ITEM 1. BUSINESS
FORWARD-LOOKING INFORMATION
Any forward-looking statement contained herein or in any other oral or written statement by the company or any of its officers, directors or employees is qualified by the fact that actual results of the company may differ materially from those projected in forward-looking statements. Additional information concerning factors that could cause actual results to differ from those in the forward-looking statements is contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations."
OVERVIEW
United Trust Group, Inc. (the "Registrant") was incorporated in 1984, under the laws of the State of Illinois to serve as an insurance holding company. The Registrant and its subsidiaries (the "Company") have only one significant industry segment - insurance. The Company's dominant business is individual life insurance which includes the servicing of existing insurance business in force, the solicitation of new individual life insurance, and the acquisition of other companies in the insurance business.
At December 31, 2001, significant majority-owned subsidiaries of the Registrant were as depicted on the following organizational chart:
This document at times will refer to the Company's largest shareholder, Mr. Jesse T. Correll and certain companies controlled by Mr. Correll. Mr. Correll holds a majority ownership of First Southern Funding LLC, a Kentucky corporation, ("FSF") and First Southern Bancorp, Inc. ("FSBI"), a bank holding company that operates out of 14 locations in central Kentucky. Mr. Correll is Chairman of the Board of Directors of UTG and is currently UTG's largest shareholder through his ownership control of FSF, FSBI and affiliates. At December 31, 2001 Mr. Correll owns or controls directly and indirectly approximately 60% of UTG.
On September 4, 2001, FSF and FSBI (and their principals) restructured the manner in which they hold shares of UTG by forming a new limited liability company under Kentucky law, First Southern Holdings, LLC ("FSH"). FSBI contributed to FSH shares of UTG common stock held by it and cash in exchange for a 99% membership interest in FSH. FSF contributed to FSH shares of UTG common stock held by it, subject to notes payable which were assumed by FSF in exchange for a 1% membership interest in FSH.
The holding companies within the group, UTG and FCC, are life insurance holding companies. These companies became members of the same affiliated group through a history of acquisitions in which life insurance companies were involved. The focus of the holding companies is the acquisition of other companies in similar lines of business and management of the insurance subsidiaries. The companies have no activities outside the life insurance focus.
The insurance companies of the group, UG, APPL and ABE, all operate in the individual life insurance business. The primary focus of these companies has been the servicing of existing insurance business in force and the solicitation of new insurance business.
REC is a wholly owned subsidiary of UTG, which was incorporated under the laws of the State of Delaware on June 1, 1971, for the purpose of dealing and brokering in securities. REC acts as an agent for its customers by placing orders of mutual funds and variable annuity contracts which are placed in the customers' names, the mutual fund shares and variable annuity accumulation units are held by the respective custodians, and the only financial involvement of REC is through receipt of commission (load). REC was originally established to enhance the life insurance sales by providing an additional option to the prospective client. The objective was to provide an insurance sale and mutual fund sale in tandem. REC functions at a minimum broker-dealer level. It does not maintain any of its customer accounts nor receives customer funds directly. Operating activity of REC accounts for less than $100,000 of earnings annually.
North Plaza is a wholly owned subsidiary of UTG, which owns for investment purposes, a shopping center in Somerset, Kentucky, approximately 12,000 acres of timberland in Kentucky, and a 50% partnership interest in an additional 11,000 acres of Kentucky timberland. Operating activity of North Plaza accounts for less than $100,000 of earnings annually.
HISTORY
UTG was incorporated December 14, 1984, as an Illinois corporation. The original name was United Trust, Inc. ("UTI"). The name was changed in 1999 following a merger with United Income Inc. ("UII"). During its first two and a half years, UTG was engaged in an intrastate public offering of its securities, raising over $12,000,000 net of offering costs. In 1986, UTG formed a life insurance subsidiary, United Trust Assurance Company ("UTAC"), and by 1987 began selling life insurance products.
On June 16, 1992, UTG and its affiliates acquired 67% of the outstanding common stock of the now dissolved Commonwealth Industries Corporation, ("CIC") for a purchase price of $15,567,000. Following the acquisition UTG controlled eleven life insurance subsidiaries and six holding companies. The Company has taken several steps to streamline and simplify the corporate structure following the acquisitions, including dissolution of intermediate holding companies and mergers of several life insurance companies.
On November 20, 1998, FSF and affiliates acquired 929,904 shares of common stock of UTG from UTG and certain UTG shareholders. As consideration for the shares, FSF paid UTG $10,999,995 and certain shareholders of UTG $999,990 in cash. Following this transaction, FSF and its affiliates were the largest shareholder of UTG. At December 31, 2001, Mr. Jess Correll controls approximately 60% of the outstanding common stock of UTG either directly or through various affiliated entities including FSH.
During 1999, the Company made several significant changes to streamline and simplify its corporate structure. There were two mergers and a liquidation, reducing the number of holding companies to two and the number of life insurance companies to three (refer to the organizational chart on page 3). The first merger and company liquidation took place in July of 1999. Prior to July 1999, UTG was known as United Trust, Inc. ("UTI"). UTI and United Income, Inc. ("UII") owned 100% of the former United Trust Group, Inc., (which was formed in February of 1992 and liquidated in July of 1999 - referred to as "UTGL99"). Through a shareholder vote and special meeting on July 26, 1999, UII merged into UTI, and simultaneously with the merger, UTGL99 was liquidated and UTI changed its corporate name to United Trust Group, Inc. The second merger occurred on December 29, 1999, when UG was the survivor to a merger with its 100% owned subsidiary United Security Assurance Company ("USA").
The first merger transaction, and an anterior corresponding proposal to increase the number of authorized shares of UTG common stock from 3,500,000 to 7,000,000, received necessary shareholder approvals at a special meeting and vote held on July 26, 1999. The Board of Directors of the respective companies concluded that the merger would benefit the business operations of UTG and UII and their respective stockholders by creating a larger more viable life insurance holding group with lower administrative costs, a simplified corporate structure, and more readily marketable securities. The second merger was completed as a part of management's efforts to reduce costs and simplify the corporate structure.
On December 31, 1999, UTG and Jesse T. Correll entered into a transaction whereby Mr. Correll, in combination with other individuals, made an additional equity investment in UTG. Under the terms of the Stock Acquisition Agreement, Mr. Correll and certain of his affiliates contributed their 100% ownership of North Plaza of Somerset, Inc. to UTG in exchange for 681,818 authorized but unissued shares of UTG common stock. The Board of Directors of UTG approved the transaction at their regular quarterly board meeting held on December 7, 1999. North Plaza of Somerset, Inc. owned for investment purposes, a shopping center in Somerset, Kentucky, approximately 12,000 acres of timberland in Kentucky, and a 50% partnership interest in an additional 11,000 acres of Kentucky timberland. North Plaza had no debt. The net assets were valued at $7,500,000, which equates to $11.00 per share for the new shares of UTG that were issued in the transaction.
On October 26, 2001, APPL effected a reverse stock split, as a result of which (i) it became a wholly-owned subsidiary of UG, and an indirect wholly-owned subsidiary of FCC and UTG, and (ii) its minority shareholders received an aggregate of $1,055,294.50 in respect of their shares. Prior to the reverse stock split, UG owned 88% of the outstanding shares of APPL.
PRODUCTS
UG's portfolio consists of two universal life insurance products. Universal life insurance is a form of permanent life insurance that is characterized by its flexible premiums, flexible face amounts, and unbundled pricing factors. The primary universal life insurance product is referred to as the "Century 2000". This product was introduced to the marketing force in 1993. This product has a minimum face amount of $25,000 and currently credits 4.5% interest with a guaranteed rate of 4.5% in the first 20 years and 3% in years 21 and greater. The policy values are subject to a $4.50 monthly policy fee, an administrative load and a premium load of 6.5% in all years. The premium and administrative loads are a general expense charge, which is added to a policy's net premium to cover the insurer's cost of doing business. A premium load is assessed upon the receipt of a premium payment. An administrative load is a monthly maintenance charge. The administrative load and surrender charge is based on the issue age, sex and rating class of the policy. A surrender charge is effective for the first 14 policy years. In general, the surrender charge is very high in the early years and then declines to zero at the end of 14 years. Policy loans are available at 7% interest in advance. The policy's accumulated fund will be credited the guaranteed interest rate in relation to the amount of the policy loan.
The second universal life product referred to as the "UL90A", has a minimum face amount of $25,000. The administrative load is based on the issue age, sex and rating class of the policy. Policy fees vary from $1 per month in the first year to $4 per month in the second and third years and $3 per month each year thereafter. The UL90A currently credits 4.5% interest with a 4.5% guaranteed interest rate. Partial withdrawals, subject to a remaining minimum $500 cash surrender value and a $25 fee, are allowed once a year after the first duration. Policy loans are available at 7% interest in advance. The policy's accumulated fund will be credited the guaranteed interest rate in relation to the amount of the policy loan. Surrender charges are based on a percentage of target premium starting at 120% for years 1-5 then grading downward to zero in year 15. This policy contains a guaranteed interest credit bonus for the long-term policyholder. From years 10 through 20, additional interest bonuses can be earned if certain criteria are met, primarily relating to the total amount of premiums paid, with a total in the twentieth year of 1.375%. The bonus is credited from the policy issue date and is contractually guaranteed.
The Company's actual experience for earned interest, persistency and mortality varies from the assumptions applied to pricing and for determining premiums. Accordingly, differences between the Company's actual experience and those assumptions applied may impact the profitability of the Company. The minimum interest spread between earned and credited rates is 1% on the "Century 2000" universal life insurance product. The Company monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads. Credited rates are reviewed and established by the Board of Directors of the respective life insurance subsidiaries.
APPL markets traditional non-participating products that include the 10-pay life traditional product and preferred whole life plans. The 10-pay life traditional product is a limited pay product whereby the owner pays premiums over a 10-year period. At the end of the 10th year, no further premiums are paid and the insurance remains in-force. The preferred whole life plan is a traditional whole life product similar to 10-pay life plan other than premiums are payable over the entire life of the contract.
The Company believes its premium rates are competitive with other insurers doing business in the states in which the Company is marketing its products.
The Company markets other products, none of which is significant to operations. The Company has a variety of policies in force different from those, which are currently being marketed. Interest sensitive products including universal life and excess interest whole life ("fixed premium UL") account for 57% of the insurance in force. Approximately 22% of the insurance in force is participating business, which represents policies under which the policyowner shares in the insurance companies statutory divisible surplus. The Company's average persistency rate for its policies in force for 2001 and 2000 has been 91.6% and 89.8%, respectively. The Company does not anticipate any material fluctuations in rates in the future that may result from competition.
Interest sensitive life insurance products have characteristics similar to annuities with respect to the crediting of a current rate of interest at or above a guaranteed minimum rate and the use of surrender charges to discourage premature withdrawal of cash values. Universal life insurance policies also involve variable premium charges against the policyholder's account balance for the cost of insurance and administrative expenses. Interest-sensitive whole-life products generally have fixed premiums. Interest-sensitive life insurance products are designed with a combination of front-end loads, periodic variable charges, and back-end loads or surrender charges.
Traditional life insurance products have premiums and benefits predetermined at issue; the premiums are set at levels that are designed to exceed expected policyholder benefits and Company expenses. Participating business is traditional life insurance with the added feature of an annual return of a portion of the premium paid by the policyholder through a policyholder dividend. This dividend is set annually by the Board of Directors of each insurance company and is completely discretionary.
MARKETING
New business production has been declining the past several years. In 2001, the Companies issued 118 universal life insurance contracts and 323 traditional life insurance contracts. In 1999 management significantly scaled back on home office support of marketing efforts in response to the declining new business production adjusting expense levels relating to new business consistent with current production. Management currently places little emphasis on new business production, believing the Companies could better utilize their resources in other ways. In 2001, the Company increased its emphasis on policy retention in an attempt to improve current persistency levels. In this regard, several of the home office staff have become licensed insurance agents enabling them broader abilities when dealing with the customer in regards to their existing policies and possible alternatives. This program is relatively new, but early indications are generally positive. Management will continue to monitor the results of this program and make adjustments as deemed necessary.
Excluding licensed home office personnel, UG has a total of 25 general agents. UG primarily markets its products in the Midwest region with most sales in the states of Illinois and Ohio. APPL has a total of 3 active agents who market primarily to rural customers in the state of West Virginia. ABE has no active agents. No individual sales agent accounted for over 10% of the Company's premium volume in 2001. The Company's sales agents do not have the power to bind the Company.
ABE is licensed to sell life insurance in Alabama, Arizona, Illinois, Indiana, Louisiana and Missouri. During 2001, Illinois and Indiana accounted for 36% and 38%, respectively of ABE's direct premiums collected.
APPL is licensed to sell life insurance in Alabama, Arizona, Arkansas, Colorado, Georgia, Illinois, Indiana, Kansas, Kentucky, Louisiana, Missouri, Montana, Nebraska, Ohio, Oklahoma, Pennsylvania, Tennessee, Utah, Virginia, West Virginia and Wyoming. During 2001, West Virginia accounted for 87% of APPL's direct premiums collected.
UG is licensed to sell life insurance in Alabama, Arizona, Arkansas, Colorado, Delaware, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Massachusetts, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, Washington, West Virginia and Wisconsin. During 2001, Illinois accounted for 20%, and Ohio accounted for 32% of direct premiums collected. No other state accounted for more than 6% of direct premiums collected in 2001.
In 2001, $22,864,330 of total direct premium was collected by the insurance subsidiaries. Ohio accounted for 28%, Illinois accounted for 18%, and West Virginia accounted for 12% of total direct premiums collected.
UNDERWRITING
The underwriting procedures of the insurance subsidiaries are established by management. Insurance policies are issued by the Company based upon underwriting practices established for each market in which the Company operates. Most policies are individually underwritten. Applications for insurance are reviewed to determine additional information required to make an underwriting decision, which depends on the amount of insurance applied for and the applicant's age and medical history. Additional information may include inspection reports, medical examinations, and statements from doctors who have treated the applicant in the past and, where indicated, special medical tests. After reviewing the information collected, the Company either issues the policy as applied for or with an extra premium charge because of unfavorable factors or rejects the application. Substandard risks may be referred to reinsurers for full or partial reinsurance of the substandard risk.
The Company's insurance subsidiaries require blood samples to be drawn with individual insurance applications for coverage over $45,000 (age 46 and above) or $95,000 (ages 16-45). Blood samples are tested for a wide range of chemical values and are screened for antibodies to the HIV virus. Applications also contain questions permitted by law regarding the HIV virus, which must be answered by the proposed insureds.
RESERVES
The applicable insurance laws under which the insurance subsidiaries operate require that each insurance company report policy reserves as liabilities to meet future obligations on the policies in force. These reserves are the amounts which, with the additional premiums to be received and interest thereon compounded annually at certain assumed rates, are calculated in accordance with applicable law to be sufficient to meet the various policy and contract obligations as they mature. These laws specify that the reserves shall not be less than reserves calculated using certain mortality tables and interest rates.
The liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance subsidiaries' experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. The Company makes these assumptions at the time the contract is issued or, in the case of contracts acquired by purchase, at the purchase date. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. Current mortality rate assumptions are based on 1975-80 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or Linton C, which are industry standard actuarial tables for forecasting assumed policy lapse rates.
Benefit reserves for universal life insurance and interest sensitive life insurance products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims in excess of related policy account balances. Interest crediting rates for universal life and interest sensitive products range from 4.0% to 5.5% for the year ended December 31, 2001 and 4.5% to 5.5% for the years ended December 31, 2000 and 1999.
REINSURANCE
As is customary in the insurance industry, the insurance subsidiaries of the Company cede insurance to, and assume insurance from, other insurance companies under reinsurance agreements. Reinsurance agreements are intended to limit a life insurer's maximum loss on a large or unusually hazardous risk or to obtain a greater diversification of risk. The ceding insurance company remains primarily liable with respect to ceded insurance should any reinsurer be unable to meet the obligations assumed by it. However, it is the practice of insurers to reduce their exposure to loss to the extent that they have been reinsured with other insurance companies. The Company sets a limit on the amount of insurance retained on the life of any one person. The Company will not retain more than $125,000, including accidental death benefits, on any one life. At December 31, 2001, the Company had gross insurance in force of $2.630 billion of which approximately $654 million was ceded to reinsurers.
The Company's reinsured business is ceded to numerous reinsurers. The Company believes the assuming companies are able to honor all contractual commitments, based on the Company's periodic reviews of their financial statements, insurance industry reports and reports filed with state insurance departments.
Currently, the Company is utilizing reinsurance agreements with Business Mens' Assurance Company, ("BMA") and Life Reassurance Corporation of America, ("LIFE RE"). Recently, Swiss Re Life and Health America Incorporated merged into LIFE RE and the merged entity was renamed Swiss Re Life and Health America Incorporated ("SWISS RE"). BMA and SWISS RE currenty hold an "A" (Excellent), and "A++" (Superior) rating, respectively, from A.M. Best, an industry rating company. The reinsurance agreements were effective December 1, 1993, and cover all new business of the Company. The agreements are a yearly renewable term ("YRT") treaty where the Company cedes amounts above its retention limit of $100,000 with a minimum cession of $25,000.
UG entered a coinsurance agreement with Park Avenue Life Insurance Company ("PALIC") as of September 30, 1996. Under the terms of the agreement, UG ceded to PALIC substantially all of its paid-up life insurance policies. Paid-up life insurance generally refers to non-premium paying life insurance policies. PALIC and its ultimate parent The Guardian Life Insurance Company of America ("Guardian"), currently hold an "A" (Excellent), and "A+" (Superior) rating, respectively, from A.M. Best, an industry rating company. The agreement with PALIC accounts for approximately 66% of the reinsurance receivables, as of December 31, 2001.
On September 30, 1998, UG entered into a coinsurance agreement with The Independent Order of Vikings, an Illinois fraternal organization ("IOV"). Under the terms of the agreement, UG agreed to assume on a coinsurance basis, 25% of the reserves and liabilities arising from all inforce insurance contracts issued by the IOV to its members. At December 31, 2001, the IOV insurance inforce was approximately $1,696,000, with reserves being held on that amount of approximately $403,500.
On June 1, 2000, UG assumed an already existing coinsurance agreement, dated January 1, 1992, between Lancaster Life Reinsurance Company, an Arizona corporation ("LLRC") and Investors Heritage Life Insurance Company, a corporation organized under the laws of the Commonwealth of Kentucky ("IHL"). Under the terms of the agreement, LLRC agreed to assume from IHL a 90% quota share of new issues of credit life and accident and health policies that have been written on or after January 1, 1992 through various branches of the First Southern National Bank. The maximum amount of credit life insurance that can be assumed on any one individual's life is $15,000. UG assumed all the rights and obligations formerly held by LLRC as the reinsurer in the agreement. LLRC liquidated its charter immediately following the transfer. At December 31, 2001, IHL has insurance inforce of approximately $4,148,000.
The Company does not have any short-duration reinsurance contracts. The effect of the Company's long-duration reinsurance contracts on premiums earned in 2001, 2000 and 1999 was as follows:
Shown in thousands ----------------------------------------------- 2001 2000 1999 Premiums Premiums Premiums Earned Earned Earned -------------- ------------- ------------- Direct $ 20,333 $ 22,970 $ 25,539 Assumed 111 76 20 Ceded (3,172) (3,556) (3,978) -------------- ------------- ------------- Net premiums $ 17,272 $ 19,490 $ 21,581 ============== ============= =============
INVESTMENTS
Investment income represents a significant portion of the Company's total income. Investments are subject to applicable state insurance laws and regulations, which limit the concentration of investments in any one category or class and further limit the investment in any one issuer. Generally, these limitations are imposed as a percentage of statutory assets or percentage of statutory capital and surplus of each company.
The following table reflects net investment income by type of investment.
December 31, ------------------------------------------------ 2001 2000 1999 ------------- ------------- ------------- Fixed maturities and fixed maturities held for sale $ 10,831,162 $ 11,775,706 $ 11,886,968 Equity securities 131,263 116,327 91,429 Mortgage loans 2,715,834 1,777,374 1,079,332 Real estate 488,168 611,494 389,181 Policy loans 970,142 997,381 991,812 Other long-term investments 0 655,418 63,528 Short-term investments 110,229 158,378 147,726 Cash 606,128 936,433 850,836 ------------- ------------- ------------- Total consolidated investment income 15,852,926 17,028,511 15,500,812 Investment expenses (785,867) (942,678) (971,275) ------------- ------------- ------------- Consolidated net investment income $ 15,067,059 $ 16,085,833 $ 14,529,537 ============= ============= =============
At December 31, 2001, the Company had a total of $200,000 in investment real estate which did not produce income during 2001.
The following table summarizes the Company's fixed maturities distribution at December 31, 2001 and 2000 by ratings category as issued by Standard and Poor's, a leading ratings analyst.
Fixed Maturities Rating % of Portfolio ------------------ 2001 2000 -------- -------- Investment Grade AAA 61% 48% AA 6% 16% A 24% 27% BBB 8% 9% Below investment grade 1% 0% -------- -------- 100% 100% ======== ========
The following table summarizes the Company's fixed maturities and fixed maturities held for sale by major classification.
Carrying Value ---------------------------------------- 2001 2000 ----------------- ----------------- U.S. government and government agencies $ 43,087,596 $ 66,795,111 States, municipalities and political 11,990,823 15,524,611 subdivisions Collateralized mortgage obligations 54,132,094 9,140,804 Public utilities 22,219,127 27,287,454 Corporate 42,204,195 46,303,263 ----------------- ----------------- $ 173,633,835 $ 165,051,243 ================= =================
The following table shows the composition and average maturity of the Company's investment portfolio at December 31, 2001.
Average Carrying Average Average Investments Value Maturity Yield ----------------------------- ------------- -------------- ---------
Fixed maturities and fixed maturities held for sale $ 169,342,539 5 years 6.40% Equity securities 4,491,144 Not applicable 2.92% Mortgage Loans 28,141,783 5 years 9.65% Investment real estate 15,761,348 Not applicable 3.10% Policy loans 13,849,678 Not applicable 7.00% Short-term investments 1,133,890 190 days 8.25% Cash and cash equivalents 15,271,212 On demand 3.97% ------------- Total Investments and Cash $ 247,991,594 6.39% =============
At December 31, 2001, fixed maturities and fixed maturities held for sale have a combined market value of $176,353,850. Fixed maturities held to maturity are carried at amortized cost. Management has the ability and intent to hold these securities until maturity. Fixed maturities held for sale are carried at market.
The Company holds $581,382 in short-term investments. Management monitors its investment maturities which in their opinion is sufficient to meet the Company's cash requirements. Fixed maturities of $17,266,473 mature in one year and $84,495,730 mature in two to five years.
The Company holds $23,386,895 in mortgage loans, which represents 7% of the total assets. All mortgage loans are first position loans. Before a new loan is issued, the applicant is subject to certain criteria set forth by Company management to ensure quality control. These criteria include, but are not limited to, a credit report, personal financial information such as outstanding debt, sources of income, and personal equity. Loans issued are limited to no more than 80% of the appraised value of the property and must be first position against the collateral.
The Company has one loan of $28,536, which is in default and in the process of foreclosure. The Company has no loans which are under a repayment plan or restructuring. Letters are sent to each mortgagee when the loan becomes 30 days or more delinquent. Loans 90 days or more delinquent are placed on a non-performing status and classified as delinquent loans. Reserves for loan losses are established based on management's analysis of the loan balances compared to the expected realizable value should foreclosure take place. Loans are placed on a non-accrual status based on a quarterly analysis of the likelihood of repayment. All delinquent and troubled loans held by the Company are loans, which were held in portfolios by acquired companies at the time of acquisition. Management believes the current internal controls surrounding the mortgage loan selection process provide a quality portfolio with minimal risk of foreclosure and/or negative financial impact.
The Company has in place a monitoring system to provide management with information regarding potential troubled loans. Management is provided with a monthly listing of loans that are 30 days or more past due along with a brief description of what steps are being taken to resolve the delinquency. Quarterly, coinciding with external financial reporting, the Company determines how each delinquent loan should be classified. All loans 90 days or more past due are classified as delinquent. Each delinquent loan is reviewed to determine the classification and status the loan should be given. Interest accruals are analyzed based on the likelihood of repayment. In no event will interest continue to accrue when accrued interest along with the outstanding principal exceeds the net realizable value of the property. The Company does not utilize a specified number of day's delinquent to cause an automatic non-accrual status.
In 1999, the Company began investing more of its funds in mortgage loans. This is the result of increased mortgage opportunities available through FSNB, an affiliate of Jesse Correll. Mr. Correll is the Chairman and CEO of, as well as a director of, UTG, FCC and their three insurance company subsidiaries. FSNB has been able to provide the Company with additional expertise and experience in underwriting commercial and residential mortgage loans, which provide more attractive yields than the traditional bond market. During 2001, the Company issued approximately $4,535,000 in new mortgage loans. These new loans were originated through FSNB and funded by the Company through participation agreements with FSNB. FSNB services the loans covered by these participation agreements. The Company pays FSNB a .25% servicing fee on these loans and a one-time fee at loan origination of .50% of the original loan amount to cover costs incurred by FSNB relating to the processing and establishment of the loan.
A mortgage loan reserve is established and adjusted based on management's quarterly analysis of the portfolio and any deterioration in value of the underlying property which would reduce the net realizable value of the property below its current carrying value. During 2001, the Company sold mortgage loans with a prior allowance of $140,000 and recorded a net loss of $20,000 decreasing the allowance to $120,000 maintained for potential mortgage loan losses. The current allowance represents approximately 50% of the total outstanding loan balances on certain loans identified by management. Although most of these loans are currently in good standing, due to economic depression in the region these loans are located, a significant potential for future losses exists.
In addition, the Company also attempts to ensure that current and adequate insurance on the properties underlying the mortgages is being maintained. The Company requires proof of insurance on each loan and further requires to be shown as a lienholder on the policy so that any change in coverage status is reported to the Company. Proof of payment of real estate taxes is another monitoring technique utilized by the Company. Management believes a change in insurance status or non-payments of real estate taxes are indicators that a loan is potentially troubled. Correspondence with the mortgagee is performed to determine the reasons for either of these events occurring.
The following table shows a distribution of the Company's mortgage loans by type.
Mortgage Loans Amount % of Total --------------------------------------------- ------------- ---------- Commercial - insured or guaranteed $ 1,923,365 8% Commercial - all other 18,343,133 78% Farm 2,903,259 12% Residential - insured or guaranteed 111,655 1% Residential - all other 105,483 1%
The following table shows a geographic distribution of the Company's mortgage loan portfolio and investment real estate.
Mortgage Real Loans Estate ---------- ------- Alabama 15% 0% Illinois 0% 12% Indiana 3% 0% Kentucky 69% 51% Louisiana 0% 1% New Hampshire 0% 36% North Carolina 11% 0% West Virginia 0% 0% Other 2% 0% ---------- ------- Total 100% 100% ========== =======
The following table summarizes delinquent mortgage loan holdings of the Company.
Delinquent 90 days or More 2001 2000 1999 ----------------------------- ---------- ----------- ---------- Non-accrual status $ 164,941 $ 0 $ 0 Other 0 83,972 58,074 Reserve on delinquent Loans (110,000) 0 (10,000) ---------- ----------- ---------- Total delinquent $ 54,941 $ 83,972 $ 48,074 ========== =========== ========== Interest income past due (delinquent loans) $ 0 $ 6,975 $ 1,296 ========== =========== ==========
In process of restructuring $ 0 $ 0 $ 0 Restructuring on other Than market terms 0 0 0 Other potential problem Loans 9,299 215,481 124,883 ---------- ----------- ---------- Total problem loans $ 9,299 $ 215,481 $ 124,883 ========== =========== ========== Interest income foregone (restructured loans) $ 0 $ 0 $ 0 ========== =========== ==========
In process of foreclosure $ 28,536 $ 0 $ 0 ---------- ----------- ---------- Total foreclosed loans $ 28,536 $ 0 $ 0 ========== =========== ========== Interest income foregone (restructured loans) $ 2,497 $ 0 $ 0 ========== =========== ==========
See Item 2, Properties, for description of real estate holdings.
COMPETITION
The insurance business is a highly competitive industry and there are a number of other companies, both stock and mutual, doing business in areas where the Company operates. Many of these competing insurers are larger, have more diversified and established lines of insurance coverage, have substantially greater financial resources and brand recognition as well as a greater number of agents. Other significant competitive factors in the insurance industry include policyholder benefits, service to policyholders, and premium rates.
The insurance industry is a mature industry. In recent years, the industry has experienced virtually no growth in life insurance sales, though the aging population has increased the demand for retirement savings products. The products offered (see Products) by the Company are similar to those offered by other major companies. The product features are regulated by the states and are subject to extensive competition among major insurance organizations. The Company believes a strong service commitment to policyholders, efficiency and flexibility of operations, timely service to the agency force and the expertise of its key executives help reduce the competitive pressures it faces in the insurance industry.
In 1999, Congress passed legislation reducing or eliminating certain barriers, which existed between insurance companies, banks and brokerages. This legislation opens markets for financial institutions to compete against one another and to acquire one another across previously established barriers. This creates both additional challenges and opportunities for the Company. The full impact of these changes on the financial industries is still evolving, and the Company continues to watch these changes and how they impact the Company.
GOVERNMENT REGULATION
The Company's insurance subsidiaries are assessed contributions by life and health guaranty associations in almost all states to indemnify policyholders of failed companies. In several states the company may reduce, premium taxes paid to recover a portion of assessments paid to the states' guaranty fund association. This right of "offset" may come under review by the various states, and the company cannot predict whether and to what extent legislative initiatives may affect this right to offset. In addition, some state guaranty associations have adjusted the basis by which they assess the cost of insolvencies to individual companies. The Company believes that its reserve for future guaranty fund assessments is sufficient to provide for assessments related to known insolvencies. This reserve is based upon management's current expectation of the availability of this right of offset, known insolvencies and state guaranty fund assessment bases. However, changes in the basis whereby assessments are charged to individual companies and changes in the availability of the right to offset assessments against premium tax payments could materially affect the company's results.
Currently, the Company's insurance subsidiaries are subject to government regulation in each of the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including the power to: (i) grant and revoke licenses to transact business; (ii) regulate and supervise trade practices and market conduct; (iii) establish guaranty associations; (iv) license agents; (v) approve policy forms; (vi) approve premium rates for some lines of business; (vii) establish reserve requirements; (viii) prescribe the form and content of required financial statements and reports; (ix) determine the reasonableness and adequacy of statutory capital and surplus; and (x) regulate the type and amount of permitted investments. Insurance regulation is concerned primarily with the protection of policyholders. The Company cannot predict the impact of any future proposals, regulations or market conduct investigations. The Company's insurance subsidiaries, UG, APPL and ABE are domiciled in the states of Ohio, West Virginia and Illinois, respectively.
The insurance regulatory framework continues to be scrutinized by various states, the federal government and the National Association of Insurance Commissioners ("NAIC"). The NAIC is an association whose membership consists of the insurance commissioners or their designees of the various states. The NAIC has no direct regulatory authority over insurance companies. However, its primary purpose is to provide a more consistent method of regulation and reporting from state to state. This is accomplished through the issuance of model regulations, which can be adopted by individual states unmodified, modified to meet the state's own needs or requirements, or dismissed entirely.
Most states also have insurance holding company statutes, which require registration and periodic reporting by insurance companies controlled by other corporations licensed to transact business within their respective jurisdictions. The insurance subsidiaries are subject to such legislation and registered as controlled insurers in those jurisdictions in which such registration is required. Statutes vary from state to state but typically require periodic disclosure, concerning the corporation that controls the registered insurers and all subsidiaries of such corporation. In addition, prior notice to, or approval by, the state insurance commission of material intercorporate transfers of assets, reinsurance agreements, management agreements (see Note 9 in the notes to the consolidated financial statements), and payment of dividends (see Note 2 in the notes to the consolidated financial statements) in excess of specified amounts by the insurance subsidiary, within the holding company system, are required.
Each year the NAIC calculates financial ratio results (commonly referred to as IRIS ratios) for each company. These ratios compare various financial information pertaining to the statutory balance sheet and income statement. The results are then compared to pre-established normal ranges determined by the NAIC. Results outside the range typically require explanation to the domiciliary insurance department.
At year-end 2001, UG had one ratio outside the normal range. The ratio is related to the decrease in premium income. The decrease was attributable to the continued business decline in new business writings combined with a decrease in renewal premiums from normal terminations of existing business. As a result, UG fell slightly outside the normal range for this ratio.
The NAIC's risk-based capital requirements require insurance companies to calculate and report information under a risk-based capital formula. The risk-based capital formula measures the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching and other business factors. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio of the insurance company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Insurance companies below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action. The levels and ratios are as follows: Ratio of Total Adjusted Capital to Authorized Control Level RBC Regulatory Event (Less Than or Equal to)
Company action level 2* Regulatory action level 1.5 Authorized control level 1 Mandatory control level 0.7
* Or, 2.5 with negative trend.
At December 31, 2001, each of the insurance subsidiaries has a Ratio that is in excess of 4, which is 400% of the authorized control level; accordingly, the insurance subsidiaries meet the RBC requirements.
The State of Florida began an investigation of industrial life insurance policies in the fall of 1999 regarding policies with race-based premiums. This investigation has quickly spread to other states and to other types of small face amount policies and was expanded to consider the fairness of premiums for all small policies including policies which did not have race-based premiums. The NAIC historically has defined a "small face amount policy" as one with a face amount of $15,000 or less. Under current reviews, some states have increased this amount to policies of $25,000 or less. These states are attempting to force insurers to refund "excess premiums" to insureds or beneficiaries of insureds based on the recent American General settlement. The Company's insurance subsidiaries have no race-based premium products, but do have policies with face amounts under the above-scrutinized limitations. The outcome of this issue could be dramatic on the insurance industry as a whole as well as the Company itself. The Company will continue to monitor developments regarding this matter to determine to what extent, if any, the Company may be exposed.
During 1999, Congress passed the Gramm-Leach-Bliley Financial Services Modernization Act, which requires financial institutions, including all insurers, to take certain steps to enhance privacy protections of nonpublic personal information for consumers. It requires financial companies to tell consumers how their financial information is protected, and what a company's financial information sharing practices are, both within a corporate family and with unrelated third parties. Companies must inform their customers of their privacy policies and practices at the start of their business relationship, and then at least once a year for the duration of the relationship. Companies also must disclose the types of information that are shared. The privacy protections under the act became effective November 13, 2000. Financial institutions had until July 1, 2001, to establish and implement privacy policies. The Company has implemented new procedures in response to this legislation and believes it has complied with the requirements of this legislation.
A task force of the NAIC undertook a project to codify a comprehensive set of statutory insurance accounting rules and regulations. Project results were approved by the NAIC with an implementation date of January 1, 2001. Many states in which the Company does business implemented these new rules with the same effective date as proposed by the NAIC. The Company implemented these new regulations effective January 1, 2001 as required. Implementation of these new rules to date has not had a material financial impact on the insurance subsidiaries financial position or results of operations. The NAIC continues to modify and amend issue papers regarding codification. The Company will continue to monitor this issue as changes and new proposals are made.
EMPLOYEES
There are approximately 58 persons who are employed by the Company and its subsidiaries.
ITEM 2.
ITEM 2. PROPERTIES
The following table shows a breakout of property, net of accumulated depreciation, owned and occupied by the Company and the distribution of real estate by type.
Property owned Amount % of Total Home Office $ 2,167,317 10%
Investment real estate Commercial 15,841,887 78% Residential development 2,384,564 12% ---------- --- 18,226,451 90% ---------- --- Grand total $20,393,768 100% ========== ====
Total investment real estate holdings represent approximately 6% of the total assets of the Company net of accumulated depreciation of $169,281 and $307,294 at year-end 2001 and 2000 respectively. The Company owns an office complex in Springfield, Illinois, which houses the primary insurance operations. The office buildings contain 57,000 square feet of office and warehouse space. The properties are carried at $2,167,317. Currently, the facilities occupied by the Company are adequate relative to the Company's present operations.
Commercial property mainly consists of North Plaza, which owns for investment purposes, a shopping center in Somerset, Kentucky, approximately 12,000 acres of timberland in Kentucky, and a 50% partnership interest in an additional 11,000 acres of Kentucky timberland. The timberland is harvested and in various stages of maturity. The property is carried at $9,350,153.
During the fourth quarter of 2001, UG purchased real estate from an outside third party through the formation of an LLC in which UG is a two-thirds owner. The other one-third partner is Millard V. Oakley, who is a Director of both UTG and FCC. Hampshire Plaza, LLC consists of a twenty story, 254,000 square foot office tower, an attached 72,000 square foot retail plaza, and an attached parking garage with approximately 350 parking spaces located in Manchester, New Hampshire for $6,333,336. The Company plans to invest an additional $2,000,000 over the next few years in order to renovate and improve existing office space within the building. The intent of these improvements would be made in order to lease the office space in the near future. A significant portion of existing office leases expires in early to mid 2002. At December 31, 2001, the property was carried at $6,491,734.
Residential development property is primarily located in Springfield, Illinois, and entails several developments, each targeted for a different segment of the population. These targets include a development primarily for the first time home buyer, an upscale development for existing homeowners looking for a larger home, and duplex condominiums for those who desire maintenance free exteriors and surroundings. The Company's primary focus in the past has been on the development and sale of lots, with an occasional home construction to help stimulate interest. During 2000, management determined it would be in the long term best interests of the Company to discontinue development and attempt to liquidate the remaining properties.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
David A. Morlan, individually and on behalf of all others similarly situated v. Universal Guaranty Life Ins., United Trust Assurance Co., United Security Assurance Co., United Trust Group, Inc. and First Commonwealth Corporation, (U.S. Court of Appeals for the Seventh Circuit, Appeal No. 01-3795)
On April 26, 1999, the above lawsuit was filed by David Morlan and Louis Black in the Southern District of Illinois against Universal Guaranty Life Insurance Company ("UG") and United Trust Assurance Company ("UTAC") (merged into UG in 1992). After the lawsuit was filed, the plaintiffs, who were former insurance salesmen, amended their complaint, dropped Louis Black as a plaintiff, and added United Security Assurance Company ("USAC"), UTG and FCC as defendants. The plaintiffs are alleging that they were employees of UG, UTAC or USAC rather than independent contractors. The plaintiffs are seeking class action status and have asked to recover various employee benefits, costs and attorneys' fees, as well as monetary damages based on the defendants' alleged failure to withhold certain taxes.
On September 18, 2001, the case was dismissed without prejudice because Morlan lacked standing to pursue the claims against defendants. The plaintiffs have appealed the dismissal of the case to the United States Court of Appeals for the Seventh Circuit.
In addition to the appeal, a second action was filed entitled; Julie Barrette Ahrens, David Dzuiban, William Milam, David Schneiderman, individually and on behalf of all others similarly situated vs Universal Guaranty Life, United Trust Assurance Company, United Security Assurance Company. United States District Court for the Southern District of Illinois. Case No: 01-4314-JPG.
The Company continues to believe that it has meritorious grounds to defend both the original and related lawsuit, and it intends to defend the cases vigorously. The Company believes that the defense and ultimate resolution of the lawsuit should not have a material adverse effect upon the business, results of operations or financial condition of the Company. Nevertheless, if the lawsuit were to be successful, it is likely that such resolution would have a material adverse effect on the Company's business, results of operations and financial condition. At December 31, 2001, the Company maintains a liability of $300,000 to cover estimated legal costs associated with the defense of this matter.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS OF A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Registrant's common stock was traded on the NASDAQ Stock Market's Small-Cap Issues system until the Registrant's voluntary de-listing on December 31, 2001. Until that time, NASDAQ quotations were listed under the symbol UTGI. With the doubling of annual listing fees beginning in 2002 from previous years by the NASDAQ, the Registrant's Board of Directors discussed and approved a decision to voluntarily de-list its common stock from NASDAQ effective at the close of business on December 31, 2001. The Registrant remains a public company. Subsequent to December 31, 2001, the Registrant's common stock has traded and will trade in the over-the-counter market. Over-the-counter quotations can be obtained with the UTGI stock symbol.
The following table shows the high and low bid quotations for each quarterly period during the past two years, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
BID PERIOD LOW HIGH
First quarter 4.625 6.375 Second quarter 4.510 5.650 Third quarter 5.010 6.600 Fourth quarter 6.100 7.400
BID PERIOD LOW HIGH
First quarter 8.000 9.000 Second quarter 6.063 8.313 Third quarter 6.250 6.500 Fourth quarter 4.000 6.500
Primary Market Maker is:
J.J.B. Hilliard, W.L. Lyons 800-627-3557
UTG has no current plans to pay dividends on its common stock and intends to retain all earnings for investment in and growth of the Company's business. The payment of future dividends, if any, will be determined by the Board of Directors in light of existing conditions, including the Company's earnings, financial condition, business conditions and other factors deemed relevant by the Board of Directors. See Note 2 in the accompanying consolidated financial statements for information regarding dividend restrictions.
Number of Common Shareholders as of March 1, 2002 is 10,220.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
FINANCIAL HIGHLIGHTS (000's omitted, except per share data) 2001 2000 1999 1998 1997 ---------- --------- --------- --------- ---------- Premium income net of reinsurance $ 17,272 $ 19,490 $ 21,581 $ 26,396 $ 28,639 Total revenues $ 33,365 $ 35,747 $ 36,057 $ 40,885 $ 43,992 Net income (loss)* $ 2,440 $ (696) $ 1,076 $ (679) $ (559) Basic income (loss) per share $ 0.65 $ (0.17) $ 0.38 $ (0.39) $ (0.32) Total assets $ 329,524 $ 333,620 $ 339,161 $ 343,196 $ 349,300 Total long-term debt $ 4,401 $ 1,817 $ 5,918 $ 9,529 $ 21,460 Dividends paid per share NONE NONE NONE NONE NONE
* Includes equity earnings of investees.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The purpose of this section is to discuss and analyze the Company's consolidated results of operations, financial condition and liquidity and capital resources. This analysis should be read in conjunction with the consolidated financial statements and related notes, which appear elsewhere in this report. The Company reports financial results on a consolidated basis. The consolidated financial statements include the accounts of UTG and its subsidiaries at December 31, 2001.
Cautionary Statement Regarding Forward-Looking Statements
Any forward-looking statement contained herein or in any other oral or written statement by the company or any of its officers, directors or employees is qualified by the fact that actual results of the company may differ materially from any such statement due to the following important factors, among other risks and uncertainties inherent in the Company's business:
1. Prevailing interest rate levels, which may affect the ability of the Company to sell its products, the market value of the Company's investments and the lapse ratio of the Company's policies, notwithstanding product design features intended to enhance persistency of the Company's products.
2. Changes in the federal income tax laws and regulations, which may affect the relative tax advantages of the Company's products.
3. Changes in the regulation of financial services, including bank sales and underwriting of insurance products, which may affect the competitive environment for the Company's products.
4. Other factors affecting the performance of the Company, including, but not limited to, market conduct claims, regulatory initiatives or changes, insurance industry insolvencies, stock market performance, and investment performance.
Results of Operations
(a) Revenues
Premiums and policy fee revenues, net of reinsurance premiums and policy fees, decreased 11% when comparing 2001 to 2000 and 10% from 2000 to 1999. The Company currently writes little new business. A majority of the new business currently written is universal life insurance. Collected premiums on universal life and interest sensitive products is not reflected in premiums and policy revenues because accounting principles generally accepted in the United States of America requires that premiums collected on these types of products be treated as deposit liabilities rather than revenue. Unless the Company acquires a block of in-force business or marketing significantly increases on traditional business, management expects premium revenue to continue to decline at a rate consistent with prior experience. The Companies' average persistency rate for all policies in force for 2001 and 2000 has been approximately 91.6% and 89.8%, respectively. Persistency is a measure of insurance in force retained in relation to the previous year.
During 2001, the Company implemented a conservation effort in an attempt to improve the persistency rate of Company policies. Several of the customer service representatives of the Company have become licensed insurance agents, allowing them to offer other products within the Company's portfolio to existing customers. Additionally, stronger efforts have been made in policy retention through more personal contact with the customer including telephone calls to discuss alternatives and reasons for a customer's request to surrender their policy. Previously, the Company's agency force was primarily responsible for conservation efforts. With the decline in the number of agents, their ability to reach these customers diminished, making conservation efforts difficult. The conservation efforts described above are relatively new, but early results are generally positive. Management will continue to monitor these efforts and make adjustments as seen appropriate to enhance the future success of the program. The Company is currently exploring the introduction of a new product to be specifically used by the licensed customer service representatives as an alternative to the customer in the conservation efforts. The new product is in the very preliminary design stage. Introduction of the new product will depend on the product competitiveness and profitability.
New business production decreased steadily and significantly over the last several years. New business production in 2001 was only 8.5% of the production levels in 1996. The Company has not placed a strong emphasis on new business production in recent years. Costs associated with supporting new business can be significant. In recent years, the insurance industry as a whole has experienced a decline in the total number of agents who sell insurance products, therefore competition has intensified for top producing sales agents. The relatively small size of the Companies, and the resulting limitations, has made it challenging to compete in this area. In early 1999, management determined it could no longer continue to support the costs of new business in light of the declining trend and no indication it would reverse itself. As such, at that time, existing agents were allowed to continue marketing Company products, but the Company significantly reduced home office support and discontinued sales leads to agents using existing inforce policies.
The Company has considered the feasibility of a marketing opportunity with First Southern National Bank, an affiliate of UTG's largest shareholder. Management has considered various products including annuity type products, mortgage protection products and existing insurance products, as a possibility to market to all banking customers. This potential is believed to be a viable niche, but is not expected to produce significant premium writings.
Net investment income decreased 6% when comparing 2001 to 2000 and increased 11% when comparing 2000 to 1999. During 2000, the Company received $632,000 in investment earnings from a joint venture real estate development project that was in its latter stages. The earnings from this activity represent approximately 4% of the 2000 investment income.
The national prime rate has declined from 9.5% at December 31, 2000 to 4.75% at December 31, 2001. This has resulted in lower earnings on short-term funds as well as on longer-term investments acquired.
The overall investment yields for 2001, 2000 and 1999, are 6.39%, 7.01% and 6.45%, respectively.
The Company's investments are generally managed to match related insurance and policyholder liabilities. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. The Company monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads, ranging from 1% to 2%. It is expected that monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on the insurance policies the Company currently has in force and will write in the future. At the March 2001 Board of Directors meeting, the Boards of the insurance subsidiaries lowered crediting rates one half percent on all products that could be lowered. With this latest reduction, the vast majority of the Company's rate-adjustable products are now at their guaranteed minimum rates, and as such, cannot be lowered any further. These adjustments were in response to continued declines in interest rates in the marketplace. The decrease is expected to result in approximately $500,000 in interest crediting savings annually, when fully implemented. Policy interest crediting rate changes become effective on an individual policy basis on the next policy anniversary. Therefore, it will take a full year from the time the change is determined for the full impact of such change to be realized. The guaranteed minimum crediting rates on these products range from 3% to 5.5%.
Realized investment gains, net of realized losses, were $436,840, $(260,078) and $(530,894) in 2001, 2000 and 1999, respectively.
During 2001, the Company sold the West Virginia properties including the former home office building of APPL, realizing a gain of $217,574. The Company also sold certain common stocks it had acquired in 2000 and 2001 realizing gains of $132,760.
During early 1999, the Company re-evaluated its real estate holdings, especially those properties acquired through acquisitions of other companies and mortgage loan foreclosures, and determined it would be in the long term interest of the Company to dispose of certain of these parcels. Parcels targeted for sale were generally non-income or low income producing and located in parts of the country where management has little other reason to travel.
During 2000, real estate accounted for almost all of the realized gain and loss activity. By third quarter of 2000, the Company had sold the remaining real estate properties identified for disposal in prior years. The Company recorded net realized gains of $728,000 from these sales. By fourth quarter 2000, remaining real estate consisted of the North Plaza holdings and development real estate located in Springfield, IL. In December 2000, management studied its development properties, analyzing such issues as remaining time to fully develop without over saturation, historic sales trends, management time and resources to continue development and other alternatives such as modifying current plans or discontinuing entirely. Management determined it would be in the long term best interests of the Company to discontinue development and attempt to liquidate the remaining properties. As such, a realized loss of $913,000 was recorded in December 2000 to reduce the book value of these properties to the amount management determined it would accept net of selling costs to facilitate liquidation. During the fourth quarter of 2000, the Company recorded a $170,000 increase to the allowance maintained for potential mortgage loan losses.
Approximately 99% of the realized loss in 1999 were from two parcels of real estate. In June 1999, the Company sold its shopping center in Gulfport, MS realizing a loss on sale of $401,000. This property was originally acquired through the foreclosure of a mortgage loan. The property was income producing, but due to the distance from the Company's headquarters, was difficult to manage and required the use of an outside property manager. Given this circumstance and the eventual need for updates and improvements, the Company determined it was in its best long-term interest to sell the property. At year-end the Company wrote down another parcel of real estate $178,000 that it determined to attempt to and ultimately did sell during 2000. The write down was the result of Management's determination of the amount it would be willing to accept for the property. The Company had other gains and losses during the periods that comprised the remaining amounts reported but were immaterial on an individual basis.
On June 1, 2001, the Company began performing administrative work as a third party administrator ("TPA") for an unaffiliated life insurance company. The business being administered is a closed block with approximately 260,000 policies, a majority of which are paid up. The Company receives monthly fees based on policy in force counts and certain other activity indicators such as number of premium collections performed. During 2001, the Company received $299,905 for this work. These TPA revenue fees are included in the line item "other income" on the Company's consolidated statements of operations. The Company intends to pursue other TPA arrangements. Management believes it is a good source of generating additional revenues while utilizing the Company's strength, excess capacity and efficient administrative services.
(b) Expenses
Benefits, claims and settlement expenses net of reinsurance benefits and claims, decreased 12% in 2001 as compared to 2000 and increased 5% in 2000 as compared to 1999. The decrease in premium revenues from normal policy terminations resulted in lower benefit reserve increases in each of the periods presented compared to the previous period. Fluctuations in death claim experience from year to year typically has a significant impact on variances in this line item. Death claims were $1,636,000 less in 2001 than in 2000 and $2,574,000 greater in 2000 than in 1999. There is no single event that caused the mortality variances. Policy claims vary from year to year and therefore, fluctuations in mortality are to be expected and are not considered unusual by management. At the March 1999 Board of Directors meeting, the Boards of the insurance subsidiaries lowered crediting rates one half percent on all products that could be lowered. The change resulted in interest crediting reductions of approximately $600,000 per year. In March 2001, the Boards of the insurance subsidiaries lowered crediting rates one-half percent on all rate-adjustable products that could be lowered. With this latest reduction the vast majority of the Company's rate-adjustable products have been lowered to their guaranteed minimum rates, and as such, cannot be lowered any further. The decrease is expected to result in approximately $500,000 in interest crediting savings annually, when fully implemented. These adjustments were in response to continued declines in interest rates in the marketplace. Policy interest crediting rate changes become effective on an individual policy basis on the next policy anniversary. Therefore, it will take a full year from the time the change is determined for the full impact of such change to be realized.
Commissions and amortization of deferred policy acquisition costs decreased 40% in 2001 compared to 2000 and decreased 28% in 2000 compared to 1999. The Company performs actuarial analysis of the recoverability of the asset based on current trends and known events compared to assumptions used in the establishment of the original asset. No impairments were recorded in 2001 or 2000.
Amortization of cost of insurance acquired decreased 1% in 2001 compared to 2000 and decreased 14% in 2000 compared to 1999. Cost of insurance acquired is established when an insurance company is acquired. The Company assigns a portion of its cost to the right to receive future cash flows from insurance contracts existing at the date of the acquisition. The cost of policies purchased represents the actuarially determined present value of the projected future cash flows from the acquired policies. Cost of insurance acquired is comprised of individual life insurance products including whole life, interest sensitive whole life and universal life insurance products. Cost of insurance acquired is amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. The interest rates utilized in the amortization calculation are 9% on approximately 25% of the balance and 15% on the remaining balance. The interest rates vary due to risk analysis performed at the time of acquisition on the business acquired. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised. The Company did not have any charge-offs during the periods covered by this report. Amortization of cost of insurance acquired is particularly sensitive to changes in persistency of certain blocks of insurance in-force. Persistency is a measure of insurance in force retained in relation to the previous year. The Company's average persistency rate for all policies in force for 2001, 2000 and 1999 has been approximately 91.6%, 89.8% and 89.4%, respectively.
Operating expenses decreased 36% in 2001 compared to 2000 and increased 34% in 2000 compared to 1999. During the fourth quarter of 2000, Mr. Jess Correll as Board Chairman, requested the resignation of James E. Melville as President of UTG and its subsidiaries. A special joint meeting of the Boards of Directors of United Trust Group, Inc. and its subsidiaries was held January 8, 2001, at which the termination of the employment agreement between First Commonwealth Corporation and James E. Melville, and the termination of James E. Melville as an officer or agent of United Trust Group, Inc. and all of its subsidiaries were approved by the Boards of Directors of each of the companies. An accrual of $562,000 was established through a charge to general expenses at year-end 2000 for the remaining payments required pursuant to the terms of Mr. Melville's employment contract and other settlement costs. A $500,000 accrual was also established at year-end 2000 for estimated legal costs associated with the defense of a legal matter. See Item 3 legal proceedings for a more complete analysis of this matter. During the third quarter 2000, the Company settled a legal matter for $550,000 and incurred an additional $150,000 in legal fees. At the March 27, 2000 Board of Directors meeting, United Trust Group, Inc. and each of its affiliates accepted the resignation of Larry E. Ryherd as Chairman of the Board of Directors and Chief Executive Officer. Mr. Ryherd had 28 months remaining on an employment contract with the Company at the end of March 2000. As such, a charge of $933,000 was incurred in first quarter 2000 for the remainder of this contract. Exclusive of the above accruals, operating expenses declined 13% in 2001 compared to 2000 and declined 2% in 2000 compared to 1999, primarily as the result of lower salary and related employee costs.
During the fourth quarter of 1999, the Company transferred the policy administration functions of its insurance subsidiary APPL from Huntington, WV to its Springfield, IL location. The transfer was completed to reduce operating costs. APPL policy administration was then converted to the same computer system used to administer the other insurance subsidiaries. Following the transfer and system conversion, all insurance administration is located at the Springfield, IL office and administered on the same computer system. This action resulted in cost savings of approximately $250,000 per year in administrative costs. During 2001, the Company transferred all remaining functions from Huntington, WV to the Springfield, IL location and sold the West Virginia property. The closing of the Huntington office resulted in approximately $250,000 per year in operating expense savings.
Interest expense declined 13% comparing 2001 to 2000 and declined 41% comparing 2000 to 1999. The Company repaid $1,302,495, $1,540,800 and $3,149,369 in outside debt in 2001, 2000 and 1999 respectively, through operating cashflows and dividends from UG to FCC. In April 2001, the Company issued $3,885,996 in new debt to purchase common stock owned primarily by James E. Melville and Larry E. Ryherd, two former officers and directors of the Company and their respective families. On July 31, 2000, $2,560,000 in convertible debt of UTG held by First Southern was converted to equity. At December 31, 2001, UTG had $4,400,670 in notes payable. The remaining debt bears interest at a fixed rate of 7% on 88% of the debt and a floating rate of 1% under prime on 12% of the debt. Principal payments of $777,199 are due annually over the next five years. Management believes overall sources available are more than adequate to service this debt. These sources include current cash balances of UTG, expected future operating cashflows and repayment of affiliate receivables held by UTG.
Deferred taxes are established to recognize future tax effects attributable to temporary differences between the financial statements and the tax return. As these differences are realized in the financial statement or tax return, the deferred income tax established on the difference is recognized in the financial statements as an income tax expense or credit.
(c) Net income (loss)
The Company had a net income (loss) of $2,439,573, $(696,426) and $1,075,909 in 2001, 2000 and 1999 respectively. Significant one time charges and accruals to operating expenses combined with an increase in death claims during 2000 were the primary differences in the 2001 to 2000 results. The Company continues to monitor and adjust those items within its control.
Financial Condition
(a) Assets
Investments are the largest asset group of the Company. The Company's insurance subsidiaries are regulated by insurance statutes and regulations as to the type of investments that they are permitted to make and the amount of funds that may be used for any one type of investment. In light of these statutes and regulations, and the Company's business and investment strategy, the Company generally seeks to invest in United States government and government agency securities and other high quality low risk investments.
The Company does not own any derivative investments or "junk bonds". As of December 31, 2001, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in the context of consolidated assets or shareholders' equity. The Company has identified securities it may sell and classified them as "investments held for sale". Investments held for sale are carried at market, with changes in market value charged directly to shareholders' equity. To provide additional flexibility and liquidity, the Company has categorized almost all fixed maturity investments acquired in 2000 and 2001 as available for sale. It was determined it would be in the Company's best financial interest to classify these new purchases as available for sale to provide additional liquidity and flexibility.
The following table summarizes the Company's fixed maturities distribution at December 31, 2001 and 2000 by ratings category as issued by Standard and Poor's, a leading ratings analyst.
Fixed Maturities Rating % of Portfolio ------------------ 2001 2000 -------- -------- Investment Grade AAA 61% 48% AA 6% 16% A 24% 27% BBB 8% 9% Below investment grade 1% 0% -------- -------- 100% 100% ======== ========
In 1999, the Company began investing more of its funds in mortgage loans. This is the result of its affiliation with FSNB. FSNB has been able to provide the Company with additional expertise and experience in underwriting commercial and residential mortgage loans, which provide more attractive yields than the traditional bond market. During 2001 and 2000, the Company issued approximately $4,535,000 and $21,863,000 respectively, in new mortgage loans. These new loans were generated through FSNB and its personnel and funded by the Company through participation agreements with FSNB. FSNB services the loans covered by these participation agreements. The Company pays FSNB a .25% servicing fee on these loans and a one-time fee at loan origination of .50% of the original loan amount to cover costs incurred by FSNB relating to the processing and establishment of the loan. All mortgage loans held by the Company are first position loans. The Company has one loan totaling $28,536 that is in default and in the process of foreclosure at December 31, 2001.
Investment real estate holdings represent approximately 5.5% of the total assets of the Company. Total investment real estate is separated into two categories: Commercial 87% and Residential Development 13%. During 2001, UG acquired a two-thirds interest in a parcel of commercial real estate located in New Hampshire. The property is a 20 story office building including a parking garage and a connected enclosed retail mall all totaling 326,610 square feet. The property was acquired for investment purposes and had a carrying value at December 31, 2001 of $6,491,734.
Policy loans remained consistent for the periods presented. Industry experience for policy loans indicates few policy loans are ever repaid by the policyholder other than through termination of the policy. Policy loans are systematically reviewed to ensure that no individual policy loan exceeds the underlying cash value of the policy.
Deferred policy acquisition costs decreased 21% in 2001 compared to 2000. Deferred policy acquisition costs, which vary with, and are primarily related to producing new business, are referred to as ("DAC"). DAC consists primarily of commissions and certain costs of policy issuance and underwriting, net of fees charged to the policy in excess of ultimate fees charged. To the extent these costs are recoverable from future profits, the Company defers these costs and amortizes them with interest in relation to the present value of expected gross profits from the contracts, discounted using the interest rate credited by the policy. The Company had $167,000 in policy acquisition costs deferred, $76,000 in interest accretion and $1,083,577 in amortization in 2000.
Cost of insurance acquired decreased 4% in 2001 compared to 2000. At December 31, 2001, cost of insurance acquired was $33,666,336 and amortization totaled $1,572,920 for the year. When an insurance company is acquired, the Company assigns a portion of its cost to the right to receive future cash flows from insurance contracts existing at the date of the acquisition. The cost of policies purchased represents the actuarially determined present value of the projected future cash flows from the acquired policies. Cost of insurance acquired is amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits.
(b) Liabilities
Total liabilities decreased 1% in 2001 compared to 2000. Policy liabilities and accruals, which represents approximately 92% of total liabilities, decreased slightly from the prior year. The decline is attributable to a shrinking policy base and declining new business production.
Notes payable increased 142% in 2001 compared to 2000. At December 31, 2001, UTG had $4,400,670 in notes payable. During 2001, the Company repaid $1,302,495 of its debt. In April 2001, the Company issued $3,885,996 in new debt in exchange for the acquisition of UTG and FCC common stock. This debt bears interest at a fixed rate of 7% per annum with payments of principal to be made in five equal installments due until maturity in 2006. Other remaining debt of $514,674 bears interest at a floating rate of 1% under prime, with no principal payments due until its maturity in 2012. Management believes overall sources available are more than adequate to service this debt. These sources include current cash balances of UTG, expected future operating cashflows and repayment of affiliate receivables held by UTG. The Company's long-term debt is discussed in more detail in Note 11 of the Notes to the Financial Statements.
(c) Shareholders' Equity
Total shareholders' equity decreased 4% in 2001 compared to 2000. This is primarily due to the UTG acquisition of its common stock in April of 2001 from two former officers and directors of the Company and their respective families. Income during the year of $2,439,573 and unrealized gains on investments held for sale of $573,457 also influenced total shareholders' equity.
Liquidity and Capital Resources
The Company has three principal needs for cash - the insurance companies' contractual obligations to policyholders, the payment of operating expenses and the servicing of its long-term debt. Cash and cash equivalents as a percentage of total assets were 5% as of December 31, 2001 and 2000, respectively. Fixed maturities as a percentage of total invested assets were 74% and 71% as of December 31, 2001 and 2000, respectively.
Future policy benefits are primarily long-term in nature and therefore, the Company's investments are predominantly in long-term fixed maturity investments such as bonds and mortgage loans which provide sufficient return to cover these obligations. The Company has the ability and intent to hold these investments to maturity; consequently, the Company's investment in long-term fixed maturities is reported in the financial statements at their amortized cost.
Many of the Company's products contain surrender charges and other features which reward persistency and penalize the early withdrawal of funds. With respect to such products, surrender charges are generally sufficient to cover the Company's unamortized deferred policy acquisition costs with respect to the policy being surrendered.
Cash provided by (used in) operating activities was $1,365,047, $(2,155,491)and $(627,939) in 2001, 2000 and 1999, respectively. Reporting regulations require cash inflows and outflows from universal life insurance products to be shown as financing activities when reporting on cash flows. The net cash provided by (used in) operating activities plus policyholder contract deposits less policyholder contract withdrawals equaled $3,384,557 in 2001, $(393,571) in 2000 and $2,325,455 in 1999. Management utilizes this measurement of cash flows as an indicator of the performance of the Company's insurance operations.
Cash provided by (used in) investing activities was $138,994, $(3,940,958) and $(4,928,225), for 2001, 2000 and 1999, respectively. The most significant aspect of cash provided by (used in) investing activities are the fixed maturity transactions. Fixed maturities account for 81%, 42% and 68% of the total cost of investments acquired in 2001, 2000 and 1999, respectively. The Company has not directed its investable funds to so-called "junk bonds" or derivative investments.
Net cash provided by (used in) financing activities was $(1,091,769), $133,721 and $205,505 for 2001, 2000 and 1999, respectively. The Company continues to pay down on its outstanding debt. Such payments are included within this category. In addition, during 2001 the board of directors of the Company authorized a repurchase program of UTG's common stock. Such transactions are included in this category as well.
Policyholder contract deposits decreased 11% in 2001 compared to 2000, and decreased 10% in 2000 when compared to 1999. The decrease in policyholder contract deposits relates to the decline in new business production experienced in the last few years by the Company. Policyholder contract withdrawals have decreased 15% in 2001 compared to 2000, and decreased 2% in 2000 compared to 1999. The change in policyholder contract withdrawals is not attributable to any one significant event. Factors that influence policyholder contract withdrawals are fluctuation of interest rates, competition and other economic factors.
At December 31, 2001, the Company had a total of $4,400,670 in long-term debt outstanding. In April 2001, the Company issued $3,885,996 in new debt in exchange for the acquisition of UTG and FCC common stock. This debt bears interest at a rate of 7% per annum with payments of principal to be made in five equal installments due until maturity in 2006. The remaining debt of $514,674 bears interest at a floating rate of 1% below prime with no principal payments due until its maturity in 2012. Management believes overall sources available are more than adequate to service this debt. These sources include current cash balances of UTG, expected future operating cashflows and repayment of affiliate receivables held by UTG. The proposed merger of UTG and FCC will result in the addition of approximately $2.5 million in additional debt through draws on a line of credit. Interest on this debt will accrue at a floating rate equal to prime.
Contractual obligations on the Company's long-term debt require total payments of $2,331,598 due in 1-3 years, $1,554,399 due in 4-5 years and $514,674 due after 5 years. In November 2001, the Company established a one-year $3,300,000 line of credit with the First National Bank of the Cumberlands (see note 11c. to the financial statements). To date, the Company has no borrowings or obligations attributable to this line of credit. Should the Company draw on this line-of-credit, interest would accrue at a floating rate equal to prime and any principal balance owed would be payable on November 15, 2002.
On November 20, 1998, FSF and affiliates acquired 929,904 shares of common stock of UTG from UTG and certain UTG shareholders. As consideration for the shares, FSF paid UTG $10,999,995 and certain shareholders of UTG $999,990 in cash. Included in the stock acquisition agreement is an earnings covenant whereby UTG warrants UTG and its subsidiaries and affiliates will have future earnings of at least $30,000,000 for a five-year period beginning January 1, 1998. Such earnings are computed based on statutory results excluding inter-company activities such as inter-company dividends plus realized and unrealized gains and losses on real estate, mortgage loans and unaffiliated common stocks. At the end of the covenant period, an adjustment is to be made equal to the difference between the then market value and statutory carrying value of real estate still owned that existed at the beginning of the covenant period. Should UTG not meet the covenant requirements, any shortfall will first be reduced by the actual average tax rate for UTG for the period, then will be further reduced by one-half of the percentage, if any, representing UTG's ownership percentage of the insurance company subsidiaries. This result will then be reduced by $250,000. The remaining amount will be paid by UTG in the form of UTG common stock valued at $15.00 per share with a maximum number of shares to be issued of 500,000. However, there shall be no limit to the number of shares transferred to the extent that there are legal fees, settlements, damage payments or other losses as a result of certain legal action taken. The price and number of shares shall be adjusted for any applicable stock splits, stock dividends or other recapitalizations. At December 31, 2001, the Company had total earnings of $14,505,204 applicable to this covenant. With one year remaining on the covenant, it appears highly unlikely UTG will meet the earnings requirements, resulting in UTG being required to issue additional shares to FSF or its assigns. Combining current results with management's expectation for 2002, it appears at this time UTG will be required to issue 500,000 shares at December 31, 2002 to satisfy this covenant.
UTG is a holding company that has no day to day operations of its own. Funds required to meet its expenses, generally costs associated with maintaining the company in good standing with states in which it does business, are primarily provided by its subsidiaries. On a parent only basis, UTG's cash flow is dependent on its earnings received on invested assets (primarily notes receivable from FCC) and cash balances. At December 31, 2001, substantially all of the consolidated shareholders equity represents net assets of its subsidiaries and receivables from its subsidiaries. The Company's insurance subsidiaries have maintained adequate statutory capital and surplus and have not used surplus relief or financial reinsurance, which have come under scrutiny by many state insurance departments. The payment of cash dividends to shareholders is not legally restricted. However, the state insurance department regulates insurance company dividend payments where the company is domiciled. UTG is the ultimate parent of UG through ownership of FCC. UG can not pay a dividend directly to UTG due to the ownership structure. However, if UG paid a dividend to its direct parent, FCC, and FCC paid a dividend equal to the amount it received, UTG would receive 82% of the original dividend paid by UG. Please refer to Note 1 of the Notes to the Consolidated Financial Statements. UG's dividend limitations are described below without effect of the ownership structure.
Ohio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 2001, UG had a statutory gain from operations of $2,212,215. At December 31, 2001, UG's statutory capital and surplus amounted to $16,105,265. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. UG paid ordinary dividends of $1,400,000 to FCC during 2001.
A life insurance company's statutory capital is computed according to rules prescribed by the National Association of Insurance Commissioners ("NAIC"), as modified by the insurance company's state of domicile. Statutory accounting rules are different from accounting principles generally accepted in the United States of America and are intended to reflect a more conservative view by, for example, requiring immediate expensing of policy acquisition costs. The achievement of long-term growth will require growth in the statutory capital of the Company's insurance subsidiaries. The subsidiaries may secure additional statutory capital through various sources, such as internally generated statutory earnings or equity contributions by the Company from funds generated through debt or equity offerings.
The NAIC's risk-based capital requirements require insurance companies to calculate and report information under a risk-based capital formula. The risk-based capital formula measures the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching and other business factors. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio of the insurance company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Insurance companies below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action. The levels and ratios are as follows:
Ratio of Total Adjusted Capital to Authorized Control Level RBC Regulatory Event (Less Than or Equal to) ---------------- ----------------------- Company action level 2* Regulatory action level 1.5 Authorized control level 1 Mandatory control level 0.7 * Or, 2.5 with negative trend.
At December 31, 2001, each of the insurance subsidiaries has a Ratio that is in excess of 4, which is 400% of the authorized control level; accordingly the insurance subsidiaries meet the RBC requirements.
The Company is not aware of any litigation that will have a material adverse effect on the financial position of the Company. In addition, the Company does not believe that the regulatory initiatives currently under consideration by various regulatory agencies will have a material adverse impact on the Company. The Company is not aware of any material pending or threatened regulatory action with respect to the Company or any of its subsidiaries. The Company does not believe that any insurance guaranty fund assessments will be materially different from amounts already provided for in the financial statements.
Management believes the overall sources of liquidity available will be sufficient to satisfy its financial obligations.
REGULATORY ENVIRONMENT
The Company's insurance subsidiaries are assessed contributions by life and health guaranty associations in almost all states to indemnify policyholders of failed companies. In several states the company may reduce, premium taxes paid to recover a portion of assessments paid to the states' guaranty fund association. This right of "offset" may come under review by the various states, and the company cannot predict whether and to what extent legislative initiatives may affect this right to offset. In addition, some state guaranty associations have adjusted the basis by which they assess the cost of insolvencies to individual companies. The Company believes that its reserve for future guaranty fund assessments is sufficient to provide for assessments related to known insolvencies. This reserve is based upon management's current expectation of the availability of this right of offset, known insolvencies and state guaranty fund assessment bases. However, changes in the basis whereby assessments are charged to individual companies and changes in the availability of the right to offset assessments against premium tax payments could materially affect the company's results.
Currently, the Company's insurance subsidiaries are subject to government regulation in each of the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including the power to: (i) grant and revoke licenses to transact business; (ii) regulate and supervise trade practices and market conduct; (iii) establish guaranty associations; (iv) license agents; (v) approve policy forms; (vi) approve premium rates for some lines of business; (vii) establish reserve requirements; (viii) prescribe the form and content of required financial statements and reports; (ix) determine the reasonableness and adequacy of statutory capital and surplus; and (x) regulate the type and amount of permitted investments. Insurance regulation is concerned primarily with the protection of policyholders. The Company cannot predict the impact of any future proposals, regulations or market conduct investigations. The Company's insurance subsidiaries, UG, APPL and ABE are domiciled in the states of Ohio, West Virginia and Illinois, respectively.
The insurance regulatory framework continues to be scrutinized by various states, the federal government and the National Association of Insurance Commissioners ("NAIC"). The NAIC is an association whose membership consists of the insurance commissioners or their designees of the various states. The NAIC has no direct regulatory authority over insurance companies. However, its primary purpose is to provide a more consistent method of regulation and reporting from state to state. This is accomplished through the issuance of model regulations, which can be adopted by individual states unmodified, modified to meet the state's own needs or requirements, or dismissed entirely.
Most states also have insurance holding company statutes, which require registration and periodic reporting by insurance companies controlled by other corporations licensed to transact business within their respective jurisdictions. The insurance subsidiaries are subject to such legislation and registered as controlled insurers in those jurisdictions in which such registration is required. Statutes vary from state to state but typically require periodic disclosure, concerning the corporation that controls the registered insurers and all subsidiaries of such corporation. In addition, prior notice to, or approval by, the state insurance commission of material intercorporate transfers of assets, reinsurance agreements, management agreements (see Note 9 in the notes to the consolidated financial statements), and payment of dividends (see Note 2 in the notes to the consolidated financial statements) in excess of specified amounts by the insurance subsidiary, within the holding company system, are required.
Each year the NAIC calculates financial ratio results (commonly referred to as IRIS ratios) for each company. These ratios compare various financial information pertaining to the statutory balance sheet and income statement. The results are then compared to pre-established normal ranges determined by the NAIC. Results outside the range typically require explanation to the domiciliary insurance department.
At year-end 2001, UG had one ratio outside the normal range. The ratio is related to the decrease in premium income. The decrease was attributable to the continued business decline in new business writings combined with a decrease in renewal premiums from normal terminations of existing business. As a result, UG fell slightly outside the normal range for this ratio.
The NAIC's risk-based capital requirements require insurance companies to calculate and report information under a risk-based capital formula. The risk-based capital formula measures the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching and other business factors. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio of the insurance company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Insurance companies below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action. The levels and ratios are as follows:
Ratio of Total Adjusted Capital to Authorized Control Level RBC Regulatory Event (Less Than or Equal to) ---------------- ----------------------- Company action level 2* Regulatory action level 1.5 Authorized control level 1 Mandatory control level 0.7
* Or, 2.5 with negative trend.
At December 31, 2001, each of the insurance subsidiaries has a Ratio that is in excess of 4, which is 400% of the authorized control level; accordingly, the insurance subsidiaries meet the RBC requirements.
The State of Florida began an investigation of industrial life insurance policies in the fall of 1999 regarding policies with race-based premiums. This investigation has quickly spread to other states and to other types of small face amount policies and was expanded to consider the fairness of premiums for all small policies including policies which did not have race-based premiums. The NAIC historically has defined a "small face amount policy" as one with a face amount of $15,000 or less. Under current reviews, some states have increased this amount to policies of $25,000 or less. These states are attempting to force insurers to refund "excess premiums" to insureds or beneficiaries of insureds based on the recent American General settlement. The Company's insurance subsidiaries have no race-based premium products, but do have policies with face amounts under the above-scrutinized limitations. The outcome of this issue could be dramatic on the insurance industry as a whole as well as the Company itself. The Company will continue to monitor developments regarding this matter to determine to what extent, if any, the Company may be exposed.
During 2000, Congress passed the Gramm-Leach-Bliley Financial Services Modernization Act, which requires financial institutions, including all insurers, to take certain steps to enhance privacy protections of nonpublic personal information for consumers. The law is one of the most sweeping systems of privacy protection and regulation ever imposed in our nation's history. It requires financial companies to tell consumers how their financial information is protected, and what a company's financial information sharing practices are, both within a corporate family and with unrelated third parties. Companies must inform their customers of their privacy policies and practices at the start of their business relationship, and then at least once a year for the duration of the relationship. Companies also must disclose the types of information that are shared. The privacy protections under the act became effective November 13, 2000. Financial institutions had until July 1, 2001, to establish and implement privacy policies. The Company has implemented new procedures and complied with the requirements of this legislation.
A task force of the NAIC undertook a project to codify a comprehensive set of statutory insurance accounting rules and regulations. Project results were approved by the NAIC with an implementation date of January 1, 2001. Many states in which the Company does business implemented these new rules with the same effective date as proposed by the NAIC. The Company implemented these new regulations effective January 1, 2001 as required. Implementation of these new rules did not have a material financial impact on the insurance subsidiaries financial position or results of operations. The NAIC continues to modify and amend issue papers regarding codification. The Company will continue to monitor this issue as changes and new proposals are made.
ACCOUNTING AND LEGAL DEVELOPMENTS
The Financial Accounting Standards Board ("FASB") has issued Statement No. 141, Business Combinations, Statement No. 142, Goodwill and Other Intangible Assets, Statement No. 143, Accounting for Asset Retirement Obligations, and Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
Statement 141 improves the transparency of accounting and reporting for business combinations by requiring that all business combinations be accounted for under a single method - the purchase method. Use of the pooling-of-interests method is no longer permitted. Statement 141 requires that the purchase method be used for business combinations initiated after June 30, 2001. The adoption of Statement 141 did not affect the Company's financial position or results of operations, since the Company has had no such business combinations during the reporting period.
Statement 142 requires that goodwill no longer be amortized to earnings, but instead be reviewed for impairment. This change provides investors with greater transparency regarding the economic value of goodwill and its impact on earnings. The amortization of goodwill ceased for the Company upon the adoption of the statement at January 1, 2002. The adoption of Statement 142 will result in an expense reduction of approximately $90,000 per year, subject to any impairment write-down that might arise from a management review.
Statement 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The standard is effective for fiscal years beginning after June 15, 2002. The adoption of Statement 143 will not affect the Company's financial position or results of operations, since the Company has no such asset retirement obligations.
Statement 144 requires that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and broadens the presentation of discontinued operations to include more disposal transactions. In addition, this statement requires entities to recognize an impairment loss if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows, and to measure an impairment loss as the difference between the carrying amount and fair value of the asset. This statement removes any previous requirements to allocate goodwill to long-lived assets to be tested for impairment, and it further prescribes a probability-weighted cash flow estimation approach to deal with situations in which alternative courses of action to recover the carrying amount of a long-lived asset are under consideration. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001. The adoption of Statement 144 will not affect the Company's financial position or results of operations, since the Company has no such disposals or impairments to long-lived assets.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Listed below are the financial statements included in this Part of the Annual Report on SEC Form 10-K:
Page No. UNITED TRUST GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
Independent Auditors' Report for the Years ended December 31, 2001, 2000, 1999.................................32
Consolidated Balance Sheets...............................................33
Consolidated Statements of Operations.....................................34
Consolidated Statements of Shareholders' Equity...........................35
Consolidated Statements of Cash Flows.....................................36
Notes to Consolidated Financial Statements............................ 37-64
Independent Auditors' Report
Board of Directors and Shareholders UNITED TRUST GROUP, INC.
We have audited the accompanying consolidated balance sheets of UNITED TRUST GROUP, INC. (an Illinois corporation) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2001. 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 auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of UNITED TRUST GROUP, INC. and subsidiaries as of December 31, 2001 and 2000, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.
We have also audited Schedule I as of December 31, 2001, and Schedules II, IV and V as of December 31, 2001 and 2000, of UNITED TRUST GROUP, INC. and subsidiaries and Schedules II, IV and V for each of the three years in the period then ended. In our opinion, these schedules present fairly, in all material respects, the information required to be set forth therein.
KERBER, ECK & BRAECKEL LLP
Springfield, Illinois March 13, 2002
UNITED TRUST GROUP, INC. CONSOLIDATED BALANCE SHEETS As of December 31, 2001 and 2000
ASSETS 2001 2000 ------------ ------------ Investments: Fixed maturities held to maturity, at amortized cost (market $77,725,410 and $122,623,563) $ 75,005,395 $ 121,922,963 Investments held for sale: Fixed maturities, at market (cost $97,584,094 and $42,914,186) 98,628,440 43,128,280 Equity securities, at market (cost $3,937,812 and $5,509,132) 3,852,716 5,129,571 Mortgage loans on real estate at amortized cost 23,386,895 32,896,671 Investment real estate, at cost, net of accumulated depreciation 18,226,451 13,296,245 Policy loans 13,608,456 14,090,900 Short-term investments 581,382 1,686,397 ------------ ------------ 233,289,735 232,151,027
Cash and cash equivalents 15,477,348 15,065,076 Accrued investment income 3,002,860 3,482,036 Reinsurance receivables: Future policy benefits 33,776,688 35,083,244 Policy claims and other benefits 4,042,779 3,911,258 Cost of insurance acquired 33,666,336 35,239,256 Deferred policy acquisition costs 3,107,919 3,948,496 Cost in excess of net assets purchased, net of accumulated amortization 345,779 1,118,525 Property and equipment, net of accumulated depreciation 2,459,117 2,762,619 Income taxes receivable, current 215,865 178,335 Other assets 139,245 680,239 ------------ ------------ Total assets $ 329,523,671 $ 333,620,111 ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities and accruals: Future policy benefits $ 236,449,241 $ 240,238,991 Policy claims and benefits payable 2,781,920 2,639,248 Other policyholder funds 1,255,990 1,445,857 Dividend and endowment accumulations 13,055,024 13,515,427 Deferred income taxes 13,569,523 12,056,497 Notes payable 4,400,670 1,817,169 Other liabilities 5,465,896 6,292,841 ------------ ------------ Total liabilities 276,978,264 278,006,030 ------------ ------------ Minority interests in consolidated subsidiaries 7,771,793 8,899,648 ------------ ------------
Shareholders' equity: Common stock - no par value, stated value $.02 per share. Authorized 7,000,000 shares - 3,549,791 and 4,175,066 shares issued and outstanding after deducting treasury shares of 75,236 and 47,507 70,996 83,501 Additional paid-in capital 42,789,636 47,730,980 Retained earnings (accumulated deficit) 1,004,238 (1,435,335) Accumulated other comprehensive income 908,744 335,287 ------------ ------------ Total shareholders' equity 44,773,614 46,714,433 ------------ ------------ Total liabilities and shareholders' equity $ 329,523,671 $ 333,620,111 ============ ============
See accompanying notes.
UNITED TRUST GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Three Years Ended December 31, 2001
2001 2000 1999 ------------- ------------- -------------
Revenues:
Premiums and policy fees $ 20,444,514 $ 23,045,858 $ 25,559,708 Reinsurance premiums and policy fees (3,172,098) (3,556,172) (3,978,565) Net investment income 15,067,059 16,085,833 14,529,537 Realized investment gains(losses), net 436,840 (260,078) (530,894) Other income 589,017 431,682 477,325 ------------- ------------- ------------- 33,365,332 35,747,123 36,057,111
Benefits and other expenses:
Benefits, claims and settlement expenses: Life 19,614,470 23,440,711 22,338,042 Reinsurance benefits and claims (2,349,102) (3,376,091) (3,610,459) Annuity 1,244,663 1,210,783 1,390,592 Dividends to policyholders 1,015,055 1,003,954 1,170,710 Commissions and amortization of deferred policy acquisition costs 1,262,974 2,089,313 2,893,898 Amortization of cost of insurance acquired 1,572,920 1,592,812 1,847,754 Operating expenses 6,485,691 10,115,786 7,533,374 Interest expense 326,499 376,924 637,647 ------------- ------------- ------------- 29,173,170 36,454,192 34,201,558 ------------- ------------- -------------
Income (loss) before income taxes, minority interest and equity in income (loss) of investees 4,192,162 (707,069) 1,855,553 Income tax expense (1,181,133) (228,783) (690,454) Minority interest in (income) loss of consolidated subsidiaries (571,456) 239,426 (142,745) Equity in income of investees 0 0 53,555 ------------- ------------- -------------
Net income (loss) $ 2,439,573 $ (696,426)$ 1,075,909 ============= ============= =============
Basic income (loss) per share from continuing operations and net income (loss) $ 0.65 $ (0.17)$ 0.38 ============= ============= =============
Diluted income (loss) per share from continuing operations and net income (loss) $ 0.65 $ (0.17)$ 0.38 ============= ============= =============
Basic weighted average shares outstanding 3,733,432 4,056,439 2,839,703 ============= ============= =============
Diluted weighted average shares outstanding 3,733,432 4,056,439 2,839,934 ============= ============= =============
See accompanying notes.
UNITED TRUST GROUP, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Three Years Ended December 31, 2001
2001 2000 1999 ------------------------- ------------------------- -------------------------
Common stock Balance, beginning of year $ 83,501 $ 79,405 $ 49,809 Issued during year 0 4,096 29,986 Treasury shares acquired (555) 0 (390) Retired during year (11,950) 0 0 ----------- ----------- ----------- Balance, end of year $ 70,996 $ 83,501 $ 79,405 =========== =========== ===========
Additional paid-in capital Balance, beginning of year $ 47,730,980 $ 45,175,076 $ 27,403,172 Issued during year 0 2,555,904 17,921,469 Treasury shares acquired (172,927) 0 (149,565) Retired during year (4,768,417) 0 0 ----------- ----------- ----------- Balance, end of year $ 42,789,636 $ 47,730,980 $ 45,175,076 =========== =========== ===========
Retained earnings (accumulated deficit) Balance, beginning of year $ (1,435,335) $ (738,909) $ (1,814,818) Net income (loss) 2,439,573 $ 2,439,573 (696,426) $ (696,426) 1,075,909 $ 1,075,909 ----------- ----------- ----------- Balance, end of year $ 1,004,238 $ (1,435,335) $ (738,909) =========== =========== ===========
Accumulated other comprehensive income (deficit) Balance, beginning of year $ 335,287 $ (1,138,900) $ (276,852) Other comprehensive income (deficit) Unrealized holding gain (loss) on securities net of minority interest and reclassification adjustment 573,457 573,457 1,474,187 1,474,187 (862,048) (862,048) ----------- ----------- ----------- ----------- ----------- ------------ Comprehensive income $ 3,013,030 $ 777,761 $ 213,861 =========== =========== ============ Balance, end of year $ 908,744 $ 335,287 $ (1,138,900) =========== =========== ===========
Total shareholders' equity, end of year $ 44,773,614 $ 46,714,433 $ 43,376,672 =========== =========== ===========
See accompanying notes.
UNITED TRUST GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Three Years Ended December 31, 2001
2001 2000 1999 ------------ ------------ ----------- Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net income (loss) $ 2,439,573 $ (696,426) $ 1,075,909 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities net of changes in assets and liabilities resulting from the sales and purchases of subsidiaries: Amortization/accretion of fixed maturities 150,579 152,917 489,491 Realized investment (gains) losses, net (436,840) 260,078 530,894 Amortization of deferred policy acquisition costs 1,007,577 1,452,040 1,917,012 Amortization of cost of insurance acquired 1,572,920 1,592,812 1,847,754 Amortization of costs in excess of net assets purchased 90,000 90,000 90,000 Depreciation 436,216 505,221 507,771 Minority interest 571,456 (239,426) 142,745 Charges for mortality and administration of universal life and annuity products (9,344,711) (10,151,024) (10,696,014) Interest credited to account balances 5,749,098 6,109,491 6,300,667 Equity in income of investees 0 0 (53,555) Policy acquisition costs deferred (141,000) (273,000) (720,000) Change in accrued investment income 479,176 (22,275) 123,747 Change in reinsurance receivables 1,175,305 928,890 606,509 Change in policy liabilities and accruals (2,721,245) (3,647,101) (2,218,519) Change in income taxes payable 1,090,064 399,435 127,588 Change in indebtedness to affiliates, net 0 0 (1,287) Change in other assets and liabilities, net (753,121) 1,382,877 (698,651) ------------ ------------ ----------- Net cash provided by (used in) operating activities 1,365,047 (2,155,491) (627,939) ------------ ------------ -----------
Cash flows from investing activities: Proceeds from investments sold and matured: Fixed maturities held for sale 27,205,225 5,607,700 1,430,000 Fixed maturities matured 50,952,814 27,103,149 31,032,290 Equity securities 6,312,727 189,270 0 Mortgage loans 14,738,313 4,279,622 4,765,678 Real estate 2,135,472 4,743,146 2,705,093 Policy loans 2,912,296 2,918,627 3,169,753 Other long-term investments 0 906,278 0 Short-term 2,229,528 1,042,826 1,336,251 ------------ ------------ ----------- Total proceeds from investments sold and matured 106,486,375 46,790,618 44,439,065 Cost of investments acquired: Fixed maturities held for sale (84,801,095) (19,996,972) (31,366,755) Fixed maturities (1,124,925) (1,486,255) (2,020,803) Equity securities (4,608,649) (2,673,199) (161,255) Mortgage loans (5,325,569) (21,862,521) (9,257,836) Real estate (6,995,455) (1,246,912) (635,303) Policy loans (2,429,852) (2,858,415) (3,186,825) Short-term (1,124,512) (498,956) (2,503,722) ------------ ------------ ----------- Total cost of investments acquired (106,410,057) (50,623,230) (49,132,499) Purchase of property and equipment (138,388) (108,346) (234,791) Sale of property and equipment 201,064 0 0 ------------ ------------ ----------- Net cash provided by (used in) investing activities 138,994 (3,940,958) (4,928,225) ------------ ------------ -----------
Cash flows from financing activities: Policyholder contract deposits 11,361,882 12,724,345 14,176,188 Policyholder contract withdrawals (9,342,372) (10,962,425) (11,222,814) Cash received in merger 0 0 607,508 Payments of principal on notes payable (1,302,495) (1,540,800) (3,149,369) Purchase of stock of affiliates (632,131) (87,399) (56,053) Purchase of treasury shares (1,176,653) 0 (149,955) ------------ ------------ ----------- Net cash provided by (used in) financing activities (1,091,769) 133,721 205,505 ------------ ------------ -----------
Net increase (decrease) in cash and cash equivalents 412,272 (5,962,728) (5,350,659) Cash and cash equivalents at beginning of year 15,065,076 21,027,804 26,378,463 ------------ ------------ ----------- Cash and cash equivalents at end of year $ 15,477,348 $ 15,065,076 $ 21,027,804 ============ ============ =========== See accompanying notes.
UNITED TRUST GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. ORGANIZATION - At December 31, 2001, the significant majority-owned subsidiaries of UNITED TRUST GROUP, INC., were as depicted on the following organizational chart.
The Company's significant accounting policies, consistently applied in the preparation of the accompanying consolidated financial statements, are summarized as follows.
B. NATURE OF OPERATIONS - United Trust Group, Inc., is an insurance holding company, which sells individual life insurance products through its subsidiaries. The Company's principal market is the Midwestern United States. The Company's dominant business is individual life insurance which includes the servicing of existing insurance business in force, the solicitation of new individual life insurance and the acquisition of other companies in the insurance business.
C. BUSINESS SEGMENTS - The Company has only one significant business segment - insurance.
D. BASIS OF PRESENTATION - The financial statements of United Trust Group, Inc., and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America which differ from statutory accounting practices permitted by insurance regulatory authorities.
E. PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Registrant and its majority-owned subsidiaries. Investments in 20% to 50% owned affiliates in which management has the ability to exercise significant influence are included based on the equity method of accounting and the Company's share of such affiliates' operating results is reflected in Equity in loss of investees. Other investments in affiliates are carried at cost. All significant intercompany accounts and transactions have been eliminated.
F. INVESTMENTS - Investments are shown on the following bases:
Fixed maturities -- at cost, adjusted for amortization of premium or discount and other-than-temporary market value declines. The amortized cost of such investments differs from their market values; however, the Company has the ability and intent to hold these investments to maturity, at which time the full face value is expected to be realized.
Investments held for sale -- at current market value, unrealized appreciation or depreciation is charged directly to shareholders' equity.
Mortgage loans on real estate -- at unpaid balances, adjusted for amortization of premium or discount, less allowance for possible losses.
Real estate - investment real estate at cost less allowance for depreciation and, as appropriate, provisions for possible losses. Accumulated depreciation on investment real estate was $169,281 and $307,294 as of December 31, 2001 and 2000, respectively.
Policy loans -- at unpaid balances including accumulated interest but not in excess of the cash surrender value.
Short-term investments -- at cost, which approximates current market value.
Realized gains and losses on sales of investments are recognized in net income on the specific identification basis.
Unrealized gains and losses on investments carried at market value are recognized in other comprehensive income on the specific identification basis.
G. CASH EQUIVALENTS - The Company considers certificates of deposit and other short-term instruments with an original purchased maturity of three months or less cash equivalents.
H. REINSURANCE - In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage and coinsurance contracts. The Company retains a maximum of $125,000 of coverage per individual life.
Amounts paid, or deemed to have been paid, for reinsurance contracts are recorded as reinsurance receivables. Reinsurance receivables are recognized in a manner consistent with the liabilities relating to the underlying reinsured contracts. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies.
I. FUTURE POLICY BENEFITS AND EXPENSES - The liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance subsidiaries' experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. The Company makes these assumptions at the time the contract is issued or, in the case of contracts acquired by purchase, at the purchase date. Future policy benefits for individual life insurance and annuity policies are computed using interest rates ranging from 2% to 6% for life insurance and 2.5% to 9.25% for annuities. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. Current mortality rate assumptions are based on 1975-80 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or Linton C, which are industry standard actuarial tables for forecasting assumed policy lapse rates.
Benefit reserves for universal life insurance and interest sensitive life insurance products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims in excess of related policy account balances. Interest crediting rates for universal life and interest sensitive products range from 4.0% to 5.5% for 2001 and 4.5% to 5.5% for the years ended December 31, 2000 and 1999, respectively.
J. POLICY AND CONTRACT CLAIMS - Policy and contract claims include provisions for reported claims in process of settlement, valued in accordance with the terms of the policies and contracts, as well as provisions for claims incurred and unreported based on prior experience of the Company. Incurred but not reported claims were $900,894 and $900,114 as of December 31, 2001 and 2000, respectively.
K. COST OF INSURANCE ACQUIRED - When an insurance company is acquired, the Company assigns a portion of its cost to the right to receive future cash flows from insurance contracts existing at the date of the acquisition. The cost of policies purchased represents the actuarially determined present value of the projected future cash flows from the acquired policies. The Company utilized 9% discount rate on approximately 25% of the business and 15% discount rate on approximately 75% of the business. Cost of insurance acquired is amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. The interest rates utilized in the amortization calculation are 9% on approximately 25% of the balance and 15% on the remaining balance. The interest rates vary due to differences in the blocks of business. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised.
2001 2000 1999 ------------- ------------- ------------- Cost of insurance acquired, Beginning of year $ 35,239,256 $ 36,832,068 $ 38,679,822 Interest accretion 4,777,576 5,032,790 5,319,462 Amortization (6,350,496) (6,625,602) (7,167,216) ------------- ------------- ------------- Net amortization (1,572,920) (1,592,812) (1,847,754)
------------- ------------- ------------- Cost of insurance acquired, End of year $ 33,666,336 $ 35,239,256 $ 36,832,068 ============= ============= =============
Estimated net amortization expense of cost of insurance acquired for the next five years is as follows:
Interest Net Accretion Amortization Amortization
2002 $ 4,571,000 $ 6,086,000 $ 1,515,000 2003 4,371,000 6,066,000 1,695,000 2004 4,140,000 6,034,000 1,894,000 2005 3,875,000 6,084,000 2,209,000 2006 3,560,000 6,422,000 2,862,000
L. DEFERRED POLICY ACQUISITION COSTS - Commissions and other costs (salaries of certain employees involved in the underwriting and policy issue functions, and medical and inspection fees) of acquiring life insurance products that vary with and are primarily related to the production of new business have been deferred. Traditional life insurance acquisition costs are being amortized over the premium-paying period of the related policies using assumptions consistent with those used in computing policy benefit reserves.
For universal life insurance and interest sensitive life insurance products, acquisition costs are being amortized generally in proportion to the present value of expected gross profits from surrender charges and investment, mortality, and expense margins. Under SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments," the Company makes certain assumptions regarding the mortality, persistency, expenses, and interest rates it expects to experience in future periods. These assumptions are to be best estimates and are to be periodically updated whenever actual experience and/or expectations for the future change from initial assumptions. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised.
The following table summarizes deferred policy acquisition costs and related data for the years shown.
2001 2000 1999 ------------- ------------- ------------- Deferred, beginning of year $ 3,948,496 $ 5,127,536 $ 6,324,548
Acquisition costs deferred: Commissions 108,000 184,000 566,000 Other expenses 59,000 89,000 154,000 ------------- ------------- ------------- Total 167,000 273,000 720,000
Interest accretion 76,000 100,000 142,000 Amortization charged to income (1,083,577) (1,552,040) (2,059,012) ------------- ------------- ------------- Net amortization (1,007,577) (1,452,040) (1,917,012)
------------- ------------- ------------- Change for the year (840,577) (1,179,040) (1,197,012) ------------- ------------- -------------
Deferred, end of year $ 3,107,919 $ 3,948,496 $ 5,127,536 ============= ============= =============
The following table reflects the components of the income statement for the line item commissions and amortization of deferred policy acquisition costs:
2001 2000 1999 ---------- ----------- ------------
Net amortization of deferred policy acquisition costs $ 1,007,577 $ 1,452,040 $ 1,917,012 Commissions 255,397 637,273 976,886 ---------- ----------- ------------ Total $ 1,262,974 $ 2,089,313 $ 2,893,898 ========== =========== ============
Estimated net amortization expense of deferred policy acquisition costs for the next five years is as follows:
Interest Net Accretion Amortization Amortization ----------- ------------- -------------
2002 $ 41,000 $ 891,000 $ 850,000 2003 36,000 763,000 727,000 2004 32,000 648,000 616,000 2005 28,000 546,000 518,000 2006 25,000 450,000 425,000
M. COST IN EXCESS OF NET ASSETS PURCHASED - Cost in excess of net assets purchased is the excess of the amount paid to acquire a company over the fair value of its net assets. Costs in excess of net assets purchased are amortized on the straight-line basis over a 40-year period. Management continually reviews the value of goodwill based on estimates of future earnings. As part of this review, management determines whether goodwill is fully recoverable from projected undiscounted net cash flows from earnings of the subsidiaries over the remaining amortization period. If management were to determine that changes in such projected cash flows no longer supported the recoverability of goodwill over the remaining amortization period, the carrying value of goodwill would be reduced with a corresponding charge to expense (no such changes have occurred). Accumulated amortization of cost in excess of net assets purchased was $1,780,146 and $1,690,146 as of December 31, 2001 and 2000, respectively.
N. PROPERTY AND EQUIPMENT - Company-occupied property, data processing equipment and furniture and office equipment are stated at cost less accumulated depreciation of $5,560,547 and $5,951,717 at December 31, 2001 and 2000, respectively. Depreciation is computed on a straight-line basis for financial reporting purposes using estimated useful lives of three to 30 years. Depreciation expense was $316,900, $372,313, and $379,715 for the years ended December 31, 2001, 2000, and 1999, respectively.
O. INCOME TAXES - Income taxes are reported under Statement of Financial Accounting Standards Number 109. Deferred income taxes are recorded to reflect the tax consequences on future periods of differences between the tax bases of assets and liabilities and their financial reporting amounts at the end of each such period.
P. EARNINGS PER SHARE - Earnings per share ("EPS") are reported under Statement of Financial Accounting Standards Number 128. The objective of both basic EPS and diluted EPS is to measure the performance of an entity over the reporting period. Basic EPS is computed by dividing income available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. In addition, the numerator also is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common shares.
Q. TREASURY SHARES - The Company holds 75,236 and 47,507 shares of common stock as treasury shares with a cost basis of $673,437 and $499,955 at December 31, 2001 and 2000, respectively.
R. RECOGNITION OF REVENUES AND RELATED EXPENSES - Premiums for traditional life insurance products, which include those products with fixed and guaranteed premiums and benefits, consist principally of whole life insurance policies, and certain annuities with life contingencies are recognized as revenues when due. Limited payment life insurance policies defer gross premiums received in excess of net premiums, which is then recognized in income in a constant relationship with insurance in force. Accident and health insurance premiums are recognized as revenue pro rata over the terms of the policies. Benefits and related expenses associated with the premiums earned are charged to expense proportionately over the lives of the policies through a provision for future policy benefit liabilities and through deferral and amortization of deferred policy acquisition costs. For universal life and investment products, generally there is no requirement for payment of premium other than to maintain account values at a level sufficient to pay mortality and expense charges. Consequently, premiums for universal life policies and investment products are not reported as revenue, but as deposits. Policy fee revenue for universal life policies and investment products consists of charges for the cost of insurance and policy administration fees assessed during the period. Expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances.
S. PARTICIPATING INSURANCE - Participating business represents 22% and 23% of the ordinary life insurance in force at December 31, 2001 and 2000, respectively. Premium income from participating business represents 26%, 27%, and 29% of total premiums for the years ended December 31, 2001, 2000 and 1999, respectively. The amount of dividends to be paid is determined annually by the respective insurance subsidiary's Board of Directors. Earnings allocable to participating policyholders are based on legal requirements that vary by state.
T. RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform to the 2001 presentation. Such reclassifications had no effect on previously reported net loss, total assets, or shareholders' equity.
U. USE OF ESTIMATES - In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
2. SHAREHOLDER DIVIDEND RESTRICTION
At December 31, 2001, substantially all of consolidated shareholders' equity represents net assets of UTG's subsidiaries. The payment of cash dividends to shareholders by UTG and FCC is not legally restricted. However, the state insurance department regulates insurance company dividend payments where the company is domiciled. UG's dividend limitations are described below.
Ohio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 2001, UG had a statutory gain from operations of $2,212,215. At December 31, 2001, UG's statutory capital and surplus amounted to $16,105,265. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation.
3. INCOME TAXES
Until 1984, the insurance companies were taxed under the provisions of the Life Insurance Company Income Tax Act of 1959 as amended by the Tax Equity and Fiscal Responsibility Act of 1982. These laws were superseded by the Deficit Reduction Act of 1984. All of these laws are based primarily upon statutory results with certain special deductions and other items available only to life insurance companies. Under the provision of the pre-1984 life insurance company income tax regulations, a portion of "gain from operations" of a life insurance company was not subject to current taxation but was accumulated, for tax purposes, in a special tax memorandum account designated as "policyholders' surplus account". Federal income taxes will become payable on this account at the then current tax rate when and if distributions to shareholders, other than stock dividends and other limited exceptions, are made in excess of the accumulated previously taxed income maintained in the "shareholders surplus account".
The following table summarizes the companies with this situation and the maximum amount of income that has not been taxed in each.
Shareholders' Untaxed Company Surplus Balance ------------------- -------------- ----------- ABE $ 5,457,880 $ 1,149,693 APPL 7,098,824 1,525,367 UG 28,897,113 4,363,821
The payment of taxes on this income is not anticipated; and, accordingly, no deferred taxes have been established.
The life insurance company subsidiaries file a consolidated federal income tax return. The holding companies of the group file separate returns.
Life insurance company taxation is based primarily upon statutory results with certain special deductions and other items available only to life insurance companies. Income tax expense consists of the following components:
2001 2000 1999 ------------- ------------- ------------- Current tax expense $ 53,539 $ 85,440 $ 12,654 Deferred tax expense 1,127,594 143,343 677,800 ------------- ------------- ------------- $ 1,181,133 $ 228,783 $ 690,454 ============= ============= =============
The Companies have net operating loss carryforwards for federal income tax purposes expiring as follows:
UTG UG FCC ----------- ----------- ------------ 2006 $ 101,718 $ 0 $ 0 2007 179,894 0 0 2019 0 1,165,779 0 2020 0 0 525,451 2021 164,902 0 0 ----------- ----------- ------------ TOTAL $ 446,514 $ 1,165,779 $ 525,451 =========== =========== ============
The Company has established a deferred tax asset of $748,211 for its operating loss carryforwards and has established an allowance of $183,908. The total allowances established on deferred tax assets decreased $195,518 in 2001.
The following table shows the reconciliation of net income to taxable income of UTG:
2001 2000 1999 ------------ ------------ ------------- Net income (loss) $ 2,439,573 $ (696,426) $ 1,075,909 Federal income tax provision 12,043 60,550 192,247 Loss (gain) of subsidiaries (2,409,467) 762,656 (615,995) Gain of investees 0 0 (53,555) ------------ ------------ ------------- Taxable income $ 42,149 $ 126,780 $ 598,606 ============ ============ =============
UTG has a net operating loss carryforward of $446,514 at December 31, 2001. UTG has averaged approximately $256,000 in taxable income over the past three years and must average taxable income of approximately $90,000 over the next five years to fully realize its net operating loss carryforwards, as UTG's operating loss carryforwards do not begin to expire until the year 2006. UG must average approximately $65,000 of taxable income per year to fully realize its net operating loss carryforward for which no allowance is established. Management believes future earnings of UG will be sufficient to fully utilize net operating loss carryforwards. FCC must average approximately $28,000 of taxable income to fully realize its net operating loss carryforwards. FCC's operating loss carryforward does not expire until the year 2020. Management has established an allowance of $183,908 for FCC's loss carryforwards.
The expense or (credit) for income differed from the amounts computed by applying the applicable United States statutory rate of 35% before income taxes as a result of the following differences:
2001 2000 1999 ------------ ------------ ------------- Tax computed at statutory rate $ 1,467,257 $ (247,474) $ 649,444 Changes in taxes due to: Cost in excess of net assets purchased 31,500 31,500 31,500 Current year loss for which no benefit 0 546,231 0 realized Benefit of prior losses (159,456) (139,061) (6,309) Other (158,168) 37,587 15,819 ------------ ------------ ------------- Income tax expense $ 1,181,133 $ 228,783 $ 690,454 ============ ============ =============
The following table summarizes the major components that comprise the deferred tax liability as reflected in the balance sheets:
2001 2000 ------------ ------------- Investments $ 1,820,177 $ 1,402,431 Cost of insurance acquired 12,835,481 13,427,963 Other assets 0 (72,468) Deferred policy acquisition costs 1,087,772 1,381,974 Agent balances 0 (6,239) Management/consulting fees (508,101) (810,717) Future policy benefits (1,531,687) (2,485,664) Gain on sale of subsidiary 2,312,483 2,312,483 Net operating loss carryforward (564,303) (815,417) Other liabilities (372,303) (614,374) Federal tax DAC (1,509,996) (1,663,475) ------------ ------------- Deferred tax liability $ 13,569,523 $ 12,056,497 ============ =============
4. ANALYSIS OF INVESTMENTS, INVESTMENT INCOME AND INVESTMENT GAIN
A. NET INVESTMENT INCOME - The following table reflects net investment income by type of investment:
December 31, ------------------------------------------------ 2001 2000 1999 ------------- ------------- ------------- Fixed maturities and fixed maturities Held for sale $ 10,831,162 $ 11,775,706 $ 11,886,968 Equity securities 131,263 116,327 91,429 Mortgage loans 2,715,834 1,777,374 1,079,332 Real estate 488,168 611,494 389,181 Policy loans 970,142 997,381 991,812 Other long-term investments 0 655,418 63,528 Short-term investments 110,229 158,378 147,726 Cash 606,128 936,433 850,836 ------------- ------------- ------------- Total consolidated investment income 15,852,926 17,028,511 15,500,812 Investment expenses (785,867) (942,678) (971,275) ------------- ------------- ------------- Consolidated net investment income $ 15,067,059 $ 16,085,833 $ 14,529,537 ============= ============= =============
At December 31, 2001, the Company had a total of $200,000 in investment real estate which did not produce income during 2001.
The following table summarizes the Company's fixed maturity holdings and investments held for sale by major classifications:
Carrying Value --------------------------------- 2001 2000 ------------- ----------- Investments held for sale: Fixed maturities U.S. Government, government agencies and authorities $ 36,182,839 $ 35,444,312 State, municipalities and political subdivisions 202,256 206,006 Collateralized mortgage obligations 54,003,623 5,962,594 All other corporate bonds 8,239,722 1,515,368 ------------- ----------- $ 98,628,440 $ 43,128,280 ============= ===========
Equity securities Banks, trust and insurance companies $ 1,100,000 $ 3,142,320 Industrial and miscellaneous 2,752,716 1,987,251 ------------- ----------- $ 3,852,716 $ 5,129,571 ============= ===========
Fixed maturities held to maturity: U.S. Government, government agencies and authorities $ 6,904,757 $ 31,350,799 State, municipalities and political subdivisions 11,788,567 15,318,605 Collateralized mortgage obligations 128,471 3,178,210 Public utilities 22,219,127 27,287,454 All other corporate bonds 33,964,473 44,787,895 ------------- ----------- $ 75,005,395 $ 121,922,963 ============= ===========
By insurance statute, the majority of the Company's investment portfolio is invested in investment grade securities to provide ample protection for policyholders. The Company does not invest in so-called "junk bonds" or derivative investments.
Below investment grade debt securities generally provide higher yields and involve greater risks than investment grade debt securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment grade issuers. In addition, the trading market for these securities is usually more limited than for investment grade debt securities. Debt securities classified as below-investment grade are those that receive a Standard & Poor's rating of BB or below.
The following table summarizes by category securities held that are below investment grade at amortized cost:
Below Investment Grade Investments 2001 2000 1999 ------------------------- ----------- ---------- ---------- Public Utilities $ 2,091,138 $ 0 $ 251,878 CMO 43,189 239,165 0 Corporate 271,420 23,000 276,649 ----------- ---------- ---------- Total $ 2,405,747 $ 262,165 $ 528,527 =========== ========== ==========
B. INVESTMENT SECURITIES
The amortized cost and estimated market values of investments in securities including investments held for sale are as follows:
Cost or Gross Gross Estimated Amortized Unrealized Unrealized Market 2001 Cost Gains Losses Value ------------------------------ ------------ ----------- ------------ ------------ Investments held for sale: U.S. Government and govt. Agencies and authorities $ 35,240,384 $ 942,455 $ 0 $ 36,182,839 States, municipalities and Political subdivisions 192,059 10,197 0 202,256 Collateralized mortgage Obligations 53,777,577 447,019 (220,973) 54,003,623 Public utilities 0 0 0 0 All other corporate bonds 8,374,074 321 (134,673) 8,239,722 ------------ ----------- ------------ ------------ 97,584,094 1,399,992 (355,646) 98,628,440 Equity securities 3,937,812 953,448 (1,038,544) 3,852,716 ------------ ----------- ------------ ------------ Total $ 101,521,906 $ 2,353,440 $ (1,394,190) $ 102,481,156 ============ =========== ============ ============
Fixed maturities held to maturity: U.S. Government and govt. Agencies and authorities $ 6,904,757 $ 280,101 $ (893) $ 7,183,965 States, municipalities and Political subdivisions 11,788,567 360,714 (119,497) 12,029,784 Collateralized mortgage Obligations 128,471 4,820 0 133,291 Public utilities 22,219,127 859,864 (70,947) 23,008,044 All other corporate bonds 33,964,473 1,410,244 (4,391) 35,370,326 ------------ ----------- ------------ ------------ Total $ 75,005,395 $ 2,915,743 $ (195,728) $ 77,725,410 ============ =========== ============ ============
Cost or Gross Gross Estimated Amortized Unrealized Unrealized Market 2000 Cost Gains Losses Value ------------------------------- ------------ ----------- ------------ ------------ Investments held for sale: U.S. Government and govt. Agencies and authorities $ 35,281,562 $ 245,119 $ (82,369) $ 35,444,312 States, municipalities and Political subdivisions 190,593 15,413 0 206,006 Collateralized mortgage Obligations 5,919,553 58,179 (15,138) 5,962,594 Public utilities 0 0 0 0 All other corporate bonds 1,522,478 0 (7,110) 1,515,368 ------------ ----------- ------------ ------------ 42,914,186 318,711 (104,617) 43,128,280 Equity securities 5,413,507 637,191 (921,127) 5,129,571 ------------ ----------- ------------ ------------ Total $ 48,327,693 $ 955,902 $ (1,025,744) $ 48,257,851 ============ =========== ============ ============
Fixed maturities held to maturity: U.S. Government and govt. Agencies and authorities $ 31,350,799 $ 148,229 $ (282,088) $ 31,216,940 States, municipalities and Political subdivisions 15,318,605 299,028 (45,335) 15,572,298 Collateralized mortgage Obligations 3,178,210 35,628 (3,323) 3,210,515 Public utilities 27,287,454 460,241 (220,316) 27,527,379 All other corporate bonds 44,787,895 505,860 (197,324) 45,096,431 ------------ ----------- ------------ ------------ Total $ 121,922,963 $ 1,448,986 $ (748,386) $ 122,623,563 ============ =========== ============ ============
The amortized cost and estimated market value of debt securities at December 31, 2001, by contractual maturity, is shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Fixed Maturities Held for Sale Estimated Amortized Market December 31, 2001 Cost Value ------------------------------------- ------------ ------------ Due in one year or less $ 2,050,564 $ 2,070,454 Due after one year through five years 30,977,228 31,727,237 Due after five years through ten years 10,621,666 10,659,999 Due after ten years 157,059 167,127 Collateralized mortgage obligations 53,777,577 54,003,623 ------------ ------------ Total $ 97,584,094 $ 98,628,440 ============ ============
Estimated Fixed Maturities Held to Maturity Amortized Market December 31, 2001 Cost Value ------------------------------------- ------------ ------------ Due in one year or less $ 15,196,020 $ 15,398,291 Due after one year through five years 52,768,493 55,169,490 Due after five years through ten years 3,315,143 3,509,525 Due after ten years 3,597,268 3,514,813 Collateralized mortgage obligations 128,471 133,291 ------------ ------------ Total $ 75,005,395 $ 77,725,410 ============ ============
An analysis of sales, maturities and principal repayments of the Company's fixed maturities portfolio for the years ended December 31, 2001, 2000 and 1999 is as follows:
Cost or Gross Gross Proceeds Amortized Realized Realized From Year ended December 31, 2001 Cost Gains Losses Sale ------------------------------- ------------ ---------- ------------ ------------ Scheduled principal repayments, Calls and tenders: Held for sale $ 20,479,560 $ 10,440 $ 0 $ 20,490,000 Held to maturity 51,025,358 34,690 (107,234) 50,952,814 Sales: Held for sale 6,518,181 197,044 0 6,715,225 Held to maturity 0 0 0 0 ------------ ---------- ------------ ------------ Total $ 78,023,099 $ 242,174 $ (107,234) $ 78,158,039 ============ ========== ============ ============
Cost or Gross Gross Proceeds Amortized Realized Realized From Year ended December 31, 2000 Cost Gains Losses Sale ------------------------------- ------------ ---------- ------------ ------------ Scheduled principal repayments, Calls and tenders: Held for sale $ 5,611,476 $ 71 $ (3,847) $ 5,607,700 Held to maturity 27,047,819 59,463 (4,133) 27,103,149 Sales: Held for sale 0 0 0 0 Held to maturity 0 0 0 0 ------------ ---------- ------------ ------------ Total $ 32,659,295 $ 59,534 $ (7,980) $ 32,710,849 ============ ========== ============ ============
Cost or Gross Gross Proceeds Amortized Realized Realized From Year ended December 31, 1999 Cost Gains Losses Sale ------------------------------- ------------ ---------- ------------ ------------ Scheduled principal repayments, Calls and tenders: Held for sale $ 1,430,000 $ 0 $ 0 $ 1,430,000 Held to maturity 31,037,532 16,480 (21,722) 31,032,290 Sales: Held for sale 0 0 0 0 Held to maturity 0 0 0 0 ------------ ---------- ------------ ------------ Total $ 32,467,532 $ 16,480 $ (21,722) $ 32,462,290 ============ ========== ============ ============
C. INVESTMENTS ON DEPOSIT - At December 31, 2001, investments carried at approximately $12,657,000 were on deposit with various state insurance departments.
5. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
The financial statements include various estimated fair value information at December 31, 2001 and 2000, as required by Statement of Financial Accounting Standards 107, Disclosure about Fair Value of Financial Instruments ("SFAS 107"). Such information, which pertains to the Company's financial instruments, is based on the requirements set forth in that Statement and does not purport to represent the aggregate net fair value of the Company.
The following methods and assumptions were used to estimate the fair value of each class of financial instrument required to be valued by SFAS 107 for which it is practicable to estimate that value:
(a) Cash and Cash equivalents
The carrying amount in the financial statements approximates fair value because of the relatively short period of time between the origination of the instruments and their expected realization.
(b) Fixed maturities and investments held for sale
Quoted market prices, if available, are used to determine the fair value. If quoted market prices are not available, management estimates the fair value based on the quoted market price of a financial instrument with similar characteristics.
(c) Mortgage loans on real estate
The fair values of mortgage loans are estimated using discounted cash flow analyses and interest rates being offered for similar loans to borrowers with similar credit ratings.
(d) Investment real estate and real estate acquired in satisfaction of debt
An estimate of fair value is based on management's review of the individual real estate holdings. Management utilizes sales of surrounding properties, current market conditions and geographic considerations. Management conservatively estimates the fair value of the portfolio is equal to the carrying value.
(e) Policy loans
It is not practicable to estimate the fair value of policy loans as they have no stated maturity and their rates are set at a fixed spread to related policy liability rates. Policy loans are carried at the aggregate unpaid principal balances in the consolidated balance sheets, and earn interest at rates ranging from 4% to 8%. Individual policy liabilities in all cases equal or exceed outstanding policy loan balances.
(f) Short-term investments
For short-term instruments, the carrying amount is a reasonable estimate of fair value. Short-term instruments represent collateral loans and certificates of deposit with various banks that are protected under FDIC.
(g) Notes payable
For borrowings subject to floating rates of interest, carrying value is a reasonable estimate of fair value. For fixed rate borrowings fair value was determined based on the borrowing rates currently available to the Company for loans with similar terms and average maturities.
The estimated fair values of the Company's financial instruments required to be valued by SFAS 107 are as follows as of December 31:
2001 2000 ------------------------------------------------------------ Estimated Estimated Carrying Fair Carrying Fair Assets Amount Value Amount Value ------------ ------------ ------------ ------------ Fixed maturities $ 75,005,395 $ 77,725,410 $ 121,922,963 $ 122,623,563 Fixed maturities held for sale 98,628,440 98,628,440 43,128,280 43,128,280 Equity securities 3,852,716 3,852,716 5,129,571 5,129,571 Mortgage loans on real estate 23,386,895 23,360,333 32,896,671 32,841,254 Investment in real estate 18,226,451 18,226,451 13,296,245 13,296,245 Policy loans 13,608,456 13,608,456 14,090,900 14,090,900 Short-term investments 581,382 581,382 1,686,397 1,686,397
Liabilities Notes payable 4,400,670 4,696,612 1,817,169 1,594,016
6. STATUTORY EQUITY AND INCOME FROM OPERATIONS
The Company's insurance subsidiaries are domiciled in Ohio, Illinois and West Virginia and prepare their statutory-based financial statements in accordance with accounting practices prescribed or permitted by the respective insurance department. These principles differ significantly from accounting principles generally accepted in the United States of America. "Prescribed" statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners ("NAIC"). "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, from company to company within a state, and may change in the future. The NAIC recently completed the process of codifying statutory accounting practices, the result of which is to constitute the only source of "prescribed" statutory accounting practices. The new rules promulgated by the codifying of statutory accounting practices became effective January 1, 2001. Accordingly, these uniform rules change prescribed statutory accounting practices and result in changes to the accounting practices that insurance enterprises use to prepare their statutory financial statements. Implementation of the codification rules did not have a material financial impact on the financial condition of the Company's life insurance subsidiaries. UG's total statutory shareholders' equity was $16,105,265 and $14,288,015 at December 31, 2001 and 2000, respectively. The Company's life insurance subsidiaries reported combined statutory operating income before taxes (exclusive of intercompany dividends) of approximately $2,913,000, $2,091,000 and $3,843,000 for 2001, 2000 and 1999, respectively.
7. REINSURANCE
As is customary in the insurance industry, the insurance affiliates cede insurance to, and assume insurance from, other insurance companies under reinsurance agreements. Reinsurance agreements are intended to limit a life insurer's maximum loss on a large or unusually hazardous risk or to obtain a greater diversification of risk. The ceding insurance company remains primarily liable with respect to ceded insurance should any reinsurer be unable to meet the obligations assumed by it. However, it is the practice of insurers to reduce their exposure to loss to the extent that they have been reinsured with other insurance companies. The Company sets a limit on the amount of insurance retained on the life of any one person. The Company will not retain more than $125,000, including accidental death benefits, on any one life. At December 31, 2001, the Company had gross insurance in force of $2.630 billion of which approximately $654 million was ceded to reinsurers.
The Company's reinsured business is ceded to numerous reinsurers. The Company believes the assuming companies are able to honor all contractual commitments, based on the Company's periodic reviews of their financial statements, insurance industry reports and reports filed with state insurance departments.
Currently, the Company is utilizing reinsurance agreements with Business Mens' Assurance Company, ("BMA") and Life Reassurance Corporation of America, ("LIFE RE"). Recently, Swiss Re Life and Health America Incorporated merged into LIFE RE and the merged entity was renamed Swiss Re Life and Health America Incorporated ("SWISS RE"). BMA and SWISS RE currenty hold an "A" (Excellent), and "A++" (Superior) rating, respectively, from A.M. Best, an industry rating company. The reinsurance agreements were effective December 1, 1993, and cover all new business of the Company. The agreements are a yearly renewable term ("YRT") treaty where the Company cedes amounts above its retention limit of $100,000 with a minimum cession of $25,000.
UG entered a coinsurance agreement with Park Avenue Life Insurance Company ("PALIC") as of September 30, 1996. Under the terms of the agreement, UG ceded to PALIC substantially all of its paid-up life insurance policies. Paid-up life insurance generally refers to non-premium paying life insurance policies. PALIC and its ultimate parent The Guardian Life Insurance Company of America ("Guardian"), currently hold an "A" (Excellent), and "A+" (Superior) rating, respectively, from A.M. Best, an industry rating company. The agreement with PALIC accounts for approximately 66% of the reinsurance receivables, as of December 31, 2001.
On September 30, 1998, UG entered into a coinsurance agreement with The Independent Order of Vikings, an Illinois fraternal organization ("IOV"). Under the terms of the agreement, UG agreed to assume on a coinsurance basis, 25% of the reserves and liabilities arising from all inforce insurance contracts issued by the IOV to its members. At December 31, 2001, the IOV insurance inforce was approximately $1,696,000, with reserves being held on that amount of approximately $403,500.
On June 1, 2000, UG assumed an already existing coinsurance agreement, dated January 1, 1992, between Lancaster Life Reinsurance Company, an Arizona corporation ("LLRC") and Investors Heritage Life Insurance Company, a corporation organized under the laws of the Commonwealth of Kentucky ("IHL"). Under the terms of the agreement, LLRC agreed to assume from IHL a 90% quota share of new issues of credit life and accident and health policies that have been written on or after January 1, 1992 through various branches of the First Southern National Bank. The maximum amount of credit life insurance that can be assumed on any one individual's life is $15,000. UG assumed all the rights and obligations formerly held by LLRC as the reinsurer in the agreement. LLRC liquidated its charter immediately following the transfer. At December 31, 2001, IHL has insurance inforce of approximately $4,148,000.
The Company does not have any short-duration reinsurance contracts. The effect of the Company's long-duration reinsurance contracts on premiums earned in 2001, 2000 and 1999 was as follows:
Shown in thousands ----------------------------------------------- 2001 2000 1999 Premiums Premiums Premiums Earned Earned Earned -------------- ------------- ------------- Direct $ 20,333 $ 22,970 $ 25,539 Assumed 111 76 20 Ceded (3,172) (3,556) (3,978) -------------- ------------- ------------- Net premiums $ 17,272 $ 19,490 $ 21,581 ============== ============= =============
8. COMMITMENTS AND CONTINGENCIES
The insurance industry has experienced a number of civil jury verdicts which have been returned against life and health insurers in the jurisdictions in which the Company does business involving the insurers' sales practices, alleged agent misconduct, failure to properly supervise agents, and other matters. Some of the lawsuits have resulted in the award of substantial judgments against the insurer, including material amounts of punitive damages. In some states, juries have substantial discretion in awarding punitive damages in these circumstances.
Under the insurance guaranty fund laws in most states, insurance companies doing business in a participating state can be assessed up to prescribed limits for policyholder losses incurred by insolvent or failed insurance companies. Although the Company cannot predict the amount of any future assessments, most insurance guaranty fund laws currently provide that an assessment may be excused or deferred if it would threaten an insurer's financial strength. Mandatory assessments may be partially recovered through a reduction in future premium tax in some states. The Company does not believe such assessments will be materially different from amounts already provided for in the financial statements.
The State of Florida began an investigation of industrial life insurance policies in the fall of 1999 regarding policies with race-based premiums. This investigation has quickly spread to other states and to other types of small face amount policies and was expanded to consider the fairness of premiums for all small policies including policies which did not have race-based premiums. The NAIC historically has defined a "small face amount policy" as one with a face amount of $15,000 or less. Under current reviews, some states have increased this amount to policies of $25,000 or less. These states are attempting to force insurers to refund "excess premiums" to insureds or beneficiaries of insureds based on the recent American General settlement. The Company's insurance subsidiaries have no race-based premium products, but do have policies with face amounts under the above-scrutinized limitations. The outcome of this issue could be dramatic on the insurance industry as a whole as well as the Company itself. The Company will continue to monitor developments regarding this matter to determine to what extent, if any, the Company may be exposed.
On November 20, 1998, FSF and affiliates acquired 929,904 shares of common stock of UTG from UTG and certain UTG shareholders. As consideration for the shares, FSF paid UTG $10,999,995 and certain shareholders of UTG $999,990 in cash. Included in the stock acquisition agreement is an earnings covenant whereby UTG warrants UTG and its subsidiaries and affiliates will have future earnings of at least $30,000,000 for a five-year period beginning January 1, 1998. Such earnings are computed based on statutory results excluding inter-company activities such as inter-company dividends plus realized and unrealized gains and losses on real estate, mortgage loans and unaffiliated common stocks. At the end of the covenant period, an adjustment is to be made equal to the difference between the then market value and statutory carrying value of real estate still owned that existed at the beginning of the covenant period. Should UTG not meet the covenant requirements, any shortfall will first be reduced by the actual average tax rate for UTG for the period, then will be further reduced by one-half of the percentage, if any, representing UTG's ownership percentage of the insurance company subsidiaries. This result will then be reduced by $250,000. The remaining amount will be paid by UTG in the form of UTG common stock valued at $15.00 per share with a maximum number of shares to be issued of 500,000. However, there shall be no limit to the number of shares transferred to the extent that there are legal fees, settlements, damage payments or other losses as a result of certain legal action taken. The price and number of shares shall be adjusted for any applicable stock splits, stock dividends or other recapitalizations. At December 31, 2001, the Company had total earnings of $14,505,204 applicable to this covenant. With one year remaining on the covenant, it appears highly unlikely UTG will meet the earnings requirements, resulting in UTG being required to issue additional shares to FSF or its assigns. Combining current results with management's expectation for 2002, it appears at this time UTG will be required to issue 500,000 shares at December 31, 2002 to satisfy this covenant.
David A. Morlan, individually and on behalf of all others similarly situated v. Universal Guaranty Life Ins., United Trust Assurance Co., United Security Assurance Co., United Trust Group, Inc. and First Commonwealth Corporation, (U.S. Court of Appeals for the Seventh Circuit, Appeal No. 01-3795)
On April 26, 1999, the above lawsuit was filed by David Morlan and Louis Black in the Southern District of Illinois against Universal Guaranty Life Insurance Company ("UG") and United Trust Assurance Company ("UTAC") (merged into UG in 1992). After the lawsuit was filed, the plaintiffs, who were former insurance salesmen, amended their complaint, dropped Louis Black as a plaintiff, and added United Security Assurance Company ("USAC"), UTG and FCC as defendants. The plaintiffs are alleging that they were employees of UG, UTAC or USAC rather than independent contractors. The plaintiffs are seeking class action status and have asked to recover various employee benefits, costs and attorneys' fees, as well as monetary damages based on the defendants' alleged failure to withhold certain taxes.
On September 18, 2001, the case was dismissed without prejudice because Morlan lacked standing to pursue the claims against defendants. The plaintiffs have appealed the dismissal of the case to the United States Court of Appeals for the Seventh Circuit.
In addition to the appeal, a second action was filed entitled; Julie Barrette Ahrens, David Dzuiban, William Milam, David Schneiderman, individually and on behalf of all others similarly situated vs Universal Guaranty Life, United Trust Assurance Company, United Security Assurance Company. United States District Court for the Southern District of Illinois. Case No: 01-4314-JPG.
The Company continues to believe that it has meritorious grounds to defend both the original and related lawsuit, and it intends to defend the cases vigorously. The Company believes that the defense and ultimate resolution of the lawsuit should not have a material adverse effect upon the business, results of operations or financial condition of the Company. Nevertheless, if the lawsuit were to be successful, it is likely that such resolution would have a material adverse effect on the Company's business, results of operations and financial condition. At December 31, 2001, the Company maintains a liability of $300,000 to cover estimated legal costs associated with the defense of this matter.
9. RELATED PARTY TRANSACTIONS
At a December 17, 2001 joint meeting of the board of directors of UTG, FCC and their insurance subsidiaries, the boards of directors of the insurance subsidiaries discussed and decided to further explore and pursue a possible sale of the insurance charters of each of APPL and ABE. In the alternative to a sale of the APPL charter, the boards also discussed and decided to further explore a possible merger of APPL into UG. Regardless of whether a merger is ultimately pursued or the charters of each subsidiary are sold, UG would likely assume and reinsure the existing insurance policies of those subsidiaries in any such transaction.
During the fourth quarter of 2001, UG purchased real estate from an outside third party through the formation of an LLC in which UG is a two-thirds owner. The other one-third partner is Millard V. Oakley, who is a Director of both UTG and FCC. Hampshire Plaza, LLC consists of a twenty story, 254,000 square foot office tower, an attached 72,000 square foot retail plaza, and an attached parking garage with approximately 350 parking spaces located in Manchester, New Hampshire for $6,333,336. At December 31, 2001, the property was carried at $6,491,734.
On November 15, 2001, UTG was extended a $3,300,000 line of credit from the First National Bank of the Cumberlands located in Livingston, Tennessee. The First National Bank of the Cumberlands is owned by Millard V. Oakley, who is a Director of both UTG and FCC. The line of credit will expire one year from the date of issue, and all funds advanced under this line of credit are to be used for the repurchase of stock. The interest rate provided for in the agreement is variable and indexed to be the lowest of the U.S. prime rates as published in the money section of the Wall Street Journal, with any interest rate adjustments to be made monthly. To date, the Company has no borrowings or obligations attributable to this line of credit.
On October 26, 2001, APPL effected a reverse stock split, as a result of which (i) it became a wholly-owned subsidiary of UG, and an indirect wholly-owned subsidiary of FCC and UTG, and (ii) its minority shareholders received an aggregate of $1,055,294.50 in respect of their shares. Prior to the reverse stock split, UG owned 88% of the outstanding shares of APPL.
On September 4, 2001, FSF and FSBI (and their principals) restructured the manner in which they hold shares of UTG by forming a new limited liability company under Kentucky law, First Southern Holdings, LLC ("FSH"). FSBI contributed to FSH shares of UTG common stock held by it and cash in exchange for a 99% membership interest in FSH. FSF contributed to FSH shares of UTG common stock held by it, subject to notes payable which were assumed by FSH in exchange for a 1% membership interest in FSH.
On April 12, 2001, UTG completed the purchase of 22,500 shares of UTG common stock and 544 shares of FCC common stock from James E. Melville and family pursuant to the Melville Purchase Agreement in exchange for five year promissory notes of UTG in the aggregate principal amount of $288,800. On April 12, 2001, UTG also completed the purchase from another family member of Mr. Melville of an additional 100 shares of UTG for a total cash payment of $800. The purchase for cash by UTG of an additional 39 shares of FCC common stock owned by Mr. Melville at a purchase price of $200.00 per share was consummated on June 27, 2001. Mr. Melville was a former director of UTG, FCC and the three insurance subsidiaries of UTG; he resigned from those boards on February 13, 2001.
On April 12, 2001, UTG also completed the purchase of 559,440 shares of UTG common stock from Larry E. Ryherd and family pursuant to the Ryherd Purchase Agreement for cash payments totaling $948,026 and a five year promissory note of UTG in the principal amount of $3,527,494. The purchase by UTG of the remaining 3,775 shares of UTG common stock to be purchased for cash at $8.00 per share pursuant to the Ryherd Purchase Agreement along with an additional 570 shares from certain parties to the Ryherd Purchase Agreement was completed on June 20, 2001. The promissory notes of UTG received by certain of the sellers pursuant to the Melville Purchase Agreement and the Ryherd Purchase Agreement bear interest at a rate of 7% per annum (paid quarterly) with payments of principal to made in five equal annual installments, the first such payment of principal to be due on the first anniversary of the closing.
On April 12, 2001, UTG also purchased in a separate transaction 10,891 shares of UTG common stock from Robert E. Cook at a price of $8.00 per share. At the closing, Mr. Cook received $17,426 in cash and a five year promissory note of UTG (substantially similar to the promissory notes issued pursuant to the Melville and Ryherd Purchase Agreements described above) in the principal amount of $69,702. Mr. Cook was a director of UTG and FCC who resigned his position on January 8, 2001. Mr. Cook proposed the stock purchase to Jesse T. Correll who agreed to purchase Mr. Cook's stock on substantially the same terms as the purchases of the stock held by Messrs. Melville and Ryherd as described above.
On December 31, 1999, UTG and Jesse T. Correll entered a transaction whereby Mr. Correll, in combination with other individuals, made an equity investment in UTG. Under the terms of the Stock Acquisition Agreement, the Correll group contributed their 100% ownership of North Plaza of Somerset, Inc. to UTG in exchange for 681,818 authorized but unissued shares of UTG common stock. The Board of Directors of UTG approved the transaction at their regular quarterly board meeting held on December 7, 1999. North Plaza of Somerset, Inc. owns for investment purposes, a shopping center in Somerset, Kentucky, approximately 12,000 acres of timberland in Kentucky, and a 50% partnership interest in an additional 11,000 acres of Kentucky timberland. North Plaza has no debt. The net assets were valued at $7,500,000, which equates to $11.00 per share for the new shares of UTG that were issued in the transaction.
Mr. Correll is Chairman of the Board of Directors of UTG and currently UTG's largest shareholder through his ownership control of FSF, FSBI and affiliates. Mr. Correll is the majority shareholder of FSF and FSBI, a bank holding company that operates out of 14 locations in central Kentucky. At December 31, 2001, Mr. Correll owns or controls directly and indirectly approximately 60% of UTG.
Following necessary regulatory approval, on December 29, 1999, UG was the survivor to a merger with its 100% owned subsidiary, USA. The merger was completed as a part of management's efforts to reduce costs and simplify the corporate structure.
On July 26, 1999, the shareholders of UTG and UII approved a merger transaction of the two companies. Prior to the merger, UTG owned 53% of UTGL99 (refers to the former United Trust Group, Inc., which was formed in February of 1992 and liquidated in July of 1999) an insurance holding company, and UII owned 47% of UTGL99. Additionally, UTG held an equity investment in UII. At the time the decision to merge was made, neither UTG nor UII had any other significant holdings or business dealings. The Board of Directors of each company thus concluded a merger of the two companies would be in the best interests of the shareholders by creating a larger more viable life insurance holding group with lower administrative costs, a simplified corporate structure, and more readily marketable securities. Following the merger approval, UTG issued 817,517 shares of its authorized but unissued common stock to former UII shareholders, net of any dissenter shareholders in the merger. Immediately following the merger, UTGL99, which was then 100% owned by UTG, was liquidated and UTG changed its name to United Trust Group, Inc. ("UTG").
Under the current structure, FCC pays a majority of the general operating expenses of the affiliated group. FCC then receives management, service fees and reimbursements from the various affiliates.
United Income, Inc. ("UII") had a service agreement with United Security Assurance Company ("USA"). The agreement was originally established upon the formation of USA which was a 100% owned subsidiary of UII. Changes in the affiliate structure have resulted in USA no longer being a direct subsidiary of UII, though still a member of the same affiliated group. The original service agreement remained in place without modification. USA paid UII monthly fees equal to 22% of the amount of collected first year premiums, 20% in second year and 6% of the renewal premiums in years three and after. UII had a subcontract agreement with UTG to perform services and provide personnel and facilities. The services included in the agreement were claim processing, underwriting, processing and servicing of policies, accounting services, agency services, data processing and all other expenses necessary to carry on the business of a life insurance company. UII's subcontract agreement with UTG states that UII pay UTG monthly fees equal to 60% of collected service fees from USA as stated above. The service fees received from UII were recorded in UTG's financial statements as other income. With the merger of UII into UTG in July 1999, the sub-contract agreement ended and UTG assumed the direct contract with USA. This agreement was terminated upon the merger of USA into UG in December 1999.
USA paid $677,807 under their agreement with UII for 1999. UII paid $223,753 under their agreement with UTG for 1999. Additionally, UII paid FCC $30,000 in 1999 for reimbursement of costs attributed to UII. These reimbursements are reflected as a credit to general expenses.
UTG paid FCC $550,000, $750,000 and $600,000 in 2001, 2000 and 1999, respectively for reimbursement of costs attributed to UTG.
On January 1, 1993, FCC entered an agreement with UG pursuant to which FCC provides management services necessary for UG to carry on its business. UG paid $6,156,903, $6,061,515 and $6,251,340 to FCC in 2001, 2000 and 1999, respectively.
ABE pays fees to FCC pursuant to a cost sharing and management fee agreement. FCC provides management services for ABE to carry on its business. The agreement requires ABE to pay a percentage of the actual expenses incurred by FCC based on certain activity indicators of ABE business to the business of all the insurance company subsidiaries plus a management fee based on a percentage of the actual expenses allocated to ABE. ABE paid fees of $332,673, $371,211 and $392,005 in 2001, 2000 and 1999, respectively under this agreement.
APPL has a management fee agreement with FCC whereby FCC provides certain administrative duties, primarily data processing and investment advice. APPL paid fees of $444,000, $444,000 and $300,000 in 2001, 2000 and 1999, respectively under this agreement.
Respective domiciliary insurance departments have approved the agreements of the insurance companies and it is Management's opinion that where applicable, costs have been allocated fairly and such allocations are based upon accounting principles generally accepted in the United States of America.
Since the Company's affiliation with FSF, UG has acquired mortgage loans through participation agreements with FSNB. FSNB services the loans covered by these participation agreements. UG pays a .25% servicing fee on these loans and a one-time fee at loan origination of .50% of the original loan amount to cover costs incurred by FSNB relating to the processing and establishment of the loan. UG paid $79,730, $34,721 and $11,578 in servicing fees and $22,626, $91,392 and $0 in origination fees to FSNB during 2001, 2000 and 1999, respectively.
The Company reimbursed expenses incurred by Mr. Correll and Mr. Attkisson relating to travel and other costs incurred on behalf of or relating to the Company. The Company paid $145,407, $96,599 and $39,336 in 2001, 2000 and 1999,respectively to First Southern Bancorp, Inc. in reimbursement of such costs. In addition, beginning in 2001, the Company began reimbursing FSBI a portion of salaries for Mr. Correll and Mr. Attkisson. The reimbursement was approved by the UTG board of directors and totaled $128,411 in 2001 which included salaries and other benefits.
10. CAPITAL STOCK TRANSACTIONS
A. STOCK REPURCHASE PROGRAM
On June 5, 2001, the board of directors of UTG authorized the repurchase from time to time in the open market or in privately negotiated transactions of up to $1 million of UTG's common stock. Repurchased shares will be available for future issuance for general corporate purposes. Through February 28, 2002, UTG has spent $353,455 in the acquisition of 50,795 shares under this program.
B. STOCK REPURCHASES
In April 2001, UTG completed the purchase of 22,500 shares of UTG common stock and 544 shares of First Commonwealth Corporation common stock from James E. Melville and family pursuant to the Melville Purchase Agreement in exchange for five year promissory notes of UTG in the aggregate principal amount of $288,800. Also, in April 2001, UTG completed the purchase of 559,440 shares of UTG common stock from Larry E. Ryherd and family pursuant to the Ryherd Purchase Agreement in exchange for cash and a five-year promissory note of UTG in the principal amount of $3,527,494.
In April 2001, UTG also purchased in a separate transaction 10,891 shares of UTG common stock from Robert E. Cook, a former director, for cash and a five-year promissory note of UTG in the principal amount of $69,702.
C. SHARES ACQUIRED BY FSF AND AFFILIATES WITH OPTIONS GRANTED
On November 20, 1998, First Southern Funding LLC, a Kentucky corporation, ("FSF") and affiliates acquired 929,904 shares of common stock of UTG from UTG and certain UTG shareholders. As consideration for the shares, FSF paid UTG $10,999,995 and certain shareholders of UTG $999,990 in cash.
Included in the stock acquisition agreement is an earnings covenant whereby UTG warrants UTG and its subsidiaries and affiliates will have future earnings of at least $30,000,000 for a five-year period beginning January 1, 1998. Such earnings are computed based on statutory results excluding inter-company activities such as inter-company dividends plus realized and unrealized gains and losses on real estate, mortgage loans and unaffiliated common stocks. At the end of the covenant period, an adjustment is to be made equal to the difference between the then market value and statutory carrying value of real estate still owned that existed at the beginning of the covenant period. Should UTG not meet the covenant requirements, any shortfall will first be reduced by the actual average tax rate for UTG for the period, then will be further reduced by one-half of the percentage, if any, representing UTG's ownership percentage of the insurance company subsidiaries. This result will then be reduced by $250,000. The remaining amount will be paid by UTG in the form of UTG common stock valued at $15.00 per share with a maximum number of shares to be issued of 500,000. However, there shall be no limit to the number of shares transferred to the extent that there are legal fees, settlements, damage payments or other losses as a result of certain legal action taken. The price and number of shares shall be adjusted for any applicable stock splits, stock dividends or other recapitalizations. At December 31, 2001, the Company had total earnings of $14,505,204 applicable to this covenant.
At the time of the stock acquisition above, UTG also granted, for nominal consideration, an irrevocable, exclusive option to FSF to purchase up to 1,450,000 shares of UTG common stock for a purchase price in cash equal to $15.00 per share, with such option to expire on July 1, 2001. UTG had a market price per share of $9.50 at the date of grant of the option. The option shares under this option are to be reduced by two shares for each share of UTG common stock that FSF or its affiliates purchases from UTG shareholders in private or public transactions after the execution of the option agreement. The option is additionally limited to a maximum when combined with shares owned by FSF of 51% of the issued and outstanding shares of UTG after giving effect to any shares subject to the option. The option expired unexercised on July 1, 2001.
As of December 31, 2001, no options were exercised and all options have been forfeited.
2001 2000 1999 ------------------------- ------------------------- ------------------------- EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ---------- ------------- ----------- ------------ ----------- ------------- Outstanding at beginning of Period 19,108 $15.00 166,104 $15.00 1,450,000 $15.00 Granted 0 0.00 0 0.00 0 0.00 Exercised 0 0.00 0 0.00 0 0.00 Forfeited 19,108 15.00 146,996 15.00 1,283,896 15.00 ---------- ------------- ----------- ------------ ----------- ------------- Outstanding at end of period 0 $15.00 19,108 $15.00 166,104 $15.00 ========== ============= =========== ============ =========== =============
D. EARNINGS PER SHARE CALCULATIONS
The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computations as presented on the income statement.
For the year ended December 31, 2001 ------------- ---- --------------- --- ------------- Income Shares Per-Share (Numerator) (Denominator) Amount ------------- --------------- ------------- Basic EPS Income available to common shareholders $ 2,439,573 3,733,432 $ 0.65 =============
Effect of Dilutive Securities Convertible notes 0 0 Options 0 0 ------------- ---------------
Diluted EPS Income available to common shareholders $ and assumed conversions 2,439,573 3,733,432 $ 0.65 ============= =============== =============
For the year ended December 31, 2000 ------------- ---- --------------- --- ------------- Income Shares Per-Share (Numerator) (Denominator) Amount ------------- --------------- ------------- Basic EPS Income available to common shareholders $ (696,426) 4,056,439 $ (0.17) =============
Effect of Dilutive Securities Convertible notes 0 0 Options 0 0 ------------- ---------------
Diluted EPS Income available to common shareholders $ and assumed conversions (696,426) 4,056,439 $ (0.17) ============= =============== =============
For the year ended December 31, 1999 ------------- ---- --------------- --- ------------- Income Shares Per-Share (Numerator) (Denominator) Amount ------------- --------------- ------------- Basic EPS Income available to common shareholders $ 1,075,909 2,839,703 $ 0.38 =============
Effect of Dilutive Securities Convertible notes 0 0 Options 0 231
------------- ---------------
Diluted EPS Income available to common shareholders $ and assumed conversions 1,075,909 2,839,934 $ 0.38 ============= =============== =============
UTG had no stock options outstanding for the year ending December 31, 2001. As such, the computation of diluted earnings per share is the same as basic earnings per share for the year ending December 31, 2001. In accordance with Statement of Financial Accounting Standards No. 128, the computation of diluted earnings per share is the same as basic earnings per share for the year ending December 31, 2000, since the Company had a loss from continuing operation for the year presented, and any assumed conversion, exercise, or contingent issuance of securities would have an antidilutive effect on earnings per share. There were no outstanding dilutive instruments during the aforementioned periods.
UTG had stock options outstanding at year end 1999 for 451 shares of common stock at $13.07 per share, 105,000 shares of common stock at $17.50 per share that were not included in the computation of diluted EPS because the exercise price was greater than the average market price of the common shares for each respective year presented. UTG had stock options for 231 shares of common stock at $.047 per share, which were included in the calculation of diluted earnings per share for UTG for the year ended December 31, 1999, since they were assumed by UTG in the 1999 merger of UII into UTG. The stock options outstanding for 451 shares, 105,000 shares, and 231 shares all expired during 2000, ending these stock option plans.
On July 31, 1997, UTG issued convertible notes for cash in the amount of $2,560,000 to seven individuals, all officers or employees of UTG. During the first three years the notes could be converted into 204,800 shares of common stock at $12.50 per share. The potential conversion of the notes was not included in the computation of diluted EPS for the years ended December 31, 1998 and 1997, respectively, because the exercise price was greater than the average market price of the common shares. In 1999, FSBI acquired all the outstanding UTG convertible notes from the original holders. Pursuant to an agreement, FSBI converted the notes to 204,800 shares of UTG common stock on July 31, 2000.
UTG had granted stock options to FSF of 1,450,000 shares of UTG which were outstanding as of year end 1998. The option shares under this option are to be reduced by two shares for each share of UTG common stock that FSF or its affiliates purchases from UTG shareholders in private or public transactions after the execution of the option agreement. The option is additionally limited to a maximum when combined with shares owned by FSF of 51% of the issued and outstanding shares of UTG after giving effect to any shares subject to the option. Due to the passage of time and the 51% limitation, all remaining stock options of 19,108 at $15.00 per share expired on July 1, 2001. No options were exercised during 2001. These options were not included in the computation of diluted EPS because the exercised price was greater than the average market price of the common shares for each respective year.
11. NOTES PAYABLE
At December 31, 2001 and 2000, the Company had $4,400,670 and $1,817,169 in long-term debt outstanding, respectively. The debt is comprised of the following components:
2001 2000 ----------- ----------- Subordinated 20 yr. Notes $ 514,674 $ 1,817,169 Other notes payable 3,885,996 0 ----------- ----------- $ 4,400,670 $ 1,817,169 =========== ===========
A. Subordinated debt
The subordinated debt was incurred June 16, 1992 as a part of the acquisition of the now dissolved Commonwealth Industries Corporation, (CIC). On October 22, 2001, UTG paid $1,302,495 of the outstanding principal of the subordinated 20 year notes, and amended the interest rate on the outstanding principal balance of the remaining notes from an 8.5% fixed rate, to a 1% under prime variable rate, with interest to begin accruing at the effective time of the amendments. Prior to these amendments, the 20-year notes accrued interest at the rate of 8 1/2% per annum. At 12/31/01 the 1% under prime variable rate was 3.75%. A lump sum principal payment on the balance of the notes remains due June 16, 2012.
B. Other notes payable
The other notes payable were incurred to facilitate the repurchase of stock in April 2001. These notes bear interest at the rate of 7% per annum (paid quarterly) with payments of principal to be made in five equal annual installments, the first such payment of principal to be due on April 12, 2002.
The collective scheduled principal reductions on these notes for the next five years is as follows:
Year Amount
2002 $ 777,199 2003 777,199 2004 777,199 2005 777,199 2006 777,200
C. Line of Credit
On November 15, 2001, UTG was extended a $3,300,000 line of credit from the First National Bank of the Cumberlands located in Livingston, Tennessee. The First National Bank of the Cumberlands is owned by Millard V. Oakley, who is a Director of both UTG and FCC. The line of credit will expire one year from the date of issue, and all funds advanced under this line of credit are to be used for the repurchase of stock. The interest rate provided for in the agreement is variable and indexed to be the lowest of the U.S. prime rates as published in the money section of the Wall Street Journal, with any interest rate adjustments to be made monthly. To date, the Company has no borrowings or obligations attributable to this line of credit.
12. OTHER CASH FLOW DISCLOSURES
On a cash basis, the Company paid $333,365, $373,988, and $643,429 in interest expense for the years 2001, 2000 and 1999, respectively. The Company paid $92,006, $(173,500) and $557,812 in federal income tax for 2001, 2000 and 1999, respectively.
In April 2001, the Company issued $3,885,996 in new debt in exchange for the acquisition of UTG and FCC common stock from two former officers and directors of the Company and their respective families.
On July 31, 2000, First Southern Bancorp, Inc., pursuant to the terms of a previous agreement, converted the $2,560,000 of convertible debt it held of United Trust Group, Inc. into 204,800 shares of common stock of UTG.
On December 31, 1999, UTG issued 681,818 shares of authorized but unissued common stock to acquire 100% ownership of North Plaza of Somerset, Inc. ("North Plaza"). North Plaza owns for investment purposes, a shopping center in Somerset, Kentucky, approximately 12,000 acres of timberland in Kentucky, and a 50% partnership interest in an additional 11,000 acres of Kentucky timberland. North Plaza has no debt. The net assets have been valued at $7,500,000, which equates to $11.00 per share for the new shares issued.
On July 26, 1999, UII was merged into UTG. UTG issued 817,517 shares of its authorized but unissued common stock to former UII shareholders in the merger. The shares issued were valued at $10,451,455. At the date of the merger, UII had cash balances of $607,508 that were transferred to UTG.
13. CONCENTRATION OF CREDIT RISK
The Company maintains cash balances in financial institutions that at times may exceed federally insured limits. The Company maintains its primary operating cash accounts with First Southern National Bank, an affiliate of the largest shareholder of UTG. In aggregate at December 31, 2001 these accounts hold approximately $4,550,000 for which there are no pledges or guarantees outside FDIC insurance limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents.
14. NEW ACCOUNTING STANDARDS
The Financial Accounting Standards Board ("FASB") has issued Statement No. 141, Business Combinations, Statement No. 142, Goodwill and Other Intangible Assets, Statement No. 143, Accounting for Asset Retirement Obligations, and Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
Statement 141 improves the transparency of accounting and reporting for business combinations by requiring that all business combinations be accounted for under a single method - the purchase method. Use of the pooling-of-interests method is no longer permitted. Statement 141 requires that the purchase method be used for business combinations initiated after June 30, 2001. The adoption of Statement 141 did not affect the Company's financial position or results of operations, since the Company has had no such business combinations during the reporting period.
Statement 142 requires that goodwill no longer be amortized to earnings, but instead be reviewed for impairment. This change provides investors with greater transparency regarding the economic value of goodwill and its impact on earnings. The amortization of goodwill ceased for the Company upon the adoption of the statement at January 1, 2002. The adoption of Statement 142 will result in an expense reduction of approximately $90,000 per year, subject to any impairment write-down that might arise from a management review.
Statement 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The standard is effective for fiscal years beginning after June 15, 2002. The adoption of Statement 143 will not affect the Company's financial position or results of operations, since the Company has no such asset retirement obligations.
Statement 144 requires that one accounting model be used for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired, and broadens the presentation of discontinued operations to include more disposal transactions. In addition, this statement requires entities to recognize an impairment loss if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows, and to measure an impairment loss as the difference between the carrying amount and fair value of the asset. This statement removes any previous requirements to allocate goodwill to long-lived assets to be tested for impairment, and it further prescribes a probability-weighted cash flow estimation approach to deal with situations in which alternative courses of action to recover the carrying amount of a long-lived asset are under consideration. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001. The adoption of Statement 144 will not affect the Company's financial position or results of operations, since the Company has no such disposals or impairments to long-lived assets.
15. PROPOSED MERGER
On June 5, 2001, UTG and FCC jointly announced their respective Boards of Directors approved a definitive agreement whereby UTG would acquire the remaining common shares (approximately 18%) of FCC which UTG does not currently own. Under the terms of the agreement, FCC will be merged with and into UTG, with UTG continuing as the surviving entity in the merger.
Pursuant to the merger agreement, UTG will pay $250 in cash for each share of FCC common stock not held by United Trust Group. The transaction is subject to various conditions precedent set forth in the merger agreement, including the approval of the transaction by the shareholders of FCC. FCC plans to submit the transaction to the vote of the FCC shareholders to be held at a special meeting to be called for that purpose. Shareholders of FCC are urged to read the Proxy Statement when it becomes available.
16. REVERSE STOCK SPLIT OF APPALACHIAN LIFE INSURANCE COMPANY
On June 5, 2001, the board of directors of APPL, a West Virginia corporation and then 88% owned indirect subsidiary of FCC, approved, subject to shareholder and any required regulatory approvals, a reverse split of the common stock of APPL. Under the terms of the reverse stock split, any shareholder of APPL who owns less than 118,700 shares prior to the effective time of the reverse split would receive a cash payment based upon $6.50 per share (pre-reverse stock split) of APPL, and APPL would become a wholly owned subsidiary of UG, a wholly owned subsidiary of FCC.
The reverse stock split was effected on October 26, 2001. At that time, APPL became a wholly owned subsidiary of UG, a wholly owned subsidiary of FCC.
17. COMPREHENSIVE INCOME
Tax Before-Tax (Expense) Net of Tax 2001 Amount or Benefit Amount ------------------------------------- -------------- -------------- -------------
Unrealized holding gains during Period $ 1,222,583 $ (427,904)$ 794,679 Less: reclassification adjustment For gains realized in net income (340,341) 119,119 (221,222) -------------- -------------- ------------- Net unrealized gains 882,242 (308,785) 573,457 -------------- -------------- ------------- Other comprehensive income $ 882,242 $ (308,785) $ 573,457 ============== ============== =============
Tax Before-Tax (Expense) Net of Tax 2000 Amount or Benefit Amount ------------------------------------- -------------- -------------- -------------
Unrealized holding gains during Period $ 1,513,673 $ 0 $ 1,513,673 Less: reclassification adjustment for gains realized in net income (39,486) 0 (39,486) -------------- -------------- ------------- Net unrealized gains 1,474,187 0 1,474,187 -------------- -------------- ------------- Other comprehensive income $ 1,474,187 $ 0 $ 1,474,187 ============== ============== =============
Tax Before-Tax (Expense) Net of Tax 1999 Amount or Benefit Amount ------------------------------------- -------------- -------------- -------------
Unrealized holding losses during Period $ (862,048) $ 0 $ (862,048) Less: reclassification adjustment for losses realized in net income 0 0 0 -------------- -------------- ------------- Net unrealized losses (862,048) 0 (862,048) -------------- -------------- ------------- Other comprehensive deficit $ (862,048) $ 0 $ (862,048) ============== ============== =============
In 1999 and 2000 the Company's deferred tax asset was carried at zero net of allowances. In 2001, the Company established a deferred tax liability of $385,432 for the unrealized gain based on the applicable United States statutory rate of 35%.
18. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
----------------------------------------------------------------------- 1st 2nd 3rd 4th ------------ ------------ ------------ ------------
Premiums and policy fees, net $ 4,554,451 $ 4,768,808 $ 4,137,361 $ 3,811,796 Net investment income 4,014,425 3,931,677 3,557,702 3,563,255 Total revenues 8,428,235 9,005,351 7,963,274 7,968,472 Policy benefits including Dividends 4,937,725 5,193,310 4,586,257 4,807,794 Commissions and amortization of DAC and COI 929,415 621,810 511,470 773,199 Operating expenses 1,514,115 1,768,758 1,573,817 1,629,001 Operating income (loss) 1,008,366 1,323,667 1,183,712 676,417 Net income (loss) 343,858 975,292 645,873 474,550 Basic earnings (loss) per share 0.08 0.27 0.18 0.13 Diluted earnings (loss) per share 0.08 0.27 0.18 0.13
------------------------------------------------------------------------ 1st 2nd 3rd 4th ------------ ------------ ------------ ------------
Premiums and policy fees, net $ 5,337,148 $ 5,201,585 $ 4,470,307 $ 4,480,646 Net investment income 4,252,494 4,009,489 3,927,944 3,895,906 Total revenues 9,933,932 9,348,373 8,471,566 7,993,252 Policy benefits including Dividends 6,119,515 5,502,941 5,128,773 5,528,128 Commissions and amortization of DAC and COI 1,097,759 804,071 775,825 1,004,470 Operating expenses 2,827,918 1,732,641 2,095,530 3,459,697 Operating income (loss) (244,223) 1,166,057 408,328 (2,037,231) Net income (loss) (47,394) 686,907 163,169 (1,499,108) Basic earnings (loss) per share (0.01) 0.17 0.04 (0.39) Diluted earnings (loss) per share (0.01) 0.17 0.04 (0.39)
------------------------------------------------------------------------ 1st 2nd 3rd 4th ------------ ------------ ------------ ------------
Premiums and policy fees, net $ 6,007,511 $ 5,705,270 $ 5,337,120 $ 4,531,242 Net investment income 3,640,387 3,603,212 3,628,538 3,657,400 Total revenues 9,835,111 9,136,482 8,964,360 8,121,158 Policy benefits including Dividends 6,115,079 5,569,046 4,864,370 4,740,390 Commissions and amortization of DAC and COI 1,366,288 1,131,407 1,070,869 1,173,088 Operating expenses 2,080,905 1,882,088 1,678,571 1,891,810 Operating income (loss) 74,962 392,486 1,198,404 189,701 Net income (loss) 132,461 123,481 883,271 (63,304) Basic earnings (loss) per share 0.05 0.05 0.29 (0.01) Diluted earnings (loss) per share 0.07 0.07 0.29 (0.00)
ITEM 9.
ITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
NONE
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF UTG
THE BOARD OF DIRECTORS
In accordance with the laws of Illinois and the Certificate of Incorporation and Bylaws of UTG, as amended, UTG is managed by its executive officers under the direction of the Board of Directors. The Board elects executive officers, evaluates their performance, works with management in establishing business objectives and considers other fundamental corporate matters, such as the issuance of stock or other securities, the purchase or sale of a business and other significant corporate business transactions. In the fiscal year ended December 31, 2001, the Board met 5 times. All directors attended at least 75% of all meetings of the board, except Millard Oakley.
The Board of Directors has an Audit Committee consisting of Messrs. Albin, Collins, O'Keefe, and Teater. The Audit Committee performs such duties as outlined in the Company's Audit Committee Charter. The Audit Committee reviews and acts or reports to the Board with respect to various auditing and accounting matters, the scope of the audit procedures and the results thereof, internal accounting and control systems of UTG, the nature of services performed for UTG and the fees to be paid to the independent auditors, the performance of UTG's independent and internal auditors and the accounting practices of UTG. The Audit Committee also recommends to the full Board of Directors the auditors to be appointed by the Board. The Audit Committee met twice in 2001.
The compensation of UTG's executive officers is determined by the full Board of Directors (see report on Executive Compensation).
Under UTG's Certificate of Incorporation, the Board of Directors should be comprised of eleven directors. At December 31, 2001 The Board consisted of eleven directors. Shareholders elect Directors to serve for a period of one year at UTG's Annual Shareholders' meeting.
Directors and officers of UTG file periodic reports regarding ownership of Company securities with the Securities and Exchange Commission pursuant to Section 16(a) of the Securities Exchange Act of 1934 as amended, and the rules promulgated thereunder.
The following information with respect to business experience of the Board of Directors has been furnished by the respective directors or obtained from the records of UTG.
AUDIT COMMITTEE REPORT TO SHAREHOLDERS
In connection with the December 31, 2001 financial statements, the audit committee: (1) reviewed and discussed the audited financial statements with management; (2) discussed with the auditors the matters required by Statement on Auditing Standards No. 61; and (3) received and discussed with the auditors the matters required by Independence Standards Board Statement No.1. Based upon these reviews and discussions, the audit committee recommended to the Board of Directors that the audited financial statements be included in the Annual Report on Form 10-K filed with the SEC.
John S. Albin - Committee Chairman John W. Collins Robert V. O'Keefe Robert W. Teater
DIRECTORS
Name, Age Position with the Company, Business Experience and Other Directorships
John S. Albin, 73 Director of UTG since 1984 and FCC since 1992; farmer in Douglas and Edgar counties, Illinois, since 1951; Chairman of the Board of Longview State Bank since 1978; President of the Longview Capitol Corporation, a bank holding company, since 1978; Chairman of First National Bank of Ogden, Illinois, since 1987; Chairman of the State Bank of Chrisman since 1988; Director and Secretary of Illini Community Development Corporation since 1990; Commissioner of Illinois Student Assistance Commission since 1996.
Randall L. Attkisson 56 Director of UTG and FCC since 1999; President and Chief Operating Officer of UTG and FCC since 2001; Chief Financial Officer, Treasurer, Director of First Southern Bancorp, Inc. since 1986; Treasurer, Director of First Southern Funding, LLC (formerly First Southern Funding Inc.) since 1992; Director of The River Foundation, Inc. since 1990; President of Randall L. Attkisson & Associates from 1982 to 1986; Commissioner of Kentucky Department of Banking & Securities from 1980 to 1982; Self-employed Banking Consultant in Miami, FL from 1978 to 1980.
John W. Collins 75 Director of UTG since 2000; Director of FCC and certain affiliate companies since 1982. Consultant and past President of Collins-Winston Group, an executive search firm, since 1976.
Jesse T. Correll 45 Chairman and CEO of UTG and FCC since 2000; Director of UTG and FCC since 1999; Chairman, President, Director of First Southern Bancorp, Inc. since 1983; President, Director or Manager of First Southern Funding since 1992; President, Director of The River Foundation since 1990; President, Director and sole member manager of Dyscim LLC (formerly Dyscim Holdings Company, Inc.) since 1990; Director of Thomas Nelson, Inc. since 2001; Director of Computer Services, Inc. since 2001; Director of Global Focus since 2001; Young Life Dominican Republic Committee Member since 2000. Jesse Correll is the son of Ward Correll.
Ward F. Correll 73 Director of UTG since 2000 and FCC since 1999; President, Director of Tradeway, Inc. of Somerset, KY since 1973; President, Director of Cumberland Lake Shell, Inc. of Somerset, KY since 1971; President, Director of Tradewind Shopping Center, Inc. of Somerset, KY since 1966; Director of First Southern Bancorp since 1988; Director or Manager of First Southern Funding since 1991; Director of The River Foundation of Stanford, KY since 1990; and Director First Southern Insurance Agency of Stanford, KY since 1987. Ward Correll is the father of Jesse Correll.
Thomas F. Darden 47 Director of UTG and FCC since 2001; Managing Partner of Cherokee Investment Partners LLC, a real estate investment firm, and President and CEO of Cherokee Sanford Group, Inc. an affiliated predecessor since 1983; Director of BTI Telecom, Inc. since 1998; Director of Waste Industries, Inc. since 1997; Director of Winston Hotels, Inc. since 1994; Trustee of Shaw University since 1993; Member of the Board of Governors of Research, Triangle Institute since 1998; Former Chairman of the Triangle Transit Authority, serving from 1993 to 1998 and Chairman from 1996 to 1997; Prior to 1996, twice appointed to the North Carolina Board of Transportation.
Luther C. Miller 71 Director of UTG since 2000 and FCC since 1984; Executive Vice President and Secretary of FCC from 1984 until 1992; officer and director of certain affiliate companies until 1992.
Millard V. Oakley 71 Director of UTG and FCC since 1999; Presently serves on Board of Directors and Executive Committee of Thomas Nelson, a publicly held publishing company based in Nashville, TN; Director of First National Bank of the Cumberlands, Livingston-Cooksville, TN; Lawyer with limited law practice since 1980; State Insurance Commissioner for State of Tennessee from 1975 to 1979; General Counsel, United States House of Representatives, Washington, D.C., Congressional Committee on Small Business from 1971-1973; four elective terms as County Attorney for Overton County, TN; delegate to National Democratic Convention in 1964; four elective terms in the Tennessee General Assembly from 1956 to 1964; Lawyer in Livingston, TN from 1953 to 1971; Elected to the Tennessee Constitutional Convention in 1952.
Robert V. O'Keefe 80 Director of UTG since 2000 and FCC since 1993; Director and Treasurer of UTG from 1988 to 1992; Director of Cilcorp, Inc. from 1982 to 1994; Director of Cilcorp Ventures, Inc. from 1985 to 1994; Director of Environmental Science and Engineering Co. from 1990 to 1994.
William W. Perry 45 Director of UTG and FCC since 2001; Owner of SES Investments, Ltd., an oil and gas investments company since 1991; President of EGL Resources, Inc., an oil and gas operations company based in Texas and New Mexico since 1992; President of Midland Yucca Realty, a Texas real estate investment company since 1993; Chairman of Perry & Perry, Inc., a Texas oil and gas consulting company since 1977; Member of the Board of Managers of Tall City Equity Fund since 2001; President of Champion Title Group, a Florida based consulting business since 1999; involved with, Young Life, youth organization as a leader, Chairman of the international Committee and National Board since 1977.
Robert W. Teater 75 Director of UTG since 1987 and FCC since 1992; member of Columbus School Board 1991-2001; Former Director, Ohio Department of Natural Resources; Founder, Teater-Gebhardt and Associates, Inc., a comprehensive consulting firm in natural resources development; Combat veteran and retired Major General, Ohio Army National Guard.
EXECUTIVE OFFICERS OF UTG
More detailed information on the following officers of UTG appears under "Directors":
Jesse T. Correll Chairman of the Board and Chief Executive Officer Randall L. Attkisson President and Chief Operating Officer
Other officers of UTG are set forth below:
Name, Age Position with UTG and, Business Experience
James P. Rousey 43 Executive Vice President and Chief Administrative Officer since September 2001; Regional CEO and Director of First Southern National Bank from 1988 to 2001. Board Member with the Illinois Fellowship of Christian Athletes since 2001.
Theodore C. Miller 39 Corporate Secretary since December 2000, Senior Vice President and Chief Financial Officer since July 1997; Vice President and Treasurer since October 1992; Vice President and Controller of certain Affiliate Companies from 1984 to 1992.
Brad M. Wilson 50 Senior Vice President and Chief Information Officer since 1992; Chief Administrative Officer from December 2000 to September 2001.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION UTG
Executive Compensation Table
The following table sets forth certain information regarding compensation paid to or earned by UTG's Chief Executive Officer and each of the Executive Officers of UTG whose salary plus bonus exceeded $100,000 during UTG's last three fiscal year: Compensation for services provided by the named executive officers to UTG and its affiliates is paid by FCC (See also Employment Contracts for Messrs. Melville and Ryherd)
SUMMARY COMPENSATION TABLE
Name and Annual Compensation Other Annual (1) All Other (1) Principal Position Year Salary ($) Bonus ($) Compensation ($) Compensation ($) ($)
Jesse T. Correll (2) 2001 56,250 - - - Chairman of the Board 2000 - - - - Chief Executive Officer 1999 - - - -
Brad M. Wilson 2001 160,000 3,000 - 3,150 Senior Vice President 2000 157,500 3,227 - 3,150 Chief Information Officer 1999 147,700 3,000 3,665 3,150
Theodore C. Miller 2001 100,000 5,000 - 3,000 Corporate Secretary 2000 91,749 - - 2,752 Senior Vice President 1999 86,783 - 3,179 2,603 Chief Financial Officer
(1) Other Annual Compensation consists of interest paid on previously deferred compensation amounts. All Other Compensation consists of UTG's matching contribution to the First Commonwealth Corporation Employee Savings Trust 401(k) Plan.
(2) On March 27, 2000, Mr. Jesse T. Correll assumed the position as Chairman of the Board and Chief Executive Officer of UTG and each of its affiliates. Mr. Correll did not receive a salary, bonus or other compensation for his duties with UTG and each of its affiliates in the year 2000. In March 2001, the Board of Directors approved an annual salary for Mr. Correll of $75,000, with payments to begin on April 1, 2001.
Option/SAR Grants/Aggregated Option/SAR Exercises in Last Fiscal Year and FY-End Option/SAR Values
At December 31, 2001 there were no shares of the common stock of UTG subject to unexercised options held by the named executive officers. There were no options or stock appreciation rights granted to the named executive officers for the past three fiscal years.
Compensation of Directors
UTG's standard arrangement for the compensation of directors provides that each director shall receive an annual retainer of $2,400, plus $300 for each meeting attended and reimbursement for reasonable travel expenses. UTG's director compensation policy also provides that directors who are employees of UTG or directors or officers of FSF and its affiliates do not receive any compensation for their services as directors except for reimbursement for reasonable travel expenses for attending each meeting.
Employment Contracts
FCC entered into an employment agreement dated July 31, 1997 with Larry E. Ryherd. Formerly, Mr. Ryherd had served as Chairman of the Board and Chief Executive Officer of UTG and its affiliates, until his resignation on March 27, 2000. Pursuant to the agreement, Mr. Ryherd agreed to serve as Chairman of the Board and Chief Executive Officer of UTG and in addition, to serve in other positions of the affiliated companies if appointed or elected. The agreement provides for an annual salary of $400,000 as determined by the Board of Directors. The term of the agreement is for a period of five years. Mr. Ryherd has deferred portions of his income under a plan entitling him to a deferred compensation payment, which was paid to him on January 2, 2000, in the amount of $240,000, which included interest at the rate of approximately 8.5% annually. Additionally, Mr. Ryherd was granted an option to purchase up to 13,800 of the Common Stock of UTG at $17.50 per share. The option was immediately exercisable and transferable. At December 31, 2000, all previously granted options expired. In accordance with the employment agreement, Mr. Ryherd continues to receive his annual Salary of $400,000 until the agreement expiration date of July 31, 2002. The entire $933,333 payable to Mr. Ryherd, from the date of his resignation until the end of his employment agreement was accrued, and thus expensed, by FCC in the first quarter of 2000.
FCC entered into an employment agreement dated July 31, 1997 with James E. Melville pursuant to which Mr. Melville is employed as President and Chief Operating Officer and in addition, to serve in other positions of the affiliated companies if appointed or elected at an annual salary of $238,200. The term of the agreement expires July 31, 2002. Mr. Melville has deferred portions of his income under a plan entitling him to a deferred compensation payment which was paid to him on January 2, 2000 of $400,000 which includes interest at the rate of approximately 8.5% annually. Additionally, Mr. Melville was granted an option to purchase up to 30,000 shares of the Common Stock of UTG at $17.50 per share. The option is immediately exercisable and transferable. At December 31, 2000, all previously granted options expired. In accordance with the employment agreement, Mr. Melville continues to receive his annual Salary of $238,200 until the agreement expiration date of July 31, 2002. An accrual of $562,000 was established through a charge to general expenses at year-end 2000 for the remaining payments required pursuant to the terms of Mr. Melville's employment contract and other settlement costs.
There are no other employment agreements in effect with any executive officers or employees of the Company.
REPORT ON EXECUTIVE COMPENSATION
Introduction
The compensation of UTG's executive officers is determined by the full Board of Directors. The Board of Directors strongly believes that UTG's executive officers directly impact the short-term and long-term performance of UTG. With this belief and the corresponding objective of making decisions that are in the best interest of UTG's shareholders, the Board of Directors places significant emphasis on the design and administration of UTG's executive compensation plans.
Executive Compensation Plan Elements
Base Salary. The Board of Directors establishes base salaries at a level intended to be within the competitive market range of comparable companies. In addition to the competitive market range, many factors are considered in determining base salaries, including the responsibilities assumed by the executive, the scope of the executive's position, experience, length of service, individual performance and internal equity considerations. In addition to a base salary, increased compensation of current and future executive officers of the Company will be determined using a "performance based" philosophy. UTG's financial results are analyzed and future increases to compensation will be proportionately based on the profitability of the Company.
Stock Options. Stock options are granted at the discretion of the Board of Directors. There were no options granted to the named executive officers during the last three fiscal years.
Deferred Compensation. There are currently no deferred compensation arrangements with any executive officers or employees of the Company.
Chief Executive Officer
On March 27, 2000, Mr. Jesse T. Correll assumed the position of Chairman of the Board and Chief Executive Officer of UTG and each of its affiliates. Under Mr. Correll's leadership, he declined to receive a salary, bonus or other forms of compensation for his duties with UTG and each of its affiliates in the year 2000. In March 2001, the Board of Directors approved an annual salary for Mr. Correll of $75,000, with payments to begin on April 1, 2001. As a reflection of Mr. Correll's leadership, the compensation of current and future executive officers of the Company will be determined by the Board of Directors using a "performance based" philosophy. The Board of Directors will consider UTG's financial results and future compensation decisions will be proportionately based on the profitability of the Company.
Conclusion
The Board of Directors believes this Executive Compensation Plan provides a competitive and motivational compensation package to the executive officer team necessary to produce the results UTG strives to achieve. The Board of Directors also believes the Executive Compensation Plan addresses both the interests of the shareholders and the executive team.
BOARD OF DIRECTORS
John S. Albin Luther C. Miller Randall L. Attkisson Millard V. Oakley John W. Collins Robert V. O'Keefe Jesse T. Correll William W. Perry Ward F. Correll Robert W. Teater Thomas F. Darden
PERFORMANCE GRAPH
The following graph compares the cumulative total shareholder return on UTG's Common Stock during the five fiscal years ended December 31, 2001 with the cumulative total return on the NASDAQ Composite Index Performance and the NASDAQ Insurance Stock Index (1). The graph assumes that $100 was invested on December 31, 1996 in each of the Company's common stock, the NASDAQ Composite Index, and the NASDAQ Insurance Stock Index, and that any dividends were reinvested.
(1) UTG selected the NASDAQ Composite Index Performance as an appropriate comparison since during the time period reflected, UTG's Common Stock was traded on the NASDAQ Small Cap exchange under the sign "UTGI". Furthermore, UTG selected the NASDAQ Insurance Stock Index as the second comparison because there is no similar single "peer company" in the NASDAQ system with which to compare stock performance and the closest additional line-of-business index which could be found was the NASDAQ Insurance Stock Index. Trading activity in UTG's Common Stock is limited, which may be due in part as a result of UTG's low profile, and its reported operating losses. The Return Chart is not intended to forecast or be indicative of possible future performance of UTG's stock.
The foregoing graph shall not be deemed to be incorporated by reference into any filing of UTG under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that UTG specifically incorporates such information by reference.
Compensation Committee Interlocks and Insider Participation
The following persons served as directors of UTG during 2001 and were officers or employees of UTG or its affiliates during 2001: Jesse T. Correll and Randall L. Attkisson. Accordingly, these individuals have participated in decisions related to compensation of executive officers of UTG and its subsidiaries.
During 2001, Jesse T. Correll and Randall L. Attkisson, executive officers of UTG, FCC and their insurance subsidiaries, were also members of the Board of Directors of FCC and the insurance subsidiaries.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF UTG
PRINCIPAL HOLDERS OF SECURITIES
The following tabulation sets forth the name and address of the entity known to be the beneficial owners of more than 5% of UTG's Common Stock and shows: (i) the total number of shares of common Stock beneficially owned by such person as of March 1, 2002 and the nature of such ownership; and (ii) the percent of the issued and outstanding shares of common stock so owned as of the same date.
Title Number of Shares Percent Of Name and Address and Nature of of Class of Beneficial Owner Beneficial Ownership Class (1) ------- ------------------- -------------------- --------- Common The Correll group (2) 2,119,921 60.2% Stock no Par value
(1) The percentage of outstanding shares is based on 3,519,065 shares of common stock outstanding.
(2) The Correll group, who file a combined 13D/A with the SEC, and their respective holdings of UTG common stock are listed as follows: (i) First Southern Holdings LLC, of 99 Lancaster Street, Stanford, KY 40484 which owns 1,483,791 shares (42.2%) of common stock directly; (ii) Jesse Correll who owns 112,704 shares (3.2%) of common stock directly; (iii) Dyscim Holding LLC, a Kentucky corporation, which owns 150,545 shares (4.3%) of common stock, all of the outstanding shares of which are owned by Jesse Correll; (iv) WCorrell Limited Partnership, which owns 72,750 shares (2.1%) of common stock, and in which Jesse Correll serves as managing general partner and, as such, has sole voting and dispositive power over the shares of common stock held by it; (v) First Southern Capital Corp. LLC of 99 Lancaster Street, Stanford, KY 40484 which owns 183,033 shares (5.2%) of common stock; (vi) Cumberland Lake Shell, Inc., which owns 98,523 shares (2.8%) of common stock, all of the outstanding voting shares of which are owned jointly by Ward F. Correll and his wife. As a result Ward F. Correll may be deemed to share the voting and dispositive power over these shares; (vii) First Southern Investments LLC which owns 18,575 shares (less than 1%) of common stock.
First Southern Funding LLC ("FSF") and First Southern Bancorp, Inc. ("FSB") are also included in the Correll entities. On September 4, 2001, FSF and FSB - and their principals - restructured the manner in which they hold shares of United Trust Group by forming a new limited liability company under Kentucky law, First Southern Holdings LLC ("FSH"). FSB contributed to FSH shares of United Trust Group common stock held by it and cash in exchange for a 99% membership interest in FSH. FSF contributed to FSH shares of United Trust Group common stock held by it, subject to notes payable which were assumed by FSH for a 1% membership interest in FSH. As a result, FSB and FSF own 99% and 1%, respectively, of the outstanding membership interests of FSH who is the aforementioned holder of 1,483,791 shares (42.2%) of United Trust Group common stock.
SECURITY OWNERSHIP OF MANAGEMENT OF UTG
The following tabulation shows with respect to each of the directors of UTG, with respect to UTG's chief executive officer and each of UTG's executive officers whose salary plus bonus exceeded $100,000 for fiscal 2001, and with respect to all executive officers and directors of UTG as a group: (i) the total number of shares of all classes of stock of UTG or any of its parents or subsidiaries, beneficially owned as of March 1, 2002 and the nature of such ownership; and (ii) the percent of the issued and outstanding shares of stock so owned, and granted stock options available as of the same date.
Title Directors, Named Executive Amount Percent of Officers, & All Directors & and Nature of of Class Executive Officers as a Group Ownership Class (1) ----- ----------------------------- --------- --------- FCC's John S. Albin 0 * Common Randall L. Attkisson 0 (2) * Stock, $1.00 John W. Collins 0 * par value Jesse T. Correll 1,217 (3) 2.2% Ward F. Correll 0 * Thomas F. Darden 0 * Luther C. Miller 0 * Theodore C. Miller 15 * Millard V. Oakley 0 * Robert V. O'Keefe 0 * William W. Perry 0 * James P. Rousey 0 * Robert W. Teater 0 * Brad M. Wilson 2 * All directors and executive officers 1,234 2.3% as a group (fourteen in number)
UTG's John S. Albin 10,503 (4) * Common Randall L. Attkisson 0 (2) * Stock, no John W. Collins 0 * par value Jesse T. Correll 2,002,823 (3) 56.9% Ward F. Correll 98,523 (5) 2.8% Thomas F. Darden 0 * Luther C. Miller 0 * Theodore C. Miller 0 * Millard V. Oakley 16,471 * Robert V. O'Keefe 300 (6) * William W. Perry 0 * James P. Rousey 0 * Robert W. Teater 7,380 (7) * Brad M. Wilson 0 * All directors and executive officers as a group (fourteen in number) 2,136,000 60.7%
(1) The percentage of outstanding shares for FCC is based on 54,385 shares of Common Stock outstanding. The percentage of outstanding shares for UTG is based on 3,519,065 shares of Common Stock outstanding.
(2) Randall L. Attkisson is an associate and business partner of Mr. Jesse T. Correll and holds minority ownership positions in certain of the companies listed as owning UTG and FCC Common Stock including First Southern Funding LLC and First Southern Bancorp, Inc. Ownership of these shares is reflected in the ownership of Jesse T. Correll.
(3) The share ownership of Mr. Correll includes 112,704 shares of United Trust Group common stock owned by him individually and 150,545 shares of United Trust Group common stock held by Dyscim, LLC. Mr. Correll owns all of the outstanding membership interests of Dyscim, LLC, and therefore has sole voting and dispositive power over the shares held by it. The share ownership of Mr. Correll also includes 72,750 shares of United Trust Group common stock held by WCorrell, Limited Partnership, a limited partnership in which Mr. Correll serves as managing general partner and, as such, has sole voting and dispositive power over the shares held by it. In addition, by virtue of his ownership of voting securities of First Southern Funding, LLC and First Southern Bancorp, Inc., and in turn, their ownership of 100% of the outstanding membership interests of First Southern Holdings, LLC (the holder of 1,483,791 shares of United Trust Group common stock), Mr. Correll may be deemed to beneficially own the total number of shares of United Trust Group common stock owned by First Southern Holdings, and may be deemed to share with First Southern Holdings the right to vote and to dispose of such shares. Mr. Correll owns approximately 82% of the outstanding membership interests of First Southern Funding; he owns directly approximately 38%, companies he controls own approximately 23%, and he has the power to vote but does not own an additional 3% of the outstanding voting stock of First Southern Bancorp. First Southern Bancorp and First Southern Funding in turn own 99% and 1%, respectively, of the outstanding membership interests of First Southern Holdings. Mr. Correll is also a manager of First Southern Capital Corp., LLC, and thereby may also be deemed to beneficially own the 183,033 shares of United Trust Group common stock held by First Southern Capital, and may be deemed to share with it the right to vote and to dispose of such shares. Share ownership of Mr. Correll in United Trust Group common stock does not include 18,575 shares of United Trust Group common stock held by First Southern Investments, LLC, of which Dyscim, LLC is a member.
First Southern Bancorp owns 1,217 shares of FCC's common stock.
(4) Includes 392 shares owned directly by Mr. Albin's spouse.
(5) Cumberland Lake Shell, Inc. owns 98,523 shares of UTG Common Stock, all of the outstanding voting shares of which are owned by Ward F. Correll and his wife. As a result Ward F. Correll may be deemed to share the voting and dispositive power over these shares. Ward F. Correll is the father of Jesse T. Correll. There are 72,750 shares of UTG Common Stock owned by WCorrell Limited Partnership in which Jesse T. Correll serves as managing general partner and, as such, has sole voting and dispositive power over the shares of Common Stock held by it. The aforementioned 72,750 shares are deemed to be beneficially owned by and listed under Jesse T. Correll in this section.
(6) Includes 300 shares owned directly by Mr. O'Keefe's spouse.
(7) Includes 210 shares owned directly by Mr. Teater's spouse.
* Less than 1%.
Except as indicated above, the foregoing persons hold sole voting and investment power.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
At a December 17, 2001 joint meeting of the board of directors of UTG, FCC and their insurance subsidiaries, the boards of directors of the insurance subsidiaries discussed and decided to further explore and pursue a possible sale of the insurance charters of each of APPL and ABE. In the alternative to a sale of the APPL charter, the boards also discussed and decided to further explore a possible merger of APPL into UG. Regardless of whether a merger is ultimately pursued or the charters of each subsidiary are sold, UG would likely assume and reinsure the existing insurance policies of those subsidiaries in any such transaction.
During the fourth quarter of 2001, UG purchased real estate from an outside third party through the formation of an LLC in which UG is a two-thirds owner. The other one-third partner is Millard V. Oakley, who is a Director of both UTG and FCC. Hampshire Plaza, LLC consists of a twenty story, 254,000 square foot office tower, an attached 72,000 square foot retail plaza, and an attached parking garage with approximately 350 parking spaces located in Manchester, New Hampshire for $6,333,336. At December 31, 2001, the property was carried at $6,491,734.
On November 15, 2001, UTG was extended a $3,300,000 line of credit from the First National Bank of the Cumberlands located in Livingston, Tennessee. The First National Bank of the Cumberlands is owned by Millard V. Oakley, who is a Director of both UTG and FCC. The line of credit will expire one year from the date of issue, and all funds advanced under this line of credit are to be used for the repurchase of stock. The interest rate provided for in the agreement is variable and indexed to be the lowest of the U.S. prime rates as published in the money section of the Wall Street Journal, with any interest rate adjustments to be made monthly. To date, the Company has no borrowings or obligations attributable to this line of credit.
On October 26, 2001, APPL effected a reverse stock split, as a result of which (i) it became a wholly-owned subsidiary of UG, and an indirect wholly-owned subsidiary of FCC and UTG, and (ii) its minority shareholders received an aggregate of $1,055,294.50 in respect of their shares. Prior to the reverse stock split, UG owned 88% of the outstanding shares of APPL.
On September 4, 2001, FSF and FSBI (and their principals) restructured the manner in which they hold shares of UTG by forming a new limited liability company under Kentucky law, First Southern Holdings, LLC ("FSH"). FSBI contributed to FSH shares of UTG common stock held by it and cash in exchange for a 99% membership interest in FSH. FSF contributed to FSH shares of UTG common stock held by it, subject to notes payable which were assumed by FSH in exchange for a 1% membership interest in FSH.
On April 12, 2001, UTG completed the purchase of 22,500 shares of UTG common stock and 544 shares of FCC common stock from James E. Melville and family pursuant to the Melville Purchase Agreement in exchange for five year promissory notes of UTG in the aggregate principal amount of $288,800. On April 12, 2001, UTG also completed the purchase from another family member of Mr. Melville of an additional 100 shares of UTG for a total cash payment of $800. The purchase for cash by UTG of an additional 39 shares of FCC common stock owned by Mr. Melville at a purchase price of $200.00 per share was consummated on June 27, 2001. Mr. Melville was a former director of UTG, FCC and the three insurance subsidiaries of UTG; he resigned from those boards on February 13, 2001.
On April 12, 2001, UTG also completed the purchase of 559,440 shares of UTG common stock from Larry E. Ryherd and family pursuant to the Ryherd Purchase Agreement for cash payments totaling $948,026 and a five year promissory note of UTG in the principal amount of $3,527,494. The purchase by UTG of the remaining 3,775 shares of UTG common stock to be purchased for cash at $8.00 per share pursuant to the Ryherd Purchase Agreement along with an additional 570 shares from certain parties to the Ryherd Purchase Agreement was completed on June 20, 2001. The promissory notes of UTG received by certain of the sellers pursuant to the Melville Purchase Agreement and the Ryherd Purchase Agreement bear interest at a rate of 7% per annum (paid quarterly) with payments of principal to be made in five equal annual installments, the first such payment of principal to be due on the first anniversary of the closing.
On April 12, 2001, UTG also purchased in a separate transaction 10,891 shares of UTG common stock from Robert E. Cook at a price of $8.00 per share. At the closing, Mr. Cook received $17,426 in cash and a five year promissory note of UTG (substantially similar to the promissory notes issued pursuant to the Melville and Ryherd Purchase Agreements described above) in the principal amount of $69,702. Mr. Cook was a director of UTG and FCC who resigned his position on January 8, 2001. Mr. Cook proposed the stock purchase to Jesse T. Correll who agreed to purchase Mr. Cook's stock on substantially the same terms as the purchases of the stock held by Messrs. Melville and Ryherd as described above.
On December 31, 1999, UTG and Jesse T. Correll entered a transaction whereby Mr. Correll, in combination with other individuals, made an equity investment in UTG. Under the terms of the Stock Acquisition Agreement, the Correll group contributed their 100% ownership of North Plaza of Somerset, Inc. to UTG in exchange for 681,818 authorized but unissued shares of UTG common stock. The Board of Directors of UTG approved the transaction at their regular quarterly board meeting held on December 7, 1999. North Plaza of Somerset, Inc. owns for investment purposes, a shopping center in Somerset, Kentucky, approximately 12,000 acres of timberland in Kentucky, and a 50% partnership interest in an additional 11,000 acres of Kentucky timberland. North Plaza has no debt. The net assets were valued at $7,500,000, which equates to $11.00 per share for the new shares of UTG that were issued in the transaction.
Mr. Correll is Chairman of the Board of Directors of UTG and currently UTG's largest shareholder through his ownership control of FSF, FSBI and affiliates. Mr. Correll is the majority shareholder of FSF and FSBI, a bank holding company that operates out of 14 locations in central Kentucky. At December 31, 2001, Mr. Correll owns or controls directly and indirectly approximately 60% of UTG.
Following necessary regulatory approval, on December 29, 1999, UG was the survivor to a merger with its 100% owned subsidiary, USA. The merger was completed as a part of management's efforts to reduce costs and simplify the corporate structure.
On July 26, 1999, the shareholders of UTG and UII approved a merger transaction of the two companies. Prior to the merger, UTG owned 53% of UTGL99 (refers to the former United Trust Group, Inc., which was formed in February of 1992 and liquidated in July of 1999) an insurance holding company, and UII owned 47% of UTGL99. Additionally, UTG held an equity investment in UII. At the time the decision to merge was made, neither UTG nor UII had any other significant holdings or business dealings. The Board of Directors of each company thus concluded a merger of the two companies would be in the best interests of the shareholders by creating a larger more viable life insurance holding group with lower administrative costs, a simplified corporate structure, and more readily marketable securities. Following the merger approval, UTG issued 817,517 shares of its authorized but unissued common stock to former UII shareholders, net of any dissenter shareholders in the merger. Immediately following the merger, UTGL99, which was then 100% owned by UTG, was liquidated and UTG changed its name to United Trust Group, Inc. ("UTG").
Under the current structure, FCC pays a majority of the general operating expenses of the affiliated group. FCC then receives management, service fees and reimbursements from the various affiliates.
United Income, Inc. ("UII") had a service agreement with United Security Assurance Company ("USA"). The agreement was originally established upon the formation of USA which was a 100% owned subsidiary of UII. Changes in the affiliate structure have resulted in USA no longer being a direct subsidiary of UII, though still a member of the same affiliated group. The original service agreement remained in place without modification. USA paid UII monthly fees equal to 22% of the amount of collected first year premiums, 20% in second year and 6% of the renewal premiums in years three and after. UII had a subcontract agreement with UTG to perform services and provide personnel and facilities. The services included in the agreement were claim processing, underwriting, processing and servicing of policies, accounting services, agency services, data processing and all other expenses necessary to carry on the business of a life insurance company. UII's subcontract agreement with UTG states that UII pay UTG monthly fees equal to 60% of collected service fees from USA as stated above. The service fees received from UII were recorded in UTG's financial statements as other income. With the merger of UII into UTG in July 1999, the sub-contract agreement ended and UTG assumed the direct contract with USA. This agreement was terminated upon the merger of USA into UG in December 1999.
USA paid $677,807 under their agreement with UII for 1999. UII paid $223,753 under their agreement with UTG for 1999. Additionally, UII paid FCC $30,000 in 1999 for reimbursement of costs attributed to UII. These reimbursements are reflected as a credit to general expenses.
UTG paid FCC $550,000, $750,000 and $600,000 in 2001, 2000 and 1999, respectively for reimbursement of costs attributed to UTG.
On January 1, 1993, FCC entered an agreement with UG pursuant to which FCC provides management services necessary for UG to carry on its business. UG paid $6,156,903, $6,061,515 and $6,251,340 to FCC in 2001, 2000 and 1999, respectively.
ABE pays fees to FCC pursuant to a cost sharing and management fee agreement. FCC provides management services for ABE to carry on its business. The agreement requires ABE to pay a percentage of the actual expenses incurred by FCC based on certain activity indicators of ABE business to the business of all the insurance company subsidiaries plus a management fee based on a percentage of the actual expenses allocated to ABE. ABE paid fees of $332,673, $371,211 and $392,005 in 2001, 2000 and 1999, respectively under this agreement.
APPL has a management fee agreement with FCC whereby FCC provides certain administrative duties, primarily data processing and investment advice. APPL paid fees of $444,000, $444,000 and $300,000 in 2001, 2000 and 1999, respectively under this agreement.
Respective domiciliary insurance departments have approved the agreements of the insurance companies and it is Management's opinion that where applicable, costs have been allocated fairly and such allocations are based upon accounting principles generally accepted in the United States of America.
Since the Company's affiliation with FSF, UG has acquired mortgage loans through participation agreements with FSNB. FSNB services the loans covered by these participation agreements. UG pays a .25% servicing fee on these loans and a one-time fee at loan origination of .50% of the original loan amount to cover costs incurred by FSNB relating to the processing and establishment of the loan. UG paid $79,730, $34,721 and $11,578 in servicing fees and $22,626, $91,392 and $0 in origination fees to FSNB during 2001, 2000 and 1999, respectively.
The Company reimbursed expenses incurred by Mr. Correll and Mr. Attkisson relating to travel and other costs incurred on behalf of or relating to the Company. The Company paid $145,407, $96,599 and $39,336 in 2001, 2000 and 1999,respectively to First Southern Bancorp, Inc. in reimbursement of such costs. In addition, beginning in 2001, the Company began reimbursing FSBI a portion of salaries for Mr. Correll and Mr. Attkisson. The reimbursement was approved by the UTG board of directors and totaled $128,411 in 2001 which included salaries and other benefits.
RELATIONSHIP WITH INDEPENDENT PUBLIC ACCOUNTANTS
Kerber, Eck and Braeckel LLP ("KEB") served as UTG's independent certified public accounting firm for the fiscal year ended December 31, 2001 and for fiscal year ended December 31, 2000. In serving its primary function as outside auditor for UTG, KEB performed the following audit services: examination of annual consolidated financial statements; assistance and consultation on reports filed with the Securities and Exchange Commission and; assistance and consultation on separate financial reports filed with the State insurance regulatory authorities pursuant to certain statutory requirements. Audit Fees billed for these audit services in the year 2001 totaled $165,000, and audit fees billed for quarterly reviews of the Company's financial statements totaled $16,979. No other services were performed by, and therefore no other fees were billed by, KEB for services in the current year.
UTG does not expect that a representative of KEB will be present at the Annual Meeting of Shareholders of UTG. No accountants have been selected for fiscal year 2002 because UTG generally chooses accountants shortly before the commencement of the annual audit work.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of the report:
(1) Financial Statements:
See Item 8, Index to Financial Statements
(2) Financial Statement Schedules
Schedule I - Summary of Investments - other than invested in related parties.
Schedule II - Condensed financial information of registrant
Schedule IV - Reinsurance
Schedule V - Valuation and qualifying accounts
NOTE: Schedules other than those listed above are omitted because they are not required or the information is disclosed in the financial statements or footnotes.
(b) Reports on Form 8-K filed during fourth quarter.
UTG filed a Form 8-K with the SEC on January 2, 2002. The topic listed under Item 5. Other Events was the voluntary de-listing of the Company's stock (symbol "UTGI") from quotation on the NASDAQ small cap market with a report date of December 31, 2001.
(c) Exhibits:
Index to Exhibits (See pages 78 and 79).
INDEX TO EXHIBITS
Exhibit Number -------
3(a) (1) Amended Articles of Incorporation for the Company dated November 20, 1987.
3(b) (1) Amended Articles of Incorporation for the Company dated December 6, 1991.
3(c) (1) Amended Articles of Incorporation for the Company dated March 30, 1993.
3(d) (1) Code of By-Laws for the Company.
10(a)(2) Coinsurance Agreement dated September 30, 1996 between Universal Guaranty Life Insurance Company and First International Life Insurance Company, including assumption reinsurance agreement exhibit and amendments.
10(b)(1) Subcontract Agreement dated September 1, 1990 between United Trust, Inc. and United Income, Inc.
10(c)(1) Service Agreement dated November 8, 1989 between United Security Assurance Company and United Income, Inc.
10(d)(1) Management and Consultant Agreement dated as of January 1, 1993 between First Commonwealth Corporation and Universal Guaranty Life Insurance Company.
10(e)(1) Management Agreement dated December 20, 1981 between Commonwealth Industries Corporation, and Abraham Lincoln Insurance Company.
10(f)(1) Reinsurance Agreement dated January 1, 1991 between Universal Guaranty Life Insurance Company and Republic Vanguard Life Insurance Company.
10(g)(1) Reinsurance Agreement dated July 1, 1992 between United Security Assurance Company and Life Reassurance Corporation of America.
10(h)(3) Employment Agreement dated as of July 31, 1997 between Larry E. Ryherd and First Commonwealth Corporation
10(i)(3) Employment Agreement dated as of July 31, 1997 between James E. Melville and First Commonwealth Corporation
10(j)(1) Agreement dated June 16, 1992 between John K. Cantrell and First Commonwealth Corporation.
10(k)(1) Stock Purchase Agreement dated February 20, 1992 between United Trust Group, Inc. and Sellers.
10(l)(1) Amendment No. One dated April 20, 1992 to the Stock Purchase Agreement between the Sellers and United Trust Group, Inc.
INDEX TO EXHIBITS
Exhibit Number ------ 10(m)(1) Security Agreement dated June 16, 1992 between United Trust Group, Inc. and the Sellers.
10(n)(1) Stock Purchase Agreement dated June 16, 1992 between United Trust Group, Inc. and First Commonwealth Corporation
10(o) Universal note and security agreement dated November 15, 2001, between United Trust Group, Inc. and First National Bank of the Cumberlands.
10(p) Line of credit agreement dated November 15, 2001, between United Trust Group, Inc. and First National Bank of the Cumberlands.
99(a)(4) Audit Committee Charter
Footnote:
(1) Incorporated by reference from the Company's Annual Report on Form 10-K, File No. 0-5392, as of December 31, 1993.
(2) Incorporated by reference from the Company's Annual Report on Form 10-K, File No. 0-5392, as of December 31, 1996.
(3) Incorporated by reference from the Company's Annual Report on Form 10-K, File No. 0-5392, as of December 31, 1997.
(4) Incorporated by reference from the Company's Annual Report on Form 10-K, File No. 0-5392, as of December 31, 2000.
UNITED TRUST GROUP, INC. SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES As of December 31, 2001
Schedule I
Column A Column B Column C Column D ------------------------------------------------------------- ------------- -------------
Amount at Which Shown in Balance Cost Value Sheet ------------- ------------- ------------- Fixed maturities: Bonds: United States Government and government agencies and authorities $ 6,904,757 $ 7,183,965 $ 6,904,757 State, municipalities, and political subdivisions 11,788,567 12,029,784 11,788,567 Collateralized mortgage obligations 128,471 133,291 128,471 Public utilities 22,219,127 23,008,044 22,219,127 All other corporate bonds 33,964,473 35,370,326 33,964,473 ------------- ------------- ------------- Total fixed maturities 75,005,395 $ 77,725,410 75,005,395 =============
Investments held for sale: Fixed maturities: United States Government and government agencies and authorities 35,240,384 $ 36,182,839 36,182,839 State, municipalities, and political subdivisions 192,059 202,256 202,256 Collateralized mortgage obligations 53,777,577 54,003,623 54,003,623 Public utilities 0 0 0 All other corporate bonds 8,374,074 8,239,722 8,239,722 ------------- ------------- ------------- 97,584,094 $ 98,628,440 98,628,440 =============
Equity securities: Banks, trusts and insurance companies 1,000,000 $ 1,100,000 1,100,000 All other corporate securities 2,937,812 2,752,716 2,752,716 ------------- ------------- ------------- 3,937,812 $ 3,852,716 3,852,716 =============
Mortgage loans on real estate 23,386,895 23,386,895 Investment real estate 18,226,451 18,226,451 Real estate acquired in satisfaction of debt 0 0 Policy loans 13,608,456 13,608,456 Other long-term investments 0 0 Short-term investments 581,382 581,382 ------------- ------------- Total investments $ 232,330,485 $ 233,289,735 ============= =============
UNITED TRUST GROUP, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT Schedule II NOTES TO CONDENSED FINANCIAL INFORMATION
(a) The condensed financial information should be read in conjunction with the consolidated financial statements and notes of United Trust Group, Inc. and Consolidated Subsidiaries.
UNITED TRUST GROUP, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT PARENT ONLY BALANCE SHEETS As of December 31, 2001 and 2000
Schedule II
2001 2000 ------------- -------------
ASSETS
Investment in affiliates $ 39,542,877 $ 36,443,353 Cash and cash equivalents 378,133 1,851,441 Notes receivable from affiliate 11,536,698 12,839,193 FIT recoverable 10,969 7,583 Accrued interest income 64,331 20,837 Receivable from affiliates, net 133,963 0 ------------- ------------- Total assets $ 51,666,971 $ 51,162,407 ============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities: Notes payable $ 4,400,670 $ 1,817,169 Payable to affiliates, net 0 156,000 Deferred income taxes 2,156,203 2,140,774 Other liabilities 336,484 334,031 ------------- ------------- Total liabilities 6,893,357 4,447,974 ------------- -------------
Shareholders' equity: Common stock, net of treasury shares 70,996 83,501 Additional paid-in capital, net of treasury 42,789,636 47,730,980 Accumulated other comprehensive income of affiliates 908,744 335,287 Retained earnings (accumulated deficit) 1,004,238 (1,435,335) ------------- ------------- Total shareholders' equity 44,773,614 46,714,433 ------------- ------------- Total liabilities and shareholders' equity $ 51,666,971 $ 51,162,407 ============= =============
UNITED TRUST GROUP, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT PARENT ONLY STATEMENTS OF OPERATIONS Three Years Ended December 31, 2001
Schedule II
2001 2000 1999 ------------- ------------- -------------
Revenues:
Management fees from affiliates $ 0 $ 0 $ 528,638 Other income from affiliates 858 4,381 43,148 Interest income from affiliates 987,886 1,242,990 1,099,013 Interest income 40,323 84,519 37,402 ------------- ------------- ------------- 1,029,067 1,331,890 1,708,201
Expenses:
Management fee to affiliate 550,000 750,000 600,000 Interest expense 326,499 376,095 387,966 Interest expense to affiliates 0 0 31,325 Operating expenses 110,419 79,015 90,304 ------------- ------------- ------------- 986,918 1,205,110 1,109,595 ------------- ------------- -------------
Operating income 42,149 126,780 598,606
Income tax expense (12,043) (60,550) (192,247) Equity in income of investees 0 0 53,555 Equity in income (loss) of subsidiaries 2,409,467 (762,656) 615,995 ------------- ------------- ------------- Net income (loss) $ 2,439,573 $ (696,426)$ 1,075,909 ============= ============= =============
Basic income (loss) per share from continuing operations and net income (loss) $ 0.65 $ (0.17)$ 0.38 ============= ============= =============
Diluted income (loss) per share from continuing operations and net income (loss) $ 0.65 $ (0.17)$ 0.38 ============= ============= =============
Basic weighted average shares outstanding 3,733,432 4,056,439 2,839,703 ============= ============= =============
Diluted weighted average shares outstanding 3,733,432 4,056,439 2,839,934 ============= ============= =============
UNITED TRUST GROUP, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT PARENT ONLY STATEMENTS OF CASH FLOWS Three Years Ended December 31, 2001 Schedule II
2001 2000 1999 ------------- ------------- -------------
Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net income (loss) $ 2,439,573 $ (696,426) $ 1,075,909 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Equity in (income) loss of subsidiaries (2,409,467) 762,656 (615,995) Equity in income of investees 0 0 (53,555) Change in accrued interest income (43,494) 20,625 12,886 Depreciation 0 5,102 7,266 Change in deferred income taxes 15,429 60,288 185,406 Change in indebtedness (to) from affiliates, net (289,963) 8,690 166,422 Change in other assets and liabilities (933) 32,966 (25,070) ------------- ------------- ------------- Net cash provided by (used in) operating activities (288,855) 193,901 753,269 ------------- ------------- -------------
Cash flows from investing activities: Purchase of stock of affiliates (7,800) (3,200) (50,325) Sale of stock of affiliates 0 0 71,195 Issuance of notes receivable to affiliates 0 0 (610,000) Payments received on notes receivable from affiliates 1,302,495 2,000,000 400,000 Payments received on mortgage loans 0 0 50,000 ------------- ------------- ------------- Net cash provided by (used in) investing activities 1,294,695 1,996,800 (139,130) ------------- ------------- -------------
Cash flows from financing activities: Purchase of treasury stock (1,176,653) 0 (149,955) Payments on notes payable (1,302,495) (1,515,800) (433,974) Cash received in merger 0 0 607,508 Cash received in liquidation of subsidiary 0 0 27,936 ------------- ------------- ------------- Net cash provided by (used in) financing activities (2,479,148) (1,515,800) 51,515 ------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents (1,473,308) 674,901 665,654 Cash and cash equivalents at beginning of year 1,851,441 1,176,540 510,886 ------------- ------------- ------------- Cash and cash equivalents at end of year $ 378,133 $ 1,851,441 $ 1,176,540 ============= ============= =============
UNITED TRUST GROUP, INC. REINSURANCE As of December 31, 2001 and the year ended December 31, 2001
Schedule IV
--------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E Column F ------------- ------------ ------------- ------------- ----------
Percentage Ceded to Assumed of amount other from other assumed to Gross amount companies companies Net amount net
--------------------------------------------------------------------------------------------------
Life insurance in force $ 2,630,460,130 $ 653,610,000 $ 1,632,820,870 $ 3,609,671,000 45.2% ============= ============ ============= =============
Premiums and policy fees:
Life insurance $ 20,150,537 $ 3,135,311 $ 109,457 $ 17,124,683 0.6%
Accident and health insurance 170,923 36,787 0 134,136 0.0% ------------ ------------ ------------- ------------
$ 20,321,460 $ 3,172,098 $ 109,457 $ 17,258,819 0.6% ============= ============ ============= ============
UNITED TRUST GROUP, INC. REINSURANCE As of December 31, 2000 and the year ended December 31, 2000
Schedule IV
--------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E Column F ------------- ------------ ------------- ------------- ----------
Percentage Ceded to Assumed of amount other from other assumed to Gross amount companies companies Net amount net
--------------------------------------------------------------------------------------------------
Life insurance in force $ 2,878,693,447 $ 734,621,000 $ 1,020,170,553 $ 3,164,243,000 32.2% ============= ============ ============= =============
Premiums and policy fees:
Life insurance $ 22,789,885 $ 3,518,015 $ 76,069 $ 19,347,939 0.4%
Accident and health insurance 179,904 38,157 0 141,747 0.0% ------------- ------------ ------------- -------------
$ 22,969,789 $ 3,556,172 $ 76,069 $ 19,489,686 0.4% ============= ============ ============= =============
UNITED TRUST GROUP, INC. REINSURANCE As of December 31, 1999 and the year ended December 31, 1999
Schedule IV
--------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E Column F ------------- ------------ ------------- ------------- ----------
Percentage Ceded to Assumed of amount other from other assumed to Gross amount companies companies Net amount net
--------------------------------------------------------------------------------------------------
Life insurance in force $ 3,142,274,477 $ 831,024,000 $ 1,008,903,523 $ 3,320,154,000 30.4% ============ ============ ============= =============
Premiums and policy fees:
Life insurance $ 25,345,843 $ 3,929,888 $ 20,324 $ 21,436,279 0.1%
Accident and health insurance 193,541 48,677 0 144,864 0.0% ------------ ------------ ------------- ------------
$ 25,539,384 $ 3,978,565 $ 20,324 $ 21,581,143 0.1% ============ ============ ============= ============
UNITED TRUST GROUP, INC. VALUATION AND QUALIFYING ACCOUNTS As of and for the years ended December 31, 2001, 2000, and 1999
Schedule V
Balance at Additions Beginning Charges Balances at Description Of Period and Expenses Deductions End of Period -----------------------------------------------------------------------------------------------------
December 31, 2001 . Allowance for doubtful accounts - mortgage loans $ 240,000 $ 30,000 $ 150,000 $ 120,000 $
December 31, 2000
Allowance for doubtful accounts - mortgage loans $ 70,000 $ 170,000 $ 0 $ 240,000 $
December 31, 1999
Allowance for doubtful accounts - mortgage loans $ 70,000 $ 0 $ 0 $ 70,000 $
SIGNATURES
Pursuant to the requirements 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.
UNITED TRUST GROUP, INC. (Registrant)
John S. Albin March 26, 2002 John S. Albin, Director
/s/ Randall L. Attkisson March 26, 2002 Randall L. Attkisson, President, Chief Operating Officer and Director
/s/ John W. Collins March 26, 2002 John W. Collins, Director
/s/ Jesse T. Correll March 26, 2002 Jesse T. Correll, Chairman of the Board, Chief Executive Officer and Director
/s/ Ward F. Correll March 26, 2002 Ward F. Correll, Director
/s/ Thomas F. Darden March 26, 2002 Thomas F. Darden, Director
/s/ Luther C. Miller March 26, 2002 Luther C. Miller, Director
/s/ Millard V. Oakley March 26, 2002 Millard V. Oakley, Director
/s/ Robert V. O'Keefe March 26, 2002 Robert V. O'Keefe, Director
/s/ William W. Perry March 26, 2002 William W. Perry, Director
/s/ Robert W. Teater March 26, 2002 Robert W. Teater, Director
/s/ Theodore C. Miller March 26, 2002 Theodore C. Miller, Corporate Secretary and Chief Financial Officer