One-time events, primarily reflected in realized gains, comprise a substantial portion of the net income and revenue reported by the Company during 2014 and 2013. The magnitude of realized investment gains and losses in a given year is a function of the timing of trades of investments relative to the markets themselves as well as the recognition of any impairments on investments. Future earnings will be significantly negatively impacted should earnings from these one-time items not be realizable in a future period. While Management believes there remain additional investments with such one-time earnings, when or if realized remains uncertain.
The Company's gross investment income and net investment income were down approximately 17% and 27%, respectively, when comparing the current and prior year results. Investment expenses were up approximately 9% when comparing the current and prior year results. The variance in investment income, when comparing the current and prior year results, is mainly attributable to fluctuations in the earnings of the trading securities, discounted mortgage loans and real estate investment portfolios.
During the current year, the Company reported a loss of approximately $(476,000) in the trading securities portfolio compared to a small loss of approximately $(1,000) in the prior year. The fluctuation in earnings from the trading securities portfolio is attributable to market value fluctuations of these investments.
Income from the discounted mortgage loan portfolio decreased approximately 52% or $4 million when comparing 2014 and 2013 results. Income from discounted mortgage loans represented 22% of the consolidated net investment income reported by the Company during 2014. Income from the discounted mortgage loan portfolio is mainly the result of one-time events.
The Company's investment expenses increased approximately 9% or $700,000 when comparing the 2014 and 2013 results. Investment expenses are expected to vary from year to year depending on the resources utilized by the Company to maintain and work the investment portfolio. The current year increase in investment expenses is mainly attributable to increased costs associated with certain real estate investments.
The Company reported net gains of approximately $2.6 million from the sale of equity securities. During the second and fourth quarters of 2014, the Company recognized gains totaling approximately $1.9 million from the redemption of a portion of a preferred stock the Company holds in the equity investment portfolio.
In recent periods, Management's focus has been directed towards promoting and growing TPA services to unaffiliated life insurance companies. The Company receives monthly fees based on policy in-force counts and certain other activity indicators, such as number of premium collections performed, or services performed. For the years ended 2014 and 2013, the Company received approximately $1.7 million and $2 million for this work, respectively. Revenues from TPA fees are included in the line item "other income" on the Company's Consolidated Statements of Operations. The Company intends to continue to pursue other TPA arrangements as well. The Company provides TPA services to insurance companies seeking business process outsourcing solutions. Management believes the Company is positioned to generate additional revenues by utilizing the Company's current excess capacity and administrative services.
In the fourth quarter of 2013, Management made the determination to not renew its largest third party administration ("TPA") contract when the contract was due for renewal in the fourth quarter of 2014. This contract represented approximately 60% of the Company's total TPA revenues. The contract with this TPA ended September 30, 2014.
In summary, the Company's basis for future revenue growth is expected to come from the following primary sources: expansion of TPA revenues, conservation of business currently in-force, the maximization of investment earnings, including realized gains, and the acquisition of other companies or policy blocks in the life insurance business. Management has placed a significant emphasis on the development of these revenue sources to enhance these opportunities.
Benefits, claims and settlement expenses, net of reinsurance benefits, increased approximately 2% in 2014 compared to 2013. The increase primarily relates to changes in the Company's death claim experience. Policy claims vary from year to year and therefore, fluctuations in mortality are to be expected and are not considered unusual by Management.
Management continues to place significant emphasis on expense monitoring and cost containment. Maintaining administrative efficiencies directly impacts net income.
The Company's total investments represented 83% of the Company's total assets in both 2014 and 2013. However, the investment mix changed from 2013 to 2014 based upon Management's investment decisions and opportunities available in the market. The Company's fixed maturities investment portfolio currently represents 60% of the Company's investment portfolio, an increase of 9% from the prior year. The Company's real estate investment portfolio currently represents 16% of the total investment portfolio, a decrease of 8% compared to the prior year. During 2014, UG's majority owned subsidiary, HPG Acquisitions, LLC, sold all of the real estate it owned in Midland, Texas and recognized a gain of approximately $10.1 million. Upon the closing of the real estate sale, HPG made a distribution to UG and the minority interest owners, which is the main reason for the fluctuation in the non-controlling interest balance reported on the Company's Consolidated Balance Sheets. UG reinvested a substantial portion of the distribution from HPG in fixed maturity securities.
Liquidity provides the Company with the ability to meet on demand the cash commitments required by its business operations and financial obligations. The Company's liquidity is primarily derived from a portfolio of marketable securities and line of credit facilities. The primary cash needs of the Company are for the payment of claims and operating expenses, maintaining adequate statutory capital and surplus levels and meeting debt service requirements.
UTG is a holding company that has no day-to-day operations of its own. Cash flows from UTG's insurance subsidiary, UG, are used to pay costs associated with maintaining the Company in good standing with states in which it does business, servicing the Company's debt and purchasing outstanding shares of UTG stock. UTG's cash flow is dependent on management fees received from its insurance subsidiary, stockholder dividends from its subsidiary and earnings received on cash balances. As of December 31, 2014 and 2013, substantially all of the consolidated shareholders equity represents net assets of its subsidiaries. In 2014, the Parent company received $4.8 million in dividends from its insurance subsidiary and $2.7 million in 2013. Certain restrictions exist on the payment of dividends from the insurance subsidiary to the Parent company. For further information regarding the restrictions on the payment of dividends by the insurance subsidiary, see Note 9 - Shareholders' Equity in the Notes to the Consolidated Financial Statements. Although these restrictions exist, dividend availability from the insurance subsidiary has historically been sufficient to meet the cash flow needs of the Parent company.
An additional source of liquidity to the Parent company and its subsidiaries is the line of credit facilities extended to them that allow borrowings of up to $12.4 million. As of December 31, 2014, the Company and its subsidiaries had available $8 million in line of credit facilities. As of December 31, 2013, the Company and its subsidiaries had available $20.9 million in line of credit facilities. For additional information regarding the line of credit facilities, see Note 7 - Credit Arrangements in the Notes to the Consolidated Financial Statements.
During 2014, the Company's investing activities provided net cash of approximately $34.3 million. During 2013, the Company's investing activities provided net cash of approximately $6.2 million. Proceeds from investments sold increased approximately 19% or $20.1 million when comparing 2014 to 2013. Investment purchases decreased approximately 10% or $10 million. The net cash provided by investing activities is expected to vary from year to year depending on market conditions and management's ability to find and negotiate favorable investment contracts.
The Company had outstanding debt of $4.4 million as of December 31, 2014. This outstanding debt belongs to UTG Avalon, LLC, a wholly owned subsidiary of UG. See Note 7 - Credit Arrangements in the Notes to the Consolidated Financial Statements for detailed disclosures regarding the Company's notes payable.
At December 31, 2014, UG has a ratio of approximately 5.08, which is 508% of the authorized control level. Accordingly, the Company meets the RBC requirements.
The Board of Directors of UTG has authorized the repurchase in the open market or in privately negotiated transactions of UTG's common stock. During December of 2014, the Board of Directors approved a resolution to increase the repurchase amount by $1 million, for a total repurchase of $7 million. Repurchased shares are available for future issuance for general corporate purposes. This program can be terminated at any time. Open market purchases are made based on the last available market price and are generally limited to a maximum per share price of the most recent reported per share GAAP equity book value of the Company. During 2014, the Company repurchased 74,172 shares through the stock repurchase program for $996,851. Through December 31, 2014, UTG has spent $6.1 million in the acquisition of 662,698 shares under this program.
We have audited the accompanying consolidated balance sheets of UTG, Inc. (a Delaware corporation, the "Company") and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income (loss), shareholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
Property and Equipment - Company-occupied property, data processing equipment and furniture and office equipment are stated at cost less accumulated depreciation of $3,868,331 and $3,559,052 at December 31, 2014 and 2013, respectively. Depreciation is computed on a straight-line basis for financial reporting purposes using estimated useful lives of three to thirty years. Depreciation expense was $309,279 and $159,743 for the years ended December 31, 2014 and 2013, respectively.
Future Policy Benefits and Expenses - The liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance subsidiary's experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. The Company makes these assumptions at the time the contract is issued or, in the case of contracts acquired by purchase, at the purchase date. Future policy benefits for individual life insurance and annuity policies are computed using interest rates ranging from 2% to 6% for life insurance and 2.5% to 7.5% for annuities. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. The mortality rate assumptions for policies currently issued by the Company are based on 2001 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or C, which are industry standard actuarial tables for forecasting assumed policy lapse rates.
Benefit reserves for universal life insurance and interest sensitive life insurance products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims in excess of related policy account balances. Interest crediting rates for universal life and interest sensitive products range from 4.0% to 5.5% as of December 31, 2014 and 2013.
Recognition of Revenues and Related Expenses - Premiums for traditional life insurance products, which include those products with fixed and guaranteed premiums and benefits, consist principally of whole life insurance policies, and certain annuities with life contingencies are recognized as revenues when due. Limited payment life insurance policies defer gross premiums received in excess of net premiums, which is then recognized in income in a constant relationship with insurance in-force. Accident and health insurance premiums are recognized as revenue pro rata over the terms of the policies. Benefits and related expenses associated with the premiums earned are charged to expense proportionately over the lives of the policies through a provision for future policy benefit liabilities and through deferral and amortization of deferred policy acquisition costs. For universal life and investment products, generally there is no requirement for payment of premium other than to maintain account values at a level sufficient to pay mortality and expense charges. Consequently, premiums for universal life policies and investment products are not reported as revenue, but as deposits. Policy fee revenue for universal life policies and investment products consists of charges for the cost of insurance and policy administration fees assessed during the period. Expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances.
Income Taxes - In July 2013, the Financial Accounting Standards Board ("FASB") issued guidance providing specific financial statement presentation requirements of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The guidance states that an unrecognized tax benefit in those circumstances should be presented as a reduction to the deferred tax asset. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The adoption of this guidance did not have a material impact on the Company's consolidated financial statements.
The following table provides a summary of fixed maturities by contractual maturity as of December 31, 2014. Actual maturities could differ from contractual maturities due to call or prepayment provisions:
The Company held below investment grade investments with an estimated market value of $9,142,063 and $13,842,824 as of December 31, 2014 and 2013, respectively. The investments are all classified as "All other corporate bonds".
The fair value of investments with sustained gross unrealized losses at December 31, 2014 and 2013 are as follows:
Substantially all of the unrealized losses on fixed maturities available for sale at December 31, 2014 and 2013 are attributable to changes in market interest rates and general disruptions in the credit market subsequent to purchase. The unrealized losses on equity investments were primarily attributable to normal market fluctuations. The Company does not currently intend to sell nor does it expect to be required to sell any of the securities in an unrealized loss position. Based upon the Company's expected continuation of receipt of contractually required principal and interest payments and its intent and ability to retain the securities until price recovery, as well as the Company's evaluation of other relevant factors, the Company deems these securities to be temporarily impaired as of December 31, 2014 and 2013.
Earnings from trading securities are classified in cash flows from operating activities.
A mortgage loan reserve is established and adjusted based on Management's quarterly analysis of the portfolio and any deterioration in value of the underlying property which would reduce the net realizable value of the property below its current carrying value. The Company acquired the discounted mortgage loans at below contract value, and believes that it will fully recover its carrying value upon disposal, therefore no reserve for delinquent loans is deemed necessary. Those not currently paying are being vigorously worked by Management. The current discounted commercial mortgage loan portfolio has an average price of 27.3% of face value and Management has determined that this deep discount provides a financial cushion or built in allowance for any of the loans that are not currently performing within the portfolio of loans purchased. The mortgage loan reserve was $0 at December 31, 2014 and 2013.
The following table summarizes the number loans held in the discounted mortgage loan portfolio and the carrying value of the loans as of December 31, 2014:
The following table summarizes discounted mortgage loan holdings of the Company for the periods ended December 31:
Equity securities may experience other-than-temporary impairments in the future based on the prospects for full recovery in value in a reasonable period of time and the Company's ability and intent to hold the security to recovery. If a decline in fair value is judged by Management to be other-than-temporary or Management does not have the intent or ability to hold a security, a loss is recognized by a charge to other-than-temporary impairment losses in the Consolidated Statements of Operations.
The other-than-temporary impairments recognized during 2014 and 2013 were taken as a result of Management's assessment and consideration of the length of time the securities have remained in an unrealized loss position and as a result of management's analysis and determination of value. The investments were written down to better reflect their current expected market value.
Equity securities available for sale consist of common and preferred stocks mainly in private equity investments and financial institutions. Equity securities for which there is sufficient market data are categorized as Level 1 or 2 in the fair value hierarchy. For the equity securities in which quoted market prices are not available, the transaction price is used as the best estimate of fair value at inception. When evidence is believed to support a change to the carrying value from the transaction price, adjustments are made to reflect the expected exit values. The Company performs ongoing reviews of the underlying investments. The reviews consist of the evaluations of expected cash flows, material events and market data. These investments are included in Level 3 of the fair value hierarchy.
The following table presents the Company's assets and liabilities measured at fair value in the consolidated balance sheet on a recurring basis as of December 31, 2013.
The following table provides reconciliations for Level 3 assets measured at fair value on a recurring basis. Transfers into and out of Level 3 are recognized as of the end of the quarter in which they occur.
There were no transfers in or out of Level 3 as of December 31, 2014. Transfers occur when there is a lack of observable market information.
The fair values of mortgage loans on real estate are estimated using discounted cash flow analyses and interest rates being offered for similar loans to borrowers with similar credit ratings. The inputs used to measure the fair value of our mortgage loans on real estate are classified as Level 3 within the fair value hierarchy.
The Company invests in collateral and non-collateral loans that are reported in the other assets balance on the Company's Consolidated Balance Sheets. The loans are carried at their unpaid principal balances, which approximates fair value. The inputs used to measure the fair value of the loans are classified as Level 3 within the fair value hierarchy.
The carrying value is a reasonable estimate of fair value for notes payable subject to floating rates of interest. The fair value of notes payable with fixed rate borrowings is determined based on the borrowing rates currently available to the Company for loans with similar terms and average maturities. The inputs used to measure the fair value of our notes payable are classified as Level 2 within the fair value hierarchy.
On September 30, 1998, UG entered into a coinsurance agreement with The Independent Order of Vikings, (IOV) an Illinois fraternal benefit society. Under the terms of the agreement, UG agreed to assume, on a coinsurance basis, 25% of the reserves and liabilities arising from all in-force insurance contracts issued by the IOV to its members. At December 31, 2014, the IOV insurance in-force assumed by UG was approximately $1,503,000, with reserves being held on that amount of approximately $346,000. At December 31, 2013, the IOV insurance in-force assumed by UG was approximately $1,551,000, with reserves being held on that amount of approximately $350,000.
The Company does not have any short-duration reinsurance contracts. The effect of the Company's long-duration reinsurance contracts on premiums earned in 2014 and 2013 were as follows:
At December 31, 2014 and 2013, respectively, the Company had gross deferred tax assets of $2,405,249 and $2,562,650, respectively, and gross deferred tax liabilities of $11,819,043 and $12,196,291, respectively, resulting from temporary differences primarily related to the life insurance subsidiary. A valuation allowance is to be provided when it is more likely than not that deferred tax assets will not be realized by the Company. No valuation allowance has been recorded relating to the Company's deferred tax assets since, in Management's judgment, the Company will more likely than not have sufficient taxable income in future periods to fully realize its existing deferred tax assets.
The Company's Federal income tax returns are periodically audited by the Internal Revenue Service ("IRS"). In February 2011, the IRS audited UTG's 2009 federal income tax return. The examination was closed with no adjustments to the return. There are currently no examinations in process, nor is Management aware of any pending examination by the IRS. The statutes of limitation for the assessments of additional tax are closed for all tax years prior to 2011. Management believes that adequate provision has been made in the consolidated financial statements for any potential assessments that may result from future tax examinations and other tax-related matters for all open tax years.
The UTG line of credit carries interest at a fixed rate of 3.75 % and is payable monthly. As collateral, UTG has pledged 100% of the common voting stock of its wholly owned subsidiary, Universal Guaranty Life Insurance Company ("UG"). During July of 2014, the Company borrorwed an additional $1,600,000 on the line of credit. The proceeds were used to purchase an interest in an aircraft. The Company made principal payments of $3,697,534 on the line of credit during 2014.
During 2010, the Company made a commitment to invest in Llano Music, LLC ("Llano"), which invests in music royalties. The Company increased its funding commitment by $2,000,000 during 2014. Llano makes capital calls to its investors as funds are needed to acquire the royalty rights.
During 2013, the Company committed to invest in MM-Appalachia IV, LP, which purchases land for leasing opportunities to those looking to harvest natural resources. MM-Appalachia IV, LP makes capital calls to investors as funds are needed for continued land purchases. During the first quarter of 2015, the Company committed to invest an additional $825,000 in this investment. Also, during the first quarter of 2015, MM-Appalachia IV, LP called $371,250 of the unfunded commitment.
UG is domiciled in the state of Ohio. Ohio requires notification within five business days to the insurance commissioner following the declaration of any ordinary dividend and at least ten calendar days prior to payment of such dividend. Ordinary dividends are defined as the greater of: a) prior year statutory net income or b) 10 % of statutory capital and surplus. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. UG paid ordinary dividends of $4,800,000 and $2,700,000 to UTG in 2014 and 2013, respectively. No extraordinary dividends were paid during the two year period. UTG used the dividends received during 2013 and 2014 to retire its outstanding debt and purchase outstanding shares of UTG stock.
On September 28, 2011 UTG entered a joint ownership agreement with Bandyco, LLC and First Southern National Bank, for an 8.08 % interest in an aircraft. Bandyco, LLC is affiliated with Ward F Correll, who is a Director of the Company. The Company paid a monthly operational fee of $25,000 through July of 2014 when the aircraft was sold. During July of 2014, the Company acquired a different aircraft. UTG paid $1,600,000 in the acquisition of the aircraft, increasing the Company's ownership interest to 30.10 %. The aircraft is used for business related travel by various officers and employees of the Company. For years 2014 and 2013, UTG paid $879,453 and $427,776 for costs associated with the aircraft.
Effective January 1, 2007, UTG entered into administrative services and cost sharing agreements with its subsidiary. Under this arrangement, the subsidiary pays its proportionate share of expenses, based on an allocation formula. During 2014 and 2013, UG paid $8,902,568 and $7,442,588 respectively, in expenses. The Ohio Department of Insurance has approved the cost sharing agreement and it is Management's opinion that where applicable, costs have been allocated fairly and such allocations are based upon accounting principles generally accepted in the United States of America.
The Company reimbursed expenses incurred by employees of FSNB relating to salaries, travel and other costs incurred on behalf of or relating to the Company. The Company paid $325,479 and $56,510 in 2014 and 2013, respectively to FSNB in reimbursement of such costs. In addition, the Company reimburses FSNB a portion of salaries and pension costs for Mr. Correll and Mr. Ditto. The reimbursement was approved by the UTG Board of Directors and totaled $332,725 and $332,029 in 2014 and 2013, respectively, which included salaries and other benefits.
During the fourth quarter of 2014, UG's wholly-owned subsidiary, UTG Avalon, LLC, entered into a noncash transaction whereby the subsidiary obtained a promissory note in the amount of $4.4 million and utilized the note to repay the line of credit.
The Company reinsures that portion of insurance risk which is in excess of its retention limits. Retention limits range up to $125,000 per life. Life insurance ceded represented 21% of total life insurance in force at December 31, 2014 and 2013. Insurance ceded represented 29% and 27% of premium income for 2014 and 2013, respectively. The Company would be liable for the reinsured risks ceded to other companies to the extent that such reinsuring companies are unable to meet their obligations.