UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 1998 Commission File Number: 001-14067
LINCOLN HERITAGE CORPORATION
(Exact name of registrant as specified in its charter)
TEXAS 36-3427454
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1250 Capital of Texas Highway
Austin, Texas 78746
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (512) 328-0075
Securities registered pursuant to
Section 12(b) of the Act: Common Stock, par value $.01
Name of exchange on which registered: Pacific Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 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. [ ]
State the aggregate market value of the voting stock held by
non-affiliates of the registrant: approximately $2,134,000 as of February 28,
1999.
Indicate the number of shares outstanding of each of the
registrant's classes of common stock, as of the latest practicable date: As of
February 28, 1999, 4,520,000 shares of Common Stock, par value $.01, were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The following document (or parts thereof) is incorporated by reference into the
indicated Part of this Report: Certain information required in Part III of this
Form 10-K is incorporated from the Registrant's Proxy Statement for its 1999
Annual Meeting of Shareholders.
PART 1
Item 1. Business
General
Lincoln Heritage Corporation (the "Company") is a life insurance
holding company engaged in the ownership and operation of life insurance
companies and related services. The Company also acquires existing life
insurance policies, either through direct purchase or the acquisition of
insurance companies. The Company's life insurance operations are conducted
through its wholly owned life insurance subsidiaries.
Substantially all of the Company's life insurance policies are issued
to fund prearranged funeral contracts that are sold by National Prearranged
Services, Inc. ("NPS") and National Prearranged Services Agency, Inc. ("NPS
Agency"). NPS is an affiliated company that collects all payments for
prearranged funeral contracts and remits; such amounts to the Company either
directly or through assumed reinsurance.
The Company was incorporated in Texas in 1980. The Company formed
Memorial Service Life Insurance Company ("Memorial") in 1986, acquired New Life
Insurance Company (formerly known as Lincoln Memorial Life Insurance Company) in
1992, and Lincoln Memorial Life Insurance Company (formerly known as World
Service Life Insurance Company of America) in 1998.
Effective December 31, 1998, the Company reorganized its insurance
company subsidiaries. The purpose of the reorganization was to streamline and
consolidate the Company's insurance operations and strengthen the existing
capital structure to facilitate the approval of acquisitions by regulatory
authorities. The reorganization was accounted for as a tax-free transaction and
had no impact on the consolidated financial statements. Concurrent with the
reorganization, the name of Lincoln Memorial Life Insurance Company was changed
to New Life Insurance Company ("New Life") and the name of World Service Life
Insurance Company of America was changed to Lincoln Memorial Life Insurance
Company ("Lincoln").
Effective September 1, 1997, the Company acquired a block of life
insurance and annuity policies from Woodmen Accident and Life Company (the
"Woodmen Block") for a purchase price of approximately $3.5 million. In
connection with this transaction, the Company assumed approximately $51 million
of insurance liabilities and received approximately $48 million in cash.
Effective April 1, 1998, the Company acquired a block of life insurance
and annuity policies through coinsurance from World Insurance Company (the
"World Block") for a purchase price of approximately $2.2 million. In connection
with this transaction, the Company assumed approximately $21.9 million of
insurance liabilities and received approximately $19.9 million in assets.
On May 15, 1998, the Company acquired all of the outstanding stock of
Lincoln for total consideration of $5.5 million. Lincoln had no active policies
in-force; however, Lincoln is licensed to conduct business in 42 states and the
District of Columbia. This acquisition expanded the number of states in which
the Company is licensed to conduct business.
On January 28, 1998, the Company executed a definitive stock purchase
agreement to acquire all of the outstanding stock of Harbourton Reassurance,
Inc. ("Harbourton") and subsequently filed an application to acquire control
with the insurance department in the State of Delaware. In March 1999, the
application was withdrawn by the Company, and a proposal to acquire Harbourton's
in-force business is pending.
Business Strategy
The Company's intended strategy is to grow its business by acquiring
blocks of in-force life insurance and annuity business and companies that have
blocks of such business. Any decision to acquire a block of business or an
insurance company will depend on the Company's assessment of various factors. No
assurance can be given that the Company will be successful in consummating any
acquisition, or that any acquisition, once completed, will ultimately enhance
the Company's results of operations.
The Company believes it is well positioned to enhance the profitability
of the businesses it acquires. The Company believes its investments in computer
and administrative capabilities will allow it to add additional blocks of
business and life insurance companies without a proportional increase in
operating expenses. In addition to such economies of scale through the
integration of systems and administration, the Company believes it can achieve
other cost savings through the elimination or reduction of management and staff,
home office and marketing expense where appropriate.
By contrast, the Lincoln acquisition was of a substantially
non-operating company acquired primarily for its state licenses. No significant
savings in expense were anticipated as a result of this transaction; however,
the Company believes the Lincoln acquisition afforded access to markets in 14
additional states more expeditiously and for a cost lower than that which would
be required if the Company's insurance subsidiaries had obtained licenses
themselves.
Another component of the Company's strategy is to grow by increasing
sales of its insurance to fund prearranged funeral contracts sold by NPS and
annuity products issued by its subsidiary insurers. In addition, the Company
believes its acquisitions may enhance its marketing capabilities by providing it
the opportunity to sell additional life insurance and annuity products to the
policyholders whose business it has acquired.
The Company currently markets insurance to fund pre-need products
through its affiliate, National Prearranged Services, Inc. ("NPS") and credit
life and disability products through independent agents.
The Company seeks to acquire in-force blocks of traditional life
insurance and annuity business and seeks products that do not strain the
Company's available statutory surplus. The Company seeks "seasoned" life
insurance business that has been in-force for several years in order to avoid
the higher rate of policy lapses and surrenders normally experienced in the
early years after issue. The assets supporting the business to be acquired are
of special concern. The Company seeks investment portfolios that are capable of
being restructured to provide yield and quality improvements consistent with the
Company's investment philosophy and reserving requirements.
In addition to the insurance product type, the Company considers
several other factors when evaluating an insurance company acquisition. Among
other things, the Company seeks to identify small-to-medium size insurers that
have relatively high operating and marketing expenses in relation to assets and
premiums and thereby provide significant opportunities to reduce such expenses
through application of the Company's cost reduction strategies.
Once the Company has identified a potential acquisition candidate it
will undertake a more detailed evaluation of the business of the company it
considers acquiring. The Company prepares an actuarial valuation of the in-force
business to determine if the business can produce profits that are consistent
with management's objectives. In connection with its normal investigation, the
Company will review claims experience, underwriting standards and mortality,
morbidity and other actuarial experience of the business. In addition, the
Company will assess the quality of the records kept and their compatibility with
the Company's computer systems in order to determine whether the business can be
assimilated by the Company in a timely and cost-effective manner.
The Company may effect its acquisitions through the purchase of shares,
if the acquisition candidate is an insurance company, or a reinsurance agreement
if the proposed acquisition concerns a block of business. In executing stock
acquisitions, the Company seeks to identify and manage acquire risks and other
liabilities through seller contractual indemnification and other techniques.
National Prearranged Services
NPS, an affiliate of the Company, has been in the business of marketing
prearranged funeral contracts since 1979 for funeral homes in Missouri, Texas
and six other states, and is licensed to expand into an additional 22 states. In
addition to marketing, NPS recruits, trains and manages an agency field force,
which is dedicated to selling only the products of the affiliated group of
companies. NPS believes that the market for preneed products is growing
significantly with the aging of the U.S. population. The market for preneed
products is primarily in the 50 and older age group. NPS's strategy is to
continue to capitalize on the demand for older age products, which management
believes, will continue to present a growing market.
The Company entered into an Exclusivity Agreement, dated April 1, 1998,
with NPS and NPS Agency, pursuant to which NPS and NPS Agency agreed to purchase
insurance policies to fund their prearranged funeral business exclusively from
the Company's subsidiaries. The Company agreed to pay, on a monthly basis, an
amount equal to 2% of the face amount of such insurance issued during the prior
month. The agreement expires in April 2003.
A prearranged funeral contract allows customers to purchase at current
prices services that may not be needed for many years. Under a prearrangement,
family members generally are removed from the planning that would otherwise have
been completed at the difficult time of death. However, by paying for the costs
of pre-planning, the client loses use of any cash paid that could have been
invested elsewhere. There is no affiliation between NPS and any funeral home for
which NPS markets prearranged funeral contracts.
In connection with issuing insurance policies to fund prearranged
funeral contracts, except in Missouri, the individual owner of the policy
assigns the policy to NPS and/or NPS Agency. As assignee, NPS and/or NPS Agency
remit premiums to and receive policy benefits from the Company. In the State of
Missouri, a trust (the "Trust") owns the policies, pays the premiums and
receives the benefits. An independent investment advisor to the Trust directs
the monies in the Trust as to the purchase of insurance policies.
NPS elects to invest in insurance policies as one of the methods of
funding such contractual obligations. NPS could invest in other statutorily
appropriate instruments to fund such obligations but like most other preneed
sellers today, prefers the use of insurance to do so. NPS determines whether to
purchase an insurance policy from the Company or use its own resources to
satisfy its obligations created under the prearranged funeral contract based on
the individual preneed laws in existence on the contract date and the
underwriting standards as established by the Company and the state in which the
purchaser resides. For example, in Missouri, the Trust may choose to retain the
funds from the prearranged funeral contract instead of purchasing an insurance
policy because of the underwriting standards set by the Company when compared to
the underwriting characteristics of the prearranged funeral contract purchaser.
The option to not purchase an insurance policy is not available in all states.
Should NPS elect to purchase an insurance policy equal to the current
cost of the contracted funeral, the insurance premiums to be charged are set by
the Company based on actuarial review and analysis of the underwriting risks
being assumed by the Company and the standardized rates are provided to NPS. In
the event a particular insurance policy has proceeds in excess of contracted-for
funeral costs at the point of death, NPS retains such proceeds as policyholder.
NPS (not the Company) is contractually obligated to provide the contracted-for
funeral service at the point of death. The death benefits provided under the
terms of the insurance policies may be greater than the cost of the funeral
services due to excess interest earnings or additional insurance benefits
provided under the terms of the participating policies or from a decline in the
funeral service costs as contracted by NPS from the funeral homes.
Product Profitability
The long-term profitability of insurance products depends on the
accuracy of the actuarial assumptions that underlie the pricing of such
products. Actuarial calculations for such insurance products, and the ultimate
profitability of such products, are based on four major factors: (i)
persistency; (ii) mortality (for life insurance); (iii) return on cash invested
by the insurer during the life of the policy; and (iv) expenses of acquiring and
administering the policies.
Operations and Administration
The Company emphasizes a high level of service to agents and
policyholders and strives to maintain low overhead costs. The Company's
principal administrative departments are its financial, policyholder services
and data processing departments. The financial department provides actuarial,
accounting and budgeting services and establishes cost control systems for the
Company. The policyholder services department reviews policy applications,
issues and administers policies and authorizes disbursements related to claims.
The data processing department oversees and administers the Company's
information processing systems.
The Company has invested in data processing hardware and software and
employs its data processing capacity in all facets of its operations. All of its
Austin, Texas and St. Louis, Missouri operations are processed on a network of
personal computers. The Company's administrative departments use a common
integrated system designed to permit the Company to function relatively
efficiently, control costs and maintain relatively low overhead. The Company's
system currently is servicing approximately 100,000 policies. Additional
policies can be added at a relatively low marginal cost, thereby increasing
economies of scale.
As part of its acquisition strategy, the Company has developed
management techniques to reduce costs by consolidating and standardizing the
procedures and data processing systems employed in the administration of
acquired companies and blocks of business. The Company believes that such
consolidation and standardization permits the efficient combination of the
facilities and operations of the Company with those of the companies and blocks
of business that it acquires. As a result, many duplicative costs connected with
training and employing personnel and with leasing or owning offices, marketing,
data processing equipment and other facilities are reduced or eliminated.
Investments
The investment income of the Company's insurance subsidiaries is an
important part of its total revenues. Profitability is significantly affected by
spreads between rates credited on insurance liabilities and interest rates
earned on invested assets. As of December 31, 1998, the average, annual interest
rate credited on the Company's total reserve liability was approximately 7.3%
per annum, and the average yield of the Company's investment portfolio was
approximately 8.6%. Increases or decreases in interest rates could increase or
decrease the interest rate spread between interest rates credited on insurance
liabilities and investment yields, which in turn could have a beneficial or
adverse effect on the future profitability of the Company. Sales of fixed
maturity securities that result in investment gains also may tend to decrease
future interest yields from the portfolio. State insurance laws and regulations
prescribe the types of permitted investments and limit their concentration in
certain classes of investments.
The Company's investment strategy is to maintain primarily an
investment grade, fixed maturity portfolio, provide adequate liquidity for
expected liability durations and other requirements and maximize total return.
Consistent with this strategy, the Company invests primarily in securities of
the U.S. government and its agencies, and collateralized mortgage obligations
("CMO's"). At December 31, 1998, approximately 85% of the book value of the
Company's fixed maturity investments consisted of investment grade securities.
From time to time when opportunities arise, however, limited amounts of below
investment grade securities may be purchased.
The Company periodically reviews the percentage of its portfolio that
is invested in below investment grade securities and intends to decrease the
percentage holdings of such securities below the December 31, 1998 level.
However, the Company's policies in this regard are affected by market and other
conditions and may change from time to time. While below investment grade
securities generally provide higher yields, they involve greater risks than
investment grade securities because their issuers typically are more highly
leveraged and more vulnerable to adverse economic conditions than investment
grade issuers. In addition, the trading markets for these securities are often
less liquid and efficient than the markets for investment grade securities.
Reserves
In accordance with applicable insurance laws, the Company's insurance
subsidiaries have established and carry as liabilities in their statutory
financial statements actuarially determined reserves to satisfy their annuity
contract and life insurance policy obligations. Reserves, together with premiums
to be received on outstanding policies and interest thereon at certain assumed
rates, are calculated to be sufficient to satisfy policy and contract
obligations. The actuarial factors used in determining such reserves are based
on statutorily prescribed mortality tables and interest rates.
The reserves recorded in the consolidated financial statements included
elsewhere in this report are calculated based on generally accepted accounting
principles ("GAAP") and differ from those specified by the laws of the various
states and recorded in the statutory financial statements of the Company's
insurance subsidiaries. These differences arise from the use of different
mortality tables and interest rate assumptions, the introduction of lapse
assumptions into the reserve calculation and the use of the net level premium
reserve method on all insurance business.
To determine policy benefit reserves for its life insurance products,
the Company performs periodic studies to compare current experience for
mortality, interest and lapse rates with projected experience used in
calculating the reserves. Differences are reflected currently in earnings for
each period. The Company historically has not experienced significant adverse
deviations from its assumptions.
Reinsurance
The Company enters into coinsurance/funds withheld treaties and
co/modco reinsurance agreements with reinsurers to increase its statutory
surplus. The cost of the increase in statutory surplus is recognized as
reinsurance premiums ceded. Consistent with the general practice of the life
insurance industry, the Company has reinsured portions of the coverage provided
by its insurance products with other insurance companies under agreements of
indemnity reinsurance. Reinsurance is not maintained with respect to products
currently marketed by Memorial. The policy risk retention limit on the life of
one individual does not exceed $50,000.
Indemnity reinsurance agreements are intended to limit a life insurer's
maximum loss on a particular risk or to obtain a greater diversification of
risk. Indemnity reinsurance does not discharge the primary liability of the
original insurer to the insured.
Competition
The life insurance industry is highly competitive and consists of a
large number of insurance companies, many of which have substantially greater
financial resources, broader and more diversified product lines and larger
staffs than those possessed by the Company. Competition also is encountered from
the expanding number of banks, securities brokerage firms and other financial
intermediaries that are marketing insurance products and that offer competing
products such as savings accounts and securities. Competition within the life
insurance industry occurs on the basis of, among other things, interest rates,
financial stability, policyholder service and ratings assigned by insurance
rating organizations.
Dividends on Participating Policies
The determination of dividends on participating policies is not
dependent on any pre-determined factor and is completely at the discretion of
the boards of directors of the insurance subsidiaries. Because the Company and
NPS are affiliated entities, NPS, as the policyholder of a significant portion
of the Company's business, may exercise significant influence over the decision
regarding the amount and timing of policyholder dividends. The insurance
subsidiaries paid no dividends in 1998, 1997 or 1996 on it's direct business.
Among other items, low levels of inflation were a factor for not paying
dividends. There currently are no plans for paying dividends on the Company's
direct business in the foreseeable future; however, dividends could be declared
should circumstances warrant. The most likely circumstance that may warrant the
declaration of policyholder dividends would be a significant increase in the
level of inflation. The declaration of policyholder dividends would, through the
provision of paid-up additions rather than cash dividends, provide additional
death benefits under the insurance policies. The increased level of death
benefits would contribute to covering the presumed increase in the cost of
funeral services to be provided in the future. The ability to provide increased
benefits under the terms of the insurance policies issued as a response to
increased levels of inflation, which, in turn, allows the Company to remain
competitive, is the primary reason for the utilization of participating
policies. The Company does pay policyholder dividends on the World Block and the
Woodmen Block. Such amounts were $90,335 for the year ended December 31, 1998.
Regulatory Factors
The Company's insurance subsidiaries are subject to regulation by the
insurance regulatory authorities in the states in which they are domiciled and
the insurance regulatory bodies in the other jurisdictions in which they are
licensed to sell insurance. The purpose of such regulation is primarily to
provide safeguards for policyholders rather than to protect the interests of
shareholders. The insurance laws of various jurisdictions establish regulatory
agencies with broad administrative powers relating to the licensing of insurers
and their agents, the regulation of trade practices, management agreements,
investments, deposits of securities, the form and content of financial
statements, rates charged by insurance companies, sales literature, terms of
insurance policies, accounting practices and the maintenance of specified
reserves, capital and surplus. The Company's insurance subsidiaries are required
to file detailed periodic financial reports with supervisory agencies in each of
the jurisdictions in which they do business. The Company's life insurance
subsidiaries are licensed in 42 states and the District of Columbia. In March
1998, the National Association of Insurance Commissioners ("NAIC") adopted the
Codification of Statutory Accounting Principles ("Codification"). The
Codification, which is intended to standardize regulatory accounting and
reporting for the insurance industry, is proposed to be effective January 1,
2001. However, statutory accounting principles will continue to be established
by individual state laws and permitted practices and it is uncertain when, or
if, the states in which the insurance companies are domiciled will require
adoption of Codification for the preparation of statutory financial statements.
In December 1992, the NAIC adopted the Risk-Based Capital for Life
and/or Health Insurers Model Act (the "Model Act"). The Model Act provides a
tool for insurance regulators to determine the levels of capital and surplus an
insurer must maintain in relation to its insurance and investment risks and
whether there is a need for possible regulatory attention. The Model Act (or
similar legislation or regulation) has been adopted in states where the
Company's insurance subsidiaries are domiciled. The Texas Department of
Insurance has adopted its own risk based capital requirements, the stated
purpose of which is to require a minimum level of capital and surplus to absorb
the financial, underwriting and investment risks assumed by an insurer. At
December 31, 1998, the total adjusted capital for each of the Company's
subsidiaries met or exceeded the required levels.
Most states have enacted legislation regulating insurance holding
companies. The insurance holding company laws and regulations vary by state, but
generally require an insurance holding company and its insurance company
subsidiaries licensed to do business in the state to register and file certain
reports with the regulatory authorities, including information concerning
capital structure, ownership, financial condition, certain intercompany
transactions and general business operations. State holding company laws also
require prior notice or regulatory agency approval of certain material
intercompany transfers of assets within the holding company structure.
As a holding company, the Company's ability to meet its financial
obligations and pay operating expenses depends on the receipt of sufficient
funds, primarily through dividends and management fees, from its subsidiaries.
As Texas domiciled insurance companies, Memorial, New Life, and Lincoln may not,
without the prior approval of the Texas Department of Insurance ("TDI"), pay any
dividend or distribution which, together with all other dividends and
distributions paid within the preceding 12 months, exceeds the lesser of: (i)
net gain from operations; or (ii) 10% of capital and surplus, in each case as
shown in its most recent annual statutory financial statements.
Under Texas law, Memorial, New Life, and Lincoln may not enter into
certain transactions, including management agreements and service contracts,
with members of its insurance holding company system, including the Company,
unless the insurance companies have notified the TDI of their intention to enter
into such transactions and the TDI has not disapproved of them within the period
specified by Texas law. Among other things, such transactions are subject to the
requirement that their terms be fair and reasonable and that the charges or fees
for services performed be reasonable.
As part of their routine regulatory oversight process, approximately
once every three to five years, state insurance departments conduct periodic
detailed examinations of the books, records and accounts of insurance companies
domiciled in their states. Memorial underwent such an examination during 1992
for the period ended December 31, 1991. New Life underwent such an examination
during 1992 for the period ended March 31, 1992. The final reports on the
examinations issued by the TDI did not raise any significant issues.
Examinations of the two insurance companies for the five-year period ended
December 31, 1997 commenced during the second quarter of 1998. Although the
final reports on such examinations have not yet been issued, the Company does
not anticipate that significant issues will be raised in the reports.
In October 1996, the TDI issued an order and letter to Memorial and New
Life, respectively, to comply with certain administrative and investment
guidelines, including those relating to permissible investments. Memorial and
New Life had invested a portion of their assets in derivative instruments in the
belief that these instruments were allowed under Texas insurance investment
guidelines. The Department alleged that these investments were not in compliance
with state guidelines. The Company complied with the Department's position,
immediately ceased investing in derivative instruments and liquidated its
existing portfolio with a net gain in excess of $1.0 million. In May 1997,
Memorial and New Life demonstrated to the Department that they had fully
complied with all applicable guidelines and regulations, the companies agreed to
furnish quarterly compliance reports to the Department and the Department
released the companies from the order. Subsequently, Texas investment
regulations were changed to allow investments in derivatives on a restricted
basis.
Employees
At December 31, 1998, the Company had approximately 70 employees. The
Company believes that it enjoys good relations with its employees and agents.
Glossary
The following are definitions of certain terms used in this Prospectus.
Where appropriate, in using such terms, the singular includes the plural,
masculine includes feminine and/or neuter, and vice versa.
"Actuarial valuation" means the appraisal of a block of insurance
business or an insurance company using the present value of future profits. The
present value of future profits is calculated by discounting projected earnings
using various actuarial assumptions such as estimations regarding future
mortality, expenses, interest rates, morbidity, cancellation rates, etc.
"Annuity policies" means a form of insurance under which premiums are
paid to purchase an anticipated periodic benefit payment to begin at some date
in the future.
"Blocks of in-force business" means groups of insurance policies in
effect.
"Co/modco reinsurance" means a combination of coinsurance and modified
coinsurance under which only a portion of the reserves are transferred to the
reinsurer and the ceding company retains the remaining portion of reserves.
Under most co/modco agreements, the amount of reserves transferred to the
reinsurer is equal to the initial ceding allowance thereby eliminating any
initial transfer of cash.
"Coinsurance" means a form of indemnity reinsurance under which
reserves as well as the risk are transferred to the reinsurer.
"Commissions" means amounts paid to agents under an agency agreement as
compensation for the sale of insurance policies.
"Deferred policy acquisition costs" means expenses that are
capitalizable under generally accepted accounting principles ("GAAP"). The
expenses must vary with the production of new business and must be primarily
related to the production of new business. Agents' first year commissions are,
by far, the largest single component of deferred policy acquisition costs.
"Funded preneed contract" means a preneed contract or a prearranged
funeral contract that has been fully paid for by the purchaser.
"Funds withheld agreements (treaties)" means reinsurance agreements
under which funds that would normally be paid to a reinsurer are withheld by the
ceding company to permit statutory credit for non-admitted reinsurance, to
reduce a potential credit risk or to retain control over investments. Under
certain conditions, the reinsurer may withhold funds from the ceding company.
"Future policy benefits" means a liability established to provide for
the payment of policy benefits that are to be paid in the future.
"GAAP benefit reserves" means a liability established to provide for
the payment of future policy benefits. The reserves are calculated as the excess
of the present value of future policy benefits over the present value of future
net premium payments. In order to calculate the present value of benefits and
net premiums, certain actuarial assumptions are made regarding various items
(including, without limitation, mortality, expenses, interest rates, lapse and
cancellation rates).
"Indemnity reinsurance" means a form of reinsurance under which
insurance risk is transferred from the ceding company to the reinsurer.
"Lapse and surrender rates" means the rates at which policies do not
renew by paying premiums that are due or by requesting that the policy be
cancelled for its surrender value.
"Lapse of insurance policies" means the non-renewal of an insurance
policy due to not paying the premiums when they come due.
"Limited pay policies" means the ordinary life insurance policies for
which the benefit period is longer than the premium paying period.
"Modified coinsurance" means a form of coinsurance under which the
reserves are retained by the ceding company while the risk is transferred to the
reinsurer. The ceding company is required to pay interest to replace that which
would have been earned by the reinsurer if it had held the reserve assets in its
own investment portfolio.
"Morbidity" means the statistical rate at which insureds become sick or
have an accident that results in a health insurance claim.
"Mortality" means the statistical rate at which insureds die.
"Net level premium reserve method" means a reserve calculation method
whereby the net premiums used for reserving purposes bears a constant
proportional relationship to the gross premiums being charged.
"Policy loan" means a loan made by an insurance company using the cash
surrender value of an insurance policy as collateral for the loan. The maximum
policy loan available will always be less than the cash value of the underlying
policy.
"Policyholder deposits" means under GAAP accounting practices and
procedures, premiums for annuity policies are classified as "Policyholder
deposits" rather than "Insurance premiums."
"Prearranged funeral contract" means an agreement under which a client
purchases funeral services to be performed at death. The cost of such funeral
services are equal to the cost at the time into which the prearranged funeral
contract is entered and does not change regardless of the date of death or
increases in the cost of funeral services to be provided.
"Preneed contract" means the same as "prearranged funeral contract."
"Reinsurance" means an arrangement under which one insurance company,
referred to as the reinsurer, for consideration, agrees to indemnify another
insurance company, referred to as the ceding company, against all or part of a
loss which the ceding company may incur under certain policies of insurance for
which it has liability.
"Reinsurance agreement" means the agreement used to effect a
reinsurance arrangement.
"Reinsurance treaty" means another term for "reinsurance agreement."
"Reserves" means a liability (or allocation of surplus) established to
provide for a certain level of assurance that enough assets will be available to
pay future policy benefits.
"Reserves for unearned premiums" means a liability established to
recognize portions of premiums that have been received by the insurance company
but are for insurance coverage extending beyond the close of the financial
reporting period.
"Retrocession reinsurance" means the transfer of reinsurance risk from
an assuming reinsurer to another insurance company.
"Single premium policies" means ordinary life insurance policies for
which single, lump-sum premiums are paid.
"Statutory accounting practices" means accounting procedures and
practices prescribed for insurance companies by the National Association of
Insurance Commissioners and as adopted by the various state insurance regulatory
bodies.
"Statutory capital and surplus" means shareholders' equity under
statutory accounting practices.
"Statutory financial statements" means financial statements produced
under statutory accounting practices and filed in each state that the insurance
company is licensed to do business.
"Statutory reserves" means reserves calculated according to statutory
prescribed methods using state mandated assumptions with regard to mortality and
interest rates.
"Underwriting standards" means standards set by an insurance company
under which an insurance applicant is reviewed in order for an insurance policy
to be issued.
Item 2. Properties
Memorial leases approximately 25,000 square feet in an office building
located at 10 S. Brentwood, St. Louis, Missouri under the terms of a lease that
expires in June 2002. Memorial also leases approximately 10,000 square feet of
property at 1250 Capital of Texas Highway, Building 3, Suite 100, Austin, Texas
under the terms of a lease that expires in August 2002. The Company believes
that the properties currently leased by Memorial are suitable for the current
operations of the Company and will allow for the expansion of the Company's
business in the near future. As the Company's operation expands, the leasing of
additional space in Austin, Texas may be necessary. The Company currently does
not foresee any material difficulties with leasing additional space that may be
required in the foreseeable future.
Item 3. Legal Proceedings
NPS, an affiliate of the Company, along with New Life have been named
defendants in a previously dismissed class-action lawsuit that was refiled
during 1996 in St. Louis, Missouri, City Circuit Court. The suit involves a
challenge to NPS's methods of funding pre-arranged funeral contracts with
policies issued by the Company. The suit contains no specified dollar amount for
damages. Both the Company and NPS believe that the claims are without merit and
a motion is pending to dismiss New Life from the case. The Company does not
believe the outcome of this lawsuit will have a material adverse effect on its
financial condition, results of operations or cash flows.
On December 31, 1998, a suit was filed in the U.S. District Court in
Galveston, Texas against the Company, along with Memorial and New Life alleging
trademark infringement regarding the use of the name "Lincoln Heritage". The
suit seeks enjoinment from the use of the name "Lincoln Heritage." The suit
contains no specified dollar amount for damages. The Company believes the claims
are defensible and without merit. The Company does not believe the outcome of
the lawsuit will have a material adverse effect on its consolidated financial
condition, results of operations or cash flows.
The Company also is subject to various other claims and contingencies
arising out of the normal course of business. The Company believes that the
total amounts that will ultimately be paid, if any, arising from these claims
and contingencies will not have a material adverse effect on its financial
condition, results of operations or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 4A. Executive Officers of the Registrant
See Part III, Item 10.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Market Price of Common Stock
The Company's Common Stock is traded on the Pacific Stock Exchange
under the symbol "LHC". The range of high and low sale prices for the Company's
Common Stock for the period from November 2, 1998 (the closing date of the
Company's initial public offering) through December 31, 1998, was $7.50 and
$5.80, respectively.
As of February 28, 1999, the approximate number of stockholders of
record of Common Stock was 810 which included approximately 807 beneficial
holders of the Common Stock, representing persons whose stock is in nominee or
"street name" accounts through brokers.
Dividend Policy
The Company has never declared, nor has it paid, any cash dividends on
its Common Stock. The Company currently intends to retain its earnings to
finance future growth and, therefore, does not anticipate paying any cash
dividends on its Common Stock in the foreseeable future. The Board of Directors
also plans to regularly review the Company's dividend policy. The Company's
ability to pay dividends will be dependent, in large measure, on its ability to
receive dividends and management fees from its life insurance subsidiaries. The
ability of these corporations to pay dividends and management fees, in turn, is
limited pursuant to applicable insurance laws. Any future determination as to
the payment of dividends will be at the discretion of the Board of Directors of
the Company and will depend on a number of factors, including future earnings,
capital requirements, financial condition and such other factors as the Board of
Directors may deem relevant.
Recent Sales of Unregistered Securities
None.
Item 6. Selected Financial Data
Selected Consolidated Financial and Other Data
The following historical summary consolidated financial information has
been derived from the consolidated financial statements of the Company. This
selected financial data should be read in conjunction with the accompanying
consolidated financial statements of the Company and the related notes included
herein, and the information set forth under "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997(1) 1996 1995 1994
(amounts in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of operations data:
Premium income $ 41,363 $ 38,044 $ 33,274 $ 27,354 $ 24,001
Net investment income and realized gains 12,575 8,838 5,729 4,514 3,908
Other revenue 748 - - - -
--------- --------- --------- --------- ---------
Total revenues 54,686 46,882 39,003 31,868 27,909
Benefits incurred 33,088 31,151 24,750 20,775 19,563
Other expenses (2) 19,142 13,404 13,351 9,625 11,848
--------- --------- --------- --------- ---------
Income (loss) before federal taxes 2,456 2,327 902 1,468 (3,502)
Income taxes (benefits) 440 672 197 317 (610)
--------- --------- --------- --------- ----------
Net income (loss) $ 2,016 $ 1,655 $ 705 $ 1,151 $ (2,892)
========= ========= ========= ========= =========
Weighted average shares outstanding
Basic 4,087 4,000 4,000 4,000 4,000
Diluted 4,190 4,000 4,000 4,000 4,000
Earnings (loss) per share:
Basic $ .49 $ .41 $ .18 $ .29 $ (.72)
Diluted .48 .41 .18 .29 (.72)
December 31,
1998(1)(3) 1997(1) 1996 1995 1994
---------- --------- --------- --------- ----------
Balance sheet data:
Invested assets $ 133,831 $ 120,041 $ 59,919 $ 56,082 $ 43,608
Total assets 164,073 141,603 76,149 71,884 60,196
Total policy liabilities 152,425 130,450 73,067 68,432 62,391
Shareholders' equity (deficit) 8,815 6,883 1,856 2,713 (2,508)
- - ----------
</TABLE>
(1) Comparison of selected consolidated financial data in the table above is
significantly affected by the assumption through coinsurance of a block of
life and annuity business from Woodmen Accident and Life Company effective
September 1, 1997. The Company received $48,025 in cash in exchange for
assuming $50,857 in insurance liabilities. For the year ended December 31,
1998, amounts related to the Woodmen Block included premiums of
approximately $58, investment income of approximately $1,227 for interest
earned on the assets purchased with the cash received, benefits incurred of
approximately $909 in interest paid on policyholder deposits and increase
in future policy benefits. As of December 31, 1998, invested and total
assets included approximately $41,657 and policy liabilities included
approximately $42,048 associated with the Woodmen Block.
(2) Other expenses for the years ended December 31, 1998 and 1997 are net of
expense reimbursements from NPS in the amount of $2,254 and $2,695,
respectively.
(3) Comparison of selected consolidated financial data in the table above is
also affected by the assumption through coinsurance of a block of life and
annuity business from World Insurance Company effective on April 1, 1998.
The Company received $19,941 in assets in exchange for assuming $21,910 in
insurance liabilities. During 1998, the Company retroceded, through a
coinsurance agreement, 50% of the life insurance assumed from the purchase
of the World Block to Alabama Reassurance Company. As of December 31, 1998,
invested and total assets included approximately $22,200 and policy
liabilities included approximately $21,800 associated with the World Block.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following should be read in connection with the Company's
consolidated financial statements and related notes, and other financial
information included elsewhere in this report.
Overview
The Company is a holding company for operating subsidiaries that
consist primarily of life insurance companies. The life insurance companies
primarily write policies sold by the Company's affiliate, NPS, in connection
with NPS's sale of prearranged funeral contracts. As a result of the growth in
the amount of pre-arranged funeral contracts sold by NPS over the past three
years, the Company's revenues have increased significantly. The Company's growth
also resulted, to a lesser extent, from the 1997 acquisition of the Woodmen
Block and the World Block (in-force insurance policies and annuities) in 1998.
The Company's revenues are derived primarily from premiums on insurance
policies generated by NPS. In the event of a decline in NPS's preneed sales, the
Company's future revenue growth could be impacted in the event that the Company
could not replace the NPS sales force with its own or another marketing entity's
sales force. Net investment income and realized investment gains also have
contributed significantly to total revenues as the Company's invested assets
have grown.
The Company's expenses consist principally of benefits paid or accrued,
commissions on the sale of policies and general and administrative costs
associated with life insurance company operations. The Company anticipates that
benefit costs and commissions will continue to increase as the Company executes
its growth plans. Although general and administrative costs have increased in
accordance with the growth in the Company's business, the Company believes its
infrastructure will support increasing levels of internal revenue growth without
the need for general and administrative expenses to increase at a similar rate.
The Company's insurance subsidiaries are subject to a high degree of
regulation from various state insurance administrators. Such regulation governs
(among other things): investment policies; financial reporting; capital
adequacy; terms of policies; and the ability of the Company's subsidiaries to
pay dividends and management fees to the Company. In addition, NPS's activities
in selling prearranged funeral contracts are highly regulated in the states in
which NPS does business. These regulatory aspects and future changes therein
could materially affect the Company's financial condition and results of
operations. See "Business - Regulatory Factors."
The Company's strategy is to increase shareholder value by growing its
insurance business through: (i) selected acquisitions of life insurance
companies and in-force life insurance policies and annuities; and (ii) increases
in life insurance policies arising out of prearranged funeral contracts sold by
NPS. The Company's ability to acquire such companies and policies will be
dependent upon (among other things) its ability to identify, negotiate and
complete transactions of favorable values, arrange necessary financing and
integrate and manage the acquisitions after completion, including preserving
customer relationships. There can be no assurance that the Company will
successfully execute its strategy.
Results of Operations
Comparison of the Years Ended December 31, 1998 and 1997. Premium
income increased $3.3 million, or 9%, from $38.0 million in the year ended
December 31, 1997 to $41.4 million in the year ended December 31, 1998, due to
higher sales volumes. Substantially all premium income was derived from NPS. The
fact that premium income increased only 9%, while the face amount of insurance
in-force increased 15.9 % reflected a shift in the relative proportions of
policies sold from single pay to limited pay business which is ultimately more
profitable to the Company.
Net investment income increased $4.4 million, or 72%, from $6.2 million
in the year ended December 31, 1997 to $10.6 million in the year ended December
31, 1998. This increase was attributable to a higher level of invested assets
(primarily resulting from the Woodmen Block and the World Block). Invested
assets increased by 11% in 1998 compared to 1997. There was a larger increase in
investment income due to the addition of the Woodmen Block late in 1997.
Net realized gains decreased $730,000, or 27%, from $2.7 million in the
year ended December 31, 1997 to $1.9 million in the year ended December 31,
1998. Gains were recognized in the year ended December 31, 1998, on sales of
invested assets. However, these gains were partially offset by losses of
approximately $1.0 million realized on the sale of certain investments whose
market values declined significantly due to announcements of operating and
financial difficulties of the issuers of these investments.
Other revenue for the year ended December 31, 1998 of $749,000
represents primarily a gain on the sale of a portion of the Company's in-force
life business.
Benefits increased $1.9 million, or 6%, from $31.2 million in the year
ended December 31, 1997 to $33.1 million in the year ended December 31, 1998,
due to increases in death benefits and surrender benefits in proportion to the
increases in overall policies in-force, increases in future policy benefits due
to higher levels of policies in-force, and interest credited to policyholder
accounts for the Woodmen Block and the World Block. These increases were
partially offset by decreases in future policy benefits due to the impact of the
surrenders and deaths.
Surrenders increased from the year ended December 31, 1997 to the year
ended December 31, 1998 by $3.1 million. This increase in surrenders was offset
by a corresponding change in the increase in future policy benefits. Surrenders
generally have little impact on current year operations due to the fact that
surrender benefits are fully reserved and as surrender benefits are paid the
reserve for future policy benefits is reduced by a corresponding amount. The
more significant effect on operations occurs in future years when the Company
loses future investment earnings on the business surrendered.
Commissions increased $5.7 million, or 51%, from $11.2 million in the
year ended December 31, 1997 to $16.9 million in the year ended December 31,
1998, due primarily to higher volumes of new policies when compared to the year
ended December 31, 1997.
General expenses, net of reimbursements, increased $2.5 million, or
100%, from $2.5 million in the year ended December 31, 1997 to $5.0 million in
the year ended December 31, 1998, due primarily to increased policy
administration and general and administration expenses as a result of increased
volume of business from new policies written, acquisitions of blocks of policies
such as the purchase of the Woodmen Block and the World Block, support for
increased levels of acquisition activities and regulatory reporting
requirements, and deferred compensation costs associated with the Company's
Long-Term Incentive Plan established in 1998.
Taxes, licenses, and fees increased $166,000, or 21%, from $782,000 in
the year ended December 31, 1997 to $948,000 in the year ended December 31,
1998, due primarily to fees associated with the routine regulatory examination
of the Company's insurance company subsidiaries which commenced in March 1998,
additional fees associated with the Lincoln acquisition as well as increased
taxes due to an increase in collected premiums.
An increase in the amortization of the cost of policies purchased of
$712,000 for the year ended December 31, 1998, compared to $262,000 for the year
ended December 31, 1997, was primarily attributable to the purchase of the
Woodmen Block and the World Block.
The increase in the change in deferred acquisition costs of $2.9
million from $1.4 million for the year ended December 31, 1997, to $4.3 million
for the year ended December 31, 1998, was due to the capitalization of the costs
of acquiring new business at a higher rate than the amortization of such costs
due to a higher volume of new policies issued.
As a result of the foregoing, net income for the year ended December
31, 1998 was $2.0 million, or $0.49 and $0.48 per basic and diluted share,
respectively, an increase of 22%, 20% and 17%, respectively, over the prior
year.
Comparison of the Years Ended December 31, 1997 and December 31, 1996.
Premium income increased $4.7 million, or 14%, from $33.3 million in 1996 to
$38.0 million in 1997 due to an increase in the amount of new business written.
The increase in new business written was primarily the result of increases in
prearranged funeral contracts sold by NPS. Such sales increased due to an
expansion of NPS's sales force. In addition, during 1997, the Company and NPS
agreed to retroactively increase premiums charged on certain policies issued by
the Company. Such additional premiums included in revenues for the year ended
December 31, 1997 were $339,828.
Net investment income and net realized gains increased $3.1 million, or
54%, from $5.7 million in 1996 to $8.8 million in 1997. This increase was
attributable to a higher level of average invested assets (primarily resulting
from the Woodmen Block) and a more actively managed investment portfolio.
Average invested assets increased $31.7 million, or 56%, from $56.5 million in
1996 to $88.2 million in 1997.
Benefits incurred increased $6.4 million, or 26%, from $24.8 million in
1996 to $31.2 million in 1997 primarily due to an overall increase in business
in-force and interest credited to policyholder accounts related to the
acquisition of the Woodmen Block.
Surrenders decreased from 1996 to 1997 by $5.1 million. This decrease
in surrenders was offset by a corresponding change in the increase in future
policy benefits. Surrenders generally have little impact on current year
operations due to the fact that surrender benefits are fully reserved and as
surrender benefits are paid the reserve for future policy benefits is reduced by
a corresponding amount. The more significant effect on operations occurs in
future years when the Company loses future investment earnings on the business
surrendered.
The Company's insurance subsidiaries have an agents' contract (the
"Contract") with NPS and NPS Agency that obligates the Company to pay first-year
and renewal commissions on policies written by NPS and NPS Agency.
Prior to January 1, 1997, the Contract called for maximum first-year
commissions of up to 23% of the face amount of policies submitted and renewal
commissions of up to 2% of the face amount of issued policies remaining in-force
in years two though six. In order to better match the commissions paid with the
profitability of the underlying polices, effective January 1, 1997, the Company,
NPS and NPS Agency agreed to amend the Contract to provide for increased
first-year commissions of up to 31.5% of the face amount on single premium
policies and terminate payments of renewal commission on policies issued on or
before December 31, 1995. The effect of the amended agreement was a reduction in
the increase in future policy benefits of $1.1 million on policies issued in
1997 and this effect net of $332,000 of income tax expense was reflected as an
increase in additional paid-in capital for the year ended December 31, 1997.
Other expenses remained relatively unchanged from 1996 to 1997;
however, this was a result of three offsetting factors: (i) policy
administration and general expenses increased $1.2 million as a result of the
acquisition of the Woodmen Block, (ii) general and administrative expenses
decreased due to the initiation of a cost sharing agreement between the Company
and NPS, whereby NPS reimbursed the Company $2.7 million for a portion of its
general and administrative expenses attributable to NPS's business (the $2.7
million was based on costs incurred by the Company in 1997 for the direct
benefit of NPS); and (iii) commissions increased $1.2 million due to higher
sales levels. The Company and NPS are affiliated companies. NPS was formed
earlier than the Company and, as such, NPS assisted in the development of the
Company. As the companies grew, and with the anticipation of the addition of
outside shareholders, a more formal relationship among the entities became
advisable, which resulted in the development of the cost sharing arrangement.
See Note 11 to the consolidated financial statements of the Company.
Net income for the year ended December 31, 1997 was $1.7 million, or
$0.41 per basic and diluted share, an increase of 135% and 128%, respectively,
over the prior year.
Liquidity and Capital Resources
The Company's insurance subsidiaries generally generate sufficient cash
receipts from premium collections and investment income to satisfy the Company's
obligations. The Company believes that the diversity of the investment portfolio
of its insurance subsidiaries provides sufficient liquidity to meet its
operating cash requirements.
Assets with a fair value of approximately $11.7 million at December 31,
1998 were on deposit with various state regulatory authorities. Assets with a
fair value of approximately $55.1 million at December 31, 1998 were restricted
as to use from the purchase of the Woodmen Block, the World Block and other
assumed business. See "Business -- Regulatory Factors."
The Company's insurance subsidiaries are restricted by state insurance
laws as to the amount of dividends that they may pay to the Company without
prior notice to, or in some cases prior approval from, their respective state
insurance departments. These restrictions on dividend distributions are based on
statutory capital and surplus and operating earnings. Statutory surplus and
statutory operating results are determined according to statutes adopted by each
state in which the subsidiaries do business. Statutory surplus bears no direct
relationship to equity as determined under generally accepted accounting
principles.
The Company's cash requirements for 1999 and in the future will depend
upon mortality experience, acquisitions, timing of expansion plans and capital
expenditures. Pursuant to its initial public offering in November 1998, the
Company issued 520,000 shares of common stock and realized net proceeds of $2.6
million. The Company believes that interest earned on the net proceeds and
anticipated revenue from operations should be adequate for the Company's working
capital requirements of its existing business over the next twelve months. In
the event that the Company's plans or assumptions change, or if its requirements
to meet unanticipated changes in business conditions prove to be insufficient to
fund operations, the Company could be required to seek additional financing
prior to that time.
Changes in the Company's consolidated balance sheet between December
31, 1998 and December 31, 1997, reflect growth through operations, changes in
the fair value of actively managed fixed maturity and equity securities, changes
in the investment portfolio mix and the purchase of the World Block.
Total cash and investments increased approximately $13.8 million from
$120.0 million at December 31, 1997 to $133.8 million at December 31, 1998,
primarily due to investment assets acquired with the purchase of the World Block
of $20 million. During 1998 there was an increase in policyholder loans to
related parties of $5.8 million due to a change in investment strategy by NPS
offset by the cancellation of policies associated with the Woodmen Block. Due to
the low risk nature of these policy loans and their contract interest rates, the
Company believes they afford comparable risk-adjusted returns to alternative
categories of invested assets. The policy loans are fully secured by the
nonforfeiture values of the policies so that, in the event of default, the
Company would not be adversely affected, except with respect to the future loss
of revenues on the policies cancelled. Changes in the separate components of
investment assets are due to the portfolio mix of the Company's investment
assets and changes in the fair value of balances in actively managed fixed
maturity and equity securities. See Note 4 to the Consolidated Financial
Statements of the Company.
Receivables from related parties increased $1.1 million from $478,000
at December 31, 1997 to $1.5 million at December 31, 1998, due primarily to
receivables due under the Company's cost sharing agreement with NPS.
Deferred policy acquisition costs increased approximately $4.3 million
from $12.6 million at December 31, 1997 to $16.9 million at December 31,1998,
due to increases in new policies issued and in-force.
Fixed assets increased approximately $550,000 from $650,000 at December
31, 1997 to $1.2 million at December 31, 1998, due to expenditures for furniture
and equipment due to the expansion of the Company's operations and ongoing
development and modifications to the Company's software system.
Cost of policies acquired increased approximately $584,000 from $3.2
million at December 31, 1997 to $3.8 million at December 31, 1998, due to the
acquisition of World Block offset by the amortization of costs.
Goodwill increased approximately $640,000 from $773,000 at December 31,
1997 to $1.4 million at December 31, 1998, due to the Lincoln acquisition and
other asset acquisitions.
Future policy benefits increased approximately $16.4 million from $87.8
million at December 31, 1997 to $104.2 million at December 31, 1998. This
increase was due to an increase in the amount of new policies issued and the
acquisition of the World Block.
Policyholder deposits increased approximately $5.6 million from $41.6
million at December 31, 1997 to $47.2 million at December 31, 1998. Policyholder
deposits are comprised primarily of annuities acquired with the Woodmen Block
and the World Block. The increase was due to the acquisition of the World Block
on April 1, 1998, offset by cancellations of policies and the absence of the
issuance of new annuity policies.
The increase in shareholders' equity reflects the net proceeds from the
Company's initial public offering of $2.6 million and earnings in 1998 of $2.5
million, offset by the increase in net unrealized depreciation on securities
held available-for-sale of $2.8 million.
During 1998 and 1996, the Company paid surrender benefits to NPS or the
Trust of approximately $2.0 million and $5.0 million, respectively. Upon
surrender, NPS purchased new policies for the same insureds using a portion of
the surrendered funds. NPS has committed to the Company to pay all future
premiums due on the blocks of policies that were reissued.
Impact of Year 2000
Many current installed computer systems and software products are coded
to accept only two-digit entries in the date code field and cannot reliably
distinguish dates beginning on January 1, 2000 from dates prior to the year
2000. Many companies' software and computer systems may need to be upgraded or
replaced in order to correctly process dates beginning in 2000.
Company Readiness
The Company's information technology personnel recently assessed the
Company's readiness to manage Year 2000 issues. This included a review of all
current computer systems in use, as well as communications with significant
vendors and other third parties to determine the extent to which the Company's
operations are vulnerable to third parties' failure to correct their own Year
2000 issues. Based on the overall assessment performed, the Company has
determined that it will not need to significantly modify or replace any of its
current systems in order to comply with Year 2000 issues. In addition, based
upon communications with significant vendors and other third parties, the
Company is not aware of any material impact from their systems relating to the
transition to the Year 2000. However, the Company has no means of ensuring that
these entities will be Year 2000 ready. The inability of third parties to
complete their Year 2000 programs in a timely manner could materially impact the
Company. The effect of non-compliant third parties is not determinable.
Year 2000 Costs
The Company's total costs of Year 2000 efforts to date and future
anticipated costs have not and are not expected to be material.
Risks Associated with the Company's Year 2000 Issues
The Company expects its internal systems to be Year 2000 compliant and
believes that the worst case scenario would result from vendors or other third
parties failing to achieve Year 2000 compliance. Due to the general uncertainty
inherent in the Year 2000 problem, the Company cannot predict whether the
consequence of Year 2000 failures will have a material adverse effect on the
Company's business, financial condition or results of operations. However, based
on the Company's assessment of its internal systems, communications with
significant vendors and other third parties, the Company does not expect Year
2000 problems to result in a material adverse effect on the Company's financial
position, results of operations or cash flows.
Forward-Looking Statements
This report contains forward-looking statements within the meaning of
the "safe harbor" provisions of the Private Securities Litigation Reform Act of
1995. Such forward-looking statements are based on the beliefs of the Company's
management as well as on assumptions made by and information currently available
to the Company at the time such statements were made. The Company can give no
assurance that the expectations indicated by such forward-looking statements
will be realized. If any of management's assumptions should prove incorrect, or
if any of the risks and uncertainties underlying such expectations should
materialize, the Company's actual results may differ materially from those
indicated by the forward-looking statements.
The following factors that are not within the Company's control and
that may have a direct bearing on operating results include, but are not limited
to: (i) general economic conditions and other factors, including prevailing
interest rate levels and stock market performance, which may affect the ability
of the Company to sell its products, the market value of the Company's
investments and the lapse rate and profitability of the Company's policies; (ii)
the Company's ability to achieve anticipated levels of operational efficiencies
at recently acquired companies, as well as through other cost-saving
initiatives; (iii) mortality, morbidity, and other factors which may affect the
profitability of the Company's insurance products; (iv) changes in the federal
income tax laws and regulations which may affect the cost of or demand for the
Company's products; (v) increasing competition in the sale of the Company's
products; (vi) regulatory changes or actions, including those relating to
regulation of financial services affecting (among other things) bank sales and
underwriting of insurance products, and regulation of the sale, underwriting and
pricing of insurance products; (vii) the availability and terms of future
acquisitions; and (viii) the risk factors or uncertainties listed in the
Company's other filings with the Securities and Exchange Commission.
Additionally, the Company may not be successful in identifying,
acquiring, and integrating other companies or their business, implementing
improved management and accounting information systems and controls and may be
dependent upon additional capital and equipment purchases for future growth.
There may be other risks and uncertainties that management is not able to
predict.
When used in this report, the words "anticipate," "believe,"
"estimate," "expect," "intends," and similar expressions, as they relate to the
Company are intended to identify forward-looking statements, although there may
be certain forward-looking statements not accompanied by such expressions.
Accounting Standards
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting
Comprehensive Income. SFAS No. 130 establishes standards for the reporting and
display of comprehensive income and its components (revenues, expenses, gains
and losses) in a full set of general purpose financial statements. SFAS No. 130
states that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. Comprehensive income is defined as the total of net income and all
other non-owner changes in equity. SFAS No. 130 is effective for fiscal years
beginning after December 15, 1997. Restatement of financial statements for
earlier periods provided for comparative purposes is required. SFAS No. 130 had
no impact on the financial condition or results of operations of the Company,
but required changes in the Company's disclosure and presentation requirements.
The principal change was the disclosure of the components of total comprehensive
income within the Consolidated Statements of Shareholders' Equity.
In June 1997, the FASB issued SFAS No. 131 Disclosures About Segments
of an Enterprise and Related Information. SFAS No. 131 establishes standards for
disclosures related to business operating segments. SFAS No. 131 had no
significant effect on the disclosures set forth in the Company's Consolidated
Financial Statements.
In December 1997, the American Institute of Certified Public
Accountants issued Statement of Position 97-3 Accounting by Insurance and Other
Enterprises for Insurance-related Assessments (SOP 97-3). SOP 97-3 provides
guidance for determining when an insurance company or other enterprise should
recognize a liability for guaranty-fund assessments and guidance for measuring
the liability. SOP 97-3 is effective for financial statements of fiscal years
beginning after December 15, 1998. The Company anticipates that the adoption of
SOP 97-3 will not have a material effect on the Company's financial position,
results of operations or cash flows.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133 requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. Changes in the
fair value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designed as part of a
hedge transaction, and if it is, the type of hedge transaction. SFAS No. 133 is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
The Company is assessing the impact that the adoption of SFAS No. 133 will have
on its consolidated financial statements, but does not expect such
implementation to have a material adverse effect on its financial position,
results of operations or cash flows.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss arising from adverse changes in market
rates and prices. The Company's primary market risk exposures are to changes in
interest rates, although the Company also has certain exposures to changes in
equity prices. The Company has no foreign exchange risk and no direct commodity
risk. The active management of market risk is integral to the Company's
operations. To manage exposure to market risk, the Company may rebalance its
existing asset or liability portfolios, change the character of its existing
asset or liability portfolios, change the character of future investments
purchased or use derivative instruments to modify the market risk
characteristics of existing assets and liabilities or assets expected to be
purchased. The Company's market risk sensitive instruments are entered into for
purposes other than trading.
The Company has investment guidelines that define the overall framework
for managing market and other investment risks, including the accountability and
control over these activities. In addition, the Company has specific investment
policies for each of its subsidiaries that delineate the investment limits and
strategies that are appropriate given each entity's liquidity, surplus and
regulatory requirements.
Interest Rate Risk
Interest rate risk is the risk that the Company will incur economic
losses due to adverse change in interest rates. This risk arises from many of
the Company's primary activities, as the Company invests substantial funds in
interest-sensitive assets and also has certain interest sensitive liabilities in
its life and annuity operations.
The Company seeks to invest premiums and deposits to create future cash
flows that will fund future claims, benefits and expense, and earn stable
margins across a wide variety of interest rate and economic scenarios. In order
to achieve this objective and limit its exposure to interest rate risk, the
Company adheres to a philosophy of managing the duration of assets and related
liabilities.
The carrying value of the Company's investment portfolio as of December
31, 1998 was $133.8 million, of which 49% was invested in fixed maturity
securities. The primary market risk to the investment portfolio is interest rate
risk associated with investments in fixed maturity securities. A 100 basis point
decrease in interest rates would have increased anticipated earnings from
operations for the year ended December 31, 1998 by approximately $500,000, which
amount represents the increase of investment income on the Company's investment
portfolio. The effect on the market value of the portfolio would be to increase
the value by approximately $2.5 million. The reverse effect would result if
interest rates increased by 100 basis points.
The impact of a change in interest rates to the fair value of the Company's
policyholder deposits would be immaterial due to the Company's ability to vary
credited interest rates on annuity policies. The liability for future policy
benefits of $104.2 million is affected by anticipated investment earnings, but
such liability has been excluded from our analysis because it is not considered
to be a financial instrument.
Equity Price Risk
Equity price risk is the risk that the Company will incur economic
losses due to adverse changes in a particular stock or stock index. At December
31, 1998, the Company had approximately $7.1 million, or less than 6% of its
cash and investments, invested in equity securities. The effect of a ten percent
change in equity prices would not materially impact the Company's financial
position, results of operations or cash flows.
Seasonality
Historically, the Company's revenues and operating results have varied
from quarter to quarter and are expected to continue to fluctuate in the future.
These fluctuations have been due to a number of factors, including a higher
mortality rate of the Company's insureds during the winter months.
Item 8. Financial Statements and Supplementary Data
Reference is made to the financial statements listed under the heading
"(a)1. Consolidated Financial Statements" of Item 14 hereof, which financial
statements are incorporated herein by reference in response to this Item 8.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Information regarding the change of accountants for the Company is
contained in "Independent Public Accountants" in the Registrant's Proxy
Statement for the 1999 Annual Meeting of Shareholders, which information is
incorporated herein by reference.
PART III
Item 10. Directors and Executive Officers of the Registrant
Information regarding the directors of the Company is contained under
"Election of Directors" and "Voting Securities and Principal Holders Thereof"
included in the Registrant's Proxy Statement for the 1999 Annual Meeting of
Shareholders, which information is incorporated herein by reference.
The following is a list, as of February 28, 1999, of the names and ages
of the executive officers of the Company and all positions and offices with the
Company presently held by the person named. There is no family relationship
between any of the named persons.
The name, age and position with respect to each of the executive
officers of the Company are set forth below:
Nicholas M. Powling, 50, has been a director, the President and the
Chief Executive Officer of the Company since April 1996. Prior to joining the
Company, Mr. Powling was the Chief Financial Officer for Bankers Protective Life
Insurance Company in Austin, Texas from April 1993 to March 1996. Prior thereto,
Mr. Powling served as Vice President of Finance and then Vice President of
Mergers and Acquisitions at Associated Insurance Companies Inc. in Indianapolis,
Indiana from 1982 to 1993.
Clifton Mitchell, 47, joined the Company in February 1998. Immediately
prior to that date, Mr. Mitchell owned C. Mitchell Company, Inc. an actuarial
consulting firm, and was the Company's consulting actuary. Mr. Mitchell is a
Fellow of the Society of Actuaries, a Member of the American Academy of
Actuaries and a Fellow of the Conference of Consulting Actuaries and has been a
consulting actuary in private practice since 1983. Mr. Mitchell has been
involved in insurance acquisitions since 1978. Mr. Mitchell has been a director
and Executive Vice President-Actuarial of the Company since March 1998.
The executive officers were appointed by and serve at the pleasure of
the Board of Directors of the Company.
Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires the Company's directors, executive officers and persons who own more
than ten percent of the Company's outstanding stock ("Reporting Persons") to
file reports of ownership and changes in ownership with the Securities and
Exchange Commission. To the Company's knowledge, based solely on its review of
such reports furnished to the Company and written representations that no other
reports were required, all Section 16(a) filings requirements applicable to the
Reporting Persons were complied with during the year ended December 31, 1998,
except for Randall K. Sutton and Howard A. Wittner, who each filed a late Form 5
to report the purchase of shares of Common Stock.
Item 11. Executive Compensation
Information regarding executive compensation is contained in
"Compensation of Executive Officers," included in the Registrant's Proxy
Statement for the 1999 Annual Meeting of Shareholders, which is incorporated
herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information regarding security ownership of certain beneficial owners
and management is contained in "Voting Securities and Principal Holders
Thereof," included in the Registrant's Proxy Statement for the 1999 Annual
Meeting of Shareholders, which is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
Information regarding certain relationships and related transactions is
contained in "Certain Relationships and Related Transactions," included in the
Registrant's Proxy Statement for the 1999 Annual Meeting of Shareholders, which
is incorporated herein by reference.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1. Consolidated Financial Statements. See Index to Consolidated Financial
Statements for a list of financial statements included in this Report.
2. Financial Statement Schedules. The following financial statement
schedules are included as part of this Report immediately following
the Consolidated Financial Statements.
Schedule II - Condensed Financial Information of Registrant (Parent
Company)
Schedule III - Supplementary Insurance Information
Schedule IV - Reinsurance
All other schedules are omitted, either because they are not
applicable, not required, or because the information they contain is included
elsewhere in the consolidated financial statements or notes.
3. Exhibits. See Exhibit Index immediately preceding the Exhibits filed with
this report.
(b) Reports on Form 8-K.
A report on Form 8-K dated December 21, 1998, was filed with the
Commission to report under Item 4, the change in the Company's
certifying accountant.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on the 31st day of
March, 1999.
LINCOLN HERITAGE CORPORATION
By: /s/ Nicholas M. Powling
Nicholas M. Powling,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on the 31st day of March, 1999.
Signature Title Date
/s/ Nicholas M. Powling President and Chief Executive March 31, 1999
- - --------------------------
Nicholas M. Powling Officer and Director
/s/ Clif Mitchell Executive Vice President and March 31, 1999
- - --------------------------
Clif Mitchell Director (Principal Financial
and Accounting Officer)
/s/ Brent D. Cassity Chairman of the Board and March 31, 1999
- - --------------------------
Brent D. Cassity Director
/s/ Randall K. Sutton Vice President and Director March 31, 1999
- - --------------------------
Randall K. Sutton
/s/ Howard A. Wittner Director March 31, 1999
- - --------------------------
Howard A. Wittner
/s/ Paul J. Gallant Director March 31, 1999
- - --------------------------
Paul J. Gallant
/s/ Mark A. Turken Director March 31, 1999
- - --------------------------
Mark A. Turken
<PAGE>
LINCOLN HERITAGE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(including notes applicable to the unaudited periods)
Item 8. Consolidated Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
The Company and Subsidiaries:
Independent Auditors' Report-Deloitte & Touche LLP.......................... F-1
Report of Independent Certified Public Accountants--Killman,
Murrell, and Company, P.C................................................... F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997................ F-3
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996............................................ F-5
Consolidated Statements of Shareholders' Equity and Comprehensive
Income for the years ended December 31, 1998, 1997 and 1996................ F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996............................................ F-7
Notes to Consolidated Financial Statements ................................. F-8
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Lincoln Heritage Corporation
Austin, Texas
We have audited the accompanying consolidated balance sheet of Lincoln Heritage
Corporation and subsidiaries (the "Company") as of December 31, 1998, and the
related consolidated statements of operations, shareholders' equity and
comprehensive income and of cash flows for the year then ended. Our audit also
included the financial statement schedules listed in the Index at Item 14. These
financial statements and financial statement schedules are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedules based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Lincoln Heritage Corporation and
subsidiaries at December 31, 1998, and the results of their operations and their
cash flows for the year then ended, in conformity with generally accepted
accounting principles. Also, in our opinion, such financial statement schedules,
when considered in relation to the basic consolidated financial statements taken
as a whole, present fairly, in all material respects, the information set forth
therein.
DELOITTE & TOUCHE LLP
March 26, 1999
Fort Worth, Texas
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors of
Lincoln Heritage Corporation:
We have audited the accompanying consolidated balance sheet of Lincoln Heritage
Corporation (a Texas corporation) and subsidiaries as of December 31, 1997 and
the related consolidated statements of operations, shareholders' equity and
comprehensive income and cash flows for each of the two years in the period
ended December 31, 1997. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes 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 Lincoln Heritage
Corporation and subsidiaries as of December 31, 1997, and the results of their
operations and their cash flows for each of the two years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
Our audits were conducted for the purpose of forming an opinion on the basic
financial statements taken as a whole. Schedules, II, III, and IV are presented
for the purposes of additional analyses and are not a required part of the basic
financial statements. Such information has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, is fairly stated in all material respects in relation to the basic
financial statements taken as a whole.
KILLMAN, MURRELL & COMPANY, P.C.
Dallas, Texas
March 11, 1998
<PAGE>
<TABLE>
<CAPTION>
LINCOLN HERITAGE CORPORATION
Consolidated Balance Sheets
December 31,
1998 1997
ASSETS
<S> <C> <C>
CASH AND INVESTMENTS
Fixed maturities available for sale
at fair value (amortized cost
$68,201,939 and $44,085,520) $ 65,628,083 $ 45,120,485
Equity securities available for sale
at fair value (cost $7,939,451 and
$1,013,365) 7,121,000 794,870
Policyholder loans 17,257,122 11,457,962
Cash and cash equivalents 43,824,537 62,667,707
-------------- --------------
TOTAL CASH AND INVESTMENTS 133,830,742 120,041,024
-------------- --------------
Accrued investment income 463,616 609,847
Accounts receivable from related party 1,535,926 478,362
Funds withheld by ceding company 526,434 498,512
Deferred policy acquisition costs, net 16,881,478 12,554,870
Fixed assets, net 1,218,352 649,546
Cost of policies acquired, net 3,833,659 3,249,365
Goodwill, net 1,413,550 773,436
Deferred tax assets, net 3,364,638 2,394,970
Other assets 1,004,118 353,078
-------------- --------------
TOTAL $ 164,072,513 $ 141,603,010
============== ==============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
LINCOLN HERITAGE CORPORATION
Consolidated Balance Sheets
(CONTINUED)
December 31,
1998 1997
LIABILITIES AND SHAREHOLDERS' EQUITY
<S> <C> <C>
LIABILITIES:
Policy liabilities:
Future policy benefits $ 104,201,323 $ 87,843,239
Policyholder deposits 47,163,465 41,613,697
Claims and benefits payable 650,000 689,000
Premiums received in advance 409,937 304,471
-------------- --------------
TOTAL POLICY LIABILITIES 152,424,725 130,450,407
-------------- --------------
Income tax payable 49,800 1,975,165
Accounts payable and accrued expenses 656,089 334,776
Accounts payable to related party 163,292 17,090
Other liabilities 1,964,045 1,942,861
-------------- --------------
TOTAL LIABILITIES 155,257,951 134,720,299
-------------- --------------
Commitments and Contingencies (Note 10)
SHAREHOLDERS' EQUITY:
Preferred stock ($0.01 par value;
1,000,000 shares authorized;
none issued) - -
Common stock ($0.01 par value;
10,000,000 shares authorized,
4,520,000 and 1,000,000 shares
issued and outstanding,
respectively) 45,200 10,000
Additional paid-in capital 4,734,350 2,075,576
Retained earnings 6,273,924 4,258,265
Accumulated other comprehensive
income (loss) (2,238,912) 538,870
-------------- ---------------
TOTAL SHAREHOLDERS' EQUITY 8,814,562 6,882,711
-------------- ---------------
TOTAL $ 164,072,513 $ 141,603,010
============== ===============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
LINCOLN HERITAGE CORPORATION
Consolidated Statements of Operations
Years Ended December 31,
1998 1997 1996
----------------- ----------------- -----------------
<S> <C> <C> <C>
REVENUES
Life premiums $ 41,363,384 $ 38,044,470 $ 33,273,417
Net investment income 10,638,406 6,171,215 3,710,720
Realized investment gains, net 1,935,935 2,666,448 2,018,362
Other revenue 747,848 - -
---------------- ----------------- -----------------
TOTAL REVENUES 54,685,573 46,882,133 39,002,499
---------------- ----------------- -----------------
BENEFITS AND EXPENSES
Death benefits 16,406,422 13,551,459 11,747,170
Surrender benefits 3,165,939 115,758 5,167,946
Increase in future policy benefits 12,019,701 16,432,947 7,621,130
Interest paid on policyholder deposits 1,495,680 1,051,087 214,054
Commissions 16,850,227 11,247,606 10,043,563
General expenses 7,211,722 5,211,651 3,856,016
General expenses reimbursed by
related party (2,253,644) (2,695,091) -
Taxes, licenses and fees 948,452 782,470 720,278
Amortization of cost of policies purchased 711,564 262,188 -
Change in deferred acquisition costs, net
of amortization (4,326,608) (1,405,263) (1,269,257)
----------------- ------------------ ------------------
TOTAL BENEFITS AND EXPENSES 52,229,455 44,554,812 38,100,900
---------------- ----------------- -----------------
INCOME BEFORE INCOME TAXES 2,456,118 2,327,321 901,599
---------------- ----------------- -----------------
INCOME TAXES
Current 49,800 1,752,358 789,216
Deferred 390,659 (1,080,463) (592,247)
---------------- ------------------ ------------------
TOTAL INCOME TAXES 440,459 671,895 196,969
---------------- ----------------- -----------------
NET INCOME $ 2,015,659 $ 1,655,426 $ 704,630
================ ================= =================
Basic earnings per share $ 0.49 $ 0.41 $ 0.18
=============== ================ ================
Diluted earnings per share $ 0.48 $ 0.41 $ 0.18
=============== ================ ================
Weighted average shares outstanding:
Basic 4,086,667 4,000,000 4,000,000
Diluted 4,189,804 4,000,000 4,000,000
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
LINCOLN HERITAGE CORPORATION
Consolidated Statements of Shareholders' Equity
and comprehensive income
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Total Additional Accumulated Other
Shareholders' Common Paid-in Comprehensive Retained
Equity Stock Capital Income (Loss) Earnings
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1996 $ 2,713,460 $ 1,000 $ 40 $ 805,211 $ 1,907,209
Comprehensive income (loss) net of tax:
Net income 704,630 - - - 704,630
Change in unrealized gains (losses)
on available for sale securities
net of tax of $804,531 and
reclassification adjustment
of $2,018,362 (1,561,735) - - (1,561,735) -
-------------
Total comprehensive income (loss) (857,105) - - - -
------------- --------- ----------- ----------------- -------------
Balance, December 31, 1996 1,856,355 1,000 40 (756,524) 2,611,839
Transfer to common stock in connection
with stock split and stock dividend - 9,000 - -
(9,000)
Retroactive premium increase treated
as paid-in capital, net of income tax
expense of $314,884 1,259,536 - 1,259,536 - -
Benefit of reduction of future
commissions treated as additional
paid-in capital, net of tax expense
of $332,000 816,000 - 816,000 - -
Comprehensive income (loss), net of tax:
Net income 1,655,426 - - - 1,655,426
Change in unrealized gains (losses)
on available for sale securities,
net of tax of $667,325 and
reclassification adjustment of
$2,666,448 1,295,394 - - 1,295,394 -
------------- --------- ----------- ----------------- -------------
Total comprehensive income 2,950,820 - - - -
------------- --------- ----------- ----------------- -------------
Balance, December 31, 1997 6,882,711 10,000 2,075,576 538,870 4,258,265
Transfer to common stock in connection
with stock split and stock dividend - 30,000 (30,000)
Effect of stock options granted, net
of applicable income tax effect
of $70,652 137,147 137,147
Issuance of common stock 2,556,827 5,200 2,551,627
Comprehensive income (loss), net of tax:
Net income 2,015,659 2,015,659
Change in unrealized gains (losses)
on available for sale securities,
net of tax of $1,430,978 and
reclassification adjustment of
$1,935,935 (2,777,782) (2,777,782)
-------------
Total comprehensive income (762,123)
Balance, December 31, 1998 $ 8,814,562 $ 45,200 $4,734,350 $ (2,238,912) $ 6,273,924
============= ========= =========== ================= =============
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
LINCOLN HERITAGE CORPORATION
Consolidated Statements of Cash Flows
Years Ended December 31,
1998 1997 1996
----------------- ----------------- -----------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income $ 2,015,659 $ 1,655,426 $ 704,630
Adjustments to reconcile net income to
cash provided by (used in) operating activities:
Realized investment gains (1,935,935) (2,666,448) (2,018,362)
Gain on sale of policies (590,142) - -
Accretion of discount on investments (1,990,046) (458,056) (47,604)
Depreciation and amortization 967,513 368,068 87,129
Deferred income taxes 390,659 (699,519) (238,533)
Stock options issued 137,147 - -
Changes in operating assets and liabilities
(net of effects of acquisitions)
Accrued investment income 195,231 (74,020) (22,695)
Accounts receivable from related party (1,057,564) 188,843 1,687,680
Funds withheld by ceding company (27,922) (252,692) 76,605
Deferred policy acquisition costs (4,326,608) (1,405,263) (1,269,257)
Other assets (484,307) (627,109) 117,883
Future policy benefits and deposit funds 1,553,757 5,573,366 4,842,595
Claims and benefits payable (39,000) (92,000) 141,000
Premiums received in advance 105,466 92,022 (272,496)
Income tax payable (1,813,790) 1,441,319 428,185
Accounts payable and accrued expenses 321,067 106,465 (53,325)
Accounts payable to related party 146,202 17,090 (62,304)
Other liabilities (103,816) 1,250,388 36,428
----------------- ----------------- -----------------
NET CASH PROVIDED BY (USED IN)
OPERATING ACTIVITIES (6,536,429) 4,417,880 4,137,559
----------------- ----------------- -----------------
INVESTING ACTIVITIES
Proceeds from sales of available
for sale investments 342,392,212 166,376,535 37,390,456
Purchase of available for sale investments (365,281,067) (106,684,537) (50,999,200)
Purchase of fixed assets (762,418) - -
Other invested assets, net - - 1,106,170
Acquisition of subsidiary (5,041,514) - -
Cash received from acquisition of life
policies 18,272,718 - -
(Increase) decrease in policyholder
loans issued (4,298,499) (10,699,794) 673,276
Other, net (145,000) - -
----------------- ----------------- -----------------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES (14,863,568) 48,992,204 (11,829,298)
----------------- ------------------ ------------------
FINANCING ACTIVITIES
Capital contributions - 2,075,536 -
Proceeds from stock offering 2,556,827 - -
---------------- ----------------- -----------------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 2,556,827 2,075,536 -
---------------- ----------------- -----------------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS (18,843,170) 55,485,620 (7,691,739)
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 62,667,707 7,182,087 14,873,826
---------------- ----------------- -----------------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 43,824,537 $ 62,667,707 $ 7,182,087
================ ================= =================
SUPPLEMENTAL CASH FLOW INFORMATION
INCOME TAXES PAID $ 1,975,165 $ 311,040 $ 92,990
================ ================= =================
</TABLE>
<PAGE>
NOTE 1. BUSINESS
Lincoln Heritage Corporation (the "Company") is a life insurance
holding company engaged in the ownership and operation of life insurance
companies. The Company also acquires existing life insurance policies either
through direct purchase or the acquisition of insurance companies. The Company's
life insurance operations are conducted through its wholly owned life insurance
subsidiaries which are subject to regulation by the state insurance department
where they are licensed and undergo periodic examinations by those departments.
The majority of the Company's life insurance premiums are derived from
the issuance of insurance policies to fund prearranged funeral contracts sold by
National Prearranged Services, Inc. ("NPS"), a related party, and National
Prearranged Services Agency, Inc. ("NPS Agency"). Funeral prearrangement is a
means through which a customer contractually agrees to the terms of a funeral to
be performed in the future. NPS or NPS Agency is the assignee and beneficiary of
substantially all policies issued directly or assumed by the Company in
connection with prearranged funeral contracts.
Effective December 31, 1998, the Company reorganized its insurance
company subsidiaries. The purpose of the reorganization was to streamline and
consolidate the Company's insurance operations and strengthen the existing
capital structure to facilitate the acceptance of acquisitions by regulatory
authorities. The reorganization was accounted for as a tax-free transaction and
had no impact on the consolidated financial statements. Concurrent with the
reorganization, the name of Lincoln Memorial Life Insurance Company was changed
to New Life Insurance Company ("New Life") and the name of World Service Life
Insurance Company of America was changed to Lincoln Memorial Life Insurance
Company ("Lincoln"). The reorganization had no effect on Memorial Service Life
Insurance Company ("Memorial").
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements include the accounts
of the Company and its direct and indirect wholly owned subsidiaries, Memorial,
New Life and Lincoln. These consolidated financial statements have been prepared
in accordance with generally accepted accounting principles ("GAAP"), which
differ from statutory accounting practices prescribed or permitted by regulatory
authorities. All intercompany accounts and transactions have been eliminated in
consolidation. Certain prior years amounts have been reclassified to conform
with the 1998 presentation.
Use of Estimates
The preparation of consolidated financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amount
of revenues and expenses during the reporting period. Actual results could
differ significantly from those estimates.
The estimates susceptible to significant change are those used in
determining deferred policy acquisition costs, cost of policies purchased, and
the liabilities for future policy benefits, policyholder deposits and claims,
and benefits payable. Although some variability is inherent in these estimates,
management believes the amounts provided are adequate.
Investments
All fixed maturity and equity securities are classified as
available-for-sale and, accordingly, such securities are carried at estimated
fair value. The Company may sell these securities prior to maturity in response
to changes in interest rates, issuer credit quality or liquidity requirements.
Realized gains and losses on the sale of investments are determined utilizing
the specific identification method. Unrealized gains and losses, net of tax, are
recorded as a component of accumulated other comprehensive income, a separate
component of shareholders' equity. The cost of fixed maturity securities is
adjusted for amortization of premiums and discounts. If the fair value of an
investment security declines for reasons other than temporary market conditions,
the carrying value of such security is written down to fair value by a charge to
operations. Policyholder loans are stated at their current unpaid principal
balance, which approximates fair value.
Cash and Cash Equivalents
For the purposes of reporting cash flows, cash and cash equivalents
includes investments readily convertible to cash with remaining maturities at
date of purchase of three months or less. Cash and cash equivalents include
commercial paper and reverse repurchase agreements that are carried at cost,
which approximates the fair value of the underlying securities.
In order to increase the Company's return on investments and improve
its liquidity, the Company enters into overnight reverse repurchase agreements.
The Company purchases U.S. Treasury notes under agreements to resell such U.S.
Treasury notes on a daily basis. The Company does not take possession of any
securities and records such purchases as a book entry only. The amount at risk
on a daily basis, in the event of default by the counterparty, is minimal as the
carrying value of the underlying securities approximates the fair value of such
securities. At December 31, 1998 and 1997, the carrying amount of overnight
reverse repurchase agreements was $4,274,884 and $29,512,372, respectively.
Goodwill
Goodwill represents the excess of cost over the fair value of net
assets acquired in acquisitions accounted for by the purchase method. Such
amounts are being amortized on the straight-line basis as charges to income over
25 to 40 years. Amortization expense was $62,337, $22,748 and $22,748 for the
years ended December 31, 1998, 1997 and 1996, respectively. Accumulated
amortization was $198,825 and $136,488 as of December 31, 1998 and 1997,
respectively. The carrying value of goodwill is periodically evaluated for
indications of impairment based upon estimates of future earnings.
Deferred Policy Acquisition Costs (DPAC)
The costs of acquiring new business generally consist of commissions,
excluding renewal commissions (approximately 90% of DPAC is commissions paid to
NPS), and other costs of acquiring new business. Such costs vary with, and are
primarily related to, the production of new business and are capitalized and
deferred to the extent that they are recoverable from future profits. These
costs are amortized over the premium paying periods of the related policies in
proportion to the ratio of the annual premium revenue to the total anticipated
premium revenue. Anticipated premium revenue was estimated using the same
assumptions used for estimating the liabilities for future policy benefits.
Cost of Policies Acquired
The cost of policies acquired represents the actuarially determined
present value of projected future cash flows from acquired policies. The
projected future cash flows are based on actuarially determined projections of
future premiums, mortality, surrenders, operating expenses, investment yields
and other factors. The projections consider all known or expected factors at the
acquisition date. Actual experience may vary from projections due to differences
in premiums collected, investment spread, mortality costs and other factors and
any such differences are recorded in the period they are determined. The amounts
are amortized over the lives of the acquired policies in relation to the
remaining present value of the future cash flows from such policies.
Furniture and Equipment
Furniture and equipment is carried at depreciated cost. Depreciation is
recorded using the straight-line method over the estimated useful lives of the
assets which range from five to seven years. Depreciation expense was $193,612,
$83,132, and $50,379 for the years ended December 31, 1998, 1997, and 1996,
respectively. Accumulated depreciation was $377,893 and $184,281 at December 31,
1998, and 1997, respectively.
Future Policy Benefits
Future policy benefits are amounts that, when accumulated with interest
and future premiums, will provide for the payment of benefits arising out of the
insurance in-force. The liabilities for future policy benefits and expenses for
limited pay life policies are computed using the net-level premium method which
is based upon assumptions as to investment yields, mortality and withdrawals.
Assumptions are based principally on modifications of the ultimate tables in
common usage in the industry. Interest assumptions are 8% in years one (1)
through five (5), graded downward to 7.5% in years six (6) through fifteen (15)
and remain at 7.5% thereafter.
Claims and Benefits Payable
The liability for claims and benefits payable is based upon the
estimated amount payable on claims reported prior to the balance sheet date
which have yet to be settled, claims reported subsequent to the balance sheet
date but incurred during the period then ended, and an estimate (based upon
prior experience) of claims incurred, but not yet reported. Actual amounts may
differ from those estimated and any such differences are recorded in the period
they are determined.
Premiums and Expenses
The Company primarily issues limited pay and single premium policies.
Accordingly, net premiums for direct and assumed policies are recorded as
revenues and the difference between the gross premium received and the net
premium is deferred and recognized in a constant relationship to the insurance
in-force. Unearned premiums of $18,262,190 and $19,633,000 at December 31, 1998
and 1997, respectively, are included as a component of future policy benefit
liabilities in the accompanying consolidated balance sheets. The change in
unearned premiums is reflected as a component of the increase in future policy
benefits in the accompanying consolidated statements of operations.
Benefits and expenses are recognized as a level percentage of earned
premiums by providing for future policy benefits and amortizing deferred
acquisition costs.
Receipts for annuities are classified as deposits instead of revenues.
Accordingly, annuity premium deposits and annuity benefit payments are recorded
as increases or decreases in a liability account rather than revenue or expense.
Revenues for annuity policies are recorded for policy administration fees and
surrender charges while expenses are recorded for interest credited to the
policy account balances.
Reinsurance
The Company's subsidiaries have coinsurance and modified coinsurance
agreements with reinsurers to increase their statutory surplus for regulatory
purposes. The terms of reinsurance agreements provide for all of the insurance
risk associated with the business ceded to be transferred to the reinsurer. The
purpose of the agreements is to allow the Company's insurance subsidiaries to
take credits for reserves ceded to the reinsurer which provides increases in the
insurance company's statutory surplus. The agreements provide for the profits of
the reinsured business to decrease the amount of the reserve credit taken,
thereby decreasing the insurance company's statutory surplus. Any losses are
retained by the reinsurer for which a risk charge is paid. The effect of these
agreements is that statutory surplus for the Company's insurance subsidiaries
was $10,450,767 and $6,236,000 greater at December 31, 1998 and 1997,
respectively, than what it would have been without these agreements. Since the
primary liability of the Company to the insured has not been discharged through
these agreements and no assets have been transferred, all reinsurance
transactions except for the risk charge have been eliminated in the accompanying
consolidated financial statements. The risk charge is recognized as reinsurance
premiums ceded.
In the normal course of business, the Company has reinsured portions of
the coverage provided by its insurance products with other insurance companies
under indemnity reinsurance agreements. Indemnity reinsurance agreements are
intended to limit a life insurer's maximum loss on a particular risk or to
obtain a greater diversification of risk. Indemnity reinsurance does not
discharge the primary liability of the original insurer to the insured.
Participating Policies
Participating policies represented 80% and 92% of the life insurance
in-force at December 31, 1998 and 1997, respectively. Determination of dividends
on participating policies is not dependent on any factor and is completely at
the discretion of the boards of directors of the insurance subsidiaries.
Policyholder dividends of $90,335 were paid for the year ended December 31,
1998. No policyholder dividends were paid during 1997 and 1996.
Income Taxes
Income taxes are accounted for under the liability method. Deferred tax
assets and liabilities are established for temporary differences between the
financial reporting basis and the tax basis of assets and liabilities at the
enacted tax rates expected to be in effect when the temporary differences are
expected to be recovered or settled. A valuation allowance is provided if it is
more likely than not that some portion of the deferred tax asset may not be
realized. An increase or decrease in the valuation allowance is included in
income. In assessing the realization of deferred income taxes, consideration is
given as to whether it is more likely than not the deferred tax assets will be
realized. The ultimate realization of deferred tax assets depends upon
generating future taxable income during the periods in which the temporary
differences become deductible.
Stock Based Compensation
In 1997 the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock
Based Compensation. The Company has elected to continue following the accounting
guidance of Accounting Principles Board (APB) Opinion No. 25, Accounting for
Stock Issued to Employees for measurement and recognition of stock-based
transactions with employees. No compensation cost is recognized for options
issued when the exercise price of the options is at least equal to the fair
market value of the common stock at the date of grant. Consistent with the
provisions of SFAS No. 123, the Company discloses the proforma effect on net
income and earnings per share as if the Company had adopted SFAS No. 123
For all options granted to individuals that are not employees of the
Company, the Company follows the requirements of SFAS No. 123. Accordingly, the
option exercise price will be compared to the fair value of the option at the
date of grant and, to the extent that the fair value exceeds the option exercise
price, compensation will be recognized in the consolidated financial statements
of the Company.
Stock Splits and Earnings Per Share
On September 19, 1997, the Company effected a 100,000-for-1 stock split
in the form of a stock dividend. Upon consummation of such stock split, the
Company had 1,000,000 shares of Common Stock issued and outstanding. On April 6,
1998, the Company effected a 3.2-for-1 stock split, in the form of a stock
dividend, and on August 18, 1998, the Company declared and paid a 25% stock
dividend. The earnings per share of the Company for all periods presented have
been computed as if these stock splits and dividends occurred at January 1,
1996. The diluted earnings per share is computed using the treasury stock method
unless the effect is anti-dilutive. The 103,137 increase in the number of shares
from basic to diluted in 1998 is a result of the options outstanding. There are
no factors that affect the net income amount in the earnings per share
computations.
Initial Public Offering
In October, 1998, the Company completed its initial public offering and
issued 520,000 shares of its Common Stock at a price of $7.50 per share. The net
proceeds were approximately $2,500,000, after underwriting discounts,
commissions, and other offering costs. The net proceeds were used to make a
capital contribution on December 31, 1998 to one of the Company's insurance
subsidiaries.
New Accounting Standards
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive
Income. SFAS No. 130 establishes standards for the reporting and display of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general purpose financial statements. SFAS No. 130 states that
all items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. Comprehensive
income is defined as the total of net income and all other non-owner changes in
equity. SFAS No. 130 is effective for fiscal years beginning after December 15,
1997. Restatement of financial statements for earlier periods provided for
comparative purposes is required. SFAS No. 130 had no impact on the financial
condition or results of operations of the Company, but required changes in the
Company's disclosure and presentation requirements. The principal change was the
disclosure of the components of and total comprehensive income within the
Consolidated Statements of Shareholders' Equity.
In June 1997, the FASB issued SFAS No. 131, Disclosures About Segments
of an Enterprise and Related Information. SFAS No. 131 establishes standards for
disclosures related to business operating segments. SFAS No. 131 had no
significant effect on the disclosures set forth in the Company's consolidated
financial statements.
In December 1997, the American Institute of Certified Public
Accountants issued Statement of Position 97-3, Accounting by Insurance and Other
Enterprises for Insurance-related Assessments (SOP 97-3). SOP 97-3 provides
guidance for determining when an insurance company or other enterprise should
recognize a liability for guaranty-fund assessments and guidance for measuring
the liability. SOP 97-3 is effective for financial statements of fiscal years
beginning after December 15, 1998. The Company anticipates that the adoption of
SOP 97-3 will not have a material effect on the Company's financial position,
results of operations or cash flows.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities which establishes accounting and reporting
standards for derivative instruments and hedging activities. SFAS No. 133
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. Changes in the fair value of derivatives are recorded each period
in current earnings or other comprehensive income, depending on whether a
derivative is designed as part of a hedge transaction, and if it is, the type of
hedge transaction. SFAS No. 133 is effective for all fiscal quarters of fiscal
years beginning after June 15, 1999. The Company is assessing the impact that
the adoption of SFAS No. 133 will have on its consolidated financial statements,
but does not expect such implementation to have a material adverse effect on its
financial position, results of operations or cash flows.
NOTE 3. COINSURANCE OF LIFE INSURANCE AND ANNUITY POLICIES
On September 1, 1997, the Company coinsured a block of life insurance
and annuity policies from Woodmen Accident and Life Company (the "Woodmen
Block"). The block of business consisted primarily of deferred annuities which
are accounted for as investment contracts using deposit accounting. The Company
assumed approximately $51,311,000 of insurance and annuity reserves in exchange
for receiving $48,018,000 in cash. The net liabilities assumed, $3,293,000, plus
other costs related to the coinsurance of the Woodmen Block in the amount of
$218,000 have been shown as additions from acquisitions to the cost of policies
purchased.
Effective April 1, 1998, the Company coinsured a block of life
insurance and annuity policies from World Insurance Company (the "World Block").
The reserves on the block of business consisted of approximately one-third
deferred annuities, one-third interest sensitive life insurance, which is
accounted for as investment contracts using deposit accounting, and one-third
traditional whole life insurance. The Company assumed approximately $21,909,000
of insurance and annuity reserves in exchange for receiving $19,941,000 in
assets. The net liabilities assumed, $2,205,716, plus other costs related to the
coinsurance of the World Block in the amount of approximately $200,000 have been
shown as additions from acquisitions to the cost of policies acquired.
<PAGE>
NOTE 4. INVESTMENTS
The amortized cost and estimated fair value of fixed maturity and
equity securities available for sale at December 31, 1998, were as follows:
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
Fixed maturity securities
U.S. government $ 11,455,626 $ 468,009 $ (184,543) $ 11,739,092
Mortgage backed securities 48,792,515 350,168 (483,129) 48,659,554
Corporate bonds 7,953,798 - (2,724,361) 5,229,437
-------------- ------------- -------------- -------------
Total fixed maturity securities 68,201,939 818,177 (3,392,033) 65,628,083
Equity securities 7,939,451 1,138,873 (1,957,324) 7,121,000
-------------- ------------- -------------- -------------
Total $ 76,141,390 $ 1,957,050 $ (5,349,357) $ 72,749,083
============== ============= ============== =============
</TABLE>
The amortized cost and estimated fair value of fixed maturity and
equity securities available for sale at December 31, 1997, were as follows:
<TABLE>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
Fixed maturity securities
U.S. government $ 11,530,209 $ 100,390 $ (17,876) $ 11,612,723
Mortgage backed securities 28,769,315 919,796 (127,599) 29,561,512
Corporate bonds 3,785,996 192,783 ( 32,529) 3,946,250
-------------- ------------- -------------- -------------
Total fixed maturity securities 44,085,520 1,212,969 (178,004) 45,120,485
Equity securities 1,013,365 42,500 (260,995) 794,870
-------------- ------------- -------------- -------------
Total $ 45,098,885 $ 1,255,469 $ (438,999) $ 45,915,355
============== ============= ============== =============
</TABLE>
Unrealized gains (losses) included in accumulated other comprehensive
income (loss) are reported net of tax effect of $1,153,395 and $227,600 in 1998
and 1997, respectively.
The amortized costs and fair value of fixed maturities available for
sale at December 31, 1998, by contractual maturity date are shown below.
Expected maturities may differ from contractual maturities since certain
borrowers have the right to call or prepay obligations with or without call or
prepayment penalties.
<TABLE>
<CAPTION>
December 31, 1998
Amortized Estimated
Cost Fair Value
<S> <C> <C>
In one year or less $ 124,976 $ 126,101
In years two through five 3,777,968 3,509,514
In years six through ten 9,467,032 7,337,789
After ten years 6,039,448 5,995,125
Mortgage backed securities 48,792,515 48,659,554
------------- -------------
Total $ 68,201,939 $ 65,628,083
============= =============
</TABLE>
Investments in fixed maturities or equity securities in any single
entity in excess of 10% of shareholders' equity at December 31, 1998 other than
investments issued or guaranteed by the United States government or a United
States government agency, were as follows:
<PAGE>
<TABLE>
<CAPTION>
December 31, 1998
Amortized Estimated
Cost Fair Value
<S> <C> <C>
CAI Wireless Systems $ 1,657,191 $ 1,198,745
American Telecasting 1,561,754 657,380
CS Wireless Systems 1,468,151 1,100,000
Wireless One, Inc. 2,503,375 1,793,311
Autobond Acceptance Corporation 3,324,512 1,875,000
Transnational Financial 1,312,800 998,750
Westower Corporation 2,202,392 3,285,000
</TABLE>
The Company invests in both investment grade and below investment grade fixed
maturity securities. At December 31, 1998, approximately 15% of the book value
of the Company's fixed maturity investments consisted of below investment grade
securities.
Assets with a fair value of $11,648,261 at December 31, 1998, were on
deposit with various state regulatory authorities. Assets with a fair value of
$55,141,485 at December 31, 1998, were restricted as to use for the acquired
Woodmen Block, World Block and other assumed business.
Major categories of investment income consisted of the following:
<TABLE>
<CAPTION>
Years Ended December 31,
1998 1997 1996
------------- -------------- -------------
<S> <C> <C> <C>
Fixed maturities $ 7,700,956 $ 5,183,674 $ 3,162,390
Equities 292,440 - -
Policyholder loans 774,306 243,879 64,430
Short-term investments 2,065,800 857,434 587,667
------------- -------------- -------------
Gross investment income 10,833,502 6,284,987 3,814,487
Investment expenses 195,096 113,772 103,767
------------- -------------- -------------
Net investment income $ 10,638,406 $ 6,171,215 $ 3,710,720
============= ============== =============
</TABLE>
Gross realized investment gains consisted of the following:
<TABLE>
<CAPTION>
Years Ended December 31,
1998 1997 1996
-------------- --------------- --------------
<S> <C> <C> <C>
Gross realized gains $ 4,198,392 $ 2,929,348 $ 2,188,649
Gross realized losses (2,262,457) (262,900) (170,287)
-------------- --------------- --------------
Net realized
investment gains $ 1,935,935 $ 2,666,448 $ 2,018,362
============== =============== ==============
</TABLE>
Proceeds from disposals of investments in fixed maturity and equity
securities during the years ended December 31, 1998, 1997, and 1996 were
$342,392,212, $162,383,038 and $50,999,200, respectively.
NOTE 5. REINSURANCE
Reinsurance contracts do not relieve the Company from its obligation to
its policyholders. Failure of reinsurers to honor their obligations could result
in losses to the Company. Consequently, allowances are established for amounts
due from reinsurers that are deemed uncollectible. The Company evaluates the
financial condition of its reinsurers and monitors concentrations of credit risk
to minimize its exposure to significant losses from reinsurance insolvencies.
Reinsurance receivables were $11,000 and $23,000 at December 31, 1998 and 1997,
respectively. Reinsurance payables were $235,000 and $36,000 at December 31,
1998 and 1997, respectively.
<PAGE>
The effect of reinsurance on premiums earned were as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
1998 1997 1996
-------------- --------------- --------------
<S> <C> <C> <C>
Direct $ 40,441,151 $ 34,925,424 $ 26,918,986
Reinsurance assumed 1,212,257 3,371,830 6,538,596
Reinsurance ceded (290,024) (252,784) (184,165)
-------------- --------------- --------------
Premiums earned $ 41,363,384 $ 38,044,470 $ 33,273,417
============== =============== ==============
</TABLE>
Death benefits incurred on the business assumed were $818,793,
$2,257,286, and $3,616,736, for the years ended December 31, 1998, 1997 and
1996, respectively. Recoveries of death benefits were not significant during
1998, 1997 and 1996 under reinsurance agreements.
NOTE 6. FAIR VALUE OF FINANCIAL INSTRUMENTS
In the normal course of business, the Company invests in various
financial assets, incurs various financial liabilities and enters into
agreements involving off-balance-sheet financial instruments. The following
estimated fair value amounts have been determined by the Company using available
market information and appropriate valuation methodologies. However,
considerable judgment is necessarily required to interpret market data to
develop the estimates of fair value. Accordingly, the estimates presented herein
are not necessarily indicative of the amounts the Company could realize in a
current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts.
The methods and assumptions used to estimate the fair value of
financial instruments are as follows:
(i) The carrying value of cash and cash equivalents approximates
fair value due to the short maturities of these investments;
(ii) Fair values of fixed maturities and equity securities with
active markets are based on quoted market prices. For
investments not actively traded, fair values were estimated
using values obtained from independent pricing services;
(iii) Fair value of policyholder loans approximates the carrying
amount of such assets because the earned rate on the policy
loans approximates the Company's current portfolio yield;
(iv) The carrying value of accounts receivable and payable and
premiums received in advance approximates fair value due to
their relatively short maturities; and
(v) The carrying amount of policyholder deposits approximates
their fair value due to the Company's ability to adjust the
rate at which interest is credited to the accounts.
Fair values and carrying amounts for the Company's financial
instruments are presented as follows:
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------------------------
1998 1997
----------------------------------- -----------------------------------
Fair Carrying Fair Carrying
Value Amount Value Amount
<S> <C> <C> <C> <C>
Cash and cash equivalents $ 43,824,537 $ 43,824,537 $ 62,667,707 $ 62,667,707
Fixed maturity securities 67,257,686 67,257,686 45,120,485 45,120,485
Equity securities 7,121,000 7,121,000 794,870 794,870
Accounts receivable 1,535,926 1,535,926 478,362 478,362
Policyholder loans 17,257,122 17,257,122 11,457,962 11,457,962
Policyholder deposits 47,163,465 47,163,465 41,613,697 41,613,697
Premiums received in advance 409,937 409,937 304,471 304,471
</TABLE>
<PAGE>
NOTE 7. DEFERRED POLICY ACQUISITION COSTS AND COSTS OF POLICIES ACQUIRED
Deferred Policy Acquisition Costs
Deferred policy acquisition costs ("DPAC") and the components of the
change in DPAC were as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
1998 1997 1996
-------------- --------------- --------------
<S> <C> <C> <C>
Balance, beginning of year $ 12,554,870 $ 11,149,607 9,880,350
Change in balance:
Deferrals 8,926,805 4,161,506 3,932,030
Amortization (4,600,197) (2,756,243) (2,662,773)
-------------- --------------- --------------
Net change 4,326,608 1,405,263 1,269,257
-------------- --------------- --------------
Balance, end of year $ 16,881,478 $ 12,554,870 $ 1,149,607
============== =============== ==============
</TABLE>
Approximately 90% of deferred costs are commissions paid to NPS, a
related party, or NPS Agency. Other costs include expenses related to the
acquisition and issuance of new policies, such as the printing of policy forms
and underwriting expenses.
Cost of Policies Acquired
The cost of policies acquired ("CPA") and the components of the changes
were as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
1998 1997
------------------ -----------------
<S> <C> <C>
Balance, beginning of year $ 3,249,365 $ -
Additions from acquisition 2,205,716 3,511,553
Gross amortization (1,047,244) (348,933)
Interest 335,680 86,745
CPA on policies sold (909,858) -
------------------ -----------------
Balance, end of year $ 3,833,659 $ 3,249,365
================== =================
</TABLE>
Interest is accrued on the unamortized balance of CPA at 7.5%.
Approximately 8.2% of the balance at December 31, 1998 is expected to be
amortized during each of the next five years. The Company had no policy
acquisitions resulting in the recognition of CPA during or prior to 1996.
NOTE 8. CLAIMS AND BENEFITS PAYABLE
Activity in the liability for life claims payable was as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
1998 1997 1996
------------- --------------- --------------
<S> <C> <C> <C>
Balance at January 1 $ 689,000 $ 781,000 $ 640,000
Incurred related to:
Current year 16,387,714 13,573,754 11,812,138
Prior year 18,708 (22,295) (64,968)
------------- --------------- --------------
Total incurred 16,406,422 13,551,459 11,747,170
------------- --------------- --------------
Paid related to:
Current year 15,737,714 12,887,754 11,031,138
Prior year 707,708 755,705 575,032
------------- --------------- --------------
Total paid 16,445,422 13,643,459 11,606,170
------------- --------------- --------------
Balance at December 31 $ 650,000 $ 689,000 $ 781,000
============= =============== ==============
</TABLE>
<PAGE>
NOTE 9. INCOME TAXES
The provision for income taxes gives effect to permanent differences
between income for financial reporting purposes and taxable income. Accordingly,
the effective income tax rate is less than the statutory federal corporate rate.
A reconciliation of the statutory income tax rate to the effective tax rate is
as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------------- --------------- --------------
<S> <C> <C> <C>
Tax at statutory rate $ 835,080 $ 791,289 $ 306,544
Small life insurance
company deduction (619,154) (126,920) (243,940)
Alternative minimum taxes - - 126,584
Other 224,533 7,526 7,781
-------------- --------------- --------------
Total tax expense $ 440,459 $ 671,895 $ 196,969
============== =============== ==============
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities were as
follows:
<TABLE>
<CAPTION>
December 31,
1998 1997
--------------- --------------
Deferred tax assets:
<S> <C> <C>
Non life losses $ 728,753 $ -
Net unrealized losses on available
for sale securities 1,153,395 -
Policy reserves and policy funds 7,991,569 4,684,072
Other liabilities 48,112 28,301
--------------- --------------
Subtotal 9,921,829 4,712,373
Valuation allowance (3,320,670) -
--------------- --------------
Total deferred tax assets,
net of valuation allowance 6,601,159 4,712,373
--------------- --------------
</TABLE>
<TABLE>
<CAPTION>
Deferred tax liabilities:
<S> <C> <C>
Net unrealized gains on available for sale
fixed maturities and equity securities - 277,600
Deferred policy acquisition costs 2,532,571 1,934,303
Other assets 703,950 105,500
--------------- --------------
Deferred tax liabilities 3,236,521 2,317,403
--------------- --------------
Net deferred tax assets $ 3,364,638 $ 2,394,970
=============== ==============
</TABLE>
The valuation allowance has been provided to reduce deferred tax
assets to an amount that management believes is more likely than not
recoverable.
NOTE 10. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases office space under two noncancelable lease
agreements accounted for as operating leases. Rental expense on operating leases
(exclusive of other expenses payable under the leases) was approximately
$710,000, $550,000 and $550,000 for the years ended December 31, 1998, 1997, and
1996, respectively. Future minimum lease payments under the terms of these
operating leases at December 31, 1998 are as follows:
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
1999 $ 795,985
2000 811,570
2001 821,269
2002 448,622
-----------
$ 2,877,446
</TABLE>
Legal and Other Proceedings
NPS, a related party, along with New Life have been named defendants in
a previously dismissed class-action lawsuit that was refiled during 1996 in St.
Louis, Missouri, City Circuit Court. The suit involves a challenge to NPS's
methods of funding prearranged funeral contracts with policies issued by the
Company. The suit contains no specified dollar amounts for damages. Both the
Company and NPS believe that the claims are without merit and a motion is
pending to dismiss the Company from the case. The Company does not believe the
outcome of this lawsuit will have a material adverse effect on its financial
condition, results of operations or cash flows.
On December 31, 1998, a suit was filed in the U.S. District Court in
Galveston, Texas against the Company, along with Memorial and New Life alleging
trademark infringement regarding the use of the name "Lincoln Heritage". The
suit seeks enjoinment from the use of the name "Lincoln Heritage". The suit
contains no specified dollar amounts for damages. The Company believes the
claims are defensible and without merit. The Company does not believe the
outcome of the lawsuit will have a material adverse effect on its financial
condition, results of operations or cash flows.
The Company also is subject to various other claims and contingencies
arising out of the normal course of business. The Company believes that the
total amounts that will ultimately be paid, if any, arising from these claims
and contingencies will not have a material adverse effect on its financial
condition, results of operations or cash flows.
NOTE 11. RELATED PARTY TRANSACTIONS
Substantially all of the Company's life insurance policies are issued
to fund prearranged funeral contracts that are sold by National Prearranged
Services, Inc. ("NPS") and National Prearranged Services Agency, Inc. ("NPS
Agency"). NPS is an affiliated company that collects all payments for
prearranged funeral contracts and remits such amounts to the Company either
directly or through assumed reinsurance.
In connection with issuing insurance policies to fund prearranged
funeral contracts, except in Missouri, the individual owner of the policy
assigns the policy to NPS and/or NPS Agency. As assignee, NPS and/or NPS Agency
remit premiums to and receive policy benefits from the Company. In the State of
Missouri, a trust (the "Trust") owns the policies, pays the premiums and
receives the benefits. An independent investment advisor to the Trust directs
the monies in the Trust as to the purchase of insurance policies. The policy
benefits that are paid in the ordinary course of business includes death
benefits, surrender benefits and policy loans. The Company is not subject to
significant credit risk on the policy loans, since the Company makes no policy
loans which exceed the reserves held on the policy securing the loan and the
Company has the right to deduct the loan amount from the death benefit payment
or from the cash surrender value. Substantially all premiums, death benefits and
surrender benefits during the years ended December 31, 1998, 1997 and 1996 were
received from or paid to NPS, NPS Agency or the Trust. At December 31, 1998 and
1997, the Company had policyholder loans of $15,556,437 and $11,457,962,
respectively, on policies of which NPS is the beneficiary.
The Company's insurance subsidiaries have a contract (the "Contract")
with NPS and NPS Agency that obligates the Company to pay first-year and renewal
commissions on policies written by NPS and NPS Agency. Substantially all
commissions incurred during the years ended December 31, 1998, 1997 and 1996,
were paid to NPS or NPS Agency.
Prior to January 1, 1997, the Contract called for maximum first-year
commissions of up to 23% of the face amount of policies submitted and renewal
commissions of up to 2% of the face amount of issued policies remaining in-force
in years two though six. In order to better match the commissions paid with the
profitability of the underlying polices, effective January 1, 1997, the Company
and NPS and NPS Agency agreed to amend the Contract to provide for increased
first-year commissions of up to 31.5% of the face amount on single premium
policies and terminate payments of renewal commission on policies issued on or
before December 31, 1995. The effect of the amended contract was a reduction in
the increase in future policy benefits of $1,148,000 on policies issued in 1997
and this effect net of $332,000 of income tax expense was recorded as an
increase in additional paid-in capital for the year ended December 31, 1997.
During 1997, the Company and NPS agreed to retroactively increase
premiums charged on certain policies issued by the Company. The policies
selected for the increase in premiums were those policies that did not meet the
profitability criteria of the Company. No plans were found to have a premium
deficiency prior to 1997. The amount of the increased premiums paid by NPS as a
result of this retroactive rate adjustment was $1,923,000. Premiums in the
amount of $1,574,420, collected as a result of the retro-active rate adjustment
applicable to years prior to January 1, 1997, have been credited to additional
paid-in-capital, net of income tax effect of $314,884. Increased premiums in the
amount of $339,828 applicable to the year ended December 31, 1997, have been
included in premium revenue.
Effective January 1, 1997, the Company entered into a cost sharing
agreement with NPS whereby NPS will reimburse the Company on a monthly basis for
a portion of certain general and administrative costs paid for by the Company
for the benefit of NPS. Costs reimbursed under the agreement were $2,253,644 and
$2,695,091 for the years ended December 31, 1998 and 1997, respectively.
Amounts receivable from NPS at December 31, 1998 and 1997, were
$1,535,926 and $478,362, respectively. Amounts payable to NPS at December 31,
1998 and 1997, were $65,000 and $17,090, respectively.
The majority shareholder of the Company has the right to cause the
Company to register the majority shareholder's shares of common stock under the
Securities Act of 1993, for resale, at the expense of the Company.
Effective February 1, 1998, the Company purchased all of the assets of
C. Mitchell Co., Inc. for $145,000. The unpaid balance of the purchase price
bears interest at the rate of eight percent (8%) and is included as accounts
payable to related parties. In connection with the sale of the assets of C.
Mitchell Co., Inc., Clif Mitchell, a current executive officer and director of
the Company, entered into a non-compete agreement with Clif Mitchell for the sum
of $60,000 payable in 15 equal installments beginning April 1, 1998.
NOTE 12. EMPLOYEE BENEFIT PLAN
The Company offers all of its employees who meet certain eligibility
requirements a savings plan (the "401K Plan") under Section 401(k) of the
Internal Revenue Code. Each employee may elect to enter into a written salary
deferral agreement under which an employee makes contributions to the 401K Plan.
In 1996, the Company began matching 12% of the employees' contribution up to 6%
of their salary. For the years ended December 31, 1998, 1997, and 1996 the
Company contributed $8,683, $5,170 and $5,067, respectively, to the 401K Plan.
NOTE 13. CONCENTRATIONS OF RISK
At December 31, 1998 and 1997, the Company had significant investments
in fixed maturity and short-term securities that are either direct obligations
of the U.S. Government or an agency authorized by the U.S. Government. The
Company periodically has significant investments in demand deposits in banks and
other financial institutions that exceed federally insured amounts. The Company
had accounts receivable from NPS and NPS Agency of $1,535,926 and $478,362 at
December 31, 1998 and 1997, respectively. In addition, at December 31, 1998 and
1997, the Company had policyholder loans outstanding of $15,556,437 and
$11,457,962, respectively, on policies of which NPS is the beneficiary. The
policy loans are collateralized by the policy cash surrender values.
NOTE 14. STATUTORY ACCOUNTING INFORMATION
The Company's life insurance subsidiaries are required to file annual
statements with insurance regulatory authorities prepared on the statutory basis
of accounting. Statutory accounting practices prescribed or permitted by
insurance regulatory authorities for the Company's insurance subsidiaries differ
from GAAP. The statutory net income and shareholders' equity reported to
regulatory authorities as of and for the periods ended were as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
1998 1997 1996
-------------- --------------- --------------
<S> <C> <C> <C>
Net income (loss) $ (1,775,721) $ 530,509 $ 2,597,707
Shareholders' equity 7,815,609 7,863,137 5,353,237
</TABLE>
The ability of the life insurance subsidiaries to pay dividends or make
other distributions is restricted by state insurance laws. Determining factors
include, but are not limited to, net income after tax and shareholder's equity
as reported on a statutory basis. At December 31, 1998, no amounts were
available for transfer to the parent company by dividend, loan or advance, or
were available for such a transfer only with prior regulatory approval. There
have been no cash dividends paid by the life insurance subsidiaries to the
parent since the formation or acquisition of the insurance subsidiaries.
NOTE 15. ACQUISITIONS
On May 15, 1998, the Company purchased all of the outstanding stock of
Lincoln for approximately $5.5 million. Lincoln had no active policies in-force;
however, Lincoln is licensed to conduct business in 42 states and the District
of Columbia. The transaction was accounted for using the purchase method of
accounting, and, accordingly, the assets and liabilities were recorded at their
fair market value at the date of acquisition. The net assets, consisting
primarily of investment securities, were approximately $5.1 million at the date
of acquisition. The excess of the purchase price over the fair value of net
assets acquired was recorded as goodwill. The results of operations of Lincoln
for the period subsequent to May 15, 1998 have been included in the Company's
consolidated statements of operations. The pro forma effect of the purchase of
Lincoln is immaterial.
NOTE 16. STOCK OPTIONS
Effective April 6, 1998, the Company adopted the Lincoln Heritage
Corporation 1998 Long-Term Incentive Plan (the Plan). The Plan allows for the
issuance of (i) stock options, (ii) stock appreciation rights, (iii) restricted
shares of common stock, and (iv) performance awards. A total of 1,200,000 shares
of common stock have been reserved for issuance under the Plan. Options may be
exercised only if the optionholder remains continuously associated with the
Company from the date of grant to the date of exercise, subject to certain
conditions as specified in the Plan. An option granted under the Plan cannot be
exercised later than ten years from the date of the grant. Any options that
expire unexercised or that terminate upon an optionee's ceasing his or her
association with the Company become available once again for issuance. Options
vest over 4 years in 25% increments commencing one year from date of grant.
The Company recognizes compensation expense for stock options granted
to employees following the guidance of APB No. 25. Accordingly, the Company
recognized compensation expense of approximately $115,000 related to awards for
employees for the year ended December 31, 1998. Had the Company implemented SFAS
No. 123, the Company's compensation expense would have increased by
approximately $40,000 and the Company's pro forma net income, net income per
share (basic) and net income per share (diluted), considering the effects of
implementing SFAS No. 123, net of tax effects, would have been approximately
$2,500,000, $0.61, and $0.60, respectively.
The Company recognizes compensation expense for stock options granted
to non employees in accordance with SFAS No. 123. The Company recognized
compensation expense of approximately $93,000 for the year ended December 31,
1998, related to awards to non-employees. In accordance with SFAS No. 123,
Accounting for Stock-Based Compensation, the fair market value of the options
granted to non-employees was estimated on the date of grant using the minimum
value approach. The expected life of the options was 7.5 years, the risk-free
interest rate used was 6% and there were no assumptions as to volatility or
dividend yield. The effect of applying SFAS No. 123 is not necessarily
indicative of the effects on future years due to, among other things, the
vesting period of the stock options.
A summary of the Company's stock option activity is as follows:
<TABLE>
<CAPTION>
Number Option
of price
shares per share
<S> <C> <C>
Balance at January 1, 1998 $ - $ -
Granted 399,500 3.75
Forfeited (3,750) 3.75
Exercised --------------- --------------
Outstanding at December 31,1998 $ 395,750 $ 3.75
=============== ==============
Options exercisable at 12/31/98 -
===============
Available for future grant 804,250
===============
</TABLE>
The weighted average fair value of the options granted during the year
ended December 31, 1998 was $7.50 per share.
NOTE 17. SUBSEQUENT EVENTS
On January 28, 1998, the Company executed a definitive stock purchase
agreement to acquire all of the outstanding stock of Harbourton Reassurance,
Inc. ("Harbourton") and subsequently filed an application to acquire control
with the insurance department in the State of Delaware. In March 1999, the
application was withdrawn by the Company and a proposal to acquire Harbourton's
in-force business is pending.
The Company has investments in certain equity securities whose fair
values have declined significantly from the fair values at December 31, 1998.
The declines may be for reasons other than normal market fluctuations that may
require the Company to recognize a loss during the first quarter of 1999. The
Company is closely monitoring the current activities of the issuers of such
securities.
<PAGE>
NOTE 18. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of unaudited quarterly results of operations
for 1998 and 1997:
<TABLE>
<CAPTION>
Year ended December 31, 1998
First Second Third Fourth
<S> <C> <C> <C> <C>
Life premiums $ 7,256,760 $ 13,476,192 $ 10,897,591 $ 9,732,841
Net investment income 2,252,156 2,580,793 2,840,302 2,965,155
Realized investment gains 450,914 617,289 442,905 424,827
Net income (loss) (109,155) 120,522 (513,297) 2,517,589
Basic earnings (loss) per share (0.03) 0.03 (0.13) 0.58
Diluted earnings (loss) per share (0.03) 0.03 (0.13) 0.57
</TABLE>
<TABLE>
<CAPTION>
Year ended December 31, 1997
First Second Third Fourth
<S> <C> <C> <C> <C>
Life premiums $ 8,630,747 $ 8,705,537 $ 8,483,146 $ 12,225,040
Net investment income 1,263,456 1,249,141 1,857,328 1,801,290
Realized investment gains 20,748 86,343 562,781 1,996,576
Net income (loss) (226,279) (126,705) 984,064 1,024,346
Basic earnings (loss) per share (0.06) (0.03) 0.25 0.25
Diluted earnings (loss) per share (0.06) (0.03) 0.25 0.25
</TABLE>
The improvement in earnings in the fourth quarter 1998 as compared to the third
quarter 1998 included a gain from the sale of a portion of the World Block of
approximately $590,000. From an operational perspective, during the fourth
quarter 1998, estimates from prior periods for the reserve liabilities and the
affiliated party cost sharing agreement were calculated for the entire calendar
year. Also, the change in future policy benefit liabilities were significantly
lower for the fourth quarter 1998 which reflects many factors such as the
seasonality of the Company's business.
<PAGE>
<TABLE>
<CAPTION>
Schedule II
Condensed Financial Information of Registrant
Lincoln Heritage Corporation (Parent Company)
Condensed Balance Sheets
December 31,
1998 1997
Assets
<S> <C> <C>
Cash and cash equivalents $ 508,774 $ 730
Accounts receivable 40,000 -
Accounts receivable from related party 65,000 -
Investment in life insurance subsidiaries 9,899,154 6,881,981
Deferred tax assets, net 330,752 -
--------------- --------------
Total $ 10,843,680 $ 6,882,711
=============== ==============
Liabilities and Shareholders' Equity
Accrued expenses $ 155,949 $ -
Accounts payable to related party 1,873,169 -
--------------- --------------
Total liabilities 2,029,118 -
Shareholders' Equity:
Preferred stock ($.01 par value; authorized,
1,000,000 shares; issued, no shares) - -
Common Stock ($0.01 par value; 10,000,000
shares authorized; 4,520,000 and
1,000,000 shares issued and outstanding,
respectively) 45,200 10,000
Additional paid-in capital 4,734,350 2,075,576
Retained earnings 6,273,924 4,258,265
Accumulated other comprehensive income (loss) (2,238,912) 538,870
--------------- --------------
Total shareholders' equity 8,814,562 6,882,711
--------------- --------------
Total $ 10,843,680 $ 6,882,711
=============== ==============
</TABLE>
See Note to Condensed Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
Schedule II
Condensed Financial Information of Registrant
Lincoln Heritage Corporation (Parent Company)
Condensed Statements of Operations
Years ended December 31,
1998 1997 1996
-------------- --------------- --------------
Revenues
<S> <C> <C> <C>
Net investment income $ 13,514 $ - $ -
-------------- --------------- --------------
Total revenues 13,514 - -
-------------- --------------- --------------
Expenses
General expenses 1,194,114 - -
-------------- --------------- --------------
Total expenses 1,194,114 - -
-------------- --------------- --------------
Income before income taxes
and equity in
undistributed net income
of subsidiaries (1,180,600) - -
Income taxes
Current (70,652) - -
Deferred (330,752) - -
-------------- --------------- --------------
Total income taxes (401,404)
Income before equity in
undistributed net income
of subsidiaries (779,196) - -
Equity in undistributed net
income of subsidiaries 2,794,855 1,655,426 704,630
-------------- --------------- --------------
Net income $ 2,015,659 $ 1,655,426 $ 704,630
============== =============== ==============
</TABLE>
See Note to Condensed Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
Schedule II
Condensed Financial Information of Registrant
Lincoln Heritage Corporation (Parent Company)
Condensed Statements of Cash Flows
Years ended December 31,
1998 1997 1996
----------- ----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net income $ 2,015,659 $ 1,655,426 $ 704,630
Adjustments to reconcile net income to net cash
provided by operating activities:
Deferred income taxes (330,752) - -
Stock options issued 137,147 - -
Increase in accounts receivable (40,000) - -
Increase in accounts receivable and payable
to related party 1,808,169 - -
Increase in accrued liabilities 155,949 - -
Equity in undistributed net income of subsidiaries (2,794,855) (1,655,426) (704,630)
------------ ----------- ------------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 951,317 - -
------------ ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital contributions to subsidiaries (3,000,100) - -
----------- ----------- -----------
NET CASH USED IN INVESTING
ACTIVITIES (3,000,100) - -
------------ ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 2,556,827 - -
------------ ----------- -----------
NET CASH PROVIDED BY FINANCING
ACTIVITIES 2,556,827 - -
------------ ----------- -----------
NET INCREASE IN CASH AND
CASH EQUIVALENTS 508,044 - -
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 730 730 730
------------ ----------- -----------
CASH AND CASH EQUIVALENTS,
END OF YEAR $508,774 $730 $730
============ =========== ===========
</TABLE>
See Note to Condensed Financial Statements.
<PAGE>
NOTE TO CONDENSED FINANCIAL STATEMENTS
The accompanying condensed financial statements should be read in conjunction
with the consolidated financial statements and notes thereto of Lincoln Heritage
Corporation and subsidiaries.
<PAGE>
<TABLE>
<CAPTION>
Schedule III
Supplementary Insurance Information
Deferred
Segment policy Future policy Unearned Other policy Premium Net Benefits, Amortization Other
acquisition benefits, premiums claims and revenue investment claims, of deferred operating
costs losses, claims benefits income losses and policy expenses
and loss payable settlement acquisition
expenses expenses costs
Life Insurance:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Year ended
12/31/98 $ 16,881,478 $ 152,014,788 $ 409,937 $ -0- $ 41,363,384 $10,638,406 $ 33,087,742 $ 4,600,197 $ 14,541,516
Year ended
12/31/97 12,554,870 130,145,936 304,471 -0- 38,044,470 6,171,215 31,151,251 2,756,243 10,647,318
Year ended
12/31/96 11,149,607 72,854,246 212,449 -0- 33,273,417 3,710,720 24,750,300 2,662,773 10,687,827
- - ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Schedule IV
Reinsurance
Gross Ceded to Assumed Net Percentage
amount other from other amount of amount
companies companies assumed to net 1998
<S> <C> <C> <C> <C> <C>
Life insurance in-force $ 234,294,031 $ -0- $ 22,403,847 $ 256,697,878 9%
Premiums 40,441,151 (290,024) 1,212,257 41,363,384 3
1997
Life insurance in-force $ 222,623,591 $ -0- $ 4,660,362 $ 227,283,953 2%
Premiums 34,925,424 (252,784) 3,371,830 38,044,470 9
1996
Life insurance in-force $ 140,788,664 $ -0- $ 36,096,526 $ 176,885,190 20%
Premiums 26,918,986 (184,165) 6,538,596 33,273,417 20
</TABLE>
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
3.1 Amended and Restated Articles of Incorporation of the Company, filed
as Exhibit 3.1 to the Company's Registration Statement on Form S-1
(Reg. No. 333-50525), are hereby incorporated by reference.
3.2 By-laws of the Company, filed as Exhibit 3.2 to the Company's
Registration Statement on Form S-1 (Reg. No. 333-50525), are hereby
incorporated by reference.
4.1 Form of Stock Certificate for Common Stock, filed as Exhibit 4.1
to the Company's Registration Statement on Form S-1 (Reg. No.
333-50525), is hereby incorporated by reference.
4.2 Registration Rights Agreement dated as of April 6, 1998 by and between
the Company and National Heritage Enterprises, Inc, filed as Exhibit
4.2 to the Company's Registration Statement on Form S-1 (Reg. No.
333-50525), is hereby incorporated by reference.
4.3 Form of Warrant Agreement between the Company and Tejas Securities
Group, Inc, filed as Exhibit 4.3 to the Company's Registration
Statement on Form S-1 (Reg. No. 333-50525), is hereby incorporated by
reference.
10.1 Lincoln Heritage Corporation 1998 Long-Term Incentive Plan, filed as
Exhibit 10.1 to the Company's Registration Statement on Form S-1 (Reg.
No. 333-50525), is hereby incorporated by reference.
10.2 Exclusivity Agreemen dated as of April 1, 1998 by and between the
Company and National Prearranged Services, Inc, filed as Exhibit 10.2
to the Company's Registration Statement on Form S-1 (Reg. No.
333-50525), is hereby incorporated by reference.
10.3 Stock Purchase Agreement dated January 26, 1998 by and between
Lincoln and NRG Acquisition Partners, L.P, filed as Exhibit 10.3 to
the Company's Registration Statement on Form S-1 (Reg. No. 333-50525),
is hereby incorporated by reference.
10.4 Award Agreement dated as of August 18, 1998 by and between the Company
and Nicholas M. Powling, filed as Exhibit 10.4 to the Company's
Registration Statement on Form S-1 (Reg. No. 333-50525), is hereby
incorporated by reference.
10.5 Award Agreement dated as of August 18, 1998 by and between the Company
and Clifton Mitchell, filed as Exhibit 10.5 to the Company's
Registration Statement on Form S-1 (Reg. No. 333-50525), is hereby
incorporated by reference.
10.6 Cost Sharing Agreement dated as of March 31, 1997 by and among
Memorial, Lincoln and NPS, filed as Exhibit 10.6 to the Company's
Registration Statement on Form S-1 (Reg. No. 333-50525), is hereby
incorporated by reference.
10.7 Cost Sharing Agreement dated as of June 1, 1998 by and between the
Company and NPS, filed as Exhibit 10.7 to the Company's Registration
Statement on Form S-1 (Reg. No. 333-50525), is hereby
incorporated by reference.
10.8 Award Agreement dated as of August 18, 1998 by and between the Company
and Brent D. Cassity, filed as Exhibit 10.8 to the Company's
Registration Statement on Form S-1 (Reg. No. 333-50525), is hereby
incorporated by reference.
10.9 General Agent Contract dated May 12, 1992 and Addendum dated February
19, 1998 by and between the Company and NPS, filed as Exhibit 10.9 to
the Company's Registration Statement on Form S-1 (Reg. No. 333-50525),
is hereby incorporated by reference.
10.10 Form of Underwriting Agreement, filed as Exhibit 1.1 to the Company's
Registration Statement on Form S-1 (Reg. No. 333-50525), is hereby
incorporated by reference.
21.1 Subsidiaries of the Company.
23.1 Consent of Deloitte & Touche LLP
23.2 Consent of Killman, Murrell and Company, P.C.
27.1 Financial Data Schedule (December 31, 1998).
EX-21.1
LIST OF SUBSIDIARIES
Corporation State
Memorial Service Life Insurance Company Texas
New Life Insurance Company
(formerly known as Lincoln Memorial Life
Insurance Company) Texas
Lincoln Memorial Life Insurance Company
(formerly known as World Service Life
Insurance Company of America) Texas
Wise & Associates, Inc. Missouri
EX-23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
333-69267 of Lincoln Heritage Corporation on Form S-8 of our report dated March
26, 1999, appearing in the Annual Report on Form 10-K of Lincoln Heritage
Corporation for the year ended December 31, 1998.
DELOITTE & TOUCHE LLP
Fort Worth, Texas
March 31, 1999
EX-23.2
INDEPENDENT ACCOUNTANTS' CONSENT
We consent to the incorporation by reference in the Registration Statement on
Form S-8 (File No. 333-69267) of Lincoln Heritage Corporation of our report
dated March 11, 1998, appearing in the Annual Report on Form 10-K of Lincoln
Heritage Corporation for the year ended December 31, 1998.
KILLMAN, MURRELL & COMPANY, P.C.
Dallas, Texas
March 31, 1999
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
The schedule below contains summary financial
information extracted from the Consolidated
Financial Statements of Lincoln Heritage
Corporation and is qualified in its entirety
by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 65,628
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 7,121
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 90,006
<CASH> 43,825
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 16,881
<TOTAL-ASSETS> 164,073
<POLICY-LOSSES> 151,365
<UNEARNED-PREMIUMS> 410
<POLICY-OTHER> 650
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 45
<OTHER-SE> 8,769
<TOTAL-LIABILITY-AND-EQUITY> 164,073
41,363
<INVESTMENT-INCOME> 10,638
<INVESTMENT-GAINS> 1,936
<OTHER-INCOME> 748
<BENEFITS> 33,088
<UNDERWRITING-AMORTIZATION> 4,600
<UNDERWRITING-OTHER> 14,541
<INCOME-PRETAX> 2,456
<INCOME-TAX> 440
<INCOME-CONTINUING> 2,016
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,016
<EPS-PRIMARY> 0.49
<EPS-DILUTED> 0.48
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
