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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
AMENDMENT NO. 1 TO
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
May 12, 1998
(Date of Report [Date of earliest event reported]))
CITIZENS FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Commission file number 0-20148
Kentucky 61-1187135
(State of Incorporation) (I.R.S. Employer Identification No.)
The Marketplace, Suite 300, 12910 Shelbyville Road, Louisville, Kentucky
40243
(Address of principal executive offices)
(502) 244-2420
(Registrant's telephone number)
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Citizens Financial Corporation and Subsidiaries
Form 8K/A, Amendment #1
This Current Report on Form 8-K was filed by Citizens Financial Corporation
(the "Company") to report its acquisition of United Liberty Life Insurance
Company ("United"). The purpose of this amendment is to amend the Report to
file, pursuant to Item 7, annual (audited) financial statements of United,
interim financial statements of United, and pro forma consolidated financial
statements of the Company.
Item 7. Financial Statements and Exhibits
(a) Annual Financial Statements (audited) of business acquired. The
following financial statements of United, notes related thereto
and report of independent auditors therein are filed as a part of
this Current Report on Form 8-K.
Index to Financial Statements of United Liberty Life Insurance
Company
(for the years ended December 31, 1997 and 1996)
Report of Independent Auditors
Statements of Operations
Statements of Financial Condition
Statements of Shareholder's Equity
Statements of Cash Flows
Notes to Financial Statements
(b) Interim Financial Statements (unaudited) of business acquired.
The following unaudited interim financial statements of United and
notes related thereto are filed as a part of this Current Report
on Form 8-K.
To be submitted in a subsequent amendment.
(c) Pro forma Financial Information (unaudited). The following pro
forma consolidated financial statements of the Company are filed as
a part of this Current Report on Form 8-K.
To be submitted in a subsequent amendment.
Signatures
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
Citizens Financial Corporation
By:/s/Darrell R. Wells
Darrell R. Wells
President
By: /s/Brent L. Nemec
Brent L. Nemec
Chief Financial Officer
Date: July 27, 1998
United Liberty Life Insurance Company
Financial Statements
Years ended December 31, 1997 and 1996
Contents
Report of Independent Auditors...............................................1
Audited Financial Statements
Statements of Operations.....................................................2
Statements of Financial Condition............................................3
Statements of Shareholder's Equity...........................................5
Statements of Cash Flows.....................................................6
Noted to Financial Statements................................................7
REPORT OF INDEPENDENT AUDITORS
The Shareholder and Board of Directors
United Liberty Life Insurance Company
We have audited the accompanying statements of financial condition of United
Liberty Life Insurance Company as of December 31, 1997 and 1996, and the
related statements of operations, shareholder's equity and cash flows for the
years then ended. 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 financial position of United Liberty Life
Insurance Company at December 31, 1997 and 1996, and the results of its
operations and its cash flows for the years then ended, in conformity with
generally accepted accounting principles.
/s/ Ernst & Young LLP
Louisville, Kentucky
July 20, 1998
Statements of Operations
United Liberty Life Insurance Company
Year Ended December 31 1997 1996
- --------------------------------------------------------------------------------
Revenues:
Premiums and other considerations $4,735,414 $9,585,659
Premiums ceded (128,050) (157,593)
- --------------------------------------------------------------------------------
Net premiums earned 4,607,364 9,428,066
Net investment income 2,374,367 2,200,511
Net realized investment gains 332,492 40,146
Other income (loss) 91,880 (294)
- --------------------------------------------------------------------------------
Total Revenues 7,406,103 11,668,429
Benefits and Expenses:
Policyholder benefits 4,420,044 4,151,960
Policy holder benefits ceded (156,607) (93,129)
- --------------------------------------------------------------------------------
Net benefits 4,263,437 4,058,831
Increase in net benefit reserves 865,179 5,043,861
Commissions 510,315 1,288,089
General expenses 1,046,629 1,468,765
Policy acquisition costs deferred (88,874) (147,037)
Amortization expense:
Deferred policy acquisition costs 194,926 178,807
Value of insurance acquired 25,000 19,000
- --------------------------------------------------------------------------------
Total Benefits and Expenses 6,816,612 11,910,316
- --------------------------------------------------------------------------------
Income (Loss) before Federal Income Tax 589,491 (241,887)
Federal Income Tax (Benefit) 104,380 (61,619)
- --------------------------------------------------------------------------------
Net Income (Loss) $485,111 $(180,268)
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Net Income (Loss) Per Common Share - Basic: $ .31 $ (0.11)
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
Statements of Financial Condition
December 31 1997 1996
- --------------------------------------------------------------------------------
ASSETS
Investments:
Securities available for sale, at fair value:
Fixed maturities (amortized cost of
$34,798,847 and $35,628,029 $31,381,084
$31,284,915 in 1997 and 1996,
respectively)
Equity securities (cost of $198,157 and
$199,048 in 85,883 87,137
1997 and 1996, respectively)
Mortgage loans on real estate 1,648,554 1,730,211
Policy loans 1,224,321 1,421,418
Real estate owned - held for sale 892,177 793,001
- --------------------------------------------------------------------------------
Total Investments 39,478,964 35,412,851
Cash and cash equivalents 239,853 2,343,383
Accrued investment income 736,924 666,764
Reinsurance recoverable:
Paid benefits and losses 802 ---
Unpaid benefits, losses and IBNR 1,505,614 1,394,570
Value of insurance acquired 918,000 943,000
Deferred policy acquisition costs 366,203 472,255
Deferred federal income tax 452,535 603,864
Federal income tax receivable --- 11,141
Receivable - defaulted investment settlement 200,000 ---
Property and equipment 9,759 18,346
Other assets 107,463 120,858
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Total Assets $44,016,117 $41,987,032
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See Notes to Financial Statements.
United Liberty Life Insurance Company
December 31 1997 1996
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LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities
Policy liabilities:
Future policy benefits $39,263,147 $38,391,580
Policy and contract claims 149,089 148,696
Unearned premiums 62,923 66,700
Other 29,120 43,135
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Total Policy Liabilities 39,504,279 38,650,111
Accrued expenses and other liabilities 755,675 561,170
Federal income tax payable 11,752 ---
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Total Liabilities 40,271,706 39,211,281
Commitments and Contingencies
Shareholder's Equity
Common stock, $1 par value; 5,000,000 shares
authorized; 1,586,891 1,586,891
1,586,891 shares issued and outstanding
Additional paid-in capital 1,794,711 1,794,711
Unrealized appreciation of investments 473,159 (10,390)
Retained earnings (110,350) (595,461)
- --------------------------------------------------------------------------------
Total Shareholder's Equity 3,744,411 2,775,751
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Total Liabilities and Shareholder's Equity $44,016,117 $41,987,032
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See Notes to Financial Statements.
Statements of Shareholder's Equity
United Liberty Life Insurance Company
<TABLE>
Net
Unrealized
Appreciation
Common Additional (Depreciation) Retained
Stock Paid-in of Earnings
Capital Available-for-Sale
Securities
- --------------------------------------------------------------------------------
<CAPTION>
<S> <C> <C> <C> <C>
Balance at January 1, 1996 $1,586,891 $1,794,711 $ 482,795 $(415,193)
Net income (180,268)
Net unrealized
depreciation of (493,185)
available-for-sale
securities
- --------------------------------------------------------------------------------
Balance at December 31, 1996 1,586,891 1,794,711 (10,390) (595,461)
Net income 485,111
Net unrealized
appreciation of 483,549
available-for-sale
securities
- --------------------------------------------------------------------------------
Balance at December 31, 1997 $1,586,891 $1,794,711 $473,159 $(110,350)
- --------------------------------------------------------------------------------
</TABLE>
See Notes to Financial Statements.
Statements of Cash Flows
United Liberty Life Insurance Company
Year Ended December 31 1997 1996
- --------------------------------------------------------------------------------
Cash Flows from Operations:
Net Income $ 485,111 $ (180,268)
Adjustments to reconcile net income to net cash flows
from operations:
Increase in policy liabilities 854,168 5,081,549
(Increase) decrease in reinsurance recoverable: (111,846) 45,757
Provision for amortization and depreciation, net of 145,589 64,706
deferrals
Amortization of premium and accretion of discount
on securities 58,976 67,818
purchased net
Net realized investment gains (332,492) (40,146)
Increase in accrued investment income (70,160) (95,611)
Change in other assets and other liabilities 207,900 120,524
Deferred federal income taxes (97,772) (111,657)
Federal income taxes payable 22,893 70,997
- --------------------------------------------------------------------------------
Net Cash Flows Provided by Operations 1,162,367 5,023,669
Cash Flows from Investment Activities:
Purchases - fixed maturities (6,780,651) (6,833,701)
Sales - fixed maturities 3,238,873 2,497,117
Purchases - mortgage loans (5,630) (1,523)
Sales - mortgage loans 87,287 60,114
Additions to real estate owned (155,543) (210,659)
Sale of real estate owned 158,620 12,664
Additions to property and equipment (5,950) (3,078)
Decrease in net policy loans 197,097 135,634
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Net Cash Used In Investment Activities (3,265,897) (4,343,432)
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Net Increase (Decrease) in Cash and Cash Equivalents (2,103,530) 680,237
Cash and Cash Equivalents at Beginning of Year 2,343,383 1,663,146
- --------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Year $ 239,853 $ 2,343,383
- --------------------------------------------------------------------------------
See notes to Financial Statements.
NOTES TO FINANCIAL STATEMENTS
Note 1--NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations. United Liberty Life Insurance Company (the "Company")
is domiciled in Ohio and is a wholly owned subsidiary of Chaswil United
Corporation ("Chaswil"). The Company sells pre-need traditional life
insurance policies along with other basic forms of traditional life insurance
primarily through independent agencies throughout the United States, with the
largest concentrations in the states of Ohio, Indiana, and Kentucky, along
with reinsurance assumed from Wisconsin (see Note 8).
By an agreement dated December 12, 1997, Chaswil entered into a stock
purchase agreement to sell all of the issued and outstanding capital stock of
the Company to Citizens Security Life Insurance Company ("Citizens
Security"). This sale was completed on May 12, 1998, for approximately $6.4
million, subject to final purchase price adjustments (see Note 12).
Use of Estimates. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Investments. The Company classifies fixed maturities and equity securities
as "available-for-sale". Available-for-sale securities are carried at fair
value, with unrealized gains and losses included in shareholder's equity, net
of applicable deferred taxes.
Fixed maturities and equity securities having a decline in value considered
by management to be other than temporary are adjusted to an amount which, in
management's judgment, reflects such declines. Such amounts are included in
net realized investment gains and losses. For purposes of computing realized
gains and losses on fixed maturities and equity securities sold, the carrying
value is determined using the specific-identification method. Mortgage loans
and policy loans are carried at unpaid balances. Real estate owned is
carried at cost. Cash and cash equivalents consist of highly liquid
investments with maturities of three months or less at the date of purchase
and are also carried at cost which approximates fair value.
Deferred Policy Acquisition Costs. Commissions and other policy acquisition
costs which vary with, and are primarily related to, the production of new
insurance contracts are deferred, to the extent recoverable from future
policy revenues and gross profits, and amortized over the life of the related
contracts. See Premiums, Benefits and Expenses regarding amortization
methods.
Property and Equipment. Property and equipment are carried at cost less
accumulated depreciation, using principally the straight-line method of
depreciation. At December 31, 1997, accumulated depreciation was $161,304
($146,767 at December 31, 1996).
Value of Insurance Acquired. Value of insurance acquired is recorded for the
estimated value assigned to the insurance in force of the purchased
subsidiaries at the dates of acquisition. The assigned value is amortized
over the expected remaining life of the insurance in force using methods
consistent with that used for amortization of policy acquisition costs (as
described under Premiums, Benefits and Expenses). At December 31, 1997,
accumulated amortization was $63,000 ($38,000 at December 31, 1996).
Benefit Reserves. Traditional life products include those contracts with
fixed and guaranteed premiums and benefits. Reserves on such policies are
based on assumed investment yields which range from 6% to 8%. Reserves on
traditional life and accident and health insurance products are determined
using the net level premium method based on future investment yields,
mortality, withdrawals and other assumptions, including dividends on
participating policies. Such assumptions are based on past experience and
include provisions for possible unfavorable deviation.
Participating insurance business at December 31, 1997 and 1996 constituted
approximately 44% and 46% respectively, of ordinary life insurance in force
and 36% and 34% respectively, of annualized ordinary life premium in force.
Participating dividends are paid annually based on statutory earnings times a
fraction derived from the number of participating policies in force.
Reserves on insurance policies acquired by purchase are based on assumptions
considered appropriate as of the date of purchase. The assumed investment
yield for such acquired policies is 8%.
Premiums, Benefits and Expenses. Premiums for traditional individual life
and accident and health policies are reported as earned when due. Benefit
claims (including an estimated provision for claims incurred but not
reported), benefit reserve changes and expenses (except those deferred) are
charged to expense as incurred. Deferred policy acquisition costs related to
traditional life and accident and health are charged to expense over the life
of the policy using methods and assumptions consistent with those used in
estimating liabilities for future policy benefits. In determining whether a
premium deficiency exists on short-duration policies, management does not
give consideration to investment income.
Liabilities for Policy Claims. Policy claim liabilities are based on known
liabilities plus estimated future liabilities developed from trends of
historical data applied to current exposures. These liabilities are closely
monitored and adjustments for changes in experience are made in the period
identified.
Federal Income Taxes. The company uses the liability method of accounting
for income taxes. Deferred income taxes are provided for cumulative
temporary differences between balances of assets and liabilities determined
under generally accepted accounting principles and balances determined for
tax reporting purposes.
Earnings Per Share. In 1997, the Financial Accounting Standards Board issued
SFAS No. 128, Earnings per Share. SFAS 128 replaced the calculation of
primary and fully diluted earnings per share with basic and diluted earnings
per share. Unlike primary earnings per share, basic earnings per share
excludes any dilutive effects of options, warrants, and convertible
securities. Diluted earnings per share is very similar to the previously
reported fully diluted earnings per share. All earnings per share amounts
for all periods have been presented to conform to the SFAS 128 requirements.
Basic earnings per share amounts are based on the weighted average number of
common shares outstanding during the year (1,586,891 shares in 1997 and
1996). There were no dilutive securities outstanding during 1997 or 1996.
Note 2--INVESTMENTS
The cost and fair value of investments in fixed maturities and equity
securities are shown below. The cost amounts are adjusted for amortization
of premium and accretion of discount on fixed maturities and for write-downs
of securities whose decline in value is believed to be other than temporary.
Amortized Gross Unrealized Fair Value
December 31, 1997 Cost Gains Losses (Carrying Value)
- -------------------------------------------------------------------------------
Fixed Maturities:
U. S. government obligations $2,211,902 $57,954 $1,206 $2,268,650
Corporate securities 28,647,680 811,971 102,272 29,357,379
Public utilities 3,939,265 70,154 7,419 4,002,000
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Total $34,798,847 $940,079 $110,897 $35,628,029
- -------------------------------------------------------------------------------
Equity securities $198,157 $ --- $112,274 $ 85,883
- -------------------------------------------------------------------------------
December 31, 1996
- -------------------------------------------------------------------------------
Fixed Maturities:
U. S. government obligations $2,233,390 $52,295 $4,435 $ 2,281,250
Corporate securities 25,188,228 359,728 287,622 25,260,334
Public utilities 3,863,297 36,155 59,952 3,839,500
- -------------------------------------------------------------------------------
Total $31,284,915 $448,178 $352,009 $31,381,084
- -------------------------------------------------------------------------------
Equity securities $199,048 $ --- $111,911 $ 87,137
- -------------------------------------------------------------------------------
The fair values for investments in fixed maturities and equity securities are
based on quoted market prices, where available. For investments in fixed
maturities and equity securities not actively traded, fair values are
estimated using values obtained from independent pricing services.
The amortized cost and fair value of investments in fixed maturities at
December 31, 1997, by contractual maturity, are shown below. Expected
maturities for investments in fixed maturities will differ from contractual
maturities because borrowers may have the right to call or prepay
obligations, sometimes without prepayment penalties.
December 31, 1997 Amortized Cost Fair Value
- -------------------------------------------------------------------------------
Due in one year or less $999,959 $1,002,500
Due after one year through five years 11,000,749 11,232,780
Due after five years through ten years 22,557,532 23,140,353
Due after ten years 240,607 252,396
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Total $34,798,847 $35,628,029
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Net unrealized appreciation (depreciation) of available-for-sale securities
is summarized as follows:
December 31 1997 1996
- -------------------------------------------------------------------------------
Net appreciation (depreciation) on
available-for-sale
Fixed maturities $ 829,182 $96,169
Equity securities (112,274) (111,911)
Deferred income taxes (243,749) 5,352
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Net Unrealized Appreciation $ 473,159 $(10,390)
- -------------------------------------------------------------------------------
The change in net unrealized investment appreciation or depreciation for the
years ended December 31, 1997 and 1996 is as follows:
Year Ended December 31 1997 1996
- -------------------------------------------------------------------------------
Fixed Maturities: $733,013 $(746,832)
Equity Securities: $ (363) $ (417)
Realized capital gains and losses for 1997 and 1996 include the following:
Year Ended December 31 1997 1996
- -------------------------------------------------------------------------------
Fixed Maturities:
Gross gains $59,468 $ 56,013
Gross losses (29,229) (21,780)
Real estate owned 102,253 5,913
Recovery on previously defaulted bond 200,000 --
- -------------------------------------------------------------------------------
Total $332,492 $ 40,146
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Major categories of investment income are summarized as follows:
Year Ended December 31 1997 1996
- -------------------------------------------------------------------------------
Fixed maturities $2,323,663 $1,985,106
Equity securities 3,008 ---
Mortgage loans on real estate 175,310 186,053
Policy loans 65,011 72,883
Real estate owned 111,747 381,198
Short-term investments and other 61,264 154,480
- -------------------------------------------------------------------------------
Subtotal 2,740,003 2,779,720
Investment expenses (365,636) (579,209)
- -------------------------------------------------------------------------------
Net Investment Income $2,374,367 $2,200,511
- -------------------------------------------------------------------------------
The Company limits credit risk by diversifying its investment portfolio among
government and corporate fixed maturities and common and preferred equity
securities. It further diversifies these investment portfolios within
industry sectors. As a result, management believes that significant
concentrations of credit risk do not exist. At December 31, 1997, and 1996,
the Company's largest investment in any entity (other than the U.S.
Government) was $892,177 and $793,001, respectively, of real estate owned.
At December 31, 1997, the Company had no investments which had not been
income producing for a period of at least twelve months prior to year end.
Pursuant to requirements of certain state insurance departments, the Company
has investments with a carrying value of approximately $9,870,000, at
December 31, 1997, placed on deposit at various financial institutions which
are restricted from withdrawal without prior regulatory approval.
Additionally, investments in bonds totaling approximately $7,448,000 at
December 31, 1997 were held in trust pursuant to terms of a reinsurance
agreement (see Note 8).
At December 31, 1997 and 1996, the carrying value of mortgage loans on real
estate was $1,648,554 and $1,730,211 respectively. The mortgage loans are
collateralized with real estate located in the states of Florida, Kentucky,
South Carolina and Ohio, and bear interest rates ranging from 7% to 14%. As
of December 31, 1997, the Company had one mortgage loan amounting to $126,701
which was over 90 days past due on principal and interest payments. The
Company has initiated foreclosure proceedings on the past due loan.
The Company owns real estate property which was acquired in satisfaction of
debt during 1995. During 1997 and 1996, the Company capitalized an
additional $153,741 and $210,659, respectively, for renovations to the
property, real estate taxes, and additional legal fees in preparation of the
property for sale.
Note 3--VALUE OF INSURANCE ACQUIRED
The value of insurance acquired is an asset which represents the present
value of future profits on business acquired, using an interest rate of 8%.
An analysis of the value of insurance acquired for the years ended December
31, 1997 and 1996 is as follows:
Year ended December 31 1997 1996
- -------------------------------------------------------------------------------
Balance at beginning of year $943,000 $962,000
Accretion of interest 75,000 77,000
Amortization (100,000) (96,000)
- -------------------------------------------------------------------------------
Balance at end of year $918,000 $943,000
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Amortization of the value of insurance acquired (net of interest accretion)
in each of the following five years will be approximately: 1998 - $30,000;
1999 - $36,000; 2000 - $41,000; 2001 - $44,000; and 2002 - $44,000.
Note 4--CAPITAL STOCK
A bank has a first priority pledge and security interest in all of the
outstanding capital stock of the Company as collateral for a term loan to
Chaswil under an agreement (the "Term Loan Agreement") between Chaswil and
the bank. Since 1995, Chaswil has not been in compliance with the terms of
certain provisions of the Term Loan Agreement, including required payments to
the bank. The bank has not provided a waiver for any noncompliance and, as a
result, the Company was sold to Citizens Security on May 12, 1998 (see Note
12) and the bank's first priority pledge and security interest in all of the
outstanding capital stock of the Company was removed.
Note 5--DEFINED CONTRIBUTION PENSION PLAN
The Company offers a defined contribution pension plan, which includes a
401(k) provision, (the "Plan") that is available to all Company employees who
have attained an age of 21. Contributions are determined by the Company for
each plan year and are fully vested to an employee after five years of
service. Contributions to the Plan during 1997 and 1996 were not significant.
Note 6--FEDERAL INCOME TAXES
The Company and Chaswil file a consolidated federal income tax return. Under
a written tax sharing agreement, the Company collects from, or refunds to,
Chaswil the amount of taxes or benefits determined as if the Company and
Chaswil filed separate returns. Subsequent to the sale of the Company to
Citizens Security, the Company will file a separate federal income tax return
with the Internal Revenue Service.
Income before federal income taxes differs from taxable income principally
due to the small life insurance company deduction, proxy deferred policy
acquisition costs, and differences in policy and contract liabilities for tax
return and financial statement purposes.
Federal income taxes consist of the following:
Year Ended December 31 1997 1996
- -------------------------------------------------------------------------------
Current tax expense $202,152 $50,038
Deferred tax benefit (97,772) (111,657)
- -------------------------------------------------------------------------------
Federal income tax expense (benefit) $104,380 $(61,619)
- -------------------------------------------------------------------------------
Deferred income taxes are provided for cumulative temporary differences
between balances of assets and liabilities determined under generally
accepted accounting principles and balances determined for tax reporting
purposes. Significant components of the Company's deferred tax liabilities
and assets as of December 31, 1997 and 1996 are as follows:
December 31 1997 1996
- -------------------------------------------------------------------------------
Deferred Tax Liabilities:
Fixed maturity securities $ 17,367 $ 10,167
Net unrealized gains on available-for-sale 243,749 ---
securities
Limited partnership investment --- 186,634
- -------------------------------------------------------------------------------
Total deferred tax liabilities $261,116 $196,801
Deferred Tax Assets:
Policy and contract reserves 849,793 833,003
Deferred policy acquisition costs 452,672 456,445
Alternative minimum tax credit carryforwards 94,382 70,392
Financial reinsurance premiums 75,269 68,381
Net unrealized gains on available-for-sale --- 5,352
securities
Other 32,201 35,994
- -------------------------------------------------------------------------------
Total deferred tax assets 1,504,317 1,469,567
Valuation allowance for deferred tax assets (790,666) (668,902)
- -------------------------------------------------------------------------------
Net deferred tax assets 713,651 800,665
- -------------------------------------------------------------------------------
Net Deferred Tax Assets $452,535 $603,864
- -------------------------------------------------------------------------------
The following is a reconciliation of the federal statutory income tax rate to
the Company's effective income tax rate:
Year Ended December 31 1997 1996
- -------------------------------------------------------------------------------
Statutory rate of income tax 34.0% 34.0%
Small life insurance deduction (17.0)% (17.0)%
Other 0.7% 8.5%
- -------------------------------------------------------------------------------
Effective rate of income tax 17.7% 25.5%
- -------------------------------------------------------------------------------
Federal income taxes paid in 1997 and 1996 were $114,000 and $39,000,
respectively.
Note 7--STATUTORY ACCOUNTING PRACTICES AND SHAREHOLDER'S EQUITY
The Company is domiciled in Ohio and prepares its statutory-basis financial
statements in accordance with statutory accounting practices ("SAP")
prescribed or permitted by the Ohio Department of Insurance ("ODI").
"Prescribed" statutory accounting practices include state insurance 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, may differ from company to company within a state, and may
change in the future. In March 1998, the NAIC completed the process of
codifying statutory accounting practices ("Codification"). Codification will
likely change, to some extent, prescribed statutory accounting practices that
the Company uses to prepare its statutory-basis financial statements.
Codification will require adoption by the various states before it becomes
the prescribed statutory basis of accounting for insurance companies
domesticated within those states. Accordingly, before Codification becomes
effective for the Company, the ODI must adopt Codification as the prescribed
basis of accounting on which domestic insurers must report their
statutory-basis results to the ODI. At this time it is unclear whether the
ODI will adopt Codification. However, based on current draft guidance,
management believes that the impact of Codification will not be material to
the Company's statutory-basis financial statements.
In 1998, the Company requested that the ODI accept the values of certain
investments in mortgage loans on real estate, real estate owned, and
preferred stock reported in the accompanying financial statements, which are
based on the statement values as reported in the Company's 1997 Annual
Statement, due to the fact that, while at December 31, 1997, the values of
such investments were not practicably determinable, such investments were
liquidated for cash totaling $2,094,795 in conjunction with the sale of the
Company to Citizens Security on May 12, 1998 (see Note 12). The reported
investment values totaled $2,064,094 at December 31, 1997 and are based on
unpaid principal balances (mortgage loans on real estate) or cost (real
estate owned and preferred stock). In recognition of the Company receiving
cash for the statement values of such assets on May 12, 1998, the ODI
provided written acknowledgment that it would accept the reported values as
of December 31, 1997.
In 1991, the Company entered into a financial (surplus relief) reinsurance
transaction which provided approximately $1,360,000 of surplus relief as a
direct credit to capital and surplus. In 1993, the Company requested and
received written approval from the ODI to reduce the surplus relief
transaction over the next five years commencing in 1994. In 1997, the
Company requested and received written approval from the ODI to extend the
approved scheduled reduction in the surplus relief transaction to the year
2000. Accordingly, the surplus relief transaction was reduced by $250,000
and $200,000 in 1997 and 1996, respectively, as a direct charge to capital
and surplus. Remaining future reductions of $160,000, $160,000 and $165,000
are required in 1998, 1999 and 2000, respectively, and will result in a
direct charge to capital and surplus in those respective years. If the ODI
were to rescind its permission for this treatment, the Company's regulatory
total adjusted capital would not fall below the Company's authorized control
level of risk-based capital amount.
Net income and capital and surplus for the Company's insurance operations as
reported in accordance with SAP for the years ended December 31, 1997 and
1996 are shown below.
Year Ended December 31 1997 1996
- -------------------------------------------------------------------------------
Net Income $589,956 $146,166
Capital and Surplus $3,438,856 $2,896,538
Principal differences between SAP and GAAP include: a) costs of acquiring new
policies are deferred and amortized for GAAP; b) value of insurance in force
acquired is established as an asset for GAAP; c) benefit reserves are
calculated using more realistic investment, mortality and withdrawal
assumptions for GAAP; d) deferred income taxes are provided for GAAP; e)
available-for-sale fixed maturity investments are reported at fair value with
unrealized gains and losses reported as a separate component of shareholder's
equity for GAAP; f) statutory asset valuation reserves and interest
maintenance reserves are not required for GAAP; and g) surplus relief
transactions are not recognized for GAAP.
Dividends paid by the Company to Chaswil cannot, without prior approval of
the ODI, exceed in any one year the greater of: (i) 10 percent of capital and
surplus as of the beginning of the year or (ii) net gain from operations for
the preceding year. Additionally, any such dividends paid from other than
unassigned surplus (deficit) must be approved by the ODI. No dividends were
paid to Chaswil in 1997 or 1996, nor are any dividends expected to be paid to
Chaswil during 1998.
Under Ohio insurance regulations, the Company is required to maintain minimum
capital and surplus of $2,500,000 at December 31, 1997. In addition, the ODI
imposes minimum risk-based capital ("RBC") requirements on insurance
enterprises that were developed by the AIC. The formulas for determining
the amount of RBC specify various weighting factors that are applied to
financial balances and various levels of activity based on the perceived
degree of risk. Regulatory compliance is determined by a ratio (the "Ratio")
of the enterprise's regulatory total adjusted capital, as defined by the
NAIC, to its authorized control level RBC, as defined by the NAIC.
Enterprises below specific trigger points or ratios are classified within
certain levels, each of which requires specified corrective action. The
Company has a Ratio that is at least 500% of the minimum RBC requirements;
accordingly, the Company meets the RBC requirements.
Note 8--REINSURANCE, MANAGEMENT AND MARKETING AGREEMENTS
Certain premiums and benefits are ceded to other insurance companies under
various reinsurance agreements. The ceded reinsurance agreements provide the
Company with increased capacity to write larger risks and maintain its
exposure to loss within its capital resources. In the event that all or any
of the reinsurers are unable to meet their obligations under such reinsurance
agreements, the Company would remain liable.
In addition, certain premiums and benefits are assumed from an insurance
company, North American Life Insurance Company ("North American"). Prior to
January 1, 1997, the Company participated in a reinsurance and management
agreement with North American whereby the Company assumed 75% of North
American's in-force pre-need business and managed and administered 100% of
North American's in-force pre-need business. Effective January 1, 1997, the
reinsurance portion of the agreement was terminated relative to new business,
and the management portion of the agreement was amended whereby North
American began paying the Company a fee for the management and administration
services. Under the terms of the agreement, the Company assumed $99,000 and
$4,517,000 of earned premium and $972,000 and $1,018,000 of incurred losses
for the years ended December 31, 1997 and 1996, respectively. In addition,
the Company assumed life reserves of $7,610,000 and $8,046,000 at December
31, 1997 and 1996, respectively. Pursuant to the terms of the agreement, the
Company is required to maintain funds in a depository trust account for the
benefit of North American in an amount equal to the life reserves assumed by
the Company. Furthermore, the Company earned fee income of $90,860 for the
year ended December 31, 1997 related to the management portion of the
agreement. There was no such fee income earned in 1996.
In conjunction with one of the Company's reinsurance agreements, the Company
administers claim activity through a cash account that belongs to the
reinsurer. This amount, which totaled $289,321 and $283,298 at December 31,
1997 and 1996, respectively, is included as cash, with a corresponding
liability in the accompanying balance sheets.
The Company participates in an exclusive marketing agreement with American
Legacy, an unaffiliated marketing organization, for the purpose of marketing
and selling new insurance policies. Cash received from sales of new and
renewal insurance policies generated by American Legacy amounted to
approximately $3,925,800 and $8,719,000 in 1997 and 1996, respectively.
Related commission expenses paid to American Legacy approximated $525,500 and
$1,281,000 in 1997 and 1996, respectively. In conjunction with the sale of
the Company to Citizens Security on May 12, 1998 (see Note 12), the Company
has elected to terminate its marketing agreement with American Legacy. This
termination resulted in a $400,000 payment by Citizens Security to American
Legacy.
Note 9--COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company is party to certain insurance
claims litigation. Management believes current liabilities for unpaid claims
are adequate to ensure these suits will be resolved without further material
financial impact to the Company.
Periodically, the Company is assessed by various state guaranty funds to
cover losses from insolvency or rehabilitation of other insurance companies.
Each state guaranty fund operates independent of any other state guaranty
fund and the methods used to levy guaranty assessments vary from state to
state. Some states permit guaranty fund payments to be partially recovered
through reduction of future premium taxes. In such situations, a guaranty
assessment recoverable asset is established. At December 31, 1997 and 1996,
the Company recorded a guaranty assessment recoverable asset of $116,855 and
$126,030, respectively.
Note 10--FAIR VALUES OF FINANCIAL INSTRUMENTS
The fair values of financial instruments and the methods and assumptions used
in estimating their fair values are as follows:
Fixed Maturities and Equity Securities: The fair values of fixed maturities
and equity securities are based on quoted market prices, where available.
For those fixed maturities and equity securities which are not actively
traded, fair values are estimated using values obtained from independent
pricing services. However, the $84,000 carrying amount of one equity security
(preferred stock) is based on cost, as it was not practicable to estimate its
fair value without incurring excessive costs. At December 31, 1997,
management believes the carrying value of this investment is not
significantly impaired, as Chaswil accepted title to it during May 1998, and
applied such full carrying value towards the previously agreed upon purchase
price of United Liberty (see Note 12).
Policy Loans: The carrying amounts of policy loans approximate their fair
values.
Cash and Short-Term Investments: The carrying amounts of cash and short-term
investments approximate their fair values.
Mortgage Loans and Real Estate Owned: The Company holds investments in
mortgage loans of $1,648,554 and $1,730,211 at December 31, 1997 and 1996,
respectively, and real estate owned (acquired in the satisfaction of debt and
held for sale) of $892,177 and $793,001 at December 31, 1997 and 1996,
respectively. The carrying amounts of investments in mortgage loans
represent their unpaid principal balances and the carrying amounts of the
real estate owned represent the cost of the investment. It was not
practicable to estimate the fair values of these investments without
incurring excessive costs. At December 31, 1997, management believes the
carrying values of such investments are not significantly impaired, as
Chaswil accepted title to these investments during May 1998, and applied such
full carrying values towards the previously agreed upon purchase price of
United Liberty (see Note 12).
Note 11--RELATED PARTY TRANSACTIONS
Amount Due from Parent
At December 31, 1997 and 1996, the Company had a receivable due from Chaswil
of approximately $1,396,000 and $1,688,000, respectively, which was not
recognized at those dates due to the financial difficulties of Chaswil (see
Note 4). In conjunction with the sale of the Company to Citizens Security
(see Note 12), this intercompany receivable from Chaswil was forgiven.
Management Contract
The Company has a Computing Services Contract (the "Contract") with Chaswil
for the purpose of providing insurance policy administration and processing
services. The Contract may be terminated by either party upon 60 days notice.
Fees paid to Chaswil in 1997 and 1996 under the Contract approximated $61,100
and $101,600, respectively, and are included in general operating expenses.
Tax Sharing Agreement
The Company has a Tax Sharing Agreement with Chaswil which requires the
Company to pay federal income taxes to Chaswil as if the Company were to
report its income and expenses to the Internal Revenue Service as a separate
entity (see Note 6). Subsequent to the sale of the Company to Citizens
Security (see Note 12), the Company will file a separate federal income tax
return to the Internal Revenue Service.
Operating Leases
The Company's headquarters were leased from a limited partnership in which
the Company had a 15 percent interest. At December 31, 1997 and 1996, there
was no carrying value associated with this limited partnership interest. The
operating lease terminated on April 30, 1998 and rent payments due in 1998
total $52,000. During 1997 and 1996, rent expense was approximately $104,000
in each of those years and is included in general operating expenses.
Note 12--SUBSEQUENT EVENTS
Effective May 12, 1998, Chaswil sold 100% of the Company's issued and
outstanding capital stock to Citizens Security, a wholly owned insurance
subsidiary of Citizens Financial Corporation, a Louisville, Kentucky based
insurance holding company. Concurrent with this transaction and upon
receiving approvals from the Ohio and Kentucky Departments of Insurance, the
Company relocated its home office to Louisville, Kentucky and is in the
process of redomesticating to Kentucky.
In conjunction with this sale, all prior agreements between the Company and
Chaswil were terminated and all intercompany obligations were forgiven. In
addition, Chaswil agreed to accept certain of the Company's investments in
mortgage loans, real estate, and preferred stock at their carrying values as
of the closing date, which aggregated $2,094,795, as partial payment toward
the agreed upon purchase price. Citizens Security simultaneously replaced
these assets with cash equal to that amount.
Note 13--IMPACT OF YEAR 2000 (UNAUDITED)
Some of the Company's older computer programs were written using two digits
rather than four to define the applicable year. As a result, those computer
programs have time-sensitive software that recognize a date using "00" as the
year 1900 rather than the year 2000. This could cause a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send premium notices,
or engage in similar normal business activities.
In conjunction with the sale of the Company to Citizens Security, all of the
Company's computer generated data will be converted to Citizens Security's
systems during 1998.
Citizens Security has completed a Year 2000 assessment and will have to
modify or replace portions of its software so that its computer systems will
function properly with respect to dates in the year 2000 and thereafter.
Citizens Security's total Year 2000 project cost is estimated at
approximately $100,000, which includes $25,000 for the purchase of new
software that will be capitalized and $75,000 of non-incremental, internal
costs that will be expensed as incurred. The direct cost of modifying
Citizens Security's two primary insurance administrative systems (individual
and group) is included in annual maintenance fees which total approximately
$25,000 per year. To date, Citizens Security has incurred and expensed
approximately $25,000 ($7,000 capitalized), primarily for modifying
peripheral programs associated with its individual life insurance
administrative system and purchase of a general ledger software package
upgrade.
The project is estimated to be completed not later than December 31, 1998,
which is prior to any anticipated impact on its operating systems. Citizens
Security believes that with modifications to existing software and
conversions to new software, the Year 2000 Issue will not pose significant
operational problems for its computer systems. However, if such
modifications and conversions are not made, or are not completed timely, the
Year 2000 Issue could have a material impact on the operations of the Company
and Citizens Security. Notwithstanding the Company's and Citizens Security's
efforts, their ability to function unaffected to and through the year 2000
may be adversely affected by actions (or failure to act) of third parties.
The costs of the project and the date on which the Company and Citizens
Security believe they will complete the Year 2000 modifications are based on
management's best estimates, which were derived utilizing numerous
assumptions of future events, including the continued availability of certain
resources and other factors. However, there can be no guarantee that these
estimates will be achieved and actual results could differ materially from
those anticipated. Specific factors that might cause such material
differences include, but are not limited to, the availability and cost of
personnel trained in this area, the ability to locate and correct all
relevant computer codes, and similar uncertainties.
