We were formed on October 31, 2003 for the primary purpose of becoming a financial services company. We have two subsidiaries that we operate our business through: 1) American Life, a Nebraska-domiciled life insurance company and 2) 1505 Capital, a Delaware limited liability company in which we own a 51% interest and which provides investment advisory and related asset management services. In 2009, American Life was issued a certificate of authority to conduct life insurance business in Nebraska. We have incurred losses since inception that resulted primarily from costs incurred while raising capital and establishing and operating American Life and other entities.
On June 28, 2018 we underwent a change in control as a result of the closing of a Loan, Convertible Preferred Stock and Convertible Senior Secured Note Purchase Agreement dated May 9, 2018 (the “Agreement”) with a non-affiliated third party, Xenith Holdings LLC, a Delaware limited liability company (“Xenith”). Xenith is a wholly controlled subsidiary of Vespoint LLC, a Delaware limited liability company (“Vespoint”), which is also the manager of Xenith. Vespoint is owned and managed by AMS Advisors LLC, a Delaware limited liability company, and Rendezvous Capital LLC, a New York limited liability company. Each of these three companies is a private investment company; they are controlled by Michael Minnich and A. Michael Salem, who are Co-Chief Executive Officers of Vespoint and executive officers and directors of Midwest and American Life.
Also, at closing of the Agreement, Xenith loaned a total of $600,000 to Midwest, repayable upon maturity in 10 years with cash interest of 4% per annum payable quarterly and accrued interest of another 4% per annum payable upon maturity. The loan was converted by Xenith into an aggregate 29,141,790 voting common shares on June 18, 2019.
Of the funds received from Xenith, we contributed $20,500,000 to American Life through capital contributions. See Note 3. - Change in Control in the Notes to Consolidated Financial Statements in this report.
Our operating goals are to create value through our ability to compete in the areas of:
Technology: As an integral part of our new business plan, American Life implemented and integrated a modern technology platform designed to facilitate our business activities. American Life contracted with a third-party software company to license a new policy administration system known as “FAST,” an end-to-end product development, new business, distribution, management and policy administration platform that utilizes state-of-the-art technology that American Life hosts in the Amazon Web Services cloud. Functional implementation was completed in November 2018, and testing completed in January 2019. In addition, several core technology integrations were added, including document management, electronic application capability, secure log-ins and an agent and policyholder portal. Management believes this new technology should enhance cost effective product sales and development and policy administration as we scale up, as well as provide American Life with the ability to seek to expand its third party administrative services (which were a minor part of our legacy business) in the future.
American Life is licensed to sell, underwrite, and market life insurance and annuity products in 15 states and is seeking to expand its licenses in additional states in 2020.
The type and amount of investments that can be made by a life insurance company are specifically controlled by applicable state statutes and rules and regulations of the respective state departments of insurance. American Life has adopted investment policies in compliance with the insurance laws of the State of Nebraska.
The Company frequently reviews its investment portfolio for declines in the fair value. The Company’s process for identifying declines in the fair value of investments that are other-than-temporary involves consideration of several facts. These factors included (i) the timer period and extent to which the fair value has been less than the amortized cost basis, b) adverse conditions specifically related to the security, industry of geographic are, c) the historical and implied volatility of the fair value of the security, d) payment structure of the security, e) failure of issuer of the security to make interest payments, f) changes to the rating of the security, and g) possible recoveries or additional declines in the fair value after the balance sheet date.
The recognition of other-than-temporary impairment losses on debt securities is dependent on the facts and circumstances related to a specific security. If we intend to sell a security or it is more likely than not that we would be required to sell a security prior to recovery of the amortized cost, the difference between amortized cost and fair value is recognized in the income statement as an other-than-temporary impairment. As it relates to debt securities, if we do not expect to recover the amortized basis, do not plan to sell the security and if it is not more likely than not that we would be required to sell a security before the recovery of its amortized cost, the recognition of the other-than-temporary impairment is bifurcated. We recognize the credit loss portion through earnings in the income statement and the noncredit loss portion in accumulated other comprehensive loss. The credit component of an other-than-temporary impairment is determined by comparing the net present value of projected cash flows with the amortized cost basis of the debt security. The net present value is calculated by discounting our best estimate of projected future cash flows at the effective interest rate implicit
Our indefinite-lived intangible assets consist of American Life’s state licenses. We compared the carrying value to the current costs of obtaining licenses in those states. As of December 31, 2019, the sum of the fair value of those licenses exceeded the carrying value of the indefinite-lived intangible assets. The assumptions and estimates used to determine future values are complex and subjective. They can be affected by various factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our revenue forecasts.
Generally, when it is cost effective, we expect to reinsure most of the risks associated with our assets and liabilities. Our reinsurers may be domestic, foreign or capital markets investors seeking to assume U.S. insurance business. We plan to mitigate the credit risk relating to reinsurers generally by either selecting well capitalized, highly rated authorized reinsurers or requiring that the reinsurer post substantial collateral or make other financial commitments to secure the reinsured risks. It should be noted that American Life will remain exposed to the credit risk of reinsurers, or the risk that one or more reinsurers becomes insolvent or otherwise unable or unwilling to pay policyholder claims.
In a typical reinsurance transaction, we will receive a ceding commission plus an ongoing fee for the administration of the business. In some cases, our reinsurers may not be “accredited” or qualified as reinsurers under Nebraska Law and in order to permit transactions with reinsurers and to reduce potential credit risk, we may hold a deposit or withhold funds from the reinsurer or require the reinsurer to maintain a trust that holds assets backing up the reinsurer’s obligation to pay claims on the business it assumes. In some cases, the reinsurer may appoint an investment manager to manage these assets pursuant to guidelines approved by us that are consistent with state investment statutes and regulations relating to reinsurance. We expect there would be a monthly or quarterly settlement of premiums, claims, surrenders and collateral.
We establish liabilities for amounts payable under insurance policies, including traditional life insurance and annuities. Generally, amounts are payable over an extended period of time. Liabilities for future policy benefits of traditional life insurance have been computed by using 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 industry experience expressed as a percentage of standard mortality tables. Such liabilities are reviewed quarterly by an independent consulting actuary. We currently do not have traditional life insurance products. We have deposit-type liabilities on our annuities products where we are using the account value of those annuities. Our fixed indexed annuities are calculated by an independent consulting actuary and includes the embedded derivatives in our GAAP reserves.
The following should be read in connection with our Consolidated Financial Statements and Notes thereto under Item 8 of this report.
On June 28, 2018, Midwest closed on the Agreement with Xenith as discussed above. Following the closing, we embarked upon a new business plan that includes leveraging technology to distribute insurance products through IMOs.
American Life closed the Legacy Reinsurance agreement on December 10, 2018 with a third party insurance company to cede 100% of the remaining legacy block of business, with the transaction being effective July 1, 2018. See Note 3 Assets and Liabilities Held for Sale in the Notes to Consolidated Financial Statements below. Due to the assumptive nature of this agreement, this transaction qualified to be reported as Discontinued Operations under ASC 2014-08 Presentation of Financial Statements (Topic 205); therefore, our 2018 income statement reflects net income from continuing operations and income from discontinued operations. The discussion below reflects continuing operations changes year over year. See Note 10. Reinsurance to our Consolidated Financial Statements for further discussion.
On July 25, 2019, American Life closed a reinsurance agreement with a third party insurance company to cede 95% of the MYGA business, with the transaction being effective from inception of the sales of the MYGA product. This transaction eliminates 95% of the interest credited on the MYGA deposit-type contracts. See Note 10. Reinsurance to our Consolidated Financial Statements for further discussion.
The following summarizes the sources of our revenue for the periods indicated:
Premium revenue: Premium revenue decreased primarily due to the premium in 2018 that was related to an assumed block of business which was commutated in July 2018. In 2019 the premium included above was a refund of premium that we had included in 2018. The introduction of our MYGA and FIA products discussed above generated a meaningful volume of premiums; however, these products are considered investment contracts and GAAP requires that the premium be deferred to deposit-type liabilities on our balance sheet. American Life is expecting to introduce new products in 2020 primarily in the annuity business. We expect that premium income from both the FIA and MYGA products will not be a significant source of revenue until American Life develops new life insurance products in the future and achieves significant additional product sales. The table below shows premium issued under statutory accounting on our two annuity products:
The decrease was due to ceding the investment income earned on the bonds purchased with the sales of our MYGA and FIA products from inception through December 31, 2019 as required by our coinsurance agreements. Our investment portfolio grew substantially in 2019 due to the increased sales of the MYGA and FIA products which American Life used to purchase investments with higher rates of return. The decrease in investment expenses was primarily related to the interest expense on the sale of certain real estate in 2018. The investment expense in 2019 related to the interest expense on the deferred ceding commissions which were calculated by our consulting actuary.
Amortization of deferred gain on reinsurance: The increase was due to 79% of indemnity coinsurance policies ceded to Unified in 2018 being converted to assumptive reinsurance where we no longer have a legal obligation for those policies. American Life released into income 79% of the remaining deferred ceding commission. This increase included $171,659 income from amortization related to the new deferred ceding commissions earned from the reinsurance transactions with the third party reinsurers entered into during 2019.
Our expenses are summarized in the table below for the periods indicated:
Interest credited: The decrease was due to the 5% retention on the sale of the new FIA product during the year of 2019 that was classified as deposit-type funds. The interest credited in 2018 related to a block of business assumed from an unaffiliated entity that was commutated on July 31, 2018.
Death and other benefits Death benefits decreased due the commutation of a block of business as of July 31, 2018. The benefits incurred in 2019 were for policies that were not included with our July 1, 2018 reinsurance transaction.
Salaries and benefits: The increase was due to the addition of remuneration for two executive officers as a result of the Xenith transaction as discussed below in Note 3. Change in Control to our Consolidated Financial Statements as well as staff increases to meet the needs of our expanded business.
Management expects salaries and benefits to increase modestly in 2020 to service our growth initiatives.
Other operating expenses: Other operating expenses increased primarily due to approximately $1,300,000 of expenses incurred for consultants, continuing technology and software development, and portal and web design. We incurred approximately $845,536 of interest on the Xenith notes payable that included approximately $131,000 for 2018 that was not previously included. Also included in the Xenith notes payable was $161,000 of deferred legal costs associated with the transaction in 2018 which was written off when the notes were converted. Xenith forgave the payment of the interest accrued upon the conversion of the notes payable; as a result the interest payable was treated as an additional capital contribution but the interest was required to be recognized for GAAP. Legal fees and license fees increased approximately $229,000 as a result of the state expansion initiatives, the settlement of the sale of real estate, and fees associated with negotiations with reinsurers. These legal fees were offset by legal costs related to the acquisition of Midwest by Xenith that occurred in 2018 that did not recur in 2019. The consolidation of 1505 Capital resulted in an increase of expenses of $382,000. The Company has established a long-term incentive plan described in Note 12. Long-Term Incentive Plan to our Consolidated
Financial Statements. In July 2019, the Board of Directors approved options to purchase granting 8,950,000 shares of stock to our employees. The consideration recognized as expense for those options was approximately $68,000. The above increases were offset by consulting fees that were incurred in 2018 that did not occur in 2019 of approximately $148,000 and the expenses attributed to the commutation of an assumption agreement of approximately $154,000. Management expects to incur additional product development and system related costs in 2020.
Reflecting the quality of securities maintained by us, 96.7% and 99.2% of all fixed maturity securities were investment grade as of December 31, 2019 and 2018, respectively.
We expect that our MYGA and FIA products sales will increase investable assets in future periods.
We hold a diversified portfolio of investments that primarily includes cash, asset-backed securities, bonds, stocks, mortgage loans, and notes receivable. Each of these investments is subject to market risks that can affect their return and their fair value. A majority of the investments are fixed maturity securities including debt issues of corporations, U.S. Treasury securities, mortgage-backed securities, or securities issued by government agencies. The primary market risks affecting the investment portfolio are interest rate risk, credit risk, equity risk, and liquidity risk.
Effective July 1, 2018, American Life completed the 2018 Legacy Reinsurance transaction discussed above. We paid no commissions or brokerage fees relating to this transaction. While the third party reinsurer assumed certain liabilities and obligations, we are not relieved of our legal liability to the policyholders until all the policies are transferred from “indemnity” to “assumptive.” Therefore, the liabilities and obligations associated with the reinsured blocks of business remain on our Consolidated Balance Sheets under Assets and Liabilities Held for Sale. We transferred $19,311,616 of GAAP net adjusted reserves as of July 1, 2018 to the third party reinsurer for cash of $14,320,817, which was net of a ceding allowance of $3,500,000 plus the accrued interest on the transaction from July 1, 2018 until it closed on December 10, 2018. The third party reinsurer assumed all responsibilities for incurred claims, surrenders and commission from the effective date. As of December 31, 2019, 79% of the reinsured block of business was converted from indemnity to assumptive reinsurance.
Surplus notes American Life had issued of $300,000 and $250,000 matured on August 1, 2016 and September 1, 2016, respectively. American Life reached an agreement with the holder of the notes in late 2018 to retire the surplus notes in full, including any accrued interest, through the transfer of 10 condominiums in Hawaii owned by American Life. This transaction received regulatory approval in December 2018. The book value at December 31, 2018 of the surplus notes was $876,400 and the book value of the 10 condominiums in Hawaii was $493,648 with an estimated market value of $830,000. We recognized a gain of $382,752 on the settlement of the transaction.