(1) All share and per share amounts have been adjusted for the October, 1995 five-for-four stock split.
Premiums, mortality and expense charges and investment income are the Company's major sources of cash flow used to meet its short-term and long-term cash requirements.
The Company has a large concentration of loans in Georgia; however, only one loan for $148,966 is past due more than three months. Because the loan-to-value ratio on these delinquent loans is 62%, the Company does not anticipate any loss should it choose to foreclose. The Company has foreclosed on only one loan since 1985 and incurred no loss on the sale of the underlying collateral.
Mortality and expense charges earned on universal life contracts increased 1%, 29% and 15% in 1995, 1994 and 1993, respectively. In 1994 and 1993, the Company changed its classification of reserve credits on reinsured universal life contracts. This reclassification resulted in additional mortality and expense charges earned of $328,000 and $430,000 in 1994 and 1993, respectively, and had an insignificant effect on net income. Without this reclassification, mortality and expense charges earned would have increased 6%, 33% and 6%, respectively. The increase for 1994 resulted from the addition of a large payroll deduction universal life case during the year, plus an increase in cost of insurance charges on all 1994 new business cases. The Company expects future growth rates to be in the 6-8% range.
Investment income increased 10% in 1995, 5% in 1994 and was flat in 1993. The increase in 1995 and 1994 is due to a larger investment portfolio.
CSI Brokerage Services provided the Company with commission income from brokerage agreements with other property and casualty insurance carriers. These carriers supply the Company's multi-line agents with property and casualty products that the Company's affiliated property and casualty companies do not underwrite. CSI earned $438,707 in 1995, $368,700 in 1994 and $321,150 in 1993. Another subsidiary, Cotton States Marketing Resources, Inc. provides the Company with commission income from brokerage agreements with other life and health insurance companies. These companies supply the Company's multi-line agents with life and health products that the Company does not want to underwrite. Marketing Resources earned $183,010 in 1995 and $88,000 in 1994 and $10,400 in 1993.
Individual benefits as a percentage of individual life premiums and mortality and expense charges were 70%, 64% and 78% for 1995, 1994 and 1993, respectively. The large decrease in 1994 was due to lower mortality experience.
Individual accident and health benefits as a percentage of accident and health premiums were 19%, 129% and 127% for 1995, 1994 and 1993, respectively. Even though experience on this line improved in 1995, the Company anticipates that even with rate increases, the loss ratio on this closed block of business will continue to be in the 110%-130% range.
Operating expenses and amortization of policy acquisition costs as a percentage of total premium
The effective tax rates were 24% for 1995, 25% for 1994 and 8% for 1993. The effective tax rate should remain at approximately 25%. On January 1, 1993, the Company adopted SFAS 109, "Accounting for Income Taxes." Deferred income taxes reflect the net tax effects of temporary differences between the carrying values of assets and liabilities (principally deferred policy acquisition costs and life future policy benefit liabilities) for financial reporting purposes and federal income tax purposes. The tax effect of these differences created a deferred tax benefit of $317,043 in 1993 versus deferred tax expense of $381,477 in 1994. This change in accounting principle contributed significantly to the decrease in effective tax rate for 1993.
Prolonged inflation can adversely affect insurance operations. Expenses and certain benefits tend to increase while premiums are generally fixed for the life of the policy. Real and nominal interest rates have fluctuated considerably over the past several years, causing major swings in investments' market values and their income growth. In an effort to control these effects, management is continuing to emphasize cost control and to invest in short-term and intermediate-term investments. Both inflation and interest rate fluctuations narrowed in the past three years in comparison to the immediately preceding years.
The Company and CSI Brokerage Services, Inc. file a consolidated federal income tax return. Cotton States Marketing Resources, Inc. files a separate federal income tax return.
On August 22, 1995, the Company's Board of Directors authorized a five-for-four stock split, effected in the form of a 25% stock dividend distributed on October 16, 1995 to shareholders of record on October 2, 1995. Share equity has been restated to give retroactive recognition to the stock split in prior periods by reclassifying from retained earnings to common stock the par value of the additional shares arising from the split. In addition, all references in the financial statements to the number of shares, per share amounts, stock option data and market prices of the Company's common stock have been restated.
Effective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards No. 115 (SFAS No. 115), "Accounting for Certain Investments in Debt and Equity Securities." The adoption of SFAS No. 115 resulted in reporting fixed maturities available for sale at fair value with changes in unrealized gains and losses included in stockholders' equity, net of applicable deferred taxes and deferred acquisition cost adjustments. The adoption of SFAS No. 115 had no effect on net earnings in 1994.
Included in investments available for sale are certain U.S. dollar denominated U.S. government agency securities amounting to $292,500 at December 31, 1995, which are payable in foreign currency. As a result of significant foreign currency fluctuations, the Company has written these securities down to current market value in 1995, 1994 and 1993 by recognizing losses of $300,000, $580,509 and $318,579, respectively.
For investment securities (which include fixed maturities held for investment and fixed maturities available for sale), fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
The fair value of mortgage loans is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics.
(A) INTEREST RATES ARE GRADED TO THE ULTIMATE RATE IN 25 YEARS.
The Company participates in certain business assumed from federally sponsored group pools. Further, it is the Company's general policy to reinsure individual life insurance in excess of $100,000, group life insurance in excess of $50,000, major medical payments in excess of $35,000 annually per individual, accidental deaths and certain disability income coverage. Amounts ceded under reinsurance agreements become liabilities of the Company should the reinsurers be unable to meet their obligations under the reinsurance agreements. The effect of reinsurance assumed and ceded on certain financial statement accounts is as follows:
Effective January 1, 1993, the Company changed its method of accounting for income taxes from the deferred method to the asset and liability method, as required by Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS No. 109). As permitted by the new rules, prior years' financial statements have not been restated. The cumulative effect of the adoption of SFAS No. 109 as of January 1, 1993 was to increase 1993 net earnings by $260,000.
The Company has established a valuation allowance for deferred tax assets of $250,000 in 1995 and $600,000 in 1994 of which $300,000 was recorded through equity due to the initial establishment of the deferred tax asset associated with unrealized losses on available-for-sale securities. The valuation allowance established through equity in 1994 was taken down through equity in 1995 as a result of an increase in the value of the securities.
Certain general expenses are allocated to the Company by Cotton States Mutual. These expenses, such as salaries, advertising, rents, etc., represent the Company's share of expenses initially paid by Cotton States Mutual and are allocated based on specific identification or, if undeterminable, generally on the basis of each company's premium income. Expenditures allocated to the Company amounted to $1,801,344 in 1995, $1,790,633 in 1994 and $1,737,914 in 1993. During 1995, 1994 and 1993, premiums earned on group policies with Cotton States Mutual and its agents were $1,576,074, $1,821,114 and $1,616,085, respectively. Premiums on the Cotton States Mutual policies were based on actual claims experience plus an expense and profit allowance of 10%. As of December 31, 1994, the Company's noninterest-bearing receivable from Cotton States Mutual amounted to $599,032. At December 31, 1995, the Company owed Cotton States Mutual $690,910.
Included in other assets are deferred software costs totaling approximately $464,000 and $1,204,000 in 1995 and 1994, respectively. The deferred software costs relate to various system development projects of the Company and Cotton States Mutual and are being amortized over five years. Rent, for use of the software, of approximately $644,000, $732,000 and $732,000 in 1995, 1994 and 1993, respectively, is being charged to Cotton States Mutual and Shield. The Company recorded amortization expense of approximately $625,000 in 1995, 1994 and 1993, respectively, relating to deferred software costs.
Accounting practices used to prepare statutory financial statements for regulatory filings of stock life insurance companies differ from GAAP. Material differences resulting from these accounting practices include: deferred policy acquisition costs, deferred federal income taxes and statutory non-admitted assets are recognized under GAAP accounting; statutory investment valuation reserves are not recognized under GAAP accounting; premiums for universal life and investment-type products are recognized as revenues for statutory purposes and as deposits to policyholders' accounts under GAAP; different assumptions are used in calculating future policyholders' benefits; and different methods are used for calculating valuation allowances for statutory and GAAP purposes.
We have audited the accompanying consolidated balance sheets of Cotton States Life Insurance Company and subsidiaries (the "Company") as of December 31, 1995 and 1994, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1995. 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.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cotton States Life Insurance Company and subsidiaries at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles.
As described in note 2, effective January 1, 1994, the Company changed its method of accounting for certain investment securities. As described in notes 5 and 6, effective January 1, 1993, the Company changed its method of accounting for income taxes and post-retirement benefits other than pensions.