UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One) | |
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| |
For the quarter ended | |
or | |
| |
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
COMMISSION FILE NUMBER 000-10685001-39812
Midwest Holding Inc.
(Exact name of registrant as specified in its charter)
|
| 20-0362426 |
(State or other jurisdiction of | (I.R.S. Employer Identification No.) | |
incorporation or organization) |
| |
2900 S. 70th, Suite 400, Lincoln, NE | 68506 | |
(Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (402) 489-8266
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
| | |
Title of each class: |
| Trading Symbol(s):Name of Each Exchange on Which Registered |
Voting Common Stock, $0.001 par value | | MDWTThe NASDAQ Stock Market, LLC |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically, if any, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐ |
| Accelerated filer ☐ |
Non-accelerated filer ☐ | Smaller reporting company ☒ | |
| Emerging growth company ☐ | |
|
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or reviewed financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act). Yes ☐ No ☒
As of AugustMay 1, 2020,2021, there were 1,361,557,7793,737,564 shares of the registrant’s Voting Common Stock, par value $0.001 per share, issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE - None
MIDWEST HOLDING INC.
FORM 10-Q
PART I – FINANCIAL INFORMATION
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Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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PART II – OTHER INFORMATION
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2
PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.STATEMENTS
MIDWEST HOLDING INC. AND SUBSIDIARIES
| | | | | | | | | | | | |
|
| June 30, 2020 |
| December 31, 2019 |
| March 31, 2021 |
| December 31, 2020 | ||||
| | | (Unaudited) | | | | | | (Unaudited) | | | |
Assets |
| |
|
| |
|
| |
|
| |
|
Investments, available for sale, at fair value fixed maturities | | $ | 200,110,287 | | $ | 117,241,861 | ||||||
Investments, available for sale, at fair value fixed maturities | | $ | 493,069,034 | | $ | 377,163,358 | ||||||
Mortgage loans on real estate, held for investment | |
| 51,171,943 | |
| 13,810,041 | |
| 109,776,321 | |
| 94,989,970 |
Derivatives instruments (See Note 6) | | | 3,228,102 | | | 575,294 | ||||||
Derivative instruments (See Note 5) | | | 9,473,398 | | | 11,361,034 | ||||||
Equity securities, at fair value (cost: $42,089,014 in 2021 and zero in 2020) | | | 42,093,166 | | | — | ||||||
Other invested assets | | | 3,090,964 | | | 2,468,947 | | | 25,606,108 | | | 21,897,130 |
Investment escrow | | | 3,317,043 | | | 3,174,047 | ||||||
Preferred stock | | | — | | | 500,000 | | | 4,300,591 | | | 3,897,980 |
Investment escrow | | | — | | | 3,899,986 | ||||||
Notes receivable | | | 5,488,101 | | | — | | | 5,737,608 | | | 5,665,487 |
Policy loans | |
| 141,172 | |
| 106,014 | |
| 48,551 | |
| 45,573 |
Total investments | |
| 263,230,569 | |
| 138,602,143 | |
| 693,421,820 | |
| 518,194,579 |
Cash and cash equivalents | |
| 75,041,902 | |
| 43,716,205 | |
| 100,927,152 | |
| 151,679,274 |
Deferred acquisition costs, net | | | 3,968,748 | | | — | | | 19,676,745 | | | 13,456,303 |
Premiums receivable | | | 349,649 | | | 355,959 | | | 313,115 | | | 313,601 |
Accrued investment income | | | 3,471,429 | | | 1,511,200 | | | 9,095,093 | | | 6,806,836 |
Reinsurance recoverables (See Note 9) | | | 43,355,941 | | | 30,579,524 | | | 38,715,577 | | | 32,146,042 |
Intangible assets | |
| 700,000 | |
| 700,000 | |
| 700,000 | |
| 700,000 |
Property and equipment, net | |
| 105,685 | |
| 85,395 | |
| 101,980 | |
| 103,964 |
Operating lease right of use assets | | | 409,165 | | | 470,132 | | | 317,715 | | | 348,198 |
Other assets | |
| 3,933,728 | |
| 241,580 | |
| 1,799,371 | |
| 1,533,179 |
Assets associated with business held for sale (See Note 3) | |
| 1,142,379 | |
| 3,653,748 | ||||||
Assets associated with business held for sale (See Note 2) | |
| 1,122,481 | |
| 1,118,783 | ||||||
Total assets | | $ | 395,709,195 | | $ | 219,915,886 | | $ | 866,191,049 | | $ | 726,400,759 |
Liabilities and Stockholders’ Equity | |
|
| |
|
| |
|
| |
|
|
Liabilities: | |
|
| |
|
| |
|
| |
|
|
Benefit reserves | | $ | 16,434,819 | | $ | 16,319,912 | | $ | 12,784,452 | | $ | 12,775,773 |
Policy claims | |
| 232,923 | |
| 225,228 | |
| 164,377 | |
| 161,703 |
Deposit-type contracts (See note 12) | |
| 321,830,976 | |
| 171,168,785 | ||||||
Deposit-type contracts (See note 11) | |
| 714,300,232 | |
| 597,868,472 | ||||||
Advance premiums | |
| 646 | |
| 261 | |
| 3,111 | |
| 2,541 |
Deferred gain on coinsurance transactions | |
| 11,487,084 | |
| 7,578,195 | |
| 20,596,683 | |
| 18,198,757 |
Lease liabilities (See Note 14): | | | | | | | ||||||
Finance lease | | | — | | | 1,860 | ||||||
Lease liabilities (See Note 13): | | | | | | | ||||||
Operating lease | | | 460,791 | | | 524,248 | | | 364,128 | | | 396,911 |
Other liabilities | | | 18,167,460 | | | 6,291,782 | | | 31,230,201 | | | 9,552,791 |
Liabilities associated with business held for sale (See Note 3) | |
| 1,141,778 | |
| 3,646,867 | ||||||
Liabilities associated with business held for sale (See Note 2) | |
| 1,115,682 | |
| 1,114,312 | ||||||
Total liabilities | |
| 369,756,477 | |
| 205,757,138 | |
| 780,558,866 | |
| 640,071,260 |
Contingencies and Commitments (See Note 13) | |
|
| |
|
| ||||||
Contingencies and Commitments (See Note 12) | |
|
| |
|
| ||||||
Stockholders’ Equity: | |
| | |
| | |
| | |
| |
Common stock, $0.001 par value; authorized 1,970,000,000 shares; 1,361,557,779 issued and outstanding as of June 30, 2020 and 1,023,408,553 as of December 31, 2019. | |
| 1,361,786 | |
| 1,023,409 | ||||||
Preferred stock, $0.001 par value; authorized 2,000,000 shares; no shares issued and outstanding as of March 31, 2021 or December 31, 2020 | |
| — | |
| — | ||||||
Voting common stock, $0.001 par value; authorized 20,000,000 shares; 3,737,564 shares issued and outstanding as of March 31, 2021 and December 31, 2020, respectively; non-voting common stock, $0.001 par value, 2,000,000 shares authorized; no shares issued and outstanding March 31, 2021 and December 31, 2020, respectively | |
| 3,738 | |
| 3,738 | ||||||
Additional paid-in capital | |
| 67,725,643 | |
| 53,472,988 | |
| 133,853,945 | |
| 133,592,605 |
Treasury stock | | | (175,333) | | | (175,333) | ||||||
Accumulated deficit | |
| (36,070,591) | |
| (41,081,710) | |
| (55,122,540) | |
| (53,522,078) |
Accumulated other comprehensive (loss) income (See Note 6) | |
| (7,064,120) | |
| 619,584 | ||||||
Total Midwest Holding Inc.'s stockholders' equity | | | 25,952,718 | | | 14,034,271 | ||||||
Noncontrolling interest | | | — | | | 124,477 | ||||||
Accumulated other comprehensive income | |
| 7,072,373 | |
| 6,430,567 | ||||||
Total stockholders' equity | |
| 25,952,718 | |
| 14,158,748 | | | 85,632,183 | | | 86,329,499 |
Total liabilities and stockholders' equity | | $ | 395,709,195 | | $ | 219,915,886 | | $ | 866,191,049 | | $ | 726,400,759 |
See Notes to Consolidated Financial Statements.
3
MIDWEST HOLDING INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) IncomeLOSS
(Unaudited)
| | | | | | | | | | | | | | | | | | | | |
| | Three months ended June 30, | | Six months ended June 30, | | | Three months ended March 31, | | ||||||||||||
|
| 2020 |
| 2019 |
| 2020 |
| 2019 | |
| 2021 |
| 2020 | | ||||||
Revenues | | |
|
| |
| | |
|
| |
| | | |
|
| |
| |
Insurance premiums | | $ | 30 | | $ | — | | $ | 51 | | $ | (2,479) | | |||||||
Premiums | | $ | — | | $ | 21 | | |||||||||||||
Investment income, net of expenses | |
| (397,842) | |
| 448,015 | |
| 843,136 | |
| 639,010 | | |
| 2,887,363 | |
| 1,240,978 | |
Net realized (losses) gains on investments (See Note 5) | |
| (12,819,871) | |
| 1,180 | |
| 9,780,139 | |
| (3,217) | | |||||||
Net realized (loss) gain on investments (See Note 4) | |
| (4,649,105) | |
| 22,600,010 | | |||||||||||||
Amortization of deferred gain on reinsurance | | | 338,269 | | | 1,046,552 | | | 520,707 | | | 1,852,599 | | | | 460,856 | | | 182,438 | |
Miscellaneous income | |
| 396,061 | |
| 66,795 | |
| 786,105 | |
| 82,335 | | |||||||
Total revenues | |
| (12,483,353) | |
| 1,562,542 | |
| 11,930,138 | |
| 2,568,248 | | |||||||
Expenses: | |
|
| |
|
| |
|
| |
|
| | |||||||
Service fee revenue, net of expenses | | | 438,146 | | | 380,267 | | |||||||||||||
Other revenue | |
| 248,969 | |
| 9,777 | | |||||||||||||
Total (loss) revenue | |
| (613,771) | |
| 24,413,491 | | |||||||||||||
Expenses | |
|
| |
|
| | |||||||||||||
Interest credited | |
| (128,052) | |
| 230,366 | |
| 83,150 | |
| 251,187 | | |
| (2,346,403) | | | 211,202 | |
Benefits | | | 4,016 | | | (1,523) | | | (3,087) | | | 1,872 | | | | 79 | | | (7,103) | |
Amortization of deferred acquisition costs | |
| 100,388 | |
| 19,796 | |
| 140,897 | |
| 21,865 | | |
| 502,737 | |
| 40,509 | |
Salaries and benefits | |
| 1,354,934 | |
| 575,625 | |
| 2,179,830 | |
| 1,115,074 | | |
| 2,927,227 | |
| 824,896 | |
Other operating expenses | |
| 2,305,687 | |
| 1,570,130 | |
| 3,630,800 | |
| 3,505,120 | | |
| (1,529,297) | |
| 1,325,113 | |
Total expenses | |
| 3,636,973 | |
| 2,394,394 | |
| 6,031,590 | |
| 4,895,118 | | |
| (445,657) | |
| 2,394,617 | |
(Loss) gain from continuing operations before taxes (See note 8) | |
| (16,120,326) | |
| (831,852) | |
| 5,898,548 | |
| (2,326,870) | | |||||||
Income tax expense | |
| (479,513) | |
| — | |
| (887,429) | |
| — | | |||||||
Net (loss) income | | | (16,599,839) | | | (831,852) | | | 5,011,119 | | | (2,326,870) | | |||||||
(Loss) income continuing from operations before taxes | |
| (168,114) | |
| 22,018,874 | | |||||||||||||
Income tax expense (See Note 8) | |
| (1,432,348) | |
| (407,916) | | |||||||||||||
Net (loss) income from continued operations | |
| (1,600,462) | |
| 21,610,958 | | |||||||||||||
Less: (Loss) income attributable to noncontrolling interest | | | — | | | (62,500) | | |||||||||||||
Net (loss) income attributable to Midwest Holding, Inc. | | | (1,600,462) | | | 21,548,458 | | |||||||||||||
Comprehensive income (loss): | |
|
| |
|
| |
|
| |
|
| | |
|
| |
|
| |
Unrealized gains on investments arising during period, net of tax | |
| 6,673,662 | |
| 863,186 | |
| 2,502,690 | |
| 1,711,156 | | |||||||
Unrealized gains (losses) on investments arising during period, net of offsets, net of tax ($180,885 and $961,012, respectively) | |
| 962,880 | |
| (4,170,973) | | |||||||||||||
Unrealized losses on foreign currency | | | (976) | | | — | | | (406,255) | | | — | | | | — | | | (405,275) | |
Less: reclassification adjustment for net realized losses (gains) on investments | |
| 12,819,871 | |
| (1,180) | |
| (9,780,139) | |
| 3,217 | | |||||||
Less: Reclassification adjustment for net realized gains on investments, net of tax ($85,348 and $4.7 million, respectively) | |
| (321,074) | |
| (22,600,010) | | |||||||||||||
Other comprehensive income (loss) | |
| 19,492,557 | |
| 862,006 | |
| (7,683,704) | |
| 1,714,373 | | |
| 641,806 | |
| (27,176,258) | |
Comprehensive income (loss): | | $ | 2,892,718 | | $ | 30,154 | | $ | (2,672,585) | | $ | (612,497) | | |||||||
Net (loss) gain per common share | | | | | | | | | | | | | | |||||||
Comprehensive loss | | $ | (958,656) | | $ | (5,627,800) | | |||||||||||||
Earnings (loss) income per common share | | | | | | | | |||||||||||||
Basic | | $ | (0.013) | | $ | (0.004) | | $ | 0.004 | | $ | (0.020) | | | $ | (0.43) | | $ | 10.55 | |
Diluted | | $ | (0.013) | | $ | (0.004) | | $ | 0.004 | | $ | (0.019) | | | $ | (0.43) | | $ | 10.43 | |
See Notes to Consolidated Financial Statements.
4
MIDWEST HOLDING INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | ||||
| | | | | Additional | | | | | | | | | Total | | | | | | | | Additional | | | | | | | | | Total | ||||||||
| | Common | | Paid-In | | Accumulated | | | | Noncontrolling | | Stockholders’ | | Treasury | | Common | | Paid-In | | Accumulated | | | | Noncontrolling | | Stockholders’ | |||||||||||||
|
| Stock |
| Capital |
| Deficit |
| AOCI* |
| Interests |
| Equity (Deficit) |
| Stock |
| Stock |
| Capital |
| Deficit |
| AOCI* |
| Interest |
| Equity | |||||||||||||
Balance, December 31, 2018 | | $ | 22,874 | | $ | 33,006,242 | | $ | (35,348,052) | | $ | (1,818,014) | | $ | — | | $ | (4,136,950) | |||||||||||||||||||||
Balance, December 31, 2019 | | $ | — | | $ | 2,042 | | $ | 54,494,355 | | $ | (41,081,710) | | $ | 619,584 | | $ | 124,477 | | $ | 14,158,748 | ||||||||||||||||||
Net loss | |
| — | |
| — | |
| (5,733,658) | |
| — | |
| — | |
| (5,733,658) | |
| — | |
| — | |
| — | |
| (12,440,368) | |
| — | |
| — | |
| (12,440,368) |
Xenith note interest waived | |
| — | |
| 845,536 | |
| — | |
| — | |
| — | |
| 845,536 | |||||||||||||||||||||
Xenith note conversion | |
| 927,680 | |
| 18,172,320 | |
| — | |
| — | |
| — | |
| 19,100,000 | |||||||||||||||||||||
Class C preferred stock conversion | | | 72,855 | | | 1,427,145 | | | — | | | — | | | — | | | 1,500,000 | |||||||||||||||||||||
Employee stock options | |
| — | |
| 21,745 | |
| — | |
| — | |
| — | |
| 21,745 | |||||||||||||||||||||
Change in equity of noncontrolling interests | | | — | | | — | | | — | | | — | | | 124,477 | | | 124,477 | |||||||||||||||||||||
Unrealized gains on investments, net of taxes | | | — | | | — | | | — | | | 2,291,413 | | | — | | | 2,291,413 | |||||||||||||||||||||
Unrealized gains on foreign currency, net of taxes | |
| — | |
| — | |
| — | |
| 146,185 | |
| — | |
| 146,185 | |||||||||||||||||||||
Balance, December 31, 2019 | | | 1,023,409 | | | 53,472,988 | | | (41,081,710) | | | 619,584 | | | 124,477 | | | 14,158,748 | |||||||||||||||||||||
Net income | |
| — | |
| — | |
| 5,011,119 | |
| — | |
| — | |
| 5,011,119 | |||||||||||||||||||||
Capital raise, net of $285,468 related expenses | | | 338,377 | | | 14,603,156 | | | — | | | — | | | — | | | 14,941,533 | |||||||||||||||||||||
Capital raise, net of $5,914,995 related expenses | | | — | | | 1,696 | | | 79,310,109 | | | — | | | — | | | — | |
| 79,311,805 | ||||||||||||||||||
Reverse stock split fractions retired | | | (175,333) | | | — | | | — | | | — | | | — | | | — | |
| (175,333) | ||||||||||||||||||
Employee stock options | | | — | | | 25,022 | | | — | | | — | | | — | | | 25,022 | | | — | | | — | | | 163,664 | | | — | | | — | | | — | | | 163,664 |
Purchase of remaining 49% of 1505 Capital LLC | | | — | | | (375,523) | | | — | | | — | | | (124,477) | | | (500,000) | | | — | | | — | | | (375,523) | | | — | | | — | | | (124,477) | |
| (500,000) |
Unrealized losses on investments | | | — | | | — | | | — | | | (7,277,449) | | | — | | | (7,277,449) | |||||||||||||||||||||
Unrealized losses on foreign currency | |
| — | |
| — | |
| — | |
| (406,255) | |
| — | |
| (406,255) | |||||||||||||||||||||
Balance, June 30, 2020 | | $ | 1,361,786 | | $ | 67,725,643 | | $ | (36,070,591) | | $ | (7,064,120) | | $ | — | | $ | 25,952,718 | |||||||||||||||||||||
Unrealized gains on investments, net of taxes | | | — | | | — | | | — | | | — | | | 5,957,168 | | | — | | | 5,957,168 | ||||||||||||||||||
Unrealized losses on foreign currency, net of taxes | | | — | | | — | | | — | | | — | | | (146,185) | | | — | | | (146,185) | ||||||||||||||||||
Balance, December 31, 2020 | | | (175,333) | | | 3,738 | | | 133,592,605 | | | (53,522,078) | | | 6,430,567 | | | — | | | 86,329,499 | ||||||||||||||||||
Net loss | |
| — | |
| — | |
| — | |
| (1,600,462) | |
| — | |
| — | |
| (1,600,462) | ||||||||||||||||||
Employee stock options | | | — | | | — | | | 261,340 | | | — | | | — | | | — | | | 261,340 | ||||||||||||||||||
Unrealized gains on investments, net of taxes | | | — | | | — | | | — | | | — | | | 641,806 | | | — | | | 641,806 | ||||||||||||||||||
Balance, March 31, 2021 | | $ | (175,333) | | $ | 3,738 | | $ | 133,853,945 | | $ | (55,122,540) | | $ | 7,072,373 | | $ | — | | $ | 85,632,183 |
* | Accumulated other comprehensive income (loss) |
See Notes to Consolidated Financial Statements.
5
MIDWEST HOLDING INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| | | | | | | | | | | | |
|
| Six months ended June 30, |
| Three months ended March 31, | ||||||||
| | 2020 |
| 2019 | | 2021 |
| 2020 | ||||
Cash Flows from Operating Activities: |
| |
|
| |
|
| |
|
| |
|
Net income (loss) | | $ | 5,011,119 | | $ | (2,326,870) | ||||||
Net (loss) income attributable to Midwest Holding, Inc. | | $ | (1,600,462) | | $ | 21,548,458 | ||||||
Adjustments to arrive at cash provided by operating activities: | |
|
| |
|
| |
|
| |
|
|
Net premium and discount on investments | |
| 104,947 | |
| 49,751 | |
| (279,584) | |
| 37,978 |
Depreciation and amortization | |
| 804,289 | |
| 32,254 | |
| 13,567 | |
| 15,321 |
Stock options | |
| 25,022 | |
| — | |
| 261,340 | |
| 11,934 |
Net transfers to noncontrolling interest | | | — | | | 62,500 | ||||||
Amortization of deferred acquisition costs | | | 140,897 | | | 21,865 | | | 502,737 | | | 40,509 |
Deferred acquisition costs capitalized | | | (4,118,436) | | | (1,157,073) | | | (6,774,293) | | | (1,483,941) |
Net realized (gains) losses on investments | |
| (9,780,139) | |
| 4,142 | ||||||
Net realized losses (gains) on investments | |
| 4,649,105 | |
| (22,600,010) | ||||||
Deferred coinsurance ceding commission | |
| 3,908,889 | |
| (1,838,878) | |
| 2,397,926 | |
| 1,033,940 |
Notes payable interest accrued | | | — | | | 845,536 | ||||||
Changes in operating assets and liabilities: | |
|
| |
|
| |
|
| |
|
|
Reinsurance recoverables | | | (4,304,381) | | | (404,451) | | | (6,164,935) | | | 2,617,495 |
Interest and dividends due and accrued | |
| (1,960,229) | |
| (255,955) | |
| (2,288,257) | |
| (1,052,329) |
Premiums receivable | |
| 6,310 | |
| (12,861) | |
| 486 | |
| 5,599 |
Policy liabilities | |
| 3,958,101 | |
| 672,825 | |
| (4,305,256) | |
| 1,699,134 |
Other assets and liabilities | |
| 8,678,265 | |
| (421,469) | |
| 21,408,109 | |
| 379,158 |
Other assets and liabilities - discontinued operations | |
| 6,280 | |
| (120,419) | |
| (2,328) | |
| 703 |
Net cash provided by or (used in) for operating activities | |
| 2,480,934 | |
| (4,911,603) | ||||||
Net cash provided by operating activities | |
| 7,818,155 | |
| 2,316,449 | ||||||
Cash Flows from Investing Activities: | |
|
| |
|
| |
|
| |
|
|
Securities available for sale: | |
|
| |
|
| |
|
| |
|
|
Purchases | |
| (107,759,107) | |
| (24,117,739) | |
| (176,433,779) | |
| (39,723,572) |
Proceeds from sale or maturity | |
| 18,409,038 | |
| 2,406,165 | |
| 61,831,341 | |
| 3,852,943 |
Mortgage loans on real estate, held for investment purchases | |
| | |
| | |
| | |
| |
Purchases | | | (35,531,866) | | | (4,176,039) | | | (16,446,861) | | | (33,342,545) |
Proceeds from sale | | | 2,069,950 | | | — | | | 1,660,510 | | | 2,069,950 |
Purchases of derivatives | | | (2,643,989) | | | — | ||||||
Derivatives | | | | | | | ||||||
Purchases | | | (4,157,582) | | | (651,661) | ||||||
Proceeds from sale | | | 660,355 | | | — | ||||||
Purchase of equity securities | | | (42,093,166) | | | — | ||||||
Other invested assets | | | | | | | | | | | | |
Purchases | | | (7,011,102) | | | — | | | (5,159,712) | | | (2,715,965) |
Proceeds from sale | | | 5,612,112 | | | — | | | 1,307,738 | | | 2,388,560 |
Notes receivable | | | (5,488,101) | | | — | ||||||
Investment in unconsolidated subsidiary | | | — | | | — | ||||||
Preferred stock | | | (474,732) | | | — | ||||||
Net change in policy loans | |
| (35,158) | |
| 589 | |
| (2,978) | |
| (22,720) |
Net purchases of property and equipment | |
| (45,513) | |
| (17,348) | |
| (10,350) | |
| (8,998) |
Net cash used in investing activities | |
| (132,423,736) | |
| (25,904,372) | |
| (179,319,216) | |
| (68,154,008) |
Cash Flows from Financing Activities: | |
|
| |
|
| |
|
| |
|
|
Finance lease | | | (111) | | | (222) | | | — | | | (111) |
Capital contribution | | | 14,941,533 | | | — | ||||||
1505 Capital LLC purchase | | | (500,000) | | | — | ||||||
Net transfers to noncontrolling interest | | | — | | | 1,846 | ||||||
Receipts on deposit-type contracts | |
| 147,486,013 | |
| 38,267,011 | |
| 123,653,931 | |
| 47,815,010 |
Withdrawals on deposit-type contracts | |
| (658,936) | |
| (11,003) | |
| (2,904,992) | |
| (186,689) |
Net cash provided by financing activities | |
| 161,268,499 | |
| 38,257,632 | |
| 120,748,939 | |
| 47,628,210 |
Net increase in cash and cash equivalents | |
| 31,325,697 | |
| 7,441,657 | |
| (50,752,122) | |
| (18,209,349) |
Cash and cash equivalents: | |
|
| |
|
| |
|
| |
|
|
Beginning | |
| 43,716,205 | |
| 2,832,567 | |
| 151,679,274 | |
| 43,716,205 |
Ending | | $ | 75,041,902 | | $ | 10,274,224 | | $ | 100,927,152 | | $ | 25,506,856 |
| | | | | | | ||||||
Supplemental Disclosure of Non-Cash Information | |
|
| |
|
| ||||||
Conversion of notes payable | | | | | | | ||||||
Book value of note payable | | | — | | | (19,100,000) | ||||||
Common stock | | | — | | | 927,680 | ||||||
Additional paid in capital | | | — | | | 18,172,320 | ||||||
Conversion of preferred stock | | | | | | | ||||||
Book value of preferred stock | | | — | | | (1,500,000) | ||||||
Common stock | | | — | | | 72,855 | ||||||
Additional paid in capital | | | — | | | 1,427,145 | ||||||
| | $ | — | | $ | — |
See Notes to Consolidated Financial Statements.
6
MIDWEST HOLDING INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Nature of Operations and Basis of Presentation
Nature of Operations
Midwest Holding Inc. (“Midwest,” “the Company,” “we,” “our,” or “us”) was incorporated in Nebraska on October 31, 2003 for the primary purpose of operating a financial services company. The Company redomesticated from the State of Nebraska to the state of Delaware on August 27, 2020. The Company is in the life and annuity insurance business and operates through its wholly owned subsidiary,subsidiaries, American Life & Security Corp. (“American Life”), and 1505 Capital LLC (“1505 Capital”) as well as through its sponsored captive reinsurance company, Seneca Reinsurance Company, LLC (“Seneca Re”). As discussed
American Life is a Nebraska-domiciled life insurance company, which is also commercially domiciled in Note 3, on June 28, 2018, we underwent a changeTexas, that is currently licensed to sell, underwrite, and market life insurance and annuity products in control as a result21 states and the District of the closing of a Loan, Convertible Preferred Stock and Convertible Senior Secured Note Purchase Agreement dated May 9, 2018 with a non-affiliated third party, Xenith Holdings LLC, a Delaware limited liability company (“Xenith”).Columbia.
On April 2, 2019, we obtained a 51% ownership in 1505 Capital, a Delaware limited liability company, that was established in 2018 to provide financial and investment advisory and management services to clients and related investment activities. On June 15, 2020, we purchased the remaining 49% ownership in 1505 Capital for $500,000. 1505 Capital’s financial results have been consolidated with the Company’s since the date of its acquisition.
Effective March 12, 2020, Seneca Reinsurance Company, LLC (“Seneca Re”), a Vermont limited liability company, was formed by Midwest to operate as a sponsored captive insurance company for the purpose of insuring and reinsuring various types of risks of its participants through one or more protected cells and to conduct any other business or activity that is permitted for sponsored captive insurance companies under Vermont insurance regulations. On March 30, 2020, Seneca Re received its Certification of Authority to transact the business of a captive insurance company. On May 12, 2020, Midwest contributed $300,000 to Seneca Re for a 100% ownership interest. As of June 30,May 13, 2020, Seneca Re had oneestablished Seneca Protected Cell-2020-01Cell 2020-01, a protected cell of Seneca Re (“SRC1”). Effective December 21, 2020, Seneca Re converted SRC1 to Seneca Incorporated Cell, LLC 2020-01. Midwest contributed $3,000,000 to capitalize SRC1. Crestline Management, L.P. (“Crestline Management”), a Delaware limited partnership, through an affiliated entity (see below) owns approximately 11.9% of Midwest’s voting common stock. On July 24, 2020, the Nebraska Department of Insurance (“NDOI”) issued its non-disapproval of the Funds Withheld Coinsurance and Modified Coinsurance Agreement with Seneca Incorporated Cell, LLC 2020-02 (“SRC2”) of Seneca Re, now known as Crestline Re SP1. Effective December 8, 2020, American Life entered into a novation agreement with SRC2 and Crestline Re SPC, an exempted segregated portfolio company incorporated under the laws of the Cayman Islands, for and on behalf of Crestline Re SP1, a segregated portfolio company of Crestline Re SPC, under which the above-described reinsurance, trust and related asset management agreements were novated and replaced with substantially similar agreements entered into by American Life and Crestline Re SP1.
On April 24, 2020, Midwest entered into a Securities Purchase Agreement with Crestline Assurance Holdings LLC, (“Crestline”), a Delaware limited liability company (“Crestline”Crestline Assurance”) Xenith, and Xenith, Vespoint, LLC, a Delaware limited liability company (“Vespoint”), and Pursuant to the Agreement, Crestline Assurance purchased 222,222,222444,444 shares of the Company’s voting common stock, par value $0.001 per share (“common stock”), at a purchase price of $0.045$22.50 per share for $10.0 million. Also, effective as of April 24, 2020, in a separate transaction, Midwest sold 115,827,004231,655 shares of common stock to various investors at $0.045$22.50 per share for $5.227 million.
Under the Crestline agreement, the Company contributed $5.0 million to American Life and the remaining proceeds are to be used for general working capital and corporate purposes.Life.
Also, effective April 24, 2020, American life entered into a Master Letter Agreement with Seneca Re and Crestline Management regarding a flow of annuity reinsurance and related asset management, whereby Crestline Management agreed to provide reinsurereinsurance funding for a quota share percentage of 25% of the liabilities of American Life arising from its multi-year guaranteed annuities ("MYGA"(“MYGA”) and a quota share percentage of 40% for American Life’s fixed indexed annuity (“FIA”) products. This agreement expires on April 24, 2023.
In December 2020, the Company completed a public offering of its voting common stock for gross proceeds of $70,000,000 (see Note 17). In connection therewith, the Company's voting common stock was approved for listing and began trading on the Nasdaq Capital Market upon the closing of the public offering.
7
Management evaluates the Company as one reporting segment in the life insurance industry. The Company is primarily engaged in the underwriting and marketing of annuity products and life insurance through American Life, and then reinsuring such products with third partythird-party reinsurers, and since April 24,May 13, 2020, with the Seneca Re entity.SRC1. The Company’s historical product offerings consisted of a multi-benefit life insurance policy that combined cash value life insurance with a tax deferred annuity and a single premium term life product. These product offerings were underwritten, marketed, and managed as a group of similar products on an overall portfolio basis. American Life presently offers five products, two MYGAs,MYGA, a FIA, and two bonus plans associated with the FIA product.
7 It is not presently offering any traditional life insurance products.
Basis of Presentation
The accompanying unauditedThese consolidated financial statements for the three months ended March 31, 2021 and 2020 and year ended December 31, 2020 have been prepared in accordanceconformity with generally accepted accounting principles in the United States of America generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions from the Securities and Exchange Commission (“SEC”) Quarterly Report on Form 10-Q, including Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. The information contained in the “Notes to Consolidated Financial Statements” included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 (“2019 Form 10-K”), should be read in connection with the reading of these interim unaudited consolidated financial statements.
Certain GAAP policies that significantly affect the determination of financial condition, results of operations and cash flows, are summarized in our 2019 Form 10-K.
In the opinion of management, these statements include all normal recurring adjustments necessary for a fair presentation of the Company’s results. Operating results for the six months ended June 30, 2020, are not necessarily indicative of the results that may be expected for the full year ending December 31, 2020.. All intercompany accounts and transactions have been eliminated in consolidation and certain immaterial reclassifications have been made to the prior period results to conform to the current period’s presentation with no impact on results of operations or total stockholders’ equity. The accompanying unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and noted thereto for the year ended December 31, 2020 included in the Company’s annual report on Form 10-K.
Investments
All fixed maturities owned by the Company are considered available-for-sale and are included in the consolidated financial statements at their fair value as of the financial statement date. Bond premiumsPremiums and discounts on fixed maturity debt instruments are amortized using the scientific-yield method over the term of the bonds. Realized gains and losses on securities sold during the year are determined using the specific identification method. Unrealized holding gains and losses, net of applicable income taxes, are included in accumulated other comprehensive income.
Declines in the fair value of available-for-sale securities below their amortized cost are evaluated to assess whether any other-than-temporary impairment loss should be recorded. In determining if these losses are expected to be other-than-temporary, the Company considers severity of impairment, duration of impairment, forecasted recovery period, industry outlook, the financial condition of the issuer, issuer credit ratings, and the intent and ability of the Company to hold the investment until the recovery of the cost.
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 statement of comprehensive income 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 statementas realized losses 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. The Company hashad no impairment recognized as of March 31, 2021. As of year-ended December 31, 2020, the Company analyzed the securities portfolio and determined that therean impairment of approximately $35,000 should be recorded for one security, an impairment of $500,000 was recognized on a preferred stock, and a valuation allowance of $776,973 established on one lease. The valuation allowance on the lease of $776,973 was released as of March 31, 2021 due to the sale of the investment. The remaining investments were not an other-than-temporary impairment for the six months ended June 30,impaired as of December 31, 2020.
Investment income consists of interest, dividends, gains and losses from equity method investments, and real estate income, which are recognized on an accrual basis andalong with the amortization of premiums and discounts.
Certain available-for-sale investments are maintained as collateral under funds withheld and modified coinsurance agreements but the assets and total returns or losses on the asset portfolios belong to the third-party reinsurers. American Life
8
has treaties with several third-party reinsurers that have funds withheld and modified coinsurance provisions. In a modified coinsurance arrangement (“Modco”), the ceding entity retains the assets equal to the modified coinsurance reserves retained. In a funds withheld coinsurance agreement (“FW”), assets that would normally be paid over to a reinsurer are withheld by the ceding company to permit statutory credit for unauthorized reinsurers to reduce the potential credit risk. The unrealized gains/losses on those investments are passed through to the third-party reinsurers as either a realized gain or loss on the Consolidated Statements of Comprehensive Loss.
Mortgage loans on real estate, held for investment
Mortgage loans on real estate, held for investment are carried at unpaid principal balances. Interest income on mortgage loans on real estate, held for investment, is recognized in net investment income at the contract interest rate when earned. A
8
mortgage loan is considered to be impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the mortgage agreement. Valuation allowances on mortgage loans are established based upon losses expected by management to be realized in connection with future dispositions or settlements of mortgage loans, including foreclosures. The Company establishes valuation allowances for estimated impairments on an individual loan basis as of the balance sheet date. Such valuation allowances are based on the excess carrying value of the loan over the present value of expected future cash flows discounted at the loan’s original effective interest rate. These evaluations are revised as conditions change and new information becomes available. No such valuation allowance was established for the as of June 30,March 31, 2021 or as of December 31, 2020, respectively.
Investment escrow
The Company held in escrow $3,317,043 and $3,174,047 as of March 31, 2021 and of December 31, 2020, respectively. The cash was used to settle other invested assets that closed in April 2021 and January 2021, respectively.
Other invested assets
The Company purchases and sells equipment leases in its investment portfolio. Other invested assets also includes loans held for investments. The Company entered into a fund investment on November 3,2020 for $15.8 million with an additional $3.9 million invested on December 16, 2020. At December 31, 2020, we had a $19.7 million investment in the fund. Effective January of 2021, this investment was repackaged into a special purpose vehicle between American Life and PF Collinwood Holdings, LLC (“PFC”) with American Life owning 100% of the entity. Subsequent to the repackaging of the fund investment into the special purpose vehicle, the classification of the investment remains in other invested assets.
Derivative Instruments
Derivatives are used to hedge the risks experienced in our ongoing operations, such as equity, interest rate, and cash flow risks, or for other risk management purposes, which primarily involve managing liability risks associated with our indexed annuity products and reinsurance agreements. Derivatives are financial instruments whose values are derived from interest rates, foreign exchange rates, financial indices, or other underlying notional amounts. Derivative assets and liabilities are carried at fair value on the consolidated balance sheets.Consolidated Balance Sheets.
To qualify for hedge accounting, at the inception of the hedging relationship, we would formally document our designation of the hedge as a cash flow or fair value hedge and our risk management objective and strategy for undertaking the hedging transaction. In this documentation, we would identify how the hedging instrument is expected to hedge the designated risks related to the hedged item, the method that would be used to retrospectively and prospectively assess the hedging instrument’s effectiveness and the method which would be used to measure ineffectiveness. A derivative designated as a hedging instrument must be assessed as being highly effective in offsetting the designated risk of the hedged item. Hedge effectiveness is formally assessed at inception and periodically throughout the life of the designated hedging relationship.
InDuring the late 2019,last quarter of 2020, the Company began investing in optionsforeign currency futures to hedge our interest rate risks on our FIA product. Options typicallythe fluctuations in the foreign currency. The formal documentation and hedge effectiveness was also not completed at the date we entered into those futures contracts; therefore, they do not qualify for hedge accounting; therefore, we chose not to use hedge accounting for our options that we currently have. We value our derivatives ataccounting. The futures fair market value with the offset beingvalues were recorded on our income statementConsolidated Statements of Comprehensive Loss as a realized gaingains or (loss)(losses).
9
Additionally, reinsurance agreements written on a funds withheld or modified coinsuranceModco basis contain embedded derivatives on our fixed indexed annuity product. Gains or (losses) associated with the performance of assets maintained in the modified coinsurance deposit and funds withheld accounts are reflected as realized gains or (losses )(losses) in Consolidated Statements of Comprehensive Loss.
Equity Securities
Equity securities at March 31, 2021 and 2020 consist of mutual funds. Equity securities are carried at fair value with the income statement.
Other invested assets
The Company purchaseschange in fair value recorded through realized gains and sells equipment leases in its investment portfolio. As of June 30, 2020, the Company owned several leases. An impairment test, as of June 30, 2020, was completedlosses on the only non-performing lease in the portfolio and it was determined that the underlying collateral value was substantially less than the remaining lease paymentsstatement of $3.4 million. The Company established a valuation allowance on the asset of $776,973 and will continue to monitor the value the underlying collateral. The valuation allowance was recorded as a bad debt expense; however, this asset is owned by a third party reinsurer. Therefore, the valuation allowance was passed through as a receivable from the reinsurers, offsetting the valuation allowance.operations.
Preferred stockStock
Preferred stock of a non-affiliated company was purchased for $500,000 during the third quarter of 2019. An impairment analysis of the preferred stock was performed as of June 30, 2020, due to a change in valuation of an invested asset held by the non-affiliated company. The investment asset had collateral supporting the investment that was less than the book value of the asset; therefore, the Company established aimpaired the full valuation allowanceamount of $500,000.$500,000 as of December 31, 2020. This was recorded as a reduction of the asset on the balance sheetConsolidated Balance Sheets and a bad debt expense on the Consolidated Statements of Comprehensive (Loss) Income.
Investment escrowLoss. There was no additional impairment of this preferred stock as of March 31, 2021.
The Company heldauthorized a series of transactions between American Life and Ascona Group Holdings Ltd (“AGH”). One of the transactions involved the acquisition of Pound Sterling (“GBP”) 3,345,022 of preferred equity in escrowAscona Group Holdings Limited (“the Preferred Equity”) along with warrants bearing no initial assigned value (the “Warrants” as of December 31, 2019, cash usedSeptember 28, 2020. American Life initially created a special purpose vehicle called Ascona Asset Holding LLC (“AAH”) to settle a mortgage loan that closed in January 2020. Ashold the Preferred Equity and Warrants, and later created Ascona Collinwood HoldCo LLC (“ACH”) to be the sole member of June 30, 2020, the Company did not hold any cash related to investments in escrow.
9AAH. American Life and Crestline Re SP1 own 74% and 26%, respectively, of ACH.
Notes receivable
The Company held in notes receivable as of June 30,March 31, 2021 and December 31, 2020, a note of $5,488,101$5,737,608 and $5,665,487, respectively, between American Life and an unconsolidated affiliatea third-party that was rated by a nationally recognized statistical rating organization (“NRSRO”). This note is being carried at the fair market value.
Policy loans
Policy loans are carried at unpaid principal balances. Interest income on policy loans is recognized in net investment income at the contract interest rate when earned. No valuation allowance is established for these policy loans as the amount of the loan is fully secured by the death benefit of the policy and cash surrender value.
Cash and cash equivalents
The Company considers all liquid investments with original maturities of three months or less when purchased to be cash equivalents. At June 30, 2020As of March 31, 2021 and December 31, 2019, the Company had no cash equivalents. At June 30, 2020, the Company held approximately 400,000GBP 47,621 and GBP 505,349 in Pound Sterling (“GBP”) in twoseveral of our custody accounts.accounts, respectively. The USD equivalent held was approximately $500,000.$65,703 and $690,787, respectively. As of June 30,March 31, 2021 and December 31, 2020, the Company recorded unrealizedheld approximately EUR 527,981 and 87,633, respectively. The USD equivalent held was approximately $620,536 and $107,000, respectively. As of March 31, 2021 and December 31, 2020, we had realized losses of approximately $260,000$75,000 and gains of approximately $45,000, respectively, related to the change in the foreign currency exchange rate (“FX”) of the GBP cash of 400,000and Euro that were recorded in other comprehensive incomerealized (losses) gains on investments in the balance sheet.Consolidated Statements of Comprehensive Loss. The Company had money market investments of approximately $61.2 million and $100.6 million at March 31, 2021 and December 31, 2020, respectively.
Deferred acquisition costs
Deferred acquisition costs (“DAC”) consist of incremental direct costs, net of amounts ceded to third partythird-party reinsurers, that result directly from and are essential to the contract acquisition transaction and would not have been incurred by the Company had the contract acquisition not occurred. These costs are capitalized, to the extent recoverable, and amortized over the life of
10
the premiums produced. The Company evaluates the types of acquisition costs it capitalizes. The Company capitalizes agent compensation and benefits and other expenses that are directly related to the successful acquisition of contracts. The Company also capitalizes expenses directly related to activities performed by the Company, such as underwriting, policy issuance, and processing fees incurred in connection with successful contract acquisitions.
Recoverability of deferred acquisition costs is evaluated periodically by comparing the current estimate of the present value of expected pretax future profits to the unamortized asset balance. If this current estimate is less than the existing balance, the difference is charged to expense. The Company performs a recoverability analysis annually in the fourth quarter unless events occur which require an immediate review. The Company determined that no events occurred in the sixthree months ended June 30, 2020March 31, 2021 that suggest a review should be undertaken.
Reinsurance
As indicated in our 2019 Form 10-K, reinsurance is an integral part The Company performed a recoverability analysis during the fourth quarter of our business plan. We expect to reinsure substantially2020 and determined that all of our new insurance policies with a variety of reinsurers in exchange for upfront ceding commissions, expense reimbursements and administrative fees. Under these reinsurance agreements, we expect there will be a monthly or quarterly settlement of premiums, claims, surrenders, collateral, and other administration fees. We believe this will help preserve American Life’s capital while supporting its growth because American Life will have lower capital requirements when its business is reinsured due to lower overall financial exposure versus retaining the insurance policy business itself. See Note 9 below for further discussion of our reinsurance activities.
There are two main categories of reinsurance transactions: 1) “indemnity,” where we cede a portion of our risk but retain the legal responsibility to our policyholders should our reinsurers not meet their financial obligations; and 2) “assumption,” where we transfer the risk and legal responsibilities to the reinsurers. The reinsurers are required to acquire the appropriate regulatory and policyholder approvals to convert indemnity policies to assumption policies.
Our reinsurers may be domestic or foreign capital markets investors or traditional reinsurance companies seeking to assume U.S. insurance business. We plan to mitigate the credit risk relating to reinsurers generally by requiring other financial commitments from the reinsurers to secure the reinsured risks (such as posting substantial collateral). It should be noted that
10
under indemnity reinsurance agreementsAmerican Life remains exposed to the credit risk of its reinsurers. If one or more reinsurers becomes insolvent or is otherwise unable or unwilling to pay claims under the terms of the applicable reinsurance agreement, American Life retains legal responsibility to pay policyholder claims, which, in such event would likely materially and adversely affect the capital and surplus of American Life.
As indicated above under “Nature of Operations,” Midwest formed Seneca Re in early 2020. On April 15, 2020, Midwest entered into an operating agreement with Seneca Re. Seneca Re currently has one Protected Cell 2020-01 (“SRC1”).
Some reinsurers are not and may not be “accredited” or qualified as reinsurers under Nebraska Law. In order to enter into reinsurance agreements with such reinsurers and to reduce potential credit risk, American Life holds a deposit or withholds 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. The reinsurer may also appoint an investment manager for such funds, which is some cases may be our investment adviser subsidiary, 1505 Capital, to manage these assets pursuant to guidelines adopted by us that are consistent with state investment statutes and reinsurance regulations.
American Life currently has treaties with four third party reinsurers and one related party reinsurer. Of the four third party reinsurers, only three have funds withheld or modified coinsurance provisions. In a modified coinsurance arrangement (“Modco”), the ceding entity retains the assets equal to the modified coinsurance reserves retained. In a funds withheld coinsurance agreement (“FW”), assets that would normally be paid over to a reinsurer are withheld by the ceding company to permit statutory credit for unauthorized reinsurance, to reduce the potential credit risk. Under those provisions with third party reinsurers, the assets backing the treaties are maintained by American Life as investments but the assets and total returns or losses on the investments are owned by the reinsurers. Under GAAP, this arrangement is considered an embedded derivative as discussed in Note 6 to our consolidated financial statements above. As a result of recent market volatility, assets carried as investments on American Life’s financial statements for the third party reinsurers contained unrealized losses of approximately $8.5 millionDAC balances were recoverable as of June 30,December 31, 2020. The terms of the contracts with the third party reinsurers provide that unrealized losses on the portfolios accrue to the third party reinsurers. Accordingly, the unrealized losses on the assets held by American Life were offset by a gain in the embedded derivative of $8.5 million. We account for this unrealized loss pass-through by recording equivalent realized gains on our income statement and in amount recoverable from our third party reinsurers on our balance sheet.
Property and equipment
Property and equipment are stated at cost net of accumulated depreciation. Annual depreciation is primarily computed using straight-line methods for financial reporting and straight-line and accelerated methods for tax purposes. Furniture and equipment is depreciated over 3 to 7 years and computer software and equipment is generally depreciated over 3 years. Depreciation expense totaled $11,996$12,334 and $9,506$10,316 for the three months ended June 30,March 31, 2021 and 2020, and 2019, respectively. Depreciation expense totaled $22,312 and $19,320 for the six months ended June 30, 2020 and 2019, respectively. Accumulated depreciation totaled $997,793$1,035,668 and $975,480$1,023,334 as of June 30, 2020March 31, 2021 and December 31, 2019,2020, respectively.
Maintenance and repairs are expensed as incurred. Replacements and improvements which extend the useful life of the asset are capitalized. The net book value of assets sold or retired are removed from the accounts, and any resulting gain or loss is reflected in earnings.
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognized if the carrying amount of an asset may not be recoverable and exceeds estimated future undiscounted cash flows of the asset. A recognized impairment loss reduces the carrying amount of the asset to its fair value. Management has determined that no such events occurred in the sixthree months ended June 30, 2020March 31, 2021 that would indicate the carrying amounts may not be recoverable.
Reinsurance
In the normal course of business, the Company seeks to limit any single exposure to losses on large risks by purchasing reinsurance. The amounts reported in the consolidated balance sheets as reinsurance recoverable include amounts billed to reinsurers on losses paid as well as estimates of amounts expected to be recovered from reinsurers on insurance liabilities that have not yet been paid. Reinsurance recoverable on unpaid losses are estimated based upon assumptions consistent with those used in establishing the liabilities related to the underlying reinsured contracts. Insurance liabilities are reported gross of reinsurance recoverable. Management believes the recoverables are appropriately established. The Company generally strives to diversify its credit risks related to reinsurance ceded. Reinsurance premiums are generally reflected in income in a manner consistent with the recognition of premiums on the reinsured contracts. Reinsurance does not extinguish the Company’s primary liability under the policies written. Therefore, the Company regularly evaluates the financial condition of its reinsurers including their activities with respect to claim settlement practices and commutations, and establishes allowances for uncollectible reinsurance recoverable as appropriate. There were no allowances established as of March 31, 2021 or December 31, 2020.
We expect to reinsure substantially all of our new insurance policies with a variety of reinsurers in exchange for upfront ceding commissions, expense reimbursements and administrative fees. Under these reinsurance agreements, we expect there will be a monthly or quarterly settlement of premiums, claims, surrenders, collateral, and other administration fees. We believe this will help preserve American Life’s capital while supporting its growth because American Life will have lower capital requirements when its business is reinsured due to lower overall financial exposure versus retaining the insurance policy business itself. See Note 8 below for further discussion of our reinsurance activities.
There are two main categories of reinsurance transactions: 1) “indemnity,” where we cede a portion of our risk but retain the legal responsibility to our policyholders should our reinsurers not meet their financial obligations; and 2) “assumption,”
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where we transfer the risk and legal responsibilities to the reinsurers. The reinsurers are required to acquire the appropriate regulatory and policyholder approvals to convert indemnity policies to assumption policies.
Our reinsurers may be domestic or foreign capital markets investors or traditional reinsurance companies seeking to assume U.S. insurance business. We plan to mitigate the credit risk relating to reinsurers generally by requiring other financial commitments from the reinsurers to secure the reinsured risks (such as posting substantial collateral). It should be noted that under indemnity reinsurance agreements American Life remains exposed to the credit risk of its reinsurers. If one or more reinsurers become insolvent or are otherwise unable or unwilling to pay claims under the terms of the applicable reinsurance agreement, American Life retains legal responsibility to pay policyholder claims, which, in such event would likely materially and adversely affect the capital and surplus of American Life.
As indicated above under “Nature of operations,” Midwest formed Seneca Re in early 2020. On April 15, 2020, Midwest entered into an operating agreement with Seneca Re and as of December 31, 2020, Seneca Re has one incorporated cell, Seneca Incorporated Cell, LLC 2020-01 (“SRC1”) which was consolidated in our financial statements.
Effective December 8, 2020, American Life entered into a novation agreement with SRC2 and Crestline Re SPC, an exempted segregated portfolio company incorporated under the laws of the Cayman Islands, for and on behalf of Crestline Re SP1, an exempted segregated portfolio company of Crestline Re SPC, under which the above-described reinsurance, trust and related asset management agreements were novated and replaced with substantially similar agreements entered into by American Life and Crestline Re SP1.
Some reinsurers are not and may not be “accredited” or qualified as reinsurers under Nebraska Law. In order to enter into reinsurance agreements with such reinsurers and to reduce potential credit risk, American Life holds a deposit or withholds funds from the reinsurer or requires the reinsurer to maintain a trust that holds assets backing up the reinsurer’s obligation to pay claims on the business it assumes. The reinsurer may also appoint an investment manager for such funds, which in some cases may be our investment adviser subsidiary, 1505 Capital, to manage these assets pursuant to guidelines adopted by us that are consistent with state investment statutes and reinsurance regulations.
American Life currently has treaties with several third-party reinsurers and one related party reinsurer. Of the third-party reinsurers, only three have funds withheld or modified coinsurance provisions. In a modified coinsurance arrangement, the ceding entity retains the assets equal to the modified coinsurance reserves retained. In a funds withheld coinsurance agreement, assets that would normally be paid over to a reinsurer are withheld by the ceding company to permit statutory credit for unauthorized reinsurers, to reduce the potential credit risk. Under those provisions with third-party reinsurers, the assets backing the treaties are maintained by American Life as investments but the assets and total returns or losses on the investments are owned by the reinsurers. Under GAAP, this arrangement is considered an embedded derivative as discussed in Note 5 below. As a result of recent market volatility, assets carried as investments on American Life’s financial statements for the third-party reinsurers contained unrealized gains of approximately $2.5 million and $2.9 million as of March 31, 2021 and December 31, 2020, respectively. The terms of the contracts with the third-party reinsurers provide that unrealized gains on the portfolios accrue to the third-party reinsurers. Accordingly, the unrealized gains on the assets held by American Life were offset by a gain in the embedded derivative of $400,000 and a loss $2.9 million as of March 31, 2021 and December 31, 2020, respectively. We account for this unrealized loss pass-through by recording equivalent realized losses on our Consolidated Statements of Comprehensive Loss and in amount payable to our third-party reinsurers on the Consolidated Balance Sheets.
Benefit reserves
The Company establishes 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 a net level premium method based upon estimates at the time of issue for investment
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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.
Policy claims
Policy claims are based on reported claims plus estimated incurred but not reported claims developed from trends of historical data applied to current exposure.
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Deposit-type contracts
Deposit-type contracts consist of amounts on deposit associated with deferred annuities, premium deposit funds and supplemental contracts without life contingencies.
Deferred gain on coinsurance transactions
American Life has entered into four reinsurance contracts where it has earned or is earning ceding commissions. These ceding commissions are recorded as a deferred liability and amortized over the life of the business ceded. American Life receives commission, administrative, and option allowances from reinsurance transactions that represent recovery of acquisition costs. These allowances first reduce the DAC associated with the reinsured blocks of business with the remainder being included in the deferred gain on coinsurance transactions that is also being amortized.
Income taxes
The Company is subject to income taxes in the U.S. federal and various state jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. With few exceptions, the Company is no longer subject to U.S. federal, state, or local tax examinations by tax authorities for the years before 2015.2016. The Company is not currently under examination for any open years. The provision for income taxes is based on income as reported in the financial statements. The income tax provision is calculated under the asset and liability method. Deferred tax assets are recorded based on the differences between the financial statement and tax basis of assets and liabilities at the enacted tax rates. The principal assets and liabilities giving rise to such differences are investments, insurance reserves, and deferred acquisition costs. A deferred tax asset valuation allowance is established when there is uncertainty that such assets would be realized. The Company has no uncertain tax positions that it believes are more-likely-than not that the benefit will not to be realized. When applicable, the Company recognizes interest accrued related to unrecognized tax benefits and penalties in income tax expense.
Revenue recognition and related expenses
Amounts received as payment for annuities are recognized as deposits to policyholder account balances and included in future insurance policy benefits. Revenues from these contracts are comprised of fees earned for administrative and contract-holder services and cost of insurance, which are recognized over the period of the contracts, and included in revenue. Deposits are shown as a financing activity in the consolidated statementsConsolidated Statements of cash flows.Cash Flows.
Revenues from ceding commissions on traditional life and annuity products are deferred on the Consolidated Balance Sheets and amortized over the life of the policies.
Revenues on traditional life insurance products consist of direct and assumed premiums reported as earned when due.
Liabilities for future policy benefits are provided and acquisition costs are amortized by associating benefits and expenses with earned premiums to recognize related profits over the life of the contracts. Acquisition costs are amortized over the expected life of the annuity contracts.
ComprehensiveRevenues on service fees and third-party administration fees are recorded as income (loss)when incurred.
Comprehensive income (loss)loss
Comprehensive loss is comprised of net (loss) income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses from marketable securities classified as available for sale and unrealized gains and losses from foreign currency transactions, net of applicable taxes. American Life has treaties with four third partyseveral third-party reinsurers that have funds withheld and modified coinsurance provisions. Under those provisions, the assets backing the treaties are maintained by American Life as collateral but are owned by the third partythird-party reinsurers, thus, the total
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return on the asset portfolio belongs to the third partythird-party reinsurers. Under GAAP this is considered an embedded derivative as discussed in Note 65 below. As a result of recent market volatility, the investments carried by American Life for the third partythird-party reinsurers contained unrealized losses of approximately $8.5 million as of June 30, 2020. The terms of the contracts with the third party reinsurers provided that unrealized losses on the portfolios accrue to the third party reinsurers. We account for this loss pass through by booking equivalent embedded derivative realized gains in our Consolidated Statements of Comprehensive (Loss) Income. Accordingly, for the first half of 2020, such gains were $8.5 million. The remaining investments retained by American Life had unrealized gains of approximately $1,631,474 that included unrealized gains$2.5 million and $2.9 million as of $1,087,700 resulting from the consolidation of SRC1.
Basic earnings per share in the first half of fiscal 2020 were $0.004 which included the aforementioned gain of $8.5 million. Basic loss per share in the first half of fiscal 2020 without the aforementioned gain was ($0.002).
Common and preferred stock and earnings (loss) per share
The par value per each Company share is $0.001 with 1,970,000,000 voting common shares authorized, 20,000,000 non-voting common shares authorized, and 10,000,000 preferred shares authorized. On June 18, 2019, Xenith exercised the right to convert its 1,500,000 Series C preferred stock and the $19,100,000 notes payable to voting common stock at the conversion rate of approximately $0.02 per common share. With the infusion of capital and the issuance of voting common stock in the Crestline transaction mentioned above under “Nature of Operations,” the Company had voting common shares issued and outstanding at June 30, 2020March 31, 2021 and December 31, 2019, 1,361,557,779 and 1,023,408,553, respectively
The Series C preferred shares were converted by Xenith to voting common shares on June 18, 2019 at a rate of approximately $0.02 per share for 72,854,474 voting common shares. The stated annual dividend rate on the Series C preferred shares was 8%. At the time of the conversion, Xenith forgave all previously accrued dividends from June 28, 2018 through the conversion date.
(Loss) gain per basic share attributable to the Company’s common stockholders was computed based on the weighted average number of shares outstanding during each period. The weighted average number of shares outstanding during the three months ended June 30, 2020, and 2019 was 1,272,367,873 and 220,781,744, respectively. The weighted average number of shares outstanding during the six months ended June 30, 2020 and 2019 were 1,147,888,213 and 122,374,461, respectively.
(Loss) gain diluted share attributable to the Company’s common stockholders was computed based on the average shares outstanding and options granted under our Long-Term Incentive Plan (“LTIP”), as if all were vested and exercised. The weighted average number of diluted shares outstanding during the three months ended June 30, 2020 and 2019 was 1,273,314,893 and 221,728,764, respectively. The weighted average number of diluted shares outstanding during the six months ended June 30, 2020 and 2019 were 1,148,835,232 and 123,321,481 shares, respectively.
Note 2. New Accounting Standards
Adoption of New Accounting Standards
In August 2018, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computer Arrangement That is a Service Contract. Under ASU No. 2018-15, the amendment aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments in this update. In order to determine which costs can be capitalized, we are to follow the guidance in Subtopic 350-40. Cost for implementation activities in the application development stage are capitalized depending on the nature of the costs, while costs incurred during the preliminary project and the post-implementation stage are expensed as the activities are performed. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The amendments in this update should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. Management has reviewed and evaluated the impact of this pending new standard and will implement this starting in fiscal year 2020. We reviewed our software enhancements as of June 30, 2020 to determine the impact of
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implementing ASU No. 2018-12 and determinedThe terms of the contracts with the third-party reinsurers provided that none of those enhancements should be capitalized as they did not meet the requirements of this ASU.
In February 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842). The guidance in this ASU supersedes the leasing guidance in Topic 840, Leases. Under the new guidance, lessees are required to recognize lease assets and lease liabilitiesunrealized gains on the balance sheetportfolios accrue to the third-party reinsurers. We account for all leases with terms longer than 12 months. Leases will be classified as either financethis gain pass through by booking equivalent embedded derivative realized losses or operating, with classification affecting the pattern of expense recognitiongains in the income statement. The lease liability is measured at the present value of the lease payments over the lease term with the right-of-use asset measured as the lease liability amount and including adjustments for certain lease incentives and initial direct costs. Lease expense recognition will continue to differentiate between finance leases and operating leases resulting in a similar pattern of lease expense recognition as under current GAAP. This ASU permitted a modified retrospective adoption approach that includes a number of optional practical expedients that entities may elect upon adoption. On January 1, 2019, the Company adopted this standard using a modified retrospective adoption approach. The adoption resulted in the Company identifying three operating leases and one financial lease which were subject to this guidance. The impact to theour Consolidated Statements of Comprehensive Income (Loss) was minimal. We identified four leases with netLoss. Accordingly, as of March 31, 2021 and 2020, such gains of $400,000 and of $23.2 million, respectively, were recorded. The remaining investments retained by American Life as of March 31, 2021 and December 31, 2020, had unrealized gains of approximately $5.9 million and $5.1 million, respectively, that included unrealized gains from assets of $409,165 and $473,045, and lease liabilities of $460,791 and $526,108held for SRC1.
Basic (loss) earnings per share for the sixthree months ended June 30,March 31, 2021 and 2020 was ($0.43) and $10.55, respectively, which included the yearaforementioned gain of $400,000 and $23.2 million, respectively. Basic loss per share for the three months ended DecemberMarch 31, 2019,2021 and 2020 without the aforementioned gain was ($0.55) and ($0.83), respectively.
Future adoptionReclassifications
Certain reclassifications have been made on the Statements of Comprehensive Loss for the three months ended March 31, 2020. These reclassifications do not impact the overall Net loss or Net loss per common shares line items of the Consolidated Statement of Comprehensive Loss for the three months ended March 31, 2020.
Adoption of New Accounting Standards
In January 2020, the FASB issued ASU No. 2020-1, Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815)-Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. The amendments in this Updateupdate clarify certain interactions between the guidance to account for certain equity securities under Topic 321, the guidance to account for investments under the equity method of accounting in Topic 323, and the guidance in Topic 815, which could change how an entity accounts for an equity security under the measurement alternative or a forward contract or purchased option to purchase securities that, upon settlement of the forward contract or exercise of the purchased option, would be accounted for under the equity method of accounting or the fair value option in accordance with Topic 825, Financial Instruments. For public business entities,This amendment was adopted effective January 1, 2021. As of March 31, 2021, the amendments inCompany does not have any equity method transactions or options to purchases securities that would fall under this Update are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. We are unableupdate; therefore, there is no impact to determine the impactCompany at this timetime.
Future adoption of ASU No. 2020-1 as we are still in the process of evaluating the standard.New Accounting Standards
In February 2020, the FASB issued ASU No. 2020-02, Financials Services Instruments-Credit Losses (Topic 326), and Leases (topic 842). The amendments in this Update adds language to Accounting Bulletin N. 119. In November 2019, the FASB issued ASU No. 2019-10, Financials Services Instruments-Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (topic 842). The Boardboard developed a philosophy to extend and simplify how effective dates are staggered between larger public companies and all other entities. For business entities that meet the definition of a smaller reporting company (“SRC”), the amendments in ASU 2018-12 are effective for fiscal years beginning after December 15, 2021. In August 2018, the FASB issued ASU No. 2018-12, Financial Services-Insurance (Topic 944). This update 1) modifies the timeliness of recognizing changes in the liability for future policy benefits and modifies the rate used to discount future cash flows, 2) simplifies the accounting for certain market-based options or guarantees associated with deposit contracts, 3) simplifies the amortization of deferred acquisition costs, and 4) addresses the effectiveness of the required disclosures. This ASU becomes effective for fiscal years, and interim periods within those years, beginning after December 15, 2023. We anticipate that the adoption of ASU 2018-12 will have a broad impact on our consolidated financial statements and related disclosures and will require us to make changes to certain of our processes, systems and controls. We are unable to determine the impact at this time of ASU No. 2018-12 as we are still in the process of evaluating the standard.
In March 2020,December 2018, the FASB issued ASU No. 2020-03,2018-12, CodificationFinancial Services—Insurance (Topic 944): Targeted Improvements to Topic 326, the Accounting for Long-Duration Contracts, as amended by ASU 2019-09, Financial Instruments—Credit Losses.Services —Insurance (Topic 944). The scopenew guidance (i) prescribes the discount rate to be used in measuring the liability for future policy benefits for traditional and limited payment long-duration contracts, and requires assumptions for those liability valuations to be updated after contract inception, (ii) requires more market-based product guarantees on certain separate account and other account balance long-duration contracts to be accounted for at fair value, (iii) simplifies the amortization of this amendmentDAC for virtually all long-duration contracts, and (iv) introduces certain financial statement presentation requirements, as well as significant additional quantitative and qualitative disclosures. The new standard becomes effective after December 15, 2023 , and interim periods within fiscal years beginning after December 15, 2024 for companies eligible as smaller reporting companies. Early application of the amendments in Update 2018-12 is to clarify the interactionpermitted.
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In November 2018, the FASB issued ASU No. 2018-10, Codification Improvements to Topic 326, Financial Instruments—Credit Losses. The amendments in this update include items brought to the Board’s attention by stakeholders to clarify the guidance in the amendments in ASU 2016-13, Financial Instruments – Credit Losses (Topic 326) which was issued in June 2016. These updated amendments clarify that receivables arising from operating leases are not within the scope of Subtopic 326-20. Under ASU 2016-13, this replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to perform credit loss estimates. This update changes the methodology from an incurred loss to an expected credit loss. An allowance for
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the expected credit loss will be set up and the net income will be impacted. The credit losses will be evaluated in the current period and an adjustment to the allowance can be made. The new standard becomes effective after December 15, 2022. We are currently evaluating the impact of our pending adoption of the new standard on our consolidated financial statements.
Note 3.2. Assets and Liabilities Associated with Business Held for Sale
On November 30, 2018, American Life entered into an Assumption and Indemnity Reinsurance Agreement (“Reinsurance Agreement”) with Unified Life Insurance Company (“Unified”), aan unaffiliated Texas domiciled stock insurance company. The Reinsurance Agreement provides that American Life cededwill cede and Unified agreedwill agree to reinsure, on an indemnity reinsurance basis, 100% of the liabilities and obligations under substantially all of American Life’s life, annuity, and health policies (“Policies”). The Agreement closed on December 10, 2018, as previously disclosed in Midwest’s Current Report on Form 8-K filed with the Securities and Exchange Commission (the “SEC”(“SEC”) on December 12, 2018. The effective date of the Agreement was July 1, 2018.
After the closing of the Reinsurance Agreement, Unified began the process of preparing and delivering certificates of assumption and other materials to policyholders of American Life in order to effect an assumption of the Policies by Unified such that all of American Life’s rights and obligations under the policies arising on and after July 1, 2018 would be completely assumed by Unified without further indemnification or other obligations, except for liabilities, claims and obligations incurred before July 1, 2018. Unified is obligated to indemnify American Life against all liabilities and claims and all of its policy obligations from and after July 1, 2018.
As of June 30,March 31, 2021 and 2020, 89%90% and 81%, respectively, of the indemnity policies were converted to assumptive policies thereby releasing American Life from all of its legal obligations related to those policies.
The consideration paid by Unified to American Life under the Reinsurance Agreement upon closing was $3,500,000 (“Ceding Commission”), subject to minor settlement adjustments. At closing, American Life transferred the Statutory Reservesstatutory reserves and Liabilities, as defined in the Reinsurance Agreement,liabilities directly related to the policies, to Unified.
The Ceding Commission is being amortized on a straight-line basis over the life of the policies. When the policies are converted to assumptive, meaning American Life has no liability exposure for those policies, the remaining Ceding Commission will beis recognized in our income statement.Consolidated Statements of Comprehensive Loss as of March 31, 2021 and 2020 were $7,628 and $67,451, respectively.
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Our balance sheet wasConsolidated Balance Sheets were required to be restated under GAAP for all periods shown with the assets and liabilities which were ceded by American Life to Unified into separate line items as assets and liabilities held for sale. The table below summarizes the assets and liabilities that are included in discontinued operations as of June 30, 2020March 31, 2021 and as of December 31, 2019:2020:
| | | | | | | | | | | | |
| | As of June 30, | | As of December 31, | | As of March 31, | | As of December 31, | ||||
|
| 2020 |
| 2019 |
| 2021 |
| 2020 | ||||
Carrying amounts of major classes of assets included as part of discontinued operations: |
| |
|
| |
|
| |
|
| |
|
Policy loans | | $ | 42,129 | | $ | 50,387 | | $ | 33,614 | | $ | 33,161 |
Reinsurance recoverables | |
| 1,077,317 | |
| 3,569,849 | |
| 1,057,488 | |
| 1,061,979 |
Premiums receivable | |
| 22,933 | |
| 33,512 | |
| 31,379 | |
| 23,643 |
Total assets held for sale in the Consolidated Balance Sheet | | $ | 1,142,379 | | $ | 3,653,748 | ||||||
Total assets held for sale in the Consolidated Balance Sheets | | $ | 1,122,481 | | $ | 1,118,783 | ||||||
| | | | | | | | | | | | |
Carrying amounts of major classes of liabilities included as part of discontinued operations: | |
|
| |
|
| |
|
| |
|
|
Benefit reserves | | $ | 620,941 | | $ | 1,403,953 | | $ | 600,534 | | $ | 594,710 |
Policy claims | |
| 24,231 | |
| 28,203 | |
| 24,029 | |
| 35,302 |
Deposit-type contracts | |
| 486,486 | |
| 2,209,195 | |
| 489,166 | |
| 482,966 |
Advance premiums | |
| 2,273 | |
| 2,226 | |
| 335 | |
| 71 |
Accounts payable and accrued expenses | |
| 7,847 | |
| 3,290 | |
| 1,618 | |
| 1,263 |
Total liabilities held for sale in the Consolidated Balance Sheets | | $ | 1,141,778 | | $ | 3,646,867 | | $ | 1,115,682 | | $ | 1,114,312 |
Note 4.3. Non-controlling Interest
On April 2, 2019, Midwest entered into a contract to acquire a 51% ownership in 1505 Capital LLC (“1505 Capital”), a Delaware limited liability company. 1505 Capital was organized to provide financial and investment advisory and management services to clients and any related investment, trading, or financial activities. Midwest purchased for $1$1.00 its 51% ownership and on June 15, 2020, we purchased the remaining 49% ownership in 1505 Capital for $500,000. Midwest used the equity method
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March 31, 2021 we had no noncontrolling interest and as of accounting for the purchase of the controlling interest eliminatingMarch 31, 2020, the non-controlling interest and recording the difference to additional paid in capital.was carried at $186,977, respectively.
Note 5. Investments
The cost or amortized cost and estimated fair value of investments as of June 30, 2020 and December 31, 2019 are as follows:
| | | | | | | | | | | | |
| | Cost or | | Gross | | Gross | | | | |||
| | Amortized | | Unrealized | | Unrealized | | Estimated | ||||
|
| Cost |
| Gains |
| Losses |
| Fair Value | ||||
June 30, 2020: |
| |
|
| |
|
| |
|
| |
|
Fixed maturities: |
| |
|
| |
|
| |
|
| |
|
U.S. government obligations | | $ | 1,730,793 | | $ | 105,936 | | $ | — | | $ | 1,836,729 |
Mortgage-backed securities | |
| 721,970 | |
| 6,445 | |
| 6,646 | |
| 721,769 |
Asset-backed securities | | | 174,795,977 | | | 1,459,587 | | | 8,347,320 | | | 167,908,244 |
States and political subdivisions -- general obligations | |
| 238,408 | |
| 11,671 | |
| — | |
| 250,079 |
States and political subdivisions -- special revenue | |
| 2,924,809 | |
| 540,547 | |
| — | |
| 3,465,356 |
Trust preferred | | | 2,218,142 | | | — | | | 93,664 | | | 2,124,478 |
Corporate | |
| 24,320,752 | |
| 626,580 | |
| 1,143,700 | |
| 23,803,632 |
Total fixed maturities | | $ | 206,950,851 | | $ | 2,750,766 | | $ | 9,591,330 | | $ | 200,110,287 |
Mortgage loans on real estate, held for investment | | | 51,171,943 | | | — | | | — | | | 51,171,943 |
Derivatives | | | 3,134,820 | | | 588,201 | | | 494,919 | | | 3,228,102 |
Other invested assets | | | 3,090,964 | | | — | | | — | | | 3,090,964 |
Notes receivable | | | 5,488,101 | | | — | | | — | | | 5,488,101 |
Policy loans | | | 141,172 | | | — | | | — | | | 141,172 |
| | $ | 269,977,851 | | $ | 3,338,967 | | $ | 10,086,249 | | $ | 263,230,569 |
| | | | | | | | | | | | |
December 31, 2019: | |
|
| |
|
| |
|
| |
|
|
Fixed maturities: | | | | | | | | | | | | |
U.S. government obligations | | | 2,091,710 | | | 7,073 | | | 17,559 | | | 2,081,224 |
Mortgage-backed securities | | | 819,678 | | | — | | | 21,070 | | | 798,608 |
Asset-backed securities | | | 95,006,241 | | | 646,335 | | | 404,752 | | | 95,247,824 |
States and political subdivisions -- general obligations | | | 240,494 | | | 8,788 | | | — | | | 249,282 |
States and political subdivisions -- special revenue | | | 25,112 | | | 179 | | | — | | | 25,291 |
Corporate | | | 18,493,077 | | | 501,022 | | | 154,467 | | | 18,839,632 |
Total fixed maturities | | | 116,676,312 | | | 1,163,397 | | | 597,848 | | | 117,241,861 |
Mortgage loans on real estate, held for investment | | | 13,810,041 | | | — | | | — | | | 13,810,041 |
Derivatives | | | 490,831 | | | 87,684 | | | 3,221 | | | 575,294 |
Investment escrow | | | 3,899,986 | | | — | | | — | | | 3,899,986 |
Other invested assets | | | 2,468,947 | | | — | | | — | | | 2,468,947 |
Preferred stock | | | 500,000 | | | — | | | — | | | 500,000 |
Policy loans | | | 106,014 | | | — | | | — | | | 106,014 |
Total fixed maturities | | $ | 137,952,131 | | $ | 1,251,081 | | $ | 601,069 | | $ | 138,602,143 |
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The Company has two securities that individually exceed 10% of the total of the state and political subdivisions categories as of June 30, 2020. Note 4. Investments
The amortized cost and estimated fair value credit ratings,of investments as of March 31, 2021 and description of each security isDecember 31, 2020 were as follows:
| | | | | | | | | | | | | | | | | | | | |
| | Amortized | | Estimated | | | | | | Gross | | Gross | | | | |||||
|
| Cost |
| Fair Value |
| Credit Rating | | Amortized | | Unrealized | | Unrealized | | Estimated | ||||||
June 30, 2020: |
| |
|
| |
|
|
| ||||||||||||
|
| Cost |
| Gains |
| Losses |
| Fair Value | ||||||||||||
March 31, 2021: |
| |
|
| |
|
| |
|
| |
| ||||||||
Fixed maturities: |
| |
|
| |
|
|
|
| |
|
| |
|
| |
|
| |
|
U.S. government obligations | | $ | 2,050,526 | | $ | 72,518 | | $ | 3,941 | | $ | 2,119,103 | ||||||||
Foreign governments | | | 1,601,810 | | | — | | | 59,622 | | | 1,542,188 | ||||||||
Mortgage-backed securities | |
| 25,177,296 | |
| 801,599 | |
| 150,316 | |
| 25,828,579 | ||||||||
Collateralized loan obligations | | | 294,652,723 | | | 7,445,031 | | | 836,415 | | | 301,261,339 | ||||||||
States and political subdivisions -- general obligations |
| |
|
| |
|
|
| |
| 106,228 | |
| 11,102 | |
| — | |
| 117,330 |
Bellingham, Washington | | $ | 107,128 | | $ | 118,028 |
| AA+ | ||||||||||||
Longview, Washington Refunding | |
| 131,280 | |
| 132,051 |
| Aa3 | ||||||||||||
Total | | $ | 238,408 | | $ | 250,079 |
|
| ||||||||||||
States and political subdivisions -- special revenue | |
| 5,288,295 | |
| 839,535 | |
| 4,703 | |
| 6,123,127 | ||||||||
Trust preferred | | | 2,218,142 | | | — | | | 65,604 | | | 2,152,538 | ||||||||
Corporate | |
| 153,045,355 | |
| 1,350,165 | |
| 470,690 | |
| 153,924,830 | ||||||||
Total fixed maturities | | $ | 484,140,375 | | $ | 10,519,950 | | $ | 1,591,291 | | $ | 493,069,034 | ||||||||
Mortgage loans on real estate, held for investment | | | 109,776,321 | | | — | | | — | | | 109,776,321 | ||||||||
Derivatives | | | 12,582,719 | | | 2,021,763 | | | 5,131,084 | | | 9,473,398 | ||||||||
Equity securities | | | 42,089,014 | | | 4,152 | | | — | | | 42,093,166 | ||||||||
Other invested assets | | | 25,606,108 | | | — | | | — | | | 25,606,108 | ||||||||
Investment escrow | | | 3,317,043 | | | — | | | — | | | 3,317,043 | ||||||||
Preferred stock | | | 4,300,591 | | | — | | | — | | | 4,300,591 | ||||||||
Notes receivable | | | 5,737,608 | | | — | | | — | | | 5,737,608 | ||||||||
Policy loans | | | 48,551 | | | — | | | — | | | 48,551 | ||||||||
Total investments | | $ | 687,598,330 | | $ | 12,545,865 | | $ | 6,722,375 | | $ | 693,421,820 | ||||||||
| | | | | | | | | | | | | ||||||||
December 31, 2020: | |
|
| |
|
| |
|
| |
|
| ||||||||
Fixed maturities: | | | | | | | | | | | | | ||||||||
U.S. government obligations | | | 5,744,221 | | $ | 426,427 | | $ | 5,665 | | | 6,164,983 | ||||||||
Mortgage-backed securities | | | 14,638,299 | |
| 276,219 | |
| 157,104 | | | 14,757,414 | ||||||||
Asset-backed securities | | | 216,500,672 | | | 5,623,083 | | | 350,146 | | | 221,773,609 | ||||||||
States and political subdivisions -- general obligations | | | 106,528 | |
| 10,802 | |
| — | | | 117,330 | ||||||||
States and political subdivisions -- special revenue | | | 5,293,365 | |
| 908,986 | |
| 147 | | | 6,202,204 | ||||||||
Trust preferred | | | 2,218,142 | | | 66,674 | | | — | | | 2,284,816 | ||||||||
Corporate | | | 124,654,841 | |
| 1,379,513 | |
| 171,352 | | | 125,863,002 | ||||||||
Total fixed maturities | | | 369,156,068 | | | 8,691,704 | | | 684,414 | | | 377,163,358 | ||||||||
Mortgage loans on real estate, held for investment | | | 94,989,970 | | | — | | | — | | | 94,989,970 | ||||||||
Derivatives | | | 8,532,252 | | | 3,257,069 | | | 428,287 | | | 11,361,034 | ||||||||
Other invested assets | | | 21,897,130 | | | — | | | — | | | 21,897,130 | ||||||||
Investment escrow | | | 3,174,047 | | | — | | | — | | | 3,174,047 | ||||||||
Preferred stock | | | 3,897,980 | | | — | | | — | | | 3,897,980 | ||||||||
Notes receivable | | | 5,665,487 | | | — | | | — | | | 5,665,487 | ||||||||
Policy loans | | | 45,573 | | | — | | | — | | | 45,573 | ||||||||
Total investments | | $ | 507,358,507 | | $ | 11,948,773 | | $ | 1,112,701 | | $ | 518,194,579 |
17
The following table shows the distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value as of March 31, 2021 and December 31, 2020.
| | | | | | | | | | | |
| | March 31, 2021 | | December 31, 2020 |
| ||||||
| | Carrying | | | | Carrying | | |
| ||
|
| Value |
| Percent |
| Value |
| Percent |
| ||
AAA and U.S. Government | | $ | 16,259,820 |
| 3.3 | % | $ | 3,070,750 |
| 0.8 | % |
AA | |
| 60,286,560 |
| 12.2 | |
| 5,818,163 |
| 1.5 | |
A | |
| 8,295,924 |
| 1.7 | |
| 49,445,266 |
| 13.1 | |
BBB | |
| 367,244,456 |
| 74.5 | |
| 247,635,730 |
| 65.7 | |
Total investment grade | |
| 452,086,760 |
| 91.7 | |
| 305,969,909 |
| 81.1 | |
BB and other | |
| 40,982,274 |
| 8.3 | |
| 71,193,449 |
| 18.9 | |
Total | | $ | 493,069,034 |
| 100.0 | % | $ | 377,163,358 |
| 100.0 | % |
Reflecting the quality of securities maintained by us, 91.7 and 81.1% of all fixed maturity securities were investment grade.
The following table summarizes, for all fixed maturity securities in an unrealized loss position at June 30, 2020as of March 31, 2021 and December 31, 2019,2020, the estimated fair value, pre-tax gross unrealized loss, and number of securities by consecutive months they have been in an unrealized loss position.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | June 30, 2020 | | December 31, 2019 | | March 31, 2021 | | December 31, 2020 | ||||||||||||||||||||||||||||
| | | | | Gross | | Number | | | | | Gross | | Number | | | | | Gross | | Number | | | | | Gross | | Number | ||||||||
| | Estimated | | Unrealized | | of | | Estimated | | Unrealized | | of | | Estimated | | Unrealized | | of | | Estimated | | Unrealized | | of | ||||||||||||
|
| Fair Value |
| Loss |
| Securities(1) |
| Fair Value |
| Loss |
| Securities(1) |
| Fair Value |
| Loss |
| Securities(1) |
| Fair Value |
| Loss |
| Securities(1) | ||||||||||||
Fixed Maturities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Less than 12 months: |
| |
|
| |
|
|
|
|
| |
|
| |
| |
|
|
| |
|
| |
|
|
|
|
| |
|
| |
| |
|
|
U.S. government obligations | | $ | — | | $ | — |
|
| — | | $ | 1,518,772 | | $ | 14,935 | |
| 9 | | $ | 181,710 | | $ | 856 |
|
| 1 | | $ | 54,910 | | $ | 180 | |
| 2 |
Asset-backed securities | | | 115,541,627 | | | 7,989,266 | | | 66 | | | 39,114,732 | | | 404,752 | | | 26 | ||||||||||||||||||
Mortgage-back securities | |
| 72,535 | |
| 392 |
|
| 3 | |
| 160,010 | |
| 4,844 | |
| 4 | ||||||||||||||||||
Foreign governments | | | 1,542,188 | | | 59,622 | | | 2 | | | — | |
| — | |
| — | ||||||||||||||||||
Mortgage-backed securities | |
| 6,199,138 | |
| 150,316 |
|
| 8 | |
| 5,707,617 | |
| 157,104 | |
| 5 | ||||||||||||||||||
Collateralized loan obligations | | | 49,601,561 | | | 783,611 | | | 81 | | | 14,878,370 | | | 246,969 | | | 19 | ||||||||||||||||||
States and political subdivisions -- special revenue | |
| 773,149 | |
| 4,703 |
|
| 13 | |
| 5,584 | |
| 147 | |
| 1 | ||||||||||||||||||
Trust preferred | | | 2,124,478 | | | 93,664 | | | 1 | | | — | | | — | | | — | | | 2,152,538 | | | 65,604 | | | 3 | | | — | | | — | | | — |
Corporate | |
| 9,025,918 | |
| 892,092 |
|
| 11 | |
| 2,800,815 | |
| 13,618 | |
| 4 | |
| 12,024,859 | |
| 411,096 |
|
| 18 | |
| 3,859,616 | |
| 104,262 | |
| 7 |
Greater than 12 months: | |
|
| |
|
|
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
|
|
| |
|
| |
|
| |
|
|
U.S. government obligations | |
| — | |
| — |
|
| — | |
| 353,834 | |
| 2,624 | |
| 2 | |
| 75,560 | |
| 3,085 |
|
| 3 | |
| 119,700 | |
| 5,485 | |
| 4 |
Asset-backed securities | |
| 12,329,718 | |
| 358,054 |
|
| 6 | |
| — | |
| — | |
| — | ||||||||||||||||||
Mortgage-back securities | | | 234,404 | | | 6,254 | | | 5 | | | 638,598 | | | 16,226 | | | 14 | ||||||||||||||||||
Collateralized loan obligations | |
| 2,906,839 | |
| 52,804 |
|
| 3 | |
| 7,020,479 | |
| 103,177 | |
| 6 | ||||||||||||||||||
Corporate | |
| 645,564 | | | 251,608 |
|
| 4 | |
| 2,201,658 | |
| 140,849 | |
| 13 | |
| 411,218 | | | 59,594 |
|
| 4 | |
| 287,473 | | | 67,090 | |
| 3 |
Total fixed maturities | | $ | 139,974,244 | | $ | 9,591,330 |
|
| 96 | | $ | 46,788,419 | | $ | 597,848 | | | 72 | | $ | 75,868,760 | | $ | 1,591,291 |
|
| 136 | | $ | 31,933,749 | | $ | 684,414 | | | 47 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(1) | We may reflect a security in more than one aging category based on various purchase dates. |
Due to significant price decreases in the capital markets, ourOur securities positions resulted in a substantialgross unrealized loss position as of March 31, 2021 that was greater than the gross unrealized loss position at June 30, 2020.December 31, 2020 due to a decline in the market. We performed an analysis of the unrealized losses and determined that there were no valuationindicators that we should do a cash flow testing analysis and no impairment onwas required as of March 31, 2021. During the impairment analysis performed at December 31, 2020 one of our fixed maturities should be recorded because the investmentsassets had been in such a loss position for less than six monthsover two years and approximately 80%had a decrease in its credit rating since 2019; therefore, the cashflow testing on that security determined an impairment existed so we had an impairment of them had durations$35,000 recorded. As of 10 to 20 years. ManagementMarch 31, 2021, management believes that the Company will fully recover its cost basis in thesethe remaining securities and management does not have the intent to sell, nor is it more likely than not that the Company will be required to sell, such securities until they recover or mature. We will continue to monitor the world and U.S. economy and the capital markets throughout the remainder of 2020 to determine if any impairment is required.
The majority of the unrealized losses are related to our collateralized loan obligations (“CLOs”). CLOs are typically illiquid and are intended to be held to maturity. Thus, risk of loss is minimal. The Company has monitored the underlying unrealized
18
losses and believes they pose little chanceminimal risk of material loss in the long-term due to the quality of the underlying credits.credits The loss on the CLOs as of March 31, 2021 and December 31, 2020 were related to interest rates and not credit related losses.
See the discussion above under “Comprehensive loss” in Note 1 regarding unrealized gains/losses on investments that are owned by our reinsurers and the corresponding offset carried as a gain in the associated embedded derivative.
The Company purchases and sells equipment leases in its investment portfolio. As of June 30, 2020,March 31, 2021, the Company owned several leases. An impairment test, as of June 30, 2020,analysis was completed on the only non-performing lease in the portfolio in June 2020 and it was determined that the underlying collateral value was substantially less than the outstanding remaining lease payments of $3.4$3.6 million. The Company establishedin June 2020 recognized a valuation allowance on the asset of $776,973 and will continue to monitoron that asset. During March 2021, the value the underlying collateral.non-performing asset was sold for a loss of $2.4 million. The valuation allowance was recorded asreleased and a bad debt expense;loss of $2.4 million was recognized; however, this asset is owned bywas held on behalf of a third partythird-party reinsurer. Therefore, due to the valuation allowanceterms of the reinsurance agreements, the loss was passed through as a receivable from the reinsurers, offsetting the valuation allowance.
17
American Life has treaties with four reinsurance companies, three third party and one related party, that have funds withheld and modified coinsurance provisions. In a modified coinsurance arrangement (“Modco”), the ceding entity retains the assets equal to the modified coinsurance reserves retained. In a funds withheld coinsurance agreement (“FW”), assets that would normally be paid over to athird-party reinsurer are withheld by the ceding company to permit statutory credit for unauthorized reinsurance, to reduce the potential credit risk. Under these provisions with third party reinsurers, the assets backing the treaties are maintained by American Life as collateral but the assets and the total return on the asset portfolios are owned by the third party reinsurers. The mortgage loans and CLOs primarily make up that asset portfolio. Under GAAP, these assets are considered embedded derivatives. The impact of the embedded derivatives is shown below in Note 6 Derivative investments.reducing its investment income earned.
The amortized cost and estimated fair value of fixed maturities at June 30, 2020,as of March 31, 2021, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. No securities due in the next year are in an unrealized loss position, further supporting management’s decision not to recognize an other-than-temporary impairment.
| | | | | | | | | | | | |
| | Amortized | | Estimated | | Amortized | | Estimated | ||||
|
| Cost |
| Fair Value |
| Cost |
| Fair Value | ||||
Due in one year or less | | $ | 201,929 | | $ | 202,962 | | $ | 39,416,008 | | $ | 39,490,973 |
Due after one year through five years | |
| 10,172,450 | |
| 10,355,681 | |
| 81,750,979 | |
| 82,444,187 |
Due after five years through ten years | |
| 52,847,487 | |
| 52,184,902 | |
| 123,414,500 | |
| 126,327,202 |
Due after ten years through twenty years | | | 129,141,495 | | | 122,598,167 | | | 189,358,612 | | | 193,167,354 |
Due after twenty years | | | 14,587,490 | | | 14,768,575 | | | 50,200,276 | | | 51,639,318 |
| | $ | 206,950,851 | | $ | 200,110,287 | | $ | 484,140,375 | | $ | 493,069,034 |
The Company is required to hold assets on deposit for the benefit of policyholders in accordance with statutory rules and regulations. At June 30, 2020As of March 31, 2021 and December 31, 2019,2020, these required deposits had a total amortized cost of $3,559,321$3,425,344 and $3,611,292$3,361,830 and fair values of $3,739,690$3,534,064 and $3,612,844,$3,486,914, respectively.
The following table presents a reconciliationMortgage loans consist of the beginning balance for the mortgage loan investments measured at fair value on a recurring basis using Level 3 inputs at June 30, 2020 and December 31, 2019:following:
| | | | | | | | | | | | | | | |
|
| | | | March 31, 2021 | | | December 31, 2020 | |||||||
| | | Carrying Value | | | Interest Income | | | Interest Income | ||||||
June 30, 2020: | | | | | | | | | | ||||||
Industrial | | $ | 500,000 | | $ | 2,871 | | $ | 16,340 | | $ | — | | $ | 1,250,000 |
Commercial mortgage loan - multi-family | | | 48,612,870 | | | 890,188 | | | 1,570,056 | | | 56,992,974 | | | 66,916,151 |
Other | | | 2,059,073 | | | 205,297 | | | 98,721 | | | 52,783,347 | | | 26,823,819 |
Total mortgage loans | | $ | 51,171,943 | | $ | 1,098,356 | | $ | 1,685,117 | | $ | 109,776,321 | | $ | 94,989,970 |
December 31, 2019: | | | | | | | | | | ||||||
Industrial | | $ | 500,000 | | $ | — | | $ | 15,889 | ||||||
Commercial mortgage loan - multi-family | | | 11,320,924 | | | 116,860 | | | 329,684 | ||||||
Other | | | 1,989,117 | | | 195,168 | | | 7,386 | ||||||
Total mortgage loans | | $ | 13,810,041 | | $ | 312,028 | | $ | 352,959 |
American Life has treaties with three third party reinsurers that have funds withheldGeographic Locations:
As of March 31, 2021, the commercial mortgages loans were secured by properties geographically dispersed throughout the United States (with the largest concentrations in New York (24%), Pennsylvania (12%), California (12%)) and modified coinsurance provisions. Under those provisions,included loans secured by properties in Europe (11%). As of December 31, 2020, the mortgagecommercial mortgages loans backingwere secured by properties geographically dispersed throughout the treaties are maintainedUnited States (with the largest concentrations in New York (28%), Pennsylvania (14%), California (14%)) and included loans secured by American Lifeproperties in Europe (12%).
The loan-to-value ratio is expressed as collateral buta percentage of the assets and total returns or losses onamount of the asset portfolios belongloan relative to the third party reinsurers; therefore,value of the Company derives minimal investment income from these mortgages.underlying property. A loan-to-value ratio in excess of 100% indicates the unpaid loan amount exceeds the underlying collateral. The following represents the loan-to-value ratio of the commercial mortgage loan portfolio, excluding those under development, net of valuation allowances.
1819
Commercial Mortgage Loans
| | | | | |
| March 31, 2021 | | December 31, 2020 | ||
Loan-to-Value Ratio: | | | | | |
0%-59.99% | $ | 62,245,607 | | $ | 49,279,601 |
60%-69.99% | | 10,123,145 | | | 22,349,295 |
70%-79.99% | | 15,724,612 | | | 23,361,074 |
80% or greater | | 21,682,957 | | | — |
Total mortgage loans | $ | 109,776,321 | | $ | 94,989,970 |
The components of net investment income for the three and six months ended June 30,March 31, 2021 and year ended December 31, 2020 and 2019 arewas as follows:
| | | | | | | | | | | | | | | | | | |
| | Three months ended June 30, | | Six months ended June 30, | | Three months ended March 31, | ||||||||||||
|
| 2020 |
| 2019 |
| 2020 |
| 2019 |
| 2021 |
| 2020 | ||||||
Fixed maturities | | $ | (128,209) | | $ | 435,427 | | $ | 1,041,929 | | $ | 631,118 | | $ | 3,050,777 | | $ | 1,167,614 |
Mortgage loans | | | — | | | 9,656 | | | — | | | 9,656 | | | 173,777 | | | 2,524 |
Other | |
| — | |
| 6,832 | |
| — | |
| 8,076 | |
| 55,813 | |
| — |
Gross investment income | |
| (128,209) | |
| 451,915 | |
| 1,041,929 | |
| 648,850 | |
| 3,280,367 | |
| 1,170,138 |
Less: refund received on investment expenses (investment expense) | |
| (269,633) | |
| (3,900) | |
| (198,793) | �� |
| (9,840) | ||||||
Less: investment (expenses) refund | |
| (393,004) | |
| 70,840 | ||||||||||||
Investment income, net of expenses | | $ | (397,842) | | $ | 448,015 | | $ | 843,136 | | $ | 639,010 | | $ | 2,887,363 | | $ | 1,240,978 |
Proceeds for the three months ended June 30,March 31, 2021 and 2020 and 2019 from sales of investments classified as available-for-sale were $14,556,095$61,831,341 and $2,040,640,$3,852,943, respectively. Gross gains of $1,038,822$572,807 and $7,382$149,548 and gross losses of $6,575$166,386 and $7,127$24,832 were realized on those sales during the three months ended June 30,March 31, 2021 and 2020, and 2019, respectively. Proceeds for the six months ended June 30, 2020 and 2019 from sales of investments classified as available-for-sale were $18,409,038 and $2,406,165, respectively. Gross gains of $1,188,370 and $9,006 and gross losses of $31,407 and $13,148 were realized on those sales during the six months ended June 30, 2019 and 2018, respectively.
The proceeds included those assets associated with the third partythird-party reinsurers. The gains and losses were relatedrelate only to the assets retained by American Life.
Note 6.5. Derivative Instruments
The Company enteredenters into derivative instruments to hedge fixed indexed annuity products that guarantee the return of principal to the policyholdersmanage risk, primarily equity, interest rate, credit, foreign currency and credit interest based on a percentage of the gain in a specified market index. To hedge against adverse changes in equity indices, the Company entered into contracts to buy equity indexed options. However, these derivatives are not designated as hedge under GAAP.
As indicated in Notes 1, 5 and 9, American Life has treaties with four reinsurance companies, three third party and one related party, that have funds withheld and modified coinsurance provisions. Under these provisions with third party reinsurers, the assets backing the treaties are maintained by American Life as collateral and are carried on the balance sheet for American Life, but the assets are owned by the third party reinsurer; thus, the total return on the asset portfolio belongs to the third party reinsurers. Under GAAP this is considered an embedded derivative but is not designated as a hedge.volatility.
The following is a summary of the notional amount, number of contracts and fair value of our asset and liability derivatives not designated as hedges and embedded derivatives in our FIA product as of June 30, 2020March 31, 2021 and December 31, 2019:2020:
| | | | | | | | | | | | | | | | | | |||||||||||||||||
| | | | | | | | | | | | | | | | | |
| | March 31, 2021 | | December 31, 2020 | ||||||||||||
|
| | June 30, 2020 | | December 31, 2019 | | Location in the | | | | | | | | | | | | ||||||||||||||||
| | Location in the | | | | | | | | | | | | | Consolidated | | | | | | | | | | | | | | | | ||||
Derivatives Not Designated | | Consolidated Statement | Notional | | Number of | | Estimated | | Notional | | Number of | | Estimated | | Statement of | Notional | | Number of | | Estimated | | Notional | | Number of | | Estimated | ||||||||
as Hedging Instruments | | of Balance Sheets | Amount | | Contracts | | Fair Value | | Amount | | Contracts | | Fair Value | | Balance Sheets | Amount | | Contracts | | Fair Value | | Amount | | Contracts | | Fair Value | ||||||||
Equity-indexed options | | Derivatives | $ | 86,093,121 | | 108 | | $ | 3,228,102 | | $ | 9,698,863 | | 24 | | $ | 575,294 | | Derivatives | $ | 369,592,465 | | 328 | | $ | 8,769,901 | | $ | 272,853,853 | | 252 | | $ | 11,361,034 |
Equity-indexed embedded derivative | | Deposit-type contracts | | 107,296,291 | | 724 | | | 3,038,675 | | | 10,720,324 | | 108 | | | 576,634 | |||||||||||||||||
Equity-indexed | | Deposit-type | | 364,115,193 | | 2,826 | | | 89,030,443 | | | 311,964,195 | | 2,101 | | | 84,501,492 |
DueFor December 31, 2020 reporting, the methodology used to significant price decreases inbifurcate the capital markets, our securities positions resulted in a substantial unrealized loss at June 30, 2020, reported in accumulated other comprehensive loss on the balance sheet. TheGAAP liability into host contract and embedded derivative relatedwas refined. In prior reporting periods a simplified approach was followed given the size of the block, which set the value of the embedded derivative equal to the asset portfolio belongingmarket value of the options held to provide for the third party reinsurers offset these unrealized losses by recording a realized gaincurrent indexed crediting obligation. At December 31, 2020, the value of the embedded derivative now considers all amounts projected to be paid in other comprehensive income.excess of the minimum guarantee (the amounts payable without any indexation increases) over future periods. The host contract reflects the minimum guaranteed values. For informational purposes only, the GAAP liability at December 31, 2020 under the old approach would have been $320,306,031, split as $308,608,885 host contract and $11,697,146 embedded derivative.
1920
The following table summarizes the impact of those embedded derivatives related to the funds withheld provision where the total return on the asset portfolio belongsis passed through to the third party reinsurers:third-party-reinsurers:
| | | | | | | | | | ||||||||||||||||||
|
| June 30, 2020 | | | | | | | | | | | | | | | | | | | |||||||
| | | | | | | | |
| March 31, 2021 | | December 31, 2020 | |||||||||||||||
| | Book Value of | | | Market Value of | | | Total Return | | Book Value | | Market Value | | Total Return | | Book Value | | Market Value | | Total Return | |||||||
Portfolio | | Assets | | | Assets | | | Swap Value | | Assets | | Assets | | Swap Value | | Assets | | Assets | | Swap Value | |||||||
Ironbound | | $ | 99,749,714 | | $ | 93,088,880 | | $ | 6,660,834 | | $ | 99,580,060 | | $ | 100,714,751 | | $ | (1,134,691) | | $ | 98,714,156 | | $ | 99,747,812 | | $ | (1,033,656) |
SDA | | | 21,116,007 | | | 20,006,611 | | | 1,109,396 | | | 30,008,920 | | | 30,177,243 | | | (168,323) | | | 27,224,279 | | | 27,479,836 | | | (255,557) |
US Alliance | | | 31,973,893 | | | 31,272,086 | | | 701,807 | | | 36,986,356 | | | 37,401,248 | | | (414,892) | | | 35,707,207 | | | 36,360,501 | | | (653,294) |
Crestline Re SP1 | | | 94,802,319 | | | 95,590,421 | | | (788,102) | | | 62,162,766 | | | 63,130,867 | | | (968,101) | |||||||||
Total | | $ | 152,839,614 | | $ | 144,367,577 | | $ | 8,472,037 | | $ | 261,377,655 | | $ | 263,883,663 | | $ | (2,506,008) | | $ | 223,808,408 | | $ | 226,719,016 | | $ | (2,910,608) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
TheAs of March 31, 2021 and December 31, 2020, the total return swap value was recorded as a decrease of $2,506,008 and an increase of $2,910,608, respectively. The decrease in our unrealized gain of $404,600 resulted in a decrease in our amounts recoverable from reinsurers of $8,472,037 on our balance sheetConsolidated Balance Sheets since December 31, 2020 and a realized gain of $8,472,037$404,600 and realized loss of $2,910,608, respectively on our income statement.Consolidated Statements of Comprehensive Loss.
Note 7.6. Fair Values of Financial Instruments
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. We use valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, accounting standards establish a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
● | Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. |
● | Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. |
● | Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. |
A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the valuation inputs, or their ability to be observed, may result in a reclassification for certain financial assets or liabilities. Reclassifications impacting Level 3 of the fair value hierarchy are reported as transfers in/out of the Level 3 category as of the beginning of the period in which the reclassifications occur.
A description of the valuation methodologies used for assets measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
Level 1 measurements
Cash:Cash equivalents: The carrying value of cash and cash equivalents and short-term investments approximate the fair value because of the short maturity of the instruments.
2021
Level 2 measurements
Cash: The carrying value of cash approximates the fair value because of the short maturity of the instruments.
Investment escrow: The Company had one asset in escrow in escrow as of March 31, 2021 and December 31, 2020 that was used to settle a mortgage loan that did not close until April 2021 and January 2021,respectively. The asset held in escrow at March 31, 2021 and December 31, 2020 was carried at cost.
Fixed maturities:maturity securities: Fixed maturitiesmaturity securities are recorded at fair value on a recurring basis utilizing a third-party pricing source.source such as the Clearwater AVS+ SVO pricing. The valuations are reviewed and validated quarterly through random testing by comparisons to separate pricing models or other third-party pricing services. For the periodthree months ended June 30,March 31, 2021 and year ended December 31, 2020, there were no material changes to the valuation methods or assumptions used to determine fair values, and no broker or third-party prices were changed from the values received.
Derivatives: Derivatives are reported at fair market value utilizing a third-party pricing source.source such as the Standard & Poor’s (“S&P’) 500 index and the S&P Multi-Asset Risk Control (“MARC”) 5% index.
Investment escrow: Equity securitiesThe Company held: Equity securities at March 31, 2021 and 2020 consist of mutual funds. Equity securities are carried at fair value with the change in escrow asfair value recorded through realized gains and losses on the statement of December 31, 2019, cash that was used to settle a mortgage loan that did not close until January 2020.operations.
Notes receivable: receivable: The Company held in notes receivable as of JuneMarch 31, 2021 and December 30, 2020, a note of $5,488,101$5,737,608 and $5,665,487, respectively, that includes paid-in-kind (“PIK”) interest, between American Life and an unconsolidated affiliatea third-party that was rated by a NRSRO. This note is being carried at the fair market value.
Embedded derivative for equity-indexed contracts: The Company has embedded derivatives in our policyholder contracts. These embedded derivatives are being carried at the fair market value as of June 30, 2020.
Level 3 measurements
Fixed maturity securities: The carrying value of assets classified as fixed maturity securities are generally carried at fair value. The Company invests in assets that are classified as fixed maturity securities that include term loans where the cost of those securities are considered their fair value; therefore, these assets are classified as Level 3 within the fair value hierarchy.
Mortgage loans on real estate, held for investment: Mortgage loans are carriedgenerally stated at their unpaid principal value asamounts outstanding, net of deferred expenses and allowance for loan loss. The Company determined that is consideredthe net principal amount represents the fair market values for thesevalue of the mortgages. Interest on loans is recognized on an accrual basis at the applicable interest rate on the principal amount outstanding. Loan origination fees and direct costs, as well as premiums and discounts, are amortized as level yield adjustments over the respective loan terms. Unamortized net fees or costs are recognized upon early repayment of the loans. Loan commitment fees are generally deferred and amortized on an effective yield basis over the term of the loan. Impaired loans are generally carried on a non-accrual status. Loans are ordinarily placed on non-accrual status when, in management’s opinion, the collection of principal or interest is unlikely, or when the collection of principal or interest is 90 days or more past due.
Other invested assets: The Company purchases and sellscarrying value of assets classified as other investments approximates fair value. Other invested assets include equipment leases, in itsa fund investment, portfolio. Asand loans held for investments. The inputs used to measure the fair value of June 30, 2020,these assets are classified as Level 3 within the Company owned several leases. An impairment test, as of June 30, 2020, was completed on the only non-performing lease in the portfolio and it was determined that the underlying collateralfair value was substantially less than the outstanding remaining lease payments of $3.4 million. The Company established a valuation allowance on the asset of $776,973 and will continue to monitor the value the underlying collateral. The valuation allowance was recorded as a bad debt expense; however, this asset is owned by a third party reinsurer. Therefore, the valuation allowance was passed through as a receivable from the reinsurers, offsetting the valuation allowance.hierarchy.
Preferred stock:Preferred stock of a non-affiliated company was purchased for $500,000 during the third quarter of 2019. An impairment analysis of the The preferred stock was performed as of June 30, 2020, due to a change in valuation of an invested asset held by the non-affiliated company. The investment asset had collateral supporting the investment that was less than the book value of the asset; therefore, the Company established a full valuation allowance of $500,000. This was recorded at its principal value as a reduction of the asset on the balance sheet and a bad debt expense on the Consolidates Statements of Comprehensive (Loss) Income.there was no traded market values for this stock.
Policy loans: Policy loans are stated at unpaid principal balances. As these loans are fully collateralized by the cash surrender value of the underlying insurance policies, the carrying value of the policy loans approximates their fair value.
Deposit-type contracts: The fair value for direct and assumed liabilities under deposit-type insurance contracts (accumulation annuities) is calculated using a discounted cash flow approach. Cash flows are projected using actuarial assumptions and discounted to the valuation date using risk-free rates adjusted for credit risk and nonperformance risk of the liabilities. The fair values for insurance contracts other than deposit-type contracts are not required to be disclosed.
2122
Embedded derivative for equity-indexed contracts: The Company has embedded derivatives in its FIA policyholder obligations. These embedded derivatives are being carried at the fair market value as of March 31, 2021 and December 31, 2020. The fair value of the embedded derivative component of our FIA obligation is estimated at each valuation date by projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and discounting the excess of projected contract value amounts at the applicable risk-free interest rates adjusted for our nonperformance risk related to those obligations. The projections of FIA policy contract values are based on best estimate assumptions for future policy growth and decrements including lapse, partial withdrawal and mortality rates. The best estimate assumptions for future policy growth include assumptions for expected index credits on the next policy anniversary date which are derived from fair values of the underlying equity call options purchased to fund such index credits and the present value of expected costs of annual call options purchased in the future by us to fund index credits beyond the next policy anniversary. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as assumptions used to project policy contract values.
23
The following table presents the Company’s fair value hierarchy for those financial instruments measured at fair value on a recurring basis as of June 30, 2020March 31, 2021 and December 31, 2019.
2020.
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | Significant | | | | | | | | | | | Significant | | | | | | | ||
| | Quoted | | Other | | Significant | | | | | Quoted | | Other | | Significant | | | | ||||||
| | In Active | | Observable | | Unobservable | | Estimated | | In Active | | Observable | | Unobservable | | Estimated | ||||||||
| | Markets | | Inputs | | Inputs | | Fair | | Markets | | Inputs | | Inputs | | Fair | ||||||||
|
| (Level 1) |
| (Level 2) |
| (Level 3) |
| Value |
| (Level 1) |
| (Level 2) |
| (Level 3) |
| Value | ||||||||
June 30, 2020 |
| |
|
| |
|
| |
|
| |
| ||||||||||||
March 31, 2021 |
| |
|
| |
|
| |
|
| |
| ||||||||||||
Financial assets | | | | | | | | | | | | | | | | | | | | | | | | |
Fixed maturities: |
| |
|
| |
|
| |
|
| |
| ||||||||||||
Fixed maturity securities: |
| |
|
| |
|
| |
|
| |
| ||||||||||||
U.S. government obligations | | $ | — | | $ | 1,836,729 | | $ | — | | $ | 1,836,729 | | $ | — | | $ | 2,119,103 | | $ | — | | $ | 2,119,103 |
Foreign governments | | | | | | 1,542,188 | | | | | | 1,542,188 | ||||||||||||
Mortgage-backed securities | | | — | | | 721,769 | | | — | | | 721,769 | | | — | | | 25,828,579 | | | — | | | 25,828,579 |
Asset-backed securities | | | — | | | 167,908,244 | | | — | | | 167,908,244 | ||||||||||||
Collateralized loan obligations | | | — | | | 301,261,339 | | | — | | | 301,261,339 | ||||||||||||
States and political subdivisions — general obligations | |
| — | |
| 250,079 | |
| — | |
| 250,079 | |
| — | |
| 117,330 | |
| — | |
| 117,330 |
States and political subdivisions — special revenue | |
| — | |
| 3,465,356 | |
| — | |
| 3,465,356 | |
| — | |
| 6,123,127 | |
| — | |
| 6,123,127 |
Trust preferred | | | — | | | 2,124,478 | | | — | | | 2,124,478 | | | — | | | 2,152,538 | | | — | | | 2,152,538 |
Corporate | |
| — | |
| 23,803,632 | |
| — | |
| 23,803,632 | |
| — | |
| 30,912,098 | |
| 123,012,732 | |
| 153,924,830 |
Total fixed maturities | | | — | | | 200,110,287 | | | — | | | 200,110,287 | ||||||||||||
Total fixed maturity securities | | | — | | | 370,056,302 | | | 123,012,732 | | | 493,069,034 | ||||||||||||
Mortgage loans on real estate, held for investment | | | — | | | — | | | 51,171,943 | | | 51,171,943 | | | — | | | — | | | 109,776,321 | | | 109,776,321 |
Derivatives | | | — | | | 3,228,102 | | | — | | | 3,228,102 | | | — | | | 9,473,398 | | | — | | | 9,473,398 |
Equity securities | | | — | | | 42,093,166 | | | — | | | 42,093,166 | ||||||||||||
Other invested assets | | | — | | | — | | | 3,090,964 | | | 3,090,964 | | | — | | | — | | | 25,606,108 | | | 25,606,108 |
Investment escrow | | | — | | | 3,317,043 | | | — | | | 3,317,043 | ||||||||||||
Preferred stock | | | — | | | — | | | 4,300,591 | | | 4,300,591 | ||||||||||||
Notes receivable | | | — | | | 5,488,101 | | | — | | | 5,488,101 | | | — | | | 5,737,608 | | | — | | | 5,737,608 |
Policy loans | | | — | | | — | | | 141,172 | | | 141,172 | | | — | | | — | | | 48,551 | | | 48,551 |
Total Investments | | $ | — | | $ | 208,826,490 | | $ | 54,404,079 | ��� | $ | 263,230,569 | | $ | — | | $ | 430,677,517 | | $ | 262,744,303 | | $ | 693,421,820 |
Financial liabilities | | | | | | | | | | | | | | | | | | | | | | | | |
Embedded derivative for equity-indexed contracts | | $ | — | | $ | 3,038,675 | | $ | — | | | 3,038,675 | | $ | — | | $ | — | | $ | 89,030,443 | | | 89,030,443 |
December 31, 2019 | |
|
| |
|
| |
|
| |
| | ||||||||||||
Fixed maturities: | |
| — | |
|
| |
|
| |
| | ||||||||||||
| | | | | | | | | | | | | ||||||||||||
December 31, 2020 | |
|
| |
|
| |
|
| |
| | ||||||||||||
Fixed maturity securities: |
| |
|
| |
|
| |
|
| |
| ||||||||||||
U.S. government obligations | | | — | | | 2,081,224 | | | — | | | 2,081,224 | | $ | — | | $ | 6,164,983 | | $ | — | | $ | 6,164,983 |
Mortgage-backed securities | | | — | | | 798,608 | | | — | | | 798,608 | | | — | | | 14,757,414 | | | — | | | 14,757,414 |
Asset-backed securities | | | — | | | 95,247,824 | | | — | | | 95,247,824 | ||||||||||||
Collateralized loan obligations | | | — | | | 221,773,609 | | | — | | | 221,773,609 | ||||||||||||
States and political subdivisions — general obligations | | | — | | | 249,282 | | | — | | | 249,282 | |
| — | |
| 117,330 | |
| — | |
| 117,330 |
States and political subdivisions — special revenue | | | — | | | 25,291 | | | — | | | 25,291 | |
| — | |
| 6,202,204 | |
| — | |
| 6,202,204 |
Trust preferred | | | — | | | 2,284,816 | | | — | | | 2,284,816 | ||||||||||||
Corporate | | | — | | | 18,839,632 | | | — | | | 18,839,632 | |
| — | |
| 18,608,995 | |
| 107,254,007 | |
| 125,863,002 |
Total fixed maturities | | | — | | | 117,241,861 | | | — | | | 117,241,861 | ||||||||||||
Total fixed maturity securities | | | — | | | 269,909,351 | | | 107,254,007 | | | 377,163,358 | ||||||||||||
Mortgage loans on real estate, held for investment | | | — | | | — | | | 13,810,041 | | | 13,810,041 | | | — | | | — | | | 94,989,970 | | | 94,989,970 |
Derivatives | | | — | | | 575,294 | | | — | | | 575,294 | | | — | | | 11,361,034 | | | — | | | 11,361,034 |
Other invested assets | | | — | | | — | | | 21,897,130 | | | 21,897,130 | ||||||||||||
Investment escrow | | | — | | | 3,899,986 | | | — | | | 3,899,986 | | | — | | | 3,174,047 | | | — | | | 3,174,047 |
Other invested assets | | | — | | | — | | | 2,468,947 | | | 2,468,947 | ||||||||||||
Preferred stock | | | — | | | — | | | 500,000 | | | 500,000 | | | — | | | — | | | 3,897,980 | | | 3,897,980 |
Notes receivable | | | — | | | 5,665,487 | | | — | | | 5,665,487 | ||||||||||||
Policy loans | | | — | | | — | | | 106,014 | | | | | | — | | | — | | | 45,573 | | | 45,573 |
Total Investments | | $ | — | | $ | 121,717,141 | | $ | 16,885,002 | | $ | 138,496,129 | | $ | — | | $ | 290,109,919 | | $ | 228,084,660 | | $ | 518,194,579 |
Financial liabilities | | | | | | | | | | | | | | | | | | | | | | | | |
Embedded derivative for equity-indexed contracts | | $ | — | | $ | 576,634 | | $ | — | | | 576,634 | | $ | — | | $ | — | | $ | 84,501,492 | | | 84,501,492 |
| | | | | | | | | | | | |
There were no transfers of financial instruments between any levels during the sixthree months ended June 30, 2020 or duringMarch 31, 2021. For the year ended December 31, 2019.2020 we transferred third-party corporate bonds between level 2 and level 3.
Accounting standards require disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring basis are discussed above. There were no financial assets or financial liabilities measured at fair value on a non-recurring basis.
2224
The following disclosure contains the carrying values, estimated fair values and their corresponding placement in the fair value hierarchy for financial assets and financial liabilities as of June 30, 2020March 31, 2021 and December 31, 2019,2020, respectively:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | June 30, 2020 | | March 31, 2021 | ||||||||||||||||||||||||||
| | | | | Fair Value Measurements Using | | | | | Fair Value Measurements Using | ||||||||||||||||||||
| | | | | Quoted Prices in | | | | | | | | | | | | | | Quoted Prices in | | | | | | | | | | ||
| | | | | Active Markets | | Significant Other | | Significant | | | | | | | | Active Markets | | Significant Other | | Significant | | | | ||||||
| | | | | for Identical Assets | | Observable | | Unobservable | | | | | | | | for Identical Assets | | Observable | | Unobservable | | | | ||||||
| | Carrying | | and Liabilities | | Inputs | | Inputs | | Fair | | Carrying | | and Liabilities | | Inputs | | Inputs | | Fair | ||||||||||
|
| Amount |
| (Level 1) |
| (Level 2) |
| (Level 3) |
| Value |
| Amount |
| (Level 1) |
| (Level 2) |
| (Level 3) |
| Value | ||||||||||
Assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Policy loans | | $ | 141,172 | | $ | — | | $ | — | | $ | 141,172 | | $ | 141,172 | | $ | 48,551 | | $ | — | | $ | — | | $ | 48,551 | | $ | 48,551 |
Cash | |
| 75,041,902 | |
| 75,041,902 | |
| — | |
| — | |
| 75,041,902 | |||||||||||||||
Cash and cash equivalents | |
| 100,927,152 | |
| 61,217,719 | |
| 39,709,433 | |
| — | |
| 100,927,152 | |||||||||||||||
Liabilities: | |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
Policyholder deposits (Deposit-type contracts) | |
| 321,830,976 | |
| — | |
| — | |
| 321,830,976 | |
| 321,830,976 | |
| 714,300,232 | |
| — | |
| — | |
| 714,300,232 | |
| 714,300,232 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2019 | | December 31, 2020 | ||||||||||||||||||||||||||
| | | | | Fair Value Measurements Using | | | | | Fair Value Measurements Using | ||||||||||||||||||||
| | | | | Quoted Prices in | | | | | | | | | | | | | | Quoted Prices in | | | | | | | | | | ||
| | | | | Active Markets | | Significant Other | | Significant | | | | | | | | Active Markets | | Significant Other | | Significant | | | | ||||||
| | | | | for Identical Assets | | Observable | | Unobservable | | | | | | | | for Identical Assets | | Observable | | Unobservable | | | | ||||||
| | Carrying | | and Liabilities | | Inputs | | Inputs | | Fair | | Carrying | | and Liabilities | | Inputs | | Inputs | | Fair | ||||||||||
|
| Amount |
| (Level 1) |
| (Level 2) |
| (Level 3) |
| Value |
| Amount |
| (Level 1) |
| (Level 2) |
| (Level 3) |
| Value | ||||||||||
Assets: |
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | | | |
Policy loans | | $ | 106,014 | | $ | — | | $ | — | | $ | 106,014 | | $ | 106,014 | | $ | 45,573 | | $ | — | | $ | — | | $ | 45,573 | | $ | 45,573 |
Cash | |
| 43,716,205 | |
| 43,716,205 | |
| — | |
| — | |
| 43,716,205 | |||||||||||||||
Cash and cash equivalents | |
| 151,679,274 | |
| 100,566,580 | |
| 51,112,694 | |
| — | |
| 151,679,274 | |||||||||||||||
Liabilities: | |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
Policyholder deposits (Deposit-type contracts) | |
| 171,168,785 | |
| — | |
| — | |
| 171,168,785 | |
| 171,168,785 | |
| 597,868,472 | |
| — | |
| — | |
| 597,868,472 | |
| 597,868,472 |
| | | | | | | | | | | | | | | |
The following tables present a reconciliation of the beginning balance for all investments measured at fair value on a recurring basis using level three inputs during the sixthree months ended June 30, 2020.March 31, 2021 and December 31, 2020:
| | | | | | | | | | | | | | | | ||||||||||||
| | | | | | | | | | | | | | | | | | | | | | | | ||||
| | Beginning | | | | | | | | | Ending | | | | | | | | | | | ||||||
| | Balance | | | | | | | | | | | Balance | | As of | | | | | | | | As of | ||||
| | As of | | | | | | | | | Valuation | | As of | | December 31, | | | | | | | | | March 31, | |||
|
| December 31, 2019 |
| Additions |
| Sales |
| | Allowance | | June 30, 2020 |
| 2020 |
| Additions |
| Sales |
| 2021 | ||||||||
Assets |
| |
|
| |
|
| |
|
| | | | |
|
| |
|
| |
|
| |
|
| |
|
Policy loans | | $ | 106,014 | | $ | 35,158 | | $ | — | | $ | — | | $ | 141,172 | ||||||||||||
Fixed maturities | | $ | 107,254,007 | | $ | 30,204,134 | | $ | 14,445,409 | | | 123,012,732 | |||||||||||||||
Mortgage loans on real estate, | | | | | | | | | | | | | | | | | | | | | | | | | | | |
held for investment | | | 13,810,041 | | | 39,431,852 | | | 2,069,950 | | | — | | | 51,171,943 | | | 94,989,970 | | | 16,446,861 | | | 1,660,510 | | | 109,776,321 |
Other invested assets | | | 2,468,947 | | | 7,011,102 | | | 5,612,112 | | | (776,973) | | | 3,090,964 | | | 21,897,130 | | | 5,016,716 | | | 1,307,738 | | | 25,606,108 |
Preferred stock | | | 500,000 | | | — | | | — | | | (500,000) | | | — | | | 3,897,980 | | | 402,611 | | | — | | | 4,300,591 |
Policy loans | | | 45,573 | | | 2,978 | | | — | | | 48,551 | |||||||||||||||
Total Investments | | $ | 16,885,002 | | $ | 46,478,112 | | $ | 7,682,062 | | $ | (1,276,973) | | $ | 54,404,079 | | $ | 228,084,660 | | $ | 52,073,300 | | $ | 17,413,657 | | $ | 262,744,303 |
| | | | | | | | | | | | | | | |
2325
| | | | | | | | | | | | | | | | | | |
| | As of | | | | | | | | | | | | | As of | |||
| | December 31, | | | | | | | | | Valuation | | | | | December 31, | ||
|
| 2019 |
| Additions |
| Sales |
| | Allowance | | Impairment | | 2020 | |||||
Assets |
| |
|
| |
|
| |
|
| | | | |
| | |
|
Fixed maturities | | $ | — | | $ | 107,254,007 | | $ | — | | $ | — | | $ | — | | $ | 107,254,007 |
Mortgage loans on real estate, | | | | | | | | | | | | | | | | | | |
held for investment | | | 13,810,041 | | | 99,356,435 | | | 18,176,506 | | | — | | | — | | | 94,989,970 |
Other invested assets | | | 2,468,947 | | | 74,722,714 | | | 54,517,558 | | | (776,973) | | | | | | 21,897,130 |
Preferred stock | | | 500,000 | | | 3,897,980 | | | — | | | — | | | (500,000) | | | 3,897,980 |
Policy loans | | | 106,014 | | | — | | | 60,441 | | | — | | | — | | | 45,573 |
Total Investments | | $ | 16,885,002 | | $ | 285,231,136 | | $ | 72,754,505 | | $ | (776,973) | | $ | (500,000) | | $ | 228,084,660 |
Significant Unobservable Inputs—Significant unobservable inputs occur when we could not obtain or corroborate the quantitative detail of the inputs. This applies to fixed maturity securities, preferred stock, mortgage loans and certain derivatives, as well as embedded derivatives in liabilities. Additional significant unobservable inputs are described below.
Interest sensitive contract liabilities – embedded derivative – Significant unobservable inputs we use in the fixed indexed annuities embedded derivative of the interest sensitive contract liabilities valuation include:
1) | Nonperformance risk – For contracts we issue, we use the credit spread, relative to the US Department of the Treasury (Treasury) curve based on our public credit rating as of the valuation date. This represents our credit risk for use in the estimate of the fair value of embedded derivatives. |
2) | Option budget – We assume future hedge costs in the derivative’s fair value estimate. The level of option budgets determines the future costs of the options and impacts future policyholder account value growth. |
3) | Policyholder behavior – We regularly review the lapse and withdrawal assumptions (surrender rate). These are based on our initial pricing assumptions updated for actual experience. Actual experience may be limited for recently issued products. |
The following summarizes the unobservable inputs for available for sale and trading securities and the embedded derivatives of fixed indexed annuities:
| | | | | | | | | | | | | | |
| | March 31, 2021 | ||||||||||||
(In millions, except for percentages) | | Fair value | | Valuation technique | | Unobservable inputs | | Minimum | | Maximum | | Weighted average* | | Impact of an increase in the input on fair value |
Interest sensitive contract liabilities - fixed indexed annuities embedded derivatives | | $89.0 | | Option Budget Method | | Nonperformance risk | | 0.3% | | 1.1% | | 0.6% | | Decrease |
| | | | | | Option budget | | 1.4% | | 3.4% | | 2.5% | | Increase |
| | | | | | Surrender rate | | 0.5% | | 15% (base) | | 7.3% | | Decrease |
* Weighted by account value | | | | | | | | | | | | | | |
26
| | | | | | | | | | | | | | |
| | December 31, 2020 | ||||||||||||
(In millions, except for percentages) | | Fair value | | Valuation technique | | Unobservable inputs | | Minimum | | Maximum | | Weighted average* | | Impact of an increase in the input on fair value |
Interest sensitive contract liabilities - fixed indexed annuities embedded derivatives | | $84.5 | | Option Budget Method | | Nonperformance risk | | 0.3% | | 1.3% | | 0.7% | | Decrease |
| | | | | | Option budget | | 2.6% | | 3.4% | | 2.7% | | Increase |
| | | | | | Surrender rate | | 0.5% | | 15% (base) | | 7.6% | | Decrease |
* Weighted by account value | | | | | | | | | | | | | | |
Note 7. Earnings Per Share
The par value per each Company share is $0.001 with 20,000,000 voting common shares authorized, 2,000,000 non-voting common shares authorized, and 2,000,000 preferred shares authorized. With the infusion of capital in our December 2020 public offering of voting common stock and the issuance of voting common stock in 3,737,564 voting common shares issued and outstanding as of March 31, 2021 and December 31, 2020.
(Loss) earnings per basic share attributable to the Company’s voting common stock was computed based on the weighted average number of shares outstanding during each period. The weighted average number of shares outstanding during the three months ended March 31, 2021 and 2020, were 3,737,564 and 2,042,670, respectively.
(Loss) earnings per diluted share attributable to the Company’s voting common stock was computed based on the average shares outstanding and options granted under our 2020 and 2019 Long-Term Incentive Plans (“LTIPs”), as if all were vested and exercised. The weighted average number of diluted shares outstanding during the three months ended March 31, 2021 and 2020 were 3,737,564 and 2,065,045, respectively.
27
Note 8. Income Tax Matters
Significant components of the Company’s deferred tax assets and liabilities as of June 30, 2020March 31, 2021 and December 31, 2019 are2020 were as follows:
| | | | | | | | | | | | |
|
| June 30, 2020 |
| December 31, 2019 |
| March 31, 2021 |
| December 31, 2020 | ||||
Deferred tax assets: |
| |
|
| |
|
| |
|
| |
|
Loss carryforwards | | $ | 781,003 | | $ | 436,777 | | $ | 1,945,126 | | $ | 1,556,855 |
Capitalized costs | |
| 195,763 | |
| 221,918 | |
| 162,476 | |
| 174,364 |
Stock option granted | | | 9,821 | | | 4,566 | | | 65,796 | | | 14,270 |
Unrealized losses on investments | |
| 1,679,207 | |
| — | |
| 1,478,807 | |
| 1,534,332 |
Policy acquisition costs | | | 3,686,674 | | | 1,468,030 | | | 2,308,354 | | | 2,243,267 |
Charitable contribution carryforward | | | 1,230 | | | 1,020 | | | 2,490 | | | 2,490 |
Property and equipment | | | 23,056 | | | 15,508 | ||||||
Sec 163(j) limitation | | | 155,492 | | | 153,809 | ||||||
Benefit reserves | |
| 435,780 | |
| 848,643 | |
| 4,316,821 | |
| 3,568,914 |
Total deferred tax assets | |
| 6,812,534 | |
| 2,996,462 | |
| 10,435,362 | |
| 9,248,301 |
Less valuation allowance | |
| (4,789,646) | |
| (2,618,741) | |
| (8,403,415) | |
| (7,001,687) |
Total deferred tax assets, net of valuation allowance | |
| 2,022,888 | |
| 377,721 | |
| 2,031,947 | |
| 2,246,614 |
Deferred tax liabilities: | |
|
| |
|
| |
|
| |
|
|
Unrealized losses on investments | |
| 1,759,153 | |
| 116,088 | |
| 1,774,671 | |
| 1,994,232 |
Due premiums | |
| 78,242 | |
| 81,789 | |
| 81,789 | |
| 81,789 |
Intangible assets | |
| 147,000 | |
| 147,000 | |
| 147,000 | |
| 147,000 |
Policy loans | |
| 38,493 | |
| 32,844 | ||||||
Bond Discount | | | 24,942 | | | 20,556 | ||||||
Property and equipment | |
| — | |
| — | |
| 3,545 | |
| 3,037 |
Total deferred tax liabilities | |
| 2,022,888 | |
| 377,721 | |
| 2,031,947 | |
| 2,246,614 |
Net deferred tax assets | | $ | — | | $ | — | | $ | — | | $ | — |
At June 30, 2020As of March 31, 2021 and December 31, 2019,2020, the Company recorded a valuation allowance of $4,789,646$8,403,415 and $2,618,741,$7,001,687, respectively, on the deferred tax assets to reduce the total to an amount that management believes will ultimately be realized. Realization of deferred tax assets is dependent upon sufficient future taxable income during the period that deductible temporary differences and carryforwards are expected to be available to reduce taxable income.
There was income tax expense of $479,513$1,432,348 and $887,429$407,916 for the three and six months ended June 30,March 31, 2021 and 2020, and no income tax expense for the three and six months ended June 30, 2019.respectively. This differed from the amounts computed by applying the statutory U.S. federal income tax rate of 21% to pretax income, as a result of the following:
| | | | | | | | | | | | | | | | | | |
| | Three months ended June 30, | | Six months ended June 30, | | Three months ended March 31, | ||||||||||||
|
| 2020 |
| 2019 |
| 2020 |
| 2019 |
| 2021 |
| 2020 | ||||||
Computed expected income tax benefit | | $ | (3,372,144) | | $ | (174,689) | | $ | 1,238,695 | | $ | (488,643) | | $ | (35,304) | | $ | 4,610,839 |
Increase (reduction) in income taxes resulting from: | |
| | |
|
| |
| | |
|
| |
| | |
|
|
Meals, entertainment and political contributions | |
| 319 | |
| 3,053 | |
| 2,930 | |
| 5,636 | ||||||
IMR and reinsurance | | | 67,045 | | | — | ||||||||||||
Nondeductible expenses | | | 1,454 | | | (55,233) | ||||||||||||
Change in valuation allowance | |
| 4,169,372 | |
| 32,209 | |
| 21,682 | | | 266,607 | |
| 1,401,730 | | | (4,147,690) |
COD Interest | | | — | | | 177,563 | | | — | | | 177,563 | ||||||
Other | |
| (318,034) | |
| (38,136) | |
| (375,878) | |
| 38,837 | ||||||
Dividends received deduction | | | (2,577) | | | — | ||||||||||||
Subtotal of increases | |
| 3,851,657 | |
| 174,689 | |
| (351,266) | |
| 488,643 | |
| 1,467,652 | |
| (4,202,923) |
Tax expense (benefit) | | $ | 479,513 | | $ | — | | $ | 887,429 | | $ | — | ||||||
Tax expense | | $ | 1,432,348 | | $ | 407,916 |
Section 382 of the Internal Revenue Code limits the utilization of U.S. net operating loss (“NOL”) carryforwards following a change of control, which occurred on June 28, 2018. As of June 30, 2020,March 31, 2021, the deferred tax assets included the expected tax benefit attributable to federal NOLs of $2,741,658.$9,164,004. The federal NOLs generated prior to June 28, 2018 which are subject to Section 382 limitation can be carried forward. If not utilized, the NOLs of $890,636$752,036 prior to 2017 will expire through the year
28
of 2032, and the NOLs generated from June 28, 2018 to June 30, 2020March 31, 2021 do not expire and will carry forward indefinitely, but their utilization in any carry forward year is limited to 80% of taxable income in that year. The Company believes that it is more likely than not that the benefit from federal NOL carryforwards will not be realized; thus, we have recorded a full valuation allowance of $4,971,956 on the deferred tax assets related to these federal NOL carryforwards.
Loss carry forwards for tax purposes as of June 30, 2020,March 31, 2021, have expiration dates that range from 2024 through 2039.
242040.
Note 9. Reinsurance
A summary of significant reinsurance amounts affecting the accompanying consolidated financial statements as of June 30, 2020March 31, 2021 and December 31, 20192020 and for the three and six months ended June 30,March 31, 2021 and, 2020, and 2019 isrespectively, are as follows:
| | | | | | | | | | | | |
|
| June 30, 2020 |
| December 31, 2019 |
| March 31, 2021 |
| December 31, 2020 | ||||
Balance sheets: |
| |
|
| |
| ||||||
Benefit and claim reserves ceded | | $ | 43,355,941 | | $ | 30,579,524 | ||||||
Assets: |
| |
|
| |
| ||||||
Reinsurance recoverables | | $ | 38,715,577 | | $ | 32,146,042 | ||||||
Liabilities: | | | | | | | ||||||
Deposit-type contracts | | | | | | | ||||||
Direct | | $ | 714,300,232 | | | 597,868,472 | ||||||
Reinsurance ceded | | | (448,843,239) | | | (405,981,150) | ||||||
Retained deposit-type contracts | | $ | 265,456,993 | | $ | 191,887,322 |
| | | | | | | | | | | | |
| | Three months ended June 30, | | Six months ended June 30, | ||||||||
|
| 2020 |
| 2019 | | 2020 |
| 2019 | ||||
Statements of comprehensive (loss) income: |
| |
|
| |
| | |
|
| |
|
Premiums ceded | | $ | 221,435 | | $ | 249,200 | | $ | 453,108 | | $ | 522,301 |
Benefits ceded | |
| 15,792 | |
| 38,326 | |
| 47,078 | |
| 116,029 |
Commissions ceded | |
| 2,613 | |
| 3,666 | |
| 5,721 | |
| 6,580 |
| | | | | |
| Three months ended March 31, | ||||
| 2021 |
| 2020 | ||
| |
|
| |
|
Premiums | | | | | |
Direct | $ | 48,087 | | $ | 231,674 |
Reinsurance ceded | | (48,087) | | | (231,674) |
Total Premiums | $ | — | | $ | — |
Future policy and other policy benefits | | | | | |
Direct | $ | 6,856 | |
| 31,287 |
Reinsurance ceded |
| (6,856) | |
| (31,287) |
Total future policy and other policy benefits | $ | — | | $ | — |
The following table provides a summary of the significant reinsurance balances recoverable on paid and unpaid policy claims by third partythird-party reinsurers except for a reinsurance with Unified as it was accounted for as discontinued operations:operations as of March 31, 2021:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | Recoverable on | | | | | Total Amount | | | | | | | | | | | Recoverable on | | | | | Total Amount | ||||
| | | | | Recoverable | | Recoverable | | Benefit | | Ceded | | Recoverable | | | | | Recoverable | | Recoverable | | Benefit | | Ceded | | Recoverable | ||||||||||
| | AM Best | | on Paid | | on Unpaid | | Reserves/Deposit- | | Due | | from | | AM Best | | on Paid | | on Unpaid | | Reserves/Deposit- | | Due | | from | ||||||||||||
Reinsurer |
| Rating |
| Losses |
| Losses |
| type Contracts |
| Premiums |
| Reinsurer |
| Rating |
| Losses |
| Losses |
| type Contracts |
| Premiums |
| Reinsurer | ||||||||||||
Ironbound Reinsurance Company Limited | | | NR | | $ | — | | $ | — | | $ | 7,323,291 | | $ | — | | $ | 7,323,291 | ||||||||||||||||||
Optimum Re Insurance Company |
| | A | | | — | | | — | | | 518,692 | | | — | | | 518,692 |
| | A | | $ | — | | $ | — | | $ | 524,932 | | $ | — | | $ | 524,932 |
Sagicor Life Insurance Company |
| | A- | |
| — | |
| 210,295 | |
| 11,224,669 | |
| 277,015 | |
| 11,157,949 |
| | A- | |
| — | |
| 143,750 | |
| 11,269,714 | |
| 273,495 | |
| 11,139,969 |
SDA Annuity & Life Re | | | NR | | | — | | | — | | | 3,995,718 | | | — | | | 3,995,718 | | | NR | | | — | | | — | | | 3,714,765 | | | — | | | 3,714,765 |
Crestline SP1 | | | NR | | | — | | | — | | | 16,319,419 | | | — | | | 16,319,419 | ||||||||||||||||||
US Alliance Life and Security Company |
| | NR | |
| — | |
| — | |
| 20,418,664 | |
| 58,373 | |
| 20,360,291 |
| | NR | |
| — | |
| — | |
| 7,045,473 | |
| 28,981 | |
| 7,016,492 |
| | | | | $ | — | | $ | 210,295 | | $ | 43,481,034 | | $ | 335,388 | | $ | 43,355,941 | | | | | $ | — | | $ | 143,750 | | $ | 38,874,303 | | $ | 302,476 | | $ | 38,715,577 |
| | | | | | | | | | | | | | | | | | |
29
The following table provides a summary of the significant reinsurance balances recoverable on paid and unpaid policy claims by reinsurer except for Unified as it is accounted for as discontinued operations as of December 31, 2020:
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | Recoverable on | | | | | Total Amount | ||
| | | | | Recoverable | | Recoverable | | Benefit | | Ceded | | Recoverable | |||||
| | AM Best | | on Paid | | on Unpaid | | Reserves/Deposit- | | Due | | from | ||||||
Reinsurer |
| Rating |
| Losses |
| Losses |
| type Contracts |
| Premiums |
| Reinsurer | ||||||
Optimum Re Insurance Company |
| | A | | $ | — | | $ | — | | $ | 524,734 | | $ | — | | $ | 524,734 |
Sagicor Life Insurance Company |
| | A- | |
| — | |
| 141,107 | |
| 11,285,364 | |
| 276,596 | |
| 11,149,875 |
SDA Annuity & Life Re | | | NR | | | — | | | — | | | 3,540,697 | | | — | | | 3,540,697 |
Crestline SP1 | | | NR | | | — | | | — | | | 9,695,427 | | | — | | | 9,695,427 |
US Alliance Life and Security Company |
| | NR | |
| — | |
| — | |
| 7,264,229 | |
| 28,920 | |
| 7,235,309 |
| | | | | $ | — | | $ | 141,107 | | $ | 32,310,451 | | $ | 305,516 | | $ | 32,146,042 |
Due to price decreases in the volatility of thecapital markets, certain assets that were carried on our balance sheet havesecurities positions resulted in approximately $6.8 millionchanges in the unrealized gains position as of unrealized losses.March 31, 2021 compared to December 31, 2020, reported in accumulated other comprehensive income on the Consolidated Balance Sheets. As discussed in Note. 1, American Life has treaties with three third partyseveral third-party reinsurers that have funds withheld and modified coinsurance provisions. In a modified coinsurance arrangement (“Modco”), the ceding entity retains the assets equal to the modified coinsurance reserves retained. In a funds withheld coinsurance agreement (“FW”), assets that would normally be paid over to a reinsurer are withheld by the ceding company to permit statutory credit for unauthorized reinsurance, to reduce the potential credit risk. Under those provisions, the assets backing the treaties are maintained by American Life as collateral but the assets and total returns or losses on the asset portfolios belong to the third partythird-party reinsurers. Under GAAP this arrangement is considered an embedded derivative as discussed in Note 6.5. As a result of the change in market volatility,prices, the assets had unrealized lossesgains of approximately $8.5$2.5 million and $2.9 million as of June 30, 2020.March 31, 2021 and December 31, 2020, respectively. The terms of the contracts with the third partythird-party reinsurers provide that unrealized lossesgains on the portfolios accrue to the third partythird-party reinsurers. Accordingly, the unrealized lossesgains on the assets held by American Life were offset by a gainloss in the embedded derivative of $8.5 million.$400,000 and $2.9 million, respectively. We account for this lossgain pass through by recording equivalent realized gainslosses on our income statement. The unrealized losses pertaining to third party reinsurers were offset by unrealized gainsConsolidated Statements of $1.7 million on assets retained by American Life.
Effective July 25, 2019, American Life entered into a Funds Withheld Coinsurance and Modified Coinsurance Agreement (“FW/Modco Ironbound Agreement”) with Ironbound Reinsurance Company Limited, an unaffiliated reinsurance company organized under the laws of Barbados (“Ironbound”). Under the FW/Modco Ironbound Agreement, American Life ceded to Ironbound, on a funds withheld coinsurance and modified coinsurance basis, an initial 95% quota share of certain liabilities with respect to its MYGA business. Starting on March 1, 2020, the quota share dropped to 30% and then again on March 11, 2020 the quota share dropped to 0%. American Life has established two accounts to hold the assets for the FW/Modco Ironbound Agreement, a Funds Withheld Account and a Modco Deposit Account.
In addition, a trust account was established on June 30, 2019 among American Life, Ironbound and Wells Fargo Bank, National Association for the sole benefit of American Life to fund the Funds Withheld Account and the Modco Deposit Account for any shortage in required reserves.
25
The initial settlement included net premium income of $45,005,536 (gross premiums of $46,568,321 minus gross commissions paid of $1,562,786) and net statutory reserves of $47,271,267. The initial settlement for the Funds Withheld Account was $24,928,934 and for the Modco Deposit Account was $16,619,289 and the reserves required was $26,944,622 and $17,963,081, respectively. The amount owed by Ironbound to the Funds Withheld Account and the Modco Deposit Account from the trust account was $2,015,688 and $1,343,792, respectively which was funded at the closing of the Ironbound transaction.Comprehensive Loss.
Effective November 7, 2019, American Life entered into a Funds Withheld Coinsurance and Modified Coinsurance Agreement (“FW/Modco SDA Agreement”) with SDA Annuity & Life Re (“SDA”), a Cayman Islands-domiciled reinsurance company. Under the FW/Modco SDA Agreement, American Life cedes to SDA, on a funds withheld coinsurance and modified coinsurance basis, 5% quota share of certain liabilities with respect to its multi-year guaranteed annuity MYGA business and an initial 95% quota share of certain liabilities with respect to its fixed indexed annuity FIA through December 31, 20192020 and thirty 30% through June 30, 2020.March 31, 2021. American Life has established two accounts to hold the assets for the FW/Modco Agreement, a Funds Withheld Account and a Modco Deposit Account.
In addition, a trust account was established on November 7, 2019 among American Life, SDA and Wells Fargo Bank, National Association for the sole benefit of American Life to fund the SDA Funds Withheld Account and the SDA Modco deposit account for any shortage in required reserves.
The initial settlement included net premium income of $3,970,509 and net statutory reserves of $3,986,411. The initial settlement for the Funds Withheld Accountfunds withheld account was $2,256,802 and for the Modco Deposit AccountModified coinsurance deposit was $1,504,535 and the reserves required was $2,391,847 and $1,594,564, respectively. The amount owed to the Funds Withheld Accountfunds withheld account and the Modco Deposit AccountModified coinsurance deposit account from the trust account was $135,044 and $90,029, respectively which was funded at the closing of the SDA transaction. Effective August 25, 2020, the quota share was reduced to zero for both MYGA and FIA products.
Effective April 15, 2020, American Life entered into a Funds Withheld and Funds Paid Coinsurance Agreement (“US Alliance Agreement”) between American Life and US Alliance Life and Security Company, a Kansas reinsurance company (“US Alliance”). Under the US Alliance Agreement, American Life will cede to US Alliance, on a funds withheld and funds paid coinsurance basis, an initial 49% quota share of certain liabilities with respect to American Life’s FIA business effective January 1, 2020 through March 31, 2020. Effective from March 1, 2020 through March 10, 2020, American Life will cede a 45.5% quota share of certain liabilities with respect to its MYGA business to US Alliance. Effective March 11, 2020 through March 31, 2020, on a funds withheld and funds paid coinsurance basis, the quota share will increase to 66.5% of certain liabilities with respect to its MYGA business. Effective April 1, 2020, the FIA quota share was reduced to 40% and the MYGA quota share was reduced to 25%. American Life has established a US Alliance Funds Withheld Account to hold the assets for the US Alliance Agreement.
30
In addition, a trust account was established among American Life, US Alliance and Capitol Federal Savings Bank, for the sole benefit of American Life to fund the Funds Withheld Account for any shortage in required reserves.
The initial settlement included net premium income of $13,542,325 and net statutory reserves of $14,706,862. The initial settlement for the Funds Withheld Account was $12,729,785 and to the trust account was $812,539 from American Life and $5,000,000 from US Alliance.
In early Effective June 30, 2020, Midwest formed Seneca Re, a wholly owned subsidiary,the FIA quota share was reduced to operate as a sponsored captive insurance company forzero and effective July 1, 2020, the purpose of insuring and reinsuring various types of risks of its participants through one or more protected cells andMYGA quota share was reduced to conduct any other business or activity that is permitted for sponsored captive insurance companies under Vermont regulations. Seneca Re has one Protected Cell 2020-01 (“SRC1”) which closed during May of 2020. zero.
Effective April 24, 2020, American life entered into a Master Letter Agreement with Seneca Re and Crestline Management regarding a flow of annuity reinsurance and related asset management, whereby Crestline Management agreed to provide reinsurance funding for a quota share percentage of 25% of the liabilities of American Life arising from the MYGA and a quota share percentage of 40% of the FIA products. This agreement expires on April 24, 2023.
26On July 24, 2020, the Nebraska Department of Insurance (“NDOI”) issued its non-disapproval of the Funds Withheld Coinsurance and Modified Coinsurance Agreement with Seneca Incorporated Cell, LLC 2020-02 (“SRC2”) of Seneca Re, now known as Crestline RE SP1. The agreement closed on July 27, 2020. Under the agreement, American Life ceded to SRC2, on a Funds Withheld and Modified Coinsurance basis, an initial 25% quota share of certain liabilities with respect to American Life’s MYGA business and 40% quota share of certain liabilities with respect to American Life’s FIA business effective April 24, 2020. American Life has established a SRC2 Funds Withheld Account and a Modified Coinsurance Account to hold the assets pursuant to the agreement. The NDOI approved the inclusion of the SRC2 coinsurance in American Life’s March 31, 2020 statutory financial statements.
The table below shows thosethe risk related to the remaining legacy block of business, see Note 2 above for further discussion. We transferred $19,311,616 of GAAP net adjusted reserves as of July 1, 2018 to Unified for cash of $14,320,817, which was net of a ceding commissionsallowance of $3,500,000 plus the accrued interest on the transaction from July 1, 2018 until it closed on December 10, 2018. Unified assumed certain responsibilities for incurred claims, surrenders and allowances receivedcommission from the above reinsurers. effective date.
The newceding commission of $3,500,000 was recorded net of the difference between statutory and GAAP net adjusted reserves, the elimination of DAC of $1,890,013, value of business acquired (“VOBA“) of $338,536, and the remaining deferred profit from our legacy business of $26,896. The remaining $3,069,690 was not cededreflected as a deferred gain and will be recognized into income over the expected duration of the legacy blocks of business. As of March 31, 2021 and 2020, Unified had converted 90% and 81%, respectively, of the indemnity coinsurance to these reinsurers untilassumptive coinsurance. American Life had amortization income for the thirdthree months ended March 31, 2021 and fourth quarters2020, of 2019; therefore, there is no comparable data in the first half$7,629 and $67,451, respectively. The ending deferred ceding commission as of 2019.March 31, 2021 and December 31, 2020 was $269,306 and $276,935, respectively.
| | | | | | | | | |
| | | | Six months ended June 30, | |||||
| | | | 2020 | | ||||
Reinsurer |
| Effective Date | | Ceding | | Expense | | ||
Ironbound Reinsurance Company Limited | | July 2019 | | $ | 688,110 | | $ | 679,076 | |
SDA Annuity & Life Re |
| November 2019 | | | 868,729 | | | 1,628,850 | |
US Alliance Life and Security Company(2) | | April 2020 | | | 2,272,784 | | | 4,009,102 | |
| | | | $ | 3,829,623 | | $ | 6,317,028 | |
| | | | | | | | | |
Under GAAP, ceding commissions are deferred on the balance sheetConsolidated Balance Sheets and are amortized over the period of the policyholder contracts. The tables below shows the ceding commissions from the reinsurers includingexcluding SRC1 and what was earned on a GAAP basis:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | ||
| | Six months ended June 30, | | | | Three months ended March 31, | |||||||||||||||||||||||||||||||||
| | 2020 | | | | 2021 | | 2020 | |||||||||||||||||||||||||||||||
Reinsurer | | Gross Ceding Commission | | Expense | | Interest on Ceding Commissions | | Earned |
| Effective Date | | Gross Ceding Commission | | Expense | | Interest on Ceding Commissions | | Earned | | Gross Ceding Commission | | Expense | | Interest on Ceding Commissions | | | Earned | ||||||||||||
Ironbound Reinsurance Company Limited | | $ | 688,110 | | $ | 679,076 | | $ | 110,022 | | $ | 188,826 | | July 2019 | | $ | — | | $ | 14,457 | | $ | 54,445 | | $ | 122,216 | | $ | 674,645 | | $ | 673,612 | | $ | 45,369 | | | $ | 95,740 |
SDA Annuity & Life Re | | 868,729 | | | 1,628,850 | | 29,527 | | | 18,341 |
| November 2019 | | | — | | | 24,317 | | | 21,712 | | | 46,072 | | | 298,982 | | | 548,464 | | | 13,526 | | | | 7,153 | ||
US Alliance Life and Security Company(2) | | | 2,272,784 | | | 4,009,102 | | | 7,711 | | | 10,465 |
| November 2019 | | | 2,178 | | | 20,735 | | | 15,339 | | | 66,606 | | | — | | | — | | | — | | | | — |
Crestline SP1 | | July 2020 | | | 2,345,135 | | | 4,678,207 | | | 49,855 | | | 215,762 | | | — | | | — | | | — | | | | — | ||||||||||||
| | $ | 3,829,623 | | $ | 6,317,028 | | $ | 147,260 | | $ | 217,632 | | | | $ | 2,347,313 | | $ | 4,737,716 | | $ | 141,351 | | $ | 450,656 | | $ | 973,627 | | $ | 1,222,076 | | $ | 58,895 | | | $ | 102,893 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(1) Includes acquisition and administrative expenses, commission expense allowance and product development fees.
(2) US Alliance Life and Security Company funds withheld and funds paid treaty.
31
The tables below shows the ceding commissions deferred on each reinsurance transaction on a GAAP basis:
| | | | | | | | | | | | | | | | | |
| | | | June 30, 2020 | | December 31, 2019 | | | | | March 31, 2021 | | December 31, 2020 | ||||
Reinsurer |
| Effective Date | | Deferred Ceding Commission | | Deferred Ceding Commission | |
| Effective Date | | Deferred Ceding Commission | | Deferred Ceding Commission | ||||
US Alliance Life and Security Company(1) |
| September 2017 | | $ | 834,487 | | $ | 858,675 | |
| September 2017 | | $ | 169,726 | | $ | 172,297 |
Unified Life Insurance Company(1) |
| July 2018 | | | 304,007 | | | 582,894 | |
| July 2018 | | | 269,306 | | | 276,935 |
Ironbound Reinsurance Company Limited(2) | | July 2019 | | | 5,752,126 | | | 5,060,359 | | | July 2019 | | | 5,634,707 | | | 5,642,095 |
SDA Annuity & Life Re(2) |
| November 2019 | | | 2,156,377 | | | — | |
| November 2019 | | | 2,662,423 | | | 2,703,496 |
US Alliance Life and Security Company(3) | | April 2020 | | | 2,440,087 | | | 1,076,267 | | | April 2020 | | | 2,446,254 | | | 2,472,559 |
Crestline SP1 | | July 2020 | | | 9,414,267 | | | 6,931,375 | |||||||||
| | | | $ | 11,487,084 | | $ | 7,578,195 | | | | | $ | 20,596,683 | | $ | 18,198,757 |
| | | | | | | | | | | | | | | | | |
(1) | These reinsurance transactions on our legacy business received gross ceding commissions on the effective dates of the transaction. The difference between the statutory net adjusted reserves and the GAAP adjusted reserves plus the elimination of DAC and value of business acquired |
(2) | These reinsurance transactions include the ceding commissions and expense allowances which are accounted for as described in (1). |
(3) | US Alliance Life and Security Company funds withheld and funds paid treaty. |
The use of reinsurance does not relieve American Life of its primary liability to pay the full amount of the insurance benefit in the event of the failure of a reinsurer to honor its contractual obligation for all blocks of business except what is included in the Unified transaction. The reinsurance agreement with Unified discharges American Life’s responsibilities once all the policies have changed from indemnity to assumptive reinsurance. No reinsurer of business ceded by American Life has failed to pay policy claims (individually or in the aggregate) with respect to our ceded business.
27
American Life monitors several factors that it considers relevant to satisfy itself as to the ongoing ability of a reinsurer to meet all obligations of the reinsurance agreements. These factors include the credit rating of the reinsurer, the financial strength of the reinsurer, significant changes or events of the reinsurer, and any other relevant factors. If American Life believes that any reinsurer would not be able to satisfy its obligations with American Life, separate contingency reserves may be established. At June 30, 2020As of March 31, 2021 and December 31, 2019,2020, no contingency reserves were established.
American Life expects to reinsure substantially all of its new insurance policies with a variety of reinsurers in exchange for upfront ceding commissions, expense reimbursements and administrative fees. American Life may retain some business with the intent to reinsure some or all at a future date.
Note 10. Notes Payable
32
On June 28, 2018, we underwent a change in control as a result
Retained and Convertible Senior Secured Note Purchase Agreement dated May 9, 2018 (the “Agreement”) with a non-affiliated third party, Xenith. Vespoint LLC, a Delaware limited liability company (“Vespoint”), owns 100% of the voting stock 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 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 of Midwest and American Life.
At closing of the Agreement with Xenith, it loaned a total of $600,000 to Midwest, repayable upon maturity in 10 years with interest of 8% per annum with 4% payable quarterly and another 4% accrued and payable upon maturity. The loans were made under two notes of $500,000 and $100,000, respectively. The Agreement further provided that Xenith, in its sole discretion, could loan up to an additional $23,500,000 to Midwest. Any loans made by Xenith under this election (“Subsequent Loans”) could also to be converted into Midwest’s voting common stock at $0.02 per share. Xenith contributed an additional $18,500,000 in the fourth quarter of 2018 following the amendment of the Midwest Articles of Incorporation to increase its authorized voting common shares to 1,970,000,000. All loans were later converted into Midwest voting common stock on June 18, 2019. Any additional borrowing capacity was terminated by written mutual consent in April 2020.Reinsurer Balance Sheets
The Company had total accrued interest of $845,536 ontables below shows the Xenith notes through June 18, 2019. All interest on the notes from inception through June 18, 2019 was waived by Xenith. The accrued interest was accounted for as an additional capital contribution. The legal fees of $161,000 associated with the Xenith transaction were capitalizedretained and subsequently written off when the notes were converted.
The following table sets forth information regarding loans made to us by Xenith through June 18, 2019 and the number of shares of voting common stock each loan was converted into on June 28, 2019:
reinsurance condensed balance sheets:
| | | | | |
| | | | | Shares of Common |
| | Loan | | Stock into which | |
| | Principal | | Loans Were | |
Date of Loan |
| Amount |
| Converted | |
June 28, 2018 | | $ | 500,000 |
| 24,284,825 |
June 28, 2018 | |
| 100,000 |
| 4,856,965 |
October 10, 2018 | |
| 1,000,000 |
| 48,569,650 |
December 7, 2018 | |
| 17,500,000 |
| 849,968,875 |
Total | | $ | 19,100,000 |
| 927,680,315 |
| | | | | | | | | | | | | | | | | | |
|
| March 31, 2021 | | December 31, 2020 | ||||||||||||||
| | | | | | | | | | | | | | | | | | |
| | Retained | | Reinsurance | | Consolidated | | Retained | | Reinsurance | | Consolidated | ||||||
Assets |
| | |
|
| |
| | | | | | | | | | | |
Total investments | | | 305,022,890 | | | 388,398,930 | | | 693,421,820 | | | 185,367,430 | | | 332,827,149 | | | 518,194,579 |
Cash and cash equivalents | | | 72,613,680 | | | 28,313,472 | | | 100,927,152 | | | 102,334,579 | | | 49,344,695 | | | 151,679,274 |
Accrued investment income | | | 3,193,353 | | | 5,901,740 | | | 9,095,093 | | | 1,955,938 | | | 4,850,898 | | | 6,806,836 |
Deferred acquisition costs, net | | | 19,676,745 | | | — | | | 19,676,745 | | | 13,456,303 | | | — | | | 13,456,303 |
Reinsurance recoverables (See Note 8) | | | — | | | 38,715,577 | | | 38,715,577 | | | — | | | 32,146,042 | | | 32,146,042 |
Other assets | | | 2,918,643 | | | 1,436,019 | | | 4,354,662 | | | 2,685,341 | | | 1,432,384 | | | 4,117,725 |
Total assets | | $ | 403,425,311 | | $ | 462,765,738 | | $ | 866,191,049 | | $ | 305,799,591 | | $ | 420,601,168 | | $ | 726,400,759 |
Liabilities and Stockholders’ Equity | | |
| | |
| | |
| | |
| | |
| | |
|
Liabilities: | | |
| | |
| | |
| | |
| | |
| | |
|
Policyholder liabilities | | $ | 265,456,993 | | $ | 461,795,179 | | $ | 727,252,172 | | $ | 191,887,322 | | $ | 418,921,167 | | $ | 610,808,489 |
Deferred gain on coinsurance transactions | | | 20,596,683 | | | — | | | 20,596,683 | | | 18,198,757 | | | — | | | 18,198,757 |
Other liabilities | | | 31,739,452 | | | 970,559 | | | 32,710,011 | | | 9,384,013 | | | 1,680,001 | | | 11,064,014 |
Total liabilities | | $ | 317,793,128 | | $ | 462,765,738 | | $ | 780,558,866 | | $ | 219,470,092 | | $ | 420,601,168 | | $ | 640,071,260 |
Stockholders’ Equity: | | |
| | |
| | |
| | | | | | | | | |
Voting common stock | | | 3,738 | | | — | | | 3,738 | | | 3,738 | | | — | | | 3,738 |
Additional paid-in capital | | | 133,678,612 | | | — | | | 133,678,612 | | | 133,417,272 | | | — | | | 133,417,272 |
Accumulated deficit | | | (55,122,540) | | | — | | | (55,122,540) | | | (53,522,078) | | | — | | | (53,522,078) |
Accumulated other comprehensive income | | | 7,072,373 | | | — | | | 7,072,373 | | | 6,430,567 | | | — | | | 6,430,567 |
Total Midwest Holding Inc.'s stockholders' equity | | $ | 85,632,183 | | $ | — | | $ | 85,632,183 | | $ | 86,329,499 | | $ | — | | $ | 86,329,499 |
Total liabilities and stockholders' equity | | $ | 403,425,311 | | $ | 462,765,738 | | $ | 866,191,049 | | $ | 305,799,591 | | $ | 420,601,168 | | $ | 726,400,759 |
As of June 30, 2020, Midwest had no notes outstanding to Xenith.
Note 11.10. Long-Term Incentive Plans
2019 Plan
On June 11, 2019, our Board of Directors (the “Board”) approved the Midwest Holding Inc. Long-Term Incentive Plan. The purposesPlan (the ”2019 Plan”) that reserves up to 102,000 shares of this Long-Term Incentive Plan (“LTIP”) is to create incentives which are designed to motivate participants to put forth maximum effort toward the success and growth of the Company and to enable the Company to attract and retain experienced individuals who by their position, ability and diligence are able to make important contributions to the Company’s
28
success. Toward these objectives, this Planour voting common stock for award issuances. It provides for the grant of Options, Restricted Stock Awards, Restricted Stock Units, SARs, Performance Units, Performance Bonuses, Stock Awardsoptions, restricted stock awards, restricted stock units, stock appreciation rights, performance units, performance bonuses, stock awards and Other Incentive Awardsother incentive awards to Eligible Employeeseligible employees, consultants and the grant of Nonqualified Stock Options, Restricted Stock Awards, Restricted Stock Units, SARs, Performance Units, Stock Awards and Other Incentive Awards to Consultants and Eligible Directors,eligible directors, subject to the conditions set forth in thisthe 2019 Plan. All awards are required to be established, approved, and/or granted by the compensation committee of our Board.
On July 19, 2019, the Companywe granted stock options for 8,950,00017,900 shares of voting common stock under the 2019 Plan that are exercisable during a ten-year period after the date of grant at a price of $0.05$25.00 per share, with one-third exercisable after July 17, 2021 and two-thirds exercisable after July 17, 2023. The fair market value of the shares was approximately $0.016 a$8.00 per share at the grant date.
The Company’s management team considered the stock options as compensation. Using the Black-ScholesBlack Scholes Model we determined the consideration should be $143,200.compensation expense was $143,200 over the vesting term of the stock options. The factors we used to determine the consideration were the following:expense were: the weighted average fair market value at grant date of $0.016 a$8.00 per share, the exercise price of $0.05 a$25.00 per share, time to maturitythe option term of 10 years, an annual risk-free interest rate of 1.84% based upon the 10 year10-year U.S. Treasury rate at grant date, and a 200% volatility based onof the change in price of the stock betweenbefore the decision and grant date of the grants, the amount of shares and the closely held nature of the stock before the grants.
On July 21, 2020, we granted stock options for 26,300 shares of voting common stock. Using the Black Scholes Model we determined the compensation expense was $334,950 over the vesting term of the stock options. The factors we used to determine the expense were: the weighted average fair market value at grant date of $14.50 per share, the exercise price of per share, the time to maturity of 10 years, an annual risk-free interest rate of .55% based upon the 10-year U.S. Treasury rate at grant date and a 60% volatility based on a valuation by an outside evaluator relating to the grants of these options.
On September 15, 2020, we granted stock options for 6,667 shares of voting common stock at an exercise price of $25.00 per share. Using the Black Scholes Model we determined the compensation expense was $144,014 over the vesting term of the stock options. The factors we used to determine the expense were: the weighted average fair market value at grant date of
33
$21.60 per share, the exercise price of $41.25 per share, the time to maturity of 10 years, an annual risk-free interest rate of .69% based upon the 10-year U.S. Treasury rate at grant date and a 66.2% volatility based on a valuation by an outside evaluator relating to the grants of these options.
On November 16, 2020, we granted stock options for 35,058 shares of voting common stock at an exercise price of $41.25 per share. Using the Black Scholes Model we determined the compensation expense was $1,032,458 over the vesting term of the stock options. The factors we used to determine the expense were: the weighted average fair market value at grant date of $29.45 per share, the exercise price of $41.25 per share, the time to maturity of 10 years, an annual risk-free interest rate of .91% based upon the 10-year U.S. Treasury rate at grant date and a 66.3% volatility based on a valuation by an outside evaluator relating to the grant of these options.
Also, on November 16, 2020 we granted an award of restricted stock for 18,597 shares of voting common stock to an officer. Using the Black Scholes Model we determined the compensation expense was $547,682 over the vesting term of the stock options. The factors we used to determine the expense were: the weighted average fair market value at grant date of $29.45 per share, the exercise price of $41.25 per share, an annual risk-free interest rate of .91% based upon the 10-year U.S. Treasury rate at grant date and a 66.3% volatility based on a valuation by an outside evaluator relating to this restricted stock grant.
On January 16, 2021 and May 1, 2020, restricted stock and stock options for 4,650 and 200 shares with a fair market value of $29.45 and $8.00 per share, respectively, became vested on the restricted stock and in connection with the resignation of two Board members. For the three months ended March 31, 2021 and six months ending June 30,the year ended December 31, 2020 we have amortized the considerationcompensation expense from the stock option grants on the three dates above, over the two and four year vesting tranches, for an expense and additional paid in capital of $13,089$261,340 and $25,022,$163,664, respectively. On May 1,As of March 31, 2021 and December 31, 2020, 100,000the outstanding non-vested stock options became vested by two Board of Director members resigning fromunder the Board. No options had been2019 Plan was 96,322 and 100,972, respectively with zero and 3,350 shares being forfeited as of June 30, 2020 orMarch 31, 2021 and December 31, 2019.2020, respectively.
Table
For the three months March 31, 2021 and 2020, we amortized the compensation expense related to the 2019 Plan, from the stock grants on the three dates above, over the two and four year vesting tranches as an expense and an increase in additional paid in capital of $261,340 and $11,933, respectively
The table below showshows the remaining non-vested shares as of June 30, 2020:under the 2019 Plan:
| | | | |
| | March 31, 2021 | | December 31, 2020 |
|
| Stock Options/ | | Stock Options |
Beginning balance | | 100,972 | | 17,900 |
Options granted under the 2019 Plan | | — | | 68,025 |
Restricted stock granted under the 2019 Plan | | — | | 18,597 |
Forfeited | | — | | (3,350) |
Vested | | (4,650) | | (200) |
Ending Balance |
| 96,322 | | 100,972 |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
34
Note 12.11. Deposit-Type Contracts
The Company’s deposit-type contracts represent the contract value that has accrued to the benefit of policyholders as of the balance sheet date. Liabilities for these deposit-type contracts are included without reduction for potential surrender charges. This liability is equal to the accumulated account deposits, plus interest credited, and less policyholder withdrawals. The following table provides information about deposit-type contracts for the sixthree months ended June 30, 2020March 31, 2021 and the year ended December 31, 2019:2020:
| | | | | | | | | | | | |
|
| June 30, 2020 |
| December 31, 2019 |
| March 31, 2021 |
| December 31, 2020 | ||||
Beginning balance | | $ | 171,168,785 | | $ | 7,234,927 | | $ | 597,868,472 | | $ | 171,168,785 |
US Alliance | |
| 398,623 | |
| 657,986 | |
| (655,762) | |
| (3,307,587) |
Ironbound Reinsurance Company Limited | |
| 1,522,105 | |
| 6,080,196 | ||||||
SDA Annuity & Life Re (includes MVA adjustment and embedded derivative) | | | (344,905) | | | 3,053,160 | ||||||
Crestline SP1 | | | (2,492,215) | | | 3,606,833 | ||||||
Deposits received | |
| 147,486,013 | |
| 161,392,700 | |
| 123,653,931 | |
| 415,561,302 |
Investment earnings (includes embedded derivative) | |
| 3,436,491 | |
| 2,043,762 | |
| (2,346,402) | |
| 4,214,828 |
Withdrawals | |
| (658,936) | |
| (160,590) | |
| (2,904,992) | |
| (2,509,045) |
Ending balance | | $ | 321,830,976 | | $ | 171,168,785 | | $ | 714,300,232 | | $ | 597,868,472 |
| | | | | | |
Note 13.12. Contingencies and Commitments
Legal Proceedings:We are involved in litigation incidental to our operations from time to time. We are not presently a party to any legal proceedings other than litigation arising in the ordinary course of our business, and we are not aware of any claims that could materially affect our financial position or results of operations.
Regulatory MattersMatters:: State regulatory bodies and other regulatory bodies regularly make inquiries and conduct examinations or investigations concerning the Company’s compliance with laws in relation to, but not limited to, insurance
29
and securities matters. American Life received a Certificate of Authority to conduct business in Iowa during the first quarter of 2019. American Life received a Certificate of Authority to conduct business during 2020 from each of the following states: Utah, Montana, Louisiana, Ohio,states and the District of Columbia.Columbia: Utah, Montana, Louisiana and Ohio. American Life has pending applications in six additional states that are expected to be approved by the end of 2020.2021. The Nebraska Department of Insurance (“NDOI”) granted American Life approval to enter into the Funds Withheld Coinsurance and Modified Coinsurance Agreement with Ironbound prior to closing of the agreement in July 2019. The NDOI granted American Life approval to enter into the Funds Withheld Coinsurance and Modified Coinsurance Agreement with SDA prior to closing of the agreement in December 2019. The NDOI granted American Life approval to enter into the Funds Withheld and Funds Paid Coinsurance Agreement with US Alliance Agreement prior to closing of the agreement on April 15, 2020. The NDOI granted American Life approval to enter into the Funds Withheld and Modified Coinsurance Agreement with Seneca Re through SRC1 prior to closing of the agreement on May 13, 2020. The NDOI granted American Life approval to enter into the FW and Modco Agreement with Seneca Re SRC2 prior to closing of the agreement on July 27, 2020.
Note 14.13. Leases
Our operating lease activities consist of leases for office space and equipment. Our finance lease activities consistconsisted of leasesone lease for hardware which we owned effectiveat the end of the lease agreement on March 31, 2020. None of our lease agreements include variable lease payments. See the discussion
35
Supplemental balance sheet information as of June 30,March 31, 2021 and December 31, 2020, regarding our leases isare as follows:
| | | | | | | | | | | | | | | | |
| | | | As of | | As of | | | | As of | | As of | ||||
Leases |
| Classification |
| June 30, 2020 |
| December 31, 2019 |
| Classification |
| March 31, 2021 |
| December 31, 2020 | ||||
Assets |
|
|
| |
|
| |
|
|
|
| |
|
| |
|
Noncurrent: |
|
|
| |
|
| |
| ||||||||
Finance |
| Office and other equipment, net of accumulated depreciation and amortization | | $ | — | | $ | 2,913 | ||||||||
Operating |
| Operating lease right-of-use assets | |
| 409,165 | |
| 470,132 |
| Operating lease right-of-use assets | | $ | 317,715 | | $ | 348,198 |
Total leased assets |
|
| | $ | 409,165 | | $ | 473,045 | ||||||||
| | | | | | | | | | | | | | | | |
Liabilities |
|
| |
|
| |
|
|
|
| |
|
| |
|
|
Current: |
|
| |
|
| |
|
| ||||||||
Finance lease |
| Finance lease liabilities | | $ | — | | $ | 1,860 | ||||||||
Noncurrent: |
|
| |
|
| |
|
| ||||||||
Operating lease |
| Operating lease liabilities | |
| 460,791 | |
| 524,248 |
| Operating lease liabilities | | $ | 364,128 | | $ | 396,911 |
Total leased liabilities |
|
| | $ | 460,791 | | $ | 526,108 |
Our operating and finance leases expenses for the three and six months ended June 30,March 31, 2021 and 2020, and 2019, were as follows:
| | | | | | | | | | | | | | | | | | | | | | |
| | | | Three months ended June 30, | | Six months ended June 30, | | | | Three months ended March 31, | ||||||||||||
Leases |
| Classification |
| 2020 |
| 2019 |
| 2020 |
| 2019 |
| Classification |
| 2021 |
| 2020 | ||||||
Operating |
| General and administrative expense | | $ | 2,485 | | $ | 3,344 | | $ | 4,577 | | $ | 7,109 |
| General and administrative expense | | $ | 1,233 | | $ | 2,092 |
| | | | | | | | | | | | | | | | | | | | | | |
Finance lease cost: |
|
| |
|
| |
|
| |
|
| |
|
|
|
| |
|
| |
|
|
|
| Amortization expense | |
| — | |
| 2,914 | |
| 2,913 | |
| 5,827 |
| Amortization expense | |
| — | |
| 2,913 |
|
| Interest expense | |
| — | |
| 111 | |
| 111 | |
| 222 |
| Interest expense | |
| — | |
| 111 |
Minimum contractual obligations for our operating leases at June 30, 2020,as of March 31, 2021, are as follows:
| | | | | | |
|
| Operating Leases |
| Operating Leases | ||
2020 (excluding six months ended June 30, 2020) | | $ | 90,167 | |||
2021 | |
| 164,081 | |||
2021 (excluding three months ended March 31, 2021) | | $ | 122,891 | |||
2022 | |
| 156,608 | |
| 156,608 |
2023 | |
| 161,674 | |
| 161,674 |
2024 | |
| 13,508 | |
| 13,508 |
Total remaining lease payments | | $ | 586,038 | | $ | 454,681 |
30
Supplemental cash flow information related to leases was as follows:
| | | | | | | | | | | | | | | | | | |
| | Three months ended June 30, | | Six months ended June 30, | | Three months ended March 31, | ||||||||||||
|
| 2020 |
| 2019 |
| 2020 |
| 2019 |
| 2021 |
| 2020 | ||||||
Cash payments |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
Operating cash flows from operating leases | | $ | (190) | | $ | (190) | | $ | (1,035) | | $ | 42 | | $ | (2,300) | | $ | (1,035) |
Operating cash flows from finance leases | |
| 1,164 | |
| 1,164 | |
| 4,657 | |
| 2,328 | |
| — | |
| 1,164 |
Financing cash flows from finance leases | |
| — | |
| (111) | |
| (111) | |
| (222) |
The weighted average remaining lease terms of our operating leases were approximately one and a half years and two years as of March 31, 2021 and 2020, respectively. The weighted average discount rate of ourused to determine the lease liabilities for finance leases was 6% and operating leases was follows:8% as of March 31, 2021 and 2020, respectively. The discount rate used for finance leases was based on the rates implicit in the leases. The discount rate used for operating leases was based on our incremental borrowing rate.
| | | | | | | |
| | As of | | As of |
| ||
| | June 30, 2020 | | | December 31, 2019 | ||
Weighted Average Remaining Lease Term |
| |
|
| |
| |
Finance lease | | | — | | | 3 months | |
Operating lease | |
| 2 years | |
| 2.5 years | |
Weighted Average Discount Rate | |
| | | | | |
Finance lease | | | 0% | | | 6% | |
Operating lease | | | 8% | | | 8% | |
Note 15.14. Statutory Net Income and Surplus
American Life is required to prepare statutory financial statements in accordance with statutory accounting practices prescribed or permitted by the Nebraska Department of Insurance. Statutory practices primarily differ from GAAP by charging policy acquisition costs to expense as incurred, establishing future policy benefit liabilities using different actuarial assumptions as well as valuing investments and certain assets and accounting for deferred taxes on a different basis. As filed in the statutory-basis annual statement with the Nebraska Department of Insurance, American Life’s statutory net gains (losses) for the sixthree months ended June 30,March 31, 2021 and 2020 were $6,109,058 and 2019 were $2,724,713 and $(2,978,004),$423,474, respectively. Capital and surplus of American Life as of June 30, 2020March 31, 2021 and December 31, 20192020 was $25,775,640$77,818,776 and $19,507,325,$77,446,537, respectively. The net gain was primarily due to the ceding commission and reserve adjustments earned on the Ironbound, SDA, US Alliance, SRC1, and SRC1Crestline Re SP1 reinsurance transactions; offset by continuing expenses incurred to provide services on the new software and related technology to distribute products through national marketing organizations. For the six monthsquarter ended June 30, 2020,March 31, 2021, the MYGA and FIA sales were $58,965,873
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$9,368,962 and $88,520,140$114,284,969 compared to the $38,238,880MYGA and FIA sales $31,565,506 and $16,249,504 as of MYGA sales for the six months ended June 30, 2019.March 31, 2020. An additional $8,575,802$3,489,795 of MYGA and $51,206,249$36,050,004 of FIA sales were pending as of June 30, 2020.
As discussed in Note 9 Reinsurance above, American Life entered into the FW/Modco Agreement with Ironbound to cede 95% of American Life’s MYGA business. On March 1, 2020, the quota share ceded to Ironbound was reduced to 30% and on March 11, 2020 the quota share was further reduced to 0%. Premiums net of commissions and ceding commission and administrative fees ceded to Ironbound were $17,738,468 and $128,760,161 and the reserve requirement of $21,746,098 and $139,093,289 was ceded to Ironbound for the six months ended June 30, 2020 and the year ended December 31, 2019, respectively. American Life entered into the FW/Modco Agreement with SDA to cede 5% of the MYGA and 95% of the FIA business through December 31, 2019. Effective January 1, 2020, the FIA quota share was reduced to 30%. Premiums net of commissions and ceding commission and administrative fees ceded to SDA were $14,981,255 and $18,984,045 and the reserve requirements of $16,715,264 and $20,822,364 were ceded to SDA for the six months ended June 30, 2020 and the year ended December 31, 2019, respectively. American Life entered into the Funds withheld and Modified Coinsurance Agreements with Seneca Re by and through SRC1 and SRC2. SRC2 closed on July 27, 2020 but was effective April 24, 2020. The NDOI approved the inclusion of the SRC2 coinsurance in American Life’s June 30, 2020 statutory financial statements. Premiums net of commissions and ceding commission and administrative fees ceded to SRC1 and SRC2 were $24,075,481 and $26,638,405, respectively. The reserve requirements of $26,396,718 and $29,148,027 were ceded to SRC1 and SRC2 for the six months ended June 30, 2020, respectively. American Life entered into the Funds Withheld and Funds Paid Coinsurance Agreement with US Alliance. Premiums net of commissions and ceding commission and administrative fees ceded to US Alliance were $42,463,587 and the reserve requirements of $46,862,126 were ceded to US Alliance for the six months ended June 30, 2020, respectively.
2021.
State insurance laws require American Life to maintain certain minimum capital and surplus amounts on a statutory basis. Our insurance subsidiary is subject to regulations that restrict the payment of dividends from statutory surplus and may require
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prior approval from its domiciliary insurance regulatory authorities. American Life is also subject to risk-based capital (“RBC”) requirements that may further affect its ability to pay dividends. American Life’s statutory capital and surplus as June 30, 2020of March 31, 2021 and December 31, 2019,2020, exceeded the amount of statutory capital and surplus necessary to satisfy regulatory requirements, including the RBC requirements.
As of June 30,December 31, 2020, American Life had an invested asset that was impaired as a result of the fair market of the underlying collateral wasbeing valued less that the book value. This was non-admitted for statutory accounting. This asset was held in our modified coinsurance account for Ironbound so it was passed through to the third partythird-party reinsurer through as a reduction of the investment income earned by the third partythird-party reinsurer. As of March 31, 2021, this invested asset was sold for a loss of $2.4 million that was passed through to the third-party reinsurer as a reduction of their investment income earned.
As of June 30, 2020,March 31, 2021 and December 31, 2019,2020, American Life did not hold any participating policyholder contracts where dividends were required to be paid.
Note 16. Third Party15. Third-Party Administration
The Company commenced its third partythird-party administrative (“TPA”) services in 2012 as an additional revenue source. These services are offered to non-affiliated entities. These agreements, for various levels of administrative services on behalf of each company, generate fee income for the Company. Services provided vary based on their needs and can include some or all aspects of back-office accounting and policy administration. TPA fee income earned for TPA administration during the three months ended March 31, 2021 and year ended December 31, 2020 were $207,500 and $8,160, respectively.
Note 16. Reverse Stock Split
On August 10, 2020, Midwest filed Articles of Amendment of Amended and Restated Articles of Incorporation (“Amendment”) that changed the total number of shares that the Company is authorized to issue to 22,000,000 shares of common stock, of which 20,000,000 were designated as voting common stock with a par value of $0.001 per share and 2,000,000 designated as non-voting common stock with a par value of $0.001 per share. The TPA contractsAmendment also provides for 2,000,000 shares of preferred stock with a par value of $0.001 per share. The Amendment provided that each 500 shares of voting common stock either issued or outstanding would be converted into one share of voting common stock through a reverse stock split. Fractional shares were not a significant source of revenueissued in connection with the reverse stock split but were paid out in cash. The Company paid approximately $175,000 for those fractional shares and is now holding treasury stock represented by that amount. The effective date, August 27, 2020, for the reverse stock split was retrospectively applied to these financial statements. Outstanding shares as of June 30, 2020.March 31, 2021 and December 31, 2020, were 3,737,564.
Note 17. Capital Raise
On December 21, 2020, Midwest completed a public offering of 1,000,000 shares of its voting common stock offered by the Company at a price to the public of $70.00 per share. The Midwest voting common stock was approved for listing on the Nasdaq Capital Market under the ticker symbol “MDWT.”
Midwest raised $70,000,000 of gross proceeds from the capital raise and incurred commissions and expenses of approximately $5,914,995 that were offset against those proceeds.
Note 17. Subsequent Events18. Equity
COVID-19 PandemicPreferred stock
Beginning in March 2020, the global pandemic associated with novel COVID-19 and related economic conditions began to impact the Company’s results. Due to the unprecedented volatility in the economy related to COVID-19, the Company’s available for sale assets values were reduced by approximately $6.8 million and was reflected in the accumulated other comprehensive income on the balance sheet. Of these unrealized losses, $8.5 million pertained to assets owned by third party reinsurers offset by unrealized gains of $1.7 million retained by American Life. These unrealized losses owned by the third party reinsurers was offset by a realized gain of $8.5 million on the related embedded derivative. Also, the derivative assets were increased by $8,800 and were reflected in our realized gains and losses in the income statement. Approximately 80% of the unrealized losses were in our CLO portfolio and are typically illiquid which are intended to be held to maturity; thus, we believe the risk of loss is not significant. The Company has monitored the underlying unrealized losses and believe they pose little threat in the long-term due to the quality of the underlying credits. We believe that the quality and duration of our investments provide reasonable assurance of continued performance of the portfolio despite the recent economic volatility. The assets backing the treaties are maintained by American Life as collateral whereas the assets and total return on the asset portfolios are owned by the third party reinsurers excluding SRC1 as a wholly owned subsidiary. The Company has only contingent exposure to these losses as the CLO’s are held as collateral in and funds withheld and modification coinsurance accounts for the performance of the third party reinsurers under the coinsurance treaties. The third party reinsurers bear the risk of loss. Under GAAP, this arrangement is considered an embedded derivative as discussed in Note 6 above.
The Company purchases and sells equipment leases in its investment portfolio. As of June 30,March 31, 2021 and December 31, 2020, the Company owned several leases. An impairment test, ashad 2,000,000 shares of June 30, 2020, was completed on the only non-performing lease in the portfolio and it was determined that the underlying collateral value was substantially less than the outstanding remaining lease payments of $3.4 million. The Company established a valuation allowance on the asset of $776,973 and will continue to monitor the value the underlying collateral. The valuation allowance was recorded as a bad debt expense; however, this asset is owned by a third party reinsurer. Therefore, the valuation allowance was passed through as a receivable from the reinsurers, offsetting the valuation allowance.
The COVD-19 pandemic has not materially impacted our sales of our annuity products as evidenced by new sales of $147.5 million inpreferred stock authorized but none issued policies and pending applications of $59.8 million. Our policies sold have surrender charges over their duration that would tend to offset future income accruals. or outstanding.
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Operationally, the Company had the vast majority of its workforce working remotely with a skeleton crew in the office through June 30, 2020. Starting in July, the majority of the Company’s workforce had returned to the office with the high risk employees still working remotely. Our technology has allowed us to move to this work environment without a reduction in our productivity. The Company’s business continuity plan has performed as expected.Common Stock
The Company’s management will continue to monitor our investments and cash flows to evaluate the impact as this pandemic evolves.
On July 14, 2020 at the Annual Meeting of Shareholders, our shareholders approved the amendment of the Company’s Amended and Restated Articles of Incorporation to (i) change its authorized capital stock to 22,000,000 shares of common stock, $0.001 par value, of which 20,000,000 shares shall be voting common stock and 2,000,000 shares shall be nonvoting common stock, and 2,000,000is traded on the NASDAQ Capital Market under the symbol “MDWT”. Midwest has authorized 20,000,000 shares of preferred stock, $0.001 par value; and (ii) to effect a reverse split of the Company’s existing voting common stock, $0.001 par value, at a ratiostock. As of 500March 31, 2021 and December 31, 2020, Midwest had 3,737,564 shares of existing common stock for one share of voting common stock issued and the paymentoutstanding.
Midwest holds approximately 4,500 shares of cash for any fractional shares resulting fromvoting common stock in its treasury due to the reverse split.stock split discussed in Note 16 above.
Additional paid-in capital
Additional paid-in capital is primarily comprised of the cumulative excess cash received by the Company in conjunction with past issuances of its shares. It also is increased by the amortization expense of the consideration calculated at inception of the stock option grant as discussed in Note. 10 – Long-Term Incentive Plan above.
Accumulated Other Comprehensive Income (Loss)
AOCI represents the cumulative OCI items that are reported separate from net income and detailed on the Consolidated Statements of Comprehensive Loss. AOCI includes the unrealized gains and losses on investments and DAC, net of offsets and taxes are as follows:
| | | | | | | | |
| Unrealized |
| Unrealized |
| Accumulated other | |||
Balance at December 31, 2019 | $ | 473,399 | | $ | 146,185 | | $ | 619,584 |
Other comprehensive income before Reclassifications |
| 7,398,432 | | | — | |
| 7,398,432 |
Unrealized gains on foreign currency | | — | | | (146,185) | | | (146,185) |
Less: Reclassification adjustments for losses realized in net income | | (1,441,264) | | | — | | | (1,441,264) |
Balance at December 31, 2020 | | 6,430,567 | | | — | | | 6,430,567 |
Other comprehensive income (loss) before reclassifications, net of tax | | 962,880 | | | — | | | 962,880 |
Less: Reclassification adjustments for losses realized in net income, net of tax | | (321,074) | | | — | | | (321,074) |
Balance at March 31, 2021 | $ | 7,072,373 | | $ | — | | $ | 7,072,373 |
Note 19. Deferred Acquisition Costs
The shareholders approved the reincorporationfollowing table represents a rollforward of Midwest from the StateDAC, net of Nebraska to the Statereinsurance:
| | | | | | |
|
| March 31, 2021 | | December 31, 2020 | ||
Beginning balance | | $ | 13,456,303 | | $ | — |
Additions | | | 6,681,991 | | | 13,919,206 |
Amortization | | | (502,737) | | | (670,233) |
Interest | | | 36,855 | | | 138,295 |
Impact of unrealized investment losses | | | 4,333 | | | 69,035 |
Ending Balance | | $ | 19,676,745 | | $ | 13,456,303 |
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Table of Delaware which the Company is in the process of completing.Contents
On July 23, 2020, the NDOI approved the Funds Withheld and Modified Coinsurance Agreement Seneca Incorporated Cell, LLC 2020-02 (“SRC2”) of Seneca Reinsurance Company, LLC. The agreement closed on July 27, 2020. Under the agreement, American Life ceded to SRC2, on a funds withheld and modified coinsurance basis, an initial 25% quota share of certain liabilities with respect to American Life’s MYGA business and 40% quota share of certain liabilities with respect to American Life’s FIA business effective April 24, 2020. American Life has established a SRC2 Funds Withheld Account and a Modco Account to hold the assets pursuant to the agreement. The NDOI approved the inclusion of the SRC2 coinsurance in American Life’s June 30, 2020 statutory financial statements.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand the financial condition of the Company as of June 30, 2020,March 31, 2021, compared with December 31, 2019,2020, and the results of operations for the three and six months ended June 30, 2020,March 31, 2021, compared with the corresponding period in 20192020 of Midwest Holding Inc. and its consolidated subsidiaries. The MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statementsConsolidated Financial Statements and the accompanying notes to the consolidated financial statementsConsolidated Financial Statements (“Notes”) presented in “Part 1 – Item 1. Financial Statements” of this Report;Report and our Form 10-K for the year ended December 31, 20192020 (“20192020 Form 10-K”), including the sections entitled “Part I – Item 1A. Risk Factors,” and “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Cautionary Note Regarding Forward-Looking Statements and Risk Factors
Except for certain historical information contained herein, this report contains certain statements that may be considered “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and such statements are subject to the safe harbor created by those sections. All statements, other than statements of historical fact, are statements that could be deemed forward-looking statements, including without limitation: any projections of revenues, earnings, cash flows, capital expenditures, or other financial items; any statement of plans, strategies, and objectives of management for future operations; any statements concerning new products or services, or developments; any statements regarding future economic conditions or performance; and any statements of belief and any statement of assumptions underlying any of the foregoing. Words such as “believe,” “may,” “could,” “expects,” “hopes,” “estimates,” “projects,” “intends,” “anticipates,” and “likely,” and variations of these words, or similar expressions, terms, or phrases, are intended to identify such forward-looking statements. Forward-looking statements are inherently subject to risks, assumptions, and uncertainties, many of which cannot be predicted or quantified, which could cause future events and actual results to differ materially from those set forth in, contemplated by, or underlying the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in “Item 1A. Risk Factors” of our 20192020 Form 10-K and below in Part III – Other Information – Item 1A Risk Factors.
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All such forward-looking statements speak only as of the date of this report. You are cautioned not to place undue reliance on such forward-looking statements. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in the events, conditions, or circumstances on which any such statements are based.
Overview
We were formed on October 31, 2003 for the primary purpose of becoming a financial services company. We operate our business primarily through three wholly owned subsidiaries: 1)subsidiaries, American Life, a Nebraska-domiciled life insurance company that was issued a certificate of authority to conduct life insurance business in Nebraska in 2009; 2) 1505 Capital, a Delaware limited liability company, which provides investment advisory and related asset management services and 3) Seneca Reinsurance Company, LLC, a Vermont domiciled company, which was formed as a captive reinsurance company to hold protective cells to reinsure the business of American. 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.
The terms and conditions of the Agreement are described in our Current Report on Form 8-K filed with the Securities and Exchange Commission (“SEC”) on May 14, 2018. The Agreement was filed as an exhibit to the referenced Current Report on Form 8-K.
Following the closing of the Agreement, we began implementation of a new business plan whose primary purpose is to leverage technology and reinsurance to distribute competitive insurance products through third-party marketing organizations.
Effective March 12, 2020, Seneca Reinsurance Company, LLC (“Seneca Re”), a Vermont limited liability company was formed by Midwest to operate as a sponsored captive insurance company for the purpose of insuring and reinsuring various types of risks of its participants through one or more protected cells and to carry on and conduct any other business or activity that is permitted for sponsored captive insurance companies under Vermont regulations. On March 30, 2020, Seneca Re received its Certification of Authority to transact the business of a captive insurance company. On May 12, 2020, Midwest contributed $300,000 to Seneca Re for a 100% ownership interest. Seneca Re had one Protected Cell-2020-01 (“SRC1”) as of June 30, 2020. Midwest contributed $3,000,000 to capitalize SRC1.
Effective on April 24, 2020, we raised capital of $5.227 million from various third-party investors and issued 115,827,004 shares of voting common stock at $0.045 per share. Also, on April 24, 2020, we signed a Securities Purchase Agreement with Crestline for additional capital of $10.0 million and issued 222,222,222 shares of our voting common stock $0.045 per share.
On April 24, 2020, American Life entered into a Master Letter Agreement with Seneca Re and Crestline regarding a flow of annuity reinsurance and related asset management, whereby Crestline agreed to provide reinsure funding for a quota share percentage of 25% of the liabilities of American Life arising from its multi-year guaranteed annuity (“MYGA”) and quota share percentage of 40% of the fixed index annuity (“FIA”) products. This agreement expires on April 24, 2023.
The Business Plan.
In 2018, subsequent to the change in control described above, we embarked upon our new business plan to become a leading, capital efficient, technology-enabled, services-oriented life and annuity fronting insurance company. Our objective is to leverage American Life, and our ancillary services business, to create and sell life and annuity products through third party independent marketing organizations using reinsurance as the primary form of capital to support our growth and to bear the financial risk associated with out insurance products. Our targeted third party field marketing organizations offer products,
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infrastructure and other services to independent insurance agents across the United States. We currently have Although we may retain some business, we expect third party reinsurers to ultimately assume substantially all of the insurance risk on our business through reinsurance agreements. In connection with these arrangements we will earn ceding fees from the reinsurers. We currently offer MYGA and FIA through several independent marketing organizations.
We are seeking 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.
Re. American Life is licensed to sell, underwrite, and market life insurance and annuity products in 21 states and the District of Columbia and has pending applications in additional states. Sales have continued consistentlyWe also provide insurance company administrative services through a division known as “m.pas” that was formed in 2019. 1505 Capital provides investment advisory and related asset management services. Seneca Re reinsures various types of the Company’s investments continuelife insurance risks through one or more single purposes entities or “cells.”
In 2018, we began implementation of a new business plan with the purpose of leveraging technology and reinsurance to perform.distribute insurance products through independent marketing organizations (“IMOs”).
American Life’s sales force continues to grow, with 15 third party field marketing organizationseight third-party IMOs presently offering our products. American Life is one of the leaders in the MYGA and FIA markets as of June 30, 2020 through our expanding sales force. American Life obtained an A.M. Best Rating of B++ in December 2018 that was affirmed in 2019.2020. A.M. Best also upgraded American Life's long-term issuer credit rating to bbb+ from bbb in December 2020.
Beginning in mid-2019, American Life began sellingceding portions of its first MYGA and FIA products during 2019 resulting in gross premiums of $145,747,737annuity business to third-party insurance companies and $15,616,831, respectively, for the year ended December 31, 2019 on a statutory basis.Seneca Re that we refer to as “quota shares.” For GAAP, such premiums are considered deposits and are not shown as premium income. Gross premiums on a statutory basis for MYGA and FIA products for the six months ended June 30, 2020 and 2019, such were $147,486,013 and $38,238,880, respectively.
On July 25, 2019, American Life closed a reinsurance agreement with a third party insurance company to cede 95% of American Life’s MYGA business, with the transaction being effective from inception of the sales of the MYGA product. This transaction eliminated 95% of the interest credited on the MYGA deposit-type contracts. On March 1, 2020, American Life reduced the quota share ceded to the third party reinsurer to 30% and again on March 11, 2020 to 0% at the request of the NDOI. See Note 9. Reinsurancedetailed information see “Note 9 — Reinsurance” to our Consolidated Financial Statements above, for further discussion.
On November 7, 2019 American Life closed a second reinsurance agreement with a third party insurance company to cede the remaining 5% of the MYGA product and 95% of the FIA product to a third party reinsurer through December 31, 2019, at which time the FIA product was reduced to 30% ceded as of January 1, 2020. See Note 9. Reinsurance to our Consolidated Financial Statements, above, for further discussion.
On April 15, 2020, American Life closed a third reinsurance agreement with a third party insurance company to cede an initial 49% quota share the FIA business effective January 1, 2020 through March 31, 2020. Effective from March 1, 2020 through March 10, 2020, American Life ceded 45.5% quota share of its MYGA business. Effective March 11, 2020 through March 31, 2020, the quota share increased to 66.5% of the MYGA business. Effective April 1, 2020, the FIA quota share was reduced to 40% and the MYGA quota share was reduced to 25%.included in this Form 10-Q.
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Effective March 12, 2020, we formed Seneca Re for the purpose of reinsuring various types of risks through one or more single purpose entitles, or “protected cells.” On March 30, 2020, Seneca Re received its certificate of authority to transact business as a captive insurance company. On May 13,12, 2020, American Life closedwe contributed $300,000 to Seneca Re for a fourth reinsurance100% ownership interest. Seneca Re has one incorporated cell, Seneca Incorporated Cell, LLC 2020-01 (“SRC1”) as of December 31, 2020. We contributed a total of $15.0 million through December 31, 2020 to capitalize SRC1, which is consolidated in our financial statements.
Effective on April 24, 2020, we raised capital of $5,227,000 from various third-party investors and issued 231,655 shares of voting common stock at $22.50 per share. Also, on April 24, 2020, we signed a securities purchase agreement with a related party insurance companyCrestline Assurance for additional capital of $10.0 million and issued 444,444 shares of our voting common stock to cede an initial 21% quota share of certain liabilities with respect to American Life’s FIA business effective January 1, 2020 through March 31, 2020. Effective from March 1, 2020 through March 10, 2020, American Life ceded a 19.5% quota share of certain liabilities with respect to its MYGA business. Effective March 11, 2020 through March 31, 2020, on a funds withheld and modified coinsurance basis, the quota share increased to 28.5% of certain liabilities with respect to its MYGA business. Effective April 1, 2020, the FIA quota share increased to 45% and the MYGA quota share increased to 72.5%. SRC1 is consolidated into Midwest financials; therefore, the ceded and assumed business between American Life and SRC1 was eliminated during the consolidation process. See Note 9. Reinsurance to our Consolidated Financial Statements, above, for further discussion.
Item Impacting Comparability
American Life has treaties with three third party reinsurers that have funds withheld and modified coinsurance provisions. Under those provisions, the assets backing the treaties are maintained by American Life as collateral, whereas the assets and the total return on the asset portfolios belong to the third party reinsurers. Under GAAP this arrangement is considered an embedded derivative as discussed in Note 6 in our “Notes to Consolidated Financial Statements.” As a result of recent market volatility, assets carried as investments on American Life’s financial statements for the third party reinsurers contained unrealized losses of approximately $8.5 million as of June 30, 2020.
The terms of the contracts with the third party reinsurers provide that unrealized losses on the portfolios accrue to the third party reinsurers. We account for this loss by recording equivalent realized gains on our income statement. Accordingly, the unrealized losses on the assets held by American Life were offset by a gain in the embedded derivative of $8.5 million.
Basic earnings per share in the first half of fiscal 2020 were $0.003 which included the aforementioned gain of $8.5 million. Basic loss per share in the first half of fiscal 2020 without the aforementioned gain was ($0.002)Crestline Assurance at $22.50 per share.
If pricesOn August 10, 2020, Midwest filed Articles of investments recover,Amendment of Amended and Restated Articles of Incorporation (“Amendment”) that changed the unrealized gains maytotal number of shares it is authorized to issue to 22,000,000 shares of common stock, of which 20,000,000 were designated as voting common stock with a par value of $0.001 per share and 2,000,000 shares were designated as non-voting common stock with a par value of $0.001 per share. The Amendment also provides for 2,000,000 shares of authorized preferred stock with a par value of $0.001 per share. The Amendment provided that upon effectiveness, each 500 shares of common stock either issued or outstanding would be reduced; therefore,converted into one share of voting common stock through a reverse stock split. The Amendment was effective as of August 27, 2020. Fractional shares were not issued in connection with the associated embedded derivative gain recognizedreverse stock split but were paid in cash. The Company paid approximately $175,000 for those fractional shares and is now holding treasury stock represented by that amount. Outstanding shares as of March 31, 2021 and December 31, 2020 were 3,737,564. All prior periods disclosed in this 10-Q have been restated to reflect the first halfreverse stock split per share amounts.
On December 21, 2020, Midwest completed a public offering of 1,000,000 shares of its voting common stock offered by the Company at a price to the public of $70.00 per share. On December 17, 2020, could be reduced accordingly,Midwest voting common stock was listed on the Nasdaq Capital Market under the ticker symbol “MDWT.” The aggregate net proceeds to the Company were approximately $64.4 million, after deducting underwriting discounts and commissions.
Midwest used the net proceeds of the offering to support the growth of its insurance subsidiaries, American Life, with a capital contribution of $50.0 million, and Seneca Re, with a capital contribution of $7.5 million. The rest of the proceeds were designated for general corporate purposes.
COVID-19
The effect ofWe continue to closely monitor developments related to the COVID-19 pandemic on the Company’s operations did not had a significantto assess any potential adverse impact on our operations during the second quarter of 2020. American Life has not seen a reduction in our productivity since the inception of the COVID-19 pandemic. Our sales force continues to grow also.
business. Due to the economic uncertainty resulting fromevolving and highly uncertain nature of this pandemic, it currently is not possible to provide a longer-term estimate of potential insurance or reinsurance exposure or the spreadindirect effects the pandemic may have on our results of COVID-19,operations, financial condition or liquidity. Management implemented the U.S. Federal Reserve decreased interest rates by 50 basis pointsCompany’s business continuity plan in its first emergency rate cut onearly March 3, 2020 and was quickly followed by a 100 basis point emergency rate cut on March 15, 2020. The economic uncertainty has created considerable volatility in both the credit and equity markets.
Due to the recent volatility in the markets, the Company’s available for sale assets values were reduced by approximately $6.8 million as of June 30,operated through July 2020 and was reflected in the accumulated other comprehensive income on the balance sheet. Of these unrealized losses, $8.5 million pertained to assets owned by third party reinsurers offset by unrealized gains of $1.7 million retained by American Life. These unrealized losses owned by the third party reinsurers was offset by a realized gain of $8.5 million on the related embedded derivative. This was offset by a realized gain of $8.5 million on the related total swap return. Also, the derivative assets were increased by $93,000 and both were reflected in our realized gains and losses in the Consolidated Statement of Comprehensive (Loss) Income. The unrealized losses attributable to the third party reinsurers was $8.5 million which was offset by a realized gain of $8.5 million. Approximately 80% of the unrealized losses were in our CLO portfolio that is typically illiquid and are intended to be held to maturity; thus, we believe the risk of loss related to these investments is not significant. The Company has monitored the underlying unrealized losses and believe they pose little threat in the long-term due to the quality of the underlying credits. We believe that the quality and duration of our investments provide reasonable assurance of continued performance of the portfolio despite the recent economic volatility. As mentioned above in Items Impacting Comparability, the assets backing the treaties are maintained by American Life as collateral whereas the assets and total return on the asset portfolios belong to the third party reinsurers. The Company has only contingent exposure to these losses as the CLO’s are held as collateral in the funds withheld and modification coinsurance accounts for the performance of
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the third party reinsurers under the coinsurance treaties. The reinsurer bears the risk of loss. Under GAAP, this arrangement is considered an embedded derivative as discussed in Note 6 in our “Notes to Consolidated Financial Statements.”
The COVD-19 pandemic has not materially impacted our sales of our annuity products as evidenced by new sales of $147.5 million in issued policies and pending applications of $59.8 million for the year ended June 30, 2020. Our policies sold have surrender charges over their duration that would tend to offset future income accruals.
Operationally, the Company had the vast majority of its workforce working remotely with a skeleton crew in the office through June 30, 2020. Starting in July 2020, the majority of the Company’s workforce hademployees working remotely. The employees returned to the office withon July 8, 2020. Operations continued as normal despite a sharp increase in sales during the high risk employees continuingperiod. We continue to work remotely. Our technology has allowed us to transition to this work environment without a reduction in our productivity. The Company’s business continuity plan has performed as expected.monitor the Center for Disease Control and Prevention and State of Nebraska guidelines regarding employee safety.
The Company’sOur management will continue to monitor our investments and cash flows to evaluate the impact as this pandemic evolves.
Unrealized Losses; Embedded Derivatives
American Life has agreements with several third-party reinsurers that have funds withheld (“FW”) and modified coinsurance (“Modco”) coinsurance provisions under which the assets related to the reinsured business are maintained by American Life as collateral; however, ownership of the assets and the total return on the asset portfolios belong to the third-party reinsurers. Under GAAP, this arrangement is considered an embedded derivative as discussed in “Note 5 — Derivative Instruments” to our Consolidated Financial Statements. As a result of price increases in 2021 and late 2020, assets carried as investments on American Life’s financial statements for the third-party reinsurers contained unrealized gains of approximately $2.5 million as of March 31, 2021 compared to unrealized losses of approximately $23.2 million as of March 31, 2020. The terms of the contracts with the third-party reinsurers provide that unrealized gains on the portfolios accrue to the third-party
40
reinsurers. We account for these unrealized gains by recording equivalent realized losses on our Consolidated Statements of Comprehensive Loss. Accordingly, the unrealized gains on the assets held by American Life on behalf of the third-party reinsurers were offset by recording an embedded derivative loss of $400,000 and derivative gains of $23.2 million, respectively. If prices of investments fluctuate, the unrealized losses of the third-party reinsurers may also fluctuate; therefore, the associated embedded derivative gain (loss) recognized by us for March 31, 2021 and December 31, 2020, would be reduced accordingly.
Critical Accounting Policies and Estimates
The MD&APart II – Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 20192020 Form 10-K (“2020 Form 10-K MD&A”) contains a detailed discussion of our critical accounting policies and estimates. This report should be read in conjunction with the “Critical Accounting Policies and Estimates” discussed in our 20192020 Form 10-K.10-K MD&A.
Net (Loss) Income
Net loss increased during the three months ended March 31, 2021 compared to the net gain during the three months ended March 31, 2020 primarily due to the following:
1. | Total (losses) revenue drivers: |
a) | There are three components associated with our FIA products: 1) the fair market value of the derivative asset entered into in order to mitigate the fluctuation of the embedded liability on our policyholder contracts, 2) the change in the fair market value of the embedded liability, and 3) the option allowance related to our third-party reinsurers that are marked to market at the end of the period. As of March 31, 2021, the change in the market value of the option derivatives decreased resulting in a realized loss of $6.3 million. The decrease in the embedded liability resulted in a decrease in our interest credited of $2.3 million. The third component resulted in a gain resulting from the mark-to-market gain of $4.1 million on our options allowance with the third-party reinsurers presented in other operating expenses. |
b) | American Life has treaties with several third-party reinsurers that have funds withheld and modified coinsurance provisions. Under those provisions, the assets backing the treaties are maintained by American Life as collateral but the assets and total returns or losses on the asset portfolios belong to the third-party reinsurers. Under GAAP this arrangement is considered an embedded derivative as discussed in Note 5. As a result of the changes in the market prices, the assets held on behalf of the third-party reinsurers had unrealized gains of approximately $2.5 million and unrealized losses of $23.2 million, respectively. The terms of the contracts with the third-party reinsurers provide that unrealized gains or losses on the asset portfolios accrue to the third-party reinsurers. We account for the change in unrealized gains or losses related to the third-party reinsurers by recording equivalent realized gains or losses on our Consolidated Statements of Comprehensive Loss. We recorded the decrease in the unrealized gains since December 31, 2020 as a realized gain of $400,000 compared to a realized gain of $23.2 million during the first quarter of 2020. |
2. | Expense drivers |
a) | As mentioned above in 1.a., the decrease in interest credited and general operating expenses related to the embedded derivatives in our FIA products of $2.3 million and the mark-to-market option allowance gain of $4.1 million was offset by our losses on our derivative assets. |
b) | Increase of $2.1 million in salaries and benefits due to increasing our personnel to service our new business growth. |
41
Consolidated Results of Operations - Three Months Ended June 30,March 31, 2021 and 2020
Item Impacting Comparability
American Life has treaties with three third party reinsurers that have funds withheld and modified coinsurance provisions. Under those provisions, the assets backing the treaties are maintained by American Life as collateral, whereas the assets and the total return on the asset portfolios belong to the third party reinsurers. Under GAAP this arrangement is considered an embedded derivative as discussed in Note 6 in our “Notes to Consolidated Financial Statements.” As a result of recent market volatility, assets carried as investments on American Life’s financial statements for the third party reinsurers contained unrealized losses of approximately $8.5 million for the six months ended June 30, 2020 which decreased approximately $20.0 million during the three months ended June 30, 2020. The terms of the contracts with the third party reinsurers provide that the unrealized losses on the portfolios accrue to the third party reinsurers.
We accounted for this change in unrealized loss by recording equivalent realized loss on our income statement of approximately $14.8 million for the three months ended June 30, 2020. These unrealized losses were offset by approximately $1.0 million gains on the sales of retained American Life investments and realized gains on our derivative assets of approximately $915,000.
If prices of investments recover or decline, the unrealized gains/losses may be reduced/increased; therefore, the associated embedded derivative loss recognized in the three months ended June 30, 2020, could be reduced/increased accordingly,
Revenues:Revenues
The following summarizes the sources of our revenue for the periods indicated:
| | | | | | | | | | | | |
| | Three months ended June 30, | | Three months ended March 31, | ||||||||
|
| 2020 |
| 2019 |
| 2021 |
| 2020 | ||||
Insurance premiums | | $ | 30 | | $ | — | ||||||
Investment (loss) income, net of expenses | |
| (397,842) | |
| 448,015 | ||||||
Net realized (losses) gains on investments (See Note 5) | |
| (12,819,871) | |
| 1,180 | ||||||
Premiums | | $ | — | | $ | 21 | ||||||
Investment income, net of expenses | |
| 2,887,363 | |
| 1,240,978 | ||||||
Net realized gains on investments (See Note 4) | |
| (4,649,105) | |
| 22,600,010 | ||||||
Amortization of deferred gain on reinsurance | |
| 338,269 | |
| 1,046,552 | |
| 460,856 | |
| 182,438 |
Miscellaneous income | |
| 396,061 | |
| 66,795 | ||||||
Service fee revenue, net of expenses | | | 438,146 | | | 380,267 | ||||||
Other revenue | |
| 248,969 | |
| 9,777 | ||||||
| | $ | (12,483,353) | | $ | 1,562,542 | | $ | (613,771) | | $ | 24,413,491 |
37
Premium revenue:Premium revenue was flat for the three months ended June 30, 2020 compared to the same period in 2019. The introduction of our MYGA and FIA products discussed above generated meaningful annuity policy sales;a large volume of new business; however, under GAAP, these products are considereddefined as investment contracts and U.S. GAAP requires that premiums be deferred and classified as deposit-type liabilities on our balance sheet. We expect that premium income under GAAP from ourConsolidated Balance Sheets. American Life expects to introduce additional versions of these annuity products will not be a significant source of revenue.in 2021.
The MYGA product sales for the three months ended June 30, 2020 and 2019 were $27.4 million and $29.9 million, respectively. The FIA product sales for the three months ended June 30, 2020 were $72.3 million. The FIA product was not launched until the fourth quarter of 2019. Included in the FIA product sales weretable below shows premium issued under statutory accounting principles (“SAP”) on our two new bonus plans released in the three months ended June 30, 2020. These new plans and the increased sales force attributed to the growth of our business.annuity products:
| | | | | | | | | | | |
| Three months ended March 31, | ||||||||||
| 2021 | | 2020 | ||||||||
| | MYGA | | | FIA | | | MYGA | | | FIA |
| Premium(1) | | Premium(1) | | Premium(1) | | Premium(1) | ||||
First quarter | $ | 9,368,962 | | $ | 114,284,969 | | $ | 31,565,506 | | $ | 16,249,504 |
(1) | Under SAP, the MYGA and FIA premiums are treated as premium revenue. Under GAAP these products are defined as deposit-type contracts; therefore, the premium revenue that is recognized under SAP is accounted for under GAAP as deposit-type liabilities on our Consolidated Balance Sheets and is not recognized on our Consolidated Statements of Comprehensive Loss. |
Investment income (loss) income,, net of expenses: The components of our net investment income (loss) income are as follows:
| | | | | | | | | | | | |
| | Three months ended June 30, | | Three months ended March 31, | ||||||||
|
| 2020 |
| 2019 |
| 2021 |
| 2020 | ||||
Fixed maturities (loss) income | | $ | (128,209) | | $ | 435,427 | ||||||
Fixed maturities | | $ | 3,050,777 | | $ | 1,167,614 | ||||||
Mortgage loans | |
| — | |
| 9,656 | |
| 173,777 | |
| 2,524 |
Other | |
| — | |
| 6,832 | |
| 55,813 | |
| — |
Gross investment (loss) income | |
| (128,209) | |
| 451,915 | ||||||
Less investment expenses | |
| (269,633) | |
| (3,900) | ||||||
Investment (loss) income, net of expenses | | $ | (397,842) | | $ | 448,015 | ||||||
Gross investment income | |
| 3,280,367 | |
| 1,170,138 | ||||||
Less: investment (expenses) refund | |
| (393,004) | |
| 70,840 | ||||||
Investment income, net of expenses | | $ | 2,887,363 | | $ | 1,240,978 |
The large decreaseincrease in investment income for 2021 over the prior period2020 was due to the reversal of the investment income recordedearned on the bonds and mortgage loans purchased with the sales of our MYGA and FIA products that were not ceded to reinsurers during the period. Our investment portfolio grew to $535,162,200 as of March 31, 2020 due the new third party reinsurance agreement which closed with the effective dates of January 1, 2020. The previously recorded investment income was subsequently ceded2021 compared to the new reinsurer. Our investment portfolio grew approximately $130.8 million$125,832,863 as of June 30,March 31, 2020, compared to December 31, 2019, as a result proceeds from our MYGA and FIA product sales. The majorityAs of theMarch 31, 2021 and 2020, American Life ceded $47.5 million and $25.7 million, respectively, of premiums to reinsurers and transferred approximately $3.1 million of investment income received on our portfolio wasrelated to the ceded to our reinsurers.premiums as required by the terms of its reinsurance agreements.
Net realized (losses) gains and losses on investments: The net realized loss(loss) gains on investments for the three months ended June 30,March 31, 2021 and 2020 was primarilywere losses of $4.6 million and gains of $22.6 million, respectively, which included a gain of $400,000 and $23.2 million from an embedded derivative, respectively. There were net realized losses of $5.4 million related to derivatives
42
utilized to hedge the volatilityobligations to FIA policyholders; such losses were offset by decreases in FIA-related interest credited expense and recovery of the capital markets, the assets that were carried on the balance sheet as of June 30, 2020, resulted an unrealized losses of approximately $6.8 million for a decrease of $20.0 million for the quarter. decreases in FIA-related mark-to-market option allowance flowing through other operating expenses.
American Life has treaties with three third partyseveral reinsurers that have funds withheld and modified coinsurance provisions. Under those provisions, under which the assets backing the treaties are maintained by American Life as collateral but the assets and total return on the asset portfolios belong to the third party reinsurers. Under GAAP this arrangement is considered an embedded derivative as discussed in Note 65 — Derivative Instruments to our Consolidated Financial Statements. The change in fair value of the Consolidated “Notes to the Financial Statements.”total return swap is included in net realized gains on investments. As a result of recentprice decreases in 2021 and the market volatility in the first quarter of 2020 and recovery in the market in the last quarter of 2020, assets carried as investments on American Life’s financial statements for the third partythird-party reinsurers contained unrealized gains of approximately $2.5 million and unrealized losses of approximately $8.5$23.2 million as of June 30, 2020.March 31, 2021 and 2020, respectively. The terms of the contracts with the third partythird-party reinsurers provide that unrealized gains or losses on the portfolios accrue to the third partythird-party reinsurers. Accordingly, the change in unrealized losses on the assets held by American Life were offset by a loss on the embedded derivative of $14.8 million for the three months ended June 30, 2020.
We accountedaccount for these unrealized gains by recording equivalent realized losses on our income statement. In the event asset prices recover or decline, the unrealized gains or losses may be reduced or increased; therefore, the associated embedded derivative loss recognized inConsolidated Statements of Comprehensive Loss. Accordingly, for the three months ended June 30,March 31, 2021 and 2020, could subsequently be reduced or increased Thesethe change in unrealized lossesgains on the assets held by American Life on behalf of the third-party reinsurers were offset by approximately $1.0recording an embedded derivative gain of $400,000 and an embedded derivative gain of $23.2 million, gains on the sales of retained American Life investments and realized gains on our derivative assets of approximately $914,765.respectively.
Amortization of deferred gain on reinsurance: The decreaseincrease in 2021 compared to the comparative period in 2020 was due to the indemnity coinsurance converted by a third-party reinsurer to assumptive reinsurance in was approximately to $204,000 and approximately $1.0 million for the three months ended June 30, 2020 and 2019, respectively. Under assumptive reinsurance we no longer have a legal obligation for policies subject to such agreement. This decrease was offset by the amortization of the ceding commission deferred from the four additional reinsurance agreements, three third party and one related party,several with third-party reinsurers which were not in effect in 2019.the first quarter of 2020.
Miscellaneous income: Service fee revenue, net of expenses:Miscellaneous expenses The increase significantly over the same period in 20192021 was due primarily to the increases in 1505 Capital’s asset management services provided on the increased investment portfolio of our third-party reinsurers.
Other revenue: The increase in servicingthird-party administration (“TPA”) fees earned results from 1505 Capital.
38providing additional administrative services to clients compared to 2020.
Table of ContentsExpenses
Expenses
Our expenses for the periods indicated are summarized in the table below:
| | | | | | | | | | | | |
| | Three months ended June 30, | | Three months ended March 31, | ||||||||
|
| 2020 |
| 2019 |
| 2021 |
| 2020 | ||||
Interest credited | | $ | (128,052) | | $ | 230,366 | | $ | (2,346,403) | | $ | 211,202 |
Death and other benefits | | | 4,016 | | | (1,523) | ||||||
Benefits | | | 79 | | | (7,103) | ||||||
Amortization of deferred acquisition costs | |
| 100,388 | |
| 19,796 | |
| 502,737 | |
| 40,509 |
Salaries and benefits | |
| 1,354,934 | |
| 575,625 | |
| 2,927,227 | |
| 824,896 |
Other operating expenses | |
| 2,305,687 | |
| 1,570,130 | |
| (1,529,297) | |
| 1,325,113 |
| | $ | 3,636,973 | | $ | 2,394,394 | | $ | (445,657) | | $ | 2,394,617 |
Interest credited: The decrease was due primarily due to the reversalFIA product and the decrease in the fair market value of the interest credit earnedembedded derivative liability owned by us to FIA policyholders. This decrease is partially offset in our net realized (loss) gains on investments, as referenced above, which saw a $5.4 million decrease in the fair market value of derivative assets used to partially hedge this obligation to FIA policyholders.
Benefits: Death benefits changed insignificantly over prior year. In the first quarter of 2020, that was subsequently ceded to a new third party reinsurer that was retroactive to January 1, 2020.
Deathwe escheated legacy claims and other benefits: Death benefits increased an insignificant amount. These benefits primarily relate toreduced our claims on legacy business that was not ceded off to third party reinsurers.accrual resulting in the 2020 negative balance.
Amortization of deferred acquisition costs: The increase was due to the deferred acquisition costs deferred on the sale of American Life’s MYGA and FIA products retained in 2021 compared to the same period in 2020 that were not ceded to third partythird-party reinsurers.
43
Salaries and benefits: The increase was due to the addition of personnel to service our new business growth. We are hiring more in-house expertise to assist demands ofservice our expanding busines.growth initiatives.
Other operating expenses: Other operating expenses increased primarily due to the valuation allowance on the investment in preferred stockwere approximately $2.9 million lower than prior year. The primary items of $500,000; recording the option allowances paid by the third party reinsurers for purchase of the derivatives at fair market value which resulted in an additional expense of $256,000; an increase in actuarial fees of $210,000; approximately $165,000 of new product development costs; and consolidation of 1505 Capital into Midwest and their expenses of approximately $48,000. These were offset by $480,000 of Xenith note interest in 2019 which did not occur in 2020, and thethis decrease in the expenses related to travel of $57,000 due to the COVID-19 pandemic.are:
Consolidated Results of Operations - Six Months Ended June 30, 2020
Item Impacting Comparability
American Life has treaties with four reinsurers, three third party and one related party, that have funds withheld and modified coinsurance provisions. Under those provisions, the assets backing the treaties are maintained by American Life as collateral, whereas the assets and the total return on the asset portfolios belong to the third party reinsurers. Under GAAP this arrangement is considered an embedded derivative as discussed in Note 6 to our consolidated financial statements. As a result of recent market volatility, assets carried as investments on American Life’s financial statements for the third party reinsurers contained unrealized losses of approximately $8.5 million as of June 30, 2020. The terms of the contracts with the third party reinsurers provide that unrealized losses on the portfolios accrue to the third party reinsurers. Accordingly, the unrealized losses on the assets held by American Life were offset by a gain in the embedded derivative of $8.5 million. We account for this loss by recording equivalent realized gains on our income statement. American Life also had gains of the assets, not pertaining to reinsurers, sold of approximately $1.2 million and realized gains on our derivative assets of approximately $8,800.
If prices of investments recover or decline, the unrealized gains or losses may be reduced or increased; therefore, the associated embedded derivative gain recognized in the six months ended June 30, 2020, could be reduced or increased accordingly,
39
Revenues:
The following summarizes the sources of our revenue for the periods indicated:
| | | | | | |
| | Six months ended June 30, | ||||
|
| 2020 |
| 2019 | ||
Insurance premiums | | $ | 51 | | $ | (2,479) |
Investment income, net of expenses | |
| 843,136 | |
| 639,010 |
Net realized gains (losses) on investments (See Note 5) | |
| 9,780,139 | |
| (3,217) |
Amortization of deferred gain on reinsurance | |
| 520,707 | |
| 1,852,599 |
Miscellaneous income | |
| 786,105 | |
| 82,335 |
| | $ | 11,930,138 | | $ | 2,568,248 |
Premium revenue: Premium revenue was flat for the six months ended June 30, 2020 compared to the same period in 2019. The introduction of our MYGA and FIA products discussed above generated meaningful annuity policy sales; however, under GAAP, these products are considered investment contracts and GAAP requires that premiums be deferred and classified as deposit-type liabilities on our balance sheet. We expect that premium income under GAAP from our annuity products will not be a significant source of revenue.
The table below shows premiums collected on our two annuity products:
| | | | | | | | | |
| Six months ended June 30, | ||||||||
| 2020 | | 2019 | ||||||
| | MYGA | | | FIA | | | MYGA | |
| Premium(1) | | Premium(1)(2) | | Premium(1) | | |||
First quarter | $ | 31,565,506 | | $ | 16,249,504 | | $ | 8,292,617 | |
Second quarter | | 27,400,367 | | | 72,270,636 | | | 29,946,263 | |
Total issued as of June 30, 2020 and 2019 | $ | 58,965,873 | | $ | 88,520,140 | | $ | 38,238,880 | |
| | | | | | | | | |
Investment (loss) income, net of expenses: The componentsInvestments
Most investments on our Consolidated Balance Sheets are held on behalf of our netreinsurers as collateral under our reinsurance agreements. As a result, our investment (loss) incomeallocations are largely a function of our collective reinsurer investment allocations. While the reinsurers own the investment risk on these assets, we typically restrict their investment allocations via control over the selection of the asset manager as follows:well as asset restrictions set forth in investment guidelines. Additionally, in many of our reinsurance agreements, our affiliate investment manager, 1505 Capital, is selected as the asset manager.
| | | | | | |
| | Six months ended June 30, | ||||
|
| 2020 |
| 2019 | ||
Fixed maturities | | $ | 1,041,929 | | $ | 631,118 |
Mortgage loans | |
| — | |
| 9,656 |
Other | |
| — | |
| 8,076 |
Gross investment income | |
| 1,041,929 | |
| 648,850 |
Less: refund received on investment expenses (investment expense) | |
| (198,793) | |
| (9,840) |
Investment income, net of expenses | | $ | 843,136 | | $ | 639,010 |
The increase over the prior period was due to the investment income earned on theguidelines typically include U.S. government bonds, purchased with the salescorporate bonds, commercial mortgages, asset backed securities, municipal bonds, mutual funds and collateral loans. The duration of our MYGA and FIA products. Our investment portfolio grewinvestments is 5 to $269,873,734 as10 years in line with that of June 30, 2020 comparedour liabilities. We do allow non-U.S. dollar denominated investments where the foreign exchange risk is hedged back to $138,602,143 as of December 31, 2019, as a result proceeds from our MYGA and FIA product sales. American Life ceded $114.4 million of premiums to reinsurers and transferred approximately $5.1 million of its investment income as required by the terms of the reinsurance agreements.
Net realized gains and losses on investments: The net realized gain for 2020 was primarily due to the contracts with reinsurers. Due to the volatility of the capital markets, the assets that were carried on the balance sheet resulted in approximately $6.8 million of unrealized losses. American Life has treaties with four reinsurers, three third party and one related party, that
40U.S. dollars.
have funds withheld and modified coinsurance provisions. Under those provisions, the assets backing the treaties are maintained by American Life as collateral but the assets and total return on the asset portfolios belong to the third party reinsurers. Under GAAP this arrangement is considered an embedded derivative as discussed in Note 6 in “Notes to Consolidated Financial Statements.” As a result of recent market volatility, assets carried as investments on American Life’s financial statements for the third party reinsurers contained unrealized losses of approximately $8.5 million as of June 30, 2020 primarily due to the CLOs. The CLOs have unique characteristics, including being typically illiquid and usually intended by us to be held to term. The terms of the contracts with the third party reinsurers provide that unrealized losses on the portfolios accrue to the reinsurers. Accordingly, the unrealized losses on the assets held by American Life were offset by a gain in the embedded derivative of $8.5 million. We account for these unrealized losses by recording equivalent realized gains on our income statement. In the event asset prices recover or deteriorate, the unrealized losses may be reduced or increased; therefore, the associated embedded derivative gain recognized in the six months ended June 30 of 2020, could be reduced or increased. The remaining unrealized gain of approximately $1.2 million related to the investments retained by American Life. Also, included in realized gains for American Life were the gains on the derivative assets of approximately $8,800.
Amortization of deferred gain on reinsurance: The decrease was due to the indemnity coinsurance converted by a third-party reinsurer to assumptive reinsurance in was approximately to $264,000 and approximately $1.7 million for the six months ended June 30, 2020 and 2019, respectively. Under assumptive reinsurance we no longer have a legal obligation for policies subject to such agreement. This decrease was offset by the amortization of the ceding commission deferred from the four additional reinsurance agreements with other reinsurers which were not in effect in 2019.
Miscellaneous income: Miscellaneous income increased due to the consolidation of 1505 Capital as of April 2, 2019 for servicing fees earned.
Expenses are summarized in the table below.
| | | | | | |
| | Six months ended June 30, | ||||
|
| 2020 |
| 2019 | ||
Interest credited | | $ | 83,150 | | $ | 251,187 |
Death and other benefits | | | (3,087) | | | 1,872 |
Amortization of deferred acquisition costs | |
| 140,897 | |
| 21,865 |
Salaries and benefits | |
| 2,179,830 | |
| 1,115,074 |
Other operating expenses | |
| 3,630,800 | |
| 3,505,120 |
| | $ | 6,031,590 | | $ | 4,895,118 |
Interest credited: The decrease for the six months ended June 30, 2020, compared to the same period in 2019 was due to not ceding the interest earned on the initial sale of the MYGA product in 2019 to reinsurers. In 2020, American Life began retaining a portion of the annuity contracts which is reflected in the balance above.
Death and other benefits: Death benefits decreased due the reduction of the amount of our accrual during 2020 related to the escheatment of aged death claims.
Amortization of deferred acquisition costs: The increase was due to the deferred acquisition costs deferred on the sale of American Life’s MYGA and FIA products retained that were not ceded to third party reinsurers.
Salaries and benefits: The increase was due to the addition of personnel to service our new business growth. We are hiring more in-house expertise to assist demands of our expanding busines. We have hired approximately 20 additional personnel during the first half of 2020.
Other operating expenses: Other operating expenses increased approximately $126,000 compared to prior year. The increase was primarily due to the $500,000 valuation allowance on preferred stock impairment; approximately $343,000 increase in audit and actuarial fees; product development fees for the two FIA bonus products and a new annuity product that was launched in July 2020 to bridge the gap between social security and retirement needs of approximately $200,000; 1505 Capital incurred expenses of approximate $155,000 related to management fees to brokers and computer equipment; an increase in actuarial fees of $137,000; and consulting fees of approximately $88,000 related to the formation of the captive reinsurance
41
company, Seneca Re. These increases were offset primarily due to approximately $1.0 million of Xenith note interest in 2019 which did not occur in 2020 as the outstanding notes were converted to outstanding shares in June of 2019.
Investments
The Company’s overall investment philosophy is reflected in the allocation of its investments. The Company emphasizes investments in asset-backed securities, mortgages, and policy loans. The Company has modified its investment strategy to purchase larger position securities with increased yields compared to prior years. 1505 Capital provides investment and management services to us. 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 as of June 30, 2020March 31, 20201 and December 31, 2019.2020. Increases in fixed maturity securities primarily resulted from the sale of our new MYGA and FIA products during 2021. Most of the investments as of March 31, 2021 and December 31, 2020 are held as collateral for our reinsurers.
| | | | | | | | | | | | | | | | | | | | | | |
| | June 30, 2020 | | December 31, 2019 |
| | March 31, 2021 | | December 31, 2020 |
| ||||||||||||
| | Carrying | | Percent | | Carrying | | Percent |
| | Carrying | | Percent | | Carrying | | Percent |
| ||||
|
| Value |
| of Total |
| Value |
| of Total |
|
| Value |
| of Total |
| Value |
| of Total |
| ||||
Fixed maturity securities: |
| |
|
|
|
| |
|
|
| |
| |
|
|
|
| |
|
|
| |
U.S. government obligations | | $ | 1,836,729 |
| 0.5 | % | $ | 2,081,224 |
| 1.1 | % | | $ | 2,119,103 |
| 0.3 | % | $ | 6,164,983 |
| 0.9 | % |
Foreign governments | | | 1,542,188 | | 0.2 | | | — | | — | | |||||||||||
Mortgage-backed securities | |
| 721,769 |
| 0.2 | |
| 798,608 |
| 0.4 | | |
| 25,828,579 |
| 3.3 | |
| 14,757,414 |
| 2.2 | |
Asset-backed securities | | | 167,908,244 | | 49.8 | | | 95,247,824 | | 52.2 | | |||||||||||
States and political subdivisions - general obligation | |
| 250,079 |
| 0.1 | |
| 249,282 |
| 0.1 | | |||||||||||
States and political subdivisions - special revenue | |
| 3,465,356 |
| 1.0 | |
| 25,291 |
| — | | |||||||||||
Collateralized loan obligations | | | 301,261,339 | | 37.9 | | | 221,773,609 | | 33.1 | | |||||||||||
States and political subdivisions -- general obligations | |
| 117,330 |
| — | |
| 117,330 |
| — | | |||||||||||
States and political subdivisions -- special revenue | |
| 6,123,127 |
| 0.8 | |
| 6,202,204 |
| 0.9 | | |||||||||||
Trust preferred | | | 2,124,478 | | 0.6 | | | — | | — | | | | 2,152,538 | | 0.3 | | | 2,284,816 | | 0.3 | |
Corporate | |
| 23,803,632 |
| 7.0 | |
| 18,839,632 |
| 10.4 | | |
| 153,924,830 |
| 19.4 | |
| 125,863,002 |
| 18.9 | |
Total fixed maturity securities | |
| 200,110,287 |
| 59.2 | |
| 117,241,861 |
| 64.2 | | |
| 493,069,034 |
| 62.2 | |
| 377,163,358 |
| 56.3 | |
Mortgage loans on real estate, held for investment | | | 51,171,943 | | 15.1 | | | 13,810,041 | | 7.6 | | | | 109,776,321 | | 13.8 | | | 94,989,970 | | 14.2 | |
Derivatives | | | 3,228,102 | | 1.0 | | | 575,294 | | 0.3 | | | | 9,473,398 | | 1.2 | | | 11,361,034 | | 1.7 | |
Equity securities | | | 42,093,166 | | 5.3 | | | — | | — | | |||||||||||
Other invested assets | | | 3,090,964 | | 0.9 | | | 2,468,947 | | 1.4 | | | | 25,606,108 | | 3.2 | | | 21,897,130 | | 3.3 | |
Investment escrow | | | 3,317,043 | | 0.4 | | | 3,174,047 | | 0.5 | | |||||||||||
Preferred stock | | | — | | — | | | 500,000 | | 0.3 | | | | 4,300,591 | | 0.5 | | | 3,897,980 | | 0.6 | |
Investment escrow | | | — | | — | | | 3,899,986 | | 2.1 | | |||||||||||
Notes receivable | | | 5,488,101 | | 1.6 | | | — | | — | | | | 5,737,608 | | 0.7 | | | 5,665,487 | | 0.8 | |
Policy Loans | |
| 48,551 |
| — | |
| 45,573 |
| — | | |||||||||||
Cash and cash equivalents | | | 75,041,902 | | 22.2 | | | 43,716,205 | | 24.0 | | | | 100,927,152 | | 12.7 | | | 151,679,274 | | 22.6 | |
Policy Loans | |
| 141,172 |
| — | |
| 106,014 |
| 0.1 | | |||||||||||
| | $ | 338,272,471 |
| 100.0 | % | $ | 182,318,348 |
| 100.0 | % | |||||||||||
Total investments, including cash and cash equivalents | | $ | 794,348,972 |
| 100.0 | % | $ | 669,873,853 |
| 100.0 | % |
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The following table shows the distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value as of June 30, 2020March 31, 2021 and December 31, 2019.2020.
| | | | | | | | | | | | | | | | | | | | | | |
| | June 30, 2020 | | December 31, 2019 |
| | March 31, 2021 | | December 31, 2020 |
| ||||||||||||
| | Carrying | | | | Carrying | | |
| | Carrying | | | | Carrying | | |
| ||||
|
| Value |
| Percent |
| Value |
| Percent |
|
| Value |
| Percent |
| Value |
| Percent |
| ||||
AAA and U.S. Government | | $ | 2,335,428 |
| 1.2 | % | $ | 2,885,004 |
| 2.5 | % | | $ | 16,259,820 |
| 3.3 | % | $ | 3,070,750 |
| 0.8 | % |
AA | |
| 5,608,888 |
| 2.8 | |
| 6,658,274 |
| 5.7 | | |
| 60,286,560 |
| 12.2 | |
| 5,818,163 |
| 1.5 | |
A | |
| 40,244,011 |
| 20.1 | |
| 23,812,502 |
| 20.3 | | |
| 8,295,924 |
| 1.7 | |
| 49,445,266 |
| 13.1 | |
BBB | |
| 138,568,407 |
| 69.2 | |
| 79,996,081 |
| 68.2 | | |
| 367,244,456 |
| 74.5 | |
| 247,635,730 |
| 65.7 | |
Total investment grade | |
| 186,756,734 |
| 93.3 | |
| 113,351,861 |
| 96.7 | | |
| 452,086,760 |
| 91.7 | |
| 305,969,909 |
| 81.1 | |
BB and other | |
| 13,353,553 |
| 6.7 | |
| 3,890,000 |
| 3.3 | | |
| 40,982,274 |
| 8.3 | |
| 71,193,449 |
| 18.9 | |
Total | | $ | 200,110,287 |
| 100.0 | % | $ | 117,241,861 |
| 100.0 | % | | $ | 493,069,034 |
| 100.0 | % | $ | 377,163,358 |
| 100.0 | % |
Reflecting the quality of securities maintained by us, 91.7% and 81.1% of all fixed maturity securities were investment grade as of March 31, 2021 and December 31, 2020, respectively.
We expect that our annuityMYGA and FIA products sales will continue to result in an increase in investable assets in future periods.
Market Risks of Financial Instruments
We hold a portfolio of investments that primarily includes cash, asset-backed securities, bonds, stocks, CLOs, mortgage loans, and notes receivable. Each of these investments is subject to market risks that can affect their return and their fair value. Further, our portfolio may be considered to have a concentration in CLOs. These securities have unique characteristics, including being typically illiquid and usually intended by us to be held to term. A majority of the investments are fixed maturity securities including debt issues of corporations, U.S. Treasury securities, mortgage-backed securities, CLOs and mortgage
42
loans 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. With respect to investments that we hold on our Consolidated Balance Sheets as collateral, our reinsurers bear the market risks related to these investments, while we bear the market risks on any net retained investments.
Interest Rate Risk
Interest rate risk arises from the price sensitivity of investments to changes in interest rates. Interest and dividend income represent the greatest portion of an investment’s return for most fixed maturity securities in stable interest rate environments. The changes in the fair value of such investments are inversely related to changes in market interest rates. As interest rates fall, the interest and dividend streams of existing fixed-rate investments become more valuable and fair values rise. As interest rates rise, the opposite effect occurs. We attempt to mitigate our exposure to adverseOur liabilities also have interest rate movements through staggeringrisk though are not required to be marked to market. We mitigate interest rate risk by monitoring and matching the maturitiesduration of the fixed maturity investments and through maintaining cash and other short term investments to assure sufficient liquidity to meet its obligations and to address reinvestment risk considerations. Dueassets compared to the compositionduration of our book of insurance business, we believe it is unlikely that we would encounter large surrender activity due to an interest rate increase that would force the disposal of fixed maturities at a loss.liabilities.
Credit Risk
We are exposed to credit risk through counterparties and within the 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 diversification of investments amongst many corporations and numerous industries. Additionally, our investment policy limits the size of holding in any particular issuer.
Liquidity Risk
We are exposed to liquidity risk when liabilities come due. In order to pay a policyholder, we may need to liquidate assets. If our assets are illiquid assets, we might be unable to convert an asset into cash without giving up capital and income due to a lack of buyers or an inefficient market. We seek to mitigate this risk by keeping a portion of our investment portfolio in liquid investments.
Statutory Accounting and Regulations
Our primary insurance subsidiary, American Life, is required to prepare statutory financial statements in accordance with SAP prescribed by the NDOI. SAP primarily differs from GAAP by charging policy acquisition costs to expense as incurred, establishing future benefit liabilities using actuarial assumptions as well as valuing investments and certain assets and accounting for deferred taxes on a different basis. For further discussion regarding SAP as well as net income (loss) of American
45
Life under SAP, see Note 16 to our Consolidated Financial Statements. American Life maintains sufficient capital and surplus to comply with regulatory requirements as of March 31, 2021.
State insurance laws and regulations govern the operations of all insurers and reinsurers such as our insurance and reinsurance company subsidiaries. These various laws and regulations require that insurance companies maintain minimum amounts of statutory surplus as regards policyholders and risk-based capital and determine the dividends that insurers can pay without prior approval from regulators. The statutory net income of American Life is one of the primary sources of additions to our statutory surplus as regards policyholders, in addition to capital contributions from us.
We have reported our insurance subsidiaries’ assets, liabilities and results of operations in accordance with GAAP, which varies from SAP. The following items are principal differences between SAP and GAAP as SAP:
46
| | | | | |
| Three months ended March 31, | ||||
| 2021 | | 2020 | ||
Consolidated GAAP net loss | $ | (1,600,462) | | $ | 21,548,458 |
Exclude: Midwest non-insurance transaction entities (American Life & Seneca Re) | | (563,308) | | | (248,457) |
GAAP net loss of statutory insurance entities | $ | (1,037,154) | | $ | 21,796,915 |
| | | | | |
GAAP net income (loss) by statutory insurance entity: | | | | | |
American Life | $ | (1,979,850) | | $ | 21,796,915 |
Seneca Re Protected Cell | | 942,696 | | | — |
| $ | (1,037,154) | | $ | 21,796,915 |
| | | | | |
Reconciliation of GAAP and SAP | | | | | |
GAAP net gain (loss) of American Life | | (1,979,850) | | | 21,796,915 |
Increase (decrease) due to: | | | | | |
Deferred acquisition costs | | (10,708,867) | | | (2,430,194) |
Coinsurance transactions | | 56,453,111 | | | 47,629,572 |
Carrying value of reserves | | (42,565,237) | | | (42,516,516) |
Foreign exchange and derivatives | | 6,013,367 | | | — |
Gain on sale of investments, net of asset valuation reserve | | (2,325,448) | | | (23,582,019) |
Other | | 1,221,982 | | | 1,050 |
SAP net income of American Life | $ | 6,109,058 | | $ | 898,808 |
| | | | | |
GAAP net income of Seneca Re Protected Cell | | 942,696 | | | — |
Increase (decrease) due to: | | | | | |
Deferred acquisition costs | | (4,867,782) | | | — |
Coinsurance transactions | | 36,234,430 | | | — |
Carrying value of reserves | | (35,076,712) | | | — |
Gain on sale of investments, net of asset valuation reserve | | 1,492,880 | | | |
Other | | (2,037,242) | | | |
SAP net loss of Seneca Re Protected Cell | | (3,311,730) | | | — |
| | | | | |
SAP net income of statutory insurance entities | $ | 2,797,328 | | $ | 898,808 |
Non-GAAP Financial Measures
We discuss below certain non-GAAP financial measures that our management uses in conjunction with GAAP financial measures as an integral part of managing our business and to, among other things:
• monitor and evaluate the performance of our business operations and financial performance;
• facilitate internal comparisons of the historical operating performance of our business operations;
• review and assess the operating performance of our management team;
• analyze and evaluate financial and strategic planning decisions regarding future operations; and
• plan for and prepare future annual operating budgets and determine appropriate levels of operating investments.
Non-GAAP financial measures used by us may be calculated differently from, and therefore may not be comparable to, similarly titled measures used by other companies. These non-GAAP financial measures should be considered along with, but not as alternatives to, our operating performance measures as prescribed by GAAP.
Annuity Premiums
Annuity premiums, also referred to as sales or direct written premiums, do not correspond to revenues under GAAP, but are relevant metrics to understand our business performance. Under statutory accounting practices, or SAP, our annuity premiums received are treated as premium revenue. Our premium metrics include all sums paid into an individual annuity in a given period. We typically transfer all or a substantial portion of the premium and policy obligations to reinsurers. Ceded premium represents the premium we transfer to reinsurers in a given period. Retained premium represents the portion of
47
premium received during a given period that was not ceded to reinsurers and will either be reinsured in a subsequent period or retained by us. We typically retain premiums prior to transferring them to reinsurers to facilitate block and other reinsurance transactions involving portfolios of annuity premiums.
The following table sets forth premiums received under SAP. Under GAAP these products are defined as deposit-type contracts; therefore, the premium revenue is accounted under GAAP as deposit-type liabilities on our Consolidated Balance Sheets and is not recognized in our Consolidated Statements of Comprehensive Loss.
| | | | | |
| Three months ended March 31, | ||||
| 2021 | 2020 | |||
Annuity Premiums (SAP) | | | | | |
Annuity direct written premiums | $ | 123,653,931 | | $ | 47,815,010 |
Ceded premiums | | (47,464,279) | | | (25,728,698) |
Net premiums retained | $ | 76,189,652 | | $ | 22,086,312 |
Adjusted Revenue
Our adjusted revenue represents the revenue we receive and retain taking into account the reinsurance transactions we complete. We define adjusted revenue as revenue including the impact of reinsurance transactions completed during the relevant period and excluding the total return on the asset portfolios that are owned by reinsurers but held by us, which in the table below is the net realized (gains) losses on investments. We hold these assets primarily to reduce potential credit risk of the reinsurers. Under our agreements with reinsurers, the assets backing the reinsurance agreements are typically maintained by us as collateral but the assets and the total return on the asset portfolios are received by the reinsurers. We receive ceding commissions from reinsurers based on ceded premium in a given period, the products reinsured and the terms of the reinsurance agreements. The revenue we receive from ceding commissions is recognized and earned immediately under SAP upon the completion of a reinsurance transaction in which we have ceded premiums to reinsurers. There is no collectability risk as the commissions are paid to us in full in cash when the policies are written and there are no further expenses associated with the collected premiums. The adjustment for deferred coinsurance ceding commission is a line item entry derived directly from our GAAP Consolidated Statements of Cash Flows in our Consolidated Financial Statements. Our management uses adjusted revenue as an internal measure of our underlying business performance and it provides useful insights into our results of operations.
Under GAAP, ceding commissions are deferred on our Consolidated Balance Sheets as a deferred gain on coinsurance transactions and are subsequently amortized through amortization of deferred gain on reinsurance on the Consolidated Statements of Comprehensive Loss over the period of the policy contracts.
The following table sets forth a reconciliation of total revenue to adjusted revenue for the three months ended March 31, 2021 and 2020 respectively:
| | | | | |
| Three months ended March 31, | ||||
| 2021 | 2020 | |||
Total revenue - GAAP | $ | (613,771) | | $ | 24,413,491 |
Adjustments: | | | | | |
Net realized gains on investments | | (404,600) | | | (23,238,919) |
Deferred coinsurance ceding commission | | 2,397,926 | | | 1,033,940 |
Adjusted revenue | $ | 1,379,555 | | $ | 2,208,512 |
Adjusted Net Income (Loss)
Adjusted net income (loss) is management’s evaluation of the impact of revenue we receive and retain taking into account the reinsurance transactions we complete. Under these provisions with third-party reinsurers, the assets backing the treaties are maintained by American Life as collateral and are carried on the Consolidated Balance Sheets for American Life, but the assets are owned by the third-party reinsurer; thus, the total return on the asset portfolio belongs to the third-party reinsurers. Under GAAP this is considered an embedded derivative but is not designated as a hedge. We make an Consolidated Statements of
48
Comprehensive Loss adjustment for net realized losses on investments related to the embedded derivative. The net realized losses on investments related to the embedded derivative is included in GAAP net loss but is reversed dollar for dollar in the calculation of GAAP other comprehensive income through a reclassification adjustment for net realized gains on investments. We define adjusted net income (loss) as net income (loss) including the impact of reinsurance transactions completed during the period and excluding the total return on the asset portfolios that are owned by reinsurers and held by us. These items have no direct expense and the tax effect of these adjustments is already included in our tax basis, which is similar to our Adjusted Net Income. Our management uses adjusted net income (loss) as an internal measure of our underlying business performance and because it provides useful insights into our results of operations.
The following table sets forth a reconciliation of net loss to adjusted net income (loss) for the three months ended March 31, 2021 and 2020, respectively:
| | | | | |
| Three months ended March 31, | ||||
| 2021 | 2020 | |||
Net loss attributable to Midwest Holding Inc. - GAAP | $ | (1,600,462) | | $ | 21,548,458 |
Adjustments: | | | | | |
Net realized gains on investments | | (404,600) | | | (23,238,919) |
Deferred coinsurance ceding commission | | 2,397,926 | | | 1,033,940 |
Total adjustments | | 1,993,326 | | | (22,204,979) |
Income tax (expense) benefit adjustment(1) | | — | | | — |
Adjusted net income (loss) | $ | 392,864 | | $ | (656,521) |
Liquidity and Capital Resources
At June 30, 2020, the CompanyAs of March 31, 2021, we had cash and cash equivalents totaling $75,041,902.$151,679,274. Approximately $15,227,000 of the increase in cash was due to the completion of private sales of our voting common stock in April 2020 and approximately $65,000,000 was due to the completion of a public offering completed on December 21, 2020. We believe that our existing cash and cash equivalents will be sufficient to fund theour anticipated operating expenses and capital transaction expenditures for the foreseeable future.
The National Association of Insurance Commissioners (“NAIC”)NAIC has established minimum capital requirements in the form of Risk-Based Capital (“RBC”). RBC that factors the type of business written by an insurance company, the quality of its assets, and various other aspects of an insurance company’sits business to develop a minimum level of capital calledknown as “authorized control level risk-based capital” and compares this level to adjusted statutory capital that includes capital and surplus as reported under statutory accounting principles,SAP, plus certain investment reserves. Should the ratio of adjusted statutory capital to control level RBC fall below 200%, a series of remedial actions by the affected company would be required. As of December 31, 2019, our2020, the RBC ratio of American Life was 840%1,092,205%.
American Life had a legacy block of business that was ceded off to a third-party reinsurer on July 1, 2018 through an indemnity reinsurance agreement that transferred 90% to assumptive reinsurer, resulting in American Life transferring all the risk and financial obligations of those policyholders to the third-party reinsurer.
Comparative Cash Flows
Cash flow is an important component of our business model because we receive annuity premiums and invest them upon receipt for our reinsurers and us and for the benefit of our policyholders.
49
The following table summarizes our cash flows from operational, investing and financing activities for the periods indicated.
| | | | | | |
| | Three months ended March 31, | ||||
| | 2021 |
| 2020 | ||
| | | | | ||
Net cash provided by operating activities | | $ | 7,818,155 | | $ | 2,316,449 |
Net cash used in investing activities | | | (179,319,216) | | | (68,154,008) |
Net cash provided by financing activities | | | 120,748,939 | | | 47,628,210 |
Net increase in cash and cash equivalents | | | (50,752,122) | | | (18,209,349) |
Cash and cash equivalents: | | | | | | |
Beginning of period | | | 151,679,274 | | | 43,716,205 |
End of period | | $ | 100,927,152 | | $ | 25,506,856 |
Cash Provided by Operating Activities
Net cash provided by operating activities was $2,480,934$7,818,155 for June 30, 2020,the three months ended March 31, 2021, which was comprised primarily by net income of $5,011,119, inan increase in other assets and liabilities of $21,408,109 primarily due to payable for securities, not settled by quarter-endan increase in net realized losses of $8,678,265, and policy liabilities of $3,958,101 primarily due increases in deposit-type contracts ceded to reinsurers, and$4,649,105, an increase in deferred coinsurance ceding commissionscommission due to thea third-party reinsurance agreements with our reinsurerstransaction of $3,908,889.$2,397,926. These were offset by the gain on investmentscapitalized deferred acquisition costs of $9,780,139$6,774,293, amounts recoverable from reinsurers of $6,164,935, policy liabilities of $4,305,256 primarily due to the swap value discussedincrease in Note 6deposit type contracts ceded to reinsurers, and accrued investment income of $2,288,257.
Cash Used in the “Notes to the Consolidated Financial Statements” of $8.5 million, by a decrease in recoverable from reinsurers of 4,304,381, and by and the deferred acquisition costs capitalized of $4,118,436.Investing Activities
Net cash used for investing activities was $132,423,736.($179,319,216). The primary use of cash used was forresulted from our purchase of our investments from sales of $158,434,165.the MYGA and FIA products of $244,765,832. Offsetting this use of cash was our sale of investments in available-for-sale securities for proceeds of $26,091,100.$65,459,944.
Cash Flow Provided by Financing Activities
Net cash provided by financing activities was $161,268,499.$120,748,939. The primary source of cash was net receipts on the MYGA and FIA products of $147,486,013$123,653,931 and the capital raise, netprimary use of related expenses,cash was withdrawals on those products of $14,941,533.$2,904,992.
Impact of Inflation
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
43
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 theour investment portfolio with a corresponding effect on investment income. CLOs are typically illiquid and usually intended to be held by us to maturity.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Contractual Obligations
As a “smaller reporting company,” the Company is not required to provide thea table of contractual obligations required pursuant to this Item.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As a “smaller reporting company,” the Company is not required to provide disclosure pursuant to this Item.
ITEM 4. CONTROLS AND PROCEDURES.
We have established disclosure controls and procedures to ensure, among other things, material information relating to our Company, including our consolidated subsidiary,subsidiaries, is made known to our officers who certify our financial reports and to the other members of our senior management and the Board of Directors.Board.
Management, (with the participation of our principal executive officers and principal financial officer), carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of June 30, 2020.March 31, 2021. Based on this evaluation, our principal executive officerand financial officers concluded that, as of the end of the period covered in this report, our disclosure controls and procedures along with the related internal controls over financial reporting were effective to provide reasonable assurance that the information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange CommissionSEC rules and forms, and is accumulated and communicated to our management, including our principal executive officerofficers and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
PART II – OTHER INFORMATION
We are involved in litigation incidental to our operations from time to time. We are not presently a party to any legal proceedings other than litigation arising in the ordinary course of our business, and we are not aware of any claims that could materially affect our financial position or results of operations.
In addition to the risks previously disclosed in Item 1A – Risk Factors of our 20192020 10-K, readers of this report should also consider that since March 13, 2020, the United States has been operating under a state of emergency declared by President Trump in response to the spread of COVID-19. COVID-19 and related federal, state and local governmental responses to COVID-19 have affected economic and financial market conditions as well as the operations, results and prospects of companies across many industries.
More specifically, readersCOVID-19 Risks
The ongoing events resulting from the outbreak of this report should consider the following additional risk factor relating toCOVID-19 pandemic, and the Company.
44
Major public health issues, such as the novel coronavirus COVID-19,uncertainty regarding future similar events, could have an adverse impact on our business andfinancial condition, results of operations.operations, cash flows, liquidity and prospects.
We are monitoringcontinue to closely monitor developments related to the COVID-19coronavirus (COVID-19) pandemic to assess itsany potential adverse impact on our business; however, duebusiness. Due to the evolving and highly uncertain nature of this event, it currently is not possible toprovide a longer-term estimate of potential insurance or reinsurance exposure or the direct and indirect impact of COVID-19effects the pandemic may have on our business, results of operations, financial condition or liquidity. Management implemented the Company’s business continuity plan in early March 2020 and operated through July 2020 with the majority of employees working remotely. Operations continued as normal despite a sharp increase in sales during the period. We continue to monitor the Centers for Disease Control and Prevention and Nebraska guidelines regarding employee safety.
If the COVID-19 pandemic and associated economic slowdown continues or other major public health issues,resurges, it could adversely impact uson our future results of operations, financial condition, cash flows, liquidity and prospects in a number of ways. We may face increased costs associated with claims under our annuity and life insurance products. The costways, including:
● | Our investment portfolio (and, specifically, the valuations of investment assets we hold) could be materially, adversely affected as a result of market developments from the COVID-19 pandemic and uncertainty regarding its outcome. Moreover, changes in interest rates, reduced liquidity or a continued slowdown in the U.S. or in |
51
global economic conditions may also adversely affect the values and cash flows of these assets. Our investments in mortgages and asset-backed securities could be negatively affected by delays or failures of borrowers to make payments of principal and interest when due or delays or moratoriums on foreclosures or enforcement actions with respect to delinquent or defaulted mortgages imposed by governmental authorities. Further, extreme market volatility may leave us unable to react to market events in a prudent manner consistent with our historical investment practices in dealing with more orderly markets; |
● | Potential impacts on our operations due to efforts to mitigate the pandemic, including government mandated shutdowns, requests or orders for employees to work remotely, and other social distancing measures, which could result in an adverse impact on our ability to conduct our business, including our ability to sell policies, and adjust certain claims; |
● | While we have implemented risk management and contingency plans and have taken preventive measures and other precautions, no predictions of specific scenarios can be made with respect to the COVID-19 pandemic, and such measures may not adequately predict the impact on our business. |
● | We also outsource certain critical business activities to third parties such as our IMOs. As a result, we rely upon the successful implementation and execution of the business continuity planning of such entities in the current environment. While we monitor the business continuity activities of these third parties, successful implementation and execution of their business continuity strategies are largely outside our control. If one or more of the third parties on whom we rely for critical business activities experience operational difficulties or failures as a result of the impacts from the spread of COVID-19, it may have a material adverse effect on our business, financial condition, results of operations, liquidity and cash flows; and |
● | Potential impacts of COVID-19 on reinsurers and the cost and availability of reinsurance. |
Our investment portfolio may be adversely affected by market volatility, changes in interest rates, reduced liquidity, or by a slowdown in U.S. or global economic conditions caused byAdditionally, there is risk that the COVID-19 pandemic or the uncertainty of its outcome. Extreme market volatility may leave us unable to react to market events in a prudent manner consistent with our historical practices in dealing with more orderly markets.
Our workforce, including particularly our executive officers, and the workforces of our vendors, service providers and counterparties, may also be affected, which could result in an adverse impact on our ability to conduct business. Thecurrent efforts ofunderway by governmental and non-governmental organizations in combatingto combat the spread and severity of COVID-19 or other majorand related public health issues may not be effective. Further,effective or may be prolonged. Finally, we cannot predict how legal and regulatory responses to concerns about COVID-19 or other majorand related public health issues, including the possible extension of insurance coverage beyond our policy language, will impact our business.
The extentcontinued spread of COVID-19 has led to disruption and volatility in the global capital markets which COVID-19 impactscould increase our funding costs and limit our access to the capital markets. Accordingly, we may in the future have difficulty accessing capital on attractive terms, or at all, which could have a material adverse effect on our business, results of operations, financial condition or liquidity will depend on future developments which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of COVID-19 and the actions taken to contain or treat its impact.liquidity.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
See the Company’s Current Report on Form 8-K filed withUse of Proceeds from Registered Securities
Pursuant to Registration Statement No. 333-249828 declared effective, by the Securities and Exchange Commission, on April 24,December 21, 2020, which Item 3.02 is incorporated hereinPiper Sandler & Co. and JMP Securities, LLC, as underwriters sold 1,000,000 shares of the Company’s $0.001 par value voting common stock at the public offering price of $70 per share. The offering closed on December 21 2020. Aggregate underwriting discounts and commissions were approximately $4,850,000 resulting in net proceeds to the Company of $65,450,000 before offering expenses.
Expenses of approximately $779,527 were paid by reference.the Company in connection with the offering through March 31, 2021 (excluding underwriting discounts and commissions set forth above) include:
| | | |
Legal, accounting and professional fees | | | 221,626 |
SEC filing, NASDAQ listing fees and expenses | | | 500,634 |
Direct payments to directors, officers and 10% | | | |
shareholders (not including regular salaries) | | | 57,267 |
|
| $ | 779,527 |
After payment of the foregoing expenses, net proceeds to the Company were approximately $64.3 million. Of this amount and through March 31, 2021, these proceeds had been applied as follows: Midwest used the net proceeds of the offering to
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support the growth of its insurance subsidiaries, American Life, with a capital contribution of $50.0 million, and Seneca Re, with a capital contribution of $7.5 million. The rest of the proceeds have been allocated for general corporate purposes.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
None.
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EXHIBIT |
| DESCRIPTION |
31.1* | ||
31.2* | ||
32.1* | ||
32.2* | ||
101.INS * | XBRL Instance Document. | |
101.SCH * | XBRL Taxonomy Extension Schema Document. | |
101.CAL * | XBRL Taxonomy Extension Calculation Linkbase Document. | |
101.LAB * | XBRL Taxonomy Extension Label Linkbase Document. | |
101.PRE * | XBRL Taxonomy Extension Presentation Linkbase Document. | |
101.DEF * | XBRL Taxonomy Extension Definition Linkbase Document. |
* | Filed herewith. |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: AugustMay 14, 20202021
|
|
|
| MIDWEST HOLDING INC. | |
|
| |
|
| |
| By: | /s/ A. Michael Salem |
| Name: | A. Michael Salem |
| Title: |
|
(Co-Principal Executive Officer) |
MIDWEST HOLDING INC. | ||
By: | /s/ Michael Minnich | |
Name: | Michael Minnich | |
Title: | Co-Chief Executive Officer | |
(Co-Principal Executive Officer) |
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