Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2010
| [ ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period From to .
Commission file number 000-52613
FIRST TRINITY FINANCIAL CORPORATION
(Exact name of small business issuer as specified in its charter)
| Oklahoma | 34-1991436 |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer number) |
| 7633 East 63rd Place, Suite 230 Tulsa, Oklahoma 74133 |
| (Address of principal executive offices) |
| |
(918) 249-2438
(Issuer's telephone number)
Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of Each Class
None
Securities registered pursuant to section 12(g) of the Exchange Act:
Title of Each Class
Common Stock, $.01 Par Value
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
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 x
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 x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ¨ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer, accelerated filer and smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer: ¨ Accelerated filer: ¨ Non accelerated filer: ¨ Smaller reporting company: x
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).
Yes o No x
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.
Because of the absence of an established trading market for the common stock, the registrant is unable to calculate the aggregate market value of the voting stock held by non-affiliates as of the last business day of the registrant’s most recently completed second fiscal quarter.
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. Common stock $.01 par value as of March 28, 2011: 6,798,758 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement to be used in connection with its 2011 Annual Meeting of Shareholders, which is expected to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year covered by this Form 10-K, are incorporated by reference into Part III of this report.
FIRST TRINITY FINANCIAL CORPORATION
TABLE OF CONTENTS
| Part I | | |
| | | |
| Item 1. | Business | 4 |
| Item 2. | Properties | 8 |
| Item 3. | Legal Proceedings | 8 |
| Item 4. | Submission of Matters to a Vote of Security Holders | 9 |
| | | |
| Part II | | |
| | | |
| Item 5. | Market for Regristrant’s Common Equity, Related Stockholder Matters and Small Business | |
| | Issuer Purchases of Equity Securities | 9 |
| Item 7. | Management’s Discussion and Analysis of Financial Condition, Results of Operations and | |
| | Liquidity and Capital Resources | 10 |
| Item 8. | Financial Statements | 22 |
| Item 9. | Changes In and Disagreements With Accountants on Accounting and Financial Disclosure | 52 |
| Item 9A. | Controls and Procedures | 52 |
| Item 9B. | Other Information | 53 |
| | | |
| Part III | | |
| | | |
| Item 10. | Directors, Executive Officers and Corporate Governance | 53 |
| Item 11. | Executive Compensation | 53 |
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder | |
| | Matters | 53 |
| Item 13. | Certain Relationships and Related Transactions, and Director Independence | 53 |
| Item 14. | Principal Accountant Fees and Services. | 53 |
| Item 15. | Exhibits | 53 |
| Signatures | | 54 |
| Exhibit Index | | 56 |
Exhibit 21.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2
PART I
Item 1. Business
Business Development
First Trinity Financial Corporation (the “Company” or “FTFC”) is the holding company of Trinity Life Insurance Company and First Trinity Capital Corporation.
FTFC was incorporated in Oklahoma on April 19, 2004, for the primary purpose of organizing a life insurance subsidiary. The Company raised $1,450,000 from two private placement stock offerings during 2004. On June 22, 2005 the Company’s intrastate public stock offering filed with the Oklahoma Department of Securities for a $12,750,000 intrastate public stock offering, which included a 10% "over-sale" provision (additional sales of $1,275,000), was declared effective. The offering was completed February 23, 2007. The Company raised $14,025,000 from this offering.
On June 29, 2010, the Company commenced a public offering of its common stock registered with the U.S. Securities and Exchange Commission and the Oklahoma Department of Securities. The public offering is for 1,333,334 shares of the Company’s common stock for $7.50 per share. The Company will receive $8.5 million after reduction for offering expenses and sales commissions if all the shares are sold. The Company has registered an additional 133,334 shares of its common stock to cover over subscriptions if any occur. The sale of all the additional shares would provide the Company with an additional $850,000 after reduction for offering expenses and sales commissions.
The offering will end on June 28, 2011, unless all the Company’s shares are sold before then or the offering is extended. As of December 31, 2010, the Company has received gross proceeds of $3,362,325 from the subscription of 448,310 shares of its common stock in this offering and incurred $486,730 in offering costs. The proceeds were originally deposited in an escrow account that was released from escrow by the Oklahoma Department of Securities in August 2010 after the offering exceeded $1,000,000 in gross proceeds. These proceeds are now available to the Company. Future proceeds from the sale of shares of the Company’s common stock in this public offering will be available to the Company without being held in escrow.
The Company purchased First Life America Corporation (“FLAC”) on December 23, 2008 and had statutory capital and surplus of $2,700,455 at December 31, 2008. On August 31, 2009, two of the Company’s subsidiaries, Trinity Life Insurance Company (“Old TLIC”) and FLAC were merged, with FLAC being the surviving company. Immediately following the merger, FLAC changed its name to Trinity Life Insurance Company (“TLIC”). After the merger, the Company has two wholly owned subsidiaries, First Trinity Capital Corporation (“FTCC”) and TLIC, domiciled in Oklahoma. FTCC was incorporated in 2006, and began operations in January 2007 providing financing for casualty insurance premiums.
TLIC is primarily engaged in the business of marketing, underwriting and distributing a broad range of individual life and annuity insurance products to individuals in eight states primarily in the Midwest. TLIC’s current product portfolio consists of a modified premium whole life insurance policy with a flexible premium deferred annuity rider, whole life, term, final expense, accidental death and dismemberment and annuity products. The term products are both renewable and convertible and issued for 10, 15, 20 and 30 years. The term products can be issued with premiums fully guaranteed for the entire term period or with a limited premium guarantee. The final expense product is issued as either a simplified issue or as a graded benefit policy, determined by underwriting. The final expense products are sold through independent agents in the states of Illinois, Kansas, Kentucky, Nebraska, North Dakota, Ohio, Oklahoma and Texas.
The Company’s operations, prior to the acquisition of FLAC, involved the sale of a modified premium whole life insurance policy with a flexible premium deferred annuity rider through its subsidiary Old TLIC in the state of Oklahoma. FTCC provides financing for casualty insurance premiums for individuals and companies and is licensed to conduct premium financing business in the states of Alabama, Arkansas, Louisiana, Mississippi and Oklahoma. The Company owns 100% of Southern Insurance Services, LLC, (“SIS”), a limited liability company, that operates a property and casualty insurance agency. FTCC is the sole member of SIS.
The Company was a development stage company until commencing operations in 2007. Significant net losses have been incurred since inception. At December 31, 2010, the Company had an accumulated deficit of $3,389,571. The losses have resulted primarily from costs incurred while raising capital and establishing the subsidiary companies as well as losses resulting from issuing and administering new and renewal life insurance policies.
Acquisition of Other Companies
On December 23, 2008, FTFC acquired 100% of the outstanding common stock of First Life America Corporation from an unaffiliated company (the “FLAC Acquisition”). The FLAC acquisition was accounted for as a purchase. The aggregate purchase price for the FLAC acquisition was approximately $2,695,000 (including direct cost associated with the acquisition of approximately $195,000). The FLAC acquisition was financed with the working capital of FTFC. On December 31, 2008, FTFC made FLAC a 15 year loan in the form of a surplus note in the amount of $250,000 with an interest rate of 6% payable monthly, that was approved by the Oklahoma Insurance Department.
Financial Information about Segments
Our business is comprised of three primary operating business segments: Life and Annuity Insurance Operations, Premium Finance Operations and Corporate Operations. Results for the parent holding company, after elimination of intercompany amounts, are allocated to the corporate operations segment.
See Note 12 of the “Notes to Consolidated Financial Statements” for operating results of our segments for each of the years ended December 31, 2010 and 2009.
Life and Annuity Insurance Operations
Our Life and Annuity Insurance Operations consists of issuing ordinary whole life insurance, modified premium whole life with an annuity rider, term, final expense, accidental death and dismemberment and annuity products. The policies can be issued with premiums fully guaranteed for the entire term period or with a limited premium guarantee. The final expense is issued as either a simplified issue or as a Graded Benefit, determined by underwriting.
Old TLIC entered into an administrative services agreement with Investors Heritage Life Insurance Company (“IHLIC”) on January 11, 2007. Under the terms of this agreement, IHLIC provided services that included underwriting, actuarial, policy issue, accounting, claims processing and other services incidental to the operations of OLD TLIC. The agreement was effective for a period of five (5) years. However, the agreement was terminated after the merger with FLAC and replaced with a new TLIC administrative services agreement dated May 28, 2009 that provides the same services as the terminated agreement with Old TLIC. The new agreement terminates on January 31, 2012 and may be terminated at any time with a 180 day prior notice.
We seek to serve middle income households in the states of Illinois, Kansas, Kentucky, Nebraska, North Dakota, Ohio, Oklahoma and Texas. The majority of our inforce business results from the acquisition of FLAC. We market our products through independent agents.
The following table sets forth our direct collected premiums by state, for each state in which we are licensed, for the years ended December 31, 2010 and 2009, in accordance with statutory accounting practices prescribed by the states of domicile of TLIC.
| | | 2010 | |
| State | | Life | | | | | | Annuity | | | | |
| Illinois | | $ | 504,128 | | | | 8 | % | | $ | 11,500 | | | | 0 | % |
| Kansas | | | 1,912,919 | | | | 30 | % | | | 2,596,393 | | | | 42 | % |
| Kentucky | | | 105,531 | | | | 2 | % | | | - | | | | - | |
| Nebraska | | | 108,450 | | | | 2 | % | | | 6,500 | | | | - | |
| North Dakota | | | 120,800 | | | | 2 | % | | | 1,793,832 | | | | 29 | % |
| Ohio | | | 605,955 | | | | 10 | % | | | 600 | | | | - | |
| Oklahoma | | | 1,836,252 | | | | 29 | % | | | 985,933 | | | | 16 | % |
| Texas | | | 1,027,304 | | | | 16 | % | | | 831,800 | | | | 13 | % |
| All other | | | 95,760 | | | | 1 | % | | | 12,185 | | | | 0 | % |
| Total direct collected premium | | $ | 6,317,099 | | | | 100 | % | | $ | 6,238,743 | | | | 100 | % |
| | | 2009 | |
| State | | Life | | | | | | Annuity | | | | |
| Illinois | | $ | 419,054 | | | | 7 | % | | $ | 39,349 | | | | 1 | % |
| Kansas | | | 1,795,227 | | | | 29 | % | | | 1,880,059 | | | | 51 | % |
| Kentucky | | | 109,560 | | | | 2 | % | | | - | | | | 0 | % |
| Nebraska | | | 80,998 | | | | 1 | % | | | 12,275 | | | | 0 | % |
| North Dakota | | | 90,808 | | | | 2 | % | | | 539,828 | | | | 15 | % |
| Ohio | | | 567,676 | | | | 9 | % | | | 1,250 | | | | 0 | % |
| Oklahoma | | | 1,996,268 | | | | 32 | % | | | 681,292 | | | | 18 | % |
| Texas | | | 1,011,839 | | | | 17 | % | | | 471,525 | | | | 13 | % |
| All other | | | 84,905 | | | | 1 | % | | | 69,702 | | | | 2 | % |
| Total direct collected premium | | $ | 6,156,335 | | | | 100 | % | | $ | 3,695,280 | | | | 100 | % |
Reinsurance
TLIC cedes reinsurance under various agreements allowing management to control exposure to potential losses arising from large risks and providing additional capacity for growth and risk diversification. TLIC reinsures all amounts of risk on any one life in excess of $55,000 for individual life insurance with Investors Heritage Life Insurance Company, Munich American Reassurance Company, Optimum Re Life Company and Wilton Reassurance Company.
TLIC is a party to an Automatic Retrocession Pool Agreement (the “Reinsurance Pool”) with Optimum Re Life Company, Catholic Order of Foresters, American Home Life Insurance Company and Woodmen of the World. The agreement provides for automatic retrocession of coverage in excess of Optimum Re Life Company’s retention on business ceded to Optimum Re Life Company by the other parties to the Reinsurance Pool. TLIC’s maximum exposure on any one insured under the Reinsurance Pool is $50,000. As of January 1, 2008, the Reinsurance Pool stopped accepting new cessions.
Effective September 29, 2005, FLAC and Wilton Reassurance Company executed a binding letter of intent whereby both parties agreed that FLAC would cede the simplified issue version of its Golden Eagle Whole Life (Final Expense) product to Wilton Reassurance Company on a 50/50 quota share original term coinsurance basis. The letter of intent was executed on a retroactive basis to cover all applicable business issued by FLAC subsequent to January 1, 2005. Wilton Reassurance Company agreed to provide various commission and expense allowances to FLAC in exchange for FLAC ceding 50% of the applicable premiums to Wilton Reassurance Company as they are collected. As of June 24, 2006, Wilton Reassurance Company terminated the reinsurance agreement for new business issued after the termination date.
To the extent that the reinsurance companies are unable to meet their obligations under the reinsurance agreements, TLIC remains primarily liable for the entire amount at risk.
Competition
The U.S. life insurance industry is a mature industry that, in recent years, has experienced little to no growth. Competition is intense because the life insurance industry is consolidating, with larger, more efficient and more effective organizations emerging from consolidation. In addition, legislation became effective in the United States that permits commercial banks, insurance companies and investment banks to combine. These factors have increased competitive pressures in general.
Many domestic life insurance companies have significantly greater financial, marketing and other resources, longer business histories and more diversified lines of insurance products than we do. We also face competition from companies marketing in person as well as with direct mail and Internet sales campaigns. Although we may be at a competitive disadvantage to these entities, we believe that our premium rates and policy features are generally competitive with those of other life insurance companies selling similar types of products.
Governmental Regulation
TLIC is subject to regulation and supervision by the Oklahoma Insurance Department (“OID”). The insurance laws of Oklahoma give the OID broad regulatory authority, including powers to: (i) grant and revoke licenses to transact business; (ii) regulate and supervise trade practices and market conduct; (iii) establish guaranty associations; (iv) license agents; (v) approve policy forms; (vi) approve premium rates for some lines of business; (vii) establish reserve requirements; (viii) prescribe the form and content of required financial statements and reports; (ix) determine the reasonableness and adequacy of statutory capital and surplus; and (x) regulate the type and amount of permitted investments.
TLIC can be required, under the solvency or guaranty laws of most states in which it does business, to pay assessments (up to prescribed limits) to fund policyholder losses or liabilities of other insurance companies that become insolvent. These assessments may be deferred or foregone under most guaranty laws if they would threaten an insurer's financial strength and, in certain instances, may be offset against future premium taxes.
Oklahoma has enacted legislation which regulates insurance holding company systems, including acquisitions, extraordinary dividends, terms of affiliate transactions, and other related matters. Under the Oklahoma statutes, TLIC may not during any year pay dividends on common stock to the parent company in excess of the lesser of the net gain from operations for the preceding year or 10% of capital and surplus at the end of the preceding year, without the consent of the Oklahoma Commissioner of Insurance. Cash dividends may only be paid out of surplus derived from realized net profits. Based on these limitations, there is no capacity to pay a dividend in 2011 without prior approval. There were no dividends paid or a return of capital to the parent company in 2010 and 2009.
There are certain factors particular to the life insurance business which may have an adverse effect on the statutory operating results of TLIC. One such factor is that the costs associated with issuing a new policy in force is usually greater than the first year’s policy premium. Accordingly, in the early years of a new life insurance company, these initial costs and the required provisions for reserves often have an adverse effect on statutory operating results.
Premium Finance Operations
The premium finance subsidiary, FTCC, provides premium financing to individuals and businesses. Many casualty insurance carriers require their premiums to be paid on an annual or lump sum basis. A premium finance company finances these casualty premiums. A typical premium finance contract requires the insured to pay 25% of the premium up front and the balance is paid over a nine month period. Premium financing is unique in that the unpaid balance due the company is lower than the unearned premium, which has in effect been assigned to the company in the event of non-payment, thus, the element of risk is minimized.
FTCC was capitalized with $4,000,000 from FTFC. The Company engages in the premium finance business, independent of its life insurance business. FTCC is licensed to conduct premium finance business in Alabama, Arkansas, Louisiana, Mississippi and Oklahoma. FTCC has contracted with over 200 insurance agencies to finance their casualty insurance premiums for approximately 30 agencies. There is no guarantee that these agencies will write contracts with FTCC. FTCC is not dependent on a single customer or a few major customers. SIS, our property and casualty insurance agency, writes commercial and personal lines of insurance, primarily in the state of Mississippi.
Premium finance companies are regulated by the individual states with no uniformity among state regulations. Commercial insurance premium finance transactions are not regulated directly in Oklahoma. Consumer insurance premium finance transactions are considered a consumer credit sale and are subject to the Oklahoma Uniform Consumer Credit Code. Therefore the regulation of the transaction is by the Oklahoma Department of Consumer Credit under the consumer credit laws. FTCC is regulated by the Department of Banking in Mississippi.
Finance companies are subject to interest rate fluctuations. An increase in the cost of funds or a decrease in interest rates that FTCC can charge could affect the net return.
The premium financing business is highly competitive in every channel in which FTCC competes. FTCC competes with large financial institutions most of which may have greater financial, marketing and other resources than FTCC. FTCC has targeted the niche market of small business and individual consumer casualty insurance financing and faces competition with many specialty financing businesses. Some competitors are affiliated with property and casualty writing agencies and may have advantageous marketing relationships with their affiliates.
Employees
As of March 11, 2011, the Company had ten full time employees and two part time employees.
The Company leased approximately 2,517 square feet of office space pursuant to a three-year lease that began July 1, 2008, leased approximately 200 square feet on a month-to-month basis during 2009 and leased 950 square feet of office space effective December 15, 2009 that terminated December 31, 2010. On June 17, 2010, the Company agreed to lease an additional 4,252 square feet of expansion office space whereby effective October 1, 2010, the Company would lease for five years a combined 6,769 square feet. Under the terms of the home office leases as amended, the monthly rent expense for the 2,517 square feet was $3,041 through June 30, 2009, $3,146 from July 1, 2009 through June 30, 2010, $3,251 from July 1, 2010 through September 30, 2010 and $7,897 from October 1, 2010 through September 30, 2015. The month to month lease was $300 per month and the 950 square feet lease was $1,225 per month. The Company incurred rent expense of $72,855 and $43,809 for the years 2010 and 2009, respectively. Future minimum lease payments to be paid under non cancelable lease agreements are $94,764 for the years 2011 through 2014 and $71,073 in 2015.
TLIC occupied approximately 7,500 square feet of its building in Topeka, Kansas until December 2009. Effective December 24, 2009, TLIC entered into a five year lease with a tenant for this space with an option to renew for five additional years. The monthly lease payments are as follows: $8,888 in 2010, $9,130 in 2011 and 2012 and $9,371 in 2013 and 2014. TLIC has leased 10,000 square feet under a lease that was renewed during 2006 to run through June 30, 2011 with a 90 day notice to terminate the lease by the lessee. The lease agreement calls for minimum monthly base lease payments of $15,757.
Effective August 29, 2005, TLIC executed a lease agreement with a tenant for 2,500 square feet. The base lease period commenced on September 1, 2005 and will end on August 31, 2010. The lease will automatically renew, if not terminated on or after August 15, 2010, for another five years with a 90 day notice to terminate the lease by the lessee. The lease agreement called for minimum monthly base lease payments of $4,332 through August 31, 2010. The lease payments decreased to $3,100 per month for the period September 1, 2010 through August 31, 2015.
The future minimum lease payments to be received under non cancelable lease agreements are $241,302, $146,760, $149,652, $149,652 and $24,800 for the years 2011 through 2015, respectively.
Item 3. Legal Proceedings
There are no material legal proceedings pending against the Company or its subsidiaries or of which any of their property is the subject. There are no proceedings in which any director, officer, affiliate or shareholder of the Company, or any of their associates, is a party adverse to the Company or any of its subsidiaries or has a material interest adverse to the Company or any of its subsidiaries.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted during the fourth quarter of the fiscal year covered by this Form 10-K to a vote of the Company's security holders, through the solicitation of proxies or otherwise.
PART II
| Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities |
Trading of the Company’s common stock is limited and an established public market does not exist.
As of March 28, 2011 there were approximately 4,000 shareholders of the Company’s outstanding common stock.
The Company has not paid any cash dividends since inception (April 19, 2004). The Board of Directors of the Company has not adopted a dividend payment policy; however, dividends must necessarily depend upon the Company's earnings and financial condition, applicable legal restrictions, and other factors relevant at the time the Board of Directors considers a dividend policy. Cash available for dividends to shareholders of the Company must initially come from income and capital gains earned on its investment portfolio and dividends paid by the Company’s subsidiaries. Provisions of the Oklahoma Insurance Code relating to insurance holding companies subject transactions between the Company and TLIC, including dividend payments, to certain standards generally intended to prevent such transactions from adversely affecting the adequacy of life insurance subsidiaries' capital and surplus available to support policyholder obligations. See Item 1. "Business - Governmental Regulation." In addition, under the Oklahoma General Corporation Act, the Company may not pay dividends if, after giving effect to a dividend, it would not be able to pay its debts as they become due in the usual course of business or if its total liabilities would exceed its total assets.
On January 10, 2011, the Company’s Board of Directors approved a 5% share dividend by which shareholders will receive a share of Common Stock for each 20 shares of common stock of the Company they hold. The dividend is payable to the holders of shares of the Corporation as of March 10, 2011. Fractional shares will be rounded to the nearest whole number of shares. It is anticipated that approximately 324,000 shares will be issued in connection with the stock dividend that will result in accumulated deficit being charged by approximately $2,430,000 with an offsetting credit of approximately $2,430,000 to common stock and additional paid-in capital.
| (iii) | Securities Authorized for Issuance Under Equity Compensation Plans |
There are no plans under which equity securities are authorized for issuance.
(c) | No share repurchases were made. |
Item 7. Management’s Discussion and Analysis of Financial Condition, Results of Operation and Liquidity and Capital Resources
Overview
First Trinity Financial Corporation (“we” “us”, “our”, or the Company) conducts operations as an insurance holding company emphasizing ordinary life insurance products in niche markets and a premium finance company, financing casualty insurance premiums.
As an insurance provider, we collect premiums in the current period to pay future benefits to our policy and contract holders. Our core operations include issuing modified premium whole life insurance with a flexible premium deferred annuity, ordinary whole life, final expense, term and annuity products to predominately middle income households in the states of Illinois, Kansas, Kentucky, Nebraska, North Dakota, Ohio, Oklahoma and Texas through independent agents.
We also realize revenues from our investment portfolio, which is a key component of our operations. The revenues we collect as premiums from policyholders are invested to ensure future benefit payments under the policy contracts. Life insurance companies earn profits on the investment spread, which reflects the investment income earned on the premiums paid to the insurer between the time of receipt and the time benefits are paid out under policies. Changes in interest rates, changes in economic conditions and volatility in the capital markets can all impact the amount of earnings that we realize from our investment portfolio.
We provide financing for casualty insurance premiums through independent property and casualty insurance agents. We are licensed in the states of Alabama, Arkansas, Louisiana, Mississippi and Oklahoma.
Recent Acquisitions
The Company expects to facilitate growth through acquisitions of other life insurance companies and/or blocks of life insurance business. In the fourth quarter of 2008, the Company completed its acquisition of 100% of the outstanding stock of First Life America Corporation, included in the life insurance segment, for $2,500,000 and had additional acquisition related expenses of $195,000.
Our profitability in the life insurance segment is a function of its ability to accurately price the policies that it writes, adequately value life insurance business acquired and administer life insurance company acquisitions at an expense level that validates the acquisition cost. Profitability in the premium financing segment is dependent on the Company’s ability to compete in that sector, maintain low administrative costs and minimize losses.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements that have been prepared in accordance with accounting principles generally accepted in the United States. Preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. We evaluate our estimates and assumptions, including those related to investments, loans from premium financing, deferred acquisition costs, value of insurance business acquired, policy liabilities, income taxes, regulatory requirements, contingencies and litigation. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following accounting policies, judgments and estimates are the most critical to the preparation of our consolidated financial statements.
Investments
Fixed maturities are comprised of bonds that are classified as available-for-sale and are carried at fair value with unrealized gains and losses, net of applicable income taxes, reported in accumulated other comprehensive income. The amortized cost of fixed maturities is adjusted for amortization of premium and accretion of discount to maturity. Interest income, as well as the related amortization of premium and accretion of discount, is included in net investment income under the effective yield method. The amortized cost of fixed maturities is written down to fair value when a decline in value is considered to be other-than-temporary.
Equity securities are comprised of common stock and are carried at fair value. The associated unrealized gains and losses, net of applicable income taxes, are included in accumulated other comprehensive income. The cost of equity securities is written down to fair value when a decline in value is considered to be other-than-temporary. Dividends from these investments are recognized in net investment income when declared.
Mortgage loans are carried at unpaid balances, net of unamortized premium or discounts. Interest income and the amortization of premiums or discounts are included in net investment income.
Investment real estate is carried at amortized cost. Depreciation on the office building is calculated over its estimated useful life of 39 years.
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.
Other long term investments are comprised of lottery prize receivables and are carried at amortized cost, net of unamortized premium or discounts. Interest income and the amortization of premium or discount are included in net investment income.
Cash and cash equivalents include cash on hand, amounts due from banks and money market instruments.
Certificates of deposit are carried at cost. The Company limits its investment in certificates of deposit to accounts that are federally insured.
Realized gains and losses on sales of investments are recognized in operations on the specific identification basis. Interest and dividends earned on investments are included in net investment income.
Deferred Policy Acquisition Costs
Commissions and other acquisition costs which vary with and are primarily related to the production of new business are deferred and amortized in a systematic manner based on the related contract revenues or gross profits as appropriate. 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. Deferred acquisition costs for traditional life insurance contracts are deferred to the extent deemed recoverable and amortized over the premium paying period of the related policies using assumptions consistent with those used in computing future policy benefit liabilities.
Deferred acquisition costs related to annuities that subject us to mortality or morbidity risk over a period that extends beyond the period or periods in which premiums are collected and that have terms that are fixed and guaranteed (i.e., limited-payment long-duration annuity contracts) are deferred to the extent deemed recoverable and amortized in relation to the present value of actual and expected gross profits on the policies. To the extent that realized gains and losses on fixed income securities result in adjustments to deferred acquisition costs related to annuities, such adjustments are reflected as a component of the amortization of deferred acquisition costs.
Deferred acquisition costs related to limited-payment long-duration annuity contracts are also adjusted, net of tax, for the change in amortization that would have been recorded if the unrealized gains (losses) from securities had actually been realized. This adjustment is included in the change in net unrealized appreciation (depreciation) on available-for-sale securities, a component of “Accumulated Other Comprehensive Income” in the shareholders’ equity section of the statement of financial position.
Loans from Premium Financing
Loans from premium financing are carried at their outstanding unpaid principal balances, net of unearned interest, charge-offs and an allowance for loan losses. Interest on loans is earned based on the interest method for computing unearned interest. The rule of 78s is used to calculate the amount of the interest charge to be forgiven in the event that a loan is repaid prior to the agreed upon number of monthly payments. When serious doubt concerning collectability arises, loans are placed on a nonaccrual basis. Generally if no payment is received after one hundred twenty days, all accrued and uncollected interest income is reversed against current period operations. Interest income on nonaccrual loans is recognized only when the loan is paid in full. Loan origination fees and costs are charged to expense as incurred.
Allowance for Loan Losses from Premium Financing
The allowance for possible loan losses from financing casualty insurance premiums is a reserve established through a provision for possible loan losses charged to expense which represents, in management’s judgment, the known and inherent credit losses existing in the loan portfolio. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses inherent in the loan portfolio and reduces the carrying value of loans from premium financing to the estimated net realizable value on the statement of financial position.
While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond our control, including the performance of the loan portfolio, the economy and changes in interest rates. The Company’s allowance for possible loan losses consists of specific valuation allowances established for probable losses on specific loans and a portfolio reserve for probable incurred but not specifically identified loans.
A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by us in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. We determine the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis.
Value of Insurance Business Acquired
As a result of our purchase of FLAC, an asset was recorded in the application of purchase accounting to recognize the value of acquired insurance in force. The Company’s value of acquired insurance in force is an intangible asset with a definite life and is amortized under Financial Accounting Standards Board (“FASB”) guidance. The value of acquired insurance in force is amortized primarily over the emerging profit of the related policies using the same assumptions that were used in computing liabilities for future policy benefits. For the amortization of the value of acquired insurance in force, the Company periodically reviews its estimates of gross profits. The most significant assumptions involved in the estimation of gross profits include interest rate spreads, future financial market performance, business surrender/lapse rates, mortality and morbidity, expenses and the impact of realized investment gains and losses. In the event actual experience differs significantly from assumptions or assumptions are significantly revised, the Company is required to record a charge or credit to amortization expense for the period in which an adjustment is made.
At December 31, 2010 and 2009 there was $604,958 and $333,493, respectively, of accumulated amortization of the value of insurance business acquired due to the purchase of FLAC that occurred at the end of 2008. We expect to amortize the value of insurance business acquired by the following amounts over the next five years: $257,729 in 2011, $211,579 in 2012, $197,041 in 2013, $184,256 in 2014 and $173,500 in 2015.
Policyholders’ Account Balances
Our liability for policyholders’ account balances represents the contract value that has accrued to the benefit of the policyholder as of the financial statement date. This liability is generally equal to the accumulated account deposits plus interest credited less policyholders’ withdrawals and other charges assessed against the account balance. Interest crediting rates for individual annuities range from 3.75% to 6.75%. Interest crediting rates for premium deposit funds range from 3% to 4%.
Future Policy Benefits
Our liability for future policy benefits is primarily comprised of the present value of estimated future payments to or on behalf of policyholders, where the timing and amount of payment depends on policyholder mortality or morbidity, less the present value of future net premiums. For life insurance and annuity products, expected mortality and morbidity is generally based on the Company’s historical experience or standard industry tables including a provision for the risk of adverse deviation. Interest rate assumptions are based on factors such as market conditions and expected investment returns. Although mortality and morbidity and interest rate assumptions are “locked-in” upon the issuance of new insurance with fixed and guaranteed terms, significant changes in experience or assumptions may require the Company to provide for expected future losses on a product by establishing premium deficiency reserves.
Federal Income Taxes
We use the liability method of accounting for income taxes. Deferred income taxes are provided for cumulative temporary differences between balances of assets and liabilities determined under GAAP and balances determined using tax bases. A valuation allowance is established for the amount of the deferred tax asset that exceeds the amount of the estimated future taxable income needed to utilize the future tax benefits.
Recent Accounting Pronouncements
In January 2010, the FASB issued Accounting Standards Update No. 2010-06, Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). The new guidance requires entities to separately disclose information relative to transfers in and out of Levels 1 and 2 in the fair value hierarchy. In addition, ASU 2010-06 requires separate presentation of transfers in, transfers out, purchases, sales, issuances and settlements of Level 3 investments in the tabular reconciliation of Level 3 activity. ASU 2010-06 also clarifies the level of disaggregation for which fair value measurements should be disclosed and requires that information about input and valuation techniques be disclosed for Level 2 and Level 3 assets and liabilities. The Company adopted this guidance effective for the first quarter of 2010.
In October 2010, the FASB issued Accounting Standards Update No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts (“ASU 2010-26”). The new guidance requires that an insurance entity capitalize only the following as acquisition costs related directly to the successful acquisition of new or renewal insurance contracts:
| | 1. | Incremental direct costs of contract acquisition. |
| | 2. | The portion of an employee’s total compensation and payroll-related fringe benefits related directly to acquisition activities for time spent performing underwriting, policy issuance, policy processing, medical, inspection and sales force contract selling for a contract that has actually been acquired. |
| | 3. | Other costs related directly to the acquisition activities described in point 2 above that would not have been incurred by the insurance entity had the acquisition contract transaction not occurred. |
| | 4. | Advertising costs that meet the capitalization criteria of Subtopic 340-20. |
All other acquisition costs should be charged to expense as incurred. In addition, administrative costs, rent, depreciation, occupancy, equipment and all other general overhead costs are considered indirect costs and should be charged to expense as incurred. ASU 2010-26 is effective for interim and annual reporting periods beginning after December 15, 2011. Early adoption is permitted, but only at the beginning of an entity’s annual reporting period. The Company will likely adopt ASU 2010-26 in first quarter 2012. The Company has assessed the guidance and has determined that it will not have a significant financial impact since the Company utilizes a dynamic model whereby deferred acquisition costs on the statement of financial position only include policies currently in force. This current dynamic model results in immediate amortization of all deferred acquisition costs on the statement of operations where the policy is no longer in force. Once adopted, the above defined acquisition costs will only be capitalized directly related to the successful acquisition of new or renewal insurance contracts. After adoption, these acquisition costs will be amortized on the statement of operations when the related policies are no longer in force.
Business Segments
FASB guidance requires a "management approach" in the presentation of business segments based on how management internally evaluates the operating performance of business units. The discussion of segment operating results that follows is being provided based on segment data prepared in accordance with this methodology. Our business segments are as follows:
| | ● | Life and annuity insurance operations, consisting of the operations of TLIC; |
| | ● | Premium finance operations, consisting of the operations of FTCC and SIS; and |
| | ● | Corporate operations, which includes the results of the parent company after the elimination of intercompany amounts. |
Please see Note 12 to the Consolidated Financial Statements for additional information regarding segment data.
Results of Operations
The Company acquired FLAC as of December 23, 2008 and Old TLIC was merged into FLAC with the name of FLAC being changed to TLIC during 2009.
On August 6, 2009, we were made aware of potentially fraudulent loans and financial transactions made by an independent insurance agency that did business with our wholly owned subsidiary, FTCC. The fraudulent loans and financial transactions totaled $1,293,450. The independent insurance agency and its owner have assigned assets having an estimated fair value of $622,377 to cover loan losses.
In addition, the independent insurance agency endorsed and deposited $326,479 of checks issued by FTCC in the agency’s bank account that were payable to other third parties for insurance premiums. FTCC recovered these funds from the banks due to improper endorsement.
FTCC and the Company continued to investigate the facts and circumstances relating to any fraudulent loans and financial transactions in 2010 and will continue to seek restitution for any losses.
Revenues
Our primary sources of revenue are life insurance premium income, income from premium financing and investment income. Premium payments are classified as first-year, renewal and single. In addition, realized gains and losses on investment holdings can significantly impact revenues from period to period.
Total Revenues
Total consolidated revenues increased 3.3% to $8,821,306 for the year ended December 31, 2010, an increase of $278,514 from $8,542,792 for the year ended December 31, 2009. The increase is primarily attributable to a $345,710 increase in net realized investment gains in excess of losses, $218,809 increase in net investment income, $34,679 increase in premiums and a $2,836 increase in other income that exceeded a $323,520 decline in income from premium financing.
The increased net realized investment gains in excess of losses represent the recording of $155,364 of impairments during 2009 and the differences in net realized investment gains and losses during 2009 compared to 2010 (net realized investment gains of $159,300 in 2010 and net realized investment losses of $31,046 in 2009). The increased investment income primarily relates to increased total investments in the consolidated statement of financial position. The increase in premiums relates to increased new business production of final expense business and increased renewal premiums. The other income increase is primarily due to increased service fees. The decrease in income from premium financing relates to a decrease in production and fraudulent transactions in 2009 by an independent insurance agency.
Premiums
Premiums increased 0.6% to $5,895,030 for the year ended December 31, 2010, an increase of $34,679 from $5,860,351 for the year ended December 31, 2009. The increase relates to increased final expense first year premium production of $282,000 and increased final expense and whole life and term renewal premium production of $173,000 and $72,000, respectively, that exceeded decreased first year whole life and term premiums of $492,000. This decrease in first year production of whole life and term premiums is due to the focus of the captive agency forces on the public stock offering that began on June 29, 2010.
Income from Premium Financing
Income from premium financing decreased 55.5% to $259,296 for the year ended December 31, 2010, a decrease of $323,520 from $582,816 for the year ended December 31, 2009. The decrease in income from premium financing relates to a decrease in production of loan agreements and fraudulent transactions in 2009 by an independent insurance agency.
Net Investment Income
Net investment income increased 9.8% to $2,441,334 for the year ended December 31, 2010, an increase of $218,809 from $2,222,525 for the year ended December 31, 2009. The increase in net investment income primarily relates to increased total investments in the consolidated statement of financial position. However, as investments are called or matured, the proceeds are being invested at lower effective interest rates that continue to decrease yields.
Net Realized Investment Gains (Losses)
Net realized investment gains were $159,300 for the year ended December 31, 2010 compared to net realized investment losses of $186,410 for the year ended December 31, 2009, an increased net gain of $345,710. The increased net gains in excess of net losses is due to call activity and planned sales of specific securities during 2010 and 2009 combined with the 2009 losses from investment impairments. We recorded $159,300 of net realized investment gains during 2010 compared to net realized investment losses of $31,046 during 2009. In addition, we recorded $155,364 of other-than-temporary impairment losses in 2009 and none in 2010.
The investment markets were very volatile at the end of 2008 and throughout 2009 due to the credit crisis and economic downturn. There has been a recovery in the investments markets in 2010. We recorded no other-than-temporary impairments in 2010. We recorded two other-than-temporary impairments during the 2009. The Company impaired its $200,000 par value General Motors (“GM”) bond as a result of a bankruptcy filing by GM and approximately $710,000 par value investment in Cit Group (“CIT”) bonds as a result of a bankruptcy filing by CIT. Both of these impairments were considered fully credit-related, resulting in a charge to the statement of operations before taxes of $155,364 for the year ended December 31, 2009. This charge represented the difference between the amortized cost basis of the securities and fair value.
Other Income
Other income was $66,346 and $63,510, respectively, for the years ended December 31, 2010 and 2009, an increase of $2,836. The increase is primarily due to a $5,000 increase in service fees in 2010 compared to 2009.
Total Benefits, Claims and Expenses
Our benefits, claims and expenses are primarily generated from benefit payments, surrenders, change in reserves, commissions and other underwriting, insurance and acquisition expenses. Benefit payments can significantly impact expenses from period to period.
Total consolidated benefits, claims and expenses decreased 4.8% to $8,936,496 for the year ended December 31, 2010, a decrease of $447,548 from $9,384,044 for the year ended December 31, 2009. The decrease is primarily attributable to a $1,141,889 decrease in other underwriting, insurance and acquisition expenses and a $358,734 increase in net deferred acquisitions costs capitalized net of the amortization of deferred acquisition costs and the amortization of value of business acquired that exceeded an $829,537 increase in benefits and claims and a $223,538 increase in commissions.
Benefits and Claims
Benefits and claims increased 19.6% to $5,063,553 for the year ended December 31, 2010, an increase of $829,537 from $4,234,016 for the year ended December 31, 2009. The increase is primarily due to a $544,883 increase in the change in reserves as the policies age, a $155,131 increase in the interest credited on annuities related to increased deposits in excess of withdrawals, an $83,312 increase in surrenders related to the growth in the number of policies and a $46,211 increase in death claims due to slightly increased mortality related to the growth in the number of policies.
Deferral and Amortization of Deferred Acquisition Costs
Certain costs related to the acquisition of life insurance policies are capitalized and amortized over the premium-paying period of the policies. These costs, which are referred to as deferred policy acquisition costs, include commissions and other costs of acquiring life insurance, which vary with, and are primarily related to, the production of new insurance contracts. These capitalized acquisition costs are amortized in a systematic manner based on the related contract revenues or gross profits as appropriate.
For the years ended December 31, 2010 and 2009, capitalized costs were $1,773,199 and $1,478,104, respectively. Amortization of deferred policy acquisition costs for the years ended December 31, 2010 and 2009 was $451,349 and $452,960, respectively. The $295,095 increase in the acquisition costs deferred relates to increased new business production primarily in the final expense business. The $1,611 decrease in the amortization of deferred acquisition costs primarily reflects improving persistency in the whole life and term business reflected in the increased renewal premiums in 2010 compared to 2009.
Amortization of Value of Insurance Business Acquired
The cost of acquiring insurance business is amortized primarily over the emerging profit of the related policies using the same assumptions that were used in computing liabilities for future policy benefits. Amortization of the value of insurance business acquired was $271,465 and $333,493 for the years ended December 31, 2010 and 2009, respectively. The decrease in the amortization of value of insurance business acquired of $62,028 reflects improving persistency in the whole life and term business reflected in the increased renewal premiums in 2010 compared to 2009.
Commissions
Commissions increased 15.4% to $1,673,975 for the year ended December 31, 2010, an increase of $223,538 compared to $1,450,437 of commissions for the year ended December 31, 2009. The increase is primarily due to increased new business production of final expense business.
Other Underwriting, Insurance and Acquisition Expenses
Other underwriting, insurance and acquisition expenses decreased 26.0% to $3,249,353 for the year ended December 31, 2010, a decrease of $1,141,889, compared to $4,391,242 for the year ended December 31, 2009. The decrease is primarily due to an approximate $479,000 decrease in loan losses and other operating expenses in the premium finance operations from 2009 to 2010 due to the significant reduction in the number of loans made and a close monitoring of the collectability of the outstanding premium finance loans. There were also decreases in office and other expenses and salaries and benefits of approximately $413,000 and $111,000, respectively, from 2009 to 2010 related to the closing of the FLAC operations in Topeka, Kansas during 2009 combined with a cost containment and control program throughout 2010. In addition, there was also a reduction in professional fees from 2009 to 2010 of approximately $131,000 related to completion of the conversion of FLAC systems and business evaluation during 2009 resulting in less 2010 usage of actuarial, finance and computer consultants combined with less use of outside legal resources throughout 2010.
Federal Income Taxes
FTFC files a consolidated federal income tax return with FTCC but does not file a consolidated tax return with TLIC. TLIC is taxed as a life insurance company under the provisions of the Internal Revenue Code and must file a separate tax return until they have been a member of the consolidated filing group for five years. Certain items included in income reported for financial statements are not included in taxable income for the current period, resulting in deferred income taxes. For the year ended December 31, 2010, deferred income tax benefit was $206,526 with no current income tax expense and for the year ended December 31, 2009 deferred income tax expense was $49,139 with no current income tax expense.
Net Loss and Net Loss Per Common Share Basic and Diluted
For the year ended December 31, 2010 there was net income of $91,336 compared to a net loss of $890,391 for the year ended December 31, 2009. The net income per common share basic and diluted for the year ended December 31, 2010 was $0.01, based upon 6,235,407 weighted average common shares basic and diluted outstanding and subscribed for the year ended December 31, 2010. The net loss per common share basic and diluted for the year ended December 31, 2009 was $0.15, based upon 6,095,250 weighted average common shares basic and diluted outstanding for the year ended December 31, 2009. These weighted average shares reflect the retrospective adjustment for the impact of the 5% stock dividend declared by the Company on January 10, 2011 and payable to holders of shares of the Company as of March 10, 2011.
Business Segments
Life and Annuity Insurance Operations
Revenues from Life and Annuity Insurance Operations increased 7.6% to $8,495,479 for the year ended December 31, 2010, an increase of $596,814 from $7,898,665 for the year ended December 31, 2009. The increase in 2010 revenue over 2009 revenue primarily relates to increased investment income, decreased realized and impairment losses and increased new business production of final expense business and increased whole life and term renewal premiums.
The income before income taxes from Life and Annuity Insurance Operations was $736,035 and $219,889 for the years ended December 31, 2010 and 2009, respectively. The $516,146 increased income for 2010 compared to 2009 is primarily due to decreased insurance and underwriting expenses, increased net investment income, increased net investment gains in excess of net investment losses and increased capitalization of deferred acquisition costs in excess of the related amortization. These items that increased income were reduced by increases in benefits, claims and commissions.
Premium Finance Operations
Revenues from Premium Finance Operations (including SIS commissions classified as other income of $47,404 and $57,084 in 2010 and 2009, respectively) decreased 49.6% to $323,816 for the year ended December 31, 2010, a decrease of $318,913 from $642,729 for the year ended December 31, 2009. The decrease in revenues from premium financing relates to a decrease in production of loan agreements and fraudulent transactions in 2009 by an independent insurance agency.
The loss before income taxes from Premium Finance Operations was $340,395 and $619,613 for the years ended December 31, 2010 and 2009, respectively. The $279,218 decreased loss is primarily attributable to a decrease in allowance for loan losses and a decrease in production of loan agreements with no significant corresponding decrease in the costs associated with Premium Finance Operations.
Corporate Operations
Revenues from corporate operations were $2,011 and $1,398 for the years ended December 31, 2010 and 2009, respectively. This $613 increase is primarily due to an increase in net investment income.
The loss before income taxes from Corporate Operations was $510,830 and $441,528 for the years ended December 31, 2010 and 2009, respectively. The $69,302 increased loss from 2009 to 2010 is primarily due to use of consultants and corporate staffing focus on preparation for the public offering of our common stock to Oklahoma residents that began on June 29, 2010.
Consolidated Financial Condition
As of December 31, 2010, our available-for-sale fixed maturity securities had a fair value of $26,623,318 and amortized cost of $23,183,633 compared to a fair value of $22,510,660 and an amortized cost of $19,772,497 at December 31, 2009. This portfolio is reported at fair value with unrealized gains and losses, net of applicable income taxes, reflected as a separate component in shareholders' equity within “Accumulated Other Comprehensive Income”. The available-for-sale fixed maturity securities portfolio is invested in a variety of companies and U. S. Government sponsored agency securities.
As of December 31, 2010, our available-for-sale equity securities had a fair value of $529,314 compared to a fair value of $448,484 at December 31, 2009. The cost of available-for-sale equity securities were $347,353 and $350,318 as of December 31, 2010 and 2009, respectively. This portfolio is also reported at fair value with unrealized gains and losses, net of applicable income taxes, reflected as a separate component in shareholders' equity within “Accumulated Other Comprehensive Income”. The available-for-sale equity securities portfolio is invested in a variety of companies.
As of December 31, 2010, we held the following additional invested assets: mortgage loans on real estate of $1,156,812; investment real estate of $3,077,520; policy loans of $367,284 and other long-term investments of $6,886,529. As of December 31, 2009, we held the following additional invested assets: mortgage loans on real estate of $1,365,953; investment real estate of $3,146,944; policy loans of $335,022 and other long-term investments of $4,975,188. The other long-term investments are comprised of lottery prize receivables.
Total investments were $38,640,777 and $32,782,251 as of December 31, 2010 and December 31, 2009, respectively.
Deferred policy acquisition costs were $3,234,285 and $1,918,994 as of December 31, 2010 and 2009, respectively. Policy acquisition expenses related to new insurance sales were capitalized in the amount of $1,773,199 and $1,478,104 for the years ended December 31, 2010 and 2009, respectively. Amortization of deferred acquisition costs for the years ended December 31, 2010 and 2009 was $451,349 and $452,960, respectively.
The value of insurance business acquired was $2,507,258 and $2,778,723 as of December 31, 2010 and 2009, respectively. Amortization of value of insurance business acquired for the years ended December 31, 2010 and 2009 was $271,465 and $333,493, respectively.
As of December 31, 2010 and 2009, we held loans from premium financing of $1,143,977 and $2,749,830, respectively. The loan balances at December 31, 2010 and 2009, respectively, are net of unearned interest of $35,519 and $72,144 and allowance for loan losses of $443,071 and $318,826.
The progression of the Company’s loans from premium financing for the years ended December 31, 2010 and 2009 is summarized as follows:
| | | December 31, 2010 | | | December 31, 2009 | |
| Balance, beginning of year | | $ | 3,140,800 | | | $ | 4,848,845 | |
| Loans financed | | | 3,486,083 | | | | 9,313,585 | |
| Unearned interest added to loans | | | 199,595 | | | | 493,647 | |
| Capitalized fees and interest reversed | | | (57,384 | ) | | | (53,176 | ) |
| Payment of loans and unearned interest | | | (5,146,527 | ) | | | (11,462,101 | ) |
| | | | | | | | | |
| Ending loan balance including unearned interest | | | 1,622,567 | | | | 3,140,800 | |
| Unearned interest included in ending loan balances | | | (35,519 | ) | | | (72,144 | ) |
| | | | | | | | | |
| Loan balance net of unearned interest | | | 1,587,048 | | | | 3,068,656 | |
| Less allowance for loan loss | | | (443,071 | ) | | | (318,826 | ) |
| | | | | | | | | |
| Loan balance net of unearned interest and | | | | | | | | |
| allowance for loan losses at the end of the year | | $ | 1,143,977 | | | $ | 2,749,830 | |
As of December 31, 2010, we held the following additional assets (excluding cash and cash equivalents and certificates of deposit that are discussed below under “Liquidity and Capital Resources”): amounts recoverable from reinsurers of $977,397; accrued investment income of $385,948; accounts receivable of $357,979; property and equipment of $102,374 and other assets of $1,151,315. As of December 31, 2009, we held the following additional assets (excluding cash and cash equivalents and certificates of deposit that are discussed below under “Liquidity and Capital Resources”): amounts recoverable from reinsurers of $870,294; accrued investment income of $340,384; accounts receivable of $273,843; property and equipment of $82,349 and other assets of $837,210. Other assets include federal and state incomes taxes recoverable, prepaid expenses, notes receivable and customer account balances receivable.
Total liabilities as of December 31, 2010 and 2009 were $44,932,914 and $36,566,153, respectively.
Total policy liabilities as of December 31, 2010 were $44,115,568 and were composed of policyholders’ account balances of $30,261,070; future policy benefits of $13,444,284; policy claims of $367,306 and premiums paid in advance of $42,908. Total policy liabilities as of December 31, 2009 were $36,075,337 and were composed of policyholders’ account balances of $24,417,483; future policy benefits of $11,349,640; policy claims of $289,273 and premiums paid in advance of $18,941.
The liability for deferred federal income taxes was $293,221 and $159,315 at December 31, 2010 and 2009, respectively. Other liabilities as of December 31, 2010 and 2009 were $524,125 and $331,501, respectively. Other assets include deposits on pending policy applications, accrued expenses, accounts payable and unearned investment income.
Liquidity and Capital Resources
Since inception, our operations have been financed primarily through the private placement of equity securities and an intrastate public stock offering. Through December 31, 2010, we received $18,837,000 from the sale of our shares. Our operations have not been profitable and have generated more than $3,389,000 of losses from operations since we were incorporated in 2004 as shown in the accumulated deficit balance in the December 31, 2010 statement of financial position.
As of December 31, 2010, we had cash and cash equivalents totaling $12,985,278. The majority of our excess funds have been invested in money market mutual funds. At December 31, 2010, cash and cash equivalents of $8,897,115 of the total $12,985,278 were held by TLIC and may not be available for use by FTFC due to the required pre-approval by the Oklahoma Insurance Department of any dividend or intercompany transaction to transfer funds to FTFC. The maximum dividend, which may be paid in any twelve-month period without notification or approval, is limited to the lesser of 10% of statutory surplus as of December 31 of the preceding year or the net gain from operations of the preceding calendar year. Cash dividends may only be paid out of surplus derived from realized net profits. Based on these limitations, there is no capacity to pay a dividend in 2011 without prior approval. There were no dividends paid or a return of capital to the parent company in 2009 or in 2010. As of December 31, 2009, we had cash and cash equivalents totaling $7,080,692. At December 31, 2009, cash and cash equivalents of $5,903,258 of the total $7,080,692 were held by TLIC.
The Federal Deposit insurance Corporation currently insures all non-interest bearings accounts. We monitor the solvency of all financial institutions in which we have funds to minimize the exposure for loss. We do not believe we are at significant risk for such a loss.
During the years ended December 31, 2010 and 2009, cash and cash equivalents increased $5,904,586 and $1,410,897, respectively. Our operating activities for the year ended December 31, 2010 provided $1,220,685 of cash compared to $324,405 of cash used in operations during the year ended December 31, 2009. The increase in cash provided by operations in 2010 is primarily due to increased net investment income and decreased underwriting, insurance and acquisition expenses that exceeded increased benefits and claims. Cash used in investing activities for the year ended December 31, 2010 was $2,809,417 and cash used by investing activities was $425,022 for the year ended December 31, 2009. Net cash provided by financing activities for the years ended December 31, 2010 and 2009 was $7,493,318 and $2,160,324, respectively. The 2010 increase in cash provided by financing activities resulted from a net increase in policy deposits for the year ended December 31, 2010 and the net proceeds from the 2010 public stock offering that commenced on June 29, 2010.
Shareholders’ equity at December 31, 2010 was $16,655,947 compared to $13,250,690 at December 31, 2009. The increase is due to an increase in fair value of fixed maturity and equity security investments, available-for-sale net of applicable income taxes and proceeds from the public stock offering that commenced on June 29, 2010 of $3,362,325 less $486,730 of offering costs. Equity per common share outstanding and subscribed increased 17.1% to $2.54 as of December 31, 2010 compared to $2.17 per share at December 31, 2009, based upon 6,565,976 common shares outstanding and subscribed as of December 31, 2010 and 6,095,250 outstanding common shares as of December 31, 2009. These weighted average shares reflect the retrospective adjustment for the impact of the 5% stock dividend declared by the Company on January 10, 2011 and payable to holders of shares of the Company as of March 10, 2011.
The liquidity requirements of our life insurance company are met primarily by funds provided from operations. Premium deposits and revenues, investment income and investment maturities are the primary sources of funds, while investment purchases, policy benefits, and operating expenses are the primary uses of funds. There were no liquidity issues in 2010 or 2009. Our investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs.
We are subject to various market risks. The quality of our investment portfolio and the current level of shareholders’ equity continue to provide a sound financial base as we strive to expand our marketing to offer competive products. Our investment portfolio recovered from the disruptions in the capital markets and had unrealized appreciation on available-for-sale securities of $3,621,646 and $2,836,329 as of December 31, 2010 and 2009, respectively, prior to the impact of income taxes and deferred acquisition cost adjustments.
A primary liquidity concern is the risk of an extraordinary level of early policyholder withdrawals. We include provisions within our insurance policies, such as surrender charges, that help limit and discourage early withdrawals. Individual life insurance policies are less susceptible to withdrawal than annuity reserves and deposit liabilities because policyholders may incur surrender charges and undergo a new underwriting process in order to obtain a new insurance policy. Cash flow projections and cash flow tests under various market interest rate scenarios are also performed annually to assist in evaluating liquidity needs and adequacy. We currently anticipate that available liquidity sources and future cash flows will be adequate to meet our needs for funds.
One of the significant risks relates to the fluctuations in interest rates. Regarding interest rates, the value of our available-for-sale fixed maturity securities investment portfolio will increase or decrease in an inverse relationship with fluctuations in interest rates, while net investment income earned on newly acquired available-for-sale fixed maturity securities increases or decreases in direct relationship with interest rate changes. From an income perspective, we are exposed to rising interest rates which could be a significant risk, as TLIC's annuity business is subject to variable interest rates. The life insurance company's life insurance policy liabilities bear fixed rates. From a liquidity perspective, our fixed rate policy liabilities are relatively insensitive to interest rate fluctuations. Accordingly, we believe gradual increases in interest rates do not present a significant liquidity exposure for the life insurance policies. We maintain conservative durations in our fixed maturity portfolio. At December 31, 2010 cash and fixed-maturity investments with maturities of less than one year equaled 31.3% of total policy liabilities. If interest rates rise significantly in a short time frame, there can be no assurance that the life insurance industry, including the Company, would not experience increased levels of surrenders and reduced sales, and thereby be materially adversely affected.
In addition to the measures described above, TLIC must comply with the NAIC promulgated Standard Valuation Law ("SVL") which specifies minimum reserve levels and prescribes methods for determining them, with the intent of enhancing solvency. Upon meeting certain tests, which TLIC met during 2010 and 2009, the SVL also requires the Company to perform annual cash flow testing for TLIC. This testing is designed to ensure that statutory reserve levels will maintain adequate protection in a variety of potential interest rate scenarios. The Actuarial Standards Board of the American Academy of Actuaries also requires cash flow testing as a basis for the actuarial opinion on the adequacy of the reserves which is a required part of the annual statutory reporting process.
Our marketing plan could be modified to emphasize certain product types and reduce others. New business levels could be varied in order to find the optimum level. We believe that our current liquidity, current bond portfolio maturity distribution and cash position give us substantial resources to administer our existing business and fund growth generated by direct sales. We will service other expenses and commitments by: (1) using available cash, (2) dividends from TLIC which are limited by law to the lesser of prior year net operating income or 10% of prior year-end capital and surplus unless specifically approved by the controlling insurance department, (3) dividends from FTCC and (4) corporate borrowings, if necessary.
We have used the majority of our capital provided from the public stock offerings to expand the premium finance business and to acquire a life insurance company. The operations of TLIC may require additional capital contributions to meet statutory capital and surplus requirements mandated by state insurance departments. Life insurance contract liabilities are generally long term in nature and are generally paid from future cash flows.
On March 12, 2009, we entered into a senior revolving loan with a bank to loan up to $3,000,000 to provide working capital and funds for expansion. The loan was renewed on April 30, 2009 and modified to increase the revolving loan amount to $3,600,000. The loan agreement terminated on May 31, 2010 and was not renewed at our election. On July 21, 2009, FTCC borrowed $100,000 under the loan agreement and repaid $99,999 on November 4, 2009. The remaining $1 was repaid on May 31, 2010.
On June 29, 2010, we commenced a public offering of our common stock registered with the U.S. Securities and Exchange Commission and the Oklahoma Department of Securities. The public offering is for 1,333,334 shares of our common stock for $7.50 per share. We will receive $8.5 million after reduction for offering expenses and sales commissions if all the shares are sold. We have registered an additional 133,334 shares of our common stock to cover over subscriptions if any occur. The sale of all the additional shares would provide us with an additional $850,000 after reduction for offering expenses and sales commissions. The offering will end on June 28, 2011, unless all the shares are sold before then or the offering is extended. As of December 31, 2010, the Company has received gross proceeds of $3,362,325 from the sale of 448,310 shares of our common stock in this offering and incurred $486,730 in offering costs. The proceeds were originally deposited in an escrow account that was released from escrow by the Oklahoma Department of Securities in August 2010 after the offering exceeded $1,000,000 in gross proceeds. These proceeds are now available to us. Future proceeds from the sale of shares of our common stock in this public offering will be available to us without being held in escrow.
We are not aware of any commitments or unusual events that could materially effect our capital resources. We are not aware of any current recommendations by any regulatory authority which, if implemented, would have a material adverse effect on our liquidity, capital resources or operations.
We believe that our existing cash and cash equivalents at December 31, 2010 will be sufficient to fund our anticipated operating expenses. Loans outstanding from premium financing declined during 2009 and have continued to decline during 2010 as we have decreased production of premium financing contracts. The growth of the premium finance subsidiary is uncertain and will require additional capital if it grows. Funds will not be available to continue the expansion of the Company’s subsidiaries without borrowing funds or raising additional capital. As introduced above, we have begun a public offering to generate additional funding. We intend to use the proceeds to finance future acquisitions of life insurance companies or blocks of life insurance business, provide up to $2.0 million of capital and/or surplus to TLIC as needed to maintain adequate capital and increase working capital. We have based this estimate upon assumptions that may prove to be wrong and we could use our capital resources sooner than we currently expect.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements
Forward Looking Information
We caution readers regarding certain forward-looking statements contained in this report and in any other statements made by, or on behalf of, the Company, whether or not in future filings with the Securities and Exchange Commission. Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results or other developments. Statements using verbs such as "expect", "anticipate", "believe" or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements which represent our beliefs concerning future levels of sales and redemptions of our products, investment spreads and yields or the earnings and profitability of our activities.
Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and many of which are subject to change. These uncertainties and contingencies could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable factors and developments. Some of these may be national in scope, such as general economic conditions, changes in tax laws and changes in interest rates. Some may be related to the insurance industry generally, such as pricing competition, regulatory developments, industry consolidation and the effects of competition in the insurance business from other insurance companies and other financial institutions operating in our market area and elsewhere. Others may relate to the Company specifically, such as credit, volatility and other risks associated with our investment portfolio. We caution that such factors are not exclusive. We disclaim any obligation to update forward-looking information.
Item 8. Financial Statements
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2010 and 2009
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| Consolidated Financial Statements | Numbers |
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| Report of Independent Registered Public Accounting Firm | 23 |
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| Consolidated Statements of Financial Position | 24 |
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| Consolidated Statements of Operations | 25 |
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| Consolidated Statements of Changes in Shareholders’ Equity | 26 |
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| Consolidated Statements of Cash Flows | 27 |
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| Notes to Consolidated Financial Statements | 28 |
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and
Shareholders of First Trinity Financial Corporation
We have audited the accompanying consolidated statements of financial position of First Trinity Financial Corporation and Subsidiaries (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for the years then ended. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Trinity Financial Corporation and Subsidiaries as of December 31, 2010 and 2009, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
/s/ Kerber, Eck & Braeckel LLP
Springfield, Illinois
March 23, 2011
