The Company currently leases office space at 8101 “O” Street, Suite S111, Lincoln, Nebraska 68510. This lease was executed August 28, 2009, amended on January 21, 2011, and expires on January 31, 2014. As part of the acquisition of Old Reliance, the Company assumed a lease for the headquarters of Old Reliance in Colorado Springs, Colorado that expires on December 31, 2012. Rent expense for the years ended December 31, 2011 and 2010 was $113,207 and $93,369, respectively. Future minimum payments for 2012, 2013 and 2014 are $145,076, $128,240 and $10,687, respectively.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes appearing elsewhere in this report. In addition to historical information, this discussion and analysis may contain forward-looking statements that involve risk, uncertainties and assumptions. Actual results may differ materially from those anticipated in these forward-looking statements.
Midwest was formed on October 31, 2003 for the primary purpose of becoming a financial services holding company. We presently conduct our business through our wholly owned subsidiary, American Life & Security Corp. Capital Reserve Life Insurance Company of Jefferson City, Missouri is a dormant, wholly owned subsidiary of American Life. Security Capital Corporation is a 60% owned subsidiary of Midwest. Hot Dot, Inc. is a 37% owned subsidiary of Midwest and Midwest controls a majority of the Board of Directors.
On June 20, 2010, American Life acquired Capital Reserve in exchange for a cash payment of approximately $1.9 million. This transaction added approximately a like amount of assets to American Life. Further, with the insurance charters acquired from Capital Reserve, we obtained access to additional markets in Missouri, Kansas and Iowa.
On July 12, 2010, in order to provide additional capital to support our continued growth, we commenced an offering of up to 2,000,000 additional shares of voting common stock to existing shareholders who were residents of the State of Nebraska. This offering was completed on February 28, 2011 and a total of 1,554,326 additional shares of voting common stock were sold. The gross proceeds of this sale were approximately $7.7 million. These proceeds were used to fund the acquisition of Old Reliance Insurance Company as described below, and will be used to further capitalize our insurance operations, for working capital and for other general corporate purposes.
On November 8, 2010, the Company entered into an agreement to acquire all of the issued and outstanding capital stock of Old Reliance. American Life merged into Old Reliance following the purchase, with the survivor changing its name to American Life & Security Corp. In the transaction, the sole shareholder of Old Reliance received: (i) approximately
During the 3rd quarter of 2011, control was attained on a previous noncontrolling interest in Security Capital Corporation. The previously held interest was remeasured at fair value and a gain of $182,200 was recognized. The acquisition of Security Capital added cash and cash equivalents of $21,471 and investments in equity securities of $434,000 to the consolidated balance sheets.
The Company’s principal investments are in fixed maturity securities. Fixed maturity securities, which are classified as available for sale, are carried at their fair value in the consolidated balance sheets, with unrealized gains or losses recorded in accumulated other comprehensive income (loss). The Company’s fair value of fixed maturity securities are derived from external brokers. The valuation of the investment portfolio involves a variety of assumptions and estimates.
The recognition of other-than-temporary impairment losses on debt securities is dependent on the facts and circumstances related to the specific security. If the Company intends to sell a security or it is more likely than not that the Company 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. If the Company does not expect to recover the amortized basis, does not plan to sell the security and if it is not more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, the recognition of the other-than-temporary impairment is bifurcated. The Company recognizes the credit loss portion 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 the Company’s best estimate of projected future cash flows at the effective interest rate implicit in the fixed income security at the date of acquisition. Cash flow estimates are driven by assumptions
regarding probability of default, including changes in credit ratings, and estimates regarding timing and amount of recoveries associated with a default.
Value of business acquired (VOBA) represents the estimated value assigned to purchased companies or insurance in force of the assumed policy obligations at the date of acquisition of a block of policies. At least annually, a review is performed of the models and the assumptions used to develop expected future profits, based upon management’s current view of future events. VOBA is reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts. Management’s view primarily reflects Company experience but can also reflect emerging trends within the industry. Short-term deviations in experience affect the amortization of VOBA in the period, but do not necessarily indicate that a change to the long-term assumptions of future experience is warranted. If it is determined that it is appropriate to change the assumptions related to future experience, then an unlocking adjustment is recognized for the block of business being evaluated. Certain assumptions, such as interest spreads and surrender rates, may be interrelated. As such, unlocking adjustments often reflect revisions to multiple assumptions. The VOBA balance is immediately impacted by any assumption changes, with the change reflected through the income statement as an unlocking adjustment in the amount of VOBA amortized. These adjustments can be positive or negative with adjustments reducing amortization limited to amounts previously deferred plus interest accrued through the date of the adjustment.
The Company assesses the recoverability of intangible assets at least annually or whenever events or circumstances suggest that the carrying value of an identifiable intangible asset may exceed the sum of the undiscounted cash flows expected to result from its use and eventual disposition. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset.
Insurance revenues are primarily generated from premium revenues and investment income. Insurance revenues for the years ended December 31, 2011 and 2010 are summarized in the table below.
Premium revenue: Premium revenue in the year ended December 31, 2011 was $3,119,457, up $1,208,895 from $1,910,562 in the year ended December 31, 2010. The increase in premium revenue is primarily attributable to the acquisition of Old Reliance on August 3, 2011, which added premium revenues of $621,858 during 2011. Additional increases in revenues were a result of the Company’s continued growth.
Consideration on reinsurance assumed: Consideration on reinsurance assumed in the year ended December 31, 2011 was $0 compared to $3,729,599 in the year ended December 31, 2010. The decrease reflects the realization in the 2010 period of $3,729,599 in consideration for the reinsurance assumed from Security National. The consideration for reinsurance assumed is a non-recurring revenue that did not reoccur in 2011.
Investment income, net of expenses: The components of net investment income for the years ended December 31, 2011 and 2010 are as follows:
Death and other benefits: Death and other policy benefits were $383,899 in the 2011 period compared to $162,099 in the 2010 period. The increase in death and other policy benefits is primarily attributable to the acquisition of Old Reliance.
Increase in benefit reserves: The increase in benefit reserves was $1,199,340 in 2011 compared to $4,650,227 in 2010. This decrease in expense primarily relates to the one-time benefit reserve increase required in 2010 as a result of the assumption of insurance from Security National discussed above. The decrease reflects the significant one-time increase in benefit reserves of $3,729,599 which was required in the 2010 period as a result of the assumption of insurance from Security National. This increase in benefit reserves was a non-recurring event that was not repeated in 2011.
Amortization of deferred acquisition costs: Life insurance companies are required to defer certain expenses that vary with, and are primarily related to, the cost of acquiring new business. The majority of these acquisition expenses consist of commissions paid to agents, underwriting costs, and certain marketing expenses. In accordance with accounting principles generally accepted in the United States of America (GAAP), these costs are capitalized and amortized over the life of the premiums produced. Amortization of such costs was $624,650 in 2011, compared to $320,935 in 2010. The increase in amortization of deferred acquisition costs directly relates to an increase in the balances of deferred acquisition costs.
Salaries and benefits: Salaries and benefits were $2,534,175 in 2011 compared to $960,154 in 2010. This increase in payroll results from the addition of 11 new employees from January 2010 to December 2011and general salary increases as a result of the anticipated growth of our life insurance business.
The Company’s overall conservative investment philosophy is reflected in the allocation of its investments. The Company emphasizes investment grade debt securities, with smaller holdings in equity securities, real estate, held for investment, mortgage loans on real estate, held for investment, policy loans, and other investments. The following table shows the carrying value of our investments by investment category and cash and cash equivalents, and the percentage of each to total invested assets.
Reflecting the high quality of securities maintained by the Company, 99.1% and 98.5% of all fixed maturity securities were investment grade as of December 31, 2011 and 2010, respectively.
Increases in fixed maturity securities primarily resulted from the acquisition of Old Reliance. The following table shows the distribution of credit ratings of our portfolio by carrying value as of December 31, 2011 specifically of the bonds acquired as part of the Old Reliance acquisition.
We are exposed to credit risk through counterparties and within our investment portfolio. Credit risk relates to the uncertainty associated with an obligor’s ability to make timely payments of principal and interest in accordance with the contractual terms of an instrument or contract. We manage our credit risk through established investment credit policies and guidelines which address the quality of creditors and counterparties, concentration limits, diversification practices and acceptable risk levels. These policies and guidelines are regularly reviewed and approved by senior management.
Since inception, our operations have been financed primarily through the sale of voting common stock and preferred stock. As a result of delays in obtaining the Certificate of Authority for American Life, our operations have not been profitable and have generated significant operating losses since the Company was incorporated in 2003.
At December 31, 2011, we had cash and cash equivalents totaling $2,469,725. We believe that our existing cash and cash equivalents will be sufficient to fund our anticipated operating expenses and capital expenditures for at least twelve months. We have based this estimate upon assumptions that may prove to be wrong and we could use our capital resources sooner than we currently expect. The growth of American Life is uncertain and will require additional capital if it continues to grow.
Insurance premiums are established before the amount of losses and loss adjustment expenses, or the extent to which inflation may affect such losses and expenses, are known. We attempt, in establishing premiums, to anticipate the potential impact of inflation. If, for competitive reasons, premiums cannot be increased to anticipate inflation, this cost would be absorbed by us. Inflation also affects the rate of investment return on our investment portfolio with a corresponding effect on investment income.