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, and the administration processing of life insurance business for other entities.
At December 31, 2002, significant majority-owned subsidiaries of the Registrant were as depicted on the following organizational chart:
This document at times will refer to the Registrant'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 financial services holding company that owns 100% of First Southern National Bank ("FSNB"), which operates out of 14 locations in central Kentucky. Mr. Correll is Chief Executive Officer and 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, 2002 Mr. Correll owns or controls directly and indirectly approximately 60% of UTG's outstanding stock.
UTG is a life insurance holding company. The focus of UTG is the acquisition of other companies in similar lines of business and management of the insurance subsidiaries. UTG has no activities outside the life insurance focus. The UTG companies became members of the same affiliated group through a history of acquisitions in which life insurance companies were involved. Effective on June 12, 2002, First Commonwealth Corporation ("FCC"), a former life insurance holding company and a then 82% owned subsidiary of UTG, merged with and into UTG, with UTG being the surviving corporation of the merger. As a result of the merger, UG became a direct wholly-owned subsidiary of UTG. (See Note 15 to the financial statements for additional information regarding the merger.)
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.
HAMPSHIRE PLAZA is 67% owned subsidiary of UG, which owns for investment purposes, a property consisting of a twenty story, 254,228 square foot office tower, and 72,382 square foot attached retail plaza totaling 326,610 square feet along with an attached 349 space parking garage, in New Hampshire. Operating activity of Hampshire Plaza accounted for approximately $150,000 of earnings in the current year.
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 one-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, 2002, Mr. Jesse T. 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. 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) through a shareholder vote and special meeting on July 26, 1999, UII merged into UTI, and simultaneously with the merger, the former UTG 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 Company 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 September 27, 2001, UG purchased real estate at a cost of $6,333,336 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 UTG. Hampshire Plaza, LLC consists of a twenty story, 254,000 square foot office tower, an attached 72,000 square foot plaza, and an attached parking garage with approximately 350 parking spaces located in Manchester, New Hampshire.
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 $1,055,295 in respect of their shares. Prior to the reverse stock split, UG owned 88% of the outstanding shares of APPL.
On June 12, 2002, FCC a life insurance holding company and a then 82% owned subsidiary of UTG, merged with and into UTG, with UTG being the surviving corporation of the merger. Minority shareholders of FCC (other than shares held by UTG or shares held in treasury by FCC or by any of its subsidiaries) received an aggregate of $2,480,000 in respect of their shares.
On October 1, 2002, APPL entered into a 100% coinsurance agreement with UG, whereby APPL ceded and UG assumed all policies in force of APPL. UG assumed ownership of APPL's 100% investment in ABE as a result of this transaction.
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 Company's primary universal life insurance product is referred to as the "UL90A", it is issued for ages 0 - 65 and 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 7.4% 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.
In 2003 UG replaced its "Century 2000" product with a new universal life contract; the "Legacy" product. This product was designed for use with several distribution channels including the Company's own internal agents, bank agent/employees and through personally producing general agents "PPGA". Similar to the UL90A this policy is issued for ages 0 - 65, in face amounts down to $25,000. But unlike the Century 2000 this product was designed with level commissions. The Legacy product has a current declared interest rate of 4.0%, which is equal to its guaranteed rate. After five years the guaranteed rate drops to 3.0%. During the first five years the policy fee will be $6.00 per month on face amounts less than $50,000 and $5.00 per month for larger amounts. After the first five years the Company may increase this rate but not more than $8.00 per month. The policy has other loads that vary based upon issue age and risk classification. 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 7.4% 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 100% for years 1 and 2 then grading downward to zero in year 5.
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 Company monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads. Credited rates are reviewed and established by the Board of Directors of the respective life insurance subsidiaries.
The 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 are 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 54% of the insurance in force. Approximately 18% 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 2002 and 2001 has been 93.6% and 91.6%, respectively.
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 2002, the Companies issued 141 universal life insurance contracts and 59 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. 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.
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. Effective December 31, 2002, external market efforts were discontinued in APPL as a preamble to either the sale of APPL's charter or its merger with and into UG as further discussed herein. ABE has no active agents. No individual sales agent accounted for over 10% of the Company's premium volume in 2002. 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 2002, Illinois and Indiana accounted for 39% and 34%, 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 2002, West Virginia accounted for 88% 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 2002, Illinois accounted for 21%, and Ohio accounted for 30% of direct premiums collected. No other state accounted for more than 6% of direct premiums collected in 2002.
In 2002, $20,528,655 of total direct premium was collected by the insurance subsidiaries. Ohio accounted for 26%, Illinois accounted for 19%, 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 years ended December 31, 2002 and 2001, and 4.5% to 5.5% for the year ended December 31, 2000.
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, 2002, the Company had gross insurance in force of $2.441 billion of which approximately $527 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 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, 2002.
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, 2002, the IOV insurance inforce was approximately $1,700,000, with reserves being held on that amount of approximately $400,000.
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, 2002, IHL has insurance inforce of approximately $3,700,000, with reserves being held on that amount of approximately $45,000.
On October 1, 2002, APPL entered into a 100% coinsurance agreement, with UG, whereby APPL ceded and UG assumed all policies in force of APPL as of the effective date of the agreement. Under the coinsurance arrangement, UG has primary responsibility for the policies, but APPL remains contingently liable for the policies. At December 31, 2002, APPL has insurance inforce of approximately $160,000,000, with reserves being held on that amount of approximately $20,800,000, which were assumed by UG in the transaction.
The Company does not have any short-duration reinsurance contracts. The effect of the Company's long-duration reinsurance contracts on premiums earned in 2002, 2001 and 2000 was as follows:
Shown in thousands --------------------------------------------------------- 2002 2001 2000 Premiums Premiums Premiums Earned Earned Earned ---------------- ---------------- ---------------- Direct $ 18,597 $ 20,333 $ 22,970 Assumed 96 111 76 Ceded (2,701) (3,172) (3,556) ---------------- ---------------- ---------------- Net premiums $ 15,992 $ 17,272 $ 19,490 ================ ================ ================
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, ------------------------------------------- 2002 2001 2000 ------------- ------------ ------------ Fixed maturities and fixed maturities held for sale $ 10,302,735 $ 10,831,162 $ 11,775,706 Equity securities 131,778 131,263 116,327 Mortgage loans 1,749,935 2,715,834 1,777,374 Real estate 730,501 488,168 611,494 Policy loans 965,227 970,142 997,381 Other long-term investments 0 0 655,418 Short-term investments 26,522 110,229 158,378 Cash 211,293 606,128 936,433 ------------ ------------- ----------- Total consolidated investment income 14,117,991 15,852,926 17,028,511 Investment expenses (771,167) (785,867) (942,678) ------------ ------------- ----------- Consolidated net investment income $ 13,346,824 $ 15,067,059 $ 16,085,833 ============ ============= ===========
At December 31, 2002, the Company had a total of $656,716 in investment real estate and $1,477,950 in equity securities, which did not produce income during 2002.
The following table summarizes the Company's fixed maturities distribution at December 31, 2002 and 2001 by ratings category as issued by Standard and Poor's, a leading ratings analyst.
Fixed Maturities
Rating % of Portfolio ---------------------- 2002 2001 ---------- ---------- Investment Grade AAA 65% 61% AA 3% 6% A 24% 24% BBB 6% 8% Below investment grade 2% 1% ---------- ---------- 100% 100% ========== ==========
The following table summarizes the Company's fixed maturities and fixed maturities held for sale by major classification.
Carrying Value -------------------------------- 2002 2001 -------------- -------------- U.S. government and government agencies $ 35,127,381 $ 43,087,596 States, municipalities and political subdivisions 8,407,263 11,990,823 Collateralized mortgage obligations 66,881,569 54,132,094 Public utilities 15,134,965 22,219,127 Corporate 41,481,003 42,204,195 -------------- -------------- $ 167,032,181 $ 173,633,835 ============== ==============
The following table shows the composition, average maturity and yield of the Company's investment portfolio at December 31, 2002.
Average Carrying Average Average Investments Value Maturity Yield ---------------------------- ---------------- -------------- -------
Fixed maturities and fixed maturities held for sale $ 170,333,008 5 years 6.05% Equity securities 4,368,293 Not applicable 3.02% Mortgage Loans 23,595,861 4 years 7.42% Investment real estate 17,865,132 Not applicable 4.09% Policy loans 13,477,480 Not applicable 7.16% Short-term investments 479,529 190 days 5.53% Cash and cash equivalents 19,763,917 On demand 1.07% ---------------- Total Investments and Cash $ 249,833,220 5.65% ================
At December 31, 2002, fixed maturities and fixed maturities held for sale have a combined market value of $169,221,583. 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 $377,676 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 $28,242,778 mature in one year and $60,230,897 mature in two to five years.
The Company holds $23,804,827 in mortgage loans, which represents approximately 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 no mortgage loans in default and in the process of foreclosure. The Company also has no loans 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 the past few years the Company has invested 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 CEO and Chairman of the board of directors of UTG and is, directly and through his affiliates, the largest shareholder of UTG. 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 2002, 2001 and 2000 the Company issued approximately $6,920,000, $4,535,000 and $21,863,000 in new mortgage loans respectively. 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.
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 $ 1,830,145 8% Commercial - all other 18,998,638 80% Farm 2,799,976 12% Residential - insured or guaranteed 96,228 0% Residential - all other 79,840 0%
The following table shows a geographic distribution of the Company's mortgage loan portfolio and investment real estate.
Mortgage Real Loans Estate ------------ ---------- Alabama 14% 0% Illinois 0% 8% Indiana 3% 0% Kentucky 72% 53% New Hampshire 0% 39% North Carolina 10% 0% Other 1% 0% ------------ ---------- Total 100% 100% ============ ==========
The following table summarizes delinquent mortgage loan holdings of the Company.
Delinquent 90 days or more 2002 2001 2000 ------------------------------- ------------- ------------- ------------- Non-accrual status $ 161,300 $ 164,941 $ 0 Other 0 0 83,972 Reserve on delinquent loans (110,000) (110,000) 0 ------------- ------------- ------------- Total delinquent $ 51,300 $ 54,941 $ 83,972 ============= ============= ============= Interest income past due (delinquent loans) $ 0 $ 0 $ 6,975 ============= ============= =============
In process of restructuring $ 0 $ 0 $ 0 Restructuring on other than market terms 0 0 0 Other potential problem loans 1,709 9,299 215,481 ------------- ------------- ------------- Total problem loans $ 1,709 $ 9,299 $ 215,481 ============= ============= ============= Interest income foregone (restructured loans) $ 0 $ 0 $ 0 ============= ============= =============
In process of foreclosure $ 0 $ 28,536 $ 0 ------------- ------------- ------------- Total foreclosed loans $ 0 $ 28,536 $ 0 ============= ============= ============= Interest income foregone (restructured loans) $ 0 $ 2,497 $ 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 Company's new business production decreased steadily and significantly over the last several years. As such, the Company has not placed an emphasis on new business production. 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. Thus, the number of agents marketing the Company's products has reduced to a negligible number.
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 250,000 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 the year ended 2002 and 2001, the Company received $521,782, and $299,905 for this work, respectively. 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, and in 2002 entered into an alliance with Fiserv Life Insurance Solutions (Fiserv LIS), to provide TPA services to insurance companies seeking business process outsourcing solutions. Fiserv LIS will be responsible for the marketing and sales function for the alliance, as well as providing the datacenter operations. UTG will staff the administration effort. Although still in its early stages, management believes this alliance with Fiserv LIS positions the Company to generate additional revenues by utilizing the Company's current excess capacity and administrative services. Fiserv LIS is a unit of Fiserv, Inc. (Nasdaq: FISV) which is an independent, full-service provider of integrated data processing and information management systems to the financial industry, headquartered in Brookfield, Wisconsin.
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. The Company has considered the feasibility of a marketing opportunity with First Southern National Bank ("FSNB") 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 marketing opportunity has potential and is believed to be a viable niche. The Company has recently designed the "Horizon" annuity product as well as the "Legacy" life product, which are both to be used in marketing efforts by FSNB. The introduction of these new products is currently not expected to produce significant premium writings.
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 Registrant's insurance subsidiaries, UG and APPL, are domiciled in the state of Ohio, while ABE is domiciled in the state of Illinois.
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 to the consolidated financial statements), and payment of dividends (see Note 2 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 insurance 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 2002, UG had two ratios outside the normal range, and APPL had three ratios outside the normal range. All five ratios resulted from a 100% coinsurance agreement between UG and APPL, which became effective on October 1, 2002. Under the terms of the agreement, APPL ceded and UG assumed all policies in force of APPL as of the effective date of the agreement. The agreement was approved by the Ohio Department of Insurance.
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 ("RBC") 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, 2002, each of the insurance subsidiaries has a Ratio that is in excess of 5, which is 500% 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. 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.
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.
On October 26, 2001, President Bush signed into law the "USA PATRIOT" Act of 2001 ("the Patriot Act"). This Law, enacted in response to the terrorist attacks of September 11, 2001, strengthens our Nation's ability to combat terrorism and prevent and detect money-laundering activities. Under Section 352 of the Patriot Act, financial institutions (definition includes insurance companies) are required to develop an anti-money laundering program. The practices and procedures implemented under the program should reflect the risks of money laundering given the entity's products, methods of distribution, contact with customers and forms of customer payment and deposits. In addition, Section 326 of the Patriot Act creates minimum standards for financial institutions regarding the identity of their customers in connection with the purchase of a policy or contract of insurance. Final regulations regarding the aforementioned Patriot Act, are to be issued by the Department of the Treasury in the spring of 2003. In anticipation of the final regulations, the Company has instituted an anti-money laundering program to comply with Section 352, and has communicated this program throughout the organization. The Company is currently working on a database program to facilitate compliance with Section 326. The Company will monitor the release of the final regulations and make any adjustments needed for continued compliance at that time.
On July 30, 2002, President Bush signed into law the "SARBANES-OXLEY" Act of 2002 ("the Act"). This Law, enacted in response to several high-profile business failures, was developed to provide meaningful reforms that protect the public interest and restore confidence in the reporting practices of publicly traded companies. The implications of the Act to public companies (which includes UTG) are vast, widespread, and evolving. Many of the new requirements will not take effect or full effect until after calendar-year-end companies have completed their 2002 annual reports. The Company has implemented requirements affecting the current reporting period, and is continually monitoring, evaluating, and planning implementation of requirements that will need to be taken into account in future reporting periods.
EMPLOYEES
There are approximately 52 persons who are employed full-time by the Company.
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 $ 2,029,272 10%
Investment real estate Commercial 16,039,771 82% Residential development 1,464,041 8% 17,503,812 90%
Grand total $19,533,084 100%
Total investment real estate holdings represent approximately 6% of the total assets of the Company net of accumulated depreciation of $460,170 and $169,281 at year-end 2002 and 2001 respectively. The Company owns an office complex in Springfield, Illinois, which houses the primary insurance operations. The office buildings in this complex contain 57,000 square feet of office and warehouse space, and are carried at $2,029,272. 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 $9,212,082.
During the fourth quarter of 2001, UG purchased real estate for $6,333,336 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 UTG. 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. The Company plans to invest approximately an additional $1,300,000 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. During the first half of 2002 a significant portion of existing office leases expired. Subsequent to year-end the Company obtained a new lease agreement whereby approximately 50% of the building would become leased. The addition of this substantial lease agreement will positively impact future cashflows on this investment. At December 31, 2002, the property was carried at $6,827,689.
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. At December 31, 2002, the Company had $1,464,041 in residential development property. In February 2003, the Company sold a significant portion of its residential development property known as Area A for approximately $732,000. At December 31, 2002, this property was carried at $450,000. Upon completion of the sale the Company realized a gain of approximately $211,000.
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. District Court for the Southern District of Illinois)
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") (merged into UG in 1999) and UTG 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. A trial date has been currently set for August 26, 2003.
The Company continues to believe that it has meritorious grounds to defend this lawsuit, and it intends to defend the case 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, 2002, the Company maintains a liability of $250,000 to cover estimated legal costs associated with the defense of this matter.
UTG and its subsidiaries are named as defendants in a number of legal actions arising as a part of the ordinary course of business relating primarily to claims made under insurance policies. Those actions have been considered in establishing the Company's liabilities. Management is of the opinion that the settlement of those actions will not have a material adverse effect on the Company's financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS OF A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2002.
PART II
ITEM 5.
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Registrant is a public company whose common stock is traded 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. The quotations below were acquired from the NASDAQ web site, which also provides quotes for over-the-counter traded securities such as UTG. UTG was listed on the NASDAQ small cap market up to December 31, 2001, at which time the Company voluntarily de-listed the stock.
BID PERIOD LOW HIGH
First quarter 6.000 9.850 Second quarter 6.000 7.250 Third quarter 6.250 7.050 Fourth quarter 6.500 8.000
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
UTG has not declared or paid any dividends on its common stock in the past two fiscal years, and has no current plans to pay dividends on its common stock as it 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, including applicable restrictions on the ability of the Company's life insurance subsidiaries to pay dividends up to the Registrant, which discussion is incorporated herein by this reference.
As of March 1, 2003 there were 9,853 record holders of UTG common stock.
The following table reflects the Company's Employee and Director Stock Purchase Plan Information:
------------------------------- ---------------------------- ----------------------------- ---------------------------- Plan category Number of securities to be Weighted-average exercise Number of securities issued upon exercise of price of outstanding options, remaining available for outstanding options, warrants and rights future issuance under warrants and rights employee and director stock purchase plans (excluding securities reflected in column (a)) (a) (b) (c) ------------------------------- ---------------------------- ----------------------------- ---------------------------- Employee and Director Stock Purchase plans approved by security holders 341,109 0 0 ------------------------------- ---------------------------- ----------------------------- ---------------------------- Employee and Director Stock Purchase plans not approved by security holders
0 0 0 ------------------------------- ---------------------------- ----------------------------- ---------------------------- Total 0 0 341,109 ------------------------------- ---------------------------- ----------------------------- ----------------------------
On March 26, 2002, the Board of Directors of UTG adopted, and on June 11, 2002, the shareholders of UTG approved, the United Trust Group, Inc. Employee and Director Stock Purchase Plan. The Plan allows for the issuance of up to 400,000 shares of UTG common stock. The plan's purpose is to encourage ownership of UTG stock by eligible directors and employees of UTG and its subsidiaries by providing them with an opportunity to invest in shares of UTG common stock. The plan is administered by the Board of Directors of UTG. A total of 58,891 shares of UTG common stock were issued under this plan in 2002, to eight individuals at a purchase price of $12.00 per share. Each participant under the plan executed a "stock restriction and buy-sell agreement", which among other things provides UTG with a right of first refusal on any future sales of the shares acquired by the participant under this plan. The purchase price of shares repurchased under the stock restriction and buy-sell agreement shall be computed, on a per share basis, equal to the sum of (i) the original purchase price paid to acquire such shares from UTG and (ii) the consolidated statutory net earnings (loss) per share of such shares during the period from the end of the month next preceding the month in which such shares were acquired pursuant to the plan, to the end of the month next preceding the month in which the sale of such shares to UTG occurs. At December 31, 2002, shares issued under this program had a value of $11.94 per share pursuant to the above formula.
The Company has no other stock plans.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical consolidated financial data should be read in conjunction with "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, 2002.
Cautionary Statement Regarding Forward-Looking Statements
Any forward-looking statement contained herein or in any other oral or written statement by the Company or any of its officers, directors or employees is qualified by the fact that actual results of the Company may differ materially from any such statement due to the following important factors, among other risks and uncertainties inherent in the Company's business:
1. Prevailing interest rate levels, which may affect the ability of the Company to sell its products, the market value of the Company's investments and the lapse ratio of the Company's policies, notwithstanding product design features intended to enhance persistency of the Company's products.
2. Changes in the federal income tax laws and regulations which may affect the relative tax advantages of the Company's products.
3. Changes in the regulation of financial services, including bank sales and underwriting of insurance products, which may affect the competitive environment for the Company's products.
4. Other factors affecting the performance of the Company, including, but not limited to, market conduct claims, insurance industry insolvencies, insurance regulatory initiatives and developments, stock market performance, an unfavorable outcome in pending litigation, and investment performance.
Results of Operations
(a) Revenues
Premiums and policy fee revenues, net of reinsurance premiums and policy fees, decreased 7% when comparing 2002 to 2001 and 11% from 2001 to 2000. 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 require 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 2002, 2001 and 2000 was approximately 93.6%, 91.6%, and 89.8%, respectively. Persistency is a measure of insurance in force retained in relation to the previous year.
New business production decreased steadily and significantly over the last several years. New business production in 2002 was approximately 10% of the production levels in 1998. The Company has not placed an 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.
During 2001, the Company implemented a conservation effort, which is still in place, 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 implementing a new product referred to as "the Legacy" to be specifically used by the licensed customer service representatives as an alternative for the customer in the conservation efforts. The new product has been developed but has yet to be marketed as of December 31, 2002. The Company hopes to start marketing the product by the end of the first quarter of 2003.
The Company has considered the feasibility of a marketing opportunity with First Southern National Bank ("FSNB") an affiliate of UTG's largest shareholder, Chariman and CEO, Jesse T. Correll. Management has considered various products including annuity type products, mortgage protection products and existing insurance products, as potential products that could be marketed to banking customers. This marketing opportunity has potential and is believed to be a viable niche. The Company has recently designed the "Horizon" annuity product as well as the "Legacy" life product which are both to be used in marketing efforts by FSNB. The introduction of these new products is currently not expected to produce significant premium writings.
Net investment income decreased 11% when comparing 2002 to 2001 and decreased 6% when comparing 2001 to 2000. The national prime rate has declined from 9.5% at December 31, 2000 to 4.25% at December 31, 2002. This has resulted in lower earnings on short-term funds as well as on longer-term investments acquired. Should this economic climate continue, net investment income may continue to decline as the Company, along with others in the insurance industry, seeks adequate returns on investments, while staying within the conservative investment guidelines set forth by insurance regulators. Many insurance companies have suffered significant losses in their investment portfolios in the last couple of years, however, because of the Company's conservative investment philosophy the Company has so far avoided such significant losses. Management shortened the length of the Company's portfolio which hurt investment earnings in the short run, but the Company has not had to write off any losses in these turbulent economic times. 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 overall investment yields for 2002, 2001 and 2000, are 5.65%, 6.39% and 6.88%, 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%. 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 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. At the March 2002 Board of Directors meeting, the Boards of the insurance subsidiaries lowered all remaining rate-adjustable products to their guaranteed minimum rates. The guaranteed minimum crediting rates on these products range from 3% to 5.5%. These adjustments were in response to the continued declines in interest rates in the marketplace described above. Policy interest crediting rate changes become effective on an individual policy basis on the next policy anniversary. If interest rates continue to decline, the Company won't be able to lower rates and both net investment income and net income will be impacted negatively.
Realized investment gains, net of realized losses, were $13,634, $436,840 and $(260,078) in 2002, 2001 and 2000, respectively. During 2002, the modest realized gain consisted primarily of real estate sales on residential development property the Company owned in Springfield, Illinois. 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, Illinois. 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.
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 250,000 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 the year ended 2002 and 2001, the Company received $521,782, and $299,905 for this work, respectively. 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, and in 2002 entered into an alliance with Fiserv Life Insurance Solutions (Fiserv LIS), to provide TPA services to insurance companies seeking business process outsourcing solutions. Fiserv LIS will be responsible for the marketing and sales function for the alliance, as well as providing the datacenter operations. UTG will staff the administration effort. Although still in its early stages, management believes this alliance with Fiserv LIS positions the Company to generate additional revenues by utilizing the Company's current excess capacity and administrative services. Fiserv LIS is a unit of Fiserv, Inc. (Nasdaq: FISV) which is an independent, full-service provider of integrated data processing and information management systems to the financial industry, headquartered in Brookfield, Wisconsin.
(b) Expenses
Benefits, claims and settlement expenses net of reinsurance benefits and claims, increased slightly in 2002 as compared to 2001 and decreased 12% in 2001 as compared to 2000. Fluctuations in death claim experience from year to year typically have a significant impact on variances in this line item. Direct (prior to reinsurance) death claims were approximately $1,812,000 greater in 2002 than in 2001 and approximately $1,636,000 less in 2001 than in 2000. 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. Policy surrender benefits decreased approximately $2,000,000 during the year 2002 compared to the same period in 2001. As discussed above, stronger efforts have been made in policy retention through more personal contact with customers including telephone calls to discuss alternatives and reasons for a request to surrender their policy. The short-term impact of such fewer policy surrenders is negligible since a reserve for future policy benefits payable is held which is, at a minimum, equal to or even greater than the cash surrender value of a policy. The benefit of fewer policy surrenders is primarily received over a longer time period through the retention of the Company's asset base.
Commissions and amortization of deferred policy acquisition costs decreased 38% in 2002 compared to 2001 and decreased 40% in 2001 compared to 2000. The most significant factor in the continuing decrease is attributable to the Company paying fewer commissions, since the Company writes very little new business and renewal premiums on existing business continue to decline. Another factor of the decrease is attributable to normal amortization of the deferred policy acquisition costs asset. The Company reviews the recoverability of the asset based on current trends and known events compared to the assumptions used in the establishment of the original asset. No impairments were recorded in any of the three periods reported.
Amortization of cost of insurance acquired decreased 4% in 2002 compared to 2001 and decreased 1% in 2001 compared to 2000. 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. 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 2002, 2001 and 2000 has been approximately 93.6%, 91.6%and 89.8%, respectively.
Operating expenses decreased 9% in 2002 compared to 2001 and decreased 36% in 2001 compared to 2000. During 2001, the Company transferred all remaining functions of its insurance subsidiary APPL from Huntington, West Virginia to the Springfield, Illinois location, and sold the West Virginia property. The closing of the Huntington office has resulted in an approximately $325,000 reduction to operating expenses in 2002. During the current year the Company changed health insurance coverage on its employees. This change reduced 2002 operating expenses approximately $75,000, while maintaining similar coverage amounts. Additional expense reductions have been made in the normal course of business, as the Company continually monitors expenditures looking for savings opportunities. The aforementioned expense reductions have been partially offset by increased operating costs of approximately $285,000 attributable to the Company's conversion of its existing business and TPA clients to "ID3", a software system owned by Fiserv LIS. Conversion costs to date include fees for initial licensing, consultation, and training.
During the fourth quarter of 2000, Mr. Jesse T. 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. 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.
Interest expense declined 19% comparing 2002 to 2001 and declined 13% comparing 2001 to 2000. The Company repaid $1,405,395, $1,302,495 and $1,540,800 in outside debt in 2002, 2001 and 2000 respectively, through operating cashflows and dividends received from its subsidiary UG. On July 31, 2000, $2,560,000 in convertible debt of UTG held by First Southern was converted to equity. 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. These notes bear interest at the fixed rate of 7% per annum (paid quarterly) with payments of principal to be made in five equal installments, the first principal payment of which, in the amount of $777,199, was made on March 31, 2002. In December 2002 advance principal payments totaling $113,522 were made on these notes. Subsequent to year-end 2002 an additional advance principal payment was made on these notes in the amount of $705,499. In May and July of 2002, principal payments of $113,112 and $401,562, respectively were made, which paid off the remaining balance owed on the Company's subordinated debt. The subordinated debt was incurred June 16, 1992 as a part of the acquisition of the now dissolved Commonwealth Industries Corporation. At December 31, 2002, UTG had $2,995,275 in notes payable remaining, all of which were incurred in the aforementioned April 2001 stock purchase transaction with Mr. Ryherd and Mr. Melville. Principal payments of $763,259 are due annually over a three-year period ending in April of 2006 with the next principal payment due in April of 2004. The Company has agressively pursued the repayment of its existing debt in recent periods. Interest rates on existing debt are fixed. With the current interest rate environment, management believes it is in the Company's best long-term interest to reduce or eliminate its debt with any excess funds available to do so.
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 payment of dividends from the Company's life subsidiaries.
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 $1,499,618, $2,439,573 and $(696,426) in 2002, 2001 and 2000 respectively. The decrease in net income in 2002 as compared to 2001 is primarily related to lower investment income returns and increased death claims. Significant one-time charges and accruals to operating expenses combined with an increase in death claims during 2000 as further described above 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 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. Many insurance companies have suffered significant losses in their investment portfolios in the last couple of years, however, because of the Company's conservative investment philosophy our Company has so far largely avoided such significant losses. Management shortened the length of the Company's portfolio which hurt investment earnings in the short run, but the Company has not had to write off any losses in these turbulent economic times.
At December 31, 2002, 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 2002 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, 2002 and 2001 by ratings category as issued by Standard and Poor's, a leading ratings analyst.
Fixed Maturities Rating % of Portfolio ---------------------- 2002 2001 ---------- ---------- Investment Grade AAA 65% 61% AA 3% 6% A 24% 24% BBB 6% 8% Below investment grade 2% 1% ---------- ---------- 100% 100% ========== ==========
In the past few years the Company has invested 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 CEO and Chairman of the board of directors of UTG, and directly and indirectly through affiliates, its largest shareholder. 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 2002, 2001 and 2000 the Company issued approximately $6,920,000, $4,535,000 and $21,863,000 respectively, 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. UG paid $70,140, $79,730 and $34,721 in servicing fees and $35,127, $22,626 and $91,392 in origination fees to FSNB during 2002, 2001 and 2000, respectively.
Total investment real estate holdings represent approximately 6% of the total assets of the Company, net of accumulated depreciation, at year-end 2002 and 2001 respectively. Total investment real estate is separated into two categories: Commercial 92% and Residential Development 8%.
Policy loans remained consistent for the periods presented. Industry experience for policy loans indicates that 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 2002 compared to 2001. 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 $69,000 in policy acquisition costs deferred, $55,000 in interest accretion and $769,432 in amortization in 2002, and had $167,000 in policy acquisition costs deferred, $76,000 in interest accretion and $1,083,577 in amortization in 2001.
Cost of insurance acquired decreased 30% in 2002 compared to 2001. 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. In both 2002 and 2001 amortization decreased the asset by $1,572,920 each year. In 2002, the balance was reduced $8,409,722 as a result of the valuation adjustment attributable to the acquisition of the minority shareholder positions of FCC through its merger with and into UTG.
(b) Liabilities
Total liabilities decreased 2% in 2002 compared to 2001. Policy liabilities and accruals, which represented 93% and 92% of total liabilities at year end 2002 and 2001, respectively, decreased slightly during the current year. The decline is attributable to a shrinking policy base and declining new business production.
Notes payable decreased 32% in 2002 compared to 2001. At December 31, 2001, UTG had $4,400,670 in notes payable. During 2002, the Company repaid $1,405,395 of its debt through operating cashflows and dividends received from its subsidiary UG. At December 31, 2002, UTG had $2,995,275 in notes payable, all remaining debt is owed to two former officers and directors of the Company and their respective families as a result of an April 2001 stock purchase transaction. These notes bear interest at the fixed rate of 7% per annum (paid quarterly), with three remaining principal payments of $763,259 due annually. The next principal payment due date is in April of 2004. Management believes overall sources of liquidity available are more than adequate to service this debt. These sources include current cash balances of UTG, expected future operating cashflows and payment of dividends from the Company's life subsidiaries. The Company's long-term debt is discussed in more detail in Note 11 to the consolidated financial statements, which is incorporated herein by this reference.
(c) Shareholders' Equity
Total shareholders' equity increased 8% in 2002 compared to 2001. This is primarily due to income during the year of $1,499,618, an increase in unrealized gains on investments in the current year of $1,289,740, and an increase in equity of $706,691 from an employee and director stock purchase plan which was approved and implemented in 2002.
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 8% and 5% as of December 31, 2002 and 2001, respectively. Fixed maturities as a percentage of total invested assets were 74% as of December 31, 2001 and 2000, respectively.
The Company's investments are predominantly in fixed maturity investments such as bonds and mortgage loans, which provide sufficient return to cover future obligations. The Company carries certain of its fixed maturity holdings as held to maturity which are 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 $38,646, $1,365,047and $(2,155,491) in 2002, 2001 and 2000, 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 $2,370,411 in 2002, $3,384,557 in 2001 and $(393,571) in 2000. 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 $9,008,183, $138,994 and $(3,940,958), for 2002, 2001 and 2000, respectively. The most significant aspect of cash provided by (used in) investing activities are the fixed maturity transactions. Fixed maturities account for 80%, 81% and 42% of the total cost of investments acquired in 2002, 2001 and 2000, respectively. The decrease in fixed maturities acquired in 2000 resulted from a corresponding increase in the acquisition of mortgage loans that year.
Net cash provided by (used in) financing activities was $(473,692), $(1,091,769) and $133,721 for 2002, 2001 and 2000, respectively. The Company continues to pay down its outstanding debt. Such payments are included within this category. In addition, in 2001 the board of directors of the Company authorized a repurchase program of UTG's common stock and the purchase of stock is still pursued as it becomes available. In addition, in 2002 this category includes payments made to former FCC shareholders for shares they owned prior to the merger of FCC into UTG. Policyholder contract deposits decreased 9% in 2002 compared to 2001, and decreased 11% in 2001 when compared to 2000. 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 2002 compared to 2001, and 15% in 2001 compared to 2000. 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, 2002, UTG had $2,995,275 in notes payable, all remaining debt is owed to two former officers and directors of the Company and their respective families as a result of an April 2001 stock purchase transaction. These notes bear interest at the fixed rate of 7% per annum (paid quarterly), with three remaining principal payments of $763,259 due annually. The next principal payment due date is in April of 2004. 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 payment of dividends from the Company's life subsidiaries. In January 2003, UTG paid $705,499 on its notes payable completing the 2003 principal payments due.
On November 15, 2001, UTG was extended a $3,300,000 line of credit ("LOC") from the First National Bank of the Cumberlands ("FNBC") located in Livingston, Tennessee. The FNBC is owned by Millard V. Oakley, who is a director of UTG. The LOC was for a one-year term from the date of issue. Upon maturity the Company renewed the LOC for an additional one-year term. The interest rate on the LOC is variable and indexed to be the lowest of the U.S. prime rates as published in the Wall Street Journal, with any interest rate adjustments to be made monthly. At December 31, 2002, the Company had no outstanding borrowings attributable to this LOC. During 2002 the Company had total borrowings of $1,600,000 on this LOC, which were all repaid during the year. The draws on this LOC were used to facilitate the payments due to the former shareholders of FCC as a result of the June 12, 2002, merger of FCC with and into UTG, as further described in note 15 to the consolidated financial statements and incorporated herein by this reference.
On April 1, 2002, UTG was extended a $5,000,000 line of credit ("LOC") from an unaffiliated third party, Southwest Bank of St. Louis. The LOC will expire one-year from the date of issue. As collateral for any draws under the line of credit, the former FCC, which has now merged into UTG, pledged 100% of the common stock of its insurance subsidiary UG. Borrowings under the LOC will bear interest at the rate of 0.25% in excess of Southwest Bank of St. Louis' prime rate. At December 31, 2002, the Company had no outstanding borrowings attributable to this LOC. During 2002 the Company had total borrowings of $400,000 on this LOC which were all repaid during the year. Draws on this LOC were used to retire the remaining subordinated debt, as described in note 11 to the consolidated financial statements and incorporated herein by this reference.
On June 10, 2002 UTG and Fiserv LIS formed an alliance between their respective organizations to provide third party administration (TPA) services to insurance companies seeking business process outsourcing solutions. Fiserv LIS will be responsible for the marketing and sales function for the alliance, as well as providing the operations processing service for the Company. The Company will staff the administration effort. To facilitate the alliance, the Company plans to convert its existing business and TPA clients to "ID3", a software system owned by Fiserv LIS to administer an array of life, health and annuity products in the insurance industry. Fiserv LIS is a unit of Fiserv, Inc. (Nasdaq: FISV) which is an independent, full-service provider of integrated data processing and information management systems to the financial industry, headquartered in Brookfield, Wisconsin.
The Company is currently evaluating its alternatives to converting its existing business to "ID3". Currently, the Company believes the conversion costs could range from $500,000 to $1,700,000. Alternatives include completing the conversion with the existing staff of the Company, to outsourcing the entire conversion to Fiserve LIS. Management expects to make a decision shortly.
In June 2002, the Company entered into a five-year contract with Fiserve LIS for services related to their purchase of the "ID3" software system. Under the contract, the Company is required to pay $12,000 per month in software maintenance costs and $5,000 per month in offsite data center costs for a five-year period from the date of the signing.
The Company has been attempting to sell the Charter (state licenses) of APPL. To accommodate such a sale, APPL entered into a 100% coinsurance agreement effective October 1, 2002, whereby APPL ceded and UG assumed all policies in force of APPL as of the effective date of the agreement. The agreement was approved by the Ohio Department of Insurance pursuant to regulatory requirements. Under the coinsurance agreement, UG has primary responsibility for the policies, but APPL remains contingently liable for the policies. Currently, a sale of the Charter appears to be remote. As an alternative, a merger proposal is being considered whereby APPL would be merged with and into UG. A decision regarding the merger is likely to be approved at the Board meeting in March 2003.
As a result of the 100% coinsurance agreement, the ownership of ABE was transferred from APPL to UG, as part of the coinsurance asset transfer. Prior to the coinsurance transaction, in September 2002, the boards of ABE and UG approved the exploration of a merger transaction whereby ABE would be merged with and into UG. The UG and ABE Boards are expected to approve the merger transaction at the March 2003 meeting. The merger will require the approval of the insurance departments of the States of Ohio and Illinois prior to completion. The merger is expected to be completed in mid 2003.
Management of the Company believes the completion of the aforementioned mergers will provide the Company with additional cost savings. These cost savings result from streamlining the Company's operations and organizational structure from three life insurance subsidiaries to one life insurance subsidiary, UG. Thus, the Company will further improve administrative efficiency.
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. For the five-year period starting January 1, 1998 and ending December 31, 2002, the Company had total earnings of $17,011,307 applicable to this covenant. Therefore, UTG did not meet the earnings requirements stipulated, and UTG believes it will be required to issue 500,000 additional shares to FSF or its assigns. Pursuant to the covenant, a final accounting and issuance of any shares due are to occur by April 30, 2003.
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 management fees received from its subsidiaries and earnings received on cash balances. On December 31, 2002, substantially all of the consolidated shareholders equity represents net assets of 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. Following the merger of FCC with and into UTG (see note 15 to the consolidated financial statements) UG became a 100% owned subsidiary of UTG. Following APPL's 100% coinsurance transaction with UG (see note 17 to the consolidated financial statements), ABE became a direct 100% owned subsidiary of UG.
Both UG and APPL are Ohio domiciled insurance companies, which 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. At December 31, 2002 UG and APPL's total statutory shareholders' equity was $16,030,200, and $9,191,715, respectively. At December 31, 2002, UG and APPL's statutory gain from operations was $2,062,744, and $526,742, respectively. 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 $800,000 to the former FCC in 2002, and $1,400,000 to UTG in 2002. APPL paid an ordinary dividend of $880,000 to UG in 2002.
ABE is an Illinois domiciled insurance company, which requires notification to the insurance commissioner for the payment of an ordinary dividend within 5 business days following the declaration and no less than 10 business days prior to payment. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. At December 31, 2002 ABE had a total statutory shareholders' equity of $2,799,296 and a statutory gain from operations of $182,866. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. ABE paid an ordinary dividend of $280,000 to UG in 2002.
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 and APPL, are domiciled in the state of Ohio, while ABE is domiciled in the state of Illinois.
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 to the consolidated financial statements), and payment of dividends (see Note 2 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 2002, UG had two ratios outside the normal range, and APPL had three ratios outside the normal range. All five ratios resulted from a 100% coinsurance agreement between UG and APPL, which became effective on October 1, 2002. Under the terms of the agreement, APPL ceded and UG assumed all policies in force of APPL as of the effective date of the agreement. The agreement was approved by the Ohio Department of Insurance.
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 ("RBC") 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, 2002, each of the insurance subsidiaries has a Ratio that is in excess of 5, which is 500% 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. 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.
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.
On October 26, 2001, President Bush signed into law the "USA PATRIOT" Act of 2001 ("the Patriot Act"). This Law, enacted in response to the terrorist attacks of September 11, 2001, strengthens our Nation's ability to combat terrorism and prevent and detect money-laundering activities. Under Section 352 of the Patriot Act, financial institutions (definition includes insurance companies) are required to develop an anti-money laundering program. The practices and procedures implemented under the program should reflect the risks of money laundering given the entity's products, methods of distribution, contact with customers and forms of customer payment and deposits. In addition, Section 326 of the Patriot Act creates minimum standards for financial institutions regarding the identity of their customers in connection with the purchase of a policy or contract of insurance. Final regulations regarding the aforementioned Patriot Act, are to be issued by the Department of the Treasury sometime this spring. In anticipation of the final regulations, the Company has instituted an anti-money laundering program to comply with Section 352, and has communicated this program throughout the organization. The Company is currently working on a database program to facilitate compliance with Section 326. The Company will monitor the release of the final regulations and make any adjustments needed for continued compliance at that time.
On July 30, 2002, President Bush signed into law the "SARBANES-OXLEY" Act of 2002 ("the Act"). This Law, enacted in response to several high-profile business failures, was developed to provide meaningful reforms that protect the public interest and restore confidence in the reporting practices of publicly traded companies. The implications of the Act to public companies, (which includes UTG) are vast, widespread, and evolving. Many of the new requirements will not take effect or full effect until after calendar-year-end companies have completed their 2002 annual reports. The Company has implemented requirements affecting the current reporting period, and is continually monitoring, evaluating, and planning implementation of requirements that will need to be taken into account in future reporting periods.
ACCOUNTING AND LEGAL DEVELOPMENTS
The Financial Accounting Standards Board ("FASB") has issued Statement No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities, Statement No. 147, Acquisitions of Certain Financial Institutions, an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9, and Statement No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123.
Under Statement 4, all gains and losses from extinguishment of debt were required to be aggregated, and, if material, classified as an extraordinary item, net of related income tax effect. Statement 145 eliminates Statement 4 and as a result, gains and losses from extinguishment of debt should be classified as extraordinary items only if they meet certain criteria as outlined in Opinion 30. Applying the provisions of Opinion 30 will distinguish transactions that are part of an entity's recurring operations from those that are unusual or infrequent or that meet the criteria for classification as an extraordinary item. Statement 64 amended Statement 4 and is no longer necessary because Statement 4 has been rescinded. Statement 44 was issued to establish accounting requirements for the effects of transition to the provisions of the Motor Carrier Act of 1980. Those transitions are completed; therefore, Statement 44 is no longer necessary. Statement 145 also amends Statement 13 to require sale-leaseback accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. Statement 145 also makes various technical corrections to existing pronouncements, none of which are substantive in nature. Statement 145 is required for fiscal years beginning after May 15, 2002, with early application encouraged. The adoption of Statement 145 did not affect the Company's financial position or results of operations since the Company has had no transactions of the aforementioned kind, during the reporting period.
Statement 146 was issued to address the accounting and reporting for costs associated with exit or disposal activities because entities increasingly are engaging in such activities and certain costs associated with those activities were recognized as liabilities at a plan (commitment) date that did not meet the definition of a liability as outlined in FASB Concepts Statement No. 6. Statement 146 improves financial reporting for cost associated with exit or disposal activities, by requiring that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The accounting for similar events and circumstances will be the same, thereby improving the comparability and representational faithfulness of reported financial information. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The adoption of Statement 146 did not affect the Company's financial position or results of operations, since the Company has had no such exit or disposal activities during the reporting period.
Statement 147 was issued to address and clarify the application of the purchase method of accounting as it applies to acquisitions of financial institutions, except transactions between two or more mutual enterprises. The provisions of Statement 147 are effective on October 1, 2002. The adoption of Statement 147 did not affect the Company's financial position or results of operations, since the Company has had no acquisitions of this nature during the reporting period.
Statement 148 was issued to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2002. The adoption of Statement 148 will not affect the Company's financial position or results of operations, since the Company has no forms of stock-based employee compensation.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risk relates, broadly, to changes in the value of financial instruments that arise from adverse movements in interest rates, equity prices and foreign exchange rates. The Company is exposed principally to changes in interest rates which affect the market prices of its fixed maturities available for sale and its variable rate debt outstanding. The Company's exposure to equity prices and foreign currency exchange rates is immaterial. The information is presented in U.S. Dollars, the Company's reporting currency.
Interest rate risk
The Company could experience economic losses if it were required to liquidate fixed income securities available for sale during periods of rising and/or volatile interest rates. The Company attempts to mitigate its exposure to adverse interest rate movements through staggering the maturities of its fixed maturity investments and through maintaining cash and other short term investments to assure sufficient liquidity to meet its obligations and to address reinvestment risk considerations.
Tabular presentation
The following table provides information about the Company's long term debt that is sensitive to changes in interest rates. The table presents principal cash flows and related weighted average interest rates by; expected maturity dates. The Company has no derivative financial instruments or interest rate swap contracts.
------------------------------------------------------------------------------------------------------------------------ December 31, 2002 ------------------------------------------------------------------------------------------------------------------------ Expected maturity date ------------------ ------------ ---------- ---------- ---------- ---------- ------------ --------------- --------------- 2003 2004 2005 2006 2007 Thereafter Total Fair value ------------------ ------------ ---------- ---------- ---------- ---------- ------------ --------------- --------------- Long term debt ------------------ ------------ ---------- ---------- ---------- ---------- ------------ --------------- --------------- Fixed rate 705,499 763,259 763,259 763,259 0 0 2,995,275 3,148,352 ------------------ ------------ ---------- ---------- ---------- ---------- ------------ --------------- --------------- Avg. int. rate 0 7.0% 7.0% 7.0% 0 0 7.0% ------------------ ------------ ---------- ---------- ---------- ---------- ------------ --------------- --------------- Variable rate 0 0 0 0 0 0 0 0 ------------------ ------------ ---------- ---------- ---------- ---------- ------------ --------------- --------------- Avg. int. rate 0 0 0 0 0 0 0 ------------------ ------------ ---------- ---------- ---------- ---------- ------------ --------------- ---------------
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, 2002, 2001, 2000................................36
Consolidated Balance Sheets..............................................37
Consolidated Statements of Operations....................................38
Consolidated Statements of Shareholders' Equity..........................39
Consolidated Statements of Cash Flows....................................40
Notes to Consolidated Financial Statements............................41-70
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, 2002 and 2001, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. 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, 2002 and 2001, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.
We have also audited Schedule I as of December 31, 2002, and Schedules II, IV and V as of December 31, 2002 and 2001, 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 14, 2003
UNITED TRUST GROUP, INC. CONSOLIDATED BALANCE SHEETS As of December 31, 2002 and 2001
ASSETS 2002 2001 --------------- -------------- Investments: Fixed maturities held to maturity, at amortized cost (market $60,517,065 and $77,725,410) $ 58,327,663 $ 75,005,395 Investments held for sale: Fixed maturities, at market (cost $105,244,887 and $97,584,094) 108,704,518 98,628,440 Equity securities, at market (cost $4,122,887 and $3,937,812) 4,883,870 3,852,716 Mortgage loans on real estate at amortized cost 23,804,827 23,386,895 Investment real estate, at cost, net of accumulated depreciation 17,503,812 18,226,451 Policy loans 13,346,504 13,608,456 Short-term investments 377,676 581,382 --------------- -------------- 226,948,870 233,289,735
Cash and cash equivalents 24,050,485 15,477,348 Accrued investment income 2,452,840 3,002,860 Reinsurance receivables: Future policy benefits 33,039,036 33,776,688 Policy claims and other benefits 3,770,285 4,042,779 Cost of insurance acquired 23,156,164 33,081,336 Deferred policy acquisition costs 2,462,487 3,107,919 Cost in excess of net assets purchased, net of accumulated amortization 0 345,779 Property and equipment, net of accumulated depreciation 2,203,408 2,459,117 Income taxes receivable, current 245,132 215,865 Other assets 574,263 139,245 --------------- -------------- Total assets $ 318,902,970 $ 328,938,671 =============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities and accruals: Future policy benefits $ 234,762,656 $ 236,449,241 Policy claims and benefits payable 1,834,952 2,781,920 Other policyholder funds 1,176,359 1,255,990 Dividend and endowment accumulations 12,628,294 13,055,024 Deferred income taxes 12,239,060 13,569,523 Notes payable 2,995,275 4,400,670 Other liabilities 4,943,507 4,880,896 --------------- -------------- Total liabilities 270,580,103 276,393,264 --------------- -------------- Minority interests in consolidated subsidiaries 0 7,771,793 --------------- --------------
Shareholders' equity: Common stock - no par value, stated value $.02 per share. Authorized 7,000,000 shares - 3,536,311 and 3,549,791 shares issued and outstanding after deducting treasury shares of 147,607 and 75,236 70,726 70,996 Additional paid-in capital 42,976,344 42,789,636 Retained earnings 2,503,856 1,004,238 Accumulated other comprehensive income 2,771,941 908,744 --------------- -------------- Total shareholders' equity 48,322,867 44,773,614 --------------- -------------- Total liabilities and shareholders' equity $ 318,902,970 $ 328,938,671 =============== ==============
UNITED TRUST GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Three Years Ended December 31, 2002
2002 2001 2000 --------------- ---------------- ----------------
Revenues:
Premiums and policy fees $ 18,693,022 $ 20,444,514 $ 23,045,858 Reinsurance premiums and policy fees (2,700,622) (3,172,098) (3,556,172) Net investment income 13,346,824 15,067,059 16,085,833 Realized investment gains(losses), net 13,634 436,840 (260,078) Other income 817,186 589,017 431,682 --------------- ---------------- ---------------- 30,170,044 33,365,332 35,747,123
Benefits and other expenses:
Benefits, claims and settlement expenses: Life 20,393,044 19,614,470 23,440,711 Reinsurance benefits and claims (3,043,115) (2,349,102) (3,376,091) Annuity 1,151,973 1,244,663 1,210,783 Dividends to policyholders 984,346 1,015,055 1,003,954 Commissions and amortization of deferred policy acquisition costs 785,861 1,262,974 2,089,313 Amortization of cost of insurance acquired 1,515,450 1,572,920 1,592,812 Operating expenses 5,876,456 6,485,691 10,115,786 Interest expense 263,441 326,499 376,924 --------------- ---------------- ---------------- 27,927,456 29,173,170 36,454,192 --------------- ---------------- ----------------
Income (loss) before income taxes and minority interest 2,242,588 4,192,162 (707,069) Income tax expense (479,355) (1,181,133) (228,783) Minority interest in (income) loss of consolidated subsidiaries (263,615) (571,456) 239,426 --------------- ---------------- ----------------
Net income (loss) $ 1,499,618 $ 2,439,573 $ (696,426) =============== ================ ================
Basic income (loss) per share from continuing operations and net income (loss) $ 0.43 $ 0.65 $ (0.17) =============== ================ ================
Diluted income (loss) per share from continuing operations and net income (loss) $ 0.37 $ 0.65 $ (0.17) =============== ================ ================
Basic weighted average shares outstanding 3,505,424 3,733,432 4,056,439 =============== ================ ================
Diluted weighted average shares outstanding 4,005,424 3,733,432 4,056,439 =============== ================ ================
UNITED TRUST GROUP, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Three Years Ended December 31, 2002
2002 2001 2000 ------------------------- ------------------------- -------------------------
Common stock Balance, beginning of year $ 70,996 $ 83,501 $ 79,405 Issued during year 1,177 0 4,096 Treasury shares acquired (1,447) (555) 0 Retired during year 0 (11,950) 0 ------------ ------------ ------------ Balance, end of year $ 70,726 $ 70,996 $ 83,501 ============ ============ ============
Additional paid-in capital Balance, beginning of year $ 42,789,636 $ 47,730,980 $ 45,175,076 Issued during year 705,514 0 2,555,904 Treasury shares acquired (518,806) (172,927) 0 Retired during year 0 (4,768,417) 0 ------------ ------------ ------------ Balance, end of year $ 42,976,344 $ 42,789,636 $ 47,730,980 ============ ============ ============
Retained earnings (accumulated deficit) Balance, beginning of year $ 1,004,238 $ (1,435,335) $ (738,909) Net income (loss) 1,499,618 $ 1,499,618 2,439,573 $ 2,439,573 (696,426) $ (696,426) ------------ ------------ ------------ Balance, end of year $ 2,503,856 $ 1,004,238 $ (1,435,335) ============ ============ ============
Accumulated other comprehensive income (deficit) Balance, beginning of year $ 908,744 $ 335,287 $ (1,138,900) Other comprehensive income Unrealized holding gain on securities net of minority interest and reclassification adjustment 1,863,197 1,863,197 573,457 573,457 1,474,187 1,474,187 ------------ ----------- ------------ ----------- ------------ ----------- Comprehensive income $ 3,362,815 $ 3,013,030 $ 777,761 =========== =========== =========== Balance, end of year $ 2,771,941 $ 908,744 $ 335,287 =========== ============ ============
Total shareholders' equity, end of year $ 48,322,867 $ 44,773,614 $ 46,714,433 ============ ============= ============
UNITED TRUST GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Three Years Ended December 31, 2002
2002 2001 2000 -------------- ------------- -------------- Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net income (loss) $ 1,499,618 $ 2,439,573 $ (696,426) 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 513,308 150,579 152,917 Realized investment (gains) losses, net (13,634) (436,840) 260,078 Amortization of deferred policy acquisition costs 714,432 1,007,577 1,452,040 Amortization of cost of insurance acquired 1,515,450 1,572,920 1,592,812 Amortization of costs in excess of net assets purchased 0 90,000 90,000 Depreciation 571,037 436,216 505,221 Minority interest 263,615 571,456 (239,426) Charges for mortality and administration of universal life and annuity products (8,660,548) (9,344,711) (10,151,024) Interest credited to account balances 5,468,318 5,749,098 6,109,491 Policy acquisition costs deferred (69,000) (141,000) (273,000) Change in accrued investment income 550,020 479,176 (22,275) Change in reinsurance receivables 1,010,146 1,175,305 928,890 Change in policy liabilities and accruals (2,279,449) (2,721,245) (3,647,101) Change in income taxes payable 413,476 1,090,064 399,435 Change in other assets and liabilities, net (1,458,143) (753,121) 1,382,877 -------------- ------------- -------------- Net cash provided by (used in) operating activities 38,646 1,365,047 (2,155,491) -------------- ------------- --------------
Cash flows from investing activities: Proceeds from investments sold and matured: Fixed maturities held for sale 29,748,521 30,309,229 5,607,700 Fixed maturities matured 19,957,888 47,848,810 27,103,149 Equity securities 0 6,312,727 189,270 Mortgage loans 6,472,013 14,738,313 4,279,622 Real estate 1,179,931 2,135,472 4,743,146 Policy loans 3,112,687 2,912,296 2,918,627 Other long-term investments 0 0 906,278 Short-term 203,706 2,229,528 1,042,826 -------------- ------------- -------------- Total proceeds from investments sold and matured 60,674,746 106,486,375 46,790,618 Cost of investments acquired: Fixed maturities held for sale (37,341,428) (84,801,095) (19,996,972) Fixed maturities (3,973,623) (1,124,925) (1,486,255) Equity securities (185,075) (4,608,649) (2,673,199) Mortgage loans (6,889,945) (5,325,569) (21,862,521) Real estate (401,318) (6,995,455) (1,246,912) Policy loans (2,850,735) (2,429,852) (2,858,415) Short-term 0 (1,124,512) (498,956) -------------- ------------- -------------- Total cost of investments acquired (51,642,124) (106,410,057) (50,623,230) Purchase of property and equipment (24,439) (138,388) (108,346) Sale of property and equipment 0 201,064 0 -------------- ------------- -------------- Net cash provided by (used in) investing activities 9,008,183 138,994 (3,940,958) -------------- ------------- --------------
Cash flows from financing activities: Policyholder contract deposits 10,291,519 11,361,882 12,724,345 Policyholder contract withdrawals (7,959,754) (9,342,372) (10,962,425) Payments of principal on notes payable (3,405,395) (1,302,495) (1,540,800) Proceeds from line of credit 2,000,000 0 0 Purchase of stock of affiliates 0 (632,131) (87,399) Payments from FCC merger (1,586,500) 0 0 Issuance of common stock 706,691 0 0 Purchase of treasury stock (520,253) (1,176,653) 0 -------------- ------------- -------------- Net cash provided by (used in) financing activities (473,692) (1,091,769) 133,721 -------------- ------------- --------------
Net increase (decrease) in cash and cash equivalents 8,573,137 412,272 (5,962,728) Cash and cash equivalents at beginning of year 15,477,348 15,065,076 21,027,804 -------------- ------------- -------------- Cash and cash equivalents at end of year $ 24,050,485 $ 15,477,348 $ 15,065,076 ============== ============= ==============
UNITED TRUST GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. ORGANIZATION - At December 31, 2002, 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. 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 $460,170 and $169,281 as of December 31, 2002 and 2001, 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 the years ended December 31, 2002 and 2001 and 4.5% to 5.5% for the year ended December 31, 2000, 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 $908,006 and $900,894 as of December 31, 2002 and 2001, 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.
2002 2001 2000 -------------- --------------- -------------- Cost of insurance acquired, beginning of year $ 33,081,336 $ 34,654,256 $ 36,247,068 Interest accretion 4,570,678 4,777,576 5,032,790 Amortization (6,086,128) (6,350,496) (6,625,602) -------------- --------------- -------------- Net amortization (1,515,450) (1,572,920) (1,592,812) Revaluation adjustment from UTG/FCC merger (8,409,722) 0 0 -------------- --------------- -------------- Cost of insurance acquired, end of year $ 23,156,164 $ 33,081,336 $ 34,654,256 ============== =============== ==============
Estimated net amortization expense of cost of insurance acquired for the next five years is as follows:
Interest Net Accretion Amortization Amortization
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 2007 3,145,000 5,994,000 2,849,000
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.
2002 2001 2000 -------------- --------------- -------------- Deferred, beginning of year $ 3,107,919 $ 3,948,496 $ 5,127,536
Acquisition costs deferred: Commissions 49,000 108,000 184,000 Other expenses 20,000 59,000 89,000 -------------- --------------- -------------- Total
Interest accretion 55,000 76,000 100,000 Amortization charged to income (769,432) (1,083,577) (1,552,040) -------------- --------------- -------------- Net amortization (714,432) (1,007,557) (1,452,040) -------------- --------------- -------------- Change for the year (645,432) (840,577) (1,179,040) -------------- --------------- --------------
Deferred, end of year $ 2,462,487 $ 3,107,919 $ 3,948,496 ============== =============== ==============
The following table reflects the components of the income statement for the line item commissions and amortization of deferred policy acquisition costs:
2002 2001 2000 ------------ ------------ --------------
Net amortization of deferred policy acquisition costs $ 714,432 $ 1,007,577 $ 1,452,040 Commissions 71,429 255,397 637,273 ------------ ------------ -------------- Total $ 785,861 $ 1,262,974 $ 2,089,313 ============ ============ ==============
Estimated net amortization expense of deferred policy acquisition costs for the next five years is as follows:
Interest Net Accretion Amortization Amortization -------------- --------------- ---------------
2003 $ 17,000 $ 790,000 $ 773,000 2004 15,000 675,000 660,000 2005 12,000 572,000 560,000 2006 10,000 476,000 466,000 2007 9,000 350,000 341,000
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. On January 1, 2002, the Company adopted FASB Statement No. 142, Goodwill and Intangible Assets, which required that goodwill no longer be amortized to earnings, but instead be reviewed for impairment. Accumulated amortization of cost in excess of net assets purchased was $1,780,146 as of December 31, 2002 and 2001, respectively. At December 31, 2002, the Company had no goodwill on its balance sheet. The goodwill balance at year end 2001 was eliminated in the purchase accounting valuations relating to the June 2002 merger of FCC.
N. PROPERTY AND EQUIPMENT - Company-occupied property, data processing equipment and furniture and office equipment are stated at cost less accumulated depreciation of $5,748,321 and $5,560,547 at December 31, 2002 and 2001, respectively. Depreciation is computed on a straight-line basis for financial reporting purposes using estimated useful lives of three to thirty years. Depreciation expense was $280,148, $316,900, and $372,313 for the years ended December 31, 2002, 2001, and 2000, 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 147,607 and 75,236 shares of common stock as treasury shares with a cost basis of $1,193,690 and $673,437 at December 31, 2002 and 2001, 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 18% and 22% of the ordinary life insurance in force at December 31, 2002 and 2001, respectively. Premium income from participating business represents 25%, 26%, and 27% of total premiums for the years ended December 31, 2002, 2001 and 2000, 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 2002 presentation. Such reclassifications had no effect on previously reported net income 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, 2002, substantially all of consolidated shareholders' equity represents net assets of UTG's subsidiaries. The payment of cash dividends to shareholders by UTG 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, 2002, UG had a statutory gain from operations of $2,062,744. At December 31, 2002, UG's statutory capital and surplus amounted to $16,030,200. 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 $800,000 to the former FCC in 2002, and $1,400,000 to UTG in 2002.
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 $ 5,286,670 $ 1,149,693 APPL 6,452,554 1,525,367 UG 28,019,005 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 non-insurance 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:
2002 2001 2000 --------------- ---------------- --------------- Current tax expense $ 7,893 $ 53,539 $ 85,440 Deferred tax expense 471,462 1,127,594 143,343 --------------- ---------------- --------------- $ 479,355 $ 1,181,133 $ 228,783 =============== ================ ===============
The Companies have net operating loss carryforwards for federal income tax purposes expiring as follows:
UTG UG ------------- ------------- 2019 0 863,986 2021 177,037 0 ------------- ------------- TOTAL $ 177,037 $ 863,986 ============= =============
The Company has established a deferred tax asset of $364,358 for its operating loss carryforwards and has established no allowance in the current year. The total allowances established on deferred tax assets in the prior year was $183,908.
The following table shows the reconciliation of net income to taxable income of UTG:
2002 2001 2000 ------------- ------------- -------------- Net income (loss) $ 1,499,618 $ 2,439,573 $ (696,426) Federal income tax provision 327,472 12,043 60,550 Loss (gain) of subsidiaries (861,049) (2,409,467) 762,656 ------------- ------------- -------------- Taxable income $ 966,041 $ 42,149 $ 598,606 ============= ============= ==============
UTG has a net operating loss carryforward of $177,037 at December 31, 2002. UTG has averaged approximately $536,000 in taxable income over the past three years and must average taxable income of approximately $10,000 over the next 19 years to fully realize its net operating loss carryforward, as UTG's operating loss carryforward does not expire until the year 2021. UG has a net operating loss carryforward of $863,986 at December 31, 2002. UG must average taxable income of approximately $50,000 over the next 17 years to fully realize its net operating loss carryforward, as UG's operating loss carryforward does not expire until the year 2019. Management believes future earnings of both UTG and UG will be sufficient to fully utilize their respective net operating loss carryforwards. Therefore, management has established no allowance for potential uncollectibility of its loss carryforwards in the current year.
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:
2002 2001 2000 ------------- ------------- -------------- Tax computed at statutory rate $ 784,906 $ 1,467,257 (247,474) Changes in taxes due to: Cost in excess of net assets purchased 0 31,500 31,500 Current year loss for which no benefit realized 0 0 546,231 Benefit of prior losses (309,710) (159,456) (139,061) Other 4,159 (158,168) 37,587 ------------- ------------- -------------- Income tax expense $ 479,355 $ 1,181,133 228,783 ============= ============= ==============
The following table summarizes the major components that comprise the deferred tax liability as reflected in the balance sheets:
2002 2001 ---------------- --------------- Investments $ 2,883,414 $ 1,820,177 Cost of insurance acquired 9,328,616 12,835,481 Deferred policy acquisition costs 861,870 1,087,772 Management/consulting fees (321,086) (508,101) Future policy benefits (1,014,369) (1,531,687) Gain on sale of subsidiary 2,312,483 2,312,483 Net operating loss carryforward (364,358) (564,303) Other liabilities (130,594) (372,303) Federal tax DAC (1,316,916) (1,509,996) ---------------- --------------- Deferred tax liability $ 12,239,060 $ 13,569,523 ================ ===============
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, ------------------------------------------------------ 2002 2001 2000 -------------- --------------- --------------- Fixed maturities and fixed maturities held for sale $ 10,302,735 $ 10,831,162 $ 11,775,706 Equity securities 131,778 131,263 116,327 Mortgage loans 1,749,935 2,715,834 1,777,374 Real estate 730,501 488,168 611,494 Policy loans 965,227 970,142 997,381 Other long-term investments 0 0 655,418 Short-term investments 26,522 110,229 158,378 Cash 211,293 606,128 936,433 -------------- --------------- --------------- Total consolidated investment income 14,117,991 15,852,926 17,028,511 Investment expenses (771,167) (785,867) (942,678) -------------- --------------- --------------- Consolidated net investment income $ 13,346,824 $ 15,067,059 $ 16,085,833 ============== =============== ===============
At December 31, 2002, the Company had a total of $656,716 in investment real estate and $1,477,950 in equity securities, which did not produce income during 2002.
The following table summarizes the Company's fixed maturity holdings and investments held for sale by major classifications:
Carrying Value ------------------------------------- 2002 2001 -------------- ------------- Investments held for sale: Fixed maturities U.S. Government, government agencies and authorities $ 27,646,891 $ 36,182,839 State, municipalities and political subdivisions 212,015 202,256 Collateralized mortgage obligations 66,820,749 54,003,623 All other corporate bonds 14,024,863 8,239,722 -------------- ------------- $ 108,704,518 $ 98,628,440 ============== =============
Equity securities Banks, trust and insurance companies $ 1,209,756 $ 1,100,000 Industrial and miscellaneous 3,674,114 2,752,716 -------------- ------------- $ 4,883,870 $ 3,852,716 ============== =============
Fixed maturities held to maturity: U.S. Government, government agencies and authorities $ 7,480,490 $ 6,904,757 State, municipalities and political subdivisions 8,195,248 11,788,567 Collateralized mortgage obligations 60,820 128,471 Public utilities 15,134,965 22,219,127 All other corporate bonds 27,456,140 33,964,473 -------------- ------------- $ 58,327,663 $ 75,005,395 ============== =============
By insurance statute, the majority of the Company's investment portfolio is invested in investment grade securities to provide ample protection for policyholders.
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 2002 2001 2000 ----------------------------- -------------- ------------ ------------ Public Utilities $ 1,274,374 $ 2,091,138 $ 0 CMO 40,146 43,189 239,165 Corporate 1,370,622 271,420 23,000 -------------- ------------ ------------ Total $ 2,685,142 $ 2,405,747 $ 262,165 ============== ============ ============
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 2002 Cost Gains Losses Value ------------------------------------ ------------- ------------ -------------- ------------- Investments held for sale: U.S. Government and govt. Agencies and authorities $ 26,271,281 $ 1,375,610 $ 0 $ 27,646,891 States, municipalities and Political subdivisions 193,619 18,396 0 212,015 Collateralized mortgage Obligations 65,603,941 1,225,986 (9,178) 66,820,749 Public utilities 0 0 0 0 All other corporate bonds 13,176,046 869,187 (20,370) 14,024,863 ------------- ------------ -------------- ------------- 105,244,887 3,489,179 (29,548) 108,704,518 Equity securities 4,122,887 1,795,527 (1,034,544) 4,883,870 ------------- ------------ -------------- ------------- Total $ 109,367,774 $ 5,284,706 $ (1,064,092) $ 113,588,388 ============= ============ ============== =============
Fixed maturities held to maturity: U.S. Government and govt. Agencies and authorities $ 7,480,490 $ 403,473 $ (3) $ 7,883,960 States, municipalities and Political subdivisions 8,195,248 406,211 (7,753) 8,593,706 Collateralized mortgage Obligations 60,820 4,296 0 65,116 Public utilities 15,134,965 509,875 (96,029) 15,548,811 All other corporate bonds 27,456,140 1,058,270 (88,938) 28,425,472 ------------- ------------ -------------- ------------- Total $ 58,327,663 $ 2,382,125 $ (192,723) $ 60,517,065 ============= ============ ============== =============
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 ============== ============ ============== =============
The amortized cost and estimated market value of debt securities at December 31, 2002, 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, 2002 Cost Value ----------------------------------------- -------------- -------------- Due in one year or less $ 1,027,197 $ 1,062,985 Due after one year through five years 31,766,665 33,309,128 Due after five years through ten years 6,688,465 7,334,766 Due after ten years 158,619 176,890 Collateralized mortgage obligations 65,603,941 66,820,749 -------------- -------------- Total $ 105,244,887 $ 108,704,518 ============== ==============
Estimated Fixed Maturities Held to Maturity Amortized Market December 31, 2002 Cost Value ----------------------------------------- -------------- -------------- Due in one year or less $ 27,179,794 $ 27,550,341 Due after one year through five years 26,921,769 28,509,885 Due after five years through ten years 1,858,205 2,070,897 Due after ten years 2,307,075 2,320,826 Collateralized mortgage obligations 60,820 65,116 -------------- -------------- Total $ 58,327,663 $ 60,517,065 ============== ==============
An analysis of sales, maturities and principal repayments of the Company's fixed maturities portfolio for the years ended December 31, 2002, 2001 and 2000 is as follows:
Cost or Gross Gross Proceeds Amortized Realized Realized From Year ended December 31, 2002 Cost Gains Losses Sale --------------------------------- ------------- ----------- ------------- ------------- Scheduled principal repayments, Calls and tenders: Held for sale $ 29,746,832 $ 1,689 $ 0 $ 29,748,521 Held to maturity 20,071,850 7,782 (6,744) 20,072,888 Sales: Held for sale 0 0 0 0 Held to maturity 0 0 0 0 ------------- ----------- ------------- ------------- Total $ 49,818,682 $ 9,471 $ (6,744) $ 49,821,409 ============= =========== ============= =============
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 $ 23,583,564 $ 10,440 $ 0 $ 23,594,004 Held to maturity 47,921,354 34,690 (107,234) 47,848,810 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 ============= =========== ============= =============
C. INVESTMENTS ON DEPOSIT - At December 31, 2002, investments carried at approximately $12,386,000 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, 2002 and 2001, 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 practical 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:
2002 2001 -------------------------------------------------------------------------- Estimated Estimated Carrying Fair Carrying Fair Assets Amount Value Amount Value -------------- -------------- --------------- --------------- Fixed maturities $ 58,327,663 $ 60,517,065 $ 75,005,395 $ 77,725,410 Fixed maturities held for sale 108,704,518 108,704,518 98,628,440 98,628,440 Equity securities 4,883,870 4,883,870 3,852,716 3,852,716 Mortgage loans on real estate 23,804,827 23,882,286 23,386,895 23,360,333 Investment in real estate 17,503,812 17,503,812 18,226,451 18,226,451 Policy loans 13,346,504 13,346,504 13,608,456 13,608,456 Short-term investments 377,676 377,676 581,382 581,382
Liabilities Notes payable 2,995,275 3,148,352 4,400,670 4,696,612
6. STATUTORY EQUITY AND INCOME FROM OPERATIONS
The Company's insurance subsidiaries are domiciled in Ohio and Illinois 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 $16,030,200 and $16,105,265 at December 31, 2002 and 2001, respectively. The Company's life insurance subsidiaries reported combined statutory operating income before taxes (exclusive of intercompany dividends) of approximately $2,700,000, $2,913,000 and $2,091,000 for 2002, 2001 and 2000, respectively.
7. 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, 2002, the Company had gross insurance in force of $2.441 billion of which approximately $527 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 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, 2002.
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, 2002, the IOV insurance inforce was approximately $1,700,000, with reserves being held on that amount of approximately $400,000.
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, 2002, IHL has insurance inforce of approximately $3,700,000, with reserves being held on that amount of approximately $45,000.
On October 1, 2002, APPL entered into a 100% coinsurance agreement, with UG, whereby APPL ceded and UG assumed all policies in force of APPL as of the effective date of the agreement. Under the coinsurance arrangement, UG has primary responsibility for the policies, but APPL remains contingently liable for the policies. At December 31, 2002, APPL has insurance inforce of approximately $160,000,000, with reserves being held on that amount of approximately $20,800,000, which were assumed by UG in the transaction.
The Company does not have any short-duration reinsurance contracts. The effect of the Company's long-duration reinsurance contracts on premiums earned in 2002, 2001 and 2000 was as follows:
Shown in thousands --------------------------------------------------------- 2002 2001 2000 Premiums Premiums Premiums Earned Earned Earned ---------------- ---------------- ---------------- Direct $ 18,597 $ 20,333 $ 22,970 Assumed 96 111 76 Ceded (2,701) (3,172) (3,556) ---------------- ---------------- ---------------- Net premiums $ 15,992 $ 17,272 $ 19,490 ================ ================ ================
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, though the Company has no control over such assessments.
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. 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 June 10, 2002 UTG and Fiserv LIS formed an alliance between their respective organizations to provide third party administration (TPA) services to insurance companies seeking business process outsourcing solutions. Fiserv LIS will be responsible for the marketing and sales function for the alliance, as well as providing the operations processing service for the Company. The Company will staff the administration effort. To facilitate the alliance, the Company plans to convert its existing business and TPA clients to "ID3", a software system owned by Fiserv LIS to administer an array of life, health and annuity products in the insurance industry. Fiserv LIS is a unit of Fiserv, Inc. (Nasdaq: FISV) which is an independent, full-service provider of integrated data processing and information management systems to the financial industry, headquartered in Brookfield, Wisconsin.
In June 2002, the Company entered into a five-year contract with Fiserv LIS for services related to their purchase of the "ID3" software system. Under the contract, the Company is required to pay $12,000 per month in software maintenance costs and $5,000 per month in offsite data center costs for a five-year period from the date of the signing.
The Company is currently evaluating its alternatives to converting its existing business to "ID3". Currently, the Company is analyzing alternatives and options for the conversion with total costs ranging from $500,000 to $1,700,000. Alternatives include completing the conversion with the existing staff of the Company, to outsourcing the entire conversion to Fiserv LIS. Management is reviewing the possible alternatives, weighing the pros and cons of each, and expects to make a decision shortly.
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. For the five-year period starting January 1, 1998 and ending December 31, 2002, the Company had total earnings of $17,011,307 applicable to this covenant. Therefore, UTG did not meet the earnings requirements stipulated, and UTG believes it will be required to issue 500,000 additional shares to FSF or its assigns. Pursuant to the covenant, a final accounting and issuance of any shares due are to occur by April 30, 2003.
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. District Court for the Southern District of Illinois)
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") (merged into UG in 1999) and UTG 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. A trial date has been currently set for August 26, 2003.
The Company continues to believe that it has meritorious grounds to defend this lawsuit, and it intends to defend the case 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, 2002, the Company maintains a liability of $250,000 to cover estimated legal costs associated with the defense of this matter.
UTG and its subsidiaries are named as defendants in a number of legal actions arising as a part of the ordinary course of business relating primarily to claims made under insurance policies. Those actions have been considered in establishing the Company's liabilities. Management is of the opinion that the settlement of those actions will not have a material adverse effect on the Company's financial position or results of operations.
9. RELATED PARTY TRANSACTIONS
On November 15, 2002, North Plaza acquired 229 acres of timberland from Millard V. Oakley, a director of UTG, for a total purchase price of $54,811. The land acquired was adjacent to land already owned by North Plaza. The purchase price was consistent with other recent similar land acquisitions made by North Plaza.
On March 26, 2002, the Board of Directors of UTG adopted, and on June 11, 2002, the shareholders of UTG approved, the United Trust Group, Inc. Employee and Director Stock Purchase Plan. The plan's purpose is to encourage ownership of UTG stock by eligible directors and employees of UTG and its subsidiaries by providing them with an opportunity to invest in shares of UTG common stock. The plan is administered by the Board of Directors of UTG.
At its September 2002 meeting, the Board of Directors of UTG approved initial offerings under the plan to qualified individuals. This initial offering was at a purchase price of $12.00 per share. A total of 58,891 shares of UTG common stock were issued under this plan in 2002, to eight individuals. Each participant under the plan executed a "stock restriction and buy-sell agreement", which among other things provides UTG with a right of first refusal on any future sales of the shares acquired by the participant under this plan.
The purchase price of shares repurchased under the stock restriction and buy-sell agreement shall be computed, on a per share basis, equal to the sum of (i) the original purchase price paid to acquire such shares from UTG and (ii) the consolidated statutory net earnings (loss) per share of such shares during the period from the end of the month next preceding the month in which such shares were acquired pursuant to the plan, to the end of the month next preceding the month in which the sale of such shares to UTG occurs. At December 31, 2002, shares issued under this program had a value of $11.94 per share pursuant to the above formula.
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. For the five-year period starting January 1, 1998 and ending December 31, 2002, the Company had total earnings of $17,011,307 applicable to this covenant. Therefore, UTG did not meet the earnings requirements stipulated, and UTG believes it will be required to issue 500,000 additional shares to FSF or its assigns. Pursuant to the covenant, a final accounting and issuance of any shares due are to occur by April 30, 2003.
On May 21, 2002, at a special meeting of shareholders, the shareholders of FCC, then an 82% owned subsidiary of UTG, voted on and approved that certain Agreement and Plan of Reorganization and related Plan of Merger, each dated as of June 5, 2001, between UTG, and FCC (collectively, the "Merger Agreement"), and the merger contemplated thereby in which FCC would be merged with and into UTG, with UTG being the surviving corporation of the merger. The merger became effective on June 12, 2002. Pursuant to the terms and conditions of the Merger Agreement, each share of FCC stock outstanding at the effective time of the merger (other than shares held by UTG or shares held in treasury by FCC or by any of its subsidiaries) was at such time automatically converted into the right to receive $250 in cash per share ($2,480,000 in the aggregate).
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. At the September 24, 2002 joint meeting of the board of directors of UTG and its insurance subsidiaries, the boards of directors of UG and ABE each approved the exploration of a merger transaction whereby ABE will be merged with and into UG. The UG and ABE Boards are expected to approve the merger transaction at the March 2003 meeting. The completion of the transaction is contingent upon the necessary regulatory approvals and is expected to be completed in mid 2003.
In preparation for a possible charter sale of APPL, UG and APPL entered into a 100% coinsurance agreement effective October 1, 2002, whereby UG assumed and APPL ceded all of the existing business of APPL. The coinsurance transaction had no financial impact on the consolidated financial statements or operating results of UTG.
On September 27, 2001, UG purchased real estate at a cost of $6,333,336 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 UTG. 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.
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 UTG. The original line of credit expired one year from the date of issue and was renewed in 2002 for an additional one-year term. The line of credit is available for general business uses. 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. During 2002, the Company borrowed a total of $1,600,000 under this line of credit and incurred interest expense of $17,419. All funds drawn were repaid prior to December 31, 2002. No borrowings were incurred during 2001.
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 UTG, and (ii) its minority shareholders received an aggregate of $1,055,295 in respect of their shares. Prior to the reverse stock split, UG owned 88% of the outstanding shares of APPL.
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.
During 2000 and 2001, FCC paid a majority of the general operating expenses of the affiliated group. FCC then received management, service fees and reimbursements from the various affiliates. Beginning in January 2002, and in anticipation of the merger of FCC, UTG began paying a majority of the general operating expenses of the affiliated group. Following the FCC merger in June 2002, UTG also assumed the rights and obligations of the management and service fees agreements with the various affiliates originally held by FCC.
UTG paid FCC $0, $550,000 and $750,000 in 2002, 2001 and 2000, respectively for reimbursement of costs attributed to UTG. During 2002 through the date of the FCC merger, FCC paid $3,200,000 to UTG for reimbursement of costs attributed to FCC and affiliates under which FCC had management and cost sharing services arrangements.
On January 1, 1993, FCC entered an agreement with UG pursuant to which FCC provided management services necessary for UG to carry on its business. UG paid $2,974,088, $6,156,903 and $6,061,515 to FCC in 2002, 2001 and 2000, respectively. UG paid $3,025,194 to UTG in 2002 under this arrangement.
ABE paid fees to FCC pursuant to a cost sharing and management fee agreement. FCC provided management services for ABE to carry on its business. The agreement required 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 $188,494, $332,673 and $371,211 in 2002, 2001 and 2000, respectively under this agreement. ABE paid fees of $170,729 in 2002 to UTG under this agreement.
APPL had a management fee agreement with FCC whereby FCC provided certain administrative duties, primarily data processing and investment advice. APPL paid fees of $222,000, $444,000 and $444,000 in 2002, 2001 and 2000, respectively under this agreement. APPL paid fees of $222,000 to UTG during 2002 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 $70,140, $79,730 and $34,721 in servicing fees and $35,127, $22,626 and $91,392 in origination fees to FSNB during 2002, 2001 and 2000, 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 $74,621, $145,407 and $96,599 in 2002, 2001 and 2000, 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 $169,651 and $128,411 in 2002 and 2001, respectively, which included salaries and other benefits.
10. CAPITAL STOCK TRANSACTIONS
A. EMPLOYEE AND DIRECTOR STOCK PURCHASE PROGRAM
On March 26, 2002, the Board of Directors of UTG adopted, and on June 11, 2002, the shareholders of UTG approved, the United Trust Group, Inc. Employee and Director Stock Purchase Plan. The plan's purpose is to encourage ownership of UTG stock by eligible directors and employees of UTG and its subsidiaries by providing them with an opportunity to invest in shares of UTG common stock. The plan is administered by the Board of Directors of UTG.
A total of 400,000 shares of common stock may be purchased under the plan, subject to appropriate adjustment for stock dividends, stock splits or similar recapitalizations resulting in a change in shares of UTG. The plan is not intended to qualify as an "employee stock purchase plan" under Section 423 of the Internal Revenue Code. At its September 2002 meeting, the Board of Directors of UTG approved initial offerings under the plan to qualified individuals totaling 367,000 shares, subject to the registration or qualification of the shares for sale under Federal or applicable state securities laws. These initial offers were made November 1, 2002, at which time each offeree had 30 days to accept the offer, execute the appropriate documents and pay for the shares to be acquired. At the end of the 30-day period, the offers expired. This initial offering was at a purchase price of $12.00 per share. Eight individuals acquired stock under the plan from this initial offering with a total of 58,891 shares of UTG common stock issued. Each participant under the plan executed a "stock restriction and buy-sell agreement", which among other things provides UTG with a right of first refusal on any future sales of the shares acquired by the participant under this plan.
The purchase price of shares repurchased under the stock restriction and buy-sell agreement shall be computed, on a per share basis, equal to the sum of (i) the original purchase price paid to acquire such shares from UTG and (ii) the consolidated statutory net earnings (loss) per share of such shares during the period from the end of the month next preceding the month in which such shares were acquired pursuant to the plan, to the end of the month next preceding the month in which the sale of such shares to UTG occurs. At December 31, 2002, shares issued under this program had a value of $11.94 per share pursuant to the above formula.
B. 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, 2003, UTG has spent $682,237 in the acquisition of 97,115 shares under this program.
C. 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. During 2002, UTG made principal reductions totaling $115,520 on the Melville notes.
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. During 2002, UTG made a principal reduction of $705,499 on the Ryherd note. Subsequent to year-end 2002 an additional principal reduction of $705,499 was made on the Ryherd note.
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. During 2002, UTG repaid this note in full.
D. SHARES ACQUIRED BY FSF AND AFFILIATES WITH OPTIONS GRANTED
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. For the five-year period starting January 1, 1998 and ending December 31, 2002, the Company had total earnings of $17,011,307 applicable to this covenant. Therefore, UTG did not meet the earnings requirements stipulated, and UTG believes it will be required to issue 500,000 additional shares to FSF or its assigns. Pursuant to the covenant, a final accounting and issuance of any shares due are to occur by April 30, 2003.
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, 2002, no options were exercised and all options have been forfeited.
2002 2001 2000 ------------------------------ ------------------------------- ------------------------------ EXERCISE PRICE EXERCISE PRICE EXERCISE PRICE SHARES SHARES SHARES ------------- --------------- ------------- ---------------- ------------- --------------- Outstanding at beginning of Period 0 $15.00 19,108 $15.00 166,104 $15.00 Granted 0 0.00 0 0.00 0 0.00 Exercised 0 0.00 0 0.00 0 0.00 Forfeited 0 15.00 19,108 15.00 146,996 15.00 ------------- --------------- ------------- ---------------- ------------- --------------- Outstanding at end of period 0 $15.00 0 $15.00 19,108 $15.00 ============= =============== ============= ================ ============= ===============
E. 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, 2002 --------------- ------ ------------------ ---- ----------------- Income Shares Per-Share (Numerator) (Denominator) Amount --------------- ------------------ ----------------- Basic EPS Income available to common shareholders $ 1,499,618 3,505,424 $ 0.43 =================
Effect of Dilutive Securities Earnings covenant 0 500,000 Options 0 0 --------------- ------------------
Diluted EPS Income available to common shareholders and $ assumed conversions 1,499,618 4,005,424 $ 0.37 =============== ================== =================
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 $ 4,056,439 assumed conversions (696,426) $ (0.17) =============== ================== =================
At December 31, 2002, UTG has an obligation to issue to FSF or its assigns 500,000 shares of UTG common stock, as the result of a failed earnings covenant (See note 10D to the consolidated financial statements above). As such, the computation of diluted earnings per share differs from basic earnings per share for the year ending December 31, 2002. UTG had no stock options outstanding for the year ended December 31, 2001. As such, the computation of diluted earnings per share is the same as basic earnings per share at 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.
UTG had granted stock options to FSF of 1,450,000 shares of UTG common stock 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, 2002 and 2001, the Company had $2,995,275 and $4,400,670 in long-term debt outstanding, respectively. The debt is comprised of the following components:
2002 2001 ------------- ------------- Subordinated 20 yr. Notes $ 0 $ 514,674 Other notes payable 2,995,275 3,885,996 ------------- ------------- $ 2,995,275 $ 4,400,670 ============= =============
A. Subordinated debt
The subordinated debt was incurred June 16, 1992 as a part of the acquisition of the now dissolved Commonwealth Industries Corporation. These notes bear interest at the variable rate of 1% under prime per annum (paid quarterly). In May 2002 a principal payment of $113,112 was made on the subordinated debt. On July 9, 2002, the remaining outstanding balance of $401,562 on these notes was paid.
B. Other notes payable
The other notes payable were incurred in April 2001 to facilitate the repurchase of common stock owned primarily by James E. Melville and Larry E. Ryherd, two former officers and directors of UTG, and members of their respective families. These notes bear interest at the fixed rate of 7% per annum (paid quarterly) with payments of principal to be made in five equal installments, the first principal payment in the amount of $777,199, was made on March 31, 2002. In December 2002 an advance principal payment of $113,522 was made on these notes. Subsequent to the current reporting period, in January 2003, UTG paid the 2003 principal reduction of $705,499.
The collective scheduled principal reductions on these notes for the next five years is as follows:
Year Amount
2003 $ 705,499 2004 763,259 2005 763,259 2006 763,258 2007 0
C. Lines of Credit
On November 15, 2001, UTG was extended a $3,300,000 line of credit ("LOC") from the First National Bank of the Cumberlands ("FNBC") located in Livingston, Tennessee. The FNBC is owned by, Millard V. Oakley, who is a director of UTG. The LOC was for a one-year term from the date of issue. Upon maturity the Company renewed the LOC for an additional one-year term. The interest rate on the LOC is variable and indexed to be the lowest of the U.S. prime rates as published in the Wall Street Journal, with any interest rate adjustments to be made monthly. At December 31, 2002, the Company had no outstanding borrowings attributable to this LOC. During 2002 the Company had total borrowings of $1,600,000 on this LOC, which were all repaid during the year. The draws on this LOC were used to facilitate the payments due to the former shareholders of FCC as a result of the June 12, 2002, merger of FCC with and into UTG, as further described in note 15 to the consolidated financial statements.
On April 1, 2002, UTG was extended a $5,000,000 line of credit ("LOC") from an unaffiliated third party, Southwest Bank of St. Louis. The LOC will expire one-year from the date of issue. As collateral for any draws under the line of credit, the former FCC, which has now merged into UTG, pledged 100% of the common stock of its insurance subsidiary UG. Borrowings under the LOC will bear interest at the rate of 0.25% in excess of Southwest Bank of St. Louis' prime rate. At December 31, 2002, the Company had no outstanding borrowings attributable to this LOC. During 2002 the Company had total borrowings of $400,000 on this LOC which were all repaid during the year. Draws on this LOC were used to retire the remaining subordinated debt, as described in note 11A above.
12. OTHER CASH FLOW DISCLOSURES
On a cash basis, the Company paid $263,441, $333,365, and $373,988 in interest expense for the years 2002, 2001 and 2000, respectively. The Company paid $60,290, $92,006 and $(173,500) in federal income tax for 2002, 2001 and 2000, respectively.
As of December 31, 2002, the Company has $893,500 that has not been disbursed to former minority shareholders of FCC in connection with FCC's merger with and into UTG. The total consideration to be paid by the Company to the former minority shareholders as a result of the merger is $2,480,000 (see note 15 to the consolidated financial statements). At December 31, 2002, the Company sold $115,000 in fixed maturity investments for which the cash had not yet been received. The receivable for these securities is included in the line item "Other assets" on the consolidated balance sheet.
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.
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, Jesse T. Correll, the Company's CEO and Chairman. In aggregate at December 31, 2002 these accounts hold approximately $5,000,000 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. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities, Statement No. 147, Acquisitions of Certain Financial Institutions, an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9, and Statement No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123.
Under Statement 4, all gains and losses from extinguishment of debt were required to be aggregated, and, if material, classified as an extraordinary item, net of related income tax effect. Statement 145 eliminates Statement 4 and as a result, gains and losses from extinguishment of debt should be classified as extraordinary items only if they meet certain criteria as outlined in Opinion 30. Applying the provisions of Opinion 30 will distinguish transactions that are part of an entity's recurring operations from those that are unusual or infrequent or that meet the criteria for classification as an extraordinary item. Statement 64 amended Statement 4 and is no longer necessary because Statement 4 has been rescinded. Statement 44 was issued to establish accounting requirements for the effects of transition to the provisions of the Motor Carrier Act of 1980. Those transitions are completed; therefore, Statement 44 is no longer necessary. Statement 145 also amends Statement 13 to require sale-leaseback accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. Statement 145 also makes various technical corrections to existing pronouncements, none of which are substantive in nature. Statement 145 is required for fiscal years beginning after May 15, 2002, with early application encouraged. The adoption of Statement 145 did not affect the Company's financial position or results of operations since the Company has had no transactions of the aforementioned kind, during the reporting period.
Statement 146 was issued to address the accounting and reporting for costs associated with exit or disposal activities because entities increasingly are engaging in exit and disposal activities and certain costs associated with those activities were recognized as liabilities at a plan (commitment) date that did not meet the definition of a liability as outlined in FASB Concepts Statement No. 6. Statement 146 improves financial reporting for cost associated with exit or disposal activities, by requiring that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The accounting for similar events and circumstances will be the same, thereby improving the comparability and representational faithfulness of reported financial information. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The adoption of Statement 146 did not affect the Company's financial position or results of operations, since the Company has had no such exit or disposal activities during the reporting period.
Statement 147 was issued to address and clarify the application of the purchase method of accounting as it applies to acquisitions of financial institutions, except transactions between two or more mutual enterprises. The provisions of Statement 147 are effective on October 1, 2002. The adoption of Statement 147 did not affect the Company's financial position or results of operations, since the Company has had no acquisitions of this nature during the reporting period.
Statement 148 was issued to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2002. The adoption of Statement 148 will not affect the Company's financial position or results of operations, since the Company has no forms of stock-based employee compensation.
15. MERGER OF UNITED TRUST GROUP, INC. AND FIRST COMMONWEALTH CORPORATION
On May 21, 2002, at a special meeting of shareholders, the shareholders of FCC, then an 82% owned subsidiary of UTG, voted on and approved that certain Agreement and Plan of Reorganization and related Plan of Merger, each dated as of June 5, 2001, between UTG, and FCC (collectively, the "Merger Agreement"), and the merger contemplated thereby in which FCC would be merged with and into UTG, with UTG being the surviving corporation of the merger. The merger became effective on June 12, 2002. Pursuant to the terms and conditions of the Merger Agreement, each share of FCC stock outstanding at the effective time of the merger (other than shares held by UTG or shares held in treasury by FCC or by any of its subsidiaries) was at such time automatically converted into the right to receive $250 in cash per share.
This allowed UTG to acquire the remaining common shares (approximately 18%) of FCC that UTG did not own prior to the effective time of the merger.
The purchase price in the merger is comprised of the following components:
Investments $ 41,475,198 Cash and cash equivalents 2,020,960 Accrued investment income 493,609 Reinsurance receivables 6,784,813 Cost of insurance acquired (1,371,740) Property and equipment 424,217 Other assets 314,974 ------------------ Total assets 50,142,031
Policy liabilities and accruals (45,981,006) Income taxes payable - current and deferred 1,063,735 Notes payable (1,958,373) Other liabilities (786,387) ------------------ Net purchase price $ 2,480,000 ==================
The following table summarizes certain unaudited operating results of UTG as though the merger transaction had taken place at the beginning of the reporting periods ending on December 31, 2002 and December 31, 2001, respectively.
December 31, December 31, 2001 ------------------ ------------------ Total revenues $ 30,064,644 $ 33,329,372 Total benefits and other expenses $ 27,927,456 $ 28,912,280 Operating income $ 2,137,188 $ 4,417,092 Net Income $ 1,394,218 $ 3,274,486 Basic earnings per share $ 0.40 $ 0.86 Diluted earnings per share $ 0.35 $ 0.86
16. COMPREHENSIVE INCOME
Tax Before-Tax (Expense) Net of Tax 2002 Amount or Benefit Amount ---------------------------------------------- ---------------- ----------------- ---------------
Unrealized holding gains during period $ 2,868,146 $ (1,003,851) $ 1,864,295
Less: reclassification adjustment for gains realized in net income (1,689) 591 (1,098) ---------------- ----------------- --------------- Net unrealized gains 2,866,457 (1,003,260) 1,863,197 ---------------- ----------------- --------------- Other comprehensive income $ 2,866,457 $ (1,003,260) $ 1,863,197 ================ ================= ===============
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) (221,222) 119,119 ---------------- ----------------- --------------- 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 losses during period $ 1,513,673 $ $ 1,513,673 Less: reclassification adjustment for losses realized in net income (39,486) (39,486) ---------------- ----------------- --------------- Net unrealized losses 1,474,187 1,474,187 ---------------- ----------------- --------------- Other comprehensive deficit $ 1,474,187 $ $ 1,474,187 ================ ================= ===============
In 2000 the Company's deferred tax asset was carried at zero net of allowances. In 2002 and 2001, the Company established a deferred tax liability of $1,170,197 and $385,432 for the unrealized gains based on the applicable United States statutory rate of 35%.
17. PROPOSED MERGER OF LIFE INSURANCE SUBSIDIARIES
The Company has been attempting to sell the Charter (state licenses) of APPL. To accommodate such a sale, APPL entered into a 100% coinsurance agreement effective October 1, 2002, whereby APPL ceded and UG assumed all policies in force of APPL as of the effective date of the agreement. The agreement was approved by the Ohio Department of Insurance pursuant to regulatory requirements. Under the coinsurance agreement, UG has primary responsibility for the policies, but APPL remains contingently liable for the policies. Currently, a sale of the Charter appears to be remote. As an alternative, a merger proposal is being considered whereby APPL would be merged with and into UG. A decision regarding the merger is likely to be approved at the Board meeting in March 2003.
As a result of the 100% coinsurance agreement, the ownership of ABE was transferred from APPL to UG, as part of the coinsurance asset transfer. Prior to the coinsurance transaction, in September 2002, the boards of ABE and UG approved the exploration of a merger transaction whereby ABE would be merged with and into UG. The UG and ABE Boards are expected to approve the merger transaction at the March 2003 meeting. The merger will require the approval of the insurance departments of the States of Ohio and Illinois prior to completion. The merger is expected to be completed in mid 2003.
Management of the Company believes the completion of the aforementioned mergers will provide the Company with additional cost savings. These cost savings result from streamlining the Company's operations and organizational structure from three life insurance subsidiaries to one life insurance subsidiary, UG. Thus, the Company will further improve administrative efficiency.
18. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
-------------------- --------------------- --------------------- -------------------- 1st 2nd 3rd 4th --------------- --------------- --------------- ---------------
Premiums and policy fees, net $ 4,276,861 $ 4,388,284 $ 3,725,823 $ 3,601,432 Net investment income 3,307,478 3,287,608 3,336,329 3,415,409 Total revenues 7,793,041 7,898,975 7,253,685 7,224,343 Policy benefits including dividends 4,835,106 4,609,999 5,110,590 4,930,553 Commissions and amortization of DAC and COI 688,618 578,688 501,283 532,722 Operating expenses 1,530,433 1,649,134 1,441,502 1,255,387 Operating income 666,674 999,760 129,080 447,074 Net income (loss) 477,034 722,679 327,499 (27,594) Basic earnings (loss) per share 0.14 0.21 (0.01) 0.09 Diluted earnings (loss) per share 0.14 0.21 (0.01) 0.09 -------------------- --------------------- --------------------- -------------------- 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 1,008,366 1,323,667 1,183,712 676,417 Net income 343,858 975,292 645,873 474,550 Basic earnings per share 0.08 0.27 0.13 0.18 Diluted earnings per share 0.08 0.27 0.13 0.18 -------------------- --------------------- --------------------- -------------------- 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)
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, 2002, the Board met 4 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, Perry, 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 2002.
The compensation of UTG's executive officers is determined by the full Board of Directors (see report on Executive Compensation).
Under UTG's By-Laws, the Board of Directors should be comprised of at least six and no more than eleven directors. At December 31, 2002 The Board consisted of nine 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. During 2002, UTG was aware of the following individuals who filed a late Form 3, initial statement of beneficial ownership of securities, with the Securities and Exchange Commission; Michael K. Borden, employee, Joyce M. Copp, employee, Thomas F. Darden, director, Theodore C. Miller, executive officer, William W. Perry, director, James P. Rousey, director and executive officer, and Brad M. Wilson, employee. Each of these individuals reported no stock ownership of UTG at the time of the filing of the Form 3.
AUDIT COMMITTEE REPORT TO SHAREHOLDERS
In connection with the December 31, 2002 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 William W. Perry Robert W. Teater
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.
DIRECTORS
Name, Age
Position with the Company, Business Experience and Other Directorships
John S. Albin, 74
Director of UTG since 1984; Director of FCC from 1984 to 2002; 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 from 1996 to 2002.
Randall L. Attkisson 57
Director of UTG since 1999; Director of FCC from 1999 to 2002; President and Chief Operating Officer of UTG since 2001; President and Chief Operating Officer of FCC from 2001 to 2002; Chief Financial Officer, Treasurer, Director of First Southern Bancorp, Inc, a bank holding company, since 1986; Treasurer, Director of First Southern Funding, LLC (formerly First Southern Funding Inc.) since 1992; Director of Kentucky Christian Foundation since 2002; 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.
Jesse T. Correll 46
Chairman and CEO of UTG since 2000; Chairman and CEO of FCC from 2000 to 2002; Director of UTG since 1999; Director of FCC from 1999 to 2002; 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; 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 74
Director of UTG since 2000 and FCC from 1999 to 2002; 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 48
Director of UTG since 2001; Director of FCC from 2001 to 2002; 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. from 1997 to 2002; 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.
Millard V. Oakley* 72
Director of UTG since 1999; Director of FCC from 1999 to 2002; 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.
William W. Perry 46
Director of UTG since 2001; Director of FCC from 2001 to 2002; 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; Secretary 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; involved with, Young Life in various capacities; Midland City Council Member
James P. Rousey 44
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.
Robert W. Teater 76
Director of UTG since 1987 and FCC from 1992 to 2002; member of Columbus School Board 1991-2001; Founder, Teater-Gebhardt and Associates, Inc., a comprehensive consulting firm in natural resources development; Member of Reserve Forces Policy Board in Department of Defense 1981-1985; Director of School of Natural Resources at Ohio State University form 1973-1975; Assistant Director of Ohio Agricultural Experiment Station 1969-1975; Associate Dean of Ohio State University, College of Agriculture and Home Economics from 1969-1972;Combat veteran and retired Major General, Ohio Army National Guard.
* Milliard V. Oakley resigned his position as a Director of UTG effective March 14, 2003.
EXECUTIVE OFFICERS OF UTG
More detailed information on the following executive 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 James P. Rousey Executive Vice President and Chief Administrative Officer
Other executive officers of UTG are set forth below:
Name, Age Position with UTG and, Business Experience
Theodore C. Miller 40
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 affiliated companies from 1984 to 1992. Vice President and Treasurer of certain affiliated companies from 1992 to 1997; Senior Vice President and Chief Financial Officer of subsidiary companies since 1997; Corporate Secretary of subsidiary companies since 2000.
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 $100,000 during UTG's last fiscal year: Compensation for services provided by the named executive officers to UTG and its affiliates is paid by UTG.
SUMMARY COMPENSATION TABLE
Name and Annual Compensation Other Annual (1) All Other (1) Principal Position Year Salary ($) Bonus ($) Compensation ($) Compensation ($) ($)
Jesse T. Correll (2) 2002 75,000 - - 4,500 Chairman of the Board 2001 56,250 - - - Chief Executive Officer 2000 - - - -
Brad M. Wilson (4) 2002 160,000 3,000 - 3,600 Senior Vice President 2001 160,000 3,000 - 3,150 Chief Information Officer 2000 157,500 3,227 - 3,150
Theodore C. Miller 2002 100,000 - - 3,000 Corporate Secretary 2001 100,000 5,000 - 3,000 Senior Vice President 2000 91,749 - - 2,752 Chief Financial Officer
James P. Rousey (3) 2002 135,000 10,000 - 2,025 Executive Vice President 2001 50,625 - - - Chief Administrative Officer 2000 - - - - Member of the Board
(1) All Other Compensation consists of UTG's matching contribution to the 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.
(3) Mr. James P. Rousey became an officer and employee of UTG and its subsidiaries effective August 16, 2001.
(4) On January 7, 2003, Mr. Wilson's employment with UTG and its insurance subsidiaries was terminated.
Option/SAR Grants/Aggregated Option/SAR Exercises in Last Fiscal Year and FY-End Option/SAR Values
At December 31, 2002 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 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
There are no employment agreements in effect with any executive officers of the Company.
Compensation Committee Interlocks and Insider Participation
The following persons served as directors of UTG during 2002 and were officers or employees of UTG or its affiliates during 2002: Jesse T. Correll, Randall L. Attkisson and James P. Rousey. Accordingly, these individuals have participated in decisions related to compensation of executive officers of UTG and its subsidiaries.
During 2002, Jesse T. Correll and Randall L. Attkisson, executive officers of UTG, and the insurance subsidiaries, were also members of the Board of Directors of the insurance subsidiaries. During 2002, James P. Rousey and Theodore C. Miller, executive officers of UTG and the insurance subsidiaries, were also members of the Board of Directors of ABE.
Jesse T. Correll and Randall L. Attkisson are each directors and executive officers of FSBI and participate in compensation decisions of FSBI. FSBI owns or controls directly and indirectly approximately 46.5% of the outstanding common stock of UTG.
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, 2003 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 Amount Percent of Name and Address and Nature of of Class of Beneficial Owner(2) Beneficial Ownership Class (1)
Common Jesse T. Correll 185,454 (3) 5.3% Stock, no First Southern Bancorp, Inc. 1,634,336 (3)(4) 46.5% par value First Southern Funding, LLC 0 (3)(4) 0% First Southern Holdings, LLC 1,483,791 (3)(4) 42.3% First Southern Capital Corp., LLC 183,033 (3)(4) 5.2% First Southern Investments, LLC 18,575 0.5% Ward F. Correll 98,523 (5) 2.8% WCorrell, Limited Partnership 72,750 (3) 2.1% Cumberland Lake Shell, Inc. 98,523 (5) 2.8%
Total(6) 2,119,921 60.4%
(1) The percentage of outstanding shares is based on 3,511,636 shares of Common Stock outstanding as of March 1, 2003.
(2) The address for each of Jesse Correll, First Southern Bancorp, Inc. ("FSBI"), First Southern Funding, LLC ("FSF"), First Southern Holdings, LLC ("FSH"), First Southern Capital Corp., LLC ("FSC"), First Southern Investments, LLC ("FSI"), and WCorrell, Limited Partnership ("WCorrell LP"), is P.O. Box 328, 99 Lancaster Street, Stanford, Kentucky 40484. The address for each of Ward Correll and Cumberland Lake Shell, Inc. ("CLS") is P.O. Box 430, 150 Railroad Drive, Somerset, Kentucky 42502.
(3) The share ownership of Jesse Correll listed includes 112,704 shares of Common Stock owned by him individually. The share ownership of Mr. Correll also includes 72,750 shares of Common Stock held by WCorrell, Limited Partnership, a limited partnership in which Jesse 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 FSF and FSBI, and in turn, their ownership of 100% of the outstanding membership interests of FSH, Jesse Correll may be deemed to beneficially own the total number of shares of Common Stock owned by FSH (as well as the shares owned by FSBI directly), and may be deemed to share with FSH (as well as FSBI) the right to vote and to dispose of such shares. Mr. Correll owns approximately 79% of the outstanding membership interests of FSF; he owns directly approximately 50%, companies he controls own approximately 14%, and he has the power to vote but does not own an additional 3% of the outstanding voting stock of FSBI. FSBI and FSF in turn own 99% and 1%, respectively, of the outstanding membership interests of FSH. Mr. Correll is also a manager of FSC and thereby may also be deemed to beneficially own the total number of shares of Common Stock owned by FSC, and may be deemed to share with it the right to vote and to dispose of such shares. The aggregate number of shares of Common Stock held by these other entities, as shown in the above table, is 1,817,369 shares.
(4) The share ownership of FSBI consists of 150,454 shares of Common Stock held by FSBI directly (which FSBI acquired by virtue of its merger with Dyscim, LLC) and 1,483,791 shares of Common Stock held by FSH of which FSBI is a 99% member and FSF is a 1% member, as further described below. As a result, FSBI may be deemed to share the voting and dispositive power over the shares held by FSH. The share ownership of FSF does not include additional shares that UTG agreed to issue to FSF or its assigns if the condition in Section 13(c) of the Acquisition Agreement ( the earnings condition) is not met. UTG did not meet the earnings requirements stipulated, and UTG believes it will be required to issue 500,000 additional shares to FSF or its assigns. Pursuant to the covenant, a final accounting and issuance of any shares due are to occur by April 30, 2003.
(5) Represents the shares of Common Stock held by CLS, 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.
(6) According to the most recent Schedule 13D, as amended, filed jointly by each of the entities and persons listed above, Jesse Correll, FSBI, FSF, FSH, FSC, and FSI, have agreed in principle to act together for the purpose of acquiring or holding equity securities of UTG. In addition, the Schedule 13D indicates that because of their relationships with Jesse Correll and these other entities, Ward Correll, CLS, and WCorrell, Limited Partnership may also be deemed to be members of this group. Because the Schedule 13D indicates that for its purposes, each of these entities and persons may be deemed to have acquired beneficial ownership of the equity securities of UTG beneficially owned by the other entities and persons, each has been identified and listed in the above tabulation.
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 2002, 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, 2003 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)
UTG's John S. Albin 10,503 (4) * Common Randall L. Attkisson 0 (2) * Stock, no Jesse T. Correll 2,002,823 (3) 7.0% par value Ward F. Correll 98,523 (5) 2.8% Thomas F. Darden 8,334 (7) * Theodore C. Miller 10,000 (7) * Millard V. Oakley 16,471 * William W. Perry 12,000 (7) * James P. Rousey 0 * Robert W. Teater 7,380 (6) * All directors and executive officers as a group (ten in number) 2,166,034 61.7%
(1) The percentage of outstanding shares for UTG is based on 3,511,636 shares of Common Stock outstanding as of March 1, 2003.
(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 Common Stock including 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 First Southern Bancorp, Inc. 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 79% of the outstanding membership interests of First Southern Funding; he owns directly approximately 50%, companies he controls own approximately 14%, 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.
(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 210 shares owned directly by Mr. Teater's spouse.
(7) Shares subject to UTG Employee and Director Stock Purchase Plan.
* Less than 1%.
Except as indicated above, the foregoing persons hold sole voting and investment power.
The following table reflects the Company's Employee and Director Stock Purchase Plan Information:
--------------------------------- ------------------------------ ------------------------------- ------------------------------ Plan category Number of securities to be Weighted-average exercise Number of securities issued upon exercise of price of outstanding options, remaining available for outstanding options, warrants and rights future issuance under warrants and rights employee and director stock purchase plans (excluding (b) securities reflected in (a) column (a)) (c) --------------------------------- ------------------------------ ------------------------------- ------------------------------ Employee and director stock purchase plans approved by security holders 341,109 0 0 --------------------------------- ------------------------------ ------------------------------- ------------------------------ Employee and director stock purchase plans not approved by security holders
0 0 0 --------------------------------- ------------------------------ ------------------------------- ------------------------------ Total 0 0 341,109 --------------------------------- ------------------------------ ------------------------------- ------------------------------
On March 26, 2002, the Board of Directors of UTG adopted, and on June 11, 2002, the shareholders of UTG approved, the United Trust Group, Inc. Employee and Director Stock Purchase Plan. The Plan allows for the issuance of up to 400,000 shares of UTG common stock. The plan's purpose is to encourage ownership of UTG stock by eligible directors and employees of UTG and its subsidiaries by providing them with an opportunity to invest in shares of UTG common stock. The plan is administered by the Board of Directors of UTG. A total of 58,891 shares of UTG common stock were issued under this plan in 2002, to eight individuals at a purchase price of $12.00 per share. Each participant under the plan executed a "stock restriction and buy-sell agreement", which among other things provides UTG with a right of first refusal on any future sales of the shares acquired by the participant under this plan. The purchase price of shares repurchased under the stock restriction and buy-sell agreement shall be computed, on a per share basis, equal to the sum of (i) the original purchase price paid to acquire such shares from UTG and (ii) the consolidated statutory net earnings (loss) per share of such shares during the period from the end of the month next preceding the month in which such shares were acquired pursuant to the plan, to the end of the month next preceding the month in which the sale of such shares to UTG occurs. At December 31, 2002, shares issued under this program had a value of $11.94 per share pursuant to the above formula.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On November 15, 2002, North Plaza acquired 229 acres of timberland from Millard V. Oakley, a director of UTG, for a total purchase price of $54,811. The land acquired was adjacent to land already owned by North Plaza. The purchase price was consistent with other recent similar land acquisitions made by North Plaza.
On March 26, 2002, the Board of Directors of UTG adopted, and on June 11, 2002, the shareholders of UTG approved, the United Trust Group, Inc. Employee and Director Stock Purchase Plan. The plan's purpose is to encourage ownership of UTG stock by eligible directors and employees of UTG and its subsidiaries by providing them with an opportunity to invest in shares of UTG common stock. The plan is administered by the Board of Directors of UTG.
At its September 2002 meeting, the Board of Directors of UTG approved initial offerings under the plan to qualified individuals. This initial offering was at a purchase price of $12.00 per share. A total of 58,891 shares of UTG common stock were issued under this plan in 2002, to eight individuals. Each participant under the plan executed a "stock restriction and buy-sell agreement", which among other things provides UTG with a right of first refusal on any future sales of the shares acquired by the participant under this plan.
The purchase price of shares repurchased under the stock restriction and buy-sell agreement shall be computed, on a per share basis, equal to the sum of (i) the original purchase price paid to acquire such shares from UTG and (ii) the consolidated statutory net earnings (loss) per share of such shares during the period from the end of the month next preceding the month in which such shares were acquired pursuant to the plan, to the end of the month next preceding the month in which the sale of such shares to UTG occurs. At December 31, 2002, shares issued under this program had a value of $11.94 per share pursuant to the above formula.
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. For the five-year period starting January 1, 1998 and ending December 31, 2002, the Company had total earnings of $17,011,307 applicable to this covenant. Therefore, UTG did not meet the earnings requirements stipulated, and UTG believes it will be required to issue 500,000 additional shares to FSF or its assigns. Pursuant to the covenant, a final accounting and issuance of any shares due are to occur by April 30, 2003.
On May 21, 2002, at a special meeting of shareholders, the shareholders of FCC, then an 82% owned subsidiary of UTG, voted on and approved that certain Agreement and Plan of Reorganization and related Plan of Merger, each dated as of June 5, 2001, between UTG, and FCC (collectively, the "Merger Agreement"), and the merger contemplated thereby in which FCC would be merged with and into UTG, with UTG being the surviving corporation of the merger. The merger became effective on June 12, 2002. Pursuant to the terms and conditions of the Merger Agreement, each share of FCC stock outstanding at the effective time of the merger (other than shares held by UTG or shares held in treasury by FCC or by any of its subsidiaries) was at such time automatically converted into the right to receive $250 in cash per share.
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. At the September 24, 2002 joint meeting of the board of directors of UTG and its insurance subsidiaries, the boards of directors of UG and ABE each approved the exploration of a merger transaction whereby ABE will be merged with and into UG. The UG and ABE Boards are expected to approve the merger transaction at the March 2003 meeting. The completion of the transaction is contingent upon the necessary regulatory approvals and is expected to be completed in mid 2003.
In preparation for a possible charter sale of APPL, UG and APPL entered into a 100% coinsurance agreement effective October 1, 2002, whereby UG assumed and APPL ceded all of the existing business of APPL. The coinsurance transaction had no financial impact on the consolidated financial statements or operating results of UTG.
On September 27, 2001, UG purchased real estate at a cost of $6,333,336 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 UTG. 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.
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 UTG. The original line of credit expired one year from the date of issue and was renewed in 2002 for an additional one-year term. The line of credit is available for general business uses. 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. During 2002, the Company borrowed a total of $1,600,000 under this line of credit and incurred interest expense of $17,419. All funds drawn were repaid prior to December 31, 2002. No borrowings were incurred during 2001.
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 UTG, and (ii) its minority shareholders received an aggregate of $1,055,295 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. At December 31, 2002, UTG owes $173,280 to Mr. Melville and family members on these promissory notes.
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. At December 31, 2002, UTG owes $2,821,995 to Mr. Ryherd and family on this promissory note.
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. During 2002, Mr. Cook's note was paid in full.
During 2000 and 2001, FCC paid a majority of the general operating expenses of the affiliated group. FCC then received management, service fees and reimbursements from the various affiliates. Beginning in January 2002, and in anticipation of the merger of FCC, UTG began paying a majority of the general operating expenses of the affiliated group. Following the FCC merger in June 2002, UTG also assumed the rights and obligations of the management and service fees agreements with the various affiliates originally held by FCC.
UTG paid FCC $0, $550,000 and $750,000 in 2002, 2001 and 2000, respectively for reimbursement of costs attributed to UTG. During 2002 through the date of the FCC merger, FCC paid $3,200,000 to UTG for reimbursement of costs attributed to FCC and affiliates under which FCC had management and cost sharing services arrangements.
On January 1, 1993, FCC entered an agreement with UG pursuant to which FCC provided management services necessary for UG to carry on its business. UG paid $2,974,088, $6,156,903 and $6,061,515 to FCC in 2002, 2001 and 2000, respectively. UG paid $3,025,194 to UTG in 2002 under this arrangement.
ABE paid 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 required 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 $188,494, $332,673 and $371,211 in 2002, 2001 and 2000, respectively under this agreement. ABE paid fees of $170,729 in 2002 to UTG under this agreement.
APPL had a management fee agreement with FCC whereby FCC provides certain administrative duties, primarily data processing and investment advice. APPL paid fees of $222,000, $444,000 and $444,000 in 2002, 2001 and 2000, respectively under this agreement. APPL paid fees of $222,000 to UTG during 2002 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 $70,140, $79,730 and $34,721 in servicing fees and $35,127, $22,626 and $91,392 in origination fees to FSNB during 2002, 2001 and 2000, 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 $74,621, $145,407 and $96,599 in 2002, 2001 and 2000,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 $169,651 and $128,411 in 2002 and 2001, respectively, which included salaries and other benefits.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
Within the 90 days prior to the filing date of this quarterly report, an evaluation was performed under the supervision and with the participation of the Company's management, including the President and Chief Executive Officer (the "CEO") and the Chief Financial Officer (the "CFO"), of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were effective in alerting them on a timely basis to material information relating to the Company required to be included in the Company's periodic reports filed or submitted under the Securities Exchange Act of 1934, as amended. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date of the evaluation.
PART IV
ITEM 15.
ITEM 15. 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.
There were no reports on Form 8-K filed during the 2002 fourth quarter.
(c) Exhibits:
Index to Exhibits incorporated herein by this reference (See pages 84 and 85).
INDEX TO EXHIBITS
Exhibit Number
2(a)
Articles of Merger of First Commonwealth Corporation, A Virginia Corporation with and into United Trust Group, Inc., An Illinois Corporation dated as of May 30, 2002, including exhibits thereto.
3(a) (1)
Articles of Incorporation of the Registrant and all amendments thereto.
3(b) (1)
By-Laws for the Registrant and all amendments thereto.
4(a)
UTG's Agreement pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K with respect to long-term debt instruments.
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)
Management and Consultant Agreement dated as of January 1, 1993 between First Commonwealth Corporation and Universal Guaranty Life Insurance Company.
10(c) (1)
Management Agreement dated December 20, 1981 between Commonwealth Industries Corporation, and Abraham Lincoln Insurance Company.
10(d) (1)
Reinsurance Agreement dated January 1, 1991 between Universal Guaranty Life Insurance Company and Republic Vanguard Life Insurance Company.
10(e) (1)
Reinsurance Agreement dated July 1, 1992 between United Security Assurance Company and Life Reassurance Corporation of America.
10(f) (1)
Agreement dated June 16, 1992 between John K. Cantrell and First Commonwealth Corporation.
10(g) (1)
Stock Purchase Agreement dated February 20, 1992 between United Trust Group, Inc. and Sellers.
10(h) (1)
Amendment No. One dated April 20, 1992 to the Stock Purchase Agreement between the Sellers and United Trust Group, Inc.
10(i) (1)
Security Agreement dated June 16, 1992 between United Trust Group, Inc. and the Sellers.
10(j) (1)
Stock Purchase Agreement dated June 16, 1992 between United Trust Group, Inc. and First Commonwealth Corporation
10(k) (3)
Universal note and security agreement dated November 15, 2001, between United Trust Group, Inc. and First National Bank of the Cumberlands.
INDEX TO EXHIBITS
Exhibit Number
10(l) (3)
Line of credit agreement dated November 15, 2001, between United Trust Group, Inc. and First National Bank of the Cumberlands.
10(m)
United Trust Group, Inc. Employee and Director Stock Purchase Plan and form of related Stock Restriction and Buy-Sell Agreement.
21(a)
List of Subsidiaries of the Registrant.
99(a) (3)
Audit Committee Charter.
99(b)
Certificate of Jesse T. Correll, Chief Executive Officer and Chairman of the Board of UTG, as required pursuant to 18 U.S.C. Section 1350.
99(c)
Certificate of Theodore C. Miller, Chief Financial Officer, Senior Vice President and Corporate Secretary of UTG, as required pursuant to 18 U.S.C. Section 1350.
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, 2001.
UNITED TRUST GROUP, INC. SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES As of December 31, 2002
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 $ 7,480,490 $ 7,883,960 $ 7,480,490 State, municipalities, and political subdivisions 8,195,248 8,593,706 8,195,248 Collateralized mortgage obligations 60,820 65,116 60,820 Public utilities 15,134,965 15,548,811 15,134,965 All other corporate bonds 27,456,140 28,425,472 27,456,140 --------------- ---------------- ---------------- Total fixed maturities 58,327,663 $ 60,517,065 58,327,663 ================
Investments held for sale: Fixed maturities: United States Government and government agencies and authorities 26,271,281 $ 27,646,891 27,646,891 State, municipalities, and political subdivisions 193,619 212,015 212,015 Collateralized mortgage obligations 65,603,941 66,820,749 66,820,749 Public utilities 0 0 0 All other corporate bonds 13,176,046 14,024,863 14,024,863 --------------- ---------------- ---------------- 105,244,887 $ 108,704,518 108,704,518 ================
Equity securities: Banks, trusts and insurance companies 2,171,494 $ 1,209,756 1,209,756 All other corporate securities 1,951,393 3,674,114 3,674,114 --------------- ---------------- ---------------- 4,122,887 $ 4,883,870 4,883,870 ================
Mortgage loans on real estate 23,804,827 23,804,827 Investment real estate 17,503,812 17,503,812 Real estate acquired in satisfaction of debt 0 0 Policy loans 13,346,504 13,346,504 Other long-term investments 0 0 Short-term investments 377,676 377,676 --------------- ---------------- Total investments $ 222,728,256 $ 226,948,870 =============== ================
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, 2002 and 2001
Schedule II
2002 2001 ---------------- ---------------
ASSETS
Investment in affiliates $ 53,983,728 $ 39,542,877 Cash and cash equivalents 1,343,501 378,133 Notes receivable from affiliate 0 11,536,698 FIT recoverable 10,969 10,969 Accrued interest income 0 64,331 Receivable from affiliates, net 23,264 133,963 Other assets 59,012 0 ---------------- --------------- Total assets $ 55,420,474 $ 51,666,971 ================ ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities: Notes payable $ 2,995,275 $ 4,400,670 Deferred income taxes 1,929,434 2,156,203 Other liabilities 2,172,898 336,484 ---------------- --------------- Total liabilities 7,097,607 6,893,357 ---------------- ---------------
Shareholders' equity: Common stock, net of treasury shares 70,726 70,996 Additional paid-in capital, net of treasury 42,976,344 42,789,636 Accumulated other comprehensive income of affiliates 2,771,941 908,744 Retained earnings (accumulated deficit) 2,503,856 1,004,238 ---------------- --------------- Total shareholders' equity 48,322,867 44,773,614 ---------------- --------------- Total liabilities and shareholders' equity $ 55,420,474 $ 51,666,971 ================ ===============
UNITED TRUST GROUP, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT PARENT ONLY STATEMENTS OF OPERATIONS Three Years Ended December 31, 2002
Schedule II
2002 2001 2000 --------------- ---------------- ----------------
Revenues:
Management fees from affiliates $ 6,510,753 $ 0 $ 0 Other income from affiliates 0 858 4,381 Interest income from affiliates 324,467 987,886 1,242,990 Interest income 11,215 40,323 84,519 Other income 52,163 0 0 --------------- ---------------- ---------------- 6,898,598 1,029,067 1,331,890
Expenses:
Management fee to affiliate 0 550,000 750,000 Interest expense 263,441 326,499 376,095 Operating expenses 5,669,116 110,419 79,015 --------------- ---------------- ---------------- 5,932,557 986,918 1,205,110 --------------- ---------------- ----------------
Operating income 966,041 42,149 126,780
Income tax expense (327,472) (12,043) (60,550) Equity in income (loss) of subsidiaries 861,049 2,409,467 (762,656) --------------- ---------------- ---------------- Net income (loss) $ 1,499,618 $ 2,439,573 $ (696,426) =============== ================ ================
Basic income (loss) per share from continuing operations and net income (loss) $ 0.43 $ 0.65 $ (0.17) =============== ================ ================
Diluted income (loss) per share from continuing operations and net income (loss) $ 0.37 $ 0.65 $ (0.17) =============== ================ ================
Basic weighted average shares outstanding 3,505,424 3,733,432 4,056,439 =============== ================ ================
Diluted weighted average shares outstanding 4,005,424 3,733,432 4,056,439 =============== ================ ================
UNITED TRUST GROUP, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT PARENT ONLY STATEMENTS OF CASH FLOWS Three Years Ended December 31, 2002 Schedule II
2002 2001 2000 ---------------- --------------- ----------------
Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net income (loss) $ 1,499,618 $ 2,439,573 $ (696,426) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Equity in (income) loss of subsidiaries (861,049) (2,409,467) 762,656 Change in accrued interest income 64,331 (43,494) 20,625 Depreciation 0 0 5,102 Change in FIT recoverable 22,817 0 0 Change in deferred income taxes 327,472 15,429 60,288 Change in indebtedness (to) from affiliates, net 674,524 (289,963) 8,690 Change in other assets and liabilities (226,075) (933) 32,966 ---------------- --------------- ---------------- Net cash provided by (used in) operating activities 1,501,638 (288,855) 193,901 ---------------- --------------- ----------------
Cash flows from investing activities: Purchase of stock of affiliates 0 (7,800) (3,200) Payments received on notes receivable from affiliates 800,000 1,302,495 2,000,000 ---------------- --------------- ---------------- Net cash provided by investing activities 800,000 1,294,695 1,996,800 ---------------- --------------- ----------------
Cash flows from financing activities: Purchase of treasury stock (520,253) (1,176,653) 0 Issuance of common stock 706,691 0 0 Payments on notes payable (3,405,395) (1,302,495) (1,515,800) Proceeds from line of credit 2,000,000 0 0 Dividend received from subsidiary 1,400,000 0 0 Cash received in FCC merger 69,187 0 0 Payments made from FCC merger (1,586,500) 0 0 ---------------- --------------- ---------------- Net cash used in financing activities (1,336,270) (2,479,148) (1,515,800) ---------------- --------------- ----------------
Net increase (decrease) in cash and cash equivalents 965,368 (1,473,308) 674,901 Cash and cash equivalents at beginning of year 378,133 1,851,441 1,176,540 ---------------- --------------- ---------------- Cash and cash equivalents at end of year $ 1,343,501 $ 378,133 $ 1,851,441 ================ =============== ================
UNITED TRUST GROUP, INC. REINSURANCE As of December 31, 2002 and the year ended December 31, 2002
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 $ 2,440,716,000 $ 527,079,000 $ 1,553,748,000 $ 3,467,385,000 44.8% =============== =============== =============== ===============
Premiums and policy fees:
Life insurance $ 18,454,030 $ 2,668,796 $ 73,979 $ 15,859,213 0.5%
Accident and health insurance 130,905 31,826 22,135 121,214 18.3% --------------- --------------- --------------- ---------------
$ 18,584,935 $ 2,700,622 $ 96,114 $ 15,980,427 0.6% =============== =============== =============== ===============
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 150,591 36,787 20,332 134,136 15.2% ---------------- ---------------- --------------- ---------------
$ 20,301,128 $ 3,172,098 $ 129,789 $ 17,258,819 0.8% ================ ================ =============== ===============
UNITED TRUST GROUP, INC. REINSURANCE As of December 31, 2000 and the year ended December 31, 2000
Schedule IV
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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
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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 171,131 38,157 8,773 141,747 6.2% ---------------- ---------------- --------------- ---------------
$ 22,961,016 $ 3,556,172 $ 84,842 $ 19,489,686 0.4% ================ ================ =============== ===============
UNITED TRUST GROUP, INC. VALUATION AND QUALIFYING ACCOUNTS As of and for the years ended December 31, 2002, 2001, and 2000
Schedule V
Balance at Additions Beginning Charges Balances at Description Of Period and Expenses Deductions End of Period ----------------------------------------------------------------------------------------------------------------
December 31, 2002
Allowance for doubtful accounts - mortgage loans $ 120,000 $ 0 $ 0 $ 120,000
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
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)
/s/ John S. Albin March 20, 2003 John S. Albin, Director
/s/ Randall L. Attkisson March 20, 2003 Randall L. Attkisson, President, Chief Operating Officer and Director
/s/ Jesse T. Correll March 20, 2003 Jesse T. Correll, Chairman of the Board, Chief Executive Officer and Director
March 20, 2003 Ward F. Correll, Director
/s/ Thomas F. Darden March 20, 2003 Thomas F. Darden, Director
s/ William W. Perry March 20, 2003 William W. Perry, Director
/s/ James P. Rousey March 20, 2003 James P. Rousey, Chief Administrative Officer and Director
/s/ Robert W. Teater March 20, 2003 Robert W. Teater, Director
/s/ Theodore C. Miller March 20, 2003 Theodore C. Miller, Corporate Secretary and Chief Financial Officer
CERTIFICATIONS
I, Jesse T. Correll, Chairman of the Board and Chief Executive Officer of United Trust Group, Inc., certify that:
1. I have reviewed this annual report on Form 10-K of the registrant, United Trust Group, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 20, 2003 By /s/ Jesse T. Correll
Chairman of the Board and Chief Executive Officer
CERTIFICATIONS
I, Theodore C. Miller, Senior Vice President, Corporate Secretary and Chief Financial Officer of United Trust Group, Inc., certify that:
1. I have reviewed this annual report on Form 10-K of the registrant, United Trust Group, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 20, 2003 By /s/ Theodore C. Miller
Senior Vice President, Corporate Secretary and Chief Financial Officer