The Company's corporate headquarters is located in a two story office building in Lake Mary, Florida, which is owned by the Company. The Company occupies the entire second floor of the building. The remaining rentable space is fully leased as of December 31, 1998.
Management's discussion and analysis of financial condition and results of operation.
In recent years the Company has primarily issued two types of insurance products, universal life and final expense products. Universal life provides insurance coverage with flexible premiums, within limits, which allow policyholders to accumulate cash values. The accumulated cash values are credited with tax-deferred interest, as adjusted by the Company on a periodic basis. Deducted from the cash accumulations are administrative charges and mortality costs. Should a policy surrender in its early years, the Company assesses a surrender fee against the cash value accumulations based on a graded formula. Final expense products are traditional endowment type insurance policies written for the senior market. Because they are written to a senior market they are designed to accommodate adverse health conditions. Because of the size of the policies they are usually issued with only limited underwriting. The coverage size of the policy is roughly equivalent to the insured's anticipated funeral costs.
Pursuant to the accounting methods prescribed by Statement of Financial Accounting Standards No. 97 (SFAS 97), premiums received from policyholders on universal life products are credited to policyholder account balances and treated as a liability rather than income. Revenues on such products result from the mortality and administrative fees charged to policyholder balances in addition to surrender charges assessed at the time of surrender as explained above. Such costs of insurance, expense charges, and surrender charges are recognized as revenue is earned. In addition, the Company has adopted policy designs with the characteristic of having higher expense charges during the first policy year than in renewal years. Under SFAS 97, the excess of these charges are reported as unearned revenue. The unearned revenue is then amortized into income over the life of the policy using the same assumptions and factors used to amortize capitalized acquisition costs. Interest credited to policyholder balances is shown as a part of benefit expenses. Premiums received from final expense products are treated as revenue when received.
In accordance with generally accepted accounting principles, certain costs directly associated with the issuance of new policies are deferred and amortized over the lives of the policies. These costs are defined as deferred policy acquisition costs and are shown in the asset section of the balance sheet of the Company.
Increased investment in debt securities coupled with reduced expenses for student loan processing are responsible for the 6.9% net yield in 1998, 6.9% in 1997 and 6.5% in 1996. No substantive changes occurred in 1998 compared to previous years. The Company continues to review its investment strategies to increase its earned interest rate. As a part of this process of review and refinement, the Company sold its entire stock portfolio just prior to year end 1996. This created a significant increase in realized gains for 1996. The resulting funds were reinvested in common stocks and fixed maturities which created an increased yield for the Company in 1998 and 1997.
The amortization of deferred acquisition costs increased in 1997 by 5% as compared to a 10% increase in 1996. No substantive change occurred in 1998 as compared to the previous years. The amortization of deferred acquisition costs is a continuous refinement process which relates to current experience in connection with revenues, mortality gains and losses, credited interest rate spreads, expense charges and surrender charges. The change in the unearned revenue liabilities is also due to unlocking for current and future experience based on the results of the changing experience encountered as required under FAS 97.
Operating expenses for the Company were $4 million, $3.4 million and $3.3 million for 1998, 1997 and 1996, respectively. New products and lead programs are responsible for the increased operating costs of 1997 and 1996. The increase in 1998 of $660,000 or 20% was primarily attributed to a lump sum settlement to the Company's former President to fulfil the obligations of his employment agreement.
Reinsurance premiums ceded for 1998, 1997 and 1996 were (on a GAAP basis) $863,436, $914,071 and $1,030,673 respectively. Policy benefits were reduced due to reinsurance recoveries of $169,892,
$336,068, and $206,428 for 1998, 1997 and 1996, respectively. Reinsurance commissions amounted to $252,154, $281,434, and $308,179 for 1998, 1997 and 1996 respectively. In addition, under the terms of the Company's treaty with Mega Life (formerly United Group Insurance Company) expenses of $984,356, $1,111,130 and $956,143 for 1998, 1997 and 1996, respectively.
The Company maintains invested assets for purposes of fulfilling policyholder obligations which are often susceptible to market risk. These assets and other financial instruments are maintained in accordance with the Company's investment policy which is designed to match corresponding policyholder obligations to relative maturities of the invested assets.
Student loans are a service the Company has historically made available to the public as well as an investment. While the Company anticipates the seasonal demand for student loan funds and the subsequent sale of such loans to the Student Loan Marketing Association (SLMA), there are times when additional funds are required to meet demand for student loans until such time as the sale thereof to SLMA can be completed. In 1997 the Company renewed its $5,000,000 line of credit with SLMA until 2007 in order to meet these seasonal borrowing requirements. The Company made no draws against this line of credit throughout the seasonal period for 1998 or 1997. The Company anticipates borrowings to be made through this line of credit with SLMA if student loan borrowings are required for the 1999 seasonal period. SLMA offers a more competitive rate of interest on such borrowings than the Company has been able to obtain through banks.
The National Association of Insurance Commissioners, in order to enhance the regulation of insurer solvency, issued a model law to implement risk-based capital (RBC) requirements for life insurance companies, which are designed to assess capital adequacy. Pursuant to the model law, insurers having less statutory surplus than required by the RBC calculation will be subject to varying
degrees of regulatory action. At December 31, 1998, the Company had statutory surplus well in excess of any RBC action level requirements.
The cost that has been incurred and paid in achieving Year 2000 compliance is approximately $1 million as discussed above. As of December 31, 1998, management does not anticipate any other significant costs to be incurred associated with its year 2000 initiatives.
We have audited the accompanying balance sheet of Southern Security Life Insurance Company as of December 31, 1998 and the related statements of operations, shareholders' equity, and cash flow for the year then ended. In connection with our audit of the financial statements, we have also audited the amounts included in the financial statement schedules as listed in the accompanying index under Item 14(a). These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 1998 financial statements referred to above present fairly, in all material respects, the financial position of Southern Security Life Insurance Company as of December 31, 1998, and the results of its operations and its cash flows for the year ended in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We have audited the accompanying balance sheet of Southern Security Life Insurance Company as of December 31, 1997 and related statements of income, shareholders' equity and cash flows for each of the years in the two year period ended December 31, 1997. In connection with our audit of the financial statements, we have also audited the amounts included in the financial statement schedules as listed in the accompanying index under Item 14(a)2 as of and for each of the years in the two year period ended December 31, 1997. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
The primary business of Southern Security Life Insurance Company (the "Company") is the issuance of long duration universal life insurance contracts. The majority of the Company's business is conducted in the states of Florida (44%), Georgia (10%) and Texas (15%). None of the remaining eleven states in which the Company is licensed to conduct business account for over 10% of the Company's total business.
Credit risk is the risk that issuers of securities owned by the Company will default or that other parties, including reinsurers, which owe the Company money, will not pay. The Company attempts to mitigate this risk by adhering to a conservative investment strategy, by maintaining sound
imates the effective yield method. Realized gains and losses on disposition of investments are included in net income. The cost of investments sold is determined on the specific identification method. Dividends are recorded as income on the ex-dividend dates.
The costs of acquiring new business, net of the effects of reinsurance, principally commissions and those home office expenses that tend to vary with and are primarily related to the production of new business, have been deferred to the extent recoverable from future profit margins. Deferred policy acquisition costs applicable to traditional life policies are being amortized over the premium-paying period of the related policies in a manner that will charge each year's operations in direct proportion to the estimated premium revenue over the life of the policies. Premium revenue estimates are made using the same interest, mortality and withdrawal assumptions as are used for computing liabilities for future policy benefits. Acquisition costs relating to universal life policies are being amortized in relation to the incidence of expected gross profits over the life of the policies. Gross profits for universal life contracts consist of revenue representing policy charges for the cost of insurance,
In 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings per Share. Statement No. 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods presented are restated to conform to Statement No. 128 requirements.
Certain amounts presented in the 1996 financial statements have been restated to conform to the 1997 and 1998 presentation.
Equity securities consist of $250,232 and $839,973 of common stock at fair value at December 31, 1998 and 1997 respectively.
The amortized cost and estimated fair value of fixed maturities at December 31, 1998 by contractual maturity, are summarized below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Investments, aggregated by issuer, in excess of 10% of shareholders' equity (before net unrealized gains and losses on available-for-sale securities) at December 31, 1998 and 1997, other than investments issued or guaranteed by the United States government are as follows:
Depreciation expense for the years ended December 31, 1998, 1997 and 1996 totaled $153,348, $145,912, and $151,950, respectively.
Life insurance in-force aggregated approximately $1.2 billion and $1.2 billion at December 31, 1998, and 1997, respectively.
For non-universal life policies written during 1983 through 1988, interest rates used are 8.0 percent for policy years one through five, decreasing by .1 percent per year for policy years six through twenty, to 6.5 percent for policy years twenty-one and thereafter. For certain non universal life contracts written in 1996-1998, interest rates of 6.75% level have been assumed. For non-universal life policies written in 1982 and prior, interest rates vary, depending on policy type, from 7 percent for all policy years to 6 percent for policy years one through five and 5 percent for years six and thereafter. For universal life policies written since 1988, the interest rate used is a credited rate generally based upon the Company's investment yield less 1 percent.
Interest expense relating to these notes payable during the years ended December 31, 1998, 1997 and 1996 totaled $0, $0, and $12,094, respectively and is included in net investment income.
A note payable to a related party consists of amounts due on demand to Security National Financial Corporation. The note's proceeds were obtained in December 1988 and the note qualifies as shareholders' equity for statutory accounting purposes in accordance with Section 628.401 of the Florida Statutes. At December 31, 1998, the note bears interest at 9.0% percent (payable monthly); principal repayment is contingent upon the Company maintaining statutory surplus in excess of $1,900,000 and obtaining approval in advance by the Florida Department of Insurance. Interest expense relating to the balance of the note payable to the related party during 1998, 1997 and 1996 aggregated $90,000, $90,000, and $90,000 respectively.
Income tax expense (benefit) for the years ended December 31, 1998, 1997 and 1996 is summarized as follows:
c. The entity ceases to qualify for taxation as a life insurance company, or;
At December 31, 1998, the balance of the Policyholders' Surplus account aggregated approximately $236,000. The Company has not recorded deferred income taxes totaling approximately $80,000 relating to this amount as it has no plan to distribute the amounts in Policyholders' Surplus in the foreseeable future.
The Tax Reform Act of 1986 enacted a new separate parallel tax system referred to as the Alternative Minimum Tax (AMT) system. AMT is based on a flat rate applied to a broader tax base. It is calculated separately from the regular federal income tax and the higher of the two taxes is paid. The excess of the AMT over regular tax is a tax credit, which can be carried forward indefinitely to reduce regular tax liabilities of future years. In 1998, 1997 and 1996, AMT exceeded regular tax by $156,820, $11,100, and $64,900, respectively. At December 31, 1998, the AMT tax credit available to reduce future regular tax totaled $252,780.
The tax effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1998 and 1997 are presented below:
The net change in the total valuation allowance for the year ended December 31, 1998 was a decrease of $156,820. The net change in the total valuation allowance for the years ended December 31, 1997, and 1996 was an increase of $11,100 and $64,900, respectively.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon
Effective December 31, 1998, the Company entered into an Administrative Services Agreement with its ultimate parent Security National Financial Corporation (Security National). Under the terms of the Administrative Services Agreement, all of the Company's employees became employees of Security National. Administrative functions previously performed by the Company will now be furnished to the Company under the Agreement. The Company will pay to Security National $250,000 per month or $3 million per year for the administrative services.
The Company has an incentive bonus plan for agents that was adopted January 1, 1995 by the Company's Board of Directors and effective through December 31, 2001. Agents that qualify under the plan have the option to purchase shares of common stock. The number of shares of common stock is determined on the date of the award as the number of whole shares equal to the award based on the applicable stock price on December 31 of the year the agent has qualified for the bonus. For each share of common stock purchased by the agent, the Company will concurrently award an equivalent number of shares to the agent.
Awards were granted in 1998 under this plan. The Company incurred expenses of approximately $6,500 relating to the Company's matching number of shares. If the agent, does not purchase the shares within the designated period, then the agent forfeits their rights to purchase the shares of common stock as well as the matching number of shares to be contributed by the Company.