Item 1. Business
First Alliance Corporation (the "Company") was organized on February 16, 1993 for the purpose of forming, owning and managing life insurance companies. The Company registered with the Securities and Exchange Commission and the Kentucky Department of Financial Institutions a $12,500,000 public stock offering.
In June of 1993, the Company sold 2,230,000 shares of its common stock to its organizing shareholders at $.10 per share for total proceeds of $223,000. Also, in July 1993, the Company sold an additional 600,000 shares of its common stock at $.50 per share in a separate private placement. The initial capital of $523,000 was primarily used to fund the Company's efforts to register the public offering. On March 4, 1994, the registration statement for First Alliance Corporation was declared effective.
The offering was sold in Units consisting of one share of 6% non-cumulative convertible, redeemable, $5.00 par value preferred stock and one share of no par value common stock for a total Unit cost of $25.00. All shares of the Company's common stock have equal voting rights, with one vote per share, on all matters submitted to the shareholders for their consideration. The shares of common stock do not have cumulative voting rights except in the election of directors. Subject to the prior rights of the holders of the preferred stock, holders of common stock are entitled to receive dividends when and if declared by the Board of Directors, out of Company funds legally available therefor. Each share of preferred stock could be converted, at the holder's option, into four (4) shares of common stock until six (6) months after the completion of the offering. The Company could, at its option, call all or, from time to time, any portion of the shares of preferred stock by paying the holder $25.00 per share, plus any declared but unpaid dividends.
On October 28, 1995, the Company completed the public stock offering. The company raised total capital of $13,750,000 which includes a 10% oversale of $1,250,000 contemplated in the public filing. The net proceeds of the offering were used to capitalize a life insurance subsidiary; form a venture capital company and provide capital for the acquisition of additional life insurance or insurance related companies. Six million dollars of the proceeds of the stock sale were used to capitalize the life insurance subsidiary. Three million dollars of the proceeds will be used to capitalize the venture capital company based on a schedule as determined by the Company's Board of Directors. During 1996, $224,000 of the proceeds were used in the initial capitalization of the Company's wholly-owned venture capital subsidiary, First Kentucky Capital Corporation ("FKCC"). The remainder of the proceeds will provide resources for one or more of the following: provide additional capital for the life insurance subsidiary; provide capital for the possible acquisition of life insurance or insurance related company(s) or provide additional working capital. At April 28, 1996, six months after completion of the offering, substantially all of the preferred shares were converted to common shares.
First Alliance Corporation
The primary revenue source for the Company is provided by its wholly owned life insurance subsidiary, First Alliance Insurance Company ("FAIC"). FAIC has contracted with the Company to provide administrative and data processing services for the insurance operations. Investment income provides additional income to the Company.
First Alliance Insurance Company
On May 17, 1995, FAIC received a Certificate of Authority from the Kentucky Department of Insurance ("KDI"). On November 1, 1995 insurance operations commenced. FAIC has $6,000,000 of capital and surplus and is wholly owned by the Company. FAIC has contracted with the Company to provide administrative and data processing services. As discussed in the following paragraph, the only expenses to be directly incurred by FAIC are direct agency expenses including commissions.
Administration
Effective November 1, 1995, the Company entered into a service agreement with FAIC to provide personnel, facilities, and services to FAIC. FAIC has no employees. The services to be performed pursuant to the service agreement
are underwriting, claim processing, accounting, processing and servicing of policies, and other services necessary to carry on FAIC's business. The agreement is in effect until either party provides ninety days written notice of dermination. Under the agreement, FAIC pays monthly fees based on life and annuity premiums recorded by FAIC. The percentages are twenty-five percent of first year premiums; twenty percent of second year premiums; ten percent of third year premiums; and five percent of premiums in years four and thereafter. FAIC will retain direct agency expenses such as agent training and licensing, agency meeting expenses, and other directly related expenditures. Pursuant to the terms of the agreement, FAIC had incurred expenses totaling $359,662 and $26,111 during 1996 and 1995, respectively.
On behalf of FAIC, the Company has retained the services of Bruce and Bruce Company, consulting actuaries of Lake Bluff, Illinois. Bruce and Bruce assisted in developing the product that the Company is marketing.
Products of FAIC
The initial insurance product being marketed is a twenty pay ordinary life policy with an annuity rider. For issue ages 0 to 50, there is also an annual income protection benefit rider (decreasing term rider). The income protection rider is not available for issue ages greater than age 50. Issue ages from 0 to 65 will use standard underwriting procedures and ages 66 through 80 will use simplified underwriting.
The product is being sold in premium units with the ability to purchase either fractional or multiple units. If a greater accumulated annuity value is desired, the policyholder may continue to make the premium payments, after the completion of the twenty pay period, with the entire payment funding the annuity.
Other products will be introduced during 1997. These products include a single premium deferred annuity and a ten year renewable term product. Marketing of these products will be used to meet niche market needs.
Product Marketing and Sales
FAIC's insurance operations commenced on November 1, 1995 following the completion of the Company's public stock offering. FAIC is using the same face-to-face marketing techniques for its life insurance products as the Company did for its public stock offering. The marketing plan is designed in its entirety around the Company's stockholder base. The Company's shareholder base provides an excellent referral system for FAIC product sales.
Once FAIC develops a substantial policyholder base in Kentucky, marketing efforts will expand into additional states. This expansion will depend largely on many factors, one of which is being admitted to do business in these additional states. Due to the uncertainties involved, management cannot reasonably estimate the time frame of such expansion.
Reinsurance
Consistent with the general practice of the life insurance industry, FAIC reinsures a portion of the coverage provided by the life insurance products it offers. The maximum amount of risk that FAIC retains is $50,000 on any one insured. The remaining coverage is reinsured with Business Men's Assurance Company of Kansas City, Missouri. At December 31, 1996, FAIC has reinsured $38,597,541 of life insurance coverage including $14,220,000 in a ccidental death benefits.
Investments
The Company has entered into an agreement with Alpha Advisors, Inc. of Chicago, Illinois, a registered investment advisor, to assist FAIC in managing its investment portfolio. Alpha Advisors is an investment firm that caters to the unique needs of life insurance companies. Alpha Advisors also provides investment services for the Company. Fees are based on a percentage of invested assets.
Investment activities are an integral part of the operations of FAIC. The Kentucky Insurance Code restricts the investments of insurance companies by the type of investment, the amount that an insurance company may invest in any one type of investment, and the amount that an insurance company may invest in the securities of any one issuer. The restrictions of the Kentucky Insurance Code are not expected to have a material effect on the investment return of FAIC. The Company is not subject to the same investment restrictions as FAIC. Credit risk is limited by emphasizing investment grade securities and by diversifying the investment portfolio among government and corporate bonds.
Competition
The life insurance industry is extremely competitive. There are a large number of insurance companies which are substantially larger, have greater financial resources, offer more diversified product lines and have larger selling organizations than FAIC. Competition also is encountered from the expanding number of banks and other financial intermediaries that offer competing products. FAIC must also compete with other insurers to attract and retain qualified agents to market FAIC's products.
Governmental Regulation
FAIC is subject to regulation and supervision by the KDI. The insurance laws of Kentucky give the KDI broad regulatory authority , including powers 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.
Kentucky has enacted legislation which regulates insurance holding company systems, including acquisitions, extraordinary dividends, the terms of affiliate transactions, and other related matters. Currently, the Company and FAIC have registered as a holding company system pursuant to the laws of the state of Kentucky.
First Kentucky Capital Corporation
During 1996, the Company funded its wholly owned venture capital subsidiary, First Kentucky Capital Corporation ("FKCC"), with the purchase of 224 shares of FKCC common stock for $224,000. FKCC provides capital for Kentucky based business for both start-up companies and for expansion of existing business. Investments may take the form of loans, guarantees, commitments, equity, or joint venture agreements, or any combination thereof. During 1996, FKCC purchased the common stock of three Kentucky based businesses, Medical Acceptance Corporation ("MAC") of Lexington, Kentucky; LGP, Inc. of Louisville, Kentucky; and Cybertyme, Inc. of Glasgow, Kentucky.
Medical Acceptance Corporation
On April 12, 1996, FKCC purchased, from MAC, common stock of the company representing a 51% interest for $50,000. MAC purchases receivables from medical providers at a discount. The receivables are in the form of contracts in which the patient makes monthly payments of principal and interest directly to MAC. MAC retains all of the principal and interest paid. The contracts are for terms of six to thirty-six months and have an annual percentage rate of nineteen percent. In the event of default, MAC has total recourse against the medical provider for the amount of the patient's unpaid principal balance. FKCC also provides MAC with a $250,000 line of credit of which MAC has drawn $35,000 through December 31, 1996.
LGP, Inc.
On October 18, 1996, FKCC purchased from LGP, Inc., common stock of the company representing a 49% interest for $49,000. LGP is a dating service using interactive-video matchmaking and combining a television dating show and an on-line profile library on the Internet. LGP commenced production of videos during December and the shows aired in January of 1997. FKCC will also provide LGP with a line of credit of $31,000.
Cybertyme
On November 12, 1996, FKCC purchased, from Cybertyme, Inc., 200 common shares of the company for $80,000, which represents a 40% ownership interest. Cybertyme provides individuals who do not have access to a personal computer the ability to access the Internet for a hourly fee. In addition, Cybertyme will provide educational classes regarding Internet use and other personal computer applications.
Financial Information Relating to Industry Segments
Employees
As of December 31, 1996, the Company had nine full time employees.
Item 2.
Item 2. Properties
The Company currently leases approximately 5,400 square feet of office space in Lexington, Kentucky. On August 31, 1995, the Company entered into a sublease agreement with Bizwill, Inc. for additional space on the same floor as the Company's current lease. The sublease agreement is for a period from October 1, 1995 to March 31, 1998. The current lease, which expired in May of 1996, was extended until March 31, 1998. Combined annual rental payments totaled $72,868 and $41,490 for 1996 and 1995, respectively.
Item 3.
Item 3. Legal Proceedings
The Company has received notice of a claim and potential litigation related to an automobile accident in October 1996 which involved an officer of the Company, who was driving the automobile. The claim alleges that the officer
was acting in the course and scope of employment with the Company at the time of the accident. The outcome of this matter is not predictable with assurance. Although any actual liability is not determinable as of December 31, 1996, the Company believes that any liability resulting from this matter, after taking into consideration insurance coverages, should not have a material adverse effect on the Company's financial position.
The Company, nor any of its subsidiaries, are presently engaged in any other material pending litigation which might have an adverse effect on its net assets.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5.
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
(a.) Market Information
(b.) Holders
As of March 1, 1997, there are approximately 5,500 shareholders of the Company's outstanding common stock.
(c.) Dividends
The Company has not paid any cash dividends since inception (February 16, 1993). Additionally, dividends are not anticipated in the foreseeable future.
Item 6
Item 6 Selected Financial Data
Item 7
Item 7 Management's Discussion and Analysis of Financial Conditions and Results of Operations
The Company makes forward-looking statements from time to time and desires to take advantage of the "safe harbor" which is afforded such statements under the Private Securities Litigation Reform Act of 1995 when they are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statements.
The statements contained in the following "Management's Discussion and Analysis of Financial Condition and results of Operations," statements contained in future filings with the Securities and Exchange Commission and publicly disseminated press releases, and statements which may be made from time to time in the future by management of the Company in presentations to shareholders, prospective investors, and others interested in the business and financial affairs of the Company, which are not historical facts, are forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statements. Any projections of financial performances or statements concerning expectations as to future developments should not be construed in any manner as a guarantee that such results or developments will, in fact, occur. There can be no assurance that any forward-looking statement will be realized or that actual results will not be significantly different from that set forth in such forward-looking statement. In addition to the risks and uncertainties of
ordinary business operations, the forward-looking statements of the Company referred to above are also subject to risks and uncertainties.
The Company operates in a highly competitive business environment, and its operations could be negatively affected by matters discussed under the caption, "Competition," on page 4 of this Form 10-K.
The following discussion should be read in conjunction with the consolidated financial statements and the notes thereto beginning on page.
Results of Operations
Revenues totaled $1,494,132 in 1996, $503,939 in 1995 and $37,389 in 1994. Since the Company commenced insurance operations in November of 1995, and 1996 was the first full year of operation for FAIC, the primary source of revenue is life insurance premium income. Premium income for 1996 increased by $838,060 in comparison to 1995 results. There were no premium revenues during 1994 since the Company was in its public stock offering. Premium income consists of life insurance premium sales of the Company's initial product referred to as the "Alliance 2000." An annuity rider is also included with the Alliance 2000; however, according to Statement of Financial Accounting Standards ("SFAS") No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from Sales of Investments", annuity premium income is not recognized as revenue. Annuity premium receipts totaled $563,314 during 1996 and are recognized as annuity contract liabilities net of a twenty percent first year load. Pursuant to the terms of the reinsurance agreement between FAIC and Business Men's Assurance Company, there are no first year premiums due. However, SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts", requires this unpaid premium to be recognized as an expense and amortized over the term of the contracts reinsured. At December 31, 1996, $32,272 of reinsurance premiums were recorded as a liability.
Investment income is an integral component of total revenues for life insurance companies. Combined net investment income for FAIC and the Company totaled $585,244 for the year ended December 31, 1996 and $440,415 for the same period in 1995. Net investment income in 1994 totaled $37,389 since the Company was in its public stock offering and the invested asset base was smaller. Net investment income increased over the last two years due to the growth of FAIC's insurance operations.
For the year ended December 31, 1996, expenses totaled $1,682,338 representing a $771,242 increase over the same period of 1995. This increase was primarily due to the growth in FAIC's insurance operations. There were no life insurance related expenses during 1994 since FAIC commenced operations in November of 1995. Life policy reserve expense totaled $354,648 in 1996 as compared to $25,272 in 1995. Policy reserves are established with the sale of life insurance. Policy reserve expense for 1996 represents sales for the entire year while 1995 amounts represent two months of sales. Expenses related to the acquisition of life insurance are deferred and amortized over the premium paying period of the related policy. These expenses, which include commissions and administrative costs, totaled $859,561 and $64,164 during 1996 and 1995, respectively, were reclassified as deferred policy acquisition costs. Amortization of these costs totaled $161,163 during 1996 and $12,952 during 1995. Death claims incurred during 1996 totaled $68,574 which are net of $40,000 of death benefits reinsured. Expenses directly related to FAIC's agency totaled $143,984 for the year ended December 31, 1996. These expenses include agent's health insurance, agency meetings, recruiting and other expenses directly related to the sale of insurance and annuities. Direct agency expenses totaled$31,085 during 1995.
Salaries and benefit expenses totaled $454,755 in 1996 and $545,327 in 1995. This decrease of $90,572 is the primary result of a reduction of bonuses to the executive officers and the allocation of salaries when the financial statements are consolidated. Professional fees totaled $119,472 for 1996 and $68,490 for 1995. Audit fees of $19,250 related to the 1995 audit were expensed during 1996. During 1996, the Company issued the common shares sold during the public stock offering. Fees related to the issuance of these shares and the ongoing maintenance of accounts totaled $15,391.
During 1996, FKCC commenced operations and incurred operating losses totaling $115,728. These losses are the primary result of the inclusion of operating losses of Medical Acceptance Corporation ("MAC") in the operating results of the Company. FKCC purchased 51% of MAC on April 12, 1996. MAC has incurred operating losses since inception and therefore the Company recognizes 100% of MAC's operating results. The losses of MAC totaled $55,241 since the date of acquisition. Intangible assets related to the acquisition of MAC totaling $26,623 were written off during 1996 due to MAC's continuing operating losses. LGP, Inc. has incurred operating losses since inception totaling $31,816. Accordingly, the Company recognized 100% of these losses in operations as a component of net investment income.
Income tax expense, which is calculated based on the earnings of FAIC, totaled $111,653 during 1996 and $35,897 during 1995. Current tax expense is based on taxable income as calculated based on federal Internal Revenue Service code requirements. These requirements include adjustments for such items as reserves and deferred policy acquisition costs. Deferred taxes are based on temporary differences which are the result of different accounting practices for financial reporting and tax reporting.
Consolidated Financial Condition
Changes in the consolidated balance sheet of 1996 compared to 1995 reflect the operations of the Company and the capital transactions discussed below.
Total investments increased $5,280,736 principally because of : (i) the conversion of cash and cash equivalents to higher yielding and longer term investments; (ii) cash provided from the insurance operations of FAIC; (iii) lending agreements with two individuals which resulted in the establishment of notes receivable of $221,096; (iv) two related party common stock investments in start-up companies in Topeka, Kansas and Jefferson City, Missouri (see Note 4 to the audited financial statements); and (v) other invested assets of $97,000 of the Company's venture capital subsidiary, FKCC. These increases were partially offset by the unrealized loss adjustment to fixed maturity investments recognized as an adjustment to shareholders' equity in accordance with SFAS No. 115.
Deferred policy acquisition costs increased $698,398 net of $161,163 of amortization as the result of new business written by FAIC.
Policy and contract liabilities increased $1,179,874 principally because of (i) life policy reserves increased $354,648 due to premiums written for an entire year and policies issued during 1995 entering a second duration; (ii) an increase in the unearned revenue liability of $109,862 related to the recognition of the first year load on annuity premiums as a liability and amortized into income over the premium paying period of the related policies; (iii) annuity premiums received recognized as annuity contract deposits and recorded as a liability which increased $471,488; (iv) the accrual of a death claim payable of $93,794 at December 31, 1996; and (v) policyholder premium deposits totaling $114,015 which accumulate interest and will result in the payment of premiums over the premium paying period of the policy.
Changes in other liabilities include an increase of $30,003 in deferred federal income taxes related to the operations of FAIC and an increase in amounts payable to the Company's Advisory Board Members of $32,122.
Liquidity
FAIC's insurance operations generally receive adequate cash flow from premium collections and investment income to meet their obligations. Insurance policy liabilities are primarily long-term and generally are paid from future cash flows. Most of the Company's invested assets are in bonds which are readily marketable. Although there is no present need or intent to dispose of such investments, the Company could liquidate portions of their investments if such a need arose.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements listed in Item 14(a) (1) and (2) are included in this report beginning on page 15.
Item 9.
Item 9. Changes in Disagreements with Accountants on Accounting and Financial Disclosure
NONE
PART III
Item 10.
Item 10. Directors and Executive Officers
Compensation of Directors
Each Director of the Company, excluding Messrs. Engebritson, Haas and Fink, receives a $1,000 annual retainer. Additionally, each Director is paid $250 per meeting attended for the Company and its subsidiaries. During 1996, there were three regular Board of Directors meetings for the Company and each of its subsidiaries.
Executive Employment Agreements
On October 23, 1995, the Company entered into Executive Employment Agreements with Messrs. Engebritson, Haas and Fink. The employment agreements are for a term of four years beginning November 1, 1995. Annual compensation under the agreement for each Executive is $75,000 adjusted annually for the increase in the Consumer Price Index Labor Component. Incentive compensation is based on percentages of first year life and renewal insurance premium of the FAIC "Alliance 2000" product. Also included in the agreement is an annual auto allowance of $7,200. Additionally, the Company provides term life insurance coverage in the amount of $500,000 and disability coverage for each Executive.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13.
Item 13. Certain Relationships and Related Transactions
NONE
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1 and 2 Financial Statements and Schedules
The consolidated financial statements and financial statement schedules of First Alliance Corporation presented in this report are listed in the index on Page.
3 Exhibits
3(i) Articles of Incorporation, as amended(1)
3(ii) By-laws, as amended (1)
4 Instruments defining the rights of security holders, including indentures (1)
10 Material Contracts
(a) Lease (1) (b) Sub-lease (2) (c) Advisory Board Contract (1) (d) Service agreement between First Alliance Insurance Company and First Alliance Corporation. (2) (e) Management Employment Agreements (2)
11 Statement re computation of per share earnings (3)
(b) Reports on Form 8-K
NONE
(1) Filed as an Exhibit to the Registrant's Registration Statement on Form S-1, Amendment Number 4, File Number 33-67312, which was declared effective on March 4, 1994, and incorporated herein by reference.
(2) Filed as an Exhibit to the Registrant's 1995 Form 10-K, File Number 33-67312, and incorporated herein by reference.
(3) Note 2 in Notes to Consolidated Financial Statements included in this Report on Page
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
By /s/Scott J. Engebritson Date 3/24/97 Scott J. Engebritson, Chairman/Director
By /s/Chris J. Haas Date 3/24/97 Chris J. Haas, Vice-Chairman/Secretary Treasurer/ Director
By /s/Thomas I. Evans Date 3/24/97 Thomas I. Evans, Vice-President Accounting/ Assistant Secretary
SIGNATURES
Pursuant to the requires of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
By /s/Scott J. Engebritson Date 3/24/97 Scott J. Engebritson, Chairman/Director
By /s/Chris J. Haas Date 3/24/97 Chris J. Haas, Vice-Chairman/Secretary/ Treasurer/Director
By /s/Michael N. Fink Date 3/24/97 Michael N. Fink, President/Director
By Date Steven B. Bing, Director
By /s/Daniel D. Briscoe Date 3/24/97 Daniel D. Briscoe, Director
By /s/Ballard W. Cassady Date 3/24/97 Ballard W. Cassady, Jr., Director
By /s/Jimmy Dan Conner Date 3/24/97 Jimmy Dan Conner, Director
By /s/Denzel E. Crum Date 3/24/97 Denzel E. Crum, Director
By /s/James M. Everett Date 3/24/97 James M. Everett, Director
By /s/Charles Hamilton Date 3/24/97 Charles Hamilton, Director
By /s/Ronda S. Paul Date 3/24/97 Ronda S. Paul, Director
FIRST ALLIANCE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996
1. Nature of Operations
First Alliance Corporation (the "Company") was incorporated on February 16, 1993 for the primary purpose of forming, owning and managing life insurance companies. On March 4, 1994, the Company's registration statement filed with the Securities and Exchange Commission and the Kentucky Department of Financial Institutions for a $12,500,000 public stock offering, which included a 10% "oversale" provision (additional sales of $1,250,000), was declared effective. The Company completed its public stock offering on October 28, 1995, raising total capital of $13,750,000.
The Company has a wholly-owned insurance subsidiary, First Alliance Insurance Company ("FAIC"), which is domiciled in Kentucky. FAIC was incorporated on December 29, 1994 and initially capitalized with $3,000,000 on January 10, 1995. The Company made an additional $3,000,000 capital contribution on May 15, 1995 and the Kentucky Department of Insurance ("KDI") granted FAIC a Certificate of Authority on May 17, 1995. Insurance operations commenced on November 1, 1995.
FAIC's initial product is a twenty pay ordinary life insurance policy with a flexible premium deferred annuity rider. For issue ages 0 to 50, a decreasing term rider is included. Other products currently being developed are a single premium deferred annuity and a ten year term policy. The Company is licensed and sells its product in the state of Kentucky. Once a substantial policyholder base is established in Kentucky, marketing efforts may be expanded into additional states.
The Company also has a wholly-owned venture capital subsidiary, First Kentucky Capital Corporation ("FKCC"), which was capitalized with $224,000 during 1996 and commenced operations on April 12, 1996. FKCC provides capital for Kentucky based businesses for both start-up companies and for expansion of existing businesses. Investments may take the form of loans, guarantees, commitments, equity, or joint venture agreements, or any combination thereof. FKCC invested in three Kentucky businesses during 1996.
2. Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP") which, for FAIC, differ from statutory accounting practices prescribed or permitted by the KDI.
During the course of the public stock offering, the Company was in the development stage. Insurance operations commenced on November 1, 1995 and therefore, the Company is no longer in the development stage. As a result, operating results in the accompanying consolidated financial statements are presented for each of the periods ended December 31, 1996, 1995 and 1994. Certain amounts from prior years have been reclassified to conform with the current year's presentation. These reclassifications had no significant effect on previously reported net income or shareholders' equity.
Principals of Consolidation
The accompanying consolidated financial statements include the accounts and operations of the Company, FAIC, FKCC and Medical Acceptance Corporation (" MAC"). All intercompany accounts and transactions are eliminated in consolidation.
Management's Estimates
The preparation of financial statements requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein.
Investments
The Company classifies all of its fixed maturities as available-for-sale. Available-for-sale fixed maturities are carried at fair value with unrealized gains and losses, net of applicable taxes, reported as a separate component of shareholders' equity.
Investments with original maturities between three months and one year are classified as short-term investments and are carried at cost which approximates fair value. Cash equivalents consist of highly liquid investments with maturities of three months or less at the date of purchase and are carried at cost which approximates fair value.
Realized gains and losses on sales of investments are recognized in operations on the specific identification basis. Interest earned on investments is included in net investment income.
Notes receivable are reported at unpaid principal balance.
Investments in related parties are reported at cost (see Note 4).
Investments in unconsolidated affiliates consist of common stock investments and are recorded using the equity method of accounting, with gains and losses reported in net investment income.
Office Furniture and Equipment
Office furniture and equipment is recorded at cost less accumulated depreciation using the 200% declining balance method over the estimated useful life of the respective assets.
Office Lease
The Company leases approximately 5,400 square feet pursuant to a 2,700 square foot lease agreement and a 2,700 square foot sub-lease agreement. Both lease agreements expire on March 31, 1998. Aggregate minimum lease payments for 1997 and 1998 are approximately $75,000 and $19,000, respectively.
Deferred Policy Acquisition Costs
Commissions and other costs of acquiring life insurance, which vary with, and are primarily related to, the production of new business have been deferred to the extent recoverable from future policy revenues and gross profits. The acquisition costs are being amortized over the premium paying period of the related policies using assumptions consistent with those used in computing policy reserves.
The fair values for investments in fixed maturities are based on quoted market prices.
Included in investments are securities which have a fair value of $991,386 at December 31, 1996, which are on deposit with the KDI.
The Company limits credit risk by emphasizing investment grade securities and by diversifying its investment portfolio among government and corporate bonds. As a result, management believes that significant concentrations of credit risk do not exist.
The Company has a $175,000 line of credit agreement with Mr. Rick Meyer, President of First American Capital Corporation (see Note 4). The line of credit bears interest at an annual rate of 10.25%. The term of the line of credit agreement extends until March 1, 1997 at which time it converts to a thirty-six month promissory note bearing interest at 10.25%. The Company has a perfected security interest in amounts due Mr. Meyer from United Security Assurance Company which will provide for payment of the note. At December 31, 1996, $128,500 had been drawn on this line of credit.
The Company has entered into a line of credit agreement with Mr. James Hayslip of Successful Solutions, Inc. in the amount of $100,000. The line of credit, which bears interest at an annual rate of 20%, will terminate on July 31, 1997 unless extended by written agreement. The entire principal balance plus accrued interest is due and payable on July 31, 1997. At December 31, 1996, $57,000 had been drawn on this line of credit.
During 1996, gross realized investment loss on the sale of a fixed maturity investment was $4,368. There were no realized investment gains during 1996. There were no sales of fixed maturity investments during 1995 and 1994.
4. Investments in Related Parties
The Company has investments in related parties of $125,000 at December 31, 1996, which are reported at cost as these investments represent organizer shares purchased in the initial private placement of the related entities (discussed below) and are restricted under Rule 144 of the Act.
First American Capital Corporation
On August 8, 1996, the Company purchased common stock of First American Capital Corporation ("FACC") of Topeka, Kansas, for $52,500. FACC has raised total capital of $812,000 to fund a proposed $12,500,000 Kansas intrastate public stock offering beginning in early 1997. The proceeds of the public offering will be used to form a Kansas domiciled life insurance company. When the public offering is completed, the Company will own less than 10% of outstanding common stock. At December 31, 1996, the Company has accounts receivable from FACC of $12,480 related to expenses incurred on behalf of the initial start-up of FACC.
Mid-American Alliance Corporation
On August 8, 1996, the Company purchased common stock of Mid-American Alliance Corporation ("MAAC") of Jefferson City, Missouri, for $72,500. MAAC has raised total organizer capital of $315,000 and is in the process of raising an additional
4. Investments in Related Parties (continued)
$2,000,000 of capital to fund (i) the possible purchase of a life insurance company and (ii) a $16,000,000 Missouri intrastate public stock offering. The proceeds of the public offering will be used to further capitalize the acquired life insurance company (if the purchase is consummated). When the public offering is completed, the Company will own less than 10% of outstanding common stock. At December 31, 1996, the Company has accounts receivable from MAAC of $33,799 related to expenses incurred on behalf of the initial start-up of MAAC.
5. Acquisitions
FKCC purchased newly issued common stock of MAC, Lexington, Kentucky, representing a 51% interest, for $50,000 on April 12, 1996. MAC purchases receivables from medical providers at a discount. The receivable are in the form of contracts in which the patient makes monthly payments of principal and interest directly to MAC. MAC retains all of the principal and interest paid. The contracts are for terms of six to thirty-six months and have an annual percentage rate of 19%. In the event of default, MAC has total recourse against the medical provider for the amount of the patient's unpaid principal balance.
The acquisition was accounted for as a purchase and resulted in intangible assets of $26,623 ($20,623 goodwill and $6,000 non-compete agreement) at the date of acquisition. MAC has incurred operating losses since inception and these losses are expected to continue. As such, the Company has included 100% of MAC's operating losses since acquisition of $55,241 in the consolidated financial statements. Further, the Company has recorded a valuation allowance of $26,623 relating to theintangible assets recorded in conjunction with the acquisition.
FKCC has entered into a $250,000 line of credit agreement with MAC, of which $35,500 has been drawn as of December 31, 1996.
FKCC also purchased a 49% interest in LGP, Inc. ("LGP"), Louisville, Kentucky, for $49,000 on October 18, 1996. LGP is a dating service using interactive-video matchmaking, which combines a television dating show and an on-line profile library on the Internet. FKCC has also entered into a line of credit agreement with LGP for $31,000. No amounts have been drawn upon this line of credit as of December 31, 1996.
Lastly, FKCC purchased a 40% interest in Cybertyme, Inc. ("Cybertyme"), Glasgow, Kentucky, for $80,000 on November 12, 1996. Cybertyme provides individuals who do not have access to a personal computer the ability to access the Internet for an hourly fee. In addition, Cybertyme will provide educational classes regarding Internet use and other personal computer applications.
The investments in LGP and Cybertyme are being accounted for on the equity method of accounting. Losses of $31,816 were recorded relative to these common stock investments during 1996.
6. Income Taxes
6. Income Taxes (continued)
The Company has net operating loss carryforwards of approximately $1,946,224, expiring in 2009, 2010 and 2011. These net operating loss carryforwards are not available to offset FAIC income. FAIC has alternative minimum tax credit carryforwards of $24,544, which have no expiration date. Federal income taxes paid during 1996 were $56,404. No federal income taxes were paid during 1995 and 1994.
7. Shareholders' Equity and Statutory Accounting Practices
FAIC prepares its statutory-basis financial statements in accordance with statutory accounting practices ("SAP") prescribed or permitted by the KDI. "Prescribed" statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners ("NAIC"). "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, may differ from company to company within a state, and may change in the future. The NAIC currently is in the process of codifying statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. Accordingly, that project, which is expected to be completed in 1997, will likely change, to some extent, prescribed statutory accounting practices, and may result in changes to the accounting practices that FAIC used to prepare its statutory-basis financial statements.
Principal differences between GAAP and SAP include: a) costs of acquiring new policies are deferred and amortized for GAAP; b) benefit reserves are calculated using more current assumptions relating to investments, mortality and withdrawals for GAAP; c) deferred income taxes are provided for GAAP; d) statutory asset valuation reserves are not required for GAAP; and e) available-for-sale fixed maturity investments are reported at fair value with unrealized gains and losses reported as a separate component of shareholders' equity for GAAP.
Statutory restrictions limit the amount of dividends which may be paid by FAIC to the Company. Generally, dividends during any year may not be paid without prior regulatory approval, in excess of the lesser of (a) 10% of statutory shareholder's surplus as of the preceding December 31, or (b) statutory net operating income for the preceding year. In addition, FAIC must maintain the minimum statutory capital and surplus, $3,000,000, required for life insurance companies domiciled in Kentucky.
The KDI imposes minimum risk-based capital ("RBC") requirements on insurance enterprises that were developed by the NAIC. The formulas for determining the amount of RBC specify various weighing factors that are applied to financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by ratio (the "Ratio") of the enterprises 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. FAIC has a Ratio that is in excess of the minimum RBC requirements; accordingly, FAIC meets the RBC requirements.
8. Reinsurance
To minimize the risk of claim exposure to surplus, the Company retains a maximum of $50,000 of risk on individual life insurance and all accidental death policies; all amounts greater than $50,000 are ceded to the Company's reinsurer, Business Men's Assurance Company ("BMA"). At December 31, 1996, the Company ceded $38,597,541 of insurance in-force to BMA and received a reserve credit of $49,162. Pursuant to the terms of the agreement, FAIC pays no premiums on first year business. However, SFAS No. 113 requires the unpaid premium to be recognized as a first year expense and amortized over the estimated life of the reinsured policies. FAIC records this unpaid premium as "Reinsurance premiums payable" in the accompanying balance sheet and recognized as "Reinsurance premiums ceded" in the accompanying income statement. At December 31, 1996, the unpaid reinsurance premiums totaled $32,272. To the extent that BMA is unable to meet its obligations under the reinsurance agreement, the Company remains primarily liable for the entire amount at risk. During 1996, FAIC paid $10,155 of reinsurance premiums.
9. Related Party Transactions
Effective November 1, 1995, the Company entered into a service agreement with FAIC to provide personnel, facilities, and services to FAIC. The services to be performed pursuant to the service agreement are underwriting, claim processing, accounting, processing and servicing of policies, and other services necessary to facilitate FAIC's business. The agreement is in effect until either party provides ninety days written notice of termination. Under the agreement, FAIC pays monthly fees based on life and annuity premiums delivered by FAIC. The percentages are 25% of first year premiums; 20% of second year premiums; 10% of third year premiums; and 5% of premiums in years four and thereafter. FAIC will retain general insurance expenses related to its sales agency, such as agent training and licensing, agency meeting expenses, and agent's health insurance. Pursuant to the terms of the agreement, FAIC had incurred expenses of $359,662 and $26,111 at December 31, 1996 and 1995, respectively.
The Company entered into service agreements with FACC and MAAC effective September 1, 1996. Pursuant to the terms of the agreements, the Company provides investment management, data processing, accounting and reporting services in return for a $1,000 per month service fee from each company. Under the terms of the agreement, FACC and MAAC each incurred expenses of $4,000. Further, the Company has accounts receivable of $12,480 and $33,799 from FACC and MAAC, respectively, at December 31, 1996 (see Note 4). Various officers and directors of the Company hold similar positions with FACC and MAAC.
FKCC has entered into a line of credit agreement with MAC. Under the terms of the agreement, MAC has available $250,000 for operations and financing medical receivables. The agreement bears interest at an annual rate of 7%. At December 31, 1996, MAC had drawn $35,500 of the line of credit.
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
Fixed maturities are carried at fair value in the accompanying consolidated balance sheet. The fair value of fixed maturities are based on quoted market prices. At December 31, 1996 and 1995, the fair value of fixed maturities was $9,946,130 and $2,496,695, respectively.
Notes Receivable and Investments in Unconsolidated Affiliates
The carrying values of notes receivable and investments in unconsolidated affiliates approximate their fair values. At December 31, 1996, the fair values of notes receivable and investments in unconsolidated affiliates were $221,096 and $97,184, respectively. There were no investments in notes receivable or unconsolidated affiliates at December 31, 1995.
Short-term Investments
The carrying value of short-term investments approximates their fair value. There were no short-term investments at December 31, 1996. At December 31, 1995, the fair value of short-term investments was $2,611,979.
Cash and Cash Equivalents
The carrying values of cash and cash equivalents approximate their fair values. At December 31, 1996 and 1995, the fair value of cash and cash equivalents was $908,276 and $6,087,294, respectively.
Investment Contracts
The carrying value of investment-type fixed annuity contracts approximates their fair value. At December 31, 1996 and 1995, the fair value of investment-type fixed annuity contracts were $504,323 and $32,835.
11. Stock Options
The Company has adopted a stock option plan for 200,000 common stock shares. The option exercise price pursuant to the plan is $1.05. Grantees have five years in which to exercise their options. Any options granted will be exercisable in installments as follows: 25% at any time after the commencement of the second year of the option term and an additional 25% at any time after the commencement of years three, four and five, such installments to be cumulative. The Company's three founding officers are not eligible to participate in the plan. The stock options will not be available for granting until March 4, 1997.
Stock options will be accounted for in accordance with Accounting Principals Board Opinion No. 25, "Accounting for Stock Issued to Employees." The Company will recognize compensation expense for financial statement purposes when options granted become vested. Such compensation expense will be the difference between the option exercise price of $1.05 and the fair market value at the date of grant.
12. Segment Information
13. Claims and Contingencies
The Company is party to a claim related to an automobile accident involving an officer of the Company. The outcome of this matter is not predictable with assurance. Although any actual liability is not determinable as of December 31, 1996, the Company believes that any liability resulting from this matter, after taking into consideration insurance coverages, should not have a material adverse effect on the Company's financial position.