UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-KSB
(Mark One)
[x] ANNUAL REPORT under Section 13 or 15(d) of the Securities
Exchange Act of 1934 [Fee Required]
For the fiscal year ended: December 31, 1998
[ ] TRANSITION REPORT under Section 13 or 15(d) of the Securities
Exchange Act of 1934
[No Fee Required]
For the transition period from ____________ to ____________
Commission file number 0-14451
Acap Corporation
(Name of small business issuer in its charter)
State of Incorporation: IRS Employer Id.:
Delaware 25-1489730
Address of Principal Executive Office:
10555 Richmond Avenue, 2nd Floor
Houston, Texas 77042
Issuer's telephone number, including area code: (713) 974-2242
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.10 per share
(Title of Class)
Check whether the issuer (1) filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 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.
[x] Yes [ ] No.
Check if disclosure of delinquent filers in response to Item 405
of Regulation S-B is not contained in this form, and no
disclosure will 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-KSB or any
amendment to this Form 10-KSB. [x]
Revenues for the issuer for its most recent fiscal year were
$8,941,475.
As of March 22, 1999, 7,240 shares of the registrant's Common
Stock, excluding shares held in treasury, were issued and
outstanding, and the aggregate market value of such shares held
by non-affiliates of the registrant on such date, based on the
average of the closing bid and asked prices for such shares on
such date, was $2,138,035.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part II, Items 5 - 7 of Form 10-KSB
is incorporated by reference from the registrant's 1998 Annual
Report to Stockholders. The information required by Part III,
Items 9 - 12 of Form 10-KSB is incorporated by reference from the
registrant's definitive information statement to be furnished in
connection with the Annual Meeting of Stockholders to be held on
or about May 3, 1999.
The Exhibit Index, Part IV, Item 13, is located on page 7 of this
Form 10-KSB.
This Form 10-KSB contains a total of 46 pages including any
exhibits.
Transitional Small Business Disclosure Format (check one):
[ ] Yes [x] No
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
Acap Corporation was incorporated under the laws of the State of
Delaware on March 18, 1985 by the management of American Capitol
Insurance Company ("American Capitol") to become the parent or
"holding company" of American Capitol. Acap Corporation began
operating in that capacity on October 31, 1985. American Capitol
is a Texas life insurance company licensed in 34 states and the
District of Columbia. American Capitol began operations as a
life insurance company on June 1, 1954.
Unless the context otherwise requires, the term "Acap" refers to
the consolidated group of Acap Corporation and its wholly-owned
subsidiaries.
Acap primarily engages in the acquisition and servicing of
existing blocks of life insurance policies. Since September
1994, the Company has marketed a small volume of final expense
insurance and prearranged funeral service contracts. Through its
life insurance subsidiaries, Acap maintains a broad portfolio of
individual life insurance policies and annuity contracts. Life
insurance is the only industry segment material to the operations
of Acap.
Fortune National Corporation ("Fortune Corp"), a Pennsylvania
corporation, acquired a majority interest in American Capitol in
1984. In the 1985 reorganization that resulted in American
Capitol becoming a wholly-owned subsidiary of Acap, Fortune
Corp's majority interest in American Capitol was exchanged for an
equivalent interest in Acap. Fortune Corp was liquidated during
1996, leaving Fortune Corp's majority stockholder, InsCap
Corporation ("InsCap"), a Delaware corporation, with the
controlling interest in Acap, approximately 46% at December 31,
1998.
Acquisition Strategy
Acap's strategy for achieving growth and profits is based upon
the acquisition of blocks of existing life insurance policies
through the direct purchase of such blocks or indirectly through
the acquisition of life insurance companies. By acquiring blocks
of life insurance directly or through the purchase of other life
insurance companies, Acap hopes to add "new" life policies to its
books more economically than through marketing.
Generally, insurance companies can acquire policies in two ways;
either by "purchasing" them policy by policy through marketing,
or by buying an existing block of policies. Purchasing an
existing block of business has the advantage that the policies
have an established "history." That is, an existing block will
have an established pattern of mortality and lapse experience.
Also, the company selling the block of existing life policies has
already absorbed the risks involved in marketing the life
insurance products. In purchasing an existing block of policies,
Acap's strategy is to set the purchase price at the sum of the
expected future profits of the block of policies discounted at a
rate of return in excess of Acap's cost of funds. Acap then
attempts to improve upon the rate of return by maintaining the
acquired policies at a lower per policy cost than was used in the
pricing assumptions and by realizing a higher investment yield on
the acquired assets than was used in the pricing assumptions.
It also should be noted that the acquisition strategy has certain
risks and disadvantages. Since the marketing of life insurance
products generally involves greater risks than acquiring existing
blocks of life insurance, the profit margins available through
marketing may be greater than the margins available with respect
to an acquired block of life insurance. Also, there are
relatively few companies or blocks of business meeting Acap's
acquisition criteria that become available for purchase each
year. Acap's acquisition strategy requires Acap to maintain the
personnel, computer systems and physical properties necessary to
accommodate large growth phases without the guarantee that such
growth will occur.
Acquisitions to Date
Acap (i.e., its predecessor, American Capitol) switched from a
traditional marketing strategy to the current acquisition
strategy in 1984 in connection with the change in control and
associated change in management resulting from Fortune Corp's
purchase of a majority of the outstanding common stock. Since
1984, Acap has acquired six companies and four blocks of
business. Primarily as a result of this acquisition activity,
Acap's assets grew from approximately $64 million at December 31,
1984 to approximately $158 million at December 31, 1998.
Products and Markets
The policies serviced by Acap are primarily traditional whole
life policies, interest-sensitive whole life policies, term life
policies, stipulated premium whole life policies, flexible
premium annuity contracts, and Medicare supplement policies.
Traditional whole life policies are generally characterized by a
uniform death benefit and a level periodic premium throughout the
insured's lifetime. These policies combine a savings element
with insurance protection. The savings element, called the cash
value, builds at a fixed rate of interest and may be borrowed
against by the policyholder and, if the policy terminates other
than through the death of the insured, may be paid to the
policyholder.
Acap's interest-sensitive whole life policies also generally have
a uniform death benefit and a level periodic premium. However,
with these policies, the interest rate credited to the savings
element of the policy may be varied at Acap's option above a
guaranteed minimum rate. The interest-sensitive policies also
provide for a surrender charge in the event that the policyholder
surrenders the policy during the first ten years following the
issue date of the policy. Further, Acap may vary below a
guaranteed maximum the amount charged against the policy for
expenses and mortality costs.
Term life policies generally offer pure insurance protection
(i.e., no savings element) for a specified period. Such policies
typically offer a conversion privilege, a renewal privilege, or
both. Premiums typically are adjusted upon the exercise of
either privilege.
Stipulated premium whole life policies are characterized by a
uniform death benefit and a level periodic premium throughout the
insured's lifetime, however, unlike traditional whole life
policies, stipulated premium whole life policies have no cash
value.
Flexible premium annuity contracts permit the annuitant to make
deposits as he sees fit, and allow the annuitant to make
withdrawals at his option, subject to deduction of applicable
surrender charges. The annuity balance earns interest on a tax
deferred basis at a rate that Acap may change annually.
Medicare supplement policies are health insurance policies that
cover specified benefits that are not covered by Medicare.
Premium rates may be changed on the policies within a state with
the advance approval of regulatory officials of that state.
From mid-1985 until September 1994, the Company relied
exclusively on its acquisition strategy and did not actively
market new business. Since September 1994, the Company has
marketed a small volume of final expense insurance and
prearranged funeral service contracts. These policies are
primarily written through independent funeral homes.
The following table sets forth information with respect to gross
insurance in force and net premium income of Acap during the past
three years:
(Dollars in Thousands) 1998 1997 1996
---- ---- ----
Life insurance in force 577,049 287,401 291,396
Premium income:
Life 2,285 2,645 2,686
Annuity 705 977 472
Health 368 -- --
-----------------------------------------
Total premiums 3,358 3,622 3,158
=========================================
The table below presents the direct collected premiums by major
geographic area for the last three years:
(Dollars in Thousands) 1998 1997 1996
---- ---- ----
Texas 4,635 4,034 3,734
Ohio 406 454 491
Alabama 833 447 18
Indiana 368 414 432
Pennsylvania 310 347 370
Michigan 251 282 312
Other U.S. 1,691 1,825 1,864
------------------------------------------
Total 8,494 7,803 7,221
==========================================
The preceding tables include certain premium amounts which under
Statement of Financial Accounting Standards No. 97 ("FAS 97") are
credited to liability accounts and are not considered revenues,
and exclude surrender charges that under FAS 97 are considered
revenue. The premiums of Acap affected by FAS 97 are the
premiums on interest-sensitive whole life policies and annuity
contracts.
Competition
The life insurance industry is highly competitive. There are
over 1,700 life insurance companies in the United States.
Although Acap's acquisition strategy is not the standard strategy
employed in the industry, Acap must compete with a significant
number of companies, both inside and outside the life insurance
industry, when looking for an acquisition. Many of these
companies have substantially greater financial resources and
larger staffs than Acap.
Acap also must compete with a significant number of other life
insurance companies to retain Acap's existing block of policies.
Many of these companies have broader and more diverse product
lines together with active agency forces, and therefore, certain
of Acap's policyholders may be induced to replace their existing
policies with those provided by Acap's competitors.
Regulation
The insurance subsidiaries of the Company are subject to
regulation by the supervisory insurance agency of each state or
other jurisdiction in which the insurance subsidiaries are
licensed to do business. These supervisory agencies have broad
administrative powers relating to the granting and revocation of
licenses to transact business, the approval of policy forms, the
form and content of mandatory financial statements, capital,
surplus, reserve requirements and the types of investments that
may be made. The insurance subsidiaries are required to file
detailed reports with each supervisory agency, and its books and
records are subject to examination by each. In accordance with
the insurance laws of the State of Texas (the insurance
subsidiaries' state of domicile) and the rules and practices of
the National Association of Insurance Commissioners (the "NAIC"),
the insurance subsidiaries are examined periodically by examiners
from Texas.
Most states have enacted legislation or adopted administrative
regulations covering such matters as the acquisition of control
of insurance companies and transactions between insurance
companies and the persons controlling them. The NAIC has
recommended model legislation on these subjects that has been
adopted, with variations, by many states. The nature and extent
of the legislation and administrative regulations now in effect
vary from state to state, and in most states prior administrative
approval of the acquisition of control of an insurance company
incorporated in the state, whether by tender offer, exchange of
securities, merger or otherwise, is required, which process
involves the filing of detailed information regarding the
acquiring parties and the plan of acquisition.
The insurance subsidiaries are members of an "insurance holding
company system" and are required to register as such with the
State of Texas and file periodic reports concerning their
relationships with the insurance holding company and other
affiliates of the holding company. Material transactions between
members of the holding company system are required to be "fair
and reasonable" and in some cases are subject to administrative
approval, and the books, accounts and records of each party are
required to be so maintained as to clearly and accurately
disclose the precise nature and details of the transactions.
Notice to or approval by the State of Texas is required for
dividends paid by the insurance subsidiaries.
Employees
At December 31, 1998, Acap had a total of 66 employees. None of
these employees is covered by a collective bargaining agreement.
Acap believes that it has excellent relations with its employees.
ITEM 2. DESCRIPTION OF PROPERTIES.
The principal offices of the Company are located at 10555
Richmond Avenue, 2nd Floor, Houston, Texas 77042. The Company
leases 21,511 square feet of office space pursuant to a five year
lease executed in 1997. The Company's offices are suitable for
the conduct of its business and the Company has an option to
lease additional space in the same building to provide room for
future growth.
The Company's investment policy prohibits making investments in
real estate without the prior approval of the Board of Directors.
There are no plans to make any real estate investments in the
foreseeable future. If the Company were interested in making a
real estate investment, regulatory restrictions applicable to
Texas life insurance companies would prohibit the life insurance
subsidiaries from investing in real estate outside of the United
States, in residential real estate, or in any property, other
than home office property, that exceeds 5% of the insurer's
statutory assets.
The Company owns and services first mortgage loans with aggregate
principal balances at December 31, 1998 of $1,930,734. The
Company's investment policy prohibits making new investments in
mortgage loans without the prior approval of the Board of
Directors. There are no plans to make any mortgage loan
investments in the foreseeable future. If the Company were
interested in making a mortgage loan investment, regulatory
restrictions applicable to Texas life insurance companies would
prohibit the life insurance subsidiaries from investing in
mortgage loans on real estate outside of the United States, in
other than first liens, or in any loan that exceeds 25% of the
insurer's statutory capital and surplus.
ITEM 3. LEGAL PROCEEDINGS.
Acap and its subsidiary are involved in various lawsuits and
legal actions arising in the ordinary course of operations.
Management is of the opinion that the ultimate disposition of
these matters will not have a material adverse effect on Acap's
financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted to a vote of security holders during the
quarter ended December 31, 1998.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The required information regarding the market for the common
equity of the Company and related stockholder matters is
incorporated herein by reference from "Stockholder Information"
on page 31 of Acap's 1998 Annual Report to Stockholders.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
Management's Discussion and Analysis of Financial Condition and
Results of Operations is incorporated herein by reference from
"Management's Financial Analysis" on pages 3 - 9 of Acap's 1998
Annual Report to Stockholders.
ITEM 7. FINANCIAL STATEMENTS.
Financial statements and supplementary data are incorporated
herein by reference from pages 10-29 of Acap's 1998 Annual Report
to Stockholders.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS.
None.
PART III
The information required by Items 9-12 is incorporated by
reference from Acap's definitive information statement, which is
to be filed pursuant to Regulation 14C.
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
Exhibits Description Location or
Incorporation by
Reference
3(a)(1) Certificate of Incorporation of *Form 10 effective June
the Registrant dated March 12, 22, 1986, pages 58-61
1985
3(a)(2) Certificate of Amendment to the *Form 10 effective June
Certificate of Incorporation of 22, 1986, pages 62-65
the Registrant dated October
25, 1985
3(a)(3) Certificate of Amendment to the *Form 10K dated December
Certificate of Incorporation of 31, 1988, pages 51-53
the Registrant dated August 22,
1986
3(a)(4) Certificate of Amendment to the *Form S4, Registration
Certificate of Incorporation of No. 33-27874
the Registrant dated March 20,
1989
3(a)(5) Certificate of Amendment to the *Form 10KSB dated
Certificate of Incorporation of December 31, 1994, pages
the Registrant dated May 9, 273- 276
1994
3(b)(1) Bylaws of the Registrant, as *Form 10K dated December
amended 31, 1988, pages 54-68
3(b)(2) Amendment to the Bylaws of the *Form 10Q dated March 31,
Registrant 1990, page 11
4 Certificate of Designations of *Form 8K dated December
the Preferred Stock of the 31, 1986, pages 23-31
Registrant
10(a)(1) 1997 American Capitol Insurance *Form 10KSB dated
Company Key Employee Incentive December 31, 1997, pages
Stock Option Plan 11-19
10(a)(2) Form of Grant of Stock Option *Form 10KSB dated
used in 1997 American Capitol December 31, 1997, pages
Insurance Company Key Employee 20-25
Incentive Stock Option Plan
10(b)(1) Employment Contract between *Form 10QSB dated March
American Capitol Insurance 31, 1997, pages 13-26
Company and John D. Cornett
10(b)(2) Stock Purchase Agreement *Form 10QSB dated March
between American Capitol 31, 1997, pages 27-36
Insurance Company and John D.
Cornett
10(c) Disability Income Agreement *Form 10KSB dated
between American Capitol December 31, 1997, pages
Insurance Company and William 26-29
F. Guest
10(d)(1) Reinsurance Agreement between *Form 10KSB dated
American Capitol Insurance December 31, 1993, pages
Company and Crown Life 10-66
Insurance Company effective
December 31, 1992, as amended
10(d)(2) Amendment dated June 30, 1996 *Form 10KSB dated
to the Reinsurance Agreement December 31, 1996, pages
between American Capitol 48-50
Insurance Company and Crown
Life Insurance Company
10(e)(1) Reinsurance Agreement effective *Form 10KSB dated
February 2, 1995 between Oakley- December 31, 1994, pages
Metcalf Insurance Company and 213- 260
Alabama Reassurance Company
10(e)(2) Amendment dated January 1, 1996 *Form 10KSB dated
to the Reinsurance Agreement December 31, 1996, pages
between Oakley-Metcalf 69-71
Insurance Company and Alabama
Reassurance Company
10(e)(3) Amendment dated December 31, *Form 10KSB dated
1996 to the Reinsurance December 31, 1996, page
Agreement between Texas 72
Imperial Life Insurance Company
and Alabama Reassurance Company
10(f) Loan Agreement and related *Form 10KSB dated
documents between Acap December 31, 1994, pages
Corporation and Central 261- 272
National Bank
10(g) Coinsurance Agreement dated *Form 10KSB dated
June 1, 1996 between World December 31, 1996, pages
Service Life Insurance Company 73-138
of America and American Capitol
Insurance Company
10(h) Administration Agreement dated *Form 10KSB dated
June 1, 1996 between South December 31, 1996, pages
Texas Life Insurance Agency, 139-147
Inc. and American Capitol
Insurance Company
10(i) Administration Agreement dated *Form 10KSB dated
June 1, 1996 between South December 31, 1996, pages
Texas Life Insurance Company 148-158
and American Capitol Insurance
Company
10(j) Assumption Agreement dated *Form 10KSB dated
August 1, 1997 between World December 31, 1997, pages
Service Life Insurance Company 30-74
of America and American Capitol
Insurance Company
10(k) Coinsurance Agreement dated *Form 10KSB dated
January 1, 1998 between December 31, 1997, pages
Universal Life Insurance 75-128
Company and American Capitol
Insurance Company
10(l) Amendments Letter dated *Form 10KSB dated
February 27, 1998 amending the December 31, 1997, pages
Coinsurance Agreement between 129-132
Universal Life Insurance
Company and American Capitol
Insurance Company
10(m) Closing Memorandum and *Form 10KSB dated
Amendments to the Coinsurance December 31, 1997, pages
Agreement between Universal 133-135
Life Insurance Company and
American Capitol Insurance
Company
10(n) Administration Agreement dated *Form 10KSB dated
January 1, 1998 between December 31, 1997, pages
Universal Life Insurance 136-153
Company and American Capitol
Insurance Company
10(o) Coinsurance Agreement dated *Form 10KSB dated
January 1, 1998 between December 31, 1997, pages
Republic-Vanguard Life 154-176
Insurance Company and American
Capitol Insurance Company
10(p) Lease Agreement dated November *Form 10KSB dated
21, 1997 between Realtycorp December 31, 1997, pages
International Group LC and 177-227
American Capitol Insurance
Company
11 Statement re computation of per *1998 Annual Report to
share earnings Stockholders, page 17
13 1998 Annual Report to Pages 10-43
Stockholders
22 Subsidiaries of the Registrant Page 44
27 Financial Data Schedule Page 45
_______________________________________________________
* Exhibit is incorporated by reference to the listed document.
(b)Reports on Form 8-K:
No reports on Form 8-K were filed in the last quarter of the year
ended December 31, 1998.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Acap Corporation
Date: March 22, 1999
By:
/s/ William F. Guest
-----------------------
William F. Guest
Chairman of the Board
In accordance with the Exchange Act, this report has been signed
below by the following persons on behalf of the registrant and in
the capacities and on the date indicated.
Date: March 22, 1999
By:
/s/ William F. Guest /s/ John D. Cornett
- ----------------------- --------------------------
William F. Guest John D. Cornett
Chairman of the Board, Executive Vice President,
Director and President and Treasurer
Principal Executive Officer) (Principal Financial and
Accounting Officer)
/s/ R. Wellington Daniels /s/ C. Stratton Hill, Jr.
- --------------------------- --------------------------
R. Wellington Daniels C. Stratton Hill, Jr.
Director Director
EXHIBIT 21
SUBSIDIARIES OF ACAP CORPORATION
Wholly-owned subsidiary of Acap Corporation:
- --------------------------------------------
American Capitol Insurance Company (Texas)
Wholly-owned subsidiaries of American Capitol Insurance Company:
- ---------------------------------------------------------------
Imperial Plan, Inc. (Texas)
Texas Imperial Life Insurance Company (Texas)
ACAP CORPORATION
CONTENTS
President's Report 1
Management's Financial Analysis 3
Consolidated Balance Sheet 10
Consolidated Statements of Operations and Comprehensive Income 11
Consolidated Statements of Stockholders' Equity 12
Consolidated Statements of Cash Flows 13
Notes to Consolidated Financial Statements 14
Independent Auditors' Report 30
Stockholder Information 31
Directors and Officers 32
Corporate Profile
Acap Corporation is a life insurance holding company that focuses on
the acquisition of existing life insurance policies, either through
direct purchase or the acquisition of life insurance companies.
Adjuncts to the acquisition-oriented growth strategy include using
financial leverage and reinsurance to make more acquisitions and to
maximize the return to stockholders, consolidating and streamlining
the operations of acquired businesses, concentrating on a limited
number of lines of business and providing superior customer service to
improve policy retention.
Acap was formed in 1985. Acap's life insurance operations are
conducted through its wholly-owned life insurance subsidiaries. All
operations are conducted from the corporate headquarters in Houston,
Texas. Acap's common stock is quoted on the NASD Electronic Bulletin
Board under the symbol AKAP.
<PAGE>
PRESIDENT'S REPORT
Corporate Developments During 1998
Effective January 1, 1998, American Capitol Insurance Company
("American Capitol"), a wholly-owned subsidiary of the Company,
acquired through coinsurance 100% of the individual life insurance
policies of Universal Life Insurance Company ("Universal") in force
on that date. The parties also executed an administrative agreement
whereby American Capitol agreed to provide specified administrative
functions for the 246,011 coinsured Universal policies. American
Capitol started administering the policies beginning July 1, 1998.
Between January 1, 1998 and July 1, 1998, Universal continued to
administer the policies, and American Capitol paid Universal the
expense allowance stipulated in the administration agreement.
Concurrent with the coinsurance of the Universal policies, American
Capitol retroceded 100% of the business to an unaffiliated reinsurance
company. The reinsurer pays American Capitol an expense allowance for
administering the policies. The Company's profits from the Universal
transaction will initially be determined by the Company's ability to
administer the policies for less than the expense allowance received
from the reinsurer. In the future, once the reinsurer has recovered
the initial ceding fee, the Company is entitled to 70% of the profits
generated by the policies. Also, the Company has the right to
recapture the retrocession under certain terms and conditions.
A significant effort was involved in transferring the administration
of the coinsured Universal policies to American Capitol's home office
and in converting the policies from Universal's policy administration
system to American Capitol's policy administration system. This
effort involved considerable expense during 1998, which expenses
should not be present in 1999. Special thanks go to all the American
Capitol employees who have put in extraordinary effort in connection
with the administration and conversion of the Universal policies.
Effective October 31, 1998, American Capitol acquired through 100%
coinsurance a block of approximately 1,900 Medicare supplement health
insurance policies from Statesman National Life Insurance Company
("Statesman"). The purchase price of the Medicare supplement block
was $1 million. As of December 31, 1998, the Medicare supplement
policies had annualized premiums in force of approximately $2.1
million.
Results of Operations
The Company had a net loss for 1998 of $13,989, or $28.42 per basic
common share, compared to net income for 1997 of $1,348,031, or
$154.43 per basic common share. The loss for 1998 was primarily the
result of an $800,000 realized investment loss on a single investment.
Pre-tax operating income (which excludes realized investment gains and
losses) for 1998 was $694,640 in comparison to $529,567 for 1997.
A more complete analysis of the results of operations is included in
the Management's Financial Analysis section of this Annual Report.
Stockholders are urged to read the entire Annual Report to gain a
better understanding of the Company, its recent financial
performance, and its prospects.
Outlook
In spite of the disappointment of the investment loss noted above,
significant progress was made during 1998.
* The Universal coinsurance was one of our largest acquisitions to
date. We now administer over 325,000 policies.
* The Statesman coinsurance expanded our product horizons. As
discussed below, we are considering expanding our presence in the
Medicare supplement market.
* We continued to see growth in the premiums from the preneed
marketing of Texas Imperial Life Insurance Company ("Texas
Imperial"), a wholly-owned subsidiary of American Capitol. While
still relatively small, Texas Imperial's premiums were 41% higher
in 1998 than in 1997, following a 33% increase in 1997 over 1996.
During 1999, we will begin the task of converting all of our
policies to a new policy administration system acquired during 1998.
While it will be a time consuming and expensive process, the new
system has greatly expanded capabilities. The system will enable
the Company to explore acquisition and marketing opportunities
beyond traditional life insurance, into such areas as universal
life, Medicare supplement and other types of business that the
Company's existing systems are not capable of administering. It is
important to note that the move to the new policy administration
system is not driven by Year 2000 considerations. As discussed in
the Management's Financial Analysis section of this Annual Report,
the Company is well on its way to being Year 2000 compliant.
We are currently evaluating whether to begin marketing Medicare
supplement health insurance. If we decide to enter the Medicare
supplement market, significant effort will be devoted during 1999 to
getting the marketing "up on track" and monitoring its progress.
We are encouraged by the recent progress of our preneed marketing
and we are excited by the potential we see in the Medicare
supplement market. Our goal through marketing is to provide a more
stable source of growth to augment the punctuated growth inherent in
the Company's acquisition activities. However, we remain committed
to the pursuit of synergies and economies of scale through
acquisitions in the insurance industry. With the ability to broaden
the acquisition focus beyond traditional life insurance, we believe
the Company is well positioned to make future acquisitions.
William F. Guest
President
April 6, 1999
<PAGE>
MANAGEMENT'S FINANCIAL ANALYSIS
RESULTS OF OPERATIONS
Premiums and other considerations were 2% higher in 1998 in comparison
to 1997. While there was relatively little net change in premium
income between 1998 and 1997, there were significant changes in the
sources and composition of the premium income between the two years.
Effective October 31, 1998, American Capitol Insurance Company
("American Capitol"), a wholly-owned subsidiary of the Company,
acquired through 100% coinsurance a block of approximately 1,900
Medicare supplement health insurance policies from Statesman
National Life Insurance Company ("Statesman"). The purchase
price of the Medicare supplement block was $1 million. As of
December 31, 1998, the Medicare supplement policies had annualized
premiums in force of approximately $2.1 million. Earned premiums
on this block of business for the last two months of 1998 were
approximately $350,000.
Premiums in American Capitol's wholly-owned subsidiary, Texas
Imperial Life Insurance Company ("Texas Imperial'), were
approximately $460,000 (41%) higher in 1998 in comparison to 1997.
Texas Imperial markets final expense life insurance and insurance-
funded prepaid funeral service contracts. Texas Imperial's
premiums have been increasing in recent years as the premiums
generated by new business have exceeded the loss of premiums
through normal policy attrition. While Texas Imperial wrote a
smaller volume of business in 1998 in comparison to 1997 (based on
face amount), a larger proportion of the new business written
during 1998 was single premium whole life policies.
During 1997, through July 31, 1997, American Capitol coinsured, and
did not retrocede, 91.4% of the policies written by World Service
Life Insurance Company of America ("World Service") during that
period. The policies written by World Service during that period
were mostly single premium whole life. As a result, while in 1997
American Capitol had approximately $510,000 in reinsurance assumed
single premium life premiums, American Capitol had no corresponding
premium amounts in 1998.
A substantial portion of the Company's premium paying business is
limited pay business, meaning that premiums are only payable for a
specified number of years instead of for the life of the insured.
Premium income can be expected to decline on this block of policies
as the limited pay policies reach the end of their premium paying
term.
The balance of the change in premium income was the decline in
premiums resulting from normal policy attrition in American
Capitol.
Net investment income was 32% higher during 1998 in comparison to
1997. The higher level of investment income in 1998 was in part due
to the larger average base of invested assets in 1998 in comparison to
1997. Investment expenses for 1998 were significantly lower than such
expenses for 1997. Investment expenses for 1997 include expenses
related to American Capitol's home office building, which was sold in
November 1997. Investment income for 1997 includes $50,000 in
forfeited earnest money American Capitol received when a prospective
purchaser of the home office building could not complete the
transaction.
The Company reported net realized investment losses of $664,327 during
1998, in comparison to net realized investment gains of $204,709 for
1997. As discussed below, the Company realized an $800,000 loss on a
single investment during 1998. But for that loss, net realized
investment gains would have been comparable between 1998 and 1997.
On December 16, 1998, Texas Imperial acquired the stock of Statesman.
Statesman was owned by the brother of the majority shareholder of
Acap, and, as a result, this qualified as a related party transaction.
Texas Imperial issued a promissory note of $100 to the sellers of the
Statesman stock ("Sellers"). At the time of the acquisition of the
Statesman stock by Texas Imperial, Statesman had approximately $1.8
million in surplus debentures issued to the Sellers. The Sellers'
debentures backed the Sellers' representations and warranties and were
to be adjusted based upon the outcome of certain post-closing price
adjustments. In connection with closing, Texas Imperial purchased an
$800,000 surplus debenture from Statesman to bring Statesman's
statutory equity to the level required by the Texas Department of
Insurance (the "Department") as a condition of the Department's
approval of Texas Imperial's acquisition of Statesman. In January,
1999, it was discovered that Statesman's claim liabilities were
significantly understated. The liability understatement exceeded the
amount of the Sellers' debentures. Given the mutual mistake of fact
upon which the stock purchase, the surplus debenture purchase and the
Department's approval of same were based, Texas Imperial, the Sellers,
and Statesman agreed to rescind the purchase of the stock and the
surplus debenture. However, the rescission required the approval of
the Department. The Department did not grant its approval. As a
result, Texas Imperial determined that the $800,000 Statesman surplus
debenture was uncollectible and recorded the realized investment loss
on the debenture and wrote off its investment in Statesman of $100.
Texas Imperial has no ongoing liability related to Statesman.
A major source of revenue for the Company is the expense allowance the
Company receives for administering certain blocks of reinsured
policies. The expense allowance for 1998 was 145% higher than the
expense allowance received during 1997. The increase in the expense
allowance is attributable to the expense allowance American Capitol
receives from Republic-Vanguard Life Insurance Company ("Republic")
for administering a block of business coinsured by American Capitol
from Universal Life Insurance Company ("Universal"), as discussed
below.
Effective January 1, 1998, American Capitol coinsured 100% of the
individual life insurance policies of Universal in force on that date.
American Capitol paid Universal an initial ceding commission of $13
million. Universal transferred approximately $40 million in assets to
American Capitol in connection with the coinsurance.
Contemporaneous with the signing of the coinsurance agreement, the
parties executed an administrative agreement (the "Administration
Agreement") whereby American Capitol agreed to provide specified
administrative functions for the 246,011 coinsured Universal policies.
American Capitol started administering the policies beginning July 1,
1998. Between January 1, 1998 and July 1, 1998, Universal continued
to administer the policies, and American Capitol paid Universal the
expense allowance stipulated in the Administration Agreement.
Concurrent with the coinsurance of the Universal policies, American
Capitol retroceded all of the coinsured Universal policies to
Republic. Republic paid American Capitol an initial ceding commission
of $13.5 million. American Capitol transferred $39.6 million in
assets to Republic in connection with the retrocession. While the
retrocession is in effect, American Capitol receives an expense
allowance from Republic. Once Republic has recovered the initial
ceding commission, Republic must, at American Capitol's sole option,
retrocede back to American Capitol 100% of the policies. Upon this
retrocession, American Capitol then pays Republic 30% of the profits
thereafter generated by the policies, retaining the other 70% of the
profits. In addition, American Capitol has the right to fully
recapture the retrocession under certain terms and conditions.
The additional expense allowance related to the Universal policies was
partially offset by the decline in the expense allowance due to normal
policy attrition of the balance of the reinsured policies.
As a result of the factors noted above, total revenue, including net
realized investment gains and losses, was 39% higher during 1998 than
during 1997. Excluding net realized investment gains and losses,
total revenue was 54% higher during 1998 than during 1997.
Policy benefits were 100% of premium income in 1998 compared to 99% of
premium income in 1997. A substantial portion of the Company's
business that is not 100% coinsured is paid up insurance. As a
result, the Company has a relatively high ratio of policy benefits to
premium income.
Total expenses were 96% higher in 1998 in comparison to 1997. The
increase in expenses is attributable to expenses incurred in
connection with the coinsurance of the Universal policies. Expenses
for 1998 include $1.3 million paid to Universal for administering the
policies American Capitol coinsured from Universal for the period
January 1, 1998 through June 30, 1998. Prior to July 1, 1998, the
Company incurred expenses in preparing to assume the administration of
the Universal policies. Expenses for 1998 also include a one-time
broker's fee of $227,500 associated with the Universal coinsurance.
The Company incurred significant expenses, including approximately
$300,000 in computer consulting expense, in connection with the
conversion of the Universal policies from the system acquired from
Universal to one of the Company's other policy administration systems.
Pre-tax operating income (which excludes net realized investment gains
and losses) for 1998 was $694,640 in comparison to $529,567 for 1997,
a 31% increase.
The Company recorded a net federal income tax expense for 1998 in
comparison to a net federal income tax benefit for 1997. During
1997, the Company realized the benefit of approximately $550,000 in
deferred tax assets upon which the Company had previously established
a valuation reserve.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity of Insurance Subsidiaries
Acap's insurance subsidiaries have a significant portion of their
assets invested in debt instruments, short-term investments, or other
marketable securities. Although there is no present need or intent to
dispose of such investments, the insurance subsidiaries could
liquidate portions of the investments should the need arise. These
assets should be sufficient to meet the insurance subsidiaries'
anticipated long-term and short-term liquidity needs.
As of December 31, 1998, 100% of the insurance subsidiaries'
portfolios of publicly-traded bonds are invested in securities that
are rated investment grade (i.e., rated BBB-/Baa3 or higher by
Standard & Poor or Moody). The Company's investment policy prohibits
making any new investment in below investment grade securities without
the advance approval of the applicable insurance subsidiary's Board of
Directors. All of the Company's bonds are classified as available for
sale and are, accordingly, reflected in the financial statements at
fair value. The insurance subsidiaries' liabilities are primarily
long term in nature. Therefore, long-term assets can be purchased
with the general intent to hold such assets to maturity. It has not
been the Company's investment practice in the past to be an active
trader with its bond portfolios. It is not expected that the
insurance subsidiaries' investment practices will change in the
future.
A significant portion (23%) of the Company's bond portfolio is
invested in mortgage-backed securities, with 90% of such mortgage-
backed securities classified as collateralized mortgage obligations
and 10% classified as pass-through securities. Mortgage-backed
securities are purchased to diversify the portfolio from credit risk
associated with corporate bonds. The majority of mortgage-backed
securities in the Company's investment portfolio have minimal credit
risk because the underlying collateral is guaranteed by specified
government agencies (e.g., GNMA, FNMA, FHLMC).
The principal risks inherent in holding mortgage-backed securities are
prepayment and extension risks that arise from changes in the general
level of interest rates. As interest rates decline and homeowners
refinance their mortgages, mortgage-backed securities prepay more
rapidly than anticipated. Conversely, as interest rates increase,
underlying mortgages prepay more slowly, causing principal repayment
of mortgage-backed securities to be extended. In general, mortgage-
backed securities provide for higher yields than corporate debt
securities of similar credit quality and expected maturity to
compensate for this greater amount of cash flow risk. Due to the
underlying structure of the individual securities, the majority of
mortgage-backed securities in the Company's investment portfolio have
relatively low cash flow variability.
The Company's investments in collateralized mortgage obligations are
primarily of the planned amortization class (59%), Z (17%) and
sequential (14%) types. A planned amortization class tranche is
structured to provide more certain cash flows and is therefore subject
to less prepayment and extension risk than other forms of mortgage-
backed securities. Planned amortization class securities derive their
stability at the expense of cash flow risk for other tranches as early
repayments are applied first to other tranches, and cash flows
originally applicable to other tranches are first applied to the
planned amortization class tranche if that tranche's originally
scheduled cash flows are received later than expected. The Z tranche
defers all interest to other tranches until those tranches are paid
down, at which time accumulated interest and principal are paid to
this class. The cash flows associated with sequential tranches can
vary as interest rates fluctuate, since these tranches are not
supported by other tranches.
The Company records its fixed maturity and equity securities at fair
value with unrealized gains and losses, net of taxes, reported as a
separate component of stockholders' equity. Primarily as a result of
decreasing interest rates during the year, the fair value of the
Company's fixed maturity and equity securities increased $271,063
during 1998, following a $344,417 increase during 1997. The
accounting standard does not permit the Company to revalue its
liabilities for changes in interest rates.
As of December 31, 1998, the Company held 23 mortgage loans as
investments. The Company's investment policy generally prohibits
making new investments in mortgage loans (although mortgage loans may
be acquired as approved assets in connection with an acquisition). In
addition to the real estate collateral, approximately $1.2 million of
the mortgage loans are guaranteed by an individual that management has
reason to believe has a net worth well in excess of the balance of the
guaranteed loans. The average yearly principal balance of the
Company's mortgage loans at December 31, 1998 was approximately
$74,000 and the weighted average maturity was 9 years. Mortgage loans
on Tennessee properties represent 35% of the mortgage loan balances at
December 31, 1998, Texas properties 34%, Alabama properties 23%, with
Louisiana, Florida and Kentucky properties representing the remainder
of the mortgage loan balances. Residential mortgages represent 56% of
the mortgage loan balances at December 31, 1998 with commercial
mortgages constituting the balance. In general, the performance of
commercial mortgages is more subject to changing U.S. and regional
economic conditions than residential mortgages. Mortgage loans are
far less liquid an investment than publicly-traded securities.
Liquidity of the Parent Company
On January 31, 1995, Acap borrowed $1.5 million from Central National
Bank of Waco, Texas. At December 31, 1998, the outstanding principal
balance of the loan was $562,500. The loan is renewable each April 30
until fully repaid. The loan bears interest at a rate equal to the
base rate of a bank plus 1%. Principal payments on the loan are due
quarterly. The loan agreement contains certain restrictions and
financial covenants. Without the written consent of the bank, Acap
may not incur any debt, pay common stock dividends or sell any
substantial amounts of assets. Also, American Capitol is subject to
minimum statutory earnings and capital and surplus requirements during
the loan term. The Company is in compliance with all of the terms of
the loan. The principal payments on the bank loan are matched by the
principal payments on a surplus debenture issued by American Capitol
to Acap.
The primary sources of funds for Acap are payments on the surplus
debenture from American Capitol and dividends from American Capitol.
American Capitol may pay dividends in any one year without the prior
approval of regulatory authorities as long as such dividends do not
exceed certain statutory limitations. As of December 31, 1998, the
amount of dividends available to the parent company from American
Capitol not limited by such restrictions is approximately $600,000.
Payments on the surplus debenture may only be made to the extent
statutory capital and surplus exceeds $2 million. At December 31,
1998, American Capitol's statutory capital and surplus was $2,202,516.
The determination of statutory surplus is governed by accounting
practices prescribed or permitted by the State of Texas. Statutory
surplus therefore bears no direct relationship to surplus as would be
determined under generally accepted accounting principles.
REINSURANCE
Reinsurance plays a significant role in the Company's operations.
In accounting for reinsurance, the Company has reported ceded reserve
credits and reinsurance claim credits as reinsurance receivables. The
cost of reinsurance related to long-duration contracts is accounted
for over the life of the underlying reinsured policies using
assumptions consistent with those used to account for the underlying
policies. At December 31, 1998, reinsurance receivables with a
carrying value of $49.3 million were associated with a single
reinsurer, Crown Life Insurance Company ("Crown"). At December 31,
1997, Crown had statutory assets in excess of $6.6 billion and
statutory stockholders' equity of approximately $500 million. Crown
is rated "Excellent" by A.M. Best Company, an insurance company rating
organization. At December 31, 1998, reinsurance receivables with a
carrying value of $49.5 million were associated with Republic-Vanguard
Life Insurance Company ("Republic"). Republic is rated
"Excellent" by A.M. Best Company. At December 31, 1997, Republic
had statutory assets of approximately $800 million and statutory
stockholders' equity of approximately $38 million. At December 31,
1998, reinsurance receivables with a carrying value of $2.3 million
were associated with Alabama Reassurance Company ("Alabama Re"). The
Alabama Re reinsurance receivables are secured by a trust account
containing a $5 million letter of credit granted in favor of an
insurance subsidiary of the Company.
With regard to the policies not 100% reinsured with Crown, Republic,
or Alabama Re, the Company seeks to limit its exposure to loss on any
single insured by reinsuring the portion of risks in excess of $50,000
on the life of any individual through various reinsurance contracts,
primarily of the coinsurance and yearly renewable term type.
The Company is contingently liable for amounts ceded to reinsurers in
the event the reinsurers are unable to meet their obligations assumed
under the reinsurance agreements. Acap evaluates the financial
condition of its reinsurers and monitors concentrations of credit
risk to minimize its exposure to significant losses from reinsurer
insolvencies.
ACCOUNTING STANDARDS
In February 1997, the FASB issued SFAS No. 128, "Earnings Per
Share." SFAS No. 128, which had to be adopted for fiscal years
ending after December 15, 1997, established standards for computing
and presenting earnings per share ("EPS") and applies to entities
with publicly-held common stock or potential common stock. It
replaces the presentation of primary EPS with a presentation of basic
EPS. It also requires dual presentation of basic and diluted EPS on
the face of the income statement for all entities with complex capital
structures and requires a reconciliation of the numerator and
denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation, with all prior period EPS
data presented restated. The Company adopted SFAS No. 128 in 1997.
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. This statement requires 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.
This statement does not require a specific format for that financial
statement but requires that an enterprise display an amount
representing total comprehensive income for the periods in that
financial statement. SFAS No. 130 is effective for fiscal years
beginning after December 15, 1997. As such, the Company adopted SFAS
No. 130 in 1998.
In June, 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131
establishes standards for the way that public business enterprises
report information about operating segments in interim financial
reports issued to stockholders. The provisions of SFAS No. 131 did
not have an impact on the Company in 1998 or 1997 since the Company
did not have different operating segments.
YEAR 2000 STATUS
The Year 2000 issue is the result of computer programs being
written using two digits rather than four to define the applicable
year. Any of the Company's computer programs or hardware that have
date-sensitive software or embedded chips may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of normal
business activities. To date, the Company has fully completed its
assessment of all systems that could be significantly affected by the
Year 2000 issue. In addition, the Company has gathered information
about the Year 2000 compliance status of material third parties with
whom the Company conducts business and continues to monitor their
compliance.
The Company's policies are administered on three policy administration
systems. One of the policy administration systems was internally
developed. The Company's assessment of that system found that minor
corrections were necessary to make the system Year 2000 compliant.
Those corrections have been completed, tested, and implemented. Based
on the testing performed, the Company believes that the system is now
Year 2000 compliant. The other two policy administration systems are
vendor developed and supported systems. The vendors have represented
that the systems are Year 2000 compliant. With all three policy
administration systems Year 2000 compliant, the Company is positioned
to perform all basic policy transactions without disruption.
The Company uses two general ledger and accounts payable systems. One
of the systems is no longer supported by the vendor who developed the
system. The Company's assessment of that system found that extensive
modifications were needed to make the system Year 2000 compliant. The
other general ledger / accounts payable system is currently supported
by the vendor. While the version of that system in production at the
Company is not Year 2000 compliant, the vendor has an updated version
that is Year 2000 compliant. The Company plans on installing the
updated version of that system during the second quarter of 1999 and
converting to exclusive use of that system for general ledger and
accounts payable functions by the end of the third quarter of 1999.
The system used for claims processing of the Medicare supplement
policies coinsured from Statesman is not Year 2000 compliant. The
Company has completed the assessment of the changes needed to make the
claims system Year 2000 compliant. The claims system will either be
remediated or replaced by October 31, 1999.
Certain of the Company's minor subsystems are not currently Year 2000
compliant and will be remediated. The Company has completed the Year
2000 assessment of these subsystems and is approximately 65% through
the remediation of these subsystems. The Company believes that the
remediation, testing, and implementation of the subsystems will be
completed by the end of the third quarter of 1999.
An assessment of the Company's operating equipment has determined that
certain of the Company's personal computers will need to be replaced
prior to January 1, 2000.
To date, the Company has used existing internal resources to remediate
the systems that are not Year 2000 compliant, and the costs thus
incurred have not been significant. Other than approximately $20,000
to upgrade the general ledger / accounts payable systems and the
replacement of some personal computers, it is expected that existing
internal resources will be used to complete the Company's Year 2000
project.
Management of the Company believes that it has an effective program in
place to resolve the Year 2000 issue in a timely manner. As noted
above, the Company has not yet completed all necessary phases of the
Year 2000 program. In the event that the Company does not complete
any additional phases, the Company would not be able to use its
general ledger system or the system used to pay Medicare supplement
claims.
The Company has contingency plans for certain critical applications
and is working on such plans for other applications. These
contingency plans involve, among other actions, manual workarounds and
adjusting staffing strategies.
CAUTIONARY STATEMENT
The 1995 Private Securities Litigation Reform Act provides issuers the
opportunity to make cautionary statements regarding forward-looking
statements. Accordingly, any forward-looking statement contained
herein or in any other oral or written statement by the Company or any
of its officers, directors or employees is qualified by the fact that
actual results of the Company may differ materially from such
statement due to the following important factors, among other risks
and uncertainties inherent in the Company's business: state insurance
regulations, rate competition, adverse changes in interest rates,
unforeseen losses with respect to loss and settlement expense reserves
for unreported and reported claims, and catastrophic events.
<PAGE>
ACAP CORPORATION
CONSOLIDATED BALANCE SHEET
December 31,1998
Assets
Investments:
Fixed maturities available for sale
(amortized cost $35,221,831) $ 36,968,374
Mortgage loans 1,930,734
Policy loans 6,811,849
Short-term investments 1,573,630
-------------
Total investments 47,284,587
Cash 120,332
Accrued investment income 543,305
Reinsurance receivables 105,155,284
Accounts receivable (less allowance for uncollectible
accounts of $88,545) 563,245
Deferred acquisition costs 2,460,183
Property and equipment (less accumulated depreciation
of $465,654) 400,128
Costs in excess of net assets of acquired business
(less accumulated amortization of $1,191,791) 1,481,985
Other assets 370,985
-------------
Total assets $158,380,034
=============
Liabilities
Policy liabilities:
Future policy benefits $139,496,503
Contract claims 2,397,219
--------------
Total policy liabilities 141,893,722
--------------
Other policyholders' funds 2,850,960
Other liabilities 1,730,420
Note payable 562,500
Net deferred tax liability 1,176,156
Deferred gain on reinsurance 2,392,999
Deferred gain on sale of real estate 388,902
--------------
Total liabilities $150,995,659
--------------
Stockholders' Equity
Series A preferred stock, par value $.10 per share,
authorized, issued and outstanding 74,000 shares
(involuntary liquidation value $2,035,000) $ 1,850,000
Common stock, par value $.10 per share, authorized
10,000 shares, issued 8,759 shares 876
Additional paid-in capital 6,259,589
Accumulated deficit (1,440,233)
Treasury stock, at cost, 1,515 common shares (500,642)
Accumulated other comprehensive income-net unrealized
investment gains, net of taxes of $531,758 1,214,785
--------------
Total stockholders' equity 7,384,375
--------------
Total liabilities and stockholders' equity $158,380,034
==============
See accompanying notes to consolidated financial statements.
<PAGE>
ACAP CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
Years Ended December 31,
1998 1997
REVENUES
Premiums and other considerations $2,581,834 2,521,103
Net investment income 2,026,734 1,536,008
Net realized investment gains (losses) (664,327) 204,709
Reinsurance expense allowance 4,744,786 1,938,314
Amortization of deferred gain on reinsurance 210,479 193,682
Other income 41,969 53,167
----------------------------
Total revenues 8,941,475 6,446,983
----------------------------
BENEFITS AND EXPENSES
Policy benefits 2,590,050 2,486,979
Commissions and general expenses 5,899,627 2,801,552
Interest expense 72,037 90,330
Amortization of costs in excess of net
acquired business 239,662 239,662
Amortization of deferred acquisition costs 109,786 94,184
--------------------------
Total benefits and expenses 8,911,162 5,712,707
--------------------------
Income before federal income tax
expense (benefit) 30,313 734,276
Federal income tax expense (benefit):
Current (49,481) 261,870
Deferred 93,783 (875,625)
--------------------------
Net income (loss) (13,989) 1,348,031
==========================
OTHER COMPREHENSIVE INCOME
Net unrealized investment gains, net of taxes
of $150,985 in 1998 and $177,416 in 1997 271,063 344,417
Net unrealized investment holding gains
arising during period, net of taxes of
$10,396 in 1998 and $16,518 in 1997 23,800 32,065
Less: reclassification adjustment for
net investment gains included in net
income, net of taxes of $17,017 in 1998 and
$52,502 in 1997 (38,960) (101,915)
--------------------------
Comprehensive income $ 241,914 1,622,598
==========================
EARNINGS PER SHARE
Basic earnings (loss) per common share $(28.42) 154.43
=========================
Diluted earnings (loss) per common share $(35.52) 145.45
=========================
See accompanying notes to consolidated financial statements.
<PAGE>
ACAP CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31,
1998 1997
------------------------
SERIES A PREFERRED STOCK
(Including Additional Paid-in Capital) $1,850,000 1,850,000
------------------------
COMMON STOCK 876 876
-------------------------
ADDITIONAL PAID-IN CAPITAL
Balance, beginning of year 6,259,189 6,259,189
Change during year 400 --
-------------------------
Balance, end of year 6,259,589 6,259,189
-------------------------
ACCUMULATED DEFICIT
Balance, beginning of year (1,231,992) (2,388,086)
Net income (loss) (13,989) 1,348,031
Preferred stock cash dividends (194,252) (191,937)
-------------------------
Balance, end of year (1,440,233) (1,231,992)
-------------------------
TREASURY STOCK
Balance, beginning of year (450,482) (426,419)
Change during year (50,160) (24,063)
------------------------
Balance, end of year (500,642) (450,482)
------------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance, beginning of year 943,722 599,305
Change during year 271,063 344,417
-- --------------------
Balance, end of year 1,214,785 943,722
======================
TOTAL STOCKHOLDERS' EQUITY $7,384,375 7,371,313
=======================
See accompanying notes to consolidated financial statements.
<PAGE>
ACAP CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
1998 1997
------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $(13,989) 1,348,031
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization 307,124 336,752
Amortization of deferred acquisition costs 109,786 94,184
Amortization of deferred gain on reinsurance (210,479) (193,682)
Premium and discount amortization (63,490) 29,945
Net realized investment gains (losses) 664,327 (204,709)
Deferred federal income tax expense (benefit) 93,783 (875,625)
Decrease in reinsurance receivables 1,657,076 1,814,662
Decease (increase) in accrued investment income 8,898 (7,997)
Decrease (increase) in accounts receivable (278,117) 116,973
Decrease in other assets 1,190,157 107,003
Decrease in policy liabilities (2,561,142) (1,056,006)
Increase (decrease) in other liabilities 34,062 246,982
-----------------------
Net cash provided by operating activities 937,996 1,756,513
-----------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of investments available
for sale and principal repayments on
mortgage loans 9,712,958 6,214,388
Purchases of investments available for sale (8,845,902) (12,177,281)
Proceeds from sale of real estate -- 1,928,769
Net decrease (increase) in policy loans 457,490 (18,779)
Net decrease (increase) in short-term
investments (693,527) 789,313
Proceeds from coinsurance/assumption agreement 759,626 2,495,774
Purchases of property and equipment (287,655) (93,099)
Purchase of surplus debenture (800,000) --
------------------------
Net cash provided by (used in) investing
activities 302,990 (860,915)
------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on note payable (250,000) (250,000)
Deposits on policy contracts 1,227,606 1,591,091
Withdrawals from policy contracts (1,951,562) (1,929,391)
Preferred stock dividends paid (194,252) (191,937)
Treasury stock purchases (50,160) (54,000)
-------------------------
Net cash used in financing activities (1,218,368) (834,237)
-------------------------
Net increase in cash 22,618 61,361
Cash at beginning of year 97,714 36,353
-------------------------
Cash at end of year $120,332 97,714
=========================
See accompanying notes to consolidated financial statements.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Nature of Operations
The consolidated financial statements of Acap Corporation ("Acap" or
"the Company"), include its wholly-owned subsidiaries, American
Capitol Insurance Company ("American Capitol"); Imperial Plan, Inc.
("Imperial Plan"); and Texas Imperial Life Insurance Company ("Texas
Imperial"). All significant intercompany transactions and accounts
have been eliminated in consolidation. Controlling interest in the
Company, approximately 46% at December 31, 1998, is owned by InsCap
Corporation ("InsCap").
Acap is a life insurance holding company that focuses on the
acquisition of existing life insurance policies, either through direct
purchase or the acquisition of insurance companies. Acap's life
insurance operations are conducted through its wholly-owned life
insurance subsidiaries. Operations are conducted from the corporate
headquarters in Houston, Texas. Approximately half of the Company's
direct collected premium comes from residents of the State of Texas,
with no other state generating as much as 10% of the Company's direct
collected premium.
Basis of Presentation
The consolidated financial statements have been prepared in accordance
with generally accepted accounting principles. Such accounting
principles differ from prescribed statutory reporting practices used
by the insurance subsidiaries in reporting to state regulatory
authorities. The more significant differences from statutory
accounting principles are: (a) acquisition costs related to acquiring
new business are deferred and amortized over the expected lives of the
policies rather than being charged to operations as incurred;
(b) future policy benefits are based on estimates of mortality,
interest and withdrawals generally representing the Company's
experience, which may differ from those based on statutory mortality
and interest requirements without consideration of withdrawals;
(c) deferred federal income taxes are provided for temporary
differences between assets and liabilities reported for financial
reporting purposes and reported for federal income tax purposes; (d)
certain assets (principally furniture and equipment, agents' debit
balances and certain other receivables) are reported as assets rather
than being charged to accumulated deficit; (e) investments in fixed
maturities available for sale are recorded at fair value rather than
at amortized cost; (f) for acquisitions accounted for as a purchase,
the identified net assets of the acquired company are valued at their
fair values and the excess of the value of the consideration over the
net assets assumed is amortized over a period not to exceed nine
years, whereas, for statutory purposes, this excess is not allowed and
acquisitions are accounted for as equity investments; (g) two
investment related reserves, the Asset Valuation Reserve ("AVR") and
the Interest Maintenance Reserve ("IMR") are recorded under the
statutory basis of accounting; (h) assets and liabilities are reported
gross of reinsurance; (i) at the time of the initial ceding of a block
of business, a deferred gain is set up and amortized over the life of
the policies ceded; and (j) the decrease in surplus relief from
reinsurance ceded agreements is amortized through net income with an
offset in surplus netting to a zero effect on surplus under the
statutory basis of accounting.
Generally, the net assets of the Company's insurance subsidiaries
available for transfer to the parent company are limited to the
amounts that the insurance subsidiaries' statutory net assets exceed
minimum statutory capital requirements; however, payment of the
amounts as dividends may be subject to approval by regulatory
authorities. As of December 31, 1998, the amount of dividends
available to the parent company from subsidiaries not limited by such
restrictions is approximately $600,000. The combined net income of
the Company's insurance subsidiaries (where applicable, from the date
such subsidiary was acquired), as determined using statutory
accounting practices, was $1,976,913 and $2,689,622 for the years
ended December 31, 1998 and 1997, respectively. The consolidated
statutory stockholders' equity of the Company's insurance subsidiaries
amounted to $2,202,516 and $3,540,343 at December 31, 1998 and 1997,
respectively. The total adjusted statutory stockholders' equity of
the Company's insurance subsidiaries exceeds the applicable Risk-Based
Capital requirements.
The preparation of financial statements in conformity with
generally accepted accounting principles 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 from those estimates.
Certain prior year amounts have been reclassified to conform to the
current year presentation. Such reclassifications had no impact on
net income or stockholders' equity as previously reported.
Investments
Investments are reported on the following bases:
All of the Company's debt securities are accounted for in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 115 and
are classified as available-for-sale securities. Accordingly, such
securities are reported at fair value, with unrealized gains and
losses, net of taxes, excluded from earnings and reported as a
separate component of stockholders' equity as accumulated other
comprehensive income.
Mortgage loans on real estate are carried at unpaid principal
balances.
Policy loans are carried at their unpaid principal balances. Policy
loans consist primarily of automatic borrowings against a policy's
cash surrender value to pay policy premiums. Interest accrues at
rates ranging from 5% to 10%.
Short-term investments, consisting primarily of commercial paper, are
carried at cost.
Write-downs and other realized gains and losses, determined on the
specific identification method, are accounted for in the consolidated
statements of operations in net realized investment gains.
Deferred Acquisition Costs
Deferred acquisition costs are the cost of policies acquired through
the purchase of insurance companies, representing the actuarially
determined present value of projected future profits from policies in
force at the purchase date.
For interest-sensitive whole life contracts, deferred costs are
amortized in relation to the present value of expected future gross
profits from the contracts. For traditional contracts, deferred costs
are amortized in relation to future anticipated premiums. The
deferred costs are reviewed to determine that the unamortized portion
of such costs does not exceed recoverable amounts. Management
believes such amounts are recoverable.
The deferred acquisition costs for the year ended December 31, 1998
are summarized as follows:
Balance at December 31, 1997 $1,569,969
Insurance in force acquired 1,000,000
Amortized during the year (109,786)
------------
Balance at December 31, 1998 $2,460,183
============
The amortization of deferred acquisition costs is expected to be
between $200,000 and $300,000 over each of the next five years.
Property and Equipment
Property and equipment are carried at cost. Depreciation is computed
using the straight-line method over the estimated useful lives, which
range from five to ten years. Depreciation expense was $67,462 and
$50,936 for the years ended December 31, 1998 and 1997, respectively.
When assets are retired or otherwise disposed of, the cost and related
accumulated depreciation are removed from the accounts, and any
resulting gains or losses are recognized in income for the period.
The cost of maintenance and repairs is charged to income as incurred;
significant renewals and betterments are capitalized.
Costs in Excess of Net Assets of Acquired Business
The costs in excess of net assets of acquired business are amortized
on a straight-line basis over remaining terms of three years and seven
years.
Recognition of Premium Revenue and Related Expenses, Liability for
Future Policy Benefits and Contract Claims
For traditional insurance contracts, premiums are recognized as
revenue when due. Benefits and expenses are associated with earned
premiums so as to result in their recognition over the premium paying
period of the contracts. Such recognition is accomplished by means of
the provision for future policy benefits and the amortization of
deferred policy acquisition costs.
For contracts with mortality risk that permit the Company to make
changes in the contract terms (such as interest-sensitive whole life
policies), premium collections and benefit payments are accounted for
as increases or decreases to a liability account rather than as
revenue and expense. In addition, decreases to the liability account
for the costs of insurance and policy administration and for surrender
penalties are recorded as revenues. Interest credited to the
liability account and benefit payments made in excess of a contract
liability account balance are charged to expense.
For investment contracts without mortality risk (such as deferred
annuities), net premium collections and benefit payments are recorded
as increases or decreases to a liability account rather than as
revenue and expense. Surrender penalties are recorded as revenues.
Interest credited to the liability account is charged to expense.
Reserves for traditional contracts are calculated using the net level
premium method and assumptions as to investment yields, mortality,
withdrawals and dividends. The assumptions are based on past and
expected experience and include provisions for possible unfavorable
deviation. These assumptions are made at the time the contract is
issued or, for contracts acquired by purchase, at the purchase date.
Interest assumptions used to compute reserves ranged from 4% to 9% at
December 31, 1998.
Reserves for interest-sensitive whole life policies and investment
contracts are based on the contract account balance if future benefit
payments in excess of the account balance are not guaranteed, or the
present value of future benefit payments when such payments are
guaranteed.
The liability for contract claims represents the liability for claims
reported in excess of the related policy benefit reserve plus an
estimate of claims incurred but not reported.
Earnings per Share
Earnings per common share for 1998 were computed as follows:
Weighted
Average Per
Income Shares Share
(Numerator) (Denominator) Amount
--------------------------------------------
Net loss $ (13,989)
Preferred dividends (194,252)
--------
BASIC EARNINGS PER SHARE
Income available to common stockholders (208,241) 7,326 $(28.42)
Effect of Dilutive Securities
Stock options (58,976) 197
----------------------------------------
DILUTED EARNINGS PER SHARE
Income available to common
stockholders plus assumed exercise ($267,217) 7,523 $(35.52)
----------------------------------------
Earnings per common share for 1997 were computed as follows:
Weighted Per
Income Average Shares Share
(Numerator) (Denominator) Amount
---------- ------------- ------
Net income $1,348,031
Preferred dividends (191,937)
---------
BASIC EARNINGS PER SHARE
Income available to common stockholders 1,156,094 7,486 $154.43
EFFECT OF DILUTIVE SECURITIES
Stock options (58,976) 57
---------------------------------------------
Diluted Earnings Per Share
Income available to common stockholders
plus assumed exercise $1,097,118 7,543 $145.45
=============================================
Participating Policies
Acap maintains both participating and nonparticipating life insurance
policies. Participating business represented approximately 11% and
23% of the life insurance in force, and 44% and 28% of life insurance
premium income at December 31, 1998 and 1997, respectively. Dividends
to participating policyholders are determined annually and are payable
only upon declaration of the Boards of Directors of the insurance
subsidiaries.
Federal Income Taxes
The Company accounts for income taxes in accordance with SFAS No. 109
which requires that a deferred tax liability be recognized for all
taxable temporary differences and a deferred tax asset be recognized
for an enterprise's deductible temporary differences and operating
loss and tax credit carryforwards. A deferred tax asset or liability
is measured using the marginal tax rate that is expected to apply to
the last dollars of taxable income in future years. The effects of
enacted changes in tax laws or rates are recognized in the period that
includes the enactment date.
Statement of Cash Flows
For purposes of reporting cash flows, cash includes cash on hand, in
demand accounts, in money market accounts and in savings accounts.
Stock Based Compensation
The Company grants stock options to employees for a fixed number of
shares with an exercise price equal to the fair market value of the
shares at the date of grant. The Company accounts for stock options
in accordance with APB Opinion No. 25, "Accounting for Stock Issued
to Employees," and accordingly recognizes no compensation expense for
the stock option grants.
Accounting Standards
In February 1997, the FASB issued SFAS No. 128, "Earnings Per
Share." SFAS No. 128, which must be adopted for fiscal years ending
after December 15, 1997, established standards for computing and
presenting earnings per share ("EPS") and applies to entities with
publicly held common stock or potential common stock. It replaces the
presentation of primary EPS with a presentation of basic EPS. It also
requires dual presentation of basic and diluted EPS on the face of the
income statement for all entities with complex capital structures and
requires a reconciliation of the numerator and denominator of the
basic EPS computation to the numerator and denominator of the diluted
EPS computation, with all prior period EPS data presented restated.
The Company adopted SFAS No. 128 in 1997.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes standards for reporting and
display of comprehensive income and its components (revenues,
expenses, gains, and losses) in a full set of general-purpose
financial statements. This statement requires 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.
This statement does not require a specific format for that financial
statement but requires that an enterprise display an amount
representing total comprehensive income for the periods in that
financial statement. SFAS No. 130 is effective for fiscal years
beginning after December 15, 1997. As such, the Company adopted SFAS
No. 130 in 1998.
In June, 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131
establishes standards for the way that public business enterprises
report information about operating segments in interim financial
reports issued to shareholders. The provisions of SFAS No. 131 did
not have an impact on the Company in 1998 or 1997 since the Company
did not have different operating segments .
2. INVESTMENTS
Fixed Maturity Securities
The amortized cost and fair values of investments in fixed maturity
securities as of December 31, 1998 are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
Government securities $3,229,941 233,141 -- 3,463,082
Corporate securities 20,171,643 915,763 (2,038) 21,085,368
Asset-backed securities 3,519,875 58,707 (19,640) 3,558,942
Mortgage-backed securities 8,300,372 560,895 (285) 8,860,982
$ 35,221,831 1,768,506 (21,963) 36,968,374
==================================================
A summary of proceeds from the sales of investments in fixed maturity
securities, exclusive of proceeds from maturities, and the gross gains
and losses realized on those sales follows:
1998 1997
----------------------------
Proceeds on sales $5,054,569 5,603,725
============================
Gross realized gains on sales 70,668 154,017
Gross realized losses on sales (19,186) --
-------------------------------
Net realized gains on sales 51,482 154,017
Realized gains on transactions other than sales 4,495 399
-------------------------------
Net realized gains $ 55,977 154,416
===============================
The amortized cost and estimated fair value of fixed maturity
securities at December 31, 1998, by contractual maturity, are shown
below. Expected maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
Amortized Fair
Cost Value
Maturing in one year or less $ 362,353 361,980
Maturing after one year through five years 6,839,944 7,059,093
Maturing after five years through ten years 14,229,721 14,906,133
Maturing after ten years 5,489,441 5,780,186
-----------------------------
26,921,459 28,107,392
Mortgage-backed securities 8,300,372 8,860,982
-----------------------------
$35,221,831 36,968,374
==============================
A summary of the fair value of mortgage-backed securities by type as of
December 31, 1998 follows:
Collateralized mortgage obligations:
Planned amortization class $5,201,244
Z 1,531,949
Sequential 1,211,301
Other 49,956
------------
7,994,450
Pass-through securities 866,532
-----------
$8,860,982
============
With a planned amortization class security, early repayments are
applied first to other tranches, and cash flows originally applicable
to other tranches are first applied to the planned amortization class
tranche if that tranche's originally scheduled cash flows are received
later than expected. The Z tranche defers all interest to other
tranches until those tranches are paid down, at which time accumulated
interest and principal are paid to this class. Sequential tranches
are not supported by other tranches.
As of December 31, 1998, 100% of the Company's fixed maturity
securities were rated investment grade (i.e., rated BBB-/Baa3 or
higher by Standard & Poor or Moody).
Mortgage Loans
The weighted average interest rate of mortgage loans held as of
December 31, 1998 was 9.2%.
The distribution of principal balances on mortgage loans held as of
December 31, 1998 by contractual maturity follows. Actual maturities
may differ from contractual maturities because borrowers may have the
right to prepay obligations with or without penalties.
Principal
Balance
-------
Maturing in one year or less $190,995
Maturing after one year through five years 577,750
Maturing after five years through ten years 564,178
Maturing after ten years 597,811
-----------
$1,930,734
============
The distribution of mortgage loans by class of loan and geographic
distribution follows:
Principal
Balance
------
Commercial loans:
Texas $ 573,656
Tennessee 215,727
Louisiana 36,097
Alabama 16,704
---------
$ 842,184
==========
Residential loans:
Tennessee $ 453,714
Alabama 423,538
Texas 81,465
Florida 63,719
Kentucky 35,103
Louisiana 31,011
----------
$1,088,550
==========
Investment Income
A summary of net investment income follows:
1998 1997
---- ----
Interest on fixed maturities $1,676,508 1,356,634
Interest on mortgage loans 293,860 256,959
Interest on policy loans 42,769 49,327
Interest on cash and short-term investments 37,025 37,396
Real estate income -- 26,582
Miscellaneous investment income 40,192 139,860
---------------------
2,090,354 1,866,758
Investment expense (63,620) (330,750)
---------------------
$2,026,734 1,536,008
=====================
Unrealized Investment Gains (Losses)
The change between cost and fair value for fixed maturity and equity
securities, net of taxes, follows:
Fixed Equity
Maturities Securities Total
---------- ---------- -----
Balance, January 1, 1997 $ 599,443 (138) 599,305
Change during the year 344,279 138 344,417
--------------------------------
Balance, December 31, 1997 943,722 -- 943,722
Change during the year 271,063 -- 271,063
--------------------------------
Balance, December 31, 1998 $1,214,785 -- 1,214,785
================================
Net Realized Investment Gains (Losses)
A summary of net realized investment gains (losses) follows:
1998 1997
---- ----
Fixed maturities $ 55,977 154,416
Equity securities (including investment
in subsidiaries) (100) (3,203)
Real estate 79,796 53,496
Surplus debenture (800,000) --
---------------------
$(664,327) 204,709
======================
On December 16, 1998, Texas Imperial acquired the stock of Statesman
National Life Insurance Company ("Statesman"). Statesman was owned
by the brother of the majority shareholder of Acap, and, as a result,
this qualified as a related party transaction. Texas Imperial issued
a promissory note of $100 to the sellers of the Statesman stock
("Sellers"). At the time of the acquisition of the Statesman stock
by Texas Imperial, Statesman had approximately $1.8 million in surplus
debentures issued to the Sellers. The Sellers' debentures backed the
Sellers' representations and warranties and were to be adjusted based
upon the outcome of certain post-closing price adjustments. In
connection with closing, Texas Imperial purchased an $800,000 surplus
debenture from Statesman to bring Statesman's statutory equity to the
level required by the Texas Department of Insurance (the
"Department") as a condition of the Department's approval of Texas
Imperial's acquisition of Statesman. In January, 1999, it was
discovered that Statesman's claim liabilities were significantly
understated. The liability understatement exceeded the amount of the
Sellers' debentures. Given the mutual mistake of fact upon which the
stock purchase, the surplus debenture purchase and the Department's
approval of same were based, Texas Imperial, the Sellers, and
Statesman agreed to rescind the purchase of the stock and the surplus
debenture. However, the rescission required the approval of the
Department. The Department did not grant its approval. As a result,
Texas Imperial determined that the $800,000 Statesman surplus
debenture was uncollectible and recorded the realized investment loss
on the debenture and wrote off its investment in Statesman of $100.
Other Investment Disclosures
At December 31, 1998, bonds with a fair value of $5,697,557 were on
deposit with various regulatory authorities.
Investments, other than investments issued or guaranteed by the United
States Government or a United States Government agency or authority,
in excess of 10% of stockholders' equity at December 31, 1998 were as
follows:
Balance
Sheet Amount Category
------------ -------------
Merrill Lynch $1,123,463 Fixed maturity
Ingersoll Rand 1,036,256 Fixed maturity
General Motors 1,020,516 Fixed maturity
Green Tree Home Equity Loan 1,004,110 Fixed maturity
La Farge Corp 988,636 Fixed maturity
AT&T 885,813 Fixed maturity
EQCC Home Equity 847,813 Fixed maturity
PNC Mortgage Security 746,197 Fixed maturity
3. FAIR VALUES
The carrying values and estimated fair values of the Company's financial
instruments as of December 31, 1998 are as follows:
Carrying Amount Fair Value
--------------- ----------
Assets:
Fixed maturities $36,968,374 36,968,374
Mortgage loans 1,930,734 1,943,679
Policy loans 6,811,849 6,811,849
Short-term investments 1,573,630 1,573,630
Liabilities
Note payable 562,500 562,500
Estimated market values of publicly-traded fixed maturity securities
are as reported by an independent pricing service. Estimated market
values of fixed maturity securities not actively traded in a liquid
market are estimated using a third party pricing system, which uses a
matrix calculation assuming a spread over U.S. Treasury bonds.
Fair values of mortgage loans are estimated by discounting expected
cash flows, using market interest rates currently being offered for
similar loans.
Policy loans have no stated maturity dates and are a part of the
related insurance contracts. Accordingly, it is not practicable for
the Company to estimate a fair value for them.
For short-term investments, the carrying amount is a reasonable
estimate of fair value.
In that the note payable is a floating rate instrument, the principal
balance is a reasonable estimate of the note's fair value.
4. NOTE PAYABLE
On January 31, 1995, the Company borrowed $1.5 million from Central
National Bank of Waco, Texas. The note is renewable by the bank each
April 30 until fully repaid. The note bears interest at a rate equal
to the base rate of a bank plus 1%. Principal payments on the note of
$62,500 are due quarterly (a six year amortization) beginning April
30, 1995. The loan agreement contains certain restrictions and
financial covenants. Without the written consent of the bank, Acap
may not incur any debt, pay common stock dividends or sell any
substantial amounts of assets. Also, American Capitol is subject to
minimum statutory earnings and capital and surplus requirements during
the loan term. The Company is in compliance with all of the terms of
the loan.
During 1997, American Capitol and Texas Imperial obtained revolving
lines of credit from a bank by signing unsecured promissory notes in
the amount of $200,000 and $150,000, respectively. Interest on both
notes are at the base interest rate of the bank. Both notes were
renewed in 1998. As of December 31, 1998 no funds have been borrowed
on these notes.
5. COMMITMENTS AND CONTINGENCIES
Leases
In conjunction with the sale of American Capitol's home office
building on November 21, 1997, American Capitol entered a lease
agreement with the new owner of the building to lease approximately
one quarter of the net rentable area of the building, the area it then
currently occupied, for five years at an annual rental of $124,320.
American Capitol has the option to extend the lease for an additional
five years at the end of the initial term of the lease. An amendment
was made to this lease agreement in 1998 to lease an additional 8,424
square feet. The effective date of the amendment was June 1, 1998 and
runs concurrently with the original lease agreement. The annual
rental for the first year is approximately $103,246 and the annual
rental for the remaining years is approximately $111,070. American
Capitol paid $203,771 in rental payments in 1998 in connection with
this lease agreement.
Reinsurance
The Company accounts for reinsurance in accordance with Statement of
Financial Accounting Standards No. 113. In accounting for
reinsurance, the Company has reported ceded reserve credits and
reinsurance claim credits as reinsurance receivables. The cost of
reinsurance related to long-duration contracts is accounted for over
the life of the underlying reinsured policies using assumptions
consistent with those used to account for the underlying policies.
At December 31, 1998, reinsurance receivables with a carrying value of
$49.5 million were associated with Republic-Vanguard Life Insurance
Company ("Republic"). Republic is rated "Excellent" by A.M. Best
Company, an insurance rating organization. At December 31, 1997,
Republic had statutory assets of approximately $800 million and
statutory stockholder equity of approximately $38 million. At
December 31, 1998, reinsurance receivables with a carrying value of
$49.3 million were associated with a single reinsurer, Crown Life
Insurance Company ("Crown"). At December 31, 1997, Crown had
statutory assets in excess of $6.6 billion and statutory stockholders'
equity of approximately $500 million. Crown is rated "Excellent" by
A.M. Best Company. At December 31, 1998, reinsurance receivables with
a carrying value of $2.3 million were associated with Alabama
Reassurance Company ("Alabama Re"). While Alabama Re is currently
rated "Fair" by A.M. Best Company, the Alabama Re reinsurance
receivables are secured by a trust account containing a $5 million
letter of credit granted in favor of an insurance subsidiary of the
Company. At December 31, 1998, the remaining reinsurance receivables
were associated with various other reinsurers.
The Company is contingently liable for amounts ceded to reinsurers in
the event the reinsurers are unable to meet their obligations assumed
under the reinsurance agreements. The Company evaluates the financial
condition of its reinsurers and monitors concentrations of credit risk
to minimize its exposure to significant losses from reinsurer
insolvencies. Other than its exposure to Crown, Alabama Re and
Republic as discussed above, management does not believe the Company
has significant concentrations of credit risk related to reinsurance,
or otherwise.
On March 5, 1998, American Capitol closed a coinsurance transaction
with Universal Life Insurance Company ("Universal"). Pursuant to
the coinsurance agreement (the "Coinsurance Agreement"), American
Capitol coinsured 100% of the individual life insurance policies of
Universal in force at January 1, 1998. The effective date of the
Coinsurance Agreement was January 1, 1998. American Capitol paid
Universal an initial ceding commission of approximately $13 million.
Universal transferred approximately $40 million in assets to American
Capitol in connection with the coinsurance.
Contemporaneous with the signing of the Coinsurance Agreement, the
parties executed an administrative agreement (the "Administration
Agreement") whereby American Capitol agreed to provide specified
administrative functions for the 246,011 coinsured Universal policies.
American Capitol started administering the policies beginning July 1,
1998. Between January 1, 1998 and July 1, 1998, Universal continued
to administer the policies, and American Capitol paid Universal the
expense allowance stipulated in the Administration Agreement.
Concurrent with the coinsurance of the Universal policies, American
Capitol retroceded all of the coinsured Universal policies to
Republic. Republic paid American Capitol an initial ceding commission
of $13.5 million. American Capitol transferred $39.6 million in
assets to Republic in connection with the retrocession. Once Republic
has recovered the initial ceding commission, Republic must, at
American Capitol's option, retrocede back to American Capitol 100% of
the policies. Upon this retrocession, American Capitol then pays
Republic 30% of the profits generated by the policies, retaining the
other 70% of the profits. In addition, American Capitol has the right
to recapture the retrocession under certain terms and conditions.
The Crown, Republic, and Alabama Re reinsurance treaties are
representative of a key use of reinsurance by the Company.
Immediately following the purchase of a block of life insurance
policies through the Company's acquisition program, the Company may
reinsure all or a portion of the acquired policies. By doing so, the
Company seeks to recover all or a portion of the purchase price of the
acquired policies and transfer the risks associated with the policies
to the reinsurer. The Company retains the administration of the
reinsured policies and seeks to profit from the compensation the
Company receives from the reinsurer for such policy administration.
The Company is entitled, but not obligated, to recapture the policies
at a price determined by a formula in the reinsurance treaty.
With regard to the policies not 100% reinsured with Crown, Republic,
or Alabama Re, the purpose of reinsurance is to limit the Company's
exposure to loss on any single insured. The Company reinsures the
portion of risks in excess of a maximum of $50,000 on the life of any
individual through various reinsurance contracts, primarily of the
coinsurance and yearly renewable term type.
Effective October 31, 1998, American Capitol coinsured from Statesman
National Life Insurance Company ("Statesman") 100% of its pre-
standard Medicare supplement policies in force. American Capitol paid
Statesman an initial ceding commission of $1 million. Statesman
transferred approximately $800,000 in assets to American Capitol in
connection with the coinsurance.
The effect of reinsurance on premiums and benefits follows:
Years ended December 31,
1998 1997
---- ----
Direct premiums $ 7,917,467 7,227,841
Reinsurance assumed 9,314,872 1,761,954
Reinsurance ceded (14,650,505) (6,468,692)
Net premiums $2,581,834 2,521,103
==========================
Direct policy benefits $ 8,139,517 7,871,643
Reinsurance assumed 8,610,983 2,771,068
Reinsurance ceded (14,160,450) (8,155,732)
---------------------------
Net policy benefits $ 2,590,050 2,486,979
===========================
Litigation
Acap and its subsidiaries are involved in various lawsuits and legal
actions arising in the ordinary course of operations. Management is
of the opinion that the ultimate disposition of the matters will not
have a material adverse effect on Acap's results of operations or
financial position.
6. SUPPLEMENTAL INFORMATION REGARDING CASH FLOWS
Cash payments for interest expense for the years ended December 31,
1998 and 1997 were $69,015 and $92,176, respectively. Net cash
payments of $208,143 and $282,779 for federal income taxes were made
during the years ended December 31, 1998 and 1997, respectively.
The following reflects assets acquired and liabilities assumed by the
Company relative to the coinsurance agreement covering the policies of
Universal, the consideration given for such reinsurance and the net
cash flow relative to such coinsurance on January 1, 1998.
Assets acquired $ 39,972,696
Liabilities assumed (53,085,774)
-----------
Cost of coinsurance $(13,113,078)
Cash paid for coinsurance $(13,113,078)
Net cash from coinsurance:
Cash acquired $ 38,597,840
Cash paid for coinsurance (13,113,078)
-----------
Net cash provided from coinsurance $ 25,484,762
===========
The following reflects assets and liabilities transferred in
connection with a coinsurance agreement whereby all policies assumed
from Universal were 100% retroceded to Republic, the ceding commission
received and the net cash flow related to the coinsurance agreement on
January 1, 1998.
Assets transferred $(39,580,339)
Liabilities transferred 53,080,339
-----------
Net cash transferred $ 13,500,000
===========
Ceding commission received $ 13,500,000
===========
Net cash from coinsurance $ --
===========
Cash paid $(38,984,762)
Cash received from coinsurance 13,500,000
-----------
Net cash used from coinsurance (25,484,762)
-----------
Net proceeds from coinsurance $ --
===========
The following reflects assets acquired and liabilities assumed
relative to the coinsurance agreement covering the pre-standard
Medicare supplement policies of Statesman, the consideration given for
such coinsurance and the net cash flow relative to such coinsurance on
October 31, 1998.
Assets acquired $ 818,443
Liabilities assumed (1,818,443)
-----------
Cost of coinsurance $ (1,000,000)
===========
Cash paid for coinsurance $ (1,000,000)
Net cash from coinsurance:
Cash acquired $ 1,759,626
Cash paid for coinsurance (1,000,000)
-----------
Net cash provided from coinsurance $ 759,626
===========
7. FEDERAL INCOME TAXES
Acap and American Capitol file a consolidated federal income tax
return. The other subsidiaries of the Company file separate federal
income tax returns. At December 31, 1998, Acap had a remaining tax
net operating loss carryover of approximately $900,000 that will
expire during the years 2001 through 2012 if not previously utilized.
At December 31, 1998, the Company had alternative minimum tax
carryforwards of approximately $500,000 that are available for an
indefinite period to reduce future regular federal income taxes.
A portion of life insurance taxable income generated prior to 1984 is
not taxable unless it exceeds certain statutory limitations or is
distributed to stockholders, in which case it becomes taxable at
ordinary corporate rates. Such income is accumulated in a
Policyholders' Surplus account that, at December 31, 1998, had a
balance of approximately $4,800,000. No provision has been made for
income taxes related to this accumulation.
A reconciliation of income tax expense (benefit) for 1998 and 1997
computed at the applicable federal tax rate of 34% to the amount recorded in
the consolidated financial statements is as follows:
1998 1997
---- ----
Federal income tax expense at statutory rate $ 10,306 249,654
Small life insurance company special deduction -- (307,981)
Change in valuation allowance (70,780) (620,895)
Tax underpayment (refund) (6,238) 10,617
Tax rate differential on net operating loss carryback 70,148 --
Other, net 40,866 54,850
--------------------
Total federal income tax expense (benefit) $ 44,302 (613,755)
====================
The small life insurance company special deduction noted above is
available to life insurance companies with assets under $500 million.
The deduction is 60% of life insurance taxable income under $3
million. The deduction is phased out for life insurance taxable
income between $3 million and $15 million, with the deduction reduced
by 15% of the life insurance taxable income in excess of $3 million.
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1998 are as follows:
Deferred Tax Assets:
Deferred gain on reinsurance $ 809,121
Deferred gain on sale of real estate 132,227
Net operating loss carryforwards 319,968
Alternative minimum tax credit carryforwards 501,091
Other 45,024
---------
Total gross deferred tax assets 1,807,431
Less: valuation allowance (1,104,942)
---------
Deferred tax assets 702,489
---------
Deferred Tax Liabilities:
Net unrealized gains on
available-for-sale securities 531,758
Deferred policy acquisition costs 310,074
Policy reserves and policy funds 971,353
Other 65,460
---------
Deferred tax liabilities 1,878,645
=========
Net deferred tax liability $1,176,156
=========
A valuation allowance for the net operating loss carryforward,
alternative minimum tax credit carryforward, and a portion of other
deferred tax assets of $1,104,942 was established at December 31,
1998 against the deferred tax asset. The net change in the total
valuation allowance for the years ended December 31, 1998 and 1997
was a decrease of $70,780 and a decrease of $620,895, respectively.
Management believes that it is more likely than not that the deferred
tax assets that are not provided for in the valuation allowance are
recoverable.
8. AMERICAN CAPITOL KEY EMPLOYEE STOCK OPTION PLAN
On July 18, 1988, the Board of Directors of American Capitol approved
a non-qualified stock option plan (the "1988 Plan"). Under the
terms of the 1988 Plan, stock options could only be granted on shares
of common stock of Acap owned by American Capitol. The options
enabled the grantee to purchase the common stock to which the options
relate at the fair market value of the common stock on the date the
options were granted. During 1997, all of the outstanding options
granted under the 1988 Plan were exercised and the 1988 Plan was
terminated.
Effective September 2, 1997, the Board of Directors of American
Capitol adopted an incentive stock option plan (the "1997 Plan").
The 1997 Plan provides that the Board of Directors of American Capitol
or the Compensation Committee of the Board of Directors may grant
stock options to any employee determined to be a key employee. The
stock options may only be granted on shares of common stock of Acap
owned by American Capitol. The options enable the grantee to purchase
the common stock to which the options relate at the fair market value
of the common stock on the date of granting the options. The options
vest five years from the date of grant and must be exercised within
ten years from the date of grant. As of December 31, 1998, options to
purchase 500 of the 743 shares of Acap common stock owned by American
Capitol had been granted, with a weighted average option price of
$244.80 per share.
Stock options granted for Acap Corporation common stock are summarized
as follows:
Number of Shares
Option Price 1998 1997
---------------------------------
Outstanding at January 1 244.80/187.50 500 68
Granted during the year $244.80 -- 500
Exercised during the year $187.50 -- (68)
---------------
Outstanding at December 31 $244.80 500 500
===============
Available for future grant 243 34
===============
9. CAPITAL STOCK
Acap has two classes of capital stock: preferred stock ($.10 par
value, authorized 80,000 shares), which may be issued in series with
such dividend, liquidation, redemption, conversion, voting, and other
rights as the Board of Directors may determine, and common stock ($.10
par value, authorized 10,000 shares), the "Common Stock." The only
series of preferred stock outstanding is the Cumulative Exchangeable
Preferred Stock, Series A, $2.50 (Adjustable), the "Series A Preferred
Stock."
Series A Preferred Stock
There are 74,000 shares of Series A Preferred Stock authorized, issued
and outstanding. Acap pays dividends quarterly on the Series A
Preferred Stock (when and as declared by the Board of Directors). The
amount of the dividend is based on the prime rate of a Pittsburgh bank
plus 2%. Acap has the right, if elected by the Board of Directors, to
redeem the Series A Preferred Stock at the fixed redemption price of
$27.50 per share. The holders of Series A Preferred Stock are
entitled to liquidating distributions of $27.50 per share. The
cumulative dividends and liquidating distributions of the Series A
Preferred Stock are payable in preference to the Common Stock. The
Series A Preferred Stock is nonvoting, except as required by law and
except that, if six quarterly dividends are unpaid and past due, the
holders of the Series A Preferred Stock may elect two directors to
Acap's Board of Directors. Prior to August 26, 1996, the Series A
Preferred Stock had been exchangeable, at the option of the holders,
into shares of common stock of Fortune National Corporation
("Fortune"). Effective August 26, 1996, Fortune adopted a plan of
dissolution and liquidation. Consequently, the exchange option of
Series A Preferred Stock expired. There was no activity related to
the Series A Preferred Stock for the two years ended December 31, 1998
other than payments of dividends.
Common Stock
Fortune, formerly the owner of 63.7% of the Company's outstanding
Common Stock, adopted a plan of dissolution and liquidation at its
annual stockholder meeting on August 26, 1996. At that date, Fortune
had no assets other than its holding of the Company's Common Stock.
Under the plan, no fractional shares of the Company's Common Stock
were issued. Fortune stockholders who did not buy from the Company
enough Fortune common stock to round up their holdings elected to
sell their "odd lot" shares of Fortune common stock to the Company.
As a result of the Company's purchase of the "odd lot" shares and the
conversion of the Company's holding of Fortune common stock into
company Common Stock, the Company added $320,566 (910 shares) to
treasury stock, reducing the number of outstanding shares of Company
Common Stock to approximately 7,603. During 1998 and 1997, the
Company added another 209 and 225, respectively, shares to treasury
stock, reducing the number of outstanding shares of Company Common
Stock.
<PAGE>
ACAP CORPORATION
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Acap Corporation
We have audited the accompanying consolidated balance sheet of Acap
Corporation and subsidiaries as of December 31, 1998, and the related
consolidated statements of operations and comprehensive income,
stockholders' equity, and cash flows for the years ended December 31,
1998 and 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 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 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 Acap Corporation and subsidiaries as of December 31, 1998, and the
results of their operations and their cash flows for the years ended
December 31, 1998 and 1997, in conformity with generally accepted
accounting principles.
KPMG LLP
Houston, Texas
March 26, 1999
<PAGE>
ACAP CORPORATION
STOCKHOLDER INFORMATION
MARKET INFORMATION
The common stock of Acap is traded over-the-counter with activity in
the stock reflected nationally on the OTC Bulletin Board electronic
quotation system of the National Association of Securities Dealers.
The Company's stock symbol is AKAP.
The table below presents the range of closing bid quotations for
Acap's common stock during the two most recent fiscal years.
1998 1997
---------------------------------------
High Low High Low
---------------------------------------
First quarter $400 370 290 240
Second quarter 475 396 275 240
Third quarter 450 442 350 247
Fourth quarter 480 442 370 360
The prices presented are bid prices, which reflect inter-dealer
transactions and do not include retail markups and markdowns or any
commission to the parties involved. As such, the prices may not
reflect prices in actual transactions.
HOLDERS
The approximate number of holders of record of Acap's common stock as
of March 22, 1999 was 696.
DIVIDENDS
Acap declared no common stock dividends in 1998 or 1997. At present,
management anticipates that no dividends will be declared or paid
with respect to Acap's common stock during 1999.
FORM 10-KSB
Stockholders may receive without charge a copy of the Company's
Annual Report on Form 10-KSB filed with the Securities and Exchange
Commission by writing to Stockholder Services, Acap Corporation,
10555 Richmond Avenue, 2nd Floor, Houston, TX 77042.
TRANSFER AGENT
The registrar and transfer agent for the Company's common stock is
Continental Stock Transfer & Trust Company, 2 Broadway, New York, NY
10004. For a change of name or address, or to replace lost stock
certificates, write to Continental at the address above or call (212)
509-4000.
INVESTOR RELATIONS
Requests for information should be directed by mail to Stockholder
Services, Acap Corporation, 10555 Richmond Avenue, 2nd Floor,
Houston, TX 77042 or by calling (713) 974-2242.
INDEPENDENT AUDITORS
The Company's consolidated financial statements for 1998 were audited
by the independent accounting firm of KPMG LLP, 700 Louisiana,
Houston, TX 77002.
ANNUAL MEETING
Stockholders are invited to attend the Annual Meeting of Stockholders
which will be held on Monday, May 3, 1999 at 8:00 a.m. at the
Company's office at 10555 Richmond Avenue, Houston, Texas, on the
second floor.
<PAGE>
ACAP CORPORATION
DIRECTORS AND OFFICERS
BOARD OF DIRECTORS OF ACAP
R. Wellington Daniels
Investor; Retired Director of National Accounts, American Cyanamid
William F. Guest
Chairman of the Board and President, Acap Corporation
C. Stratton Hill, Jr., M.D.
Physician
OFFICERS OF ACAP
William F. Guest
Chairman of the Board and President
John D. Cornett
Executive Vice President and Treasurer
H. Kathleen Musselwhite
Secretary and Assistant Treasurer
OFFICERS OF AMERICAN CAPITOL AND TEXAS IMPERIAL
William F. Guest
Chairman of the Board
John D. Cornett
President
H. Kathleen Musselwhite
Secretary, Treasurer and Controller
Dan R. Stites
Senior Vice President
Eugene L. Ligon
Vice President
G. Mike Rambo
Vice President
Carolyn M. Rawlins
Assistant Secretary
Linda G. Stark
Assistant Vice President
C. Stratton Hill, Jr., M.D.
Medical Director
<PAGE>
ACAP CORPORATION
10555 Richmond Avenue, 2nd Floor Houston, Texas 77042
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM DECEMBER 31,
1998 FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 36,968,374
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 0
<MORTGAGE> 1,930,734
<REAL-ESTATE> 0
<TOTAL-INVEST> 47,284,587
<CASH> 120,332
<RECOVER-REINSURE> 105,155,284
<DEFERRED-ACQUISITION> 2,460,183
<TOTAL-ASSETS> 158,380,034
<POLICY-LOSSES> 139,496,503
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 2,397,219
<POLICY-HOLDER-FUNDS> 2,850,960
<NOTES-PAYABLE> 562,500
0
1,850,000
<COMMON> 876
<OTHER-SE> 5,533,499
<TOTAL-LIABILITY-AND-EQUITY> 158,380,034
2,581,834
<INVESTMENT-INCOME> 2,026,734
<INVESTMENT-GAINS> (664,327)
<OTHER-INCOME> 41,969
<BENEFITS> 2,590,050
<UNDERWRITING-AMORTIZATION> 109,786
<UNDERWRITING-OTHER> 5,899,627
<INCOME-PRETAX> 30,313
<INCOME-TAX> 44,302
<INCOME-CONTINUING> (13,989)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,989)
<EPS-PRIMARY> (28.42)
<EPS-DILUTED> (35.52)
<RESERVE-OPEN> 924,702
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 1,022,250
<PAYMENTS-PRIOR> 1,083,921
<RESERVE-CLOSE> 2,397,219
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
