SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
AMENDMENT NUMBER 1 TO
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997Commission File Number 0-18540
UNITED INCOME, INC.
(Exact name of registrant as specified in its charter)
2500 CORPORATE EXCHANGE DRIVE
COLUMBUS, OH 43231
(Address of principal executive offices, including zip code)
OHIO 37-1224044
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Registrant's telephone number, including area code: (614) 899-6773
Amendment No. 1
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.
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 INCOME, 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: June 1, 1998
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UNITED INCOME, INC.
FORM 10-K/A
INDEX
PART I
ITEM 1. BUSINESS
Products 3
Marketing 4
PART II
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 5-18
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PART I, ITEM 1, BUSINESS, PRODUCTS OF UII SHOULD BE AMENDED AS FOLLOWS:
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 load is a general expense charge that is added to a
policy's net premium to cover the insurer's cost of doing business. 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 affiliates.
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,
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.
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
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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.
PART I, ITEM 1, BUSINESS, MARKETING OF UII SHOULD BE AMENDED AS FOLLOWS:
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. Captive agents work under an ordinary agency
distribution system which relies on career agents to sell and service
insurance and annuity policies of a single company. Independent agents
work under a brokerage distribution system which relies on brokers to
distribute the insurance and annuity policies of more than one company.
Both captive and independent agents work on a contractual basis and are
paid commissions on a percentage of premiums written. 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 referrals from existing policyholders and new
prospect lists obtained from newly recruited sales agents. Recruiting of
sales agents is based on referrals from existing agents and the invitation
to attend our Company's comprehensive training school. 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
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are progressing with a different unrelated party for change in control of
UTI. Please refer to 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
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.
AMEND PART II , ITEM 7 AS FOLLOWS:
UII MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997
At December 31, 1997 and 1996, the balance sheet reflects the assets and
liabilities of UII and its 47% equity interest in UTG. The statements of
operations and statements of cash flows presented for 1997, 1996 and 1995
include the operating results of UII.
RESULTS OF OPERATIONS
1997COMPARED TO 1996
(a) REVENUES
The Company's source of revenues is derived from service fee income which
is provided via a service agreement with USA. The service agreement
between UII and USA is to provide USA with certain administrative services.
Pursuant to the terms of the agreement, USA pays UII monthly fees equal to
22% of the amount of collected first year statutory premiums, 20% in second
year and 6% of the renewal premiums in years three and after. The Company
recognized service agreement income of $989,295, $1,567,891 and $2,015,325
in 1997, 1996 and 1995, respectively, based on statutory collected premiums
in USA of $10,300,332, $13,298,597, and $14,128,199 in 1997,1996 and 1995,
respectively. First year premium revenues of USA decreased 54% in 1997
from 1996. This decline is primarily related to the potential change in
control of UTI over the last two years to two different parties. The
possible changes and resulting uncertainties have hurt USA's ability to
recruit and maintain sales agents. Management expects first year
production to decline slightly in 1998, and then growth is anticipated in
subsequent periods following the resolution of the change in control of
UTI.
The Company holds $864,100 of notes receivable from affiliates. The notes
receivable from affiliates consists of three separate notes. The $700,000
note bears interest at the rate of 1% above the variable per annum rate of
interest most recently published by the Wall Street Journal as the prime
rate. Interest is payable quarterly with principal due at maturity on May
8, 2006. In February 1996, FCC borrowed an additional $150,000 from UII to
provide additional cash for liquidity. The note bears interest at the rate
of 1% over prime as published in the Wall Street Journal, with interest
payments due quarterly and principal due upon maturity of the note on June
1, 1999. The remaining $14,100 are 20 year notes of UTG with interest at
8.5% payable semi-annually. At current interest levels, the notes will
generate approximately $80,000 annually.
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(b) EXPENSES
The Company has a sub-contract service agreement with United Trust, Inc.
("UTI") for certain administrative services. Through its facilities and
personnel, UTI performs such services as may be mutually agreed upon
between the parties. The fees are based on 60% of the fees paid to UII by
USA. The Company has incurred $744,000, $1,241,000 and $1,809,000 in
service fee expense in 1997, 1996, and 1995, respectively.
Interest expense of $85,000, $84,000 and $89,000 was incurred in 1997, 1996
and 1995, respectively. The interest expense is directly attributable to
the convertible debentures. The Debentures bear interest at a variable
rate equal to one percentage point above the prime rate published in the
Wall Street Journal from time to time.
(c) EQUITY IN LOSS OF INVESTEES
Equity in earnings of investees represents UII's 47% share of the net loss
of UTG. Included with this filing as Exhibit 99(d) are audited financial
statements of UTG. Following is a discussion of the results of operations
of UTG:
Revenues of UTG
Premiums and policy fee revenues, net of reinsurance premiums and
policy fees, decreased 7% when comparing 1997 to 1996. UTG and its
subsidiaries 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
Principles ("GAAP") requires that premiums collected on these types of
products be treated as deposit liabilities rather than revenue. Unless
UTG and its subsidiaries' acquires a block of in-force business or
marketing changes its focus to traditional business, premium revenue
will continue to decline.
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 of UTG 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 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 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. UTG'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, UG sold $18,737,000 of fixed maturity investments.
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The overall investment yields for 1997, 1996 and 1995, are 7.25%, 7.31%
and 7.14%, 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 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 primary sales product. UTG and its subsidiaries'
monitor 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 $466,000 in 1997 and 1996,
respectively. UTG and its subsidiaries sold two foreclosed real estate
properties that resulted in approximately $357,000 in realized losses
in 1996. There were other gains and losses during the period that
comprised the remaining amount reported but were immaterial in nature
on an individual basis.
Expenses of UTG
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 UTG and its subsidiaries' 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 UTG and its subsidiaries' to repurchase
as many of the non-standard policies as possible. Through December 31,
1996, the UTG and its subsidiaries' 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
UTG and its subsidiaries' incurred life benefit costs of $3,307,000,
and $720,000 in 1996 and 1995, respectively. UTG and its subsidiaries'
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.
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
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 56% in 1997
compared to 1996. Cost of insurance acquired is amortized in relation
to expected future profits, including direct charge-offs for any excess
of the unamortized asset over the projected future profits. UTG and
its subsidiaries' did not have any charge-offs during the periods
covered by this report. The decrease in amortization during the
current period is a normal 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 average persistency rate for all policies in force for 1997
and 1996 has been approximately 89.4% and 87.9%, respectively.
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Operating expenses decreased 21% in 1997 compared to 1996. The
decrease in operating expenses is directly related to settlement of
certain litigation in December of 1996. UTG and its subsidiaries'
incurred legal costs of $0, $906,000 and $687,000 in 1997, 1996 and
1995, respectively in relation to the settlement of the non-standard
insurance policies.
Interest expense decreased 4% in 1997 compared to 1996. Since December
31, 1996, notes payable decreased approximately $758,000. Average
outstanding indebtedness was $19,461,000 with an average cost of 8.6%
in 1997 compared to average outstanding indebtedness of 20,652,000 with
an average cost of 8.5% in 1996. 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 Notes to the Consolidated Financial
Statements of UTG for more information.
Net loss of UTG
UTG had a net loss of $923,000 in 1997 compared to a net loss of
$1,661,000 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.
(d) NET LOSS
The Company recorded a net loss of $79,000 for 1997 compared to $319,000
for the same period one year ago. The net loss is from the equity share of
UTG's operating results.
RESULTS OF OPERATIONS
1996 COMPARED TO 1995
(a) REVENUES
The Company's source of revenues is derived from service fee income which
is provided via a service agreement with USA. The service agreement
between UII and USA is to provide USA with certain administrative services.
The fees are based on a percentage of premium revenue of USA. The
percentages are applied to both first year and renewal premiums at
different rates.
The Company holds $864,100 of notes receivable from affiliates. The notes
receivable from affiliates consists of three separate notes. The $700,000
note bears interest at the rate of 1% above the variable per annum rate of
interest most recently published by the Wall Street Journal as the prime
rate. Interest is payable quarterly with principal due at maturity on May
8, 2006. In February 1996, FCC borrowed an additional $150,000 from UII to
provide additional cash for liquidity. The note bears interest at the rate
of 1% over prime as published in the Wall Street Journal, with interest
payments due quarterly and principal due upon maturity of the note on June
1, 1999. The remaining $14,100 are 20 year notes of UTG with interest at
8.5% payable semi-annually. At current interest levels, the notes will
generate approximately $80,000 annually.
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(b) EXPENSES
The Company has a sub-contract service agreement with United Trust, Inc.
("UTI") for certain administrative services. Through its facilities and
personnel, UTI performs such services as may be mutually agreed upon
between the parties. The fees are based on a percentage of the fees paid
to UII by USA. The Company has incurred $1,241,000, $1,809,000, and
$1,210,000 in service fee expense in 1996, 1995, and 1994, respectively.
Interest expense of $84,000, $89,000 and $59,000 was incurred in 1996, 1995
and 1994, respectively. The interest expense is directly attributable to
the convertible debentures. The Debentures bear interest at a variable
rate equal to one percentage point above the prime rate published in the
Wall Street Journal from time to time.
(c) EQUITY IN LOSS OF INVESTEES
Equity in earnings of investees represents UII's 47% share of the net loss
of UTG. Included with this filing as Exhibit 99(d) are audited financial
statements of UTG. Following is a discussion of the results of operations
of UTG:
Revenues of UTG
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. UTG
and its subsidiaries' changed its marketing strategy from traditional
life insurance products to universal life insurance products.
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. UTG and its
subsidiaries' changed its marketing strategy to remain competitive
based on consumer demand.
In addition, UTG and its subsidiaries' changed its focus from primarily
a broker agency distribution system to a captive agent system.
Business written by the broker agency force, in recent years, did not
meet UTG and its subsidiaries' 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. Broker agents sell insurance and
related products for several companies. Captive agents sell for only
one company.
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. 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 7.31% and 7.14%,
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 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 primary sales product. UTG and its subsidiaries'
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 UTG and its subsidiaries'
currently has in force and will write in the future.
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Realized investment losses were $466,000 and $114,000 in 1996 and 1995,
respectively. UTG and its subsidiaries' sold two foreclosed real
estate properties that resulted in approximately $357,000 in realized
losses in 1996. There were other gains and losses during the period
that comprised the remaining amount reported but were immaterial in
nature on an individual basis.
Expenses of UTG
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 UTG and its subsidiaries' 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 UTG and its subsidiaries' to repurchase
as many of the non-standard policies as possible. Through December 31,
1996, UTG and its subsidiaries' 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
UTG and its subsidiaries incurred life benefits of $3,307,000 and
$720,000 in 1996 and 1995, respectively. UTG and its subsidiaries'
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. UTG and its insurance subsidiaries'
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 26% in 1996
compared to 1995. Cost of insurance acquired is amortized in relation
to expected future profits, including direct charge-offs for any excess
of the unamortized asset over the projected future profits. UTG and
its subsidiaries' did not have any charge-offs during the periods
covered by this report. The increase in amortization during the
current period is a normal 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.
UTG and its subsidiaries' 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 change in distribution
systems. UTG and its subsidiaries' 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
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.
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Operating expenses increased 6% 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.
UTG and its subsidiaries' 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.
Interest expense decreased 12% in 1996 compared to 1995. Since
December 31, 1995, notes payable decreased approximately $1,623,000
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 12 "Notes Payable" of the
Consolidated Notes to the Financial Statements of UTG for more
information on this matter.
Net loss of UTG
UTG and its subsidiaries' had a net loss of $1,661,000 in 1996 compared
to a net loss of $5,321,000 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.
(d) NET LOSS
The Company recorded a net loss of $319,000 for 1996 compared to a net loss
of $2,148,000 for the same period one year ago. The net loss is from the
equity share of UTG's operating results.
FINANCIAL CONDITION
The Company owns 47% equity interest in UTG which controls total assets of
approximately $348,000,000. Audited financial statements of UTG are
presented as Exhibit 99(d) of this filing.
LIQUIDITY AND CAPITAL RESOURCES
Since UII is a holding company, funds required to meet its debt service
requirements and other expenses are primarily provided by its affiliates.
UII's cash flow is dependent on revenues from a management agreement with
USA and its earnings received on invested assets and cash balances. At
December 31, 1997,substantially all of the shareholders equity represents
investment in affiliates. UII does not have significant day to day
operations of its own. Cash requirements of UII primarily relate to the
payment of interest on its convertible debentures and expenses related to
maintaining the Company as a corporation in good standing with the various
regulatory bodies which govern corporations in the jurisdictions where the
Company does business. 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 UII due to the
ownership structure. Please refer to Note 1 of the Notes to the Financial
Statements. UG's dividend limitations are described below without effect
of the ownership structure. Please refer to Note 1 of the Notes to the
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 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.
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The Company currently has $711,000 in cash and cash equivalents. The
Company holds one mortgage loan. Operating activities of the Company
produced cash flows of $324,097, $255,675 and $326,905 in 1997, 1996 and
1995, respectively. The Company had uses of cash from investing activities
of $50,764, $180,402 and $192,801 in 1997, 1996 and 1995, respectively.
Cash flows from financing activities were ($2,112), $33 and $0 in 1997,
1996 and 1995, respectively.
In early 1994, UII received $902,300 from the sale of Debentures. The
Debentures were issued pursuant to an indenture between the Company and
First of America Bank - Southeast Michigan, N.A., as trustee. The
Debentures are general unsecured obligations of UII, subordinate in right
of payment to any existing or future senior debt of UII. The Debentures
are exchangeable and transferable, and are convertible at any time prior to
March 31, 1999 into UII's Common Stock at a conversion price of $25 per
share, subject to adjustment in certain events. The Debentures bear
interest from March 31, 1994, payable quarterly, at a variable rate equal
to one percentage point above the prime rate published in the Wall Street
Journal from time to time. The prime rate was 8.25% during first quarter
1997, increasing to 8.5% April 1, 1997, and has remained unchanged. On or
after March 31, 1999, the Debentures will be redeemable at UII's option, in
whole or in part, at redemption prices declining from 103% of their
principal amount. No sinking fund will be established to redeem the
Debentures. The Debentures will mature on March 31, 2004. The Debentures
are not listed on any national securities exchange or the NASDAQ National
Market System.
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
affiliates. 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 that the overall sources of liquidity available to the
Company will be more than sufficient to satisfy its financial obligations.
REGULATORY ENVIRONMENT
The Company's insurance affiliates 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 affiliates 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 affiliates,
USA, UG, APPL and ABE are domiciled in the states of Ohio, Ohio, West
Virginia and Illinois, respectively.
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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 affiliates 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 affiliates 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
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.
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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.
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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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
affiliates. 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.
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.
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.
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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.
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