposits, $0.9 million or 47% in new variable universal life deposits and $9.4 million or 37% in new variable annuity deposits. New fixed deferred annuity deposits increased $4.1 million or 15% in 2008, while new variable annuity deposits decreased 13%, new universal life deposits were flat, and new variable universal life deposits decreased 22%. Total renewal deposits increased 3% in 2009, as a 54% increase in fixed deferred annuity deposits was partially offset by a 3% decrease in universal life deposits, an 8% decrease in variable universal life deposits and an 8% decrease in variable annuity deposits. Total renewal deposits decreased 4% in 2008, reflecting a 30% decline in variable annuity deposits, a 5% decline in variable universal life deposits and a 2% decrease in universal life deposits. These reductions were partially offset by a 16% increase in fixed deferred annuity deposits. The increases in sales of fixed deferred annuities can be attributed to consumer preferences for fixed-rate products resulting from the volatility in the equity markets. This volatility and the difficult economic environment are attributable to the declines in variable annuities, variable universal life and universal life.
Net investment income was flat in 2009 following a 7% decrease in 2008. Investment income is primarily driven by changes in interest rates, asset levels and investment expenses. The results for 2009 reflected a decline in investment assets that was mostly offset by an increase in investment yields. The decline in investment assets largely reflects lower book value due to sales, maturities and calls. The increase in investment yields was largely due to a higher return on alternative investment fund compared to last year. In 2009, this investment added gross investment income of $2.1 million. However, as a result of the significant decline in the economic environment experienced last year, this investment resulted in a decline in gross investment income of $3.7 million in 2008. The decline in 2008 was primarily due to reduced investment assets and lower yields from the investment portfolio. The decline from lower yields was largely due to a reduction in income from an alternative investment fund, as mentioned above. In 2007, this investment added gross investment income of $2.5 million.
One security was a CDO that was written down $0.2 million. This security has been impacted by the rapid rise in delinquencies and foreclosures in the subprime and Alt-A mortgage markets, along with a decline in the fair value of securities issued by financial institutions. Ongoing CDO liquidations and investor selling had caused extreme declines in market valuations, regardless of individual security performance. This security had been written down in previous periods.
One security from a global commercial finance company that provides financial products and advisory services to a range of industry sectors was written down $0.5 million. This company had been affected by the credit crisis, forcing reduced access to liquidity and higher borrowing costs. The Company determined that a credit-related impairment had occurred.
The Company’s analysis of securities for the quarter ended March 31, 2009 resulted in the determination that six fixed-maturity issuers (seven specific securities) had other-than-temporary impairments affecting the Individual Insurance segment. These securities were written down by a combined $6.0 million due to credit impairments. The aggregate impairment for these securities was $19.2 million, and $13.2 million of this amount was determined to be non-credit and was recognized in other comprehensive income (loss).
One security was from a mortgage and financial guaranty insurer that was written down $1.6 million. Mortgage insurers have suffered from the deterioration in the U.S. housing market and mortgage credit market. Rising
One security was from a company that develops, manufactures and markets imaging products that was written down $1.2 million. This company’s past emphasis was in traditional film, which has been largely surpassed by digital photography. The decline in the economy has negatively affected sales, as the consumer photography industry is a discretionary item. The company’s declining revenues and liquidity position led to the other-than-temporary impairment.
Two securities (from one issuer) were residential mortgage-backed securities that were written down by a total of $0.5 million. The significant decline in the subprime and non-conforming mortgage markets and the specific performance of the underlying collateral caused the Company’s cash flow projections to be less than the amortized cost of the securities and created an other-than-temporary impairment.
The Company’s analysis of securities for the quarter ended December 31, 2008 resulted in the determination that 16 securities (14 issuers) had other-than-temporary impairments affecting the Individual Insurance segment. These securities were written down by a combined $19.5 million.
Three securities were CDOs that were written down by a total of $5.1 million. These securities were impacted by the rapid rise in delinquencies and foreclosures in the sub-prime and Alt-A mortgage markets, along with a decline in the fair value of securities issued by financial institutions. Ongoing CDO liquidations and investor selling caused extreme declines in market valuations, regardless of individual security performance.
One security is from an issuer that designs, manufactures and services cars and trucks and provides vehicle-related financing, leasing and insurance was written down $1.2 million, largely resulting from the decline in the U.S. automotive industry.
The Company’s analysis of securities for the quarter ended September 30, 2008 resulted in the determination that ten fixed-maturity issuers (twelve specific securities) had other-than-temporary impairments affecting the Individual Insurance segment. These securities were written down by a combined $30.9 million in the third quarter.
Following is a description of the securities that were written down during the third quarter of 2008.
One security was written down $1.1 million as continued price deterioration occurred on this security that was previously written down. The issuer is primarily in the radio and advertising business.
One security provides custom-tailored financing to private and corporate owners of real estate nationwide. This security had a rating decline to below investment grade status combined with continued price deterioration and was written down $2.3 million.
The Company’s analysis of securities for the quarter ended June 30, 2008 resulted in the determination that seven fixed-maturity securities had other-than-temporary impairments affecting the Individual Segment. These securities were written down by a combined $9.7 million in the second quarter.
Three of the securities were written down by a total of $3.0 million, primarily as a result of declines in price and rating agency downgrades on debt issues from issuers that had recently completed LBO transactions. These LBO transactions greatly increased the debt level of each issuer. One of these securities had been written down previously, and the other two securities were below cost by 20% or more for at least six consecutive months.
One security was written down by $3.3 million due to a combination of a decline in price that had persisted for a period longer than the Company considered temporary, rating agency downgrades and a debt restructuring during the quarter.
One security filed for Chapter 11 protection and indicated that it would not be able to fully meet all of the obligations of its borrowings. The Company recognized an other-than-temporary impairment on this security at year-end 2006 of $1.1 million. As a result of this new action, the Company recognized an additional $0.7 million impairment in 2007. At December 31, 2006, this security was below cost by 20% or more for more than twelve consecutive months. It was in a highly competitive and cyclical industry that was experiencing weakened demand and overcapacity. Capital expenditures for equipment upgrades were exceeding cash generation.
Other revenues decreased $2.4 million or 19% in 2009, largely due to a reduction in income from reduced volumes of sales of LIHTC investments and broker-dealer transactions. Other revenues increased $1.5 million or 14% in 2008 versus 2007. This increase was largely due to additional sales of LIHTC credits.
Policyholder benefits increased $1.2 million or 1% compared to an $8.1 million or 9% increase in 2008. The largest factor in the increase in 2009 was higher benefit and contract reserves. This increase can largely be attributed to higher annuity sales, as reserves are established virtually on a one-for-one basis with premiums. Partially offsetting this was a decrease in benefit and contract reserves for the GMWB. This rider is considered to be a financial derivative and is accounted for at fair value. The Company determines the fair value of the GMWB rider using a risk-neutral valuation method. This method is a probability measure that results when the current value of all financial assets is assumed to equal the expected value of the future payoff of the asset discounted at the risk-free rate. The value of the riders will fluctuate depending on market conditions. These annuity riders had a decrease in value of $2.4 million during 2009, largely due to favorable returns in the capital markets, decreases in market volatility, increases in risk-free (swap) rates and changes in the reference spread used for issuer discount. In addition, the Company has a guaranteed minimum death benefit (GMWB) on certain products. The benefit reserve for GMDB declined from $0.5 million at December 31, 2008 to $0.3 million at December 31, 2009. Partially offsetting the increase in benefit and contract reserves, death benefits and other benefits declined. The decline in death benefits reflects favorable mortality and the decline in other benefits was largely due to lower accumulated dividends and interest thereon. The increase in policyholder benefits in 2008 was primarily due to two factors. First, death benefits increased $2.8 million or 5% compared to a year ago, reflecting adverse mortality. Second, benefit and contract reserves increased, largely due to two items. The first item was higher annuity sales. The second item was an increase in value of the GMWB rider of $0.8 million during 2008, largely due to changes in the equity and credit markets, along with changes in interest rates and volatility.
The amortization of DAC and VOBA decreased 10% in 2009 compared to 2008, following a 5% increase in 2008 compared to 2007. The amortization of DAC decreased 1% in 2009. This decline was largely due to a reduction in amortization resulting from lower actual gross profits on the variable universal life and annuity products during 2009. Mostly offsetting this was the difference in unlocking in 2009 compared to 2008. While no unlocking adjustment was made during 2009, DAC amortization was reduced by $3.0 million due to unlocking during the second quarter of 2008. DAC amortization increased 17% in 2008, primarily related to negative market performance on variable products. As previously mentioned, DAC amortization was reduced $3.0 million in the second quarter of 2008 due to unlocking, primarily related to interest margins and mortality experience on selected products. In the second quarter of 2007, unlocking totaled $3.4 million and was primarily related to unlocking adjustments for interest spreads. Partially offsetting these changes, the amortization of DAC decreased in 2008 compared to 2007 due to several large policy surrenders that occurred in 2007, resulting in additional DAC amortization in 2007.
The decline in 2009 was largely due to two factors. First, the Company refined its method for calculating VOBA from a premium-based method to a volume-based method for certain traditional life products during the second quarter of 2009. Since the establishment of the VOBA, the measure of premium in force has fluctuated from period to period. This has resulted in a corresponding volatile amortization of the VOBA unrelated to the actual run off of the in force policies. Second, the unlocking adjustment on interest-sensitive products in the second quarter of 2009 decreased VOBA amortization by $0.2 million, whereas the unlocking adjustment in the second quarter of 2008 increased VOBA amortization by $0.2 million. The decline in 2008 was largely attributed to a decrease in the unlocking adjustment from $1.0 million in the second quarter of 2007 to $0.2 million in the second quarter of 2008. The unlocking adjustment in the second quarter of 2007 was related to the assumptions for mortality margins. The unlocking adjustment in the second quarter of 2008 was primarily related to a change in the policy surrender assumptions.
Operating expenses consist of commissions net of the capitalization of commissions, expenses from the Company’s operations, and other expenses. Capitalized commissions consist primarily of commissions and non-recurring expenses related to the sale of business. In total, operating expenses increased 8% in 2009 and 10% in 2008. The largest factors in the increase in 2009 were a $4.2 million increase in pension expense and $3.1 million in separation costs associated with a reduction in staffing. Also contributing to the increase were legal and incentive compensation expenses. Partially offsetting these increases were decreases in salaries, travel expenses and outside labor and services. The primary factors contributing to the increase in 2008 were employee and agent medical plan and benefit costs largely resulting from a reduction of accruals in the prior year, expense associated with LIHTC credits, travel expenses, premium taxes and consulting services.
Total group premiums increased $0.8 million or 1% in 2009, following a $2.1 million or 4% increase in 2008. New premiums decreased 6% in 2009, largely the result of a $1.7 million or 19% decrease in new group dental premiums and a
$0.5 million or 23% decrease in new group life premiums. These declines occurred in comparison with 2008, which experienced higher premiums. The 2009 declines in new dental and life premiums were partially offset by a $1.5 million or 93% increase in new group disability premiums. The increase was due to an arrangement with an independent marketing organization specializing in voluntary group products. The growth in premiums in 2008 was the result of a $2.2 million or 32% increase in new group dental premiums and a $0.6 million or 37% increase in new group life premiums. This segment exited the stop loss market, but continued to process existing business until the stop loss contracts expired in 2007.
Primarily due to the improved sales in 2008 and 2007 from the group dental product, renewal premiums increased $1.5 million or 4% in 2009. Renewal premiums increased $0.7 million or 2% in 2008.
The Company has used reinsurance in several of its group product lines to help mitigate risk. Reinsurance on premiums increased $1.7 million or 23% in 2009, following a $0.8 million or 10% decrease in 2008. The 2009 increase was primarily due to group short- and long-term disability business. Disability premiums sold through an arrangement with an independent marketing organization were 100% reinsured. The 2008 decrease was largely due to the termination of the stop loss business. A major portion of the stop loss premiums was reinsured in order to manage the potential risks associated with this product line. Excluding stop loss from the ongoing product lines, reinsurance ceded was flat in 2008.
Improvement efforts for this segment continue to be focused in three primary areas. First, emphasis is being placed on the growth of the in-force business. Increased productivity from existing group representatives and the continued planned expansion of the group distribution system are priorities for growth. This segment is also seeking additional third-party arrangements to advance its sales objectives. Second, improvement in administrative efficiency is targeted through the increased use of technology, which should ultimately reduce expenses. Finally, this segment added a new voluntary disability product to the portfolio in 2008 and a new voluntary life product in 2009. Voluntary products are sponsored by employers, but are elected by the employee and are entirely paid by the employee. This coverage is portable, as the employees can continue this coverage if they change employers. Voluntary products tend to be more profitable, and are expected to become a larger share of the group marketplace.
The following table presents financial data for the Old American business segment for the years ended December 31.
The following table reconciles premiums included in insurance revenues and provides detail by new and renewal business over the three years ended December 31.
Total new premiums increased 20% in 2009 and 11% in 2008. Total renewal premiums decreased 2% in 2009 and 4% in 2008. The increase in new premiums reflects a combination of expanded distribution efforts and improved agency productivity. Old American continues to focus on the recruitment and development of new agencies and agents, along with
Two securities, one issuer a parent organization of the other, were from financial guarantee insurance companies that provide credit enhancement for bond issuers as well as investment management services and were written down by a total of $1.0 million. These issuers had also experienced declines in value related to the mortgage credit crisis, including significant and continuing reductions in capital and liquidity positions. These securities were sold during the fourth quarter of 2009.
The Company’s analysis of securities for the quarter ended September 30, 2009 resulted in the determination that two fixed-maturity securities had other-than-temporary impairments affecting the Old American segment and were written down by a combined $0.4 million.
One security was from a financial institution that had been impacted by the housing and mortgage credit crisis and had been supported through TARP funds. This company has experienced large losses in its real estate loan portfolios and has had an increase in non-performing loans over the past year. This security was written down by a total of $0.4 million before it was sold during the third quarter of 2009.
One security was from a company that provides custom-tailored financing to private and corporate owners of real estate nationwide and was written down $0.4 million. During the second quarter of 2009, the Company accepted an
The Company’s analysis of securities for the quarter ended September 30, 2008 resulted in the determination that an investment in two issuers of fixed-maturity securities had other-than-temporary impairment affecting the Old American segment. These investments were written down by $1.5 million in the third quarter.
One security provides custom-tailored financing to private and corporate owners of real estate nationwide. This security had a rating decline to below investment grade status combined with continued price deterioration and was written down $0.5 million.
Following is a description of the security that was written down during the second quarter of 2008:
A CDO security was written down by $0.2 million, primarily due to a price decline that had persisted for a period longer than the Company considered temporary. The security was below cost by 20% or more for at least six consecutive months.
The Company’s analysis of fixed maturity securities for the quarter ended December 31, 2007 resulted in the determination that one security had an other-than-temporary decline which was written down by $0.4 million. This security was below cost
Amortization of deferred acquisition costs and value of business acquired increased $0.5 million or 4% in 2009, and increased $0.4 million or 3% in 2008 compared to 2007. The increase in both years was primarily due to higher DAC amortization from an increase in sales at an increased commission rate. Beginning in mid 2007, Old American increased the initial commissions paid on the sale of certain new individual life policies. This change increased capitalization and the DAC asset, but also resulted in a higher amount of amortization.
Operating expenses consist of commissions net of the capitalization of commissions, expenses from the Company’s operations, and other expenses. Capitalized commissions consist primarily of commissions and non-recurring expenses related to the sale of business. Operating expenses increased 4% in 2009 compared to a 6% decrease in 2008. The increase in 2009 was largely due to higher employee benefits due to an increase in pension expense. The decrease in 2008 was primarily due to decreases in salaries, lead production expenses and taxes.
An adjustment was reflected in 2007 that related to deferred tax expense attributable to years 2003 and prior through 2006. The unrecorded deferred tax expense in 2003 and prior, 2004, 2005 and 2006 was $0.3 million, $0.4 million, and $0.1 million and none, respectively.
The Company meets liquidity requirements primarily through positive cash flows from operations. Management believes that the Company has sufficient sources of liquidity to satisfy operational requirements and to finance expansion plans and strategic initiatives. Primary sources of cash flow are premiums, other insurance considerations and deposits, receipts for policyholder accounts, investment sales and maturities, investment income and access to credit from other financial institutions. In addition, the Company has credit facilities that are available for additional working capital needs or investment opportunities. The principal uses of cash are for the insurance operations, including the purchase of investments, payment of insurance benefits, operating expenses, dividends, income taxes, withdrawals from policyholder accounts and costs related to acquiring new business. There can be no assurance that the Company will continue to generate cash flows at or above current levels or that the ability to borrow under the current credit facilities will be maintained.
Cash provided from operating activities in each of the three years ended 2009, 2008 and 2007 was $28.7 million, $12.3 million, and $32.9 million, respectively. Cash provided from operating activities increased $16.3 million in 2009 compared with a decrease in cash provided from operating activities of $20.6 million in 2008. Contributing to the increase in 2009 compared to 2008 were a $7.2 million increase in premium receipts, a $3.1 million decrease in cash benefit payments and a $3.5 million decrease in Federal income tax payments. Offsetting these items were a $3.9 million decrease in net investment income, a $4.2 million increase in commissions paid and a $5.8 million increase in operating expenses paid. Cash is also affected by fluctuations in the Company’s receivables and payables. Contributing to the increase in cash, receivables increased $1.7 million, accounts payable and accrued expenses increased $3.5 million, income taxes receivable increased $4.9 million and suspense items on ongoing operations increased $1.6 million. The decrease in 2008 compared with 2007 was largely the result of a $15.3 million decline in net investment income and a $4.4 million increase in cash benefit payments. These were partially offset by a $6.5 million increase in premium receipts. Income taxes payable decreased $33.1 million during 2008, largely due to the net loss incurred. Suspense items on ongoing operations also decreased $1.3 million. These decreases were partially offset by a $3.7 million increase in accrued investment income, a $1.9 million increase in reinsurance receivables established at the time claims are paid, and a $23.1 million increase in accrued employee and agent benefits. Accrued employee and agent benefits were higher because of the lower return on plan assets in the cash balance pension plan due to market conditions.
Net cash provided by financing activities was $36.0 million in 2009, and net cash used in financing activities was $63.7 million in 2008 and $108.8 million in 2007. The net repayments of notes payable were $2.9 million in 2009, $7.5 million in 2008 and $4.3 million in 2007. Deposits on policyholder account balances equaled $239.6 million in 2009, $200.5 million in 2008 and $205.8 million in 2007. Withdrawals on policyholder account balances were $203.0 million in 2009, $240.5 million in 2008 and $294.8 million in 2007. Deposits net of withdrawals on policyholder account balances were $36.6 million in 2009. This resulted in a $76.7 million increase in 2009 versus 2008. The decrease in withdrawals can be attributed to the volatility in the equity markets and is consistent with falling interest rates. The net disposition of treasury stock totaled $0.3 million in 2009 compared to $16.8 million acquired in 2008 and $4.5 million acquired in 2007. The net disposition of treasury stock in 2009 reflects net sales from employee benefit plans of $2.6 and $2.3 million of open market purchases under the stock repurchase program. The net acquisition of treasury stock in 2008 reflects purchases from employee benefit plans of $8.5 million and $8.3 million of open market purchases. Finally, the Company’s stockholder dividends were $12.5 million in both 2009 and 2008 and were $36.4 million in 2007. During 2007, the Company paid a special, one-time dividend of $2.00 per share in addition to its quarterly dividends.
At December 31, 2009, the Company had $312.8 million in separate account assets. This was an increase of $54.3 million from $258.6 million at December 31, 2008. An improvement in investment performance increased separate accounts by $70.1 million in 2009 versus a decrease of $135.3 million in 2008. Also contributing to the increase in assets, policyholder withdrawals declined from $61.3 million in 2008 to $38.6 million in 2009. Deposits in separate accounts decreased in 2009 to $35.2 million versus $49.0 million in 2008. In addition, contract charges were $12.4 million and $14.2 million in 2009 and 2008, respectively.
The Company has access to unsecured revolving lines of credit of $60.0 million with two major commercial banks with no balances outstanding. These lines of credit will expire in June of 2010. The Company anticipates renewing these lines of credit as they come due.
Unrealized gains on available for sale securities, which are included as a component of stockholders’ equity (net of securities gains and losses, related taxes, policyholder account balances and deferred acquisition costs), totaled $0.8 million at December 31, 2009. This represents an improvement of $83.1 million from the $82.3 million unrealized investment loss position at December 31, 2008.
The Company’s statutory equity exceeds the minimum capital deemed necessary to support its insurance business, as determined by the risk-based capital calculations and guidelines established by the National Association of Insurance Commissioners. The Company believes these statutory limitations impose no practical restrictions on its dividend payment plans.
On January 25, 2010, the Board of Directors declared a quarterly dividend of $0.27 per share that was paid February 10, 2010 to stockholders of record as of February 4, 2010. On January 26, 2009, the Board of Directors declared a quarterly dividend of $0.27 per share, totaling $3.1 million, which was paid on February 10, 2009 to shareholders of record as of February 5, 2009.
Current legislative activities are not expected to have a significant impact on the ongoing operations of the Company.
The following table summarizes (in millions) the Company’s contractual obligations by due date and expiration date as of December 31, 2009. Contractual obligations of the Company are those obligations fixed by agreement as to dollar amount and date of payment.
Purchase obligations include contracts where the Company has a non-cancelable commitment to purchase goods and services.
Interest rate risk arises from the price sensitivity of investments to changes in interest rates. Coupon 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 coupon and dividend streams of existing fixed-rate investments become more valuable and market values rise. As interest rates rise, the opposite effect occurs.
The Company mitigates credit risk by diversifying the investment portfolio across a broad range of issuers, investment sectors and security types, and by limiting the amount invested in any particular entity. With the exception of certain GSEs, there is no exposure to any single corporate issuer greater than one percent of assets on a book value basis. The Company also invests in securities collateralized by physical assets. These securities can improve the likelihood of payment according to contractual terms and increase recovery amounts in the case of bankruptcy or restructuring.
The Company currently holds $137.0 million of foreign bonds. The foreign securities do not expose the Company directly to foreign currency risk, as the securities are denominated in U.S. dollars. As a result, the foreign currency risk lies with the issuer of the securities and may expose the issuer to fluctuations in the foreign currency market.
Kansas City Life believes its asset/liability management programs and procedures, along with certain product features, provide protection for the Company against the effects of changes in interest rates under various scenarios.
The Company performs cash flow scenario testing through models of its in-force business. These models reflect specific product characteristics and include assumptions based on current and anticipated experience regarding the relationships between short-term and long-term interest rates (i.e., the slope of the yield curve), credit spreads, market liquidity and other factors, including policyholder behavior in certain market conditions. In addition, these models include asset cash flow projections, reflecting interest payments, sinking fund payments, principal payments, bond calls and mortgage prepayments.
The Company has a risk that the asset or liability portfolio performance may differ from forecasted results as a result of unforeseen economic circumstances, estimates or assumptions that prove incorrect, unanticipated policyholder behavior or other factors. The result of such deviation of actual versus expected performance could include excess or insufficient liquidity in future periods. Excess liquidity, in turn, could result in reduced profitability on one or more product lines. Insufficient liquidity could result in the need to generate liquidity through borrowing, asset sales or other means. The Company believes that adherence to its asset/liability management programs will provide sufficient liquidity to enable it to fulfill its obligation to pay benefits under its various insurance and deposit contracts. On a historical basis, the Company has not needed to liquidate assets to ensure sufficient cash flows. The Company maintains borrowing lines on a secured and unsecured basis to provide additional liquidity, if needed.
The Company markets certain variable products. The policyholder assumes essentially all the investment earnings risk for the portion of the account balance invested in the separate accounts. However, the Company assesses certain charges based on the policy account values and changes to the account values can affect the Company's earnings. The portion of the policyholder's account balance invested in the fixed general account, if any, is affected by many factors, including the absolute level of interest rates, relative performance of the fixed income and equity markets, spreads between interest yields on investments and rates credited to the policyholder's accounts, and changes in consumer preferences.
Investment income is recognized when earned. Realized gains and losses on the sale of investments are determined on the basis of specific security identification recorded on the trade date. Securities available for sale are stated at fair value. Unrealized gains and losses, net of adjustments to deferred acquisition costs (DAC), value of business acquired (VOBA), policyholder account balances and deferred income taxes, are reported as a separate component of accumulated other comprehensive loss in stockholders' equity. Unrealized losses represent the difference between amortized cost and fair value on the valuation date. The adjustments to DAC and VOBA represent changes in the amortization of DAC and VOBA that would have been required as a charge or credit to income had such unrealized amounts been realized. The adjustment to policyholder account balances represents the increase from using a discount rate that would have been required if such unrealized gains or losses had been realized and the proceeds reinvested at current market interest rates, which were lower than the then-current effective portfolio rate.
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, 2009, approximately 92% of the carrying value of these investments was from external pricing services and 8% 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. Premiums and discounts on fixed maturity securities are amortized over the life of the related security as an adjustment to yield using the effective interest method. See Note 3 - Investments for further details.
Mortgage loans are stated at cost, adjusted for amortization of premium and accrual of discount, less a valuation reserve for probable losses. A loan is considered impaired if it is probable that contractual amounts due will not be collected. The valuation reserve is determined based upon historical impairment experience and insurance industry studies. Loans in foreclosure and loans considered to be impaired are placed on a non-accrual status.
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 balance sheet, with unrealized gains or losses recorded in accumulated other comprehensive loss. The unrealized gains or losses are recorded net of the adjustment to policyholder account balances to reflect what would have been earned had those gains or losses been realized and the proceeds reinvested.
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 with greater than 20% declines in fair value for six months or more, investments that have previously been written down and that remain in an unrealized loss position greater than 20% of their value, 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 economic outlook will be worse than expected or have more of an impact on the issuer than anticipated;
When a new block of business is acquired or when an insurance company is purchased, a portion of the purchase price is allocated to a separately identifiable intangible asset, called the value of business acquired (VOBA). VOBA is established as the actuarially determined present value of future gross profits of the business acquired and is amortized in proportion to future premium revenues or the expected future profits, depending on the type of business acquired. Amortization of VOBA occurs with interest over the anticipated lives of the underlying business to which it relates, initially 15 to 30 years. Similar to DAC, the assumptions regarding future experience can affect the carrying value of VOBA, including interest spreads, mortality, expense margins and policy and premium persistency experience. Significant changes in these assumptions can impact the carrying balance of VOBA and produce changes that are reflected in the current period’s income as an unlocking adjustment. A VOBA unlocking adjustment was made in the second quarter of 2009, which decreased the amortization of VOBA in the amount of $0.2 million for interest margins (2008 - increase of $0.2 million; 2007 - decrease of $1.1 million).
VOBA is 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 gross profits are insufficient to support the value of VOBA, 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 VOBA 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 VOBA asset from unrealized losses on fixed maturity securities in 2009 was $(12.4) million (2008 - $15.2 million; 2007 - $0.1 million).
In the normal course of business, the Company cedes risks to other insurers, primarily to protect the Company against adverse fluctuations in mortality experience and for capital management. Business is reinsured primarily through yearly renewable term and coinsurance agreements. Under yearly renewable term insurance, the Company pays annual premiums and the reinsurer reimburses claims paid related to this coverage. Under coinsurance, the reinsurer receives a proportionate share of the premiums less applicable commissions and is liable for a corresponding share of policy benefits. The Company remains contingently liable if the reinsurer should be unable to meet obligations assumed under the reinsurance contract. The Company also assumes risks ceded by other companies.
December 31, 2009 (2008 - $0.8 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 total separate account assets were $312.8 million as of December 31, 2009. Variable universal life and variable annuity assets comprised 29% and 71% of this amount, respectively. Guarantees are offered under variable universal life and variable annuity contracts: a guaranteed minimum death benefit (GMDB) rider is available on certain variable universal life contracts, and GMDB are provided on all variable annuities. The GMDB rider for variable universal life and variable annuity contracts guarantees the death benefit for specified periods of time, regardless of investment performance, provided cumulative premium requirements are met.
The following table presents the GMDB for the variable annuity incurred and paid death benefits for the three years ended December 31.
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 VBT and the 1975-1980 Select and Ultimate Basic Table serve as the bases for most mortality assumptions.
Liabilities for future policy benefits of accident and health insurance represent estimates of payments to be made on reported insurance claims, as well as claims incurred but not yet reported. These liabilities are estimated using actuarial analyses and case basis evaluations that are based upon past claims experience, claim trends and industry experience.
Premiums for traditional life insurance products are reported as revenue when due. Premiums on accident and health insurance are reported as earned ratably over the contract period in proportion to the amount of insurance protection provided. A reserve is provided for the portion of premiums written which relate to unexpired terms of coverage.
The Company and its subsidiaries file a consolidated federal income tax return that includes both life insurance companies and non-life insurance companies.
Due to the Company's capital structure and the absence of other potentially dilutive securities, there is no difference between basic and diluted earnings per common share for any of the years reported. The average number of shares outstanding during 2009 was 11,550,016 shares (2008 - 11,568,635 shares; 2007 - 11,836,213 shares). The number of shares outstanding at year-end 2009 was 11,565,091 (2008 - 11,435,204).
The Company has some insurance contracts where the policyholder is entitled to share in the earnings through dividends that reflect the difference between the premium charged and the actual experience. Participating business at year-end 2009 approximated 4% of statutory premiums and 5% of the life insurance in force. The amount of dividends to be paid is determined annually by the Board of Directors. Provision has been made in the liability for future policy benefits to allocate amounts to participating policyholders on the basis of dividend scales contemplated at the time the policies were issued. Additional provisions have been made for policyholder dividends in excess of the original scale, which have been declared by the Board of Directors.
In September 2005, guidance was issued for accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance contracts. Internal replacement is defined as a modification in product benefits, features, rights, or coverage that occurs by exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. This guidance became effective for internal replacements occurring in fiscal years beginning after December 31, 2006. The Company adopted this guidance on January 1, 2007 with no material impact to the consolidated financial statements.
In June 2006, the FASB issued guidance regarding accounting for uncertainty in income taxes. This guidance addresses whether tax positions taken or to be taken on tax returns should be reflected in the financial statements before they are resolved with the appropriate taxing authority. This guidance was adopted on January 1, 2007, with no material impact to the consolidated financial statements.
All other new accounting standards and updates of existing standards issued during 2009 did not relate to accounting policies and procedures pertinent to the Company at this time.
The Company owned six issues of similar securities for which values were not provided from either of the Company’s pricing services as of December 31, 2009. The Company received quoted prices from brokers for two of these securities and a documented market transaction price for a third. The Company utilized the mid-point of these prices to determine the fair value of the remaining three similar securities.
Fixed maturities and equity securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are determined as described in the preceding paragraphs.
The Company also has loans made to policyholders. These loans cannot exceed the cash surrender value of the policy. Fair value is calculated by discounting contractual cash flows, using discount rates based on the Company’s estimate of appropriate risk-adjusted discount rates for these loans.
The Company introduced a GMWB rider in 2007 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 $57.9 million (2008 - $31.1 million) and the guarantee liability was $(1.6) million at December 31, 2009 (2008 - $0.8 million). The value of the GMWB rider is recorded at fair value, and 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. 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 tables present categories reported at fair value on a recurring basis.
The roll forward of Level 3 assets begins with the prior period balance and adjusts the balance for the gains or losses (realized and unrealized) that occurred during the current period. Any new purchases that are identified as Level 3 securities are then added and any sales of securities which were previously identified as Level 3 are subtracted. Next, any securities which were previously identified as Level 1 or Level 2 securities and which are currently identified as Level 3 are added. Securities which were previously identified as Level 3 and which are now designated as Level 1 or as Level 2 are subtracted. Finally, securities which were previously identified as Level 3 and which are now designated as Level 1 or as Level 2 are subtracted. The ending balance represents the current fair value of securities which are designated as Level 3.
The Company had $4.1 million transfers into Level 3 and $40.2 million transfers out of Level 3 for the year ended December 31, 2009. The Company did not exclude any realized or unrealized gain or losses on items transferred into Level 3. Transfers into Level 3 occur when the Company, it its opinion, cannot obtain a fair value that it believes is a Level 1 or Level 2 fair value.
The following table provides amortized cost and fair value of securities by asset class at December 31, 2009.
The following table provides the net unrealized gains (losses) reported in accumulated other comprehensive income (loss) on the Company’s investments in securities available for sale, at December 31.
The following table provides a rollforward of credit losses recognized in earnings for the year ending December 31, 2009.
During 2009, net impairment losses of $18.9 million were due to other-than-temporarily impaired write-downs of investments securities, compared to $62.7 million in 2008. In the fourth quarter of 2009, the Company experienced $1.9 million of net impairment losses on of the Company’s real estate joint ventures, specifically attributable to two 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.
One security from a global commercial finance company that provides financial products and advisory services to a range of industry sectors was written down $0.3 million. This company has been affected by the credit crisis, causing reduced access to liquidity and higher borrowing costs. This security had been written down in a previous period. The Company determined that a credit-related impairment had occurred, and this security was sold during the third quarter of 2009.
One security was from a financial institution that had been impacted by the housing and mortgage credit crisis and had been supported through Troubled Assets Relief Program (TARP) funds. This company has experienced large losses in its real estate loan portfolios and has had an increase in non-performing loans over the past year. This security was written down by a total of $1.5 million before it was sold during the third quarter of 2009.
The Company’s analysis of securities for the quarter ended December 31, 2008 resulted in the determination that 16 securities (14 issuers) had other-than-temporary impairments and were written down by a combined $20.0 million.
Two of the securities were preferred stocks of government-sponsored agencies that were written down by a total of $0.4 million. These entities buy and hold mortgages and issue and sell guaranteed residential mortgage-backed securities to facilitate housing ownership. They are now operated in conservatorship by the U.S. government and their existing common and preferred stock securities are severely diluted. Dividend payments were suspended, driving the fair value of these securities down.
Three securities were CDOs that were written down by a total of $5.3 million. These securities were impacted by the rapid rise in delinquencies and foreclosures in the sub-prime and Alt-A mortgage markets, along with a decline in the fair value of securities issued by financial institutions. Ongoing CDO liquidations and investor selling caused extreme declines in market valuations, regardless of individual security performance.
Two securities were written down by $1.9 million due to a decline in price that had persisted for a period longer than the Company considered temporary. One of these securities was subsequently sold during the fourth quarter of 2008.
One security was from an originator of residential prime, Alt-A and subprime mortgages that was written down $4.2 million. The significant decline in the subprime and non-conforming mortgage markets resulted in a reduction in value for this security.
One security was from an issuer that designs, manufactures and services cars and trucks and provides vehicle-related financing, leasing and insurance was written down $1.2 million, largely resulting from the decline in the U.S. automotive industry.
Four securities (two issuers) were perpetual preferred securities that were written down $3.3 million. These securities had been negatively impacted by the housing and mortgage credit crisis and have received TARP (Troubled Assets Relief Program) funds.
The Company’s analysis of securities for the quarter ended September 30, 2008 resulted in the determination that ten fixed-maturity issuers (twelve specific securities) had other-than-temporary impairments and were written down by a combined $32.5 million in the third quarter.
The Company’s analysis of securities for the quarter ended June 30, 2008 resulted in the determination that seven fixed-maturity securities had other-than-temporary impairments. These securities were written down by a combined $10.2 million in the second quarter.
The following table provides information regarding investment securities with unrealized losses on fixed maturity and equity security investments for sale, 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, 2009, the Company had unrealized losses on its investment portfolio for fixed maturities and equity securities as follows:
At December 31, 2008, the Company had unrealized losses on its investment portfolio for fixed maturities and equity securities as follows:
security issues representing 61% of the issues with unrealized losses, including 94% being rated as investment grade, were below cost for less than one year;
security issues representing 26% of the issues with unrealized losses, including 92% being rated as investment grade, were below cost for three years or more.
In addition, securities having unrealized losses greater than 20% are further evaluated based upon the length of time that they have been above the 20% unrealized loss threshold. Securities in this classification are divided into three different categories, including less than six months, six months or more and less than twelve months, and twelve months or greater. The Company had investment grade securities with unrealized losses of greater than 20% that totaled $3.3 million and $5.8 million for less than six months and six or more and less than twelve-month periods, respectively, at December 31, 2009. The Company had investment grade securities with unrealized losses of greater than 20% for twelve months or greater that totaled $12.7 million. The Company had below investment grade securities with unrealized losses of greater than 20% for six months or more and less than twelve months that totaled $1.7 million at December 31, 2009. Below investment grade securities with unrealized losses greater than 20% for twelve months or greater totaled $4.0 million.
The Company had investment grade securities with unrealized losses of greater than 20% that totaled $5.6 million for twelve months or greater at December 31, 2009. The Company had below investment grade securities with unrealized losses of greater than 20% that totaled $17.7 million. The Company had below investment grade securities with unrealized losses of greater than 20% for twelve months or greater that totaled $15.7 million at December 31, 2009.
The following table provides information regarding fixed maturity securities by asset class at December 31, 2009.
Investments in mortgage loans totaled $457.6 million at December 31, 2009 ($445.4 million - December 31, 2008). The Company’s mortgage loans are mostly secured by commercial real estate and are carried net of a reserve of $3.4 million (2008 - $3.4 million). The valuation reserve for mortgage loans is maintained at a level believed by management to be adequate to absorb estimated 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. No mortgage loans were foreclosed upon and transferred to real estate investments during the past three years. Also, there were no delinquent mortgage loans at December 31, 2009 and there were no delinquent mortgage loans at December 31, 2008. The Company does not hold mortgage loans of any borrower that exceeds 5% of stockholders’ equity.
The Company had commitments to originate mortgage loans of $7.7 million at December 31, 2009. These commitments expire in 2010.
In December 2009, a construction-to-permanent loan in the amount of $16.0 million was executed. The Company anticipates that disbursement of loan proceeds will start in July 2010 with completion of the construction and stabilization phase by September 2011.
Investments in real estate totaled $114.1 million at December 31, 2009 ($99.6 million at December 31, 2008). The table below provides information concerning the Company's real estate investments by major category as of December 31.
As a member of the FHLB with a capital investment of $5.0 million, the Company has the ability to borrow on a collateralized basis from the FHLB. The Company received annual dividends on the capital investment in the FHLB equal to $0.1 million (2008 - $0.3 million; 2007 - $0.3 million).
The Company has unsecured revolving lines of credit of $60.0 million with two major commercial banks with no balances outstanding and which are at variable interest rates. These lines of credit will expire in June of 2010. The Company anticipates renewing these lines of credit as they come due.
Interest paid on all borrowings was less than $.01 million in 2009 (2008 - $1.1 million; 2007 - $1.6 million). The interest expense on all borrowings was less than $.01 million in 2009 (2008 - $1.1 million; 2007 - $1.6 million).
Stockholder dividends may not exceed statutory unassigned surplus. Additionally, under Missouri law, the Company must have the prior approval of the Missouri Director of Insurance in order to pay dividends in any consecutive twelve-month period exceeding the greater of statutory net gain from operations for the preceding year or 10% of statutory stockholders' equity at the end of the preceding year. The maximum stockholder dividends payable in 2010 without prior approval is $31.3 million, 10% of 2009 surplus. The Company believes these statutory limitations impose no practical restrictions on its dividend payment plans.
The total amount of unrecognized tax benefits, if recognized, that would impact the effective tax rate was $0.6 million and $0.7 million as of December 31, 2009 and 2008, respectively.
The Company recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense (benefit). During the years ended December 31, 2009, 2008, and 2007, the Company recognized expense (benefit) of approximately ($0.2) million, $0.1 million, and $0.3 million in interest and penalties, respectively. The Company had approximately $0.7 million and $0.9 million for the payment of interest and penalties accrued at December 31, 2009 and 2008, respectively.
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 2010.
marketplace, 4) actual returns on plan assets, and 5) current and anticipated future allocation among asset classes. The asset classes used for this analysis are domestic and international equities, investment grade corporate bonds, alternative assets, and cash. The overall rate is derived as a weighted average of the estimated long-term returns on the asset classes represented in the investment portfolio of the plan.
The assumed discount rates used to determine the benefit obligation for pension benefits and postretirement benefits are 5.62% and 6.01%, respectively. The discount rates were determined by reference to the Citigroup Pension Liability Yield Curve on December 31, 2009. 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 market 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.
Non-contributory defined contribution retirement plans for eligible general agents and sales agents provide supplemental payments based upon earned agency first year individual life and annuity commissions. Contributions to these plans in 2009 were $0.1 million (2008 - $0.1 million; 2007 - $0.1 million). Non-contributory deferred compensation plans for eligible agents based upon earned first year commissions are also offered. Contributions to these plans were $0.3 million (2008 - $0.4 million; 2007 - $0.4 million).
The Company recognizes the funded status of its defined pension and postretirement plans, measured as the difference between plan assets at fair value and the benefit obligation, on the balance sheet. Changes in the funded status that arise during the period but are not recognized as components of net periodic benefit cost are recognized within other comprehensive income (loss) net of taxes.
The following table presents the fair value of each major category of pension plan and other postretirement assets as of December 31:
The following table discloses the changes in Level 3 assets measured at fair value on a recurring basis for the years ended December 31:
The estimated net loss and prior service cost for the pension plans that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost over the next year is $3.5 million and ($0.6 million), respectively.
For measurement purposes a 10.5% annual increase in the per capita cost of covered health care benefits was assumed to decrease gradually to 6.0% in 2018 and thereafter.
The following table provides information about the outstanding three-year intervals as of December 31, 2009.
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. During 2007, the plan made a payment of $1.0 million to plan participants for the three-year interval ended December 31, 2006. The change in accrual for share-based compensation that reduced operating expense during 2009 was $0.1 million, net of tax. The cost of
Kansas City Life acquired a block of traditional life and universal life products in 1997. As of December 31, 2009, the block had $1.5 billion of life insurance in force (2008 - $1.6 billion). The block generated life insurance premiums of $3.2 million (2008 - $3.4 million) and had reinsurance ceded of $1.0 million (2008 - $1.0 million).
The maximum retention on any one life is $350 for ordinary life plans and $100 for group coverage. A contingent liability exists with respect to reinsurance, which may become a liability of the Company in the unlikely event that the reinsurers should be unable to meet obligations assumed under reinsurance contracts. The solvency of reinsurers is reviewed annually.
Comprehensive income (loss) is comprised of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes the unrealized investment gains or losses on securities available for sale (net of adjustments for realized investment gains or losses) net of adjustments to DAC, VOBA and policyholder account balances. In addition, other comprehensive income (loss) includes the change in the benefit plan obligations liability. Other comprehensive income (loss) also includes deferred income taxes on these items.
Effective for the period ended March 31, 2009, the Company adopted FASB ASC 320. Pursuant to this guidance, the Company reviewed all previously-recorded other-than-temporary impairments of securities and developed an estimate of the portion of such impairments using a methodology consistent with that applied to the current period other-than-temporary bifurcation of credit and non-credit as of January 1, 2009. As a result, the Company determined that $13.5 million in previously recorded other-than-temporary impairments had been due to non-credit impairments.
The process used by the Company in estimating the portion of previously recorded other-than-temporary impairments due to credit is consistent with the methodology employed for those securities determined to be other-than-temporarily impaired for the twelve-month period ended December 31, 2009. Specifically, if the security is unsecured, secured by an asset or includes a guaranty of payment by a third-party, the estimate of the portion of impairment due to credit was based upon a comparison of ratings and maturity horizon for the security relative to historical default probabilities from one or more nationally recognized rating organizations. When appropriate for any given security, sector or period in the business cycle, the historical default probability was adjusted to reflect periods or situations of distress by adding to the default probability increments of standard deviations from mean historical results. The credit impairment analysis was supplemented by estimates of potential recovery values for the specific security, including the potential impact of the value of any secured assets, in the event of default. This information is used to determine the Company’s best estimate, derived from probability-weighted cash flows.
In addition, as an insurance enterprise, the Company must also consider the impact of DAC and VOBA on any realized and unrealized loss and the appropriate tax effect. The establishment of non-credit impairments to accumulated other comprehensive income (loss) in accordance with the guidance from retained earnings also requires a netting of applicable DAC and VOBA and income taxes. The methodology by which DAC and VOBA are calculated and applied to realized gains and losses is different than the methodology employed to calculate DAC and VOBA charges on unrealized gains and losses and results in differences among the transfer between retained earnings and accumulated other comprehensive loss.
Although no assurances can be given and no determinations can be made at this time, management believes that the ultimate liability, if any, with respect to these claims and actions, would not have a material effect on the Company’s business, results of operations or financial position.
Premium revenue includes direct premiums and premiums from reinsurance, reduced by premiums on reinsurance ceded.
All other information required by this Schedule is shown in Note 12 - Reinsurance
We have audited the accompanying consolidated balance sheets of Kansas City Life Insurance Company and subsidiaries (the Company) as of December 31, 2009 and 2008, 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, 2009. In connection with our audit of the consolidated financial statements, we have also audited financial statement schedules I-V. We also audited the Company’s internal control over financial reporting as of December 31, 2009, based on, criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. 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 of Kansas City Life Insurance Company and subsidiaries (the Company) is responsible for establishing and maintaining effective internal control over financial reporting. Management of the Company has conducted an assessment of the Company’s internal control over financial reporting at December 31, 2009, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based upon that assessment, Management concluded that the Company’s internal control over financial reporting was effective at December 31, 2009.
The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives, and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to a future period are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Kansas City Life Insurance Company recorded net income of $2.1 million or $0.18 per share in the fourth quarter of 2009 compared with a net loss of $7.2 million or $0.62 per share for the same quarter in the prior year. The increase in earnings in the fourth quarter of 2009 was primarily due to an $11.9 million decrease in realized investment losses and a $4.2 million improvement in net investment income. Partially offsetting these improvements was a $2.4 million increase in operating
The Company’s investment performance improved through increased net investment income, reduced realized investment losses and increased values on securities owned. Net investment income increased $4.2 million in the fourth quarter compared with a year ago and was flat for the year versus the prior year. In the fourth quarter, the Company experienced an improvement in rates earned, primarily from yields on an alternative investment fund. Realized investment losses totaled $2.8 million for the fourth quarter, which was an $11.9 million improvement compared with the prior year’s fourth quarter. Likewise, realized investment losses were $10.1 million for the year compared with realized investment losses of $52.3 million one year earlier. A significant factor in the reduced realized investment losses was improved market values on a broad range of asset classes and sectors. During 2009, the Company’s investment securities improved $192.3 million, ending the year in an unrealized gain position of $0.2 million.
Total benefits and expenses decreased less than 1% for the fourth quarter but increased 1% for the year. Most significantly, death benefits improved in the fourth quarter and for the year compared with the prior year and quarter. Interest credited to policyholder account balances increased $0.2 million or less than 1% in the fourth quarter, reflecting a slight increase in crediting rates on selected products. Interest credited on policyholder account balances for the year was down $0.2 million or less than 1%.
On January 25, 2010, the Kansas City Life Board of Directors declared a quarterly dividend of $0.27 per share that was paid on February 10, 2010 to stockholders of record on February 4, 2010.