SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
AMENDMENT NUMBER 3 TO
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997 Commission File Number 0-16867
UNITED TRUST, INC.
(Exact name of registrant as specified in its charter)
5250 SOUTH SIXTH STREET
P.O. BOX 5147
SPRINGFIELD, IL 62705
(Address of principal executive offices, including zip code)
ILLINOIS 37-1172848
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Registrant's telephone number, including area code: (217)241-6300
Amendment No. 3
The undersigned registrant hereby amends the following items, financial
statements, exhibits, or other portions of its December 31, 1997 filing of
Form 10-K as set forth in the pages attached hereto:
Each amendment as shown on the index page is amended to
replace the existing item, statement or exhibit
reflected in the December 31, 1997 Form 10-K filing.
Changes to the original filing have been shaded for
easy identification.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant duly caused this amendment to be signed on its behalf by the
undersigned , thereunto duly authorized.
UNITED TRUST, INC.
(Registrant)
By: /s/ James E. Melville
James E. Melville
President and Chief
Operating Officer
By: /s/ Theodore C. Miller
Senior Vice President and
Chief Financial Officer
Date: January 15, 1999
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UNITED TRUST, INC,
FORM 10-K/A
INDEX
CERTIFIED PUBLIC ACCOUNTANT'S CONSENT
KERBER, ECK & BRAECKEL LLP 3
PART I
ITEM 1. BUSINESS 4
ITEM 3. LEGAL PROCEEDINGS 16
PART II
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 16
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 30
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Consent of Independent Certified Public Accountant
We consent to the amendments on pages 30-59 of this Form 10-K/A dated
January 15, 1999, and to the use of our opinion dated March 26, 1998, as
originally filed with the United Trust, Inc. Form 10-K for 1997 after such
amendment.
KERBER, ECK & BRAECKEL LLP
Springfield, Illinois
January 15, 1999
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PART I, ITEM I. BUSINESS SHOULD BE AMENDED AS FOLLOWS:
PART 1
ITEM 1. BUSINESS
United Trust, Inc. (the "Registrant") was incorporated in 1984, under the
laws of the State of Illinois to serve as an insurance holding company. At
December 31, 1997, significant majority-owned subsidiaries and affiliates
of the Registrant were as depicted on the following organizational chart:
ORGANIZATIONAL CHART
AS OF DECEMBER 31, 1997
United Trust, Inc. ("UTI") is the ultimate controlling company. UTI owns
53% of United Trust Group ("UTG") and 41% of United Income, Inc. ("UII").
UII owns 47% of UTG. UTG owns 79% of First Commonwealth Corporation
("FCC") and 100% of Roosevelt Equity Corporation ("REC"). FCC owns 100% of
Universal Guaranty Life Insurance Company ("UG"). UG owns 100% of United
Security Assurance Company ("USA"). USA owns 84% of Appalachian Life
Insurance Company ("APPL") and APPL owns 100% of Abraham Lincoln Insurance
Company ("ABE").
The Registrant and its subsidiaries (the "Company") operate principally in
the individual life insurance business. The primary business of the
Company has been the servicing of existing insurance business in force, the
solicitation of new insurance business, and the acquisition of other
companies in similar lines of business.
United Trust, Inc., ("UTI") was incorporated December 14, 1984, as an
Illinois corporation. During the next two and a half years, UTI was
engaged in an intrastate public offering of its securities, raising over
$12,000,000 net of offering costs. In 1986, UTI formed a life insurance
subsidiary, United Trust Assurance Company ("UTAC"), and by 1987 began
selling life insurance products.
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United Income, Inc. ("UII"), an affiliated company, was incorporated on
November 2, 1987, as an Ohio corporation. Between March 1988 and August
1990, UII raised a total of approximately $15,000,000 in an intrastate
public offering in Ohio. During 1990, UII formed a life insurance
subsidiary, United Security Assurance (USA), and began selling life
insurance products.
UTI currently owns 41% of the outstanding common stock of UII and accounts
for its investment in UII using the equity method.
On February 20, 1992, UTI and UII, formed a joint venture, United Trust
Group, Inc., ("UTG"). On June 16, 1992, UTI contributed $2.7 million in
cash, an $840,000 promissory note and 100% of the common stock of its
wholly owned life insurance subsidiary, (UTAC). UII contributed $7.6
million in cash and 100% of its life insurance subsidiary, (USA), to UTG.
After the contributions of cash, subsidiaries, and the note, UII owns 47%
and UTI owns 53% of UTG.
On June 16, 1992, UTG acquired 67% of the outstanding common stock of the
now dissolved Commonwealth Industries Corporation, ("CIC") for a purchase
price of $15,567,000. Following the acquisition UTI controlled eleven life
insurance subsidiaries. The Company has taken several steps to streamline
and simplify the corporate structure following the acquisitions.
On December 28, 1992, Universal Guaranty Life Insurance Company ("UG") was
the surviving company of a merger with Roosevelt National Life Insurance
Company ("RNLIC"), United Trust Assurance Company ("UTAC"), Cimarron Life
Insurance Company ("CIM") and Home Security Life Insurance Company
("HSLIC"). On June 30, 1993, Alliance Life Insurance Company ("ALLI"), a
subsidiary of UG, was merged into UG.
On July 31, 1994, Investors Trust Assurance Company ("ITAC") was merged
into Abraham Lincoln Insurance Company ("ABE").
On August 15, 1995, the shareholders of CIC, Investors Trust, Inc.,
("ITI"), and Universal Guaranty Investment Company, ("UGIC"), all
intermediate holding companies within the UTI group, voted to voluntarily
liquidate each of the companies and distribute the assets to the
shareholders (consisting solely of common stock of their respective
subsidiary). As a result, the shareholders of the liquidated companies
became shareholders of FCC.
On March 25, 1997, the Board of Directors of UTI and UII voted to recommend
to the shareholders a merger of the two companies. Under the Plan of
Merger, UTI would be the surviving entity with UTI issuing one share of its
stock for each share held by UII shareholders. Neither UTI nor UII have
any other significant holdings or business dealings. The Board of
Directors of each company thus concluded a merger of the two companies
would be in the best interests of the shareholders. The merger will result
in certain cost savings, primarily related to costs associated with
maintaining a corporation in good standing in the states in which it
transacts business. A vote of the shareholders of UTI and UII regarding
the proposed merger is anticipated to occur sometime during the third
quarter of 1998.
The holding companies within the group, UTI, UII UTG and FCC, are all life
insurance holding companies. These
companies became members of the same affiliated group through a history of
acquisitions in which life insurance companies were involved. The focus of
the holding companies is the acquisition of other companies in similar
lines of business and management of the insurance subsidiaries. The
companies have no activities outside the life insurance focus.
The insurance companies of the group, UG, USA, APPL and ABE, all operate in
the individual life insurance business. The primary focus of these
companies has been the servicing of existing insurance business in force
and the solicitation of new insurance business.
On February 19, 1998, UTI signed a letter of intent with Jesse T. Correll,
whereby Mr. Correll will personally or in combination with other
individuals make an equity investment in UTI over a period of three years.
Under the terms of the letter of intent Mr. Correll will buy 2,000,000
authorized but unissued shares of UTI common stock for $15.00 per share and
will also buy 389,715 shares of UTI common stock, representing stock of UTI
and UII, that UTI purchased during the last eight months in private
transactions at the average price UTI paid for such stock, plus interest,
or approximately $10.00 per share. Mr. Correll also will purchase 66,667
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shares of UTI common stock and $2,560,000 of face amount of convertible
bonds (which are due and payable on any change in control of UTI) in
private transactions, primarily from officers of UTI.
UTI intends to use the equity that is being contributed to expand their
operations through the acquisition of other life insurance companies. The
transaction is subject to negotiation of a definitive purchase agreement;
completion of due diligence by Mr. Correll; the receipt of regulatory and
other approvals; and the satisfaction of certain conditions. The
transaction is not expected to be completed before June 30, 1998, and there
can be no assurance that the transaction will be completed.
PRODUCTS
The Company's portfolio consists of two universal life insurance products.
Universal life insurance is a form of permanent life insurance that is
characterized by its flexible premiums, flexible face amounts, and
unbundled pricing factors. The primary universal life insurance product is
referred to as the "Century 2000". This product was introduced to the
marketing force in 1993 and has become the cornerstone of current
marketing. This product has a minimum face amount of $25,000 and currently
credits 6% interest with a guaranteed rate of 4.5% in the first 20 years
and 3% in years 21 and greater. The policy values are subject to a $4.50
monthly policy fee, an administrative load and a premium load of 6.5% in
all years. The premium AND ADMINISTRATIVE LOADS ARE a general expense
charge which is added to a policy's net premium to cover the insurer's cost
of doing business. A PREMIUM LOAD IS ASSESSED UPON THE RECEIPT OF A
PREMIUM PAYMENT. AN ADMINISTRATIVE LOAD IS A MONTHLY MAINTENANCE CHARGE.
The administrative load and surrender charge are based on the issue age,
sex and rating class of the policy. A surrender charge is effective for
the first 14 policy years. In general, the surrender charge is very high
in the first couple of years and then declines to zero at the end of 14
years. Policy loans are available at 7% interest in advance. The policy's
accumulated fund will be credited the guaranteed interest rate in relation
to the amount of the policy loan.
The second universal life product referred to as the "UL90A", has a minimum
face amount of $25,000. The administrative load is based on the issue age,
sex and rating class of the policy. Policy fees vary from $1 per month in
the first year to $4 per month in the second and third years and $3 per
month each year thereafter. The UL90A currently credits 5.5% interest with
a 4.5% guaranteed interest rate. Partial withdrawals, subject to a
remaining minimum $500 cash surrender value and a $25 fee, are allowed once
a year after the first duration. Policy loans are available at 7% interest
in advance. The policy's accumulated fund will be credited the guaranteed
interest rate in relation to the amount of the policy loan. Surrender
charges are based on a percentage of target premium starting at 120% for
years 1-5 then grading downward to zero in year 15. This policy contains a
guaranteed interest credit bonus for the long-term policyholder. From
years 10 through 20, additional interest bonuses are earned with a total in
the twentieth year of 1.375%. The bonus is calculated from the policy
issue date and is contractually guaranteed.
The Company's actual experience for earned interest, persistency and
mortality vary from the assumptions applied to pricing and for determining
premiums. Accordingly, differences between the Company's actual experience
and those assumptions applied may impact the profitability of the Company.
The minimum interest spread between earned and credited rates is 1% on the
"Century 2000" universal life insurance product. The Company monitors
investment yields, and when necessary adjusts credited interest rates on
its insurance products to preserve targeted interest spreads. Credited
rates are reviewed and established by the Board of Directors of the
respective life insurance subsidiaries.
The premium rates are competitive with other insurers doing business in the
states in which the Company is marketing its products.
The Company markets other products, none of which is significant to
operations. The Company has a variety of policies in force different from
those which are currently being marketed. The previously defined Universal
life and interest sensitive whole life, which is a type of indeterminate
premium life insurance which provides that the policy's cash value may be
greater than that guaranteed if changing assumptions warrant an increase,
business account for approximately 46% of the insurance in force.
Approximately 29% of the insurance in force is participating business,
which represents policies under which the policyowner shares in the
insurance companies divisible surplus. The Company's average persistency
rate for its policies in force for 1997 and 1996 has been 89.4% and 87.9%,
respectively. The Company does not anticipate any material fluctuations in
these rates in the future that may result from competition.
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Interest-sensitive life insurance products have characteristics similar to
annuities with respect to the crediting of a current rate of interest at or
above a guaranteed minimum rate and the use of surrender charges to
discourage premature withdrawal of cash values. Universal life insurance
policies also involve variable premium charges against the policyholder's
account balance for the cost of insurance and administrative expenses.
Interest-sensitive whole life products generally have fixed premiums.
Interest-sensitive life insurance products are designed with a combination
of front-end loads, periodic variable charges, and back-end loads or
surrender charges. Traditional life insurance products have premiums and
benefits predetermined at issue; the premiums are set at levels that are
designed to exceed expected policyholder benefits and Company expenses.
Participating business is traditional life insurance with the added feature
of an annual return of a portion of the premium paid by the policyholder
through a policyholder dividend. This dividend is set annually by the
Board of Directors of each insurance company and is completely
discretionary.
MARKETING
The Company markets its products through separate and distinct agency
forces. The Company has approximately 45 captive agents who actively write
new business, and 15 independent agents who primarily service their
existing customers. No individual sales agent accounted for over 10% of
the Company's premium volume in 1997. The Company's sales agents do not
have the power to bind the Company.
Marketing is based on referral network of community leaders and
shareholders of UII and UTI. Recruiting of sales agents is also based on
the same referral network. The industry has experienced a downward trend
in the total number of agents who sell insurance products, and competition
for the top sales producers has intensified. As this trend appears to
continue, the recruiting focus of the Company has been on introducing
quality individuals to the insurance industry through an extensive internal
training program. The Company feels this approach is conducive to the
mutual success of our new recruits and the Company as these recruits market
our products in a professional, company structured manner.
New sales are marketed by UG and USA through their agency forces using
contemporary sales approaches with personal computer illustrations.
Current marketing efforts are primarily focused on the Midwest region.
USA is licensed in Illinois, Indiana and Ohio. During 1997, Ohio accounted
for 99% of USA's direct premiums collected.
ABE is licensed in Alabama, Arizona, Illinois, Indiana, Louisiana and
Missouri. During 1997, Illinois and Indiana accounted for 46% and 32%,
respectively of ABE's direct premiums collected.
APPL is licensed in Alabama, Arizona, Arkansas, Colorado, Georgia,
Illinois, Indiana, Kansas, Kentucky, Louisiana, Missouri, Montana,
Nebraska, Ohio, Oklahoma, Pennsylvania, Tennessee, Utah, Virginia, West
Virginia and Wyoming. During 1997, West Virginia accounted for 95% of
APPL's direct premiums collected.
UG is licensed in Alabama, Arizona, Arkansas, Colorado, Delaware, Florida,
Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana,
Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana,
Nebraska, Nevada, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma,
Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota,
Tennessee, Texas, Utah, Virginia, Washington, West Virginia and Wisconsin.
During 1997, Illinois accounted for 33%, and Ohio accounted for 14% of
direct premiums collected. No other state accounted for more than 7% of
direct premiums collected in 1997.
In 1997 $38,471,452 of total direct premium was written by USA, ABE, APPL
and UG. Ohio accounted for 35% , Illinois accounted for 21%, and West
Virginia accounted for 10% of total direct premiums collected.
New business production has decreased 15% from 1995 to 1996 and 43% from
1996 to 1997. Several factors have had a significant impact on new
business production. Over the last two years there has been the
possibility of a change in control of UTI. In September of 1996, an
agreement was reached effecting a change in control of UTI to an unrelated
party. The transaction did not materialize. At this writing negotiations
are progressing with a different unrelated party for change in control of
UTI. Please refer to note 17 in the Notes to the Consolidated Financial
Statements for additional information. The possible changes in control,
and the uncertainty surrounding each potential event, have hurt the
insurance Companies' ability to attract and maintain sales agents. In
addition, increased competition for consumer dollars from other financial
institutions, product Illustration guideline changes by State Insurance
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Departments, and a decrease in the total number of insurance sales agents
in the industry, have all had an impact, given the relatively small size of
the Company.
Management recognizes the aforementioned challenges and is responding. The
potential change in control of the Company is progressing, bringing the
possibility for future growth, efforts are being made to introduce
additional products, and the recruitment of quality individuals for
intensive sales training, are directed at reversing current marketing
trends.
UNDERWRITING
The underwriting procedures of the insurance subsidiaries are established
by management. Insurance policies are issued by the Company based upon
underwriting practices established for each market in which the Company
operates. Most policies are individually underwritten. Applications for
insurance are reviewed to determine additional information required to make
an underwriting decision, which depends on the amount of insurance applied
for and the applicant's age and medical history. Additional information
may include inspection reports, medical examinations, and statements from
doctors who have treated the applicant in the past and, where indicated,
special medical tests. After reviewing the information collected, the
Company either issues the policy as applied for or with an extra premium
charge because of unfavorable factors or rejects the application.
Substandard risks may be referred to reinsurers for full or partial
reinsurance of the substandard risk.
The Company's insurance subsidiaries require blood samples to be drawn with
individual insurance applications for coverage over $45,000 (age 46 and
above) or $95,000 (ages 16-45). Blood samples are tested for a wide range
of chemical values and are screened for antibodies to the HIV virus.
Applications also contain questions permitted by law regarding the HIV
virus which must be answered by the proposed insureds.
RESERVES
The applicable insurance laws under which the insurance subsidiaries
operate require that each insurance company report policy reserves as
liabilities to meet future obligations on the policies in force. These
reserves are the amounts which, with the additional premiums to be received
and interest thereon compounded annually at certain assumed rates, are
calculated in accordance with applicable law to be sufficient to meet the
various policy and contract obligations as they mature. These laws specify
that the reserves shall not be less than reserves calculated using certain
mortality tables and interest rates.
The liabilities for traditional life insurance and accident and health
insurance policy benefits are computed using a net level method. These
liabilities include assumptions as to investment yields, mortality,
withdrawals, and other assumptions based on the life insurance
subsidiaries' experience adjusted to reflect anticipated trends and to
include provisions for possible unfavorable deviations. The Company makes
these assumptions at the time the contract is issued or, in the case of
contracts acquired by purchase, at the purchase date. Benefit reserves for
traditional life insurance policies include certain deferred profits on
limited-payment policies that are being recognized in income over the
policy term. Policy benefit claims are charged to expense in the period
that the claims are incurred. Current mortality rate assumptions are based
on 1975-80 select and ultimate tables. Withdrawal rate assumptions are
based upon Linton B or Linton C, which are industry standard actuarial
tables for forecasting assumed policy lapse rates.
Benefit reserves for universal life insurance and interest sensitive life
insurance products are computed under a retrospective deposit method and
represent policy account balances before applicable surrender charges.
Policy benefits and claims that are charged to expense include benefit
claims in excess of related policy account balances. Interest crediting
rates for universal life and interest sensitive products range from 5.0% to
6.0% in each of the years 1997, 1996 and 1995.
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REINSURANCE
As is customary in the insurance industry, the insurance affiliates cede
insurance to other insurance companies under reinsurance agreements.
Reinsurance agreements are intended to limit a life insurer's maximum loss
on a large or unusually hazardous risk or to obtain a greater
diversification of risk. The ceding insurance company remains PRIMARILY
liable with respect to ceded insurance should any reinsurer be unable to
meet the obligations assumed by it, however it is the practice of insurers
to reduce their EXPOSURE TO LOSS to the extent that they have been
reinsured with other insurance companies. The Company sets a limit on the
amount of insurance retained on the life of any one person. The Company
will not retain more than $125,000, including accidental death benefits, on
any one life. At December 31, 1997, the Company had insurance in force of
$3.692 billion of which approximately $1.022 billion was ceded to
reinsurers.
The Company's reinsured business is ceded to numerous reinsurers. The
Company believes the assuming companies are able to honor all contractual
commitments, based on the Company's periodic reviews of their financial
statements, insurance industry reports and reports filed with state
insurance departments.
Currently, the Company is utilizing reinsurance agreements with Business
Men's Assurance Company, ("BMA") and Life Reassurance Corporation, ("LIFE
RE") for new business. BMA and LIFE RE each hold an "A+" (Superior) rating
from A.M. Best, an industry rating company. The reinsurance agreements
were effective December 1, 1993, and cover all new business of the Company.
The agreements are a yearly renewable term ("YRT") treaty where the Company
cedes amounts above its retention limit of $100,000 with a minimum cession
of $25,000.
One of the Company's insurance subsidiaries (UG) entered into a coinsurance
agreement with First International Life Insurance Company ("FILIC") as of
September 30, 1996. Under the terms of the agreement, UG ceded to FILIC
substantially all of its paid-up life insurance policies. Paid-up life
insurance generally refers to non-premium paying life insurance policies.
A.M. Best assigned FILIC a Financial Performance Rating (FPR) of 7 (Strong)
on a scale of 1 to 9. A.M. Best assigned a Best's Rating of A++ (Superior)
to The Guardian Life Insurance Company of America ("Guardian"), parent of
FILIC, based on the consolidated financial condition and operating
performance of the company and its life/health subsidiaries. During 1997,
FILIC changed its name to Park Avenue Life Insurance Company ("PALIC").
The agreement with PALIC accounts for approximately 65% of the reinsurance
receivables as of December 31, 1997.
The Company does not have any short-duration reinsurance contracts. The
effect of the Company's long-duration reinsurance contracts on premiums
earned in 1997, 1996 and 1995 was as follows:
Shown in thousands
1997 1996 1995
Premiums Premiums Premiums
Earned Earned Earned
<TABLE>
<S> <C> <C> <C>
Direct $ 33,374 $ 35,891 $ 38,482
Assumed 0 0 0
Ceded (4,735) (4,947) (5,383)
Net
premiums $ 28,639 $ 30,944 $ 33,099
</TABLE>
INVESTMENTS
The Company retains the services of a registered investment advisor to
assist the Company in managing its investment portfolio. The Company may
modify its present investment strategy at any time, provided its strategy
continues to be in compliance with the limitations of state insurance
department regulations.
Investment income represents a significant portion of the Company's total
income. Investments are subject to applicable state insurance laws and
regulations which limit the concentration of investments in any one
category or class and further limit the investment in any one issuer.
Generally, these limitations are imposed as a percentage of statutory
assets or percentage of statutory capital and surplus of each company.
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The following table reflects net investment income by type of investment.
December 31,
1997 1996 1995
<TABLE>
<S> <C> <C> <C>
Fixed maturities and fixed
maturities held for sale $ 12,677,348 $ 13,326,312 $ 13,190,121
Equity securities 87,211 88,661 52,445
Mortgage loans 802,123 1,047,461 1,257,189
Real estate 745,502 794,844 975,080
Policy loans 976,064 1,121,538 1,041,900
Short-term investments 70,624 21,423 21,295
Other 696,486 691,111 642,632
Total consolidated
investment income 16,055,358 17,091,350 17,180,662
Investment expenses (1,198,061) (1,222,903) (1,724,438)
Consolidated net investment
income $ 14,857,297 $ 15,868,447 $ 15,456,224
</TABLE>
At December 31, 1997, the Company had a total of $5,797,000 of investments,
comprised of $3,848,000 in real estate and $1,949,000 in equity securities,
which did not produce income during 1997.
The following table summarizes the Company's fixed maturities distribution
at December 31, 1997 and 1996 by ratings category as issued by Standard and
Poor's, a leading ratings analyst.
Fixed Maturities
Rating % of Portfolio
1997 1996
<TABLE>
<S> <C> <C>
Investment Grade
AAA 31% 30%
AA 14% 13%
A 46% 46%
BBB 9% 10%
Below investment grade 0% 1%
100% 100%
</TABLE>
The following table summarizes the Company's fixed maturities and fixed
maturities held for sale by major classification.
Carrying Value
1997 1996
<TABLE>
<S> <C> <C>
U.S. government and
government agencies $ 29,701,879 $ 29,998,240
States, municipalities
and political subdivisions 22,814,301 14,561,203
Collateralized mortgage
obligations 11,093,926 13,246,780
Public utilities 48,064,818 51,941,647
Corporate 70,964,039 72,140,081
$ 182,638,963 $ 181,887,951
</TABLE>
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The following table shows the composition and average maturity of the
Company's investment portfolio at December 31, 1997.
Carrying Average Average
Investments Value Maturity Yield
<TABLE>
<S> <C> <C> <C>
Fixed maturities and fixed
maturities held for sale $182,638,963 4 years 6.95%
Equity securities 3,001,744 not applicable 3.63%
Mortgage loans 9,469,444 10 years 7.82%
Investment real estate 11,485,276 not applicable 6.48%
Policy loans 14,207,189 not applicable 6.81%
Short-term investments 1,798,878 330 days 6.33%
Total Investments $222,601,494 7.24%
</TABLE>
At December 31, 1997, fixed maturities and fixed maturities held for sale
have a combined market value of $186,451,198. Fixed maturities are carried
at amortized cost. Management has the ability and intent to hold these
securities until maturity. Fixed maturities held for sale are carried at
market.
The Company holds approximately $1,798,878 in short-term investments.
Management monitors its investment maturities and in their opinion is
sufficient to meet the Company's cash requirements. Fixed maturities of
$15,107,100 mature in one year and $120,382,870 mature in two to five
years.
The Company holds approximately $9,469,444 in mortgage loans which
represents 3% of the total assets. All mortgage loans are first position
loans. Before a new loan is issued, the applicant is subject to certain
criteria set forth by Company management to ensure quality control. These
criteria include, but are not limited to, a credit report, personal
financial information such as outstanding debt, sources of income, and
personal equity. Loans issued are limited to no more than 80% of the
appraised value of the property and must be first position against the
collateral.
The Company has $298,000 of mortgage loans, net of a $10,000 reserve
allowance, which are in default and in the process of foreclosure. These
loans represent approximately 3% of the total portfolio. The Company has
one loan of $3,404 which is under a repayment plan. Letters are sent to
each mortgagee when the loan becomes 30 days or more delinquent. Loans 90
days or more delinquent are placed on a non-performing status and
classified as delinquent loans. Reserves for loan losses are established
based on management's analysis of the loan balances compared to the
expected realizable value should foreclosure take place. Loans are placed
on a non-accrual status based on a quarterly analysis of the likelihood of
repayment. All delinquent and troubled loans held by the Company are loans
which were held in portfolios by acquired companies at the time of
acquisition. Management believes the current internal controls
surrounding, the mortgage loan selection process provide a quality
portfolio with minimal risk of foreclosure and/or negative financial
impact.
The Company has in place a monitoring system to provide management with
information regarding potential troubled loans. Management is provided
with a monthly listing of loans that are 30 days or more past due along
with a brief description of what steps are being taken to resolve the
delinquency. Quarterly, coinciding with external financial reporting, the
Company determines how each delinquent loan should be classified. All
loans 90 days or more past due are classified as delinquent. Each
delinquent loan is reviewed to determine the classification and status the
loan should be given. Interest accruals are analyzed based on the
likelihood of repayment. In no event will interest continue to accrue when
accrued interest along with the outstanding principal exceeds the net
realizable value of the property. The Company does not utilize a specified
number of days delinquent to cause an automatic non-accrual status.
The mortgage loan reserve is established and adjusted based on management's
quarterly analysis of the portfolio and any deterioration in value of the
underlying property which would reduce the net realizable value of the
property below its current carrying value.
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In addition, the Company also monitors that current and adequate
insurance on the properties are being maintained. The Company requires
proof of insurance on each loan and further requires to be shown as a
lienholder on the policy so that any change in coverage status is reported
to the Company. Proof of payment of real estate taxes is another
monitoring technique utilized by the Company. Management believes a change
in insurance status or non-payment of real estate taxes are indicators that
a loan is potentially troubled. Correspondence with the mortgagee is
performed to determine the reasons for either of these events occurring.
The following table shows a distribution of mortgage loans by type.
Mortgage Amount % of Total
Loans
<TABLE>
<S> <C> <C>
FHA/VA $ 536,443 5%
Commercial 1,565,643 17%
Residential 7,367,358 78%
</TABLE>
The following table shows a geographic distribution of the mortgage loan
portfolio and real estate held.
Mortgage Real
Loans Estate
<TABLE>
<S> <C> <C>
New Mexico 3% 0%
Illinois 10% 55%
Kansas 13% 0%
Louisiana 15% 14%
Mississippi 0% 20%
Missouri 2% 1%
North Carolina 7% 6%
Oklahoma 5% 1%
Virginia 4% 0%
West Virginia 38% 2%
Other 3% 1%
Total 100% 100%
</TABLE>
12
<PAGE>
The following table summarizes delinquent mortgage loan holdings.
<TABLE>
<S> <C> <C> <C>
Delinquent
31 Days or More 1997 1996 1995
Non-accrual status $ 0 $ 0 $ 0
Other 308,000 613,000 628,000
Reserve on
delinquent loans (10,000) (10,000) (10,000)
Total Delinquent $ 298,000 $ 603,000 $ 618,000
Interest income
foregone
(Delinquent loans) $ 29,000 $ 29,000 $ 16,000
In Process of
Restructuring $ 0 $ 0 $ 0
Restructuring on
other than
market terms 0 0 0
Other potential
problem loans 0 0 0
Total Problem Loans $ 0 $ 0 $ 0
Interest income
foregone
(Restructured loans)$ 0 $ 0 $ 0
</TABLE>
See Item 2, Properties, for description of real estate holdings.
COMPETITION
The insurance business is a highly competitive industry and there are a
number of other companies, both stock and mutual, doing business in areas
where the Company operates. Many of these competing insurers are larger,
have more diversified lines of insurance coverage, have substantially
greater financial resources and have a greater number of agents. Other
significant competitive factors include policyholder benefits, service to
policyholders, and premium rates.
The insurance industry is a mature industry. In recent years, the industry
has experienced virtually no growth in life insurance sales, though the
aging population has increased the demand for retirement savings products.
The products offered (see Products) are similar to those offered by other
major companies. The product features are regulated by the states and are
subject to extensive competition among major insurance organizations. The
Company believes a strong service commitment to policyholders, efficiency
and flexibility of operations, timely service to the agency force and the
expertise of its key executives help minimize the competitive pressures of
the insurance industry.
The industry has experienced a downward trend in the total number of agents
who sell insurance products, and competition for the top sales producers
has intensified. As this trend appears to continue, the recruiting focus
of the Company has been on introducing quality individuals to the insurance
industry through an extensive internal training program. The Company feels
this approach is conducive to the mutual success of our new recruits and
the Company as these recruits market our products in a professional,
company structured manner.
13
<PAGE>
GOVERNMENT REGULATION
The Company's insurance subsidiaries are assessed contributions by life and
health guaranty associations in almost all states to indemnify
policyholders of failed companies. In several states the company may
reduce premium taxes paid to recover a portion of assessments paid to the
states' guaranty fund association. This right of "offset" may come under
review by the various states, and the company cannot predict whether and to
what extent legislative initiatives may affect this right to offset. Also,
some state guaranty associations have adjusted the basis by which they
assess the cost of insolvencies to individual companies. The company
believes that its reserve for future guaranty fund assessments is
sufficient to provide for assessments related to known insolvencies. This
reserve is based upon management's current expectation of the availability
of this right of offset, known insolvencies and state guaranty fund
assessment bases. However, changes in the basis whereby assessments are
charged to individual companies and changes in the availability of the
right to offset assessments against premium tax payments could materially
affect the company's results.
Currently, the Company's insurance subsidiaries are subject to government
regulation in each of the states in which they conduct business. Such
regulation is vested in state agencies having broad administrative power
dealing with all aspects of the insurance business, including the power to:
(i) grant and revoke licenses to transact business; (ii) regulate and
supervise trade practices and market conduct; (iii) establish guaranty
associations; (iv) license agents; (v) approve policy forms; (vi)
approve premium rates for some lines of business; (vii) establish reserve
requirements; (viii) prescribe the form and content of required financial
statements and reports; (ix) determine the reasonableness and adequacy of
statutory capital and surplus; and (x) regulate the type and amount of
permitted investments. Insurance regulation is concerned primarily with
the protection of policyholders. The Company cannot predict the form of
any future proposals or regulation. The Company's insurance subsidiaries,
USA, UG, APPL and ABE are domiciled in the states of Ohio, Ohio, West
Virginia and Illinois, respectively.
The insurance regulatory framework continues to be scrutinized by various
states, the federal government and the National Association of Insurance
Commissioners ("NAIC"). The NAIC is an association whose membership
consists of the insurance commissioners or their designees of the various
states. The NAIC has no direct regulatory authority over insurance
companies, however its primary purpose is to provide a more consistent
method of regulation and reporting from state to state. This is
accomplished through the issuance of model regulations, which can be
adopted by individual states unmodified, modified to meet the state's own
needs or requirements, or dismissed entirely.
Most states also have insurance holding company statutes which require
registration and periodic reporting by insurance companies controlled by
other corporations licensed to transact business within their respective
jurisdictions. The insurance subsidiaries are subject to such legislation
and registered as controlled insurers in those jurisdictions in which such
registration is required. Statutes vary from state to state but typically
require periodic disclosure concerning the corporation that controls the
registered insurers and all subsidiaries of such corporation. In addition,
prior notice to, or approval by, the state insurance commission of material
intercorporate transfers of assets, reinsurance agreements, management
agreements (see Note 9 of the Notes to the Consolidated Financial
Statements), and payment of dividends (see Note 2 of the Notes to the
Consolidated Financial Statements) in excess of specified amounts by the
insurance subsidiary within the holding company system are required.
Each year the NAIC calculates financial ratio results (commonly referred to
as IRIS ratios) for each company. These ratios compare various financial
information pertaining to the statutory balance sheet and income statement.
The results are then compared to pre-established normal ranges determined
by the NAIC. Results outside the range typically require explanation to
the domiciliary insurance department.
At year end 1997, the insurance companies had one ratio outside the normal
range. The ratio is related to the decrease in premium income. The ratio
fell outside the normal range the last three years. The cause for the
decrease in premium income is related to the possible change in control of
UTI over the last two years to two different parties. At year end 1996 it
was announced that UTI was to be acquired by an unrelated party, but the
sale did not materialize. At this writing negotiations are progressing
with a different unrelated party for the change in control of UTI. Please
refer to the Notes to the Consolidated Financial Statements for additional
information. The possible changes in control over the last two years have
hurt the insurance companies' ability to recruit new agents. The active
agents were apprehensive due to uncertainties in relation to the change in
control of UTI. In recent years, the industry experienced a decline in the
total number of agents selling insurance products and therefore competition
14
<PAGE>
has increased for quality agents. Accordingly, new business production
decreased significantly over the last two years.
A life insurance company's statutory capital is computed according to rules
prescribed by the National Association of Insurance Commissioners ("NAIC"),
as modified by the insurance company's state of domicile. Statutory
accounting rules are different from generally accepted accounting
principles and are intended to reflect a more conservative view by, for
example, requiring immediate expensing of policy acquisition costs. The
achievement of long-term growth will require growth in the statutory
capital of the Company's insurance subsidiaries. The subsidiaries may
secure additional statutory capital through various sources, such as
internally generated statutory earnings or equity contributions by the
Company from funds generated through debt or equity offerings.
The NAIC's risk-based capital requirements require insurance companies to
calculate and report information under a risk-based capital formula. The
risk-based capital formula measures the adequacy of statutory capital and
surplus in relation to investment and insurance risks such as asset
quality, mortality and morbidity, asset and liability matching and other
business factors. The RBC formula is used by state insurance regulators as
an early warning tool to identify, for the purpose of initiating regulatory
action, insurance companies that potentially are inadequately capitalized.
In addition, the formula defines new minimum capital standards that will
supplement the current system of low fixed minimum capital and surplus
requirements on a state-by-state basis. Regulatory compliance is
determined by a ratio of the insurance company's regulatory total adjusted
capital, as defined by the NAIC, to its authorized control level RBC, as
defined by the NAIC. Insurance companies below specific trigger points or
ratios are classified within certain levels, each of which requires
specific corrective action.
The levels and ratios are as follows:
Ratio of Total Adjusted Capital to
Authorized Control Level RBC
Regulatory Event (Less Than or Equal to)
Company action level 2*
Regulatory action level 1.5
Authorized control level 1
Mandatory control level 0.7
* Or, 2.5 with negative trend.
At December 31, 1997, each of the insurance subsidiaries has a Ratio that
is in excess of 3, which is 300% of the authorized control level;
accordingly the insurance subsidiaries meet the RBC requirements.
The NAIC, in conjunction with state regulators, has been reviewing existing
insurance laws and regulations. A committee of the NAIC proposed changes
in the regulations governing insurance company investments and holding
company investments in subsidiaries and affiliates which were adopted by
the NAIC as model laws in 1996. The Company does not presently anticipate
any material adverse change in its business as a result of these changes.
Legislative and regulatory initiatives regarding changes in the regulation
of banks and other financial services businesses and restructuring of the
federal income tax system could, if adopted and depending on the form they
take, have an adverse impact on the company by altering the competitive
environment for its products. The outcome and timing of any such changes
cannot be anticipated at this time, but the company will continue to
monitor developments in order to respond to any opportunities or increased
competition that may occur.
The NAIC has recently released the Life Illustration Model Regulation.
Many states have adopted the regulation effective January 1, 1997. This
regulation requires products which contain non-guaranteed elements, such as
universal life and interest sensitive life, to comply with certain
actuarially established tests. These tests are intended to target future
performance and profitability of a product under various scenarios. The
regulation does not prevent a company from selling a product that does not
meet the various tests. The only implication is the way in which the
product is marketed to the consumer. A product that does not pass the
tests uses guaranteed assumptions rather than current assumptions in
presenting future product performance to the consumer. The Company
conducts an ongoing thorough review of its sales and marketing process and
continues to emphasize its compliance efforts.
15
<PAGE>
A task force of the NAIC is currently undertaking a project to codify a
comprehensive set of statutory insurance accounting rules and regulations.
This project is not expected to be completed earlier than 1999. Specific
recommendations have been set forth in papers issued by the NAIC for
industry review. The Company is monitoring the process, but the potential
impact of any changes in insurance accounting standards is not yet known.
EMPLOYEES
There are approximately 90 persons who are employed by the Company and its
affiliates.
PART I, ITEM 3, LEGAL PROCEEDINGS, SHOULD BE AMENDED AS FOLLOWS:
LEGAL PROCEEDINGS
The Company and its affiliates are named as defendants in a number of legal
actions arising primarily from claims made under insurance policies. Those
actions have been considered in establishing the Company's liabilities.
Management is of the opinion that the settlement of those actions will not
have a material adverse effect on the Company's financial position or
results of operations.
PART II, ITEM 7 SHOULD BE AMENDED AS FOLLOWS:
UTI MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The purpose of this section is to discuss and analyze the Company's
consolidated results of operations, financial condition and liquidity and
capital resources. This analysis should be read in conjunction with the
consolidated financial statements and related notes which appear elsewhere
in this report. The Company reports financial results on a consolidated
basis. The consolidated financial statements include the accounts of UTI
and its subsidiaries at December 31, 1997.
RESULTS OF OPERATIONS
1997 COMPARED TO 1996
(A) REVENUES
Premiums and policy fee revenues, net of reinsurance premiums and policy
fees, decreased 7% when comparing 1997 to 1996. The Company currently
writes little new traditional business, consequently, traditional premiums
will decrease as the amount of traditional business in-force decreases.
Collected premiums on universal life and interest sensitive products is not
reflected in premiums and policy revenues because Generally Accepted
Accounting Procedures ("GAAP") requires that premiums collected on these
types of products be treated as deposit liabilities rather than revenue.
Unless the Company acquires a block of in-force business or marketing
changes its focus to traditional business, premium revenue will continue to
decline at a rate consistent with prior experience.
Another cause for the decrease in premium revenues is related to the
potential change in control of UTI over the last two years to two different
parties. During September of 1996, it was announced that control of UTI
would pass to an unrelated party, but the change in control did not
materialize. At this writing, negotiations are progressing with a
different unrelated party for the change in control of UTI. Please refer
to the Notes to the Consolidated Financial Statements for additional
information. The possible changes and resulting uncertainties have hurt
the insurance companies' ability to recruit and maintain sales agents.
New business production decreased significantly over the last two years.
New business production decreased 43% or $3,935,000 when comparing 1997 to
1996. In recent years, the insurance industry as a whole has experienced a
decline in the total number of agents who sell insurance products,
therefore competition has intensified for top producing sales agents. The
16
<PAGE>
relatively small size of our companies, and the resulting limitations, have
made it challenging to compete in this area.
A positive impact on premium income is the improvement of persistency.
Persistency is a measure of insurance in force retained in relation to the
previous year. The Companies' average persistency rate for all policies in
force for 1997 and 1996 has been approximately 89.4% and 87.9%,
respectively.
Net investment income decreased 6% when comparing 1997 to 1996. The
decrease relates to the decrease in invested assets from a coinsurance
agreement. The Company's insurance subsidiary UG entered into a
coinsurance agreement with First International Life Insurance Company
("FILIC"), an unrelated party, as of September 30, 1996. During 1997,
FILIC changed its name to Park Avenue Life Insurance Company ("PALIC").
Under the terms of the agreement, UG ceded to FILIC substantially all of
its paid-up life insurance policies. Paid-up life insurance generally
refers to non-premium paying life insurance policies. At closing of the
transaction, UG received a coinsurance credit of $28,318,000 for policy
liabilities covered under the agreement. UG transferred assets equal to
the credit received. This transfer included policy loans of $2,855,000
associated with policies under the agreement and a net cash transfer of
$19,088,000, after deducting the ceding commission due UG of $6,375,000.
To provide the cash required to be transferred under the agreement, the
Company sold $18,737,000 of fixed maturity investments.
The overall investment yields for 1997, 1996 and 1995, are 7.24%, 7.29% and
7.12%, respectively. Since 1995, investment yield improved due to the
fixed maturity investments. Cash generated from the sales of universal
life insurance products, has been invested primarily in our fixed maturity
portfolio.
The Company's investments are generally managed to match related insurance
and policyholder liabilities. The comparison of investment return with
insurance or investment product crediting rates establishes an interest
spread. The minimum interest spread between earned and credited rates is
1% on the "Century 2000" universal life insurance product, which currently
is the Company's primary sales product. The Company monitors investment
yields, and when necessary adjusts credited interest rates on its insurance
products to preserve targeted interest spreads. It is expected that
monitoring of the interest spreads by management will provide the necessary
margin to adequately provide for associated costs on the insurance policies
the Company currently has in force and will write in the future.
Realized investment losses were $279,000 and $988,000 in 1997 and 1996,
respectively. Approximately $522,000 of realized losses in 1996 are due to
the charge-off of two specific investments. The Company realized a loss of
$207,000 from a single loan and $315,000 from an investment in First
Fidelity Mortgage Company ("FFMC"). The charge-off of the loan represented
the entire loan balance at the time of the charge-off. Additionally, the
Company sold two foreclosed real estate properties that resulted in
approximately $357,000 in realized losses in 1996. The Company had other
gains and losses during the period that comprised the remaining amount
reported but were immaterial in nature on an individual basis.
(B) EXPENSES
Life benefits, net of reinsurance benefits and claims, decreased 11% in
1997 as compared to 1996. The decrease in premium revenues resulted in
lower benefit reserve increases in 1997. In addition, policyholder
benefits decreased due to a decrease in death benefit claims of $162,000.
In 1994, UG became aware that certain new insurance business was being
solicited by certain agents and issued to individuals considered to be not
insurable by Company standards. These non-standard policies had a face
amount of $22,700,000 and represented 1/2 of 1% of the insurance in-force
in 1994. Management's initial analysis indicated that expected death
claims on the business in-force was adequate in relation to mortality
assumptions inherent in the calculation of statutory reserves.
Nevertheless, management determined it was in the best interest of the
Company to repurchase as many of the non-standard policies as possible.
Through December 31, 1996, the Company spent approximately $7,099,000 for
the settlement of non-standard policies and for the legal defense of
related litigation. In relation to settlement of non-standard policies the
Company incurred life benefit costs of $3,307,000, and $720,000 in 1996 and
1995, respectively. The Company incurred legal costs of $906,000 and
$687,000 in 1996 and 1995, respectively. All policies associated with this
issue have been settled as of December 31, 1996. Therefore, expense
reductions for 1997 would follow.
17
<PAGE>
Commissions and amortization of deferred policy acquisition costs decreased
14% in 1997 compared to 1996. The decrease is due primarily due to a
reduction in commissions paid. Commissions decreased 19% in 1997 compared
to 1996. The decrease in commissions was due to the decline in new business
production. There is a direct relationship between premium revenues and
commission expense. First year premium production decreased 43% and first
year commissions decreased 33% when comparing 1997 to 1996. Amortization
of deferred policy acquisition costs decreased 6% in 1997 compared to 1996.
Management would expect commissions and amortization of deferred policy
acquisition costs to decrease in the future if premium revenues continue to
decline.
AMORTIZATION OF COST OF INSURANCE ACQUIRED DECREASED 57% IN 1997 COMPARED
TO 1996. COST OF INSURANCE ACQUIRED IS ESTABLISHED WHEN AN INSURANCE
COMPANY IS ACQUIRED. THE COMPANY ASSIGNS A PORTION OF ITS COST TO THE
RIGHT TO RECEIVE FUTURE CASH FLOWS FROM INSURANCE CONTRACTS EXISTING AT THE
DATE OF THE ACQUISITION. THE COST OF POLICIES PURCHASED REPRESENTS THE
ACTUARIALLY DETERMINED PRESENT VALUE OF THE PROJECTED FUTURE CASH FLOWS
FROM THE ACQUIRED POLICIES. COST OF INSURANCE ACQUIRED IS COMPRISED OF
INDIVIDUAL LIFE INSURANCE PRODUCTS INCLUDING WHOLE LIFE, INTEREST SENSITIVE
WHOLE LIFE AND UNIVERSAL LIFE INSURANCE PRODUCTS. COST OF INSURANCE
ACQUIRED IS AMORTIZED WITH INTEREST IN RELATION TO EXPECTED FUTURE PROFITS,
INCLUDING DIRECT CHARGE-OFFS FOR ANY EXCESS OF THE UNAMORTIZED ASSET OVER
THE PROJECTED FUTURE PROFITS. THE INTEREST RATES UTILIZED IN THE
AMORTIZATION CALCULATION ARE 9% ON APPROXIMATELY 24% OF THE BALANCE AND 15%
ON THE REMAINING BALANCE. THE INTEREST RATES VARY DUE TO RISK ANALYSIS
PERFORMED AT THE TIME OF ACQUISITION ON THE BUSINESS ACQUIRED. THE
AMORTIZATION IS ADJUSTED RETROSPECTIVELY WHEN ESTIMATES OF CURRENT OR
FUTURE GROSS PROFITS TO BE REALIZED FROM A GROUP OF PRODUCTS ARE REVISED.
The Company did not have any charge-offs during the periods covered by this
report. The decrease in amortization during the current period is a
fluctuation due to the expected future profits. Amortization of cost of
insurance acquired is particularly sensitive to changes in persistency of
certain blocks of insurance in-force. The improvement of persistency
during the year had a positive impact on amortization of cost of insurance
acquired. Persistency is a measure of insurance in force retained in
relation to the previous year. The Company's average persistency rate for
all policies in force for 1997 and 1996 has been approximately 89.4% and
87.9%, respectively.
OPERATING EXPENSES DECREASED 23% IN 1997 COMPARED TO 1996. APPROXIMATELY
ONE-HALF OF THE DECREASE IN OPERATING EXPENSES IS RELATED TO THE SETTLEMENT
OF CERTAIN LITIGATION IN DECEMBER OF 1996 REGARDING NON-STANDARD POLICIES.
INCLUDED IN THIS DECREASE WERE LEGAL FEES AND PAYMENTS TO THE LITIGANTS TO
SETTLE THE ISSUE. IN 1992, AS PART OF THE ACQUISITION OF COMMONWEALTH
INDUSTRIES CORPORATION, AN AGREEMENT WAS ENTERED INTO BETWEEN JOHN CANTRELL
AND FCC FOR FUTURE PAYMENTS TO BE MADE BY FCC. A LIABILITY WAS ESTABLISHED
AT THE DATE OF THE AGREEMENT. UPON THE DEATH OF MR. CANTRELL IN LATE 1997,
OBLIGATIONS UNDER THIS AGREEMENT TRANSFERRED TO MR. CANTRELL'S WIFE AT A
REDUCED AMOUNT. THIS RESULTED IN A REDUCTION OF APPROXIMATELY $600,000 OF
THE LIABILITY HELD FOR FUTURE PAYMENTS UNDER THE AGREEMENT. IN ADDITION,
1997 CONSULTING FEES, PRIMARILY IN THE AREA OF ACTUARIAL SERVICES. WERE
REDUCED APPROXIMATELY $400,000 AS THE COMPANY WAS ABLE TO HIRE AN ACTUARY,
ON A PART-TIME BASIS, AT A COST LESS THAN FEES PAID IN THE PREVIOUS YEAR TO
CONSULTING ACTUARIES. THE REMAINING REDUCTION IN OPERATING EXPENSES IS
ATTRIBUTABLE TO REDUCED SALARY AND EMPLOYEE BENEFIT COSTS IN 1997, AS A
RESULT OF NATURAL ATTRITION.
Interest expense increased 5% in 1997 compared to 1996. Since December 31,
1996, notes payable increased approximately $1,886,000. Average
outstanding indebtedness was $20,517,000 with an average cost of 8.9% in
1997 compared to average outstanding indebtedness of 20,510,000 with an
average cost of 8.5% in 1996. The increase in outstanding indebtedness was
due to the issuance of convertible notes to seven individuals, all officers
or employees of UTI. In March 1997, the base interest rate for most of the
notes payable increased a quarter of a point. The base rate is defined as
the floating daily, variable rate of interest determined and announced by
First of America Bank. Please refer to Note 12 "Notes Payable" in the
Consolidated Notes to the Financial Statements for more information.
(C) NET LOSS
The Company had a net loss of $559,000 in 1997 compared to a net loss of
$938,000 in 1996. The improvement is directly related to the decrease in
life benefits and operating expenses primarily associated with the 1996
settlement and other related costs of the non-standard life insurance
policies.
18
<PAGE>
1996 COMPARED TO 1995
(A) REVENUES
Premium and policy fee revenues, net of reinsurance premium, decreased 7%
when comparing 1996 to 1995. The decrease in premium income is primarily
attributed to a 15% decrease in new business production. THE DECREASE IS
DUE TO TWO FACTORS. THE FIRST FACTOR IS THAT THE COMPANY CHANGED ITS FOCUS
FROM PRIMARILY A BROKER AGENCY DISTRIBUTION SYSTEM TO A CAPTIVE AGENT
SYSTEM. THE SECOND FACTOR IS THAT THE Company changed its PRODUCT
PORTFOLIO from primarily traditional life insurance to universal life
insurance.
Business written by the broker agency force, in recent years, did not meet
Company expectations. With the change in focus of distribution systems,
most of the broker agents were terminated. (The termination of the broker
agency force caused a non-recurring write down of the value of agency force
asset in 1995, see discussion of amortization of agency force for further
details.). The change in distribution systems effectively reduced the
total number of agents representing and producing business for the Company.
Broker agents sell insurance and related products for several companies.
Captive agents sell for only one company. THE CHANGE FROM A BROKERAGE
AGENCY SYSTEM TO A CAPTIVE AGENT SYSTEM CAUSED A DECLINE IN NEW PREMIUM
WRITINGS AS THE CAPTIVE AGENTS REQUIRED TRAINING FROM THE HOME OFFICE AND
OFTEN HAD LITTLE OR NO PREVIOUS INSURANCE SALES EXPERIENCE. ADDITIONALLY,
THE PRODUCTS SOLD WERE CHANGED FROM TRADITIONAL WHOLE LIFE TO UNIVERSAL
LIFE, RESULTING IN VETERAN CAPTIVE AGENTS HAVING TO LEARN THE FEATURES OF
THE NEW PRODUCTS. BROKER AGENTS TYPICALLY SELL PRODUCTS FOR SEVERAL
COMPANIES AND TYPICALLY HAVE MORE EXPERIENCE IN THE INDUSTRY OR HAVE
EXPERIENCED AGENTS WITHIN THE AGENCY TO ASSIST AND TRAIN THEM. THE CAPTIVE
AGENT APPROACH, THOUGH SLOWER AND REQUIRING MORE HOME OFFICE TRAINING, IS
BELIEVED TO BE THE BEST LONG TERM APPROACH FOR THE COMPANY AS AGENTS WILL
BE TRAINED IN THE PROCEDURES AND PRACTICES OF THE COMPANY AND WILL BE MORE
FAMILIAR TO THE COMPANY THROUGH THE TRAINING PROCESS. THIS WILL HELP IN
RECRUITING QUALITY INDIVIDUALS WITH THE CHARACTER AND ATTITUDE CONDUCIVE
WITH COMPANY DESIRES.
Universal life and interest sensitive products contribute only the risk
charge to premium income; however, traditional insurance products
contribute all monies received to premium income. The Company changed its
PRODUCT PORTFOLIO to remain competitive based on consumer demand.
A positive impact on premium income is the improvement of persistency.
Persistency is a measure of insurance in force retained in relation to the
previous year. The Companies' average persistency rate for all policies in
force for 1996 and 1995 has been approximately 87.9% and 87.3%,
respectively.
Net investment income increased 3% when comparing 1996 to 1995. The
overall investment yields for 1996 and 1995 are 7.29% and 7.12%,
respectively. The improvement in investment yield is primarily attributed
to fixed maturity investments. Cash generated from the sales of universal
life insurance products, has been invested primarily in our fixed
investment portfolio.
The Company's investments are generally managed to match related insurance
and policyholder liabilities. The comparison of investment return with
insurance or investment product crediting rates establishes an interest
spread. The minimum interest spread between earned and credited rates is
1% on the "Century 2000" universal life insurance product, which currently
is the Company's primary sales product. The Company monitors investment
yields, and when necessary adjusts credited interest rates on its insurance
products to preserve targeted interest spreads. It is expected that
monitoring of the interest spreads by management will provide the necessary
margin to adequately provide for associated costs on the insurance policies
the Company currently has in force and will write in the future.
Realized investment losses were $988,000 and $124,000 in 1996 and 1995,
respectively. Approximately $522,000 of realized losses in 1996 are due to
the charge-off of two specific investments. The Company realized a loss of
$207,000 from a single loan and $315,000 from an investment in First
Fidelity Mortgage Company ("FFMC"). The charge-off of the loan represented
the entire loan balance at the time of the charge-off. Additionally, the
Company sold two foreclosed real estate properties that resulted in
approximately $357,000 in realized losses in 1996. The Company had other
gains and losses during the period that comprised the remaining amount
reported but were immaterial in nature on an individual basis.
19
<PAGE>
(B) EXPENSES
Life benefits, net of reinsurance benefits and claims, increased 2%
compared to 1995. The increase in life benefits is due primarily to
settlement expenses discussed in the following paragraph:
In 1994, UG became aware that certain new insurance business was being
solicited by certain agents and issued to individuals considered to be not
insurable by Company standards. These non-standard policies had a face
amount of $22,700,000 and represented 1/2 of 1% of the insurance in-force
in 1994. Management's initial analysis indicated that expected death
claims on the business in-force was adequate in relation to mortality
assumptions inherent in the calculation of statutory reserves.
Nevertheless, management determined it was in the best interest of the
Company to repurchase as many of the non-standard policies as possible.
Through December 31, 1996, the Company spent approximately $7,099,000 for
the settlement of non-standard policies and for the legal defense of
related litigation. In relation to settlement of non-standard policies the
Company incurred life benefits of $3,307,000 and $720,000 in 1996 and 1995,
respectively. The Company incurred legal costs of $906,000 and $687,000 in
1996 and 1995, respectively. All the policies associated with this issue
have been settled as of December 31, 1996. The Company has approximately
$3,742,000 of insurance in-force and $1,871,000 of reserves from the
issuance of paid-up life insurance policies for settlement of matters
related to the original non-standard policies. Management believes the
reserves are adequate in relation to expected mortality on this block of in-
force.
Commissions and amortization of deferred policy acquisition costs decreased
14% in 1996 compared to 1995. The decrease is due to a decrease in
commissions expense. Commissions decreased 15% in 1996 compared to 1995.
The decrease in commissions was due to the decline in new business
production. There is a direct relationship between premium revenues and
commission expenses. First year premium production decreased 15% and first
year commissions decreased 32% when comparing 1996 to 1995. Amortization
of deferred policy acquisition costs decreased 12% in 1996 compared to
1995. Management expects commissions and amortization of deferred policy
acquisition costs to decrease in the future if premium revenues continue to
decline.
Amortization of cost of insurance acquired increased 25% in 1996 compared
to 1995. COST OF INSURANCE ACQUIRED IS ESTABLISHED WHEN AN INSURANCE
COMPANY IS ACQUIRED. THE COMPANY ASSIGNS A PORTION OF ITS COST TO THE RIGHT
TO RECEIVE FUTURE CASH FLOWS FROM INSURANCE CONTRACTS EXISTING AT THE DATE
OF THE ACQUISITION. THE COST OF POLICIES PURCHASED REPRESENTS THE
ACTUARIALLY DETERMINED PRESENT VALUE OF THE PROJECTED FUTURE CASH FLOWS
FROM THE ACQUIRED POLICIES. COST OF INSURANCE ACQUIRED IS COMPRISED OF
INDIVIDUAL LIFE INSURANCE PRODUCTS INCLUDING WHOLE LIFE, INTEREST SENSITIVE
WHOLE LIFE AND UNIVERSAL LIFE INSURANCE PRODUCTS. COST OF INSURANCE
ACQUIRED IS AMORTIZED WITH INTEREST IN RELATION TO EXPECTED FUTURE PROFITS,
INCLUDING DIRECT CHARGE-OFFS FOR ANY EXCESS OF THE UNAMORTIZED ASSET OVER
THE PROJECTED FUTURE PROFITS. THE INTEREST RATES UTILIZED IN THE
AMORTIZATION CALCULATION ARE 9% ON APPROXIMATELY 24% OF THE BALANCE AND 15%
ON THE REMAINING BALANCE. THE INTEREST RATES VARY DUE TO RISK ANALYSIS
PERFORMED AT THE TIME OF ACQUISITION ON THE BUSINESS ACQUIRED. THE
AMORTIZATION IS ADJUSTED RETROSPECTIVELY WHEN ESTIMATES OF CURRENT OR
FUTURE GROSS PROFITS TO BE REALIZED FROM A GROUP OF PRODUCTS ARE REVISED.
The Company did not have any charge-offs during the periods covered by this
report. The increase in amortization during the current period is a
fluctuation due to the expected future profits. Amortization of cost of
insurance acquired is particularly sensitive to changes in persistency of
certain blocks of insurance in-force.
The Company reported a non-recurring write down of value of agency force of
$0 and $8,297,000 in 1996 and 1995, respectively. The write down was
directly related to the Company's change in distribution systems. The
Company changed its focus from primarily a broker agency distribution
system to a captive agent system. Business produced by the broker agency
force in recent years did not meet Company expectations. With the change
in focus of distribution systems, most of the broker agents were
terminated. The termination of most of the agents involved in the broker
agency force caused management to re-evaluate and write-off the value of
the agency force carried on the balance sheet.
Operating expenses increased 4% in 1996 compared to 1995. The primary
factor that caused the increase in operating expenses is directly related
to increased legal costs and reserves established for litigation. The
legal costs are due to the settlement of non-standard insurance policies as
was discussed in the review of life benefits. The Company incurred legal
costs of $906,000 and $687,000 in 1996 and 1995, respectively in relation
to the settlement of the non-standard insurance policies.
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Interest expense decreased 12% in 1996 compared to 1995. Since
December 31, 1995, notes payable decreased approximately $1,873,000 that
has directly attributed to the decrease in interest expense during 1996.
Interest expense was also reduced, as a result of the refinancing of the
senior debt under which the new interest rate is more favorable. Please
refer to Note 11 "Notes Payable" of the Consolidated Notes to the Financial
Statements for more information on this matter.
(C) NET LOSS
The Company had a net loss of $938,000 in 1996 compared to a net loss of
$3,001,000 in 1995. The net loss in 1996 is attributed to the increase in
life benefits net of reinsurance and operating expenses primarily
associated with settlement and other related costs of the non-standard life
insurance policies.
FINANCIAL CONDITION
(A) ASSETS
Investments are the largest asset group of the Company. The Company's
insurance subsidiaries are regulated by insurance statutes and regulations
as to the type of investments that they are permitted to make and the
amount of funds that may be used for any one type of investment. In light
of these statutes and regulations, and the Company's business and
investment strategy, the Company generally seeks to invest in United States
government and government agency securities and corporate securities rated
investment grade by established nationally recognized rating organizations.
The liabilities are predominantly long-term in nature and therefore, the
Company invests in long-term fixed maturity investments that are reported
in the financial statements at their amortized cost. The Company has the
ability and intent to hold these investments to maturity; consequently, the
Company does not expect to realize any significant loss from these
investments. The Company does not own any derivative investments or "junk
bonds". As of December 31, 1997, the carrying value of fixed maturity
securities in default as to principal or interest was immaterial in the
context of consolidated assets or shareholders' equity. The Company has
identified securities it may sell and classified them as "investments held
for sale". Investments held for sale are carried at market, with changes
in market value charged directly to shareholders' equity.
The following table summarizes the Company's fixed maturities distribution
at December 31, 1997 and 1996 by ratings category as issued by Standard and
Poor's, a leading ratings analyst.
Fixed Maturities
Rating % of Portfolio
1997 1996
Investment Grade
AAA 31% 30%
AA 14% 13%
A 46% 46%
BBB 9% 10%
Below investment
grade 0% 1%
100% 100%
Mortgage loans decreased 14% in 1997 as compared to 1996. The Company is
not actively seeking new mortgage loans, and the decrease is due to early
pay-offs from mortgagee's seeking refinancing at lower interest rates. All
mortgage loans held by the Company are first position loans. The Company
has $298,227 in mortgage loans, net of a $10,000 reserve allowance, which
are in default and in the process of foreclosure, this represents
approximately 3% of the total portfolio.
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Investment real estate and real estate acquired in satisfaction of debt
decreased slightly in 1997 compared to 1996. Investment real estate
holdings represent approximately 3% of the total assets of the Company.
Total investment real estate is separated into three categories:
Commercial 38%, Residential Development 47% and Foreclosed Properties 15%.
Policy loans decreased 2% in 1997 compared to 1996. Industry experience
for policy loans indicates few policy loans are ever repaid by the
policyholder other than through termination of the policy. Policy loans
are systematically reviewed to ensure that no individual policy loan
exceeds the underlying cash value of the policy. Policy loans will
generally increase due to new loans and interest compounding on existing
policy loans.
Deferred policy acquisition costs decreased 6% in 1997 compared to 1996.
Deferred policy acquisition costs, which vary with, and are primarily
related to producing new business, are referred to as ("DAC"). DAC
consists primarily of commissions and certain costs of policy issuance and
underwriting, net of fees charged to the policy in excess of ultimate fees
charged. To the extent these costs are recoverable from future profits,
the Company defers these costs and amortizes them with interest in relation
to the present value of expected gross profits from the contracts,
discounted using the interest rate credited by the policy. The Company had
$586,000 in policy acquisition costs deferred, $425,000 in interest
accretion and $1,735,636 in amortization in 1997. The Company did not
recognize any impairment during the period.
Cost of insurance acquired decreased 5% in 1997 compared to 1996. At
December 31, 1997, cost of insurance acquired was $41,523,000 and
amortization totaled $2,394,000 for the year. When an insurance company is
acquired, the Company assigns a portion of its cost to the right to receive
future cash flows from insurance contracts existing at the date of the
acquisition. The cost of policies purchased represents the actuarially
determined present value of the projected future cash flows from the
acquired policies. Cost of Insurance Acquired is amortized with interest
in relation to expected future profits, including direct charge-offs for
any excess of the unamortized asset over the projected future profits.
(B) LIABILITIES
Total liabilities increased slightly in 1997 compared to 1996. However,
future policy benefits which represented 81% of total liabilities at
December 31, 1997, decreased slightly in 1997.
Policy claims and benefits payable decreased 35% in 1997 compared to 1996.
There is no single event that caused this item to decrease. Policy claims
vary from year to year and therefore, fluctuations in this liability are to
be expected and are not considered unusual by management.
Other policyholder funds decreased 12% in 1997 compared to 1996. The
decrease can be attributed to a decrease in premium deposit funds. Premium
deposit funds are funds deposited by the policyholder with the insurance
company to accumulate interest and pay future policy premiums. The change
in marketing from traditional insurance products to universal life
insurance products is the primary reason for the decrease. Universal life
insurance products do not have premium deposit funds. All premiums
received from universal life insurance policyholders are credited to the
life insurance policy and are reflected in future policy benefits.
Dividend and endowment accumulations increased 7% in 1997 compared to 1996.
The increase is attributed to the significant amount of participating
business the Company has in force. Over 47% of all dividends paid were put
on deposit with the Company to accumulate with interest. Management
expects this liability to increase in the future.
Income taxes payable and deferred income taxes payable increased 7% in 1997
compared to 1996. The change in deferred income taxes payable is
attributable to temporary differences between Generally Accepted Accounting
Principles ("GAAP") and tax basis accounting. Federal income taxes are
discussed in more detail in Note 3 of the Consolidated Notes to the
Financial Statements.
Notes payable increased approximately $1,886,000 in 1997 compared to 1996.
On July 31, 1997, United Trust Inc. issued convertible notes totaling
$2,560,000 to seven individuals, all officers or employees of United Trust
Inc. The notes bear interest at a rate of 1% over prime, with interest
payments due quarterly and principal due upon maturity of July 31, 2004.
The conversion price of the notes are graded from $12.50 per share for the
first three years, increasing to $15.00 per share for the next two years
and increasing to $20.00 per share for the last two years. As of December
31, 1997, the notes were convertible into 204,800 shares of UTI common
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stock with no conversion privileges having been exercised. The Company's
long-term debt is discussed in more detail in Note 12 of the Notes to the
Financial Statements.
(C) SHAREHOLDERS' EQUITY
Total shareholders' equity decreased 15% in 1997 compared to 1996. The
decrease is attributable to the Company's acquisition of treasury stock.
As indicated in the notes payable paragraph above, on July 31, 1997 UTI
issued convertible notes totaling $2,560,000. The notes were issued to
provide UTI with additional funds to be used for the following purposes.
A portion of the proceeds in combination with debt instruments were used to
acquire approximately 16% of the Larry E. Ryherd and family stock holdings
in UTI. This transaction reduced the largest shareholder's stock holdings
for the purpose of making UTI stock more attractive to the investment
community.
Additionally, a portion of the proceeds in combination with debt
instruments were used to acquire the stock holdings of Thomas F. Morrow and
family in UTI and UII. Simultaneous to this stock acquisition Mr. Morrow
retired as an executive officer of UTI. Mr. Morrow's retirement will
provide an annual cost savings to the Company in excess of debt service on
the new notes.
The remaining proceeds of approximately $1,500,000, of the original
$2,560,000, will be used to reduce the outstanding debt of the Company.
LIQUIDITY AND CAPITAL RESOURCES
The Company has three principal needs for cash - the insurance companies'
contractual obligations to policyholders, the payment of operating expenses
and the servicing of its long-term debt. Cash and cash equivalents as a
percentage of total assets were 5% as of December 31, 1997and 1996,
respectively. Fixed maturities as a percentage of total invested assets
were 82% as of December 31, 1997and 1996..
Future policy benefits are primarily long-term in nature and therefore, the
Company's investments are predominantly in long-term fixed maturity
investments such as bonds and mortgage loans which provide sufficient
return to cover these obligations. The Company has the ability and intent
to hold these investments to maturity; consequently, the Company's
investment in long-term fixed maturities is reported in the financial
statements at their amortized cost.
Many of the Company's products contain surrender charges and other features
which reward persistency and penalize the early withdrawal of funds. With
respect to such products, surrender charges are generally sufficient to
cover the Company's unamortized deferred policy acquisition costs with
respect to the policy being surrendered.
Cash provided by operating activities was $23,000, $3,140,000 and 486,000
in 1997, 1996 and 1995, respectively. The net cash provided by operating
activities plus net policyholder contract deposits after the payment of
policyholder withdrawals equaled $3,412,000 in 1997, $9,952,000 in 1996 and
$9,499,000 in 1995. Management utilizes this measurement of cash flows as
an indicator of the performance of the Company's insurance operations,
since reporting regulations require cash inflows and outflows from
universal life insurance products to be shown as financing activities when
reporting on cash flows.
Cash provided by (used in) investing activities was ($2,989,000),
$15,808,000 and ($8,063,000), for 1997, 1996 and 1995, respectively. The
most significant aspect of cash provided by (used in) investing activities
are the fixed maturity transactions. Fixed maturities account for 70%, 81%
and 76% of the total cost of investments acquired in 1997, 1996 and 1995,
respectively. The net cash provided by investing activities in 1996, is
due to the fixed maturities sold in conjunction with the coinsurance
agreement with FILIC. The Company has not directed its investable funds to
so-called "junk bonds" or derivative investments.
Net cash provided by (used in) financing activities was $1,746,000,
($14,150,000) and $8,408,000 for 1997, 1996 and 1995, respectively. The
change between 1997 and 1996 is due to a coinsurance agreement with FILIC
as of September 30, 1996. At closing of the transaction, UG received a
reinsurance credit of $28,318,000 for policy liabilities covered under the
agreement. UG transferred assets equal to the credit received. This
transfer included policy loans of $2,855,000 associated with policies under
the agreement and a net cash transfer of $19,088,000 after deducting the
ceding commission due UG of $6,375,000.
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Policyholder contract deposits decreased 20% in 1997 compared to 1996, and
decreased 11% in 1996 when compared to 1995. Policyholder contract
withdrawals has decreased 6% in 1997 compared to 1996, and decreased 4% in
1996 compared to 1995.. The change in policyholder contract withdrawals is
not attributable to any one significant event. Factors that influence
policyholder contract withdrawals are fluctuation of interest rates,
competition and other economic factors.
At December 31, 1997, the Company had a total of $21,460,000 in long-term
debt outstanding. Long-term debt principal reductions are approximately
$1.5 million per year over the next FOUR years. THE DEBT STRUCTURE IS
DESCRIBED IN THE FOLLOWING PARAGRAPHS.
The senior debt is through First of America Bank - NA and is subject to a
credit agreement. AS OF DECEMBER 31, 1997 THE OUTSTANDING PRINCIPAL
BALANCE OF THE SENIOR DEBT IS $6,900,000. The debt bears interest to a
rate equal to the "base rate" plus nine-sixteenths of one percent. The
Base rate is defined as the floating daily, variable rate of interest
determined and announced by First of America Bank from time to time as its
"base lending rate". The base rate at issuance of the loan was 8.25%, until
March of 1997, when it changed to 8.5%. The base rate has remained
unchanged at 8.5% through the date of this filing. Interest is paid
quarterly and principal payments of $1,000,000 are due in May of each year
beginning in 1997, with a final payment due May 8, 2005. On November 8,
1997, the Company prepaid the $1,000,000 May 8,1998, principal payment.
PRINCIPAL AND INTEREST PAYMENTS EXPECTED TO BE PAID ON THIS DEBT ARE $0 AND
$625,000 IN 1998 AND $1,000,000 AND $580,000 IN 1999, RESPECTIVELY.
The subordinated debt was incurred June 16, 1992 as a part of an
acquisition AND CONSISTS OF 10 AND 20 YEAR NOTES. AS OF DECEMBER 31, 1997
THE OUTSTANDING PRINCIPAL BALANCE OF THE 10-YEAR NOTES IS $5,747,000 AND
THE 20-YEAR NOTES IS $3,902,000. The 10-year notes bear interest at the
rate of 7 1/2% per annum, payable semi-annually beginning December 16,
1992. These notes except for one $840,000 note provide for principal
payments equal to 1/20th of the principal balance due with each interest
installment beginning December 16, 1997, with a final payment due June 16,
2002. The $840,000 note provides for a lump sum principal payment due June
16, 2002. In June 1997, the Company refinanced $204,267 of its
subordinated 10-year notes to subordinated 20-year notes bearing interest
at the rate of 8.75%. The repayment terms of these notes are the same as
the original subordinated 20 year notes. The 20-year notes bear interest
at the rate of 8 1/2% per annum on $3,530,000 and 8.75% per annum on
$505,000, payable semi-annually with a lump sum principal payment due June
16, 2012. PRINCIPAL AND INTEREST PAYMENTS EXPECTED TO BE PAID ON THE 10-
YEAR NOTES ARE $516,000 AND $412,000 IN 1998 AND $516,000 AND $373,000 IN
1999, RESPECTIVELY. PRINCIPAL AND INTEREST PAYMENTS EXPECTED TO BE PAID ON
THE 20-YEAR NOTES ARE $0 AND $333,000 IN 1998 AND $0 AND $333,000 IN 1999,
RESPECTIVELY.
On July 31, 1997, United Trust Inc. issued convertible notes totaling
$2,560,000 to seven individuals, all officers or employees of United Trust
Inc. AS OF DECEMBER 31, 1997 THE OUTSTANDING PRINCIPAL BALANCE OF THE
CONVERTIBLE NOTES IS $2,560,000. The notes bear interest at a rate of 1%
over prime, which has remained unchanged at 8.5%, with interest payments
due quarterly and principal due upon maturity of July 31, 2004. The
conversion price of the notes are graded from $12.50 per share for the
first three years, increasing to $15.00 per share for the next two years
and increasing to $20.00 per share for the last two years. As of December
31, 1997, the notes were convertible into 204,800 shares of UTI common
stock with no conversion privileges having been exercised. PRINCIPAL AND
INTEREST PAYMENTS EXPECTED TO BE PAID ON THE CONVERTIBLE NOTES ARE $0 AND
$243,000 IN 1998 AND $0 AND $243,000 IN 1999, RESPECTIVELY.
As of December 31, 1997 the Company has a total $22,575,000 of cash and
cash equivalents, short-term investments and investments held for sale in
comparison to $21,460,000 of notes payable. UTI and FCC service this debt
through existing cash balances and management fees received from the
insurance subsidiaries. FCC is further able to service this debt through
dividends it may receive from UG. See Note 2 in the notes to the
consolidated financial statements for additional information regarding
dividends.
Since UTI is a holding company, funds required to meet its debt service
requirements and other expenses are primarily provided by its subsidiaries.
On a parent only basis, UTI's cash flow is dependent on revenues from a
management agreement with UII and its earnings received on invested assets
and cash balances. At December 31, 1997, substantially all of the
consolidated shareholders equity presents net assets of its subsidiaries.
Cash requirements of UTI primarily relate to servicing its long-term debt.
The Company's insurance subsidiaries have maintained adequate statutory
capital and surplus and have not used surplus relief or financial
reinsurance, which have come under scrutiny by many state insurance
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departments. The payment of cash dividends to shareholders is not legally
restricted. However, insurance company dividend payments are regulated by
the state insurance department where the company is domiciled. UTI is the
ultimate parent of UG through ownership of several intermediary holding
companies. UG can not pay a dividend directly to UTI due to the ownership
structure. HOWEVER, IF UG PAID A DIVIDEND TO ITS DIRECT PARENT AND EACH
SUBSEQUENT INTERMEDIATE COMPANY WITHIN THE HOLDING COMPANY STRUCTURE PAID A
DIVIDEND EQUAL TO THE AMOUNT IT RECEIVED, UTI WOULD RECEIVE 42% OF THE
ORIGINAL DIVIDEND PAID BY UG. Please refer to Note 1 of the Notes to the
Consolidated Financial Statements. UG's dividend limitations are described
below without effect of the ownership structure.
Ohio domiciled insurance companies require five days prior notification to
the insurance commissioner for the payment of an ordinary dividend.
Ordinary dividends are defined as the greater of: a) prior year statutory
earnings or b) 10% of statutory capital and surplus. For the year ended
December 31, 1997, UG had a statutory gain from operations of $1,779,000.
At December 31, 1997, UG's statutory capital and surplus amounted to
$10,997,000. Extraordinary dividends (amounts in excess of ordinary
dividend limitations) require prior approval of the insurance commissioner
and are not restricted to a specific calculation.
A life insurance company's statutory capital is computed according to rules
prescribed by the National Association of Insurance Commissioners ("NAIC"),
as modified by the insurance company's state of domicile. Statutory
accounting rules are different from generally accepted accounting
principles and are intended to reflect a more conservative view by, for
example, requiring immediate expensing of policy acquisition costs. The
achievement of long-term growth will require growth in the statutory
capital of the Company's insurance subsidiaries. The subsidiaries may
secure additional statutory capital through various sources, such as
internally generated statutory earnings or equity contributions by the
Company from funds generated through debt or equity offerings.
The NAIC's risk-based capital requirements require insurance companies to
calculate and report information under a risk-based capital formula. The
risk-based capital formula measures the adequacy of statutory capital and
surplus in relation to investment and insurance risks such as asset
quality, mortality and morbidity, asset and liability matching and other
business factors. The RBC formula is used by state insurance regulators as
an early warning tool to identify, for the purpose of initiating regulatory
action, insurance companies that potentially are inadequately capitalized.
In addition, the formula defines new minimum capital standards that will
supplement the current system of low fixed minimum capital and surplus
requirements on a state-by-state basis. Regulatory compliance is
determined by a ratio of the insurance company's regulatory total adjusted
capital, as defined by the NAIC, to its authorized control level RBC, as
defined by the NAIC. Insurance companies below specific trigger points or
ratios are classified within certain levels, each of which requires
specific corrective action.
The levels and ratios are as follows:
Ratio of Total Adjusted Capital to
Authorized Control Level RBC
Regulatory Event (Less Than or Equal to)
Company action level 2*
Regulatory action level 1.5
Authorized control level 1
Mandatory control level 0.7
* Or, 2.5 with negative trend.
At December 31, 1997, each of the insurance subsidiaries has a Ratio that
is in excess of 3, which is 300% of the authorized control level;
accordingly the insurance subsidiaries meet the RBC requirements.
The Company is not aware of any litigation that will have a material
adverse effect on the financial position of the Company. In addition, the
Company does not believe that the regulatory initiatives currently under
consideration by various regulatory agencies will have a material adverse
impact on the Company. The Company is not aware of any material pending or
threatened regulatory action with respect to the Company or any of its
subsidiaries. The Company does not believe that any insurance guaranty
fund assessments will be materially different from amounts already provided
for in the financial statements.
Management believes the overall sources of liquidity available will be
sufficient to satisfy its financial obligations.
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REGULATORY ENVIRONMENT
The Company's insurance subsidiaries are assessed contributions by life and
health guaranty associations in almost all states to indemnify
policyholders of failed companies. In several states the company may
reduce premium taxes paid to recover a portion of assessments paid to the
states' guaranty fund association. This right of "offset" may come under
review by the various states, and the company cannot predict whether and to
what extent legislative initiatives may affect this right to offset. Also,
some state guaranty associations have adjusted the basis by which they
assess the cost of insolvencies to individual companies. The Company
believes that its reserve for future guaranty fund assessments is
sufficient to provide for assessments related to known insolvencies. This
reserve is based upon management's current expectation of the availability
of this right of offset, known insolvencies and state guaranty fund
assessment bases. However, changes in the basis whereby assessments are
charged to individual companies and changes in the availability of the
right to offset assessments against premium tax payments could materially
affect the company's results.
Currently, the Company's insurance subsidiaries are subject to government
regulation in each of the states in which they conduct business. Such
regulation is vested in state agencies having broad administrative power
dealing with all aspects of the insurance business, including the power to:
(i) grant and revoke licenses to transact business; (ii) regulate and
supervise trade practices and market conduct; (iii) establish guaranty
associations; (iv) license agents; (v) approve policy forms; (vi)
approve premium rates for some lines of business; (vii) establish reserve
requirements; (viii) prescribe the form and content of required financial
statements and reports; (ix) determine the reasonableness and adequacy of
statutory capital and surplus; and (x) regulate the type and amount of
permitted investments. Insurance regulation is concerned primarily with
the protection of policyholders. The Company cannot predict THE IMPACT OF
ANY FUTURE PROPOSALS, REGULATIONS OR MARKET CONDUCT INVESTIGATIONS. The
Company's insurance subsidiaries, USA, UG, APPL and ABE are domiciled in
the states of Ohio, Ohio, West Virginia and Illinois, respectively.
The insurance regulatory framework continues to be scrutinized by various
states, the federal government and the National Association of Insurance
Commissioners ("NAIC"). The NAIC is an association whose membership
consists of the insurance commissioners or their designees of the various
states. The NAIC has no direct regulatory authority over insurance
companies, however its primary purpose is to provide a more consistent
method of regulation and reporting from state to state. This is
accomplished through the issuance of model regulations, which can be
adopted by individual states unmodified, modified to meet the state's own
needs or requirements, or dismissed entirely.
Most states also have insurance holding company statutes which require
registration and periodic reporting by insurance companies controlled by
other corporations licensed to transact business within their respective
jurisdictions. The insurance subsidiaries are subject to such legislation
and registered as controlled insurers in those jurisdictions in which such
registration is required. Statutes vary from state to state but typically
require periodic disclosure, concerning the corporation, that controls the
registered insurers and all subsidiaries of such corporation. In addition,
prior notice to, or approval by, the state insurance commission of material
intercorporate transfers of assets, reinsurance agreements, management
agreements (see Note 9 in the notes to the consolidated financial
statements), and payment of dividends (see note 2 in the notes to the
consolidated financial statements) in excess of specified amounts by the
insurance subsidiary, within the holding company system, are required.
Each year the NAIC calculates financial ratio results (commonly referred to
as IRIS ratios) for each company. These ratios compare various financial
information pertaining to the statutory balance sheet and income statement.
The results are then compared to pre-established normal ranges determined
by the NAIC. Results outside the range typically require explanation to
the domiciliary insurance department.
At year-end 1997, the insurance companies had one ratio outside the normal
range. The ratio is related to the decrease in premium income. The ratio
fell outside the normal range the last three years. A primary cause for
the decrease in premium revenues is related to the potential change in
control of UTI over the last two years to two different parties. During
September of 1996, it was announced that control of UTI would pass to an
unrelated party, but the transaction did not materialize. At this writing,
negotiations are progressing with a different unrelated party for the
change in control of UTI. Please refer to the Notes to the Consolidated
Financial Statements for additional information. The possible changes and
resulting uncertainties have hurt the insurance companies' ability to
recruit and maintain sales agents. The industry has experienced a downward
trend in the total number of agents who sell insurance products, and
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competition for the top sales producers has intensified. As this trend
appears to continue, the recruiting focus of the Company has been on
introducing quality individuals to the insurance industry through an
extensive internal training program. The Company feels this approach is
conducive to the mutual success of our new recruits and the Company as
these recruits market our products in a professional, company structured
manner.
The NAIC, in conjunction with state regulators, has been reviewing existing
insurance laws and regulations. A committee of the NAIC proposed changes
in the regulations governing insurance company investments and holding
company investments in subsidiaries and affiliates which were adopted by
the NAIC as model laws in 1996. The Company does not presently anticipate
any material adverse change in its business as a result of these changes.
Legislative and regulatory initiatives regarding changes in the regulation
of banks and other financial services businesses and restructuring of the
federal income tax system could, if adopted and depending on the form they
take, have an adverse impact on the Company by altering the competitive
environment for its products. The outcome and timing of any such changes
cannot be anticipated at this time, but the Company will continue to
monitor developments in order to respond to any opportunities or increased
competition that may occur.
The NAIC adopted the Life Illustration Model Regulation. Many states have
adopted the regulation effective January 1, 1997. This regulation requires
products which contain non-guaranteed elements, such as universal life and
interest sensitive life, to comply with certain actuarially established
tests. These tests are intended to target future performance and
profitability of a product under various scenarios. The regulation does
not prevent a company from selling a product that does not meet the various
tests. The only implication is the way in which the product is marketed to
the consumer. A product that does not pass the tests uses guaranteed
assumptions rather than current assumptions in presenting future product
performance to the consumer. The Company conducts an ongoing thorough
review of its sales and marketing process and continues to emphasize its
compliance efforts.
A task force of the NAIC is currently undertaking a project to codify a
comprehensive set of statutory insurance accounting rules and regulations.
This project is not expected to be completed earlier than 1999. Specific
recommendations have been set forth in papers issued by the NAIC for
industry review. The Company is monitoring the process, but the potential
impact of any changes in insurance accounting standards is not yet known.
ACCOUNTING AND LEGAL DEVELOPMENTS
The Financial Accounting Standards Board (FASB) has issued Statement of
Financial Accounting Standards (SFAS) No. 128 entitled Earnings per share,
which is effective for financial statements for fiscal years beginning
after December 15, 1997. SFAS No. 128 specifies the computation,
presentation, and disclosure requirements for earnings per share (EPS) for
entities with publicly held common stock or potential common stock. The
Statement's objective is to simplify the computation of earnings per share,
and to make the U.S. standard for computing EPS more compatible with the
EPS standards of other countries.
Under SFAS No. 128, primary EPS computed in accordance with previous
opinions is replaced with a simpler calculation called basic EPS. Basic
EPS is calculated by dividing income available to common stockholders
(i.e., net income or loss adjusted for preferred stock dividends) by the
weighted-average number of common shares outstanding. Thus, in the most
significant change in current practice, options, warrants, and convertible
securities are excluded from the basic EPS calculation. Further,
contingently issuable shares are included in basic EPS only if all the
necessary conditions for the issuance of such shares have been satisfied by
the end of the period.
Fully diluted EPS has not changed significantly but has been renamed
diluted EPS. Income available to common stockholders continues to be
adjusted for assumed conversion of all potentially dilutive securities
using the treasury stock method to calculate the dilutive effect of options
and warrants. However, unlike the calculation of fully diluted EPS under
previous opinions, a new treasury stock method is applied using the average
market price or the ending market price. Further, prior opinion
requirement to use the modified treasury stock method when the number of
options or warrants outstanding is greater than 20% of the outstanding
shares also has been eliminated. SFAS 128 also includes certain shares
that are contingently issuable; however, the test for inclusion under the
new rules is much more restrictive.
27
<PAGE>
SFAS No. 128 requires companies reporting discontinued operations,
extraordinary items, or the cumulative effect of accounting changes are to
use income from operations as the control number or benchmark to determine
whether potential common shares are dilutive or antidilutive. Only
dilutive securities are to be included in the calculation of diluted EPS.
This statement was adopted for the 1997 Financial Statements. For all
periods presented the Company reported a loss from continuing operations so
any potential issuance of common shares would have an antidilutive effect
on EPS. Consequently, the adoption of SFAS No. 128 did not have an impact
on the Company's financial statement.
The FASB has issued SFAS No. 130 entitled Reporting Comprehensive Income
and SFAS No. 132 Employers' Disclosures about Pensions and Other
Postretirement Benefits. Both of the above statements are effective for
financial statements with fiscal years beginning after December 15, 1997.
SFAS No. 130 defines how to report and display comprehensive income and its
components in a full set of financial statements. The purpose of reporting
comprehensive income is to report a measure of all changes in equity of an
enterprise that result from recognized transactions and other economic
events of the period other than transactions with owners in their capacity
as owners.
SFAS No. 132 addresses disclosure requirements for post-retirement
benefits. The statement does not change post-retirement measurement or
recognition issues.
The Company will adopt both SFAS No. 130 and SFAS No. 132 for the 1998
financial statements. Management does not expect either adoption to have a
material impact on the Company's financial statements.
The Company is not aware of any litigation that will have a material
adverse effect on the financial position of the Company. In addition, the
Company does not believe that the regulatory initiatives currently under
consideration by various regulatory agencies will have a material adverse
impact on the Company. The Company is not aware of any material pending or
threatened regulatory action with respect to the Company or any of its
subsidiaries. The Company does not believe that any insurance guaranty
fund assessments will be materially different from amounts already provided
for in the financial statements.
YEAR 2000 ISSUE
The "Year 2000 Issue" is the inability of computers and computing
technology to recognize correctly the Year 2000 date change. The problem
results from a long-standing practice by programmers to save memory space
by denoting Years using just two digits instead of four digits. Thus,
systems that are not Year 2000 compliant may be unable to read dates
correctly after the Year 1999 and can return incorrect or unpredictable
results. This could have a significant effect on the Company's
business/financial systems as well as products and services, if not
corrected.
The Company established a project to address year 2000 processing concerns
in September of 1996. In 1997 the Company completed the review of the
Company's internally and externally developed software, and made
corrections to all year 2000 non-compliant processing. The Company also
secured verification of current and future year 2000 compliance from all
major external software vendors. In December of 1997, a separate computer
operating environment was established with the system dates advanced to
December of 1999. A parallel model office was established with all dates
in the data advanced to December of 1999. Parallel model office processing
is being performed using dates from December of 1999 to January of 2001, to
insure all year 2000 processing errors have been corrected. Testing should
be completed by the end of the first quarter of 1998. After testing is
completed, periodic regression testing will be performed to monitor
continuing compliance. By addressing year 2000 compliance in a timely
manner, compliance will be achieved using existing staff and without
significant impact on the Company operationally or financially.
28
<PAGE>
PROPOSED MERGER
On March 25, 1997, the Board of Directors of UTI and UII voted to recommend
to the shareholders a merger of the two companies. Under the Plan of
Merger, UTI would be the surviving entity with UTI issuing one share of its
stock for each share held by UII shareholders.
UTI owns 53% of United Trust Group, Inc., an insurance holding company, and
UII owns 47% of United Trust Group, Inc. Neither UTI nor UII have any
other significant holdings or business dealings. The Board of Directors of
each company thus concluded a merger of the two companies would be in the
best interests of the shareholders. The merger will result in certain cost
savings, primarily related to costs associated with maintaining a
corporation in good standing in the states in which it transacts business.
A vote of the shareholders of UTI and UII regarding the proposed merger is
anticipated to occur sometime during the third quarter of 1998.
SUBSEQUENT EVENT
On February 19, 1998, UTI signed a letter of intent with Jesse T. Correll,
whereby Mr. Correll will personally or in combination with other
individuals make an equity investment in UTI over a period of three years.
UPON COMPLETION OF THE TRANSACTION MR. CORRELL WILL OWN 51% OF UTI. Under
the terms of the letter of intent Mr. Correll will buy 2,000,000 authorized
but unissued shares of UTI common stock for $15.00 per share and will also
buy 389,715 shares of UTI common stock, representing stock of UTI and UII,
that UTI purchased during the last eight months in private transactions at
the average price UTI paid for such stock, plus interest, or approximately
$10.00 per share. Mr. Correll also will purchase 66,667 shares of UTI
common stock and $2,560,000 of face amount of convertible bonds (which are
due and payable on any change in control of UTI) in private transactions,
primarily from officers of UTI. Upon completion of the transaction, Mr.
Correll would be the largest shareholder of UTI.
UTI intends to use the equity that is being contributed to expand their
operations through the acquisition of other life insurance companies. The
transaction is subject to negotiation of a definitive purchase agreement;
completion of due diligence by Mr. Correll; the receipt of regulatory and
other approvals; and the satisfaction of certain conditions. The
transaction is not expected to be completed before June 30, 1998, and there
can be no assurance that the transaction will be completed.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
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 any such statement due to the following important
factors, among other risks and uncertainties inherent in the company's
business:
1. Prevailing interest rate levels, which may affect the ability of the
company to sell its products, the market value of the company's
investments and the lapse ratio of the company's policies,
notwithstanding product design features intended to enhance
persistency of the company's products.
2. Changes in the federal income tax laws and regulations which may
affect the relative tax advantages of the company's products.
3. Changes in the regulation of financial services, including bank sales
and underwriting of insurance products, which may affect the
competitive environment for the company's products.
4. Other factors affecting the performance of the company, including, but
not limited to, market conduct claims, insurance industry
insolvencies, stock market performance, and investment performance.
29
<PAGE>
PART II, ITEM 8, FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA SHOULD
BE AMENDED AS FOLLOWS:
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Listed below are the financial statements included in this Part of the
Annual Report on SEC Form 10-K:
Page No.
UNITED TRUST, INC. AND CONSOLIDATED SUBSIDIARIES
Independent Auditor's Report for the
Years ended December 31, 1997, 1996, 1995 31
Consolidated Balance Sheets 32
Consolidated Statements of Operations 33
Consolidated Statements of Shareholders' Equity 34
Consolidated Statements of Cash Flows 35
Notes to Consolidated Financial Statements 36-60
30
<PAGE>
Independent Auditors' Report
Board of Directors and Shareholders
United Trust, Inc.
We have audited the accompanying consolidated balance sheets of United
Trust, Inc. (an Illinois corporation) and subsidiaries as of December 31,
1997 and 1996, and the related consolidated statements of operations,
shareholders' equity, and cash flows for each of the three years in the
period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these 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 financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
United Trust, Inc. and subsidiaries as of December 31, 1997 and 1996, and
the consolidated results of their operations and their consolidated cash
flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
We have also audited Schedule I as of December 31, 1997, and Schedules
II, IV and V as of December 31, 1997 and 1996, of United Trust, Inc. and
subsidiaries and Schedules II, IV and V for each of the three years in the
period then ended. In our opinion, these schedules present fairly, in all
material respects, the information required to be set forth therein.
KERBER, ECK & BRAECKEL LLP
Springfield, Illinois
March 26, 1998
31
<PAGE>
UNITED TRUST, INC.
CONSOLIDATED BALANCE SHEETS
As of December 31, 1997 and 1996
ASSETS
Investments: 1997 1996
<TABLE>
<S> <C> <C>
Fixed maturities at amortized cost
(market $184,782,568 and
$181,815,255) $ 180,970,333 $ 179,926,785
Investments held for sale:
Fixed maturities, at market
(cost $1,672,298 and $1,984,661) 1,668,630 1,961,166
Equity securities, at market
(cost $3,184,357 and $2,086,159) 3,001,744 1,794,405
Mortgage loans on real estate
at amortized cost 9,469,444 11,022,792
Investment real estate, at cost, net
of accumulated depreciation 9,760,732 9,779,984
Real estate acquired in
satisfaction of debt 1,724,544 1,724,544
Policy loans 14,207,189 14,438,120
Short-term investments 1,798,878 430,983
222,601,494 221,078,779
Cash and cash equivalents 16,105,933 17,326,235
Investment in affiliates 5,636,674 4,826,584
Accrued investment income 3,686,562 3,461,799
Reinsurance receivables:
Future policy benefits 37,814,106 38,745,013
Policy claims and other benefits 3,529,078 3,856,124
Other accounts and notes receivable 845,066 894,321
Cost of insurance acquired 41,522,888 43,917,280
Deferred policy acquisition costs 10,600,720 11,325,356
Cost in excess of net assets purchased,
net of accumulated amortization 2,777,089 5,496,808
Property and equipment, net
of accumulated depreciation 3,412,956 3,255,171
Other assets 767,258 1,290,192
Total assets $ 349,299,824 $ 355,473,662
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities and accruals:
Future policy benefits $ 248,805,695 $ 248,879,317
Policy claims and benefits payable 2,080,907 3,193,806
Other policyholder funds 2,445,469 2,784,967
Dividend and endowment accumulations 14,905,816 13,913,676
Income taxes payable:
Current 15,730 70,663
Deferred 14,174,260 13,193,431
Notes payable 21,460,223 19,573,953
Indebtedness to affiliates, net 18,475 31,837
Other liabilities 3,790,051 5,975,483
Total liabilities 307,696,626 307,617,133
Minority interests in consolidated
Subsidiaries 26,246,580 29,842,672
Shareholders' equity:Common stock - no par value,
stated value $.02 per share.
Authorized 3,500,000 shares -
1,634,779 and 1,870,093 shares
issued after deducting treasury
shares of 277,460 and 42,384 32,696 37,402
Additional paid-in capital 16,488,375 18,638,591
Unrealized depreciation of
investments held for sale (29,127) (86,058)
Accumulated deficit (1,135,326) (576,078)
Total shareholders' equity 15,356,618 18,013,857
Total liabilities and
shareholders' equity $ 349,299,824 $ 355,473,662
See accompanying notes
32
<PAGE>
UNITED TRUST, INC.CONSOLIDATED STATEMENTS OF OPERATIONS
Three Years Ended December 31, 1997
1997 1996 1995
</TABLE>
<TABLE>
<S> <C> <C> <C>
Revenues:
Premiums and
policy fees $ 33,373,950$ 35,891,609$ 38,481,638
Reinsurance
premiums
and policy fees (4,734,705) (4,947,151) (5,383,102)
Net investment
income 14,857,297 15,868,447 15,456,224
Realized investment
gains and
(losses), net (279,096) (987,930) (124,235)
Other income 774,884 1,151,395 1,438,559
43,992,330 46,976,370 49,869,084
Benefits and other expenses:
Benefits, claims and
settlement expenses:
Life 23,644,252 26,568,062 26,680,217
Reinsurance
benefits and
claims (2,078,982) (2,283,827) (2,850,228
Annuity 1,560,828 1,892,489 1,797,475
Dividends to
Policyholders 3,929,073 4,149,308 4,228,300
Commissions and
amortization of deferred
policy
acquisition
costs 3,616,365 4,224,885 4,907,653
Amortization of cost
of insurance
acquired 2,394,392 5,524,815 4,303,237
Amortization of
agency force 0 0 396,852
Non-recurring write down
of value of agenc 0 0 8,296,974
Operating expenses 9,222,913 11,994,464 11,517,648
Interest expense 1,816,491 1,731,309 1,966,776
44,105,332 53,801,505 61,244,904
Loss before income taxes,
minority interest
and equity in loss of
investees (113,002) (6,825,135) (11,375,820)
Income tax credit (expense) (986,229) 4,703,741 4,571,028
Minority interest in loss
of consolidated
subsidiaries 563,699 1,278,883 4,439,496
Equity in loss of investees (23,716) (95,392) (635,949)
Net loss $ (559,248)$ (937,903)$ (3,001,245)
Net loss per
common share $ (0.32)$ (0.50)$ (1.61)
Average common
shares outstanding 1,772,870 1,869,511 1,866,851
</TABLE>
See accompanying notes
33
<PAGE>
UNITED TRUST, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Three Years Ended December 31, 1997
1997 1996 1995
<TABLE>
<S> <C> <C> <C>
Common stock
Balance, beginning
of year $ 37,402 $ 37,352 $ 37,312
Issued during year 0 50 40
Stock retired from
purchase of fractional
shares of reverse
stock split (7) 0 0
Purchase treasury
stock (4,699) 0 0
Balance, end of year $32,696 $ 37,402 $ 37,352
Additional paid-in capital
Balance, beginning
of year $ 18,638,591$ 18,624,578$ 18,612,118
Issued during year 0 14,013 12,460
Stock retired from
purchase of fractional
shares of reverse
stock split (2,374) 0 0
Purchase treasury
stock (2,147,842) 0 0
Balance, end of $ 16,488,375$ 18,638,591$ 18,624,578
Unrealized appreciation (depreciation) of
investments held for sale
Balance, beginning
of year $ (86,058)$ (1,499)$ (143,405)
Change during year 56,931 (84,559) 141,906
Balance, end of year (29,127)$ (86,058)$ (1,499)
Retained earnings (accumulated deficit)
Balance, beginning
of year $ (576,078)$ 361,825 $ 3,363,070
Net loss (559,248) (937,903) (3,001,245)
Balance, end
of year $ (1,135,326)$ (576,078)$ 361,825
Total shareholders' equity,
end of year $ 15,356,618$ 18,013,857$ 19,022,256
</TABLE>
See accompanying notes
34
<PAGE>
UNITED TRUST, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Years Ended December 31, 1997
1997 1996 1995
<TABLE>
<S> <C> <C> <C>
Increase (decrease) in cash
and cash equivalents
Cash flows from
operating
activities:
Net loss $ (559,248)$ (937,903)$ (3,001,245)
Adjustments to reconcile net
loss to net cash provided by
(used in) operating activities
net of changes in assets and
liabilities resulting from the
sales and purchases
of subsidiaries:
Amortization/accretion
of fixed
maturities 670,185 899,445 803,696
Realized investment
(gains) losses, net 279,096 987,930 124,235
Policy acquisition
costs deferred (586,000) (1,276,000) (2,370,000)
Amortization of
deferred policy
acquisition
costs 1,310,636 1,387,372 1,567,748
Amortization of cost
of insurance
acquired 2,394,392 5,524,815 4,303,237
Amortization of value
of agency force 0 0 396,852
Non-recurring write
down of value of
agency force 0 0 8,296,974
Amortization of costs
in excess of net
assets purchased 155,000 185,279 423,192
Depreciation 469,854 390,357 720,605
Minority interest (563,699) (1,278,883) (4,439,496)
Equity in loss of
investees 23,716 95,392 635,949
Change in accrued
Investment
income (224,763) 210,043 (171,257)
Change in reinsurance
receivables 1,257,953 83,871 (482,275)
Change in policy
liabilities and
accruals (547,081) 3,326,651 3,581,928
Charges for mortality
and administration
of universal life and
annuity
products (10,588,874) (10,239,476) (9,757,354)
Interest credited to
account balances 7,212,406 7,075,921 6,644,282
Change in income
taxes payable 925,896 (4,714,258) (4,595,571)
Change in indebtedness
(to) from
affiliates, net (13,362) 119,706 (20,004)
Change in other assets
and liabilities,
net (1,593,358) 1,299,773 (2,175,839)
Net cash provided by (used in)
operating activities 22,749 3,140,035 485,657
Cash flows from investing activities:
Proceeds from investments
sold and matured:
Fixed maturities
held for sale 290,660 1,219,036 619,612
Fixed maturities sold 0 18,736,612 0
Fixed maturities
matured 21,488,265 20,721,482 16,265,140
Equity securities 76,302 8,990 104,260
Mortgage loans 1,794,518 3,364,427 2,252,423
Real estate 1,136,995 3,219,851 1,768,254
Policy loans 4,785,222 3,937,471 4,110,744
Short term 410,000 825,000 25,000
Total proceeds from
investments sold
and matured 29,981,962 52,032,869 25,145,433
Cost of investments acquired:
Fixed maturities (23,220,172) (29,365,111) (25,112,358)
Equity securities (1,248,738) 0 (1,000,000)
Mortgage loans (245,234) (503,113) (322,129)
Real estate (1,444,980) (813,331) (1,902,609)
Policy loans (4,554,291) (4,329,124) (4,713,471)
Short term (1,726,035) (830,983) (100,000)
Total cost of investments
acquired (32,439,450) (35,841,662) (33,150,567)
Purchase of property
and equipment (531,528) (383,411) (57,625)
Net cash provided by (used in)
investing activities (2,989,016) 15,807,796 (8,062,759
Cash flows from financing activities:
Policyholder contract
deposits 17,905,246 22,245,369 25,021,983
Policyholder contract
withdrawals (14,515,576) (15,433,644) (16,008,462)
Net cash transferred
from coinsurance ceded 0 (19,088,371) 0
Proceeds from notes
payable 2,560,000 9,050,000 300,000
Payments of principal
on notes payable (1,874,597) (10,923,475) (905,861)
Payment for fractional
shares from reverse
stock split (2,381) 0 0
Payment for fractional
shares from reverse
stock split
of subsidiary (534,251) 0 0
Purchase of stock
of affiliates (865,877) 0 0
Purchase of
treasury stock (926,599) 0 0
Proceeds from issuance
of common stock 0 500 400
Net cash provided by (used in )
financing activities 1,745,965 (14,149,621) 8,408,060
Net increase (decrease) in
cash and cash
equivalents (1,220,302) 4,798,210 830,958
Cash and cash equivalents
at beginning of year 17,326,235 12,528,025 11,697,067
Cash and cash equivalents
at end of year $ 16,105,933 $ 17,326,235$ 12,528,025
</TABLE>
See accompanying notes
35
<PAGE>
UNITED TRUST, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. ORGANIZATION - At December 31, 1997, the
parent, significant majority-owned subsidiaries and affiliates of
United Trust, Inc., were as depicted on the following organizational
chart.
ORGANIZATIONAL CHART
AS OF DECEMBER 31, 1997
United Trust, Inc. ("UTI") is the ultimate controlling company. UTI owns
53% of United Trust Group ("UTG") and 41% of United Income, Inc. ("UII").
UII owns 47% of UTG. UTG owns 79% of First Commonwealth Corporation
("FCC") and 100% of Roosevelt Equity Corporation ("REC"). FCC owns 100% of
Universal Guaranty Life Insurance Company ("UG"). UG owns 100% of United
Security Assurance Company ("USA"). USA owns 84% of Appalachian Life
Insurance Company ("APPL") and APPL owns 100% of Abraham Lincoln Insurance
Company ("ABE").
36
<PAGE>
The Company's significant accounting
policies consistently applied in the preparation of the accompanying
consolidated financial statements are summarized as follows.
B. NATURE OF OPERATIONS - United Trust, Inc.
is an insurance holding company, which sells individual life
insurance products through its subsidiaries. The Company's principal
market is the Midwestern United States. The primary focus of the
Company has been the servicing of existing insurance business in
force, the solicitation of new life insurance products and the
acquisition of other companies in similar lines of business.
C. PRINCIPLES OF CONSOLIDATION - The
consolidated financial statements include the accounts of the Company
and its majority-owned subsidiaries. Investments in 20% to 50% owned
affiliates in which management has the ability to exercise
significant influence are included based on the equity method of
accounting and the Company's share of such affiliates' operating
results is reflected in Equity in loss of investees. Other
investments in affiliates are carried at cost. All significant
intercompany accounts and transactions have been eliminated.
D. BASIS OF PRESENTATION - The financial
statements of United Trust, Inc.'s life insurance subsidiaries have
been prepared in accordance with generally accepted accounting
principles which differ from statutory accounting practices permitted
by insurance regulatory authorities.
E. USE OF ESTIMATES - In preparing financial
statements in conformity with generally accepted accounting
principles, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ
from those estimates.
F. INVESTMENTS - Investments are shown on the following bases:
Fixed maturities -- at cost, adjusted for
amortization of premium or discount and other-than-temporary market
value declines. The amortized cost of such investments differs from
their market values; however, the Company has the ability and intent
to hold these investments to maturity, at which time the full face
value is expected to be realized.
Investments held for sale -- at current
market value, unrealized appreciation or depreciation is charged
directly to shareholders' equity.
Mortgage loans on real estate -- at
unpaid balances, adjusted for amortization of premium or discount,
less allowance for possible losses.
Real estate - Investment real estate at
cost, less allowances for depreciation and, as appropriate,
provisions for possible losses. Foreclosed real estate is adjusted
for any impairment at the foreclosure date. Accumulated depreciation
on investment real estate was $539,366 and $442,373 as of December
31, 1997 and 1996, respectively.
Policy loans -- at unpaid balances
including accumulated interest but not in excess of the cash
surrender value.
Short-term investments -- at cost, which approximates current market
value.
Realized gains and losses on sales of
investments are recognized in net income on the specific
identification basis.
37
<PAGE>
G. RECOGNITION OF REVENUES AND RELATED EXPENSES - Premiums for
traditional life insurance products, which include those products
with fixed and guaranteed premiums and benefits, consist principally
of whole life insurance policies, and certain annuities with life
contingencies are recognized as revenues when due. LIMITED PAYMENT
LIFE INSURANCE POLICIES DEFER GROSS PREMIUMS RECEIVED IN EXCESS OF
NET PREMIUMS, WHICH IS THEN RECOGNIZED IN INCOME IN A CONSTANT
RELATIONSHIP WITH INSURANCE IN FORCE. Accident and health insurance
premiums are recognized as revenue pro rata over the terms of the
policies. Benefits and related expenses associated with the premiums
earned are charged to expense proportionately over the lives of the
policies through a provision for future policy benefit liabilities
and through deferral and amortization of deferred policy acquisition
costs. For universal life and investment products, generally there
is no requirement for payment of premium other than to maintain
account values at a level sufficient to pay mortality and expense
charges. Consequently, premiums for universal life policies and
investment products are not reported as revenue, but as deposits.
Policy fee revenue for universal life policies and investment
products consists of charges for the cost of insurance and policy
administration fees assessed during the period. Expenses include
interest credited to policy account balances and benefit claims
incurred in excess of policy account balances.
H. DEFERRED POLICY ACQUISITION COSTS -
Commissions and other costs (SALARIES OF CERTAIN EMPLOYEES INVOLVED
IN THE UNDERWRITING AND POLICY ISSUE FUNCTIONS, AND MEDICAL AND
INSPECTION FEES) of acquiring life insurance products that vary with
and are primarily related to the production of new business have been
deferred. Traditional life insurance acquisition costs are being
amortized over the premium-paying period of the related policies
using assumptions consistent with those used in computing policy
benefit reserves.
For universal life insurance and interest
sensitive life insurance products, acquisition costs are being
amortized generally in proportion to the present value of expected
gross profits from surrender charges and investment, mortality, and
expense margins. Under SFAS No. 97, "Accounting and Reporting by
Insurance Enterprises for Certain Long-Duration Contracts and for
Realized Gains and Losses from the Sale of Investments," the Company
makes certain assumptions regarding the mortality, persistency,
expenses, and interest rates it expects to experience in future
periods. These assumptions are to be best estimates and are to be
periodically updated whenever actual experience and/or expectations
for the future change from initial assumptions. The amortization is
adjusted retrospectively when estimates of current or future gross
profits to be realized from a group of products are revised.
The following table summarizes deferred
policy acquisition costs and related data for the years shown.
1997 1996 1995
<TABLE>
<S> <C> <C> <C>
Deferred, beginning
of year $ 11,325,356 $ 11,436,728 $ 10,634,476
Acquisition costs
deferred:
Commissions 312,000 845,000 1,838,000
Other expenses 274,000 431,000 532,000
Total 586,000 1,276,000 2,370,000
Interest accretion 425,000 408,000 338,000
Amortization charged
to income (1,735,636) (1,795,372) (1,905,748)
Net amortization (1,310,636) (1,387,372) (1,567,748)
Change for the year (724,636) (111,372) 802,252
Deferred, end of year $ 10,600,720 $ 11,325,356 $ 11,436,728
</TABLE>
38
<PAGE> The following table reflects the
components of the income statement for the line item Commissions and
amortization of deferred policy acquisition costs:
1997 1996 1995
<TABLE>
<S> <C> <C> <C>
Net amortization of deferred
policy acquisition costs $ 1,310,636 $ 1,387,372 $ 1,567,748
Commissions 2,305,729 2,837,513 3,339,905
Total $ 3,616,365 $ 4,224,885 $ 4,907,653
</TABLE>
Estimated net amortization expense of deferred policy acquisition
costs for the next five years is as follows:
Interest Net
Accretion Amortization Amortization
<TABLE>
<S> <C> <C> <C>
1998 $ 403,000 $ 1,530,000 $ 1,127,000
1999 365,000 1,359,000 994,000
2000 330,000 1,211,000 881,000
2001 299,000 1,082,000 783,000
2002 270,000 969,000 699,000
</TABLE>
I.COST OF INSURANCE ACQUIRED - When an insurance company is acquired,
the Company assigns a portion of its cost to the right to receive
future cash flows from insurance contracts existing at the date of
the acquisition. The cost of policies purchased represents the
actuarially determined present value of the projected future cash
flows from the acquired policies. THE COMPANY UTILIZED 9% DISCOUNT
RATE ON APPROXIMATELY 24% OF THE BUSINESS AND 15% DISCOUNT RATE ON
APPROXIMATELY 76% OF THE BUSINESS. Cost of Insurance Acquired is
amortized with interest in relation to expected future profits,
including direct charge-offs for any excess of the unamortized asset
over the projected future profits. The interest rates utilized in
the amortization calculation are 9% on approximately 24% of the
balance and 15% on the remaining balance. The interest rates vary
due to differences in the blocks of business. The amortization is
adjusted retrospectively when estimates of current or future gross
profits to be realized from a group of products are revised.
<TABLE>
1997 1996 1995
<S> <C> <C> <C>
Cost of insurance acquired,
beginning of year $ 43,917,280 $ 55,816,934 $ 60,120,171
Interest accretion 5,962,644 6,312,931 7,044,239
Amortization (8,357,036) (11,837,746) (11,347,476)
Net amortization (2,394,392) (5,524,815) (4,303,237)
Balance attributable to
coinsurance agreement 0 (6,374,839) 0
Cost of insurance acquired,
end of year $ 41,522,888 $ 43,917,280 $ 55,816,934
</TABLE>
39
<PAGE>
Estimated net amortization expense of cost of insurance acquired for
the next five years is as follows:
Interest Net
Accretion Amortization Amortization
<TABLE>
<S> <C> <C> <C>
1998 $ 6,113,000 $8,261,000 $2,148,000
1999 5,787,000 7,271,000 1,484,000
2000 5,559,000 6,811,000 1,252,000
2001 5,367,000 6,828,000 1,461,000
2002 4,737,000 6,203,000 1,466,000
</TABLE>
J. COST IN EXCESS OF NET ASSETS PURCHASED - Cost in excess of net
assets purchased is the excess of the amount paid to acquire a
company over the fair value of its net assets. Costs in excess of
net assets purchased are amortized on the straight-line basis over a
40-year period. Management continually reviews the value of goodwill
based on estimates of future earnings. As part of this review,
management determines whether goodwill is fully recoverable from
projected undiscounted net cash flows from earnings of the
subsidiaries over the remaining amortization period. If management
were to determine that changes in such projected cash flows no longer
supported the recoverability of goodwill over the remaining
amortization period, the carrying value of goodwill would be reduced
with a corresponding charge to expense (no such changes have
occurred). Accumulated amortization of cost in excess of net assets
purchased was $1,420,146 and $1,265,146 as of December 31, 1997 and
1996, respectively. A reverse stock split of FCC in May of 1997
created negative goodwill of $2,564,719. The credit to goodwill
resulted from the retirement of fractional shares. Please refer to
Note 11 to the Consolidated Financial Statements for additional
information concerning the reverse stock split.
K. PROPERTY AND EQUIPMENT - Company-
occupied property, data processing equipment and furniture and office
equipment are stated at cost less accumulated depreciation of
$1,990,314 and $1,617,453 at December 31, 1997 and 1996,
respectively. Depreciation is computed on a straight-line basis for
financial reporting purposes using estimated useful lives of three to
30 years. Depreciation expense was $372,861 and $418,449 for the
years ended December 31, 1997 and 1996, respectively.
L.FUTURE POLICY BENEFITS AND EXPENSES - The liabilities for
traditional life insurance and accident and health insurance policy
benefits are computed using a net level method. These liabilities
include assumptions as to investment yields, mortality, withdrawals,
and other assumptions based on the life insurance subsidiaries'
experience adjusted to reflect anticipated trends and to include
provisions for possible unfavorable deviations. The Company makes
these assumptions at the time the contract is issued or, in the case
of contracts acquired by purchase, at the purchase date. Benefit
reserves for traditional life insurance policies include certain
deferred profits on limited-payment policies that are being
recognized in income over the policy term. Policy benefit claims are
charged to expense in the period that the claims are incurred.
Current mortality rate assumptions are based on 1975-80 select and
ultimate tables. Withdrawal rate assumptions are based upon Linton B
or Linton C, which are industry standard actuarial tables for
forecasting assumed policy lapse rates.
Benefit reserves for universal life insurance and interest sensitive
life insurance products are computed under a retrospective deposit
method and represent policy account balances before applicable
surrender charges. Policy benefits and claims that are charged to
expense include benefit claims in excess of related policy account
balances. Interest crediting rates for universal life and interest
sensitive products range from 5.0% to 6.0% in 1997, 1996 and 1995.
M.POLICY AND CONTRACT CLAIMS - Policy and contract claims include
provisions for reported claims in process of settlement, valued in
accordance with the terms of the policies and contracts, as well as
provisions for claims incurred and unreported based on prior
experience of the Company.
N.PARTICIPATING INSURANCE - Participating business represents 29% and
30% of the ordinary life insurance in force at December 31, 1997 and
1996, respectively. Premium income from participating business
represents 50%, 52%, and 55% of total premiums for the years ended
December 31, 1997, 1996 and 1995, respectively. The amount of
dividends to be paid is determined annually by the respective
40
<PAGE>
insurance subsidiary's Board of Directors. Earnings allocable to
participating policyholders are based on legal requirements that vary
by state.
O.INCOME TAXES - Income taxes are reported under Statement of
Financial Accounting Standards Number 109. Deferred income taxes are
recorded to reflect the tax consequences on future periods of
differences between the tax bases of assets and liabilities and their
financial reporting amounts at the end of each such period.
P.BUSINESS SEGMENTS - The Company operates principally in the
individual life insurance business.
Q.EARNINGS PER SHARE - Earnings per share are based on the weighted
average number of common shares outstanding during each year,
retroactively adjusted to give effect to all stock splits. In
accordance with Statement of Financial Accounting Standards No. 128,
the computation of diluted earnings per share is not shown since the
Company has a loss from continuing operations in each period
presented, and any assumed conversion, exercise, or contingent
issuance of securities would have an antidilutive effect on earnings
per share. HAD THE COMPANY NOT BEEN IN A LOSS POSITION, THE
OUTSTANDING DILUTIVE INSTRUMENTS WOULD HAVE BEEN CONVERTIBLE NOTES OF
204,800, 0 AND 0 SHARES IN 1997, 1996 AND 1995, RESPECTIVELY, AND
STOCK OPTIONS EXERCISABLE OF 1,562, 1,562, AND 4,062 SHARES IN 1997,
1996, AND 1995, RESPECTIVELY, UTI HAD STOCK OPTIONS OUTSTANDING
DURING EACH OF THE PERIODS PRESENTED FOR 105,000 SHARES OF COMMON
STOCK AT A PER SHARE PRICE IN EXCESS OF THE AVERAGE MARKET PRICE, AND
WOULD THEREFORE NOT HAVE BEEN INCLUDED IN THE COMPUTATION OF DILUTED
EARNINGS PER SHARE
R.CASH EQUIVALENTS - The Company considers certificates of deposit
and other short-term instruments with an original purchased maturity
of three months or less cash equivalents.
S.RECLASSIFICATIONS - Certain prior year amounts have been
reclassified to conform with the 1997 presentation. Such
reclassifications had no effect on previously reported net loss,
total assets, or shareholders' equity.
T.REINSURANCE - In the normal course of business, the Company seeks
to limit its exposure to loss on any single insured and to recover a
portion of benefits paid by ceding reinsurance to other insurance
enterprises or reinsurers under excess coverage and coinsurance
contracts. The Company retains a maximum of $125,000 of coverage per
individual life.
Amounts paid or deemed to have been paid for reinsurance contracts
are recorded as reinsurance receivables. Reinsurance receivables is
recognized in a manner consistent with the liabilities relating to
the underlying reinsured contracts. 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.
2. SHAREHOLDER DIVIDEND RESTRICTION
At December 31, 1997, substantially all of consolidated shareholders'
equity represents net assets of UTI's subsidiaries. The payment of cash
dividends to shareholders is not legally restricted. However, insurance
company dividend payments are regulated by the state insurance department
where the company is domiciled. UTI is the ultimate parent of UG through
ownership of several intermediary holding companies. UG can not pay a
dividend directly to UTI due to the ownership structure. UG's dividend
limitations are described below without effect of the ownership structure.
Ohio domiciled insurance companies require five days prior notification to
the insurance commissioner for the payment of an ordinary dividend.
Ordinary dividends are defined as the greater of: a) prior year statutory
earnings or b) 10% of statutory capital and surplus. For the year ended
December 31, 1997, UG had a statutory gain from operations of $1,779,246.
At December 31, 1997, UG's statutory capital and surplus amounted to
$10,997,365. Extraordinary dividends (amounts in excess of ordinary
dividend limitations) require prior approval of the insurance commissioner
and are not restricted to a specific calculation.
41
<PAGE>
3. INCOME TAXES
Until 1984, the insurance companies were taxed under the provisions of the
Life Insurance Company Income Tax Act of 1959 as amended by the Tax Equity
and Fiscal Responsibility Act of 1982. These laws were superseded by the
Deficit Reduction Act of 1984. All of these laws are based primarily upon
statutory results with certain special deductions and other items available
only to life insurance companies. Under the provision of the pre-1984 life
insurance company income tax regulations, a portion of "gain from
operations" of a life insurance company was not subject to current taxation
but was accumulated, for tax purposes, in a special tax memorandum account
designated as "policyholders' surplus account". Federal income taxes will
become payable on this account at the then current tax rate when and if
distributions to shareholders, other than stock dividends and other limited
exceptions, are made in excess of the accumulated previously taxed income
maintained in the "shareholders surplus account".
The following table summarizes the companies with this situation and the
maximum amount of income that has not been taxed in each.
Shareholder's Untaxed
Company Surplus Balance
<TABLE>
<S> <C> <C>
ABE $ 5,237,958 $ 1,149,693
APPL 5,417,825 1,525,367
UG 27,760,313 4,363,821
USA 0 0
</TABLE>
The payment of taxes on this income is not anticipated; and, accordingly,
no deferred taxes have been established.
The life insurance company subsidiaries file a consolidated federal income
tax return. The holding companies of the group file separate returns.
Life insurance company taxation is based primarily upon statutory results
with certain special deductions and other items available only to life
insurance companies. Income tax expense consists of the following
components:
1997 1996 1995
<TABLE>
<S> <C> <C> <C>
Current tax expense $ 5,400 $ (148,148) $ 2,641
Deferred tax expense (credit) 980,829 (4,555,593) (4,573,669)
$ 986,229 $ (4,703,741) $ (4,571,028)
</TABLE>
The Companies have net operating loss carryforwards for federal income tax
purposes expiring as follows:
UTI UG FCC
<TABLE>
<S> <C> <C> <C>
2004 $ 597,103 $ 0 $ 163,334
2005 292,656 0 138,765
2006 212,852 2,400,574 33,345
2007 110,758 782,452 676,067
2008 0 939,977 4,595
2009 0 0 168,800
2010 0 0 19,112
2012 0 2,970,692 0
TOTAL $ 1,213,369 $ 7,093,695 $ 1,204,018
</TABLE>
The Company has established a deferred tax asset of $3,328,879 for its
operating loss carryforwards and has established an allowance of $2,904,200.
42
<PAGE>
The following table shows the reconciliation of net income to taxable
income of UTI:
1997 1996 1995
<TABLE>
<S> <C> <C> <C>
Net income (loss) $ (559,248) $ (937,903) $ (3,001,245)
Federal income tax
provision (credit) 414,230 (59,780) 153,764
Loss of subsidiaries 356,422 714,916 2,613,546
Loss of investees 23,716 95,392 635,949
Write off of investment
in affiliate 0 315,000 10,000
Write off of note receivable 0 211,419 0
Depreciation 0 1,046 3,095
Other 44,059 25,528 22,091
Taxable income $ 279,179 $ 365,618 $ 437,200
</TABLE>
UTI has a net operating loss carryforward of $1,213,369 at December 31,
1997. UTI has averaged $300,000 in taxable income over the past four years
and must average taxable income of $122,000 per year to fully realize its
net operating loss carryforwards. UTI's operating loss carryforwards do
not begin to expire until the year 2004. Management believes future
earnings of UTI will be sufficient to fully utilize its net operating loss
carryforwards.
The expense or (credit) for income differed from the amounts computed by
applying the applicable United State statutory rate of 35% to the loss
before income taxes as a result of the following differences:
1997 1996 1995
<TABLE>
<S> <C> <C> <C>
Tax computed at
statutory rate $ (39,551) $ (2,388,797) $ (3,981,537)
Changes in taxes due to:
Cost in excess of net
assets purchased 54,250 64,848 60,594
Current year loss for which
no benefit realized 1,039,742 0 0
Benefit of prior losses (324,705) (2,393,395) (601,563)
Other 256,493 13,603 (48,522)
Income tax expense
(credit) $ 986,229 $ (4,703,741) $ (4,571,028)
</TABLE>
43
<PAGE>
The following table summarizes the major components that comprise the
deferred tax liability as reflected in the balance sheets:
1997 1996
<TABLE>
<S> <C> <C>
Investments $ (228,027) $ (122,251)
Cost of insurance
acquired 15,753,308 16,637,884
Other assets (72,468) (187,747)
Deferred policy
acquisition costs 3,710,252 3,963,875
Agent balances (23,954) (65,609)
Property and
equipment (19,818) (37,683)
Discount of notes 1,097,352 922,766
Management/
consulting fees (573,182) (733,867)
Future policy
benefits (4,421,038) (5,906,087)
Gain on sale
of subsidiary 2,312,483 2,312,483
Net operating
loss carryforward (424,679) (522,392)
Other liabilities (756,482) (1,151,405)
Federal tax DAC (2,179,487) (1,916,536)
Deferred tax
liability $ 14,174,260 $ 13,193,431
</TABLE>
4. ANALYSIS OF INVESTMENTS, INVESTMENT INCOME AND INVESTMENT GAIN
A.NET INVESTMENT INCOME - The following table reflects net investment
income by type of investment:
December 31,
1997 1996 1995
<TABLE>
<S> <C> <C> <C>
Fixed maturities and fixed
maturities held for sale $ 12,677,348 $ 13,326,312 $ 13,190,121
Equity securities 87,211 88,661 52,445
Mortgage loans 802,123 1,047,461 1,257,189
Real estate 745,502 794,844 975,080
Policy loans 976,064 1,121,538 1,041,900
Short-term investments 70,624 21,423 21,295
Other 696,486 691,111 642,632
Total consolidated
investment income 16,055,358 17,091,350 17,180,662
Investment expenses (1,198,061) (1,222,903) (1,724,438)
Consolidated net
investment income $ 14,857,297 $ 15,868,447 $ 15,456,224
</TABLE>
At December 31, 1997, the Company had a total of $5,797,000 of
investments, comprised of $3,848,000 in real estate and $1,949,000 in
equity securities, which did not produce income during 1997.
44
<PAGE>
The following table summarizes the Company's fixed maturity holdings
and investments held for sale by major classifications:
Carrying Value
1997 1996
<TABLE>
<S> <C> <C>
Investments held for sale:
Fixed maturities $ 1,668,630 $ 1,961,166
Equity securities 3,001,744 1,794,405
Fixed maturities:
U.S. Government, government
agencies and authorities 28,259,322 28,554,631
State, municipalities and
political subdivisions 22,778,816 14,421,735
Collateralized mortgage obligations 11,093,926 13,246,781
Public utilities 47,984,322 51,821,989
All other corporate bonds 70,853,947 71,891,649
$ 185,640,707 $ 183,692,356
</TABLE>
By insurance statute, the majority of the Company's investment portfolio
is required to be invested in investment grade securities to provide
ample protection for policyholders. The Company does not invest in so-
called "junk bonds" or derivative investments.
Below investment grade debt securities generally provide higher yields
and involve greater risks than investment grade debt securities because
their issuers typically are more highly leveraged and more vulnerable to
adverse economic conditions than investment grade issuers. In addition,
the trading market for these securities is usually more limited than for
investment grade debt securities. Debt securities classified as below-
investment grade are those that receive a Standard & Poor's rating of BB
or below.
The following table summarizes by category securities held that are
below investment grade at amortized cost:
<TABLE>
<S> <C> <C> <C>
Below Investment
Grade Investments 1997 1996 1995
State,
Municipalities and
political
Subdivisions $ 0 $ 10,042 $ 0
Public 80,497 117,609 116,879
Utilities
Corporate 656,784 813,717 819,010
Total $ 737,281 $ 941,368 $ 935,889
</TABLE>
45
<PAGE>
B. INVESTMENT SECURITIES
The amortized cost and estimated market values of investments in
securities including investments held for sale are as follows:
Cost or Gross Gross Estimated
Amortized Unrealized Unrealized Market
1997 Cost Gains Losses Value
<TABLE>
<S> <C> <C> <C> <C>
Investments Held
for Sale:
U.S. Government
and govt. agencies and
authorities $ 1,448,202 $ 0 $ (5,645) $ 1,442,557
States,
municipalities and
political subdivisions 35,000 485 0 35,485
Collateralized
mortgage obligations 0 0 0 0
Public utilities 80,169 328 0 80,496
All other
corporate bonds 108,927 1,164 0 110,092
1,672,298 1,977 (5,645) 1,668,630
Equity securities 3,184,357 176,508 (359,121) 3,001,744
Total $ 4,856,655 $ 178,485 $ (364,766) $ 4,670,374
Held to Maturity
Securities:
U.S. Government
and govt. agencies and
authorities $ 28,259,322 $ 415,419 $ (51,771) $ 28,622,970
States,
municipalities and political
subdivisions 22,778,816 672,676 (1,891) 23,449,601
Collateralized
mortgage
obligations 11,093,926 210,435 (96,714) 11,207,647
Public utilities 47,984,322 1,241,969 (84,754) 49,141,537
All other corporate
bonds 70,853,947 1,599,983 (93,117) 72,360,813
Total $ 180,970,333 $ 4,140,482 $ (328,247) $ 184,782,568
</TABLE>
46
<PAGE>
Cost or Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
1996
<TABLE>
<S> <C> <C> <C> <C>
Investments Held
for Sale:
U.S. Government
and govt. agencies and
authorities $ 1,461,068 $ 0 $ (17,458) $ 1,443,609
States,
municipalities and political
subdivisions 145,199 665 (6,397) 139,467
Collateralized
mortgage obligations 0 0 0 0
Public utilities 119,970 363 (675) 119,658
All other corporate
bonds 258,424 4,222 (4,215) 258,432
1,984,661 5,250 (28,745) 1,961,166
Equity securities 2,086,159 37,000 (328,754) 1,794,405
Total $ 4,070,820 $ 42,250 $ (357,499) $ 3,755,571
Held to Maturity
Securities:
U.S. Government
and govt. agencies and
authorities $ 28,554,631 $ 421,523 $ (136,410) $ 28,839,744
States,
municipalities and political
subdivisions 14,421,735 318,682 (28,084) 14,712,333
Collateralized
mortgage
obligations 13,246,780 175,163 (157,799) 13,264,145
Public utilities 51,821,990 884,858 (381,286) 52,325,561
All other corporate
bonds 71,881,649 1,240,230 (448,437) 72,673,442
Total $ 179,926,785 $ 3,040,456 $ (1,152,016) $ 181,815,225
</TABLE>
The amortized cost of debt securities at December 31, 1997, 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.
Fixed Maturities Held Estimated
for Sale Amortized Market
December 31, 1997 Cost Value
<TABLE>
<S> <C> <C>
Due in one year or less $ 83,927 $ 84,952
Due after one year
through five years 1,533,202 1,528,211
Due after five years
through ten years 55,169 55,467
Due after ten years 0 0
Collateralized mortgage obligations 0 0
Total $ 1,672,298 $ 1,668,630
</TABLE>
47
<PAGE>
Fixed Maturities Held to Amortized Estimated
Maturity Cost Market
December 31, 1997 Value
<TABLE>
<S> <C> <C>
Due in one year or less $ 15,023,173 $ 15,003,728
Due after one year
through five years 118,849,668 120,857,201
Due after five years
through ten years 30,266,228 31,726,265
Due after ten years 5,737,338 5,987,726
Collateralized mortgage
obligations 11,093,926 11,207,648
Total $ 180,970,333 $ 184,782,568
</TABLE>
An analysis of sales, maturities and principal repayments of the
Company's fixed maturities portfolio for the years ended December 31,
1997, 1996 and 1995 is as follows:
Cost or Gross Gross Proceeds
Amortized Realized Realized From
Year ended December Cost Gains Losses Sale
31, 1997
<TABLE>
<S> <C> <C> <C> <C>
Scheduled principal repayments,
calls and tenders:
Held for sale $ 299,390 $ 931 $ (9,661) $ 290,660
Held to maturity 21,467,552 21,435 (722) 21,488,265
Sales:
Held for sale 0 0 0 0
Held to maturity 0 0 0 0
Total $ 21,766,942 $ 22,366 $(10,383) $ 21,778,925
</TABLE>
Cost or Gross Gross Proceeds
Amortized Realized Realized From
Year ended December Cost Gains Losses Sale
31, 1996
<TABLE>
<S> <C> <C> <C> <C>
Scheduled principal repayments,
calls and tenders:
Held for sale $ 699,361 $ 6,035 $ (813) $ 704,583
Held to maturity 20,900,159 13,469 (192,146) 20,721,482
Sales:
Held for sale 517,111 0 (2,658) 514,453
Held to maturity 18,735,848 81,283 (80,519) 18,736,612
Total $ 40,852,479 $ 100,787 $ (276,136) $ 40,677,130
</TABLE>
48
<PAGE>
Cost or Gross Gross Proceeds
Amortized Realized Realized From
Year ended December Cost Gains Losses Sale
31, 1995
<TABLE>
<S> <C> <C> <C> <C>
Scheduled principal repayments,
calls and tenders:
Held for sale $ 621,461 $ 0 $ (1,849) $ 619,612
Held to maturity 16,383,921 125,740 (244,521) 16,265,140
Sales:
Held for sale 0 0 0 0
Held to maturity 0 0 0 0
Total $ 17,005,382 $ 125,740 $ (246,370) $ 16,884,752
</TABLE>
C.INVESTMENTS ON DEPOSIT - At December 31, 1997, investments carried at
approximately $17,801,000 were on deposit with various state insurance
departments.
D.INVESTMENTS IN AND ADVANCES TO AFFILIATED COMPANIES - The Company's
investment in United Income, Inc., a 40% owned affiliate, is carried at
an amount equal to the Company's share of the equity of United Income.
The Company's equity in United Income, Inc. includes the original
investment of $194,304, an increase of $4,359,749 resulting from a
public offering of stock and the Company's share of earnings and losses
since inception.
5. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
The financial statements include various estimated fair value information
at December 31, 1997 and 1996, as required by Statement of Financial
Accounting Standards 107, Disclosure about Fair Value of Financial
Instruments ("SFAS 107"). Such information, which pertains to the
Company's financial instruments, is based on the requirements set forth in
that Statement and does not purport to represent the aggregate net fair
value of the Company.
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument required to be valued by SFAS 107 for
which it is practicable to estimate that value:
(a) Cash and Cash equivalents
The carrying amount in the financial statements approximates fair value
because of the relatively short period of time between the origination of
the instruments and their expected realization.
(b) Fixed maturities and investments held for sale
Quoted market prices, if available, are used to determine the fair value.
If quoted market prices are not available, management estimates the fair
value based on the quoted market price of a financial instrument with
similar characteristics.
(c) Mortgage loans on real estate
The fair values of mortgage loans are estimated using discounted cash flow
analyses and interest rates being offered for similar loans to borrowers
with similar credit ratings.
49
<PAGE>
(d) Investment real estate and real estate acquired in satisfaction
of debt
An estimate of fair value is based on management's review of the individual
real estate holdings. Management utilizes sales of surrounding properties,
current market conditions and geographic considerations. Management
conservatively estimates the fair value of the portfolio is equal to the
carrying value.
(e) Policy loans
It is not practicable to estimate the fair value of policy loans as they
have no stated maturity and their rates are set at a fixed spread to
related policy liability rates. Policy loans are carried at the aggregate
unpaid principal balances in the consolidated balance sheets, and earn
interest at rates ranging from 4% to 8%. Individual policy liabilities in
all cases equal or exceed outstanding policy loan balances.
(f) Short-term investments
For short-term instruments, the carrying amount is a reasonable estimate of
fair value. Short-term instruments represent United States Government
Treasury Bills and certificates of deposit with various banks that are
protected under FDIC.
(g) Notes and accounts receivable and uncollected premiums
The Company holds a $840,066 note receivable for which the determination of
fair value is estimated by discounting the future cash flows using the
current rates at which similar loans would be made to borrowers with
similar credit ratings and for the same remaining maturities. Accounts
receivable and uncollected premiums are primarily insurance contract
related receivables which are determined based upon the underlying
insurance liabilities and added reinsurance amounts, and thus are excluded
for the purpose of fair value disclosure by paragraph 8(c) of SFAS 107.
(h) Notes payable
For borrowings under the senior loan agreement, which is subject to
floating rates of interest, carrying value is a reasonable estimate of fair
value. For subordinated borrowings fair value was determined based on the
borrowing rates currently available to the Company for loans with similar
terms and average maturities.
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The estimated fair values of the Company's financial instruments
required to be valued by SFAS 107 are as follows as of December 31:
1997 1996
Estimated Estimated
Assets Carrying Fair Carrying Fair
Amount Value Amount Value
<TABLE>
<S> <C> <C> <C> <C>
Fixed
maturities $ 180,970,333 $ 184,782,568 $ 179,926,785 $ 181,815,225
Fixed maturities
held for sale 1,668,630 1,668,630 1,961,166 1,961,166
Equity
securities 3,001,744 3,001,744 1,794,405 1,794,405
Mortgage loans
on real estate 9,469,444 9,837,530 11,022,792 11,022,792
Policy loans 14,207,189 14,207,189 14,438,120 14,438,120
Short-term
investments 1,798,878 1,798,878 430,983 430,983
Investment in
real estate 9,760,732 9,760,732 9,779,984 9,779,984
Real estate
acquired in
satisfaction
of debt 1,724,544 1,724,544 1,724,544 1,724,544
Notes receivable 840,066 784,831 840,066 783,310
Liabilities
Notes payable 21,460,223 20,925,184 19,573,953 18,937,055
</TABLE>
6. STATUTORY EQUITY AND GAIN FROM OPERATIONS
The Company's insurance subsidiaries are domiciled in Ohio, Illinois and
West Virginia and prepare their statutory-based financial statements in
accordance with accounting practices prescribed or permitted by the
respective insurance department. These principles differ significantly
from generally accepted accounting principles. "Prescribed" statutory
accounting practices include state laws, regulations, and general
administrative rules, as well as a variety of publications of the National
Association of Insurance Commissioners ("NAIC"). "Permitted" statutory
accounting practices encompass all accounting practices that are not
prescribed; such practices may differ from state to state, from company to
company within a state, and may change in the future. The NAIC currently
is in the process of codifying statutory accounting practices, the result
of which is expected to constitute the only source of "prescribed"
statutory accounting practices. Accordingly, that project, which has not
yet been completed, will likely change prescribed statutory accounting
practices and may result in changes to the accounting practices that
insurance enterprises use to prepare their statutory financial statements.
UG's total statutory shareholders' equity was $10,997,365 and $10,226,566
at December 31, 1997 and 1996, respectively. The Company's insurance
subsidiaries reported combined statutory gain from operations (exclusive of
intercompany dividends) was $3,978,000, $10,692,000 and $4,076,000 for
1997, 1996 and 1995, respectively.
7. REINSURANCE
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. Failure of reinsurers to honor their obligations could
result in losses to the Company. The Company evaluates the financial
condition of its reinsurers to minimize its exposure to significant losses
from reinsurer insolvencies.
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The Company assumes risks from, and reinsures certain parts of its
risks with other insurers under yearly renewable term and coinsurance
agreements that are accounted for by passing a portion of the risk to the
reinsurer. Generally, the reinsurer receives a proportionate part of the
premiums less commissions and is liable for a corresponding part of all
benefit payments. While the amount retained on an individual life will
vary based upon age and mortality prospects of the risk, the Company
generally will not carry more than $125,000 individual life insurance on a
single risk.
The Company has reinsured approximately $1.022 billion, $1.109 billion and
$1.088 billion in face amount of life insurance risks with other insurers
for 1997, 1996 and 1995, respectively. Reinsurance receivables for future
policy benefits were $37,814,106 and $38,745,093 at December 31, 1997 and
1996, respectively, for estimated recoveries under reinsurance treaties.
Should any reinsurer be unable to meet its obligation at the time of a
claim, obligation to pay such claim would remain with the Company.
Currently, the Company is utilizing reinsurance agreements with Business
Men's Assurance Company, ("BMA") and Life Reassurance Corporation, ("LIFE
RE") for new business. BMA and LIFE RE each hold an "A+" (Superior) rating
from A.M. Best, an industry rating company. The reinsurance agreements
were effective December 1, 1993, and cover all new business of the Company.
The agreements are a yearly renewable term ("YRT") treaty where the Company
cedes amounts above its retention limit of $100,000 with a minimum cession
of $25,000.
One of the Company's insurance subsidiaries (UG) entered into a coinsurance
agreement with First International Life Insurance Company ("FILIC") as of
September 30, 1996. THE TRANSACTION RESULTED IN NO GAIN OR LOSS IN THE
GAAP FINANCIAL STATEMENTS. THE TRANSACTION WAS ENTERED INTO TO INCREASE
THE STATUTORY SURPLUS POSITION OF UG. THE CEDING COMMISSION RECEIVED WAS
EQUAL TO THE VALUE REFLECTED ON THIS BLOCK OF BUSINESS IN THE COST OF
INSURANCE ACQUIRED ASSET. THE CEDING COMMISSION REDUCED THIS ASSET. Under
the terms of the agreement, UG ceded to FILIC substantially all of its paid-
up life insurance policies. Paid-up life insurance generally refers to non-
premium paying life insurance policies. A.M. Best assigned FILIC a
Financial Performance Rating (FPR) of 7 (Strong) on a scale of 1 to 9.
A.M. Best assigned a Best's Rating of A++ (Superior) to The Guardian Life
Insurance Company of America ("Guardian"), parent of FILIC, based on the
consolidated financial condition and operating performance of the company
and its life/health subsidiaries. During 1997, FILIC changed its name to
Park Avenue Life Insurance Company ("PALIC"). The agreement with PALIC
accounts for approximately 65% of the reinsurance receivables as of
December 31, 1997.
The Company does not have any short-duration reinsurance contracts. The
effect of the Company's long-duration reinsurance contracts on premiums
earned in 1997, 1996 and 1995 was as follows:
Shown in thousands
1997 1996 1995
Premiums Premiums Premiums
Earned Earned Earned
<TABLE>
<S> <C> <C> <C>
Direct $ 33,374 $ 35,891 $ 38,482
Assumed 0 0 0
Ceded (4,735) (4,947) (5,383)
Net
premiums $ 28,639 $ 30,944 $ 33,099
</TABLE>
8. COMMITMENTS AND CONTINGENCIES
The insurance industry has experienced a number of civil jury verdicts
which have been returned against life and health insurers in the
jurisdictions in which the Company does business involving the insurers'
sales practices, alleged agent misconduct, failure to properly supervise
agents, and other matters. Some of the lawsuits have resulted in the award
of substantial judgments against the insurer, including material amounts of
punitive damages. In some states, juries have substantial discretion in
awarding punitive damages in these circumstances.
Under the insurance guaranty fund laws in most states, insurance companies
doing business in a participating state can be assessed up to prescribed
limits for policyholder losses incurred by insolvent or failed insurance
companies. Although the Company cannot predict the amount of any future
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assessments, most insurance guaranty fund laws currently provide that an
assessment may be excused or deferred if it would threaten an insurer's
financial strength. Mandatory assessments may be partially recovered
through a reduction in future premium tax in some states. The Company does
not believe such assessments will be materially different from amounts
already provided for in the financial statements.
The Company and its subsidiaries are named as defendants in a number of
legal actions arising primarily from claims made under insurance policies.
Those actions have been considered in establishing the Company's
liabilities. Management and its legal counsel are of the opinion that the
settlement of those actions will not have a material adverse effect on the
Company's financial position or results of operations.
9. RELATED PARTY TRANSACTIONS
UNDER THE CURRENT STRUCTURE, FCC PAYS A MAJORITY OF THE GENERAL OPERATING
EXPENSES OF THE AFFILIATED GROUP. FCC THEN RECEIVES MANAGEMENT, SERVICE
FEES AND REIMBURSEMENTS FROM THE VARIOUS AFFILIATES.
UII HAS A SERVICE AGREEMENT WITH USA. THE AGREEMENT WAS ORIGINALLY
ESTABLISHED UPON THE FORMATION OF USA WHICH WAS A 100% OWNED SUBSIDIARY OF
UII. CHANGES IN THE AFFILIATE STRUCTURE HAVE RESULTED IN USA NO LONGER
BEING A DIRECT SUBSIDIARY OF UII, THOUGH STILL A MEMBER OF THE SAME
AFFILIATED GROUP. THE ORIGINAL SERVICE AGREEMENT HAS REMAINED IN PLACE
WITHOUT MODIFICATION. USA IS TO PAY UII MONTHLY FEES EQUAL TO 22% OF THE
AMOUNT OF COLLECTED FIRST YEAR PREMIUMS, 20% IN SECOND YEAR AND 6% OF THE
RENEWAL PREMIUMS IN YEARS THREE AND AFTER. UII has a subcontract agreement
with UTI to perform services and provide personnel and facilities. The
services included in the agreement are claim processing, underwriting,
processing and servicing of policies, accounting services, agency services,
data processing and all other expenses necessary to carry on the business
of a life insurance company. UII's subcontract agreement with UTI states
that UII is to pay UTI monthly fees equal to 60% of collected service fees
from USA as stated above. THE SERVICE FEES RECEIVED FROM UII ARE RECORDED
IN UTI'S FINANCIAL STATEMENTS AS OTHER INCOME.
USA paid $989,295, $1,567,891 and $2,015,325 under their agreement with UII
for 1997, 1996 and 1995, respectively. UII paid $593,577, $940,734 and
$1,209,195 under their agreement with UTI for 1997, 1996 and 1995,
respectively. ADDITIONALLY, UII PAID FCC $150,000, $300,000 AND $600,000
IN 1997, 1996 AND 1995, RESPECTIVELY FOR REIMBURSEMENT OF COSTS ATTRIBUTED
TO UII. THESE REIMBURSEMENTS ARE REFLECTED AS A CREDIT TO GENERAL
EXPENSES.
Respective domiciliary insurance departments have approved the agreements
of the insurance companies and it is Management's opinion that where
applicable, costs have been allocated fairly and such allocations are based
upon generally accepted accounting principles. The costs paid by UTI for
services include costs related to the production of new business, which are
deferred as policy acquisition costs and charged off to the income
statement through "Amortization of deferred policy acquisition costs".
AMOUNTS RECORDED BY USA AS DEFERRED ACQUISITION COSTS ARE NO GREATER THAN
WHAT WOULD HAVE BEEN RECORDED HAD ALL SUCH EXPENSES BEEN DIRECTLY INCURRED
BY USA. Also included are costs associated with the maintenance of
existing policies that are charged as current period costs and included in
"general expenses".
On July 31, 1997, United Trust Inc. issued convertible notes for cash
received totaling $2,560,000 to seven individuals, all officers or
employees of United Trust Inc. The notes bear interest at a rate of 1%
over prime, with interest payments due quarterly and principal due upon
maturity of July 31, 2004. The conversion price of the notes are graded
from $12.50 per share for the first three years, increasing to $15.00 per
share for the next two years and increasing to $20.00 per share for the
last two years. Conditional upon the seven individuals placing the funds
with the Company were the acquisition by UTI of a portion of the holdings
of UTI owned by Larry E. Ryherd and his family and the acquisition of
common stock of UTI and UII held by Thomas F. Morrow and his family and the
simultaneous retirement of Mr. Morrow. Neither Mr. Morrow nor Mr. Ryherd
was a party to the convertible notes.
Approximately $1,048,000 of the cash received from the issuance of the
convertible notes was used to acquire stock holdings of United Trust Inc.
and United Income, Inc. of Mr. Morrow and to acquire a portion of the
United Trust Inc. holdings of Larry E. Ryherd and his family. The
remaining cash received will be used by the Company to provide additional
operating liquidity and for future acquisitions of life insurance
companies. On July 31, 1997, the Company acquired a total of 126,921
shares of United Trust Inc. common stock and 47,250 shares of United
Income, Inc. common stock from Thomas F. Morrow and his family. Mr. Morrow
simultaneously retired as an executive officer of the Company. Mr. Morrow
will remain as a member of the Board of Directors. In exchange for his
stock, Mr. Morrow and his family received approximately $348,000 in cash,
promissory notes valued at $140,000 due in eighteen months, and promissory
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<PAGE>
notes valued at $1,030,000 due January 31, 2005. These notes bear interest
at a rate of 1% over prime, with interest due quarterly and principal due
upon maturity. The notes do not contain any conversion privileges.
Additionally, on July 31, 1997, the Company acquired a total of 97,499
shares of United Trust Inc. common stock from Larry E. Ryherd and his
family. Mr. Ryherd and his family received approximately $700,000 in cash
and a promissory note valued at $251,000 due January 31, 2005. The
acquisition of approximately 16% of Mr. Ryherd's stock holdings in United
Trust Inc. was completed as a prerequisite to the convertible notes placed
by other management personnel to reduce the total holdings of Mr. Ryherd
and his family in the Company to make the stock more attractive to the
investment community. Following the transaction, Mr. Ryherd and his family
own approximately 31% of the outstanding common stock of United Trust Inc.
THE MARKET PRICE OF UTI COMMON STOCK ON JULY 31, 1997 WAS $6.00 PER SHARE.
THE STOCK ACQUIRED IN THE ABOVE TRANSACTION WAS FROM THE LARGEST TWO
SHAREHOLDERS OF UTI STOCK. THERE WERE NO ADDITIONAL STATED OR UNSTATED
ITEMS OR AGREEMENTS RELATING TO THE STOCK PURCHASE.
On September 23, 1997, the Company acquired 10,056 shares of UTI common
stock from Paul Lovell, a director, for $35,000 and a promissory note
valued at $61,000 due September 23, 2004. The note bears interest at a
rate of 1% over prime, with interest due quarterly and principal reductions
of $10,000 annually until maturity. Simultaneous with the stock purchase,
Mr. Lovell resigned his position on the UTI board.
On July 31,1997, the Company entered into employment agreements with eight
individuals, all officers or employees of the Company. The agreements have
a term of three years, excepting the agreements with Mr. Ryherd and Mr.
Melville, which have five-year terms. The agreements secure the services
of these key individuals, providing the Company a stable management
environment and positioning for future growth.
10. CAPITAL STOCK TRANSACTIONS
A. STOCK OPTION PLAN
In 1985, the Company initiated a nonqualified stock option plan for
employees, agents and directors of the Company under which options to
purchase up to 44,000 shares of UTI's common stock are granted at a
fixed price of $.20 per share. Through December 31, 1997 options for
42,438 shares were granted and exercised. Options for 1,562 shares
remain available for grant.
A summary of the status of the Company's stock option plan for the three
years ended December 31, 1997, and changes during the years ending on
those dates is presented below.:
1997 1996 1995
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
<TABLE>
<S> <C>
Outstanding at
beginning of year 1,562 $ 0.20 4,062 $ 0.20 6,062 $0.20
Granted 0 0.00 0 0.00 0 0.00
Exercised 0 0.00 (2,500) 0.20 (2,000) 0.20
Forfeited 0 0.00 0 0.00 0 0.00
Outstanding at end
of year 1,562 $ 0.20 1,562 $ 0.20 4,062 $0.20
Options exercisable
at year end 1,562 $ 0.20 1,562 $ 0.20 4,062 $0.20
Fair value of options granted
during the year $ 0.00 $ 5.43 $6.05
</TABLE>
The following information applies to options outstanding at December 31, 1997:
Number outstanding 1,562
Exercise price $ 0.20
Remaining contractual life Indefinite
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<PAGE>
B. DEFERRED COMPENSATION PLAN
UTI and FCC established a deferred compensation plan during 1993
pursuant to which an officer or agent of FCC, UTI or affiliates of UTI,
could defer a portion of their income over the next two and one-half
years in return for a deferred compensation payment payable at the end
of seven years in the amount equal to the total income deferred plus
interest at a rate of approximately 8.5% per annum and a stock option
to purchase shares of common stock of UTI. At the beginning of the
deferral period an officer or agent received an immediately exercisable
option to purchase 2,300 shares of UTI common stock at $17.50 per share
for each $25,000 ($10,000 per year for two and one-half years) of total
income deferred. The option expires on December 31, 2000. A total of
105,000 options were granted in 1993 under this plan. As of December
31, 1997 no options were exercised. At December 31, 1997 and 1996, the
Company held a liability of $1,376,384 and $1,267,598, respectively,
relating to this plan. At December 31, 1997, UTI common stock had a bid
price of $8.00 and an ask price of $9.00 per share.
The following information applies to deferred compensation plan stock
options outstanding at December 31, 1997:
Number outstanding 105,000
Exercise price $17.50
Remaining contractual life 3 years
C. CONVERTIBLE NOTES
On July 31, 1997, United Trust Inc. issued convertible notes for cash
in the amount of $2,560,000 to seven individuals, all officers or
employees of United Trust Inc. The notes bear interest at a rate of 1%
over prime, with interest payments due quarterly and principal due upon
maturity of July 31, 2004. The conversion price of the notes are
graded from $12.50 per share for the first three years, increasing to
$15.00 per share for the next two years and increasing to $20.00 per
share for the last two years. As of December 31, 1997, the notes were
convertible into 204,800 shares of UTI common stock with no conversion
privileges having been exercised. At December 31, 1997, UTI common
stock had a bid price of $8.00 and an ask price of $9.00 per share.
D. REVERSE STOCK SPLIT
On May 13, 1997, UTI effected a 1 for 10 reverse stock split.
Fractional shares received a cash payment on the basis of $1.00 for
each old share. The reverse split was completed to enable UTI to meet
new NASDAQ requirements regarding market value of stock to remain
listed on the NASDAQ market and to increase the market value per share
to a level where more brokers will look at UTI and its stock. Prior
period numbers have been restated to give effect of the reverse split.
11. REVERSE STOCK SPLIT OF FCC
On May 13, 1997, FCC effected a 1 for 400 reverse stock split.
Fractional shares received a cash payment on the basis of $.25 for each
old share. FCC maintained a significant number of shareholder accounts
with less than $100 of market value of stock. The reverse stock split
enabled these smaller shareholders to receive cash for their shares
without incurring broker costs and will save the Company administrative
costs associated with maintaining these small accounts.
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<PAGE>
12. NOTES PAYABLE
At December 31, 1997 and 1996, the Company has $21,460,223 and $19,573,953
in long-term debt outstanding, respectively. The debt is comprised of the
following components:
1997 1996
<TABLE>
<S> <C> <C>
Senior debt $ 6,900,000 $ 8,400,000
Subordinated 10 yr.
notes 5,746,774 6,209,293
Subordinated 20 yr.
notes 3,902,582 3,814,660
Convertible notes 2,560,000 0
Other notes payable 2,350,867 1,150,000
$ 21,460,223 $ 19,573,953
</TABLE>
A. Senior debt
The senior debt is through First of America Bank - Illinois NA and is
subject to a credit agreement. The debt bears interest at a rate equal to
the "base rate" plus nine-sixteenths of one percent. The Base rate is
defined as the floating daily, variable rate of interest determined and
announced by First of America Bank from time to time as its "base lending
rate." The base rate at December 31, 1997 was 8.5%. Interest is paid
quarterly. Principal payments of $1,000,000 are due in May of each year
beginning in 1997, with a final payment due May 8, 2005. On November 8,
1997, the Company prepaid the May 1998 principal payment.
The credit agreement contains certain covenants with which the Company must
comply. These covenants contain provisions common to a loan of this type
and include such items as; a minimum consolidated net worth of FCC to be no
less than 400% of the outstanding balance of the debt; Statutory capital
and surplus of Universal Guaranty Life Insurance Company be maintained at
no less than $6,500,000; an earnings covenant requiring the sum of the pre-
tax earnings of Universal Guaranty Life Insurance Company and its
subsidiaries (based on Statutory Accounting Practices) and the after-tax
earnings plus non-cash charges of FCC (based on parent only GAAP practices)
shall not be less than two hundred percent (200%) of the Company's interest
expense on all of its debt service. The Company is in compliance with all
of the covenants of the agreement.
B. Subordinated debt
The subordinated debt was incurred June 16, 1992 as a part of the
acquisition of the now dissolved Commonwealth Industries Corporation,
(CIC). The 10-year notes bear interest at the rate of 7 1/2% per annum,
payable semi-annually beginning December 16, 1992. These notes, except for
one $840,000 note, provide for principal payments equal to 1/20th of the
principal balance due with each interest installment beginning December 16,
1997, with a final payment due June 16, 2002. The aforementioned $840,000
note provides for a lump sum principal payment due June 16, 2002. In June
1997, the Company refinanced a $204,267 subordinated 10-year note as a
subordinated 20-year note bearing interest at the rate of 8.75% per annum.
The repayment terms of the refinanced note are the same as the original
subordinated 20 year notes. The original 20-year notes bear interest at
the rate of 8 1/2% per annum on $3,397,620 and 8.75% per annum on $504,962
(of which the $204,267 note refinanced in the current year is included),
payable semi-annually with a lump sum principal payment due June 16, 2012.
C. Convertible notes
On July 31, 1997, United Trust Inc. issued convertible notes for cash in
the amount of $2,560,000 to seven individuals, all officers or employees of
United Trust Inc. The notes bear interest at a rate of 1% over prime, with
interest payments due quarterly and principal due upon maturity of July 31,
2004. The conversion price of the notes are graded from $12.50 per share
for the first three years, increasing to $15.00 per share for the next two
years and increasing to $20.00 per share for the last two years.
D. Other notes payable
United Income, Inc. holds two promissory notes receivable totaling $850,000
due from FCC. Each note bears interest at the rate of 1% over prime as
published in the Wall Street Journal, with interest payments due quarterly.
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<PAGE>
Principal of $150,000 is due upon the maturity date of June 1, 1999, with
the remaining principal payment of $700,000 becoming due upon the maturity
date of May 8, 2006.
As partial proceeds in the acquisition of common stock from certain
officers and directors in the third quarter of 1997, the Company issued
unsecured promissory notes. These notes bear interest at 1% over prime
with interest payments due quarterly. Principal comes due at varying times
with $150,000 maturing on January 31, 1999, $1,654,507 maturing on July 31,
2005 and one note of $70,392 requiring annual principal reductions of
$10,000 until maturity on September 23, 2004. The interest rates were
deemed favorable to UTI and as a result, the Company has discounted the
notes to reflect a 15% effective rate of interest for financial statement
purposes. The notes have a total face maturity value of $1,874,899 and a
discounted value at December 31, 1997 of $1,500,867.
Scheduled principal reductions on the Company's debt for the next five
years is as follows:
Year Amount
1998 $ 526,504
1999 1,826,504
2000 1,526,504
2001 1,526,504
2002 4,690,758
13. OTHER CASH FLOW DISCLOSURES
On a cash basis, the Company paid $1,800,110, $1,700,973 and $1,934,326 in
interest expense for the years 1997, 1996 and 1995, respectively. The
Company paid $57,277, $17,634 and $25,821 in federal income tax for 1997,
1996 and 1995, respectively.
As partial proceeds for the acquisition of common stock of UTI and UII
during 1997, UTI issued promissory notes of $140,000 due in eighteen
months, $61,000 due in seven years and $1,281,000 due in seven and one-half
years.
One of the Company's insurance subsidiaries ("UG") entered into a
coinsurance agreement with Park Avenue Life Insurance Company ("PALIC") at
September 30, 1996. At closing of the transaction, UG received a
coinsurance credit of $28,318,000 for policy liabilities covered under the
agreement. UG transferred assets equal to the credit received. This
transfer included policy loans of $2,855,000 associated with policies under
the agreement and a net cash transfer of $19,088,000 after deducting the
ceding commission due UG of $6,375,000. THE TRANSACTION RESULTED IN NO
GAIN OR LOSS IN THE GAAP FINANCIAL STATEMENTS. THE TRANSACTION WAS ENTERED
INTO TO INCREASE THE STATUTORY SURPLUS POSITION OF UG. THE CEDING
COMMISSION RECEIVED WAS EQUAL TO THE VALUE REFLECTED ON THIS BLOCK OF
BUSINESS IN THE COST OF INSURANCE ACQUIRED ASSET. THE CEDING COMMISSION
REDUCED THIS ASSET. To provide the cash required to be transferred under
the agreement, the Company sold $18,737,000 of fixed maturity investments
HELD TO MATURITY.
14. NON-RECURRING WRITE DOWN OF VALUE OF AGENCY FORCE ACQUIRED
During the year-ended December 31, 1995, the Company recognized a non-
recurring write down of $8,297,000 on its value of agency force acquired.
The write down released $2,904,000 of the deferred tax liability and
$3,327,000 was attributed to minority interest in loss of consolidated
subsidiaries. In addition, equity loss of investees was negatively
impacted by $542,000. The effect of this write down resulted in an
increase in the net loss of $2,608,000. This write down is directly
related to the Company's change in distribution systems. Due to the broker
agency force not meeting management's expectations and lack of production,
the Company has changed its focus from a primarily broker agency
distribution system to a captive agent system. With the change in focus,
most of the broker agents were terminated and therefore, management re-
evaluated the value of the agency force carried on the balance sheet. For
purposes of the write-down, the broker agency force has no future expected
cash flows and therefore warranted a write-off of the value. The write
down is reported as a separate line item "non-recurring write down of value
of agency force acquired" and the release of the deferred tax liability is
reported in the credit for income taxes payable in the Statement of
Operations. In addition, the impact to minority interest in loss of
consolidated subsidiaries and equity loss of investees is in the Statement
of Operations.
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15. CONCENTRATION OF CREDIT RISK
The Company maintains cash balances in financial institutions that at times
may exceed federally insured limits. The Company has not experienced any
losses in such accounts and believes it is not exposed to any significant
credit risk on cash and cash equivalents.
16. NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board (FASB) has issued Statement of
Financial Accounting Standards (SFAS) No. 128 entitled Earnings per share,
which is effective for financial statements for fiscal years beginning
after December 15, 1997. SFAS No. 128 specifies the computation,
presentation, and disclosure requirements for earnings per share (EPS) for
entities with publicly held common stock or potential common stock. The
Statement's objective is to simplify the computation of earnings per share,
and to make the U.S. standard for computing EPS more compatible with the
EPS standards of other countries.
Under SFAS No. 128, primary EPS computed in accordance with previous
opinions is replaced with a simpler calculation called basic EPS. Basic
EPS is calculated by dividing income available to common stockholders
(i.e., net income or loss adjusted for preferred stock dividends) by the
weighted-average number of common shares outstanding. Thus, in the most
significant change in current practice, options, warrants, and convertible
securities are excluded from the basic EPS calculation. Further,
contingently issuable shares are included in basic EPS only if all the
necessary conditions for the issuance of such shares have been satisfied by
the end of the period.
Fully diluted EPS has not changed significantly but has been renamed
diluted EPS. Income available to common stockholders continues to be
adjusted for assumed conversion of all potentially dilutive securities
using the treasury stock method to calculate the dilutive effect of options
and warrants. However, unlike the calculation of fully diluted EPS under
previous opinions, a new treasury stock method is applied using the average
market price or the ending market price. Further, prior opinion
requirement to use the modified treasury stock method when the number of
options or warrants outstanding is greater than 20% of the outstanding
shares also has been eliminated. SFAS 128 also includes certain shares
that are contingently issuable; however, the test for inclusion under the
new rules is much more restrictive.
SFAS No. 128 requires companies reporting discontinued operations,
extraordinary items, or the cumulative effect of accounting changes are to
use income from operations as the control number or benchmark to determine
whether potential common shares are dilutive or antidilutive. Only
dilutive securities are to be included in the calculation of diluted EPS.
This statement was adopted for the 1997 Financial Statements. For all
periods presented the Company reported a loss from continuing operations so
any potential issuance of common shares would have an antidilutive effect
on EPS. Consequently, the adoption of SFAS No. 128 did not have an impact
on the Company's financial statement.
The FASB has issued SFAS No. 130 entitled Reporting Comprehensive Income
and SFAS No. 132 Employers' Disclosures about Pensions and Other
Postretirement Benefits. Both of the above statements are effective for
financial statements with fiscal years beginning after December 15, 1997.
SFAS No. 130 defines how to report and display comprehensive income and its
components in a full set of financial statements. The purpose of reporting
comprehensive income is to report a measure of all changes in equity of an
enterprise that result from recognized transactions and other economic
events of the period other than transactions with owners in their capacity
as owners.
SFAS No. 132 addresses disclosure requirements for post-retirement
benefits. The statement does not change post-retirement measurement or
recognition issues.
The Company will adopt both SFAS No. 130 and SFAS No. 132 for the 1998
financial statements. Management does not expect either adoption to have a
material impact on the Company's financial statements.
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17. PENDING CHANGE IN CONTROL OF UNITED TRUST, INC.
On February 19, 1998, UTI signed a letter of intent with Jesse T. Correll,
whereby Mr. Correll will personally or in combination with other
individuals make an equity investment in UTI over a period of three years.
UPON COMPLETION OF THE TRANSACTION MR. CORRELL WILL OWN 51% OF UTI. Under
the terms of the letter of intent Mr. Correll will buy 2,000,000 authorized
but unissued shares of UTI common stock for $15.00 per share and will also
buy 389,715 shares of UTI common stock, representing stock of UTI and UII,
that UTI purchased during the last eight months in private transactions at
the average price UTI paid for such stock, plus interest, or approximately
$10.00 per share. Mr. Correll also will purchase 66,667 shares of UTI
common stock and $2,560,000 of face amount of convertible bonds (which are
due and payable on any change in control of UTI) in private transactions,
primarily from officers of UTI.
UTI intends to use the equity that is being contributed to expand their
operations through the acquisition of other life insurance companies. The
transaction is subject to negotiation of a definitive purchase agreement;
completion of due diligence by Mr. Correll; the receipt of regulatory and
other approvals; and the satisfaction of certain conditions. The
transaction is not expected to be completed before June 30, 1998, and there
can be no assurance that the transaction will be completed.
18. PROPOSED MERGER
On March 25, 1997, the Board of Directors of UTI and UII voted to recommend
to the shareholders a merger of the two companies. Under the Plan of
Merger, UTI would be the surviving entity with UTI issuing one share of its
stock for each share held by UII shareholders.
UTI owns 53% of United Trust Group, Inc., an insurance holding company, and
UII owns 47% of United Trust Group, Inc. Neither UTI nor UII have any
other significant holdings or business dealings. The Board of Directors of
each company thus concluded a merger of the two companies would be in the
best interests of the shareholders. The merger will result in certain cost
savings, primarily related to costs associated with maintaining a
corporation in good standing in the states in which it transacts business.
A vote of the shareholders of UTI and UII regarding the proposed merger is
anticipated to occur sometime during the third quarter of 1998.
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19. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
1997
1st 2nd 3rd 4th
<TABLE>
<S> <C> <C> <C> <C>
Premium income
and other considerations,
net $ 7,926,386 $ 7,808,782 $ 6,639,394 $ 6,264,683
Net investment
income 3,844,899 3,825,457 3,686,861 3,500,080
Total revenues 11,965,571 11,871,953 10,354,133 9,800,673
Policy benefits
including dividends 7,718,015 6,861,699 6,467,739 6,007,718
Commissions and
amortization of DAC 1,110,410 553,913 1,083,006 869,036
Operating expenses 2,589,176 2,777,409 2,378,618 1,477,710
Operating income (loss)(393,242) 683,223 (679,495) 276,512
Net income (loss) 47,026 101,812 (524,441) (183,645)
Net income (loss)
per share 0.03 0.05 (0.28) (0.12)
</TABLE>
1996
1st 2nd 3rd 4th
<TABLE>
<S> <C> <C> <C> <C>
Premium income
and other considerations,
net $ 8,481,511 $ 8,514,175 $ 7,348,199 $ 6,600,573
Net investment income 3,973,349 3,890,127 4,038,831 3,966,140
Total revenues 12,870,140 12,455,875 11,636,614 10,013,741
Policy benefits
including dividends 6,528,760 7,083,803 8,378,710 8,334,759
Commissions and
amortization of DAC 1,161,850 924,174 703,196 1,435,665
Operating expenses 3,447,329 2,851,752 3,422,654 2,272,729
Operating income (loss) (71,615) (137,198) (2,346,454) (4,269,870)
Net income (loss) 304,737 9,038 (892,761) (358,917)
Net income (loss)
per share 0.16 0.00 (0.48) (0.18)
</TABLE>
1995
1st 2nd 3rd 4th
<TABLE>
<S> <C> <C> <C> <C>
Premium income
and other considerations,
net $ 9,445,222 $ 8,765,804 $ 7,868,803 $ 7,018,707
Net investment income 3,850,161 3,843,518 3,747,069 4,015,476
Total revenues 13,694,471 12,933,370 11,829,921 11,411,322
Policy benefits
including dividends 8,097,830 9,113,933 5,978,795 6,665,206
Commissions and
amortization of DAC 1,556,526 1,960,458 1,350,662 40,007
Operating expenses 3,204,217 2,492,689 2,232,938 3,587,804
Operating income (loss)(495,966) (1,939,361) 120,393 (9,060,886)
Net income (loss) 179,044 (689,602) 198,464 (2,689,151)
Net income (loss)
per share 0.10 (0.37) 0.11 (1.45)
</TABLE>
60
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