SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC

FORM 10-Q

QUARTERLY REPORT

Under Section 13 or 15(d) of the Securities Exchange Act of 1934

FOR THREE AND NINE MONTHS ENDED

SEPTEMBER 30, 2004

Commission File: 0-1999

KENTUCKY INVESTORS, INC.

(Exact Name of registrant as specified in Charter)

KENTUCKY 

(State of Other Jurisdiction of Incorporation or Organization)

61-6030333

(IRS Employer Identification Number)

200 Capital Avenue, P. O. Box 717

Frankfort, Kentucky 40602

(Address of Principal Executive Offices)

Registrant's Telephone Number - (502) 223-2361

Securities registered pursuant to Section 13(g) of the Act:

Common Capital Stock par value $1.00 per share

(Title of Class)

Number of outstanding shares as of September 30, 2004 - 1,129,924.72

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   X   No      

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes       No   X  

CONTENTS

PART I - FINANCIAL INFORMATION

Page

ITEM 1.

Consolidated Financial Statements

3

ITEM 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

12

ITEM 3.

Quantitative and Qualitative Disclosures about Market Risk

20

ITEM 4.

Controls and Procedures

20

PART II - OTHER INFORMATION

ITEM 1.

Legal Proceedings

21

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

21

ITEM 3.

Defaults Upon Senior Securities

21

ITEM 4.

Submission of Matters to a Vote of Security Holders

21

ITEM 5.

Other Information

21

ITEM 6.

Exhibits and Reports on Form 8-K

22

SIGNATURES

22

EXHIBIT 31.1

23

EXHIBIT 31.2

24

EXHIBIT 32

25

PART I - FINANCIAL INFORMATION

ITEM 1. Consolidated Financial Statements

KENTUCKY INVESTORS, INC.

Condensed Consolidated Balance Sheets

(Unaudited)

September 30, 2004

December 31, 2003

Assets

   Investments

     Securities available for sale, at fair

         value:

       Fixed maturities (amortized cost

         2004-$269,568,083; 2003 -

         $265,097,987)

$287,550,049

$284,531,244

       Equity securities (cost: 2004 -

         $4,997,915; 2003 - $4,997,915)

5,955,159

5,872,424

   Mortgage loans on real estate

24,478,146

25,749,708

   Other long term investments

750,957

557,461

   Short term investments

884,399

813,000

   Policy loans

     7,522,699

     7,918,258

       Total investments

327,141,409

325,442,095

   Cash and cash equivalents

3,084,645

5,844,281

   Due and deferred premiums

4,251,882

4,441,828

   Deferred acquisition costs

22,800,044

23,298,369

   Present value of future profits

414,033

482,721

   Leased property under capital leases

138,415

227,822

   Other assets

20,216,658

9,272,869

   Amounts recoverable from reinsurers

    58,492,712

    60,465,147

Total assets

$436,539,798

$429,475,132

Liabilities and Stockholders' Equity

   Liabilities

     Policy liabilities

       Benefit reserves

$331,968,629

$335,604,439

       Unearned premium reserves

15,803,097

17,014,697

       Other policyholders' funds

     3,699,911

     3,728,729

         Total policy liabilities

351,471,637

356,347,865

       Federal income taxes

9,530,898

9,673,564

       Obligations under capital leases

134,939

224,628

       Notes payable

8,915,444

9,033,355

       Other liabilities

     16,158,434

      4,041,199

       Total liabilities

386,211,352

379,320,611

Stockholders' Equity

   Common Stock (shares issued:

     2004 - 1,129,925, 2003 -

1,136,361)

    1,129,925

    1,136,361

   Paid-in surplus

8,549,970

8,549,970

   Accumulated other comprehensive

     income

11,506,539

12,139,714

   Retained earnings

    29,142,012

    28,328,476

       Total stockholders' equity

$  50,328,446

$  50,154,521

Total liabilities and stockholders'

     equity

$436,539,798

$429,475,132

See accompanying notes.

KENTUCKY INVESTORS, INC.

Condensed Consolidated Income Statements (Unaudited)

Three Months Ended September 30

           2004

            2003

REVENUES

   Premiums and other considerations

$  9,125,243 

$10,699,479

   Investment income, net of expenses

4,647,233 

4,386,931

   Realized gain on investments, net

2,050 

343,948

   Other income

      276,080 

      243,853

      Total revenues

$14,050,606 

 $15,674,211

BENEFITS AND EXPENSES

   Death and other policyholder benefits

14,255,743 

  8,092,330 

   Guaranteed annual endowments

148,037 

153,555 

   Dividends to policyholders

137,782 

170,111 

   Increase (decrease) in benefit reserves

     and unearned premiums

(4,438,301)

3,445,070 

   Amortization of deferred acquisition

     costs, net

278,720 

365,997 

   Commissions

611,571 

820,692 

   Other insurance expenses

    2,321,643 

    2,909,933 

      Total benefits and expenses

$13,315,195 

$15,957,688 

Income (loss) from operations before

     federal income tax

$     735,411 

$   (283,477)

Provision (benefit) for income taxes:

   Current

$       15,418 

$   (178,081)

   Deferred

         38,000 

       102,000 

$       53,418 

$     (76,081)

Net income (loss)

$     681,993 

$   (207,396)

Earnings per share, basic and diluted

$           0.60 

$         (0.18)

Dividends per share

$           0.00 

$           0.00 

See accompanying notes.

KENTUCKY INVESTORS, INC.

Condensed Consolidated Income Statements (Unaudited)

Nine Months Ended September 30

           2004

            2003

REVENUES

   Premiums and other considerations

$28,341,874 

$31,932,317 

   Investment income, net of expenses

13,690,102 

13,617,978 

   Realized gain on investments, net

156,351 

869,028 

   Other income

   1,042,314 

      802,574 

      Total revenues

$43,230,641 

$47,221,897 

BENEFITS AND EXPENSES

   Death and other policyholder benefits

33,296,340 

  24,971,581 

   Guaranteed annual endowments

506,940 

518,703 

   Dividends to policyholders

501,047 

535,485 

   Increase (decrease) in benefit reserves

     and unearned premiums

(2,730,773)

8,775,856 

   Amortization of deferred acquisition

     costs, net

907,525 

763,588 

   Commissions

1,930,072 

2,655,419 

   Other insurance expenses

    7,121,869 

    8,650,792 

      Total benefits and expenses

$41,533,020 

$46,871,424 

Income from operations before

     federal income tax

$  1,697,621 

$     350,473 

Provision for income taxes:

   Current

$       47,483 

$      44,077 

   Deferred

      207,000 

       41,000 

$     254,483 

$      85,077 

Net income

$  1,443,138 

$    265,396 

Earnings per share, basic and diluted

$           1.27 

$          0.23 

Dividends per share

$           0.38 

$          0.38 

See accompanying notes.

KENTUCKY INVESTORS, INC.

Condensed Consolidated Statements of Cash Flow (Unaudited)

Nine Months Ended September 30

2004

2003

Net cash provided by operating activities

$  1,402,647 

$   9,552,300 

Investing activities

   Securities available-for-sale:

     Purchases

(26,421,743)

(63,780,653)

     Sales and maturities

21,799,264 

54,081,908 

   Other investments:

     Cost of acquisition

(1,932,481)

(3,688,420)

     Sales and maturities

3,334,707 

3,215,695 

   Other investing activities

        35,712 

      (256,012)

Net cash used by investing activities

(3,184,541)

(10,427,482)

Financing activities

   Receipts from universal life policies

     credited to policyholder account

     balances

6,008,518 

5,873,353 

   Return of policyholder account balances

     on universal life policies

(6,232,310)

(5,773,247)

   Payments on notes payable

(561,911)

(625,726)

   Proceeds from notes payable

444,000 

214,042 

   Other financing activities

    (636,039)

     (303,484)

Net cash used by financing activities

    (977,742)

     (615,062)

Decrease in cash and cash

     equivalents

(2,759,636)

(1,490,244)

Cash and cash equivalents at beginning

    of period

    5,844,281 

    7,773,597 

Cash and cash equivalents at end of period

$  3,084,645 

$  6,283,353 

See accompanying notes.

KENTUCKY INVESTORS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2004

(Unaudited)

NOTE A - Nature of Operations: Kentucky Investors, Inc. is the holding company of Investors Heritage Life Insurance Company, Investors Heritage Printing, Inc., a printing company, Investors Heritage Financial Services Group, Inc., an insurance marketing company, and is the sole member of At Need Funding, LLC, a limited liability company that provides advance funding of funerals in exchange for the irrevocable assignment of life insurance policies from other nonaffiliated companies. These entities are collectively hereinafter referred to as the "Company". The operations of Kentucky Investors are principally that of its life insurance company, Investors Heritage Life. The operations of the non-insurance subsidiaries of Kentucky Investors account for less than 2% of the Company's total operations.

The Company's operations involve the sale and administration of various insurance and annuity products, including, but not limited to, participating, non-participating, whole life, limited pay, universal life, annuity contracts, credit life, credit accident and health and group insurance policies. The principal markets for the Company's products are in the Commonwealths of Kentucky and Virginia, and the states of North Carolina, South Carolina, Ohio, Indiana, Florida, Tennessee, Illinois, Georgia, West Virginia, Michigan, Mississippi, Alabama and Maryland.

NOTE B - Basis of Presentation: The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2003, as included in the C ompany's Annual Report on Form 10-K.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

NOTE C - Earnings per Share: Earnings per share of common stock were computed based on the weighted average number of common shares outstanding during each period.

Income

Shares

Per Share

Amount

Three months ended September 30, 2004

Basic EPS

Net income

$   681,993 

1,129,925 

$       0.60

Dilutive effect of common equivalent shares of

   stock options

                 -

        3,012 

               -

Diluted EPS

Net income

$   681,993 

1,132,937 

$       0.60

Three months ended September 30, 2003

Basic EPS

Net loss

$ (207,396)

1,148,510 

$    (0.18)

Dilutive effect of common equivalent shares of

   stock options

                 -

                -

               -

Diluted EPS

Net loss

$ (207,396)

1,148,510 

$   ( 0.18)

Income

Shares

Per Share

Amount

Nine months ended September 30, 2004

Basic EPS

Net income

$ 1,443,138 

1,131,874 

$     1.27 

Dilutive effect of common equivalent shares of

   stock options

                 -

       3,012 

              -

Diluted EPS

Net income

$ 1,443,138 

1,134,886 

$     1.27 

Nine months ended September 30, 2003

Basic EPS

Net income

$   265,396 

1,148,510 

$     0.23 

Dilutive effect of common equivalent shares of

   stock options

                 -

        9,778 

              -

Diluted EPS

Net income loss

$   265,396 

1,158,288 

$      0.23 

Pursuant to the Company's stock option and stock appreciation rights plan, there were 66,000 outstanding options, having an exercise price of $23.00 per share as of September 30, 2004. The Company's stock price decreased from $26.55 per share at December 31, 2003 to $24.10 at September 30, 2004. Accordingly, the Company recognized a decrease in stock compensation expense associated with such options of $161,700 for the nine month period ended September 30, 2004.

NOTE D - Segment Data: The Company operates in four segments as shown in the following table. All segments include both individual and group insurance. Identifiable revenues and expenses are assigned directly to the applicable segment. Net investment income is generally allocated to the insurance and the corporate segments in proportion to policy liabilities and stockholders' equity, respectively. Corporate segment results for the parent company, Investors Heritage Printing, Inc., Investors Heritage Financial Services Group, Inc. and At Need Funding LLC, after elimination of intercompany amounts, are presented.

Three Months Ended

September 30, 2004

September 30, 2003

Revenues:

   Preneed & Burial Products

$10,620,866 

$12,004,079 

   Traditional & Universal Life Products

2,859,449 

2,746,014 

   Credit Insurance Products &

      Administrative Services

45,086 

78,474 

   Corporate & Other

       525,205 

     845,644 

$14,050,606 

$15,674,211 

Pre-Tax Income (Loss) from Operations:

   Preneed & Burial Products

$     602,617 

$   (397,587)

   Traditional & Universal Life Products

174,841 

(184,079)

   Credit Insurance Products &

      Administrative Services

10,947 

6,218 

   Corporate & Other

       (52,994)

      291,971 

$   735,411 

$   (283,477)

Nine Months Ended

September 30, 2004

September 30, 2003

Revenues:

   Preneed & Burial Products

$32,086,609 

$35,412,122 

   Traditional & Universal Life Products

8,771,036 

8,987,969 

   Credit Insurance Products &

      Administrative Services

133,211 

235,343 

   Corporate & Other

    2,239,785 

    2,586,463 

$43,230,641 

$47,221,897 

Pre-Tax Income (Loss) from Operations:

   Preneed & Burial Products

$     331,158 

$   (713,445)

   Traditional & Universal Life Products

604,287 

199,748 

   Credit Insurance Products &

      Administrative Services

36,195 

22,542 

   Corporate & Other

       725,981 

       841,628 

$   1,697,621 

$     350,473 

NOTE E - Federal Income Taxes: Current taxes are provided based on estimates of the projected effective annual tax rate. Deferred taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Income before federal income taxes differs from taxable income principally due to the small life insurance company tax deduction and dividends-received tax deduction. Other factors affecting this difference during the nine month period include the following non taxable events: a death benefit received by the Company on a company owned life insurance policy; a decrease in stock compensation expense associated with the Company's stock option plan relative to a decline in the value of Company stock options; and the release of the Company's previously non taxable self insurance reserve.

NOTE F - Comprehensive Income: The components of comprehensive income, net of related tax, are as follows:

Three Months Ended

September 30, 2004 

September 30, 2003

Net income (loss)

$      681,993 

$    (207,396)

Net unrealized gains (losses) on

  available-for-sale securities, net of tax

     3,942,959 

   (3,590,451)

Comprehensive income (loss)

$   4,624,952 

$ (3,797,847)

Nine Months Ended

September 30, 2004 

September 30, 2003

Net income

$    1,443,138 

$      265,396 

Net unrealized losses on

  available-for-sale securities, net of tax

       (633,175)

      (684,072)

Comprehensive income (loss)

$       809,963 

$    (418,676)

NOTE G - Notes Payable: Information relative to the Company's material notes payable at September 30, 2004 is as follows:

Outstanding

Current

Interest

Interest

Description

Principal

Interest Rate

Expense

Paid

Fifth Third Bank Note

$3,000,000

4.25%

$ 83,438

$ 77,896

Cherokee National Note

4,000,000

4.75%

122,556

122,500

At Need Funding Line of

    Credit

336,000

4.75%

11,454

11,658

Fifth Third Bank Note

1,553,924

3.75%

39,295

39,203

Farmers Bank Line of

    Credit

1

3.75%

782

816

Chrysler Financial

25,519

-%

-

-

NOTE H - Employee Benefit Plans: The Company participates in a noncontributory retirement plan which covers substantially all employees. Benefits are based on years of service and the highest consecutive 60 months average earnings within the last 120 months of credited service. Benefits are funded based on actuarially-determined amounts.

The following table provides the components of the net periodic benefit cost:

Three Months Ended

September 30, 2004

September 30, 2003

Service cost

$   80,391 

$   92,175 

Interest cost

160,876 

164,624 

Expected return on plan assets

(153,075)

(163,955)

Amortization of prior service cost

(5,265)

(8,775)

Amortization of net loss

     41,129 

     35,261 

Net periodic benefit cost

$ 124,056 

$ 119,330 

Nine Months Ended

September 30, 2004

September 30, 2003

Service cost

$ 241,174 

$ 276,527 

Interest cost

482,630 

493,871 

Expected return on plan assets

(459,225)

(491,865)

Amortization of prior service cost

(15,794)

(26,327)

Amortization of net loss

   123,389 

   105,782 

Net periodic benefit cost

$ 372,174 

$ 357,988 

Effective August 10, 2004, the Company cash surrendered its deposit administration fund, which was the most significant component of plan assets, held with Investors Heritage and invested these proceeds with an outside advisor in a diversified pension portfolio predominantly including equity securities and bonds.

The Company previously disclosed in its financial statements for the year ended December 31, 2003, that it expected to contribute $540,000 to its pension plan in 2004. As of September 30, 2004, $405,000 had been contributed. The Company presently anticipates contributing an additional $135,000 to fund its pension plan in 2004.

NOTE I - Investments: During the third quarter of 2004, the Company began participating in a securities lending program, primarily for investment yield enhancement purposes, with third parties, mostly large brokerage firms. Securities loaned are treated as financing arrangements and the unrestricted collateral received is recorded in other assets, with an offsetting liability recorded in other liabilities to account for the Company's obligation to return the collateral. The Company obtains collateral in an amount equal to 102% of the fair value of domestic securities loaned, monitors the market value of securities loaned on a daily basis and obtains additional collateral as necessary. At September 30, 2004, fixed income securities with a carrying value of $11,940,000 were on loan under this agreement. Income earned relative to this program was $4,315 for the period ended September 30, 2004.

NOTE J - Unusual or Infrequent Events: During June 2004, the Company recognized approximately $226,000 in miscellaneous income arising from the death proceeds payable to the Company as owner and beneficiary of a life insurance policy carried on a previous member of management.

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

General

Kentucky Investors is incorporated under the laws of the Commonwealth of Kentucky and wholly owns Investors Heritage Life Insurance Company, a life insurance company also incorporated under the laws of the Commonwealth of Kentucky. Kentucky Investors also wholly owns Investors Heritage Financial Services Group, Inc., a Kentucky insurance marketing company which was formed in 1994, Investors Heritage Printing, Inc., a Kentucky printing company that provides printing to Investors Heritage Life and other unaffiliated parties, and is the sole member of At Need Funding, LLC, a Kentucky limited liability company that provides advance funding of funerals in exchange for the irrevocable assignment of life insurance policies from other nonaffiliated companies.

Investors Heritage Life offers a full line of life insurance products including, but not limited to, whole life, term life, single premium life, multi-pay life and annuities. Investors Heritage Life's primary lines of business are insurance policies and annuities utilized to fund preneed funeral contracts, credit life and credit disability insurance, and term life and reducing term life sold through financial institutions.

Investors Heritage Life introduced a new product series during the first quarter of 2003, the Legacy Protector and Legacy Preferred pre-need product series, which replaced the Legacy 2000 series. These new plans were designed to help combat a challenging economic environment and increased mortality anti-selection. In general, commissions are slightly lower, guaranteed benefits have been moved further from issue, reserves have been adjusted to better reflect experience, and an underwritten plan has been added.

Investors Heritage Life's final expense product is the Heritage Final Expense, which was introduced during 2002 and replaced the Legacy 2000 Final Expense series. This product is being marketed through funeral homes and independent agencies. It is reinsured on an 80% quota share basis with Munich American Reassurance Company to help reduce first year surplus strain associated with new sales and minimize fluctuations in future profits.

Investors Heritage Life also provides term insurance products, both on a decreasing and a level basis. The Term to 95 product provides level coverage. We will continue to provide our decreasing term policy that is primarily sold through financial institutions.

The Company's operating earnings are derived primarily from revenues generated from the sale of insurance products by Investors Heritage Life, plus the Company's investment results, including realized gains (losses), less interest credited to policyholders, benefits to policyholders and expenses.

While the Company continues to expand the operations of Investors Heritage Financial, Investors Heritage Printing and At Need Funding, less than 2% of the Company's total operations were generated by those subsidiaries. As expected, more than 10% of Investors Heritage Financial's revenues during the second quarter 2004 were derived from the sale of Investors Heritage Life's credit insurance products. During the third quarter of 2004, the Company received dividends from Investors Heritage Financial in the amount of $40,000. The Company anticipates dividend payments from Investors Heritage Financial during the fourth quarter in 2004.

The Company's primary uses of cash are operating expenses, debt service and dividend payments, and the Company's principal sources of cash are the dividends paid to it by Investors Heritage Life, Investors Heritage Financial and Investors Heritage Printing. Investors Heritage Life's principal sources of cash are from the sale of life insurance policies and investment income, including realized gains (losses), less benefits to policyholders and expenses. Therefore, the remainder of the discussion will deal with the financial condition and results of operations of Investors Heritage Life.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company's discussion and analysis of its financial condition and results of operations are based on its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On a continuing basis, the Company evaluates its estimates, including those related to investments, deferred acquisition costs, present value of future profits, policy liabilities, income taxes, regulatory requirements, contingencies and litigation. The Company bases such estimates on historical experience and other assumptions believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following accounting policies, judgments and estimates are the most critical to the preparation of its consolidated financial statements.

Investment in Fixed Maturities, Equity Securities and Mortgage Loans

The Company holds fixed maturities and equity interests in a variety of companies. Additionally, the Company originates, underwrites and manages mortgage loans. The Company continuously evaluates all of its investments based on current economic conditions, credit loss experience and other developments. The Company evaluates the difference between the cost/amortized cost and estimated fair value of its investments to determine whether any decline in value is temporary or other-than-temporary in nature. This determination involves a degree of uncertainty. If a decline in the fair value of a security is determined to be temporary, the decline is recorded as an unrealized loss in shareholders' equity. If a decline in a security's fair value is considered to be other-than-temporary and the Company has the intent and ability to hold the security until it recovers, the security is written down to the estimated fair value with a corresponding realized loss recognized in th e consolidated statements of income. 

The assessment of whether a decline in fair value is considered temporary or other-than-temporary includes management's judgment as to the financial position and future prospects of the entity issuing the security. It is not possible to accurately predict when it may be determined that a specific security will become impaired. Future adverse changes in market conditions, poor operating results of underlying investments and defaults on mortgage loan payments could result in losses or an inability to recover the current carrying value of the investments, thereby possibly requiring an impairment charge in the future.

Deferred Acquisition Costs

At September 30, 2004, the balance of our deferred acquisition costs was $22,800,000 compared to $23,298,000 at December 31, 2003. The recovery of these costs is dependent on the future profitability of the related business. Periodically, we evaluate the recoverability of the unamortized balance of the deferred acquisition costs. We consider estimated future gross profits or future premiums, expected mortality or morbidity, interest earned and credited rates, persistency and expenses in determining whether the balance is recoverable. If we determine a portion of the unamortized balance is not recoverable, it is immediately charged to amortization expense. The assumptions we use to amortize and evaluate the recoverability of the deferred acquisition costs involve significant judgment. A significant revision to these assumptions will impact future financial results.

Policy Liabilities

Establishing liabilities for the Company's long-duration insurance contracts requires various assumptions, including policyholder persistency, mortality rates, investment yields, discretionary benefit increases, new business pricing, and operating expense levels. The Company evaluates historical experience for these factors when assessing the need for changing current assumptions. However, since many of these factors are interdependent and subject to short-term volatility during the long-duration contract period, substantial estimates and judgment are required. Accordingly, if actual experience emerges differently from that assumed, material financial statement adjustments could be required.

Investments, Liquidity and Capital Resources

Premiums, which include mortality and expense charges, and investment income are Investors Heritage Life's primary sources of cash flow used to meet short-term and long-term cash requirements.

Investors Heritage Life's short-term obligations consist primarily of policyholder benefits and operating expenses. Investors Heritage Life has historically been able to meet these obligations out of operating cash, premiums and investment income.

Management is not aware of any commitments or unusual events that could materially affect capital resources.

The Company has not had any material changes in its debt agreements since December 31, 2003. The Company and Investors Heritage Life will continue to explore various opportunities including corporate reorganizations, acquisitions and purchasing blocks of business from other companies, which may dictate an additional need for either long-term or short-term debt.

Investors Heritage Life has maintained a sound, conservative investment strategy. At September 30, 2004, 87.9% of invested assets consisted of fixed income public bonds compared to 87.4% at December 31, 2003. Fixed income assets are managed by Conning Asset Management Company, an independent portfolio manager.

During the third quarter of 2004 the Company began participating in a securities lending program, primarily for investment yield enhancement purposes, with third parties, mostly large brokerage firms. Securities loaned are treated as financing arrangements and the unrestricted collateral received is recorded in other assets, with an offsetting liability recorded in other liabilities to account for the Company's obligation to return the collateral.

Additionally, Investors Heritage Life also engages in commercial and residential mortgage lending with approximately 97.8% of these investments being in commercial properties. All mortgage loans are originated in-house and all loans are secured by first mortgages on the real estate. At September 30, 2004, 7.5% of invested assets consisted of mortgage loans compared to 7.9% at December 31, 2003. Management anticipates funding several new mortgage loan investments during the remainder of 2004 to maintain a similar to slightly higher percentage of mortgage loans to total invested assets.

Investors Heritage Life's conservative approach in the product development area and the strength and stability of its fixed income and mortgage loan portfolios provide adequate liquidity both in the short-term and the long-term. At September 30, 2004 and December 31, 2003, Investors Heritage Life's fixed income investments were 100% investment grade as rated by Standard & Poor's. None of Investors Heritage Life's fixed income assets are in default and there has been no material change in the distribution of its fixed income portfolio.

Investors Heritage Life's principal long-term obligations are fixed contractual obligations incurred in the sale of its life insurance products. The premiums charged for these products are based on conservative and actuarially sound assumptions as to mortality, persistency and interest. Management believes these assumptions will produce revenues sufficient to meet its future contractual benefit obligations and operating expenses, and provide an adequate profit margin.

The Company continuously evaluates all of its investments based on current economic conditions, credit loss experience and other developments. The Company evaluates the difference between the cost/amortized cost and estimated fair value of its investments to determine whether a decline in value is temporary or other than temporary in nature. This determination involves a degree of uncertainty. If a decline in the fair value of a security is determined to be temporary, the decline is recorded as an unrealized loss in shareholders' equity. If a decline in a security's fair value is considered to be other than temporary and the Company has the intent and ability to hold the security until it recovers, the security is written down to the estimated fair value with a corresponding realized loss recognized in the consolidated statements of income.

The assessment of whether a decline in fair value is considered temporary or other than temporary includes management's judgment as to the financial position and future prospects of the entity issuing the security. It is not possible to accurately predict when it may be determined that a specific security will become impaired. Future impairment charges could be material to the results of operations of the Company. The amount of impairment charge before tax was $-0- in the third quarter of 2004 and 2003, and $-0- and $300,000 for the first nine months of 2004 and 2003, respectively.

Management believes that it will recover the cost basis in the securities held with unrealized losses as it has both the intent and ability to hold the securities until they mature or recover in value. Securities are sold to achieve management's investment goals, which include the diversification of credit risk, the maintenance of adequate portfolio liquidity and the management of interest rate risk. In order to achieve these goals, sales of investments are based upon current market conditions, liquidity needs and estimates of the future market value of the individual securities.

Results of Operations

Total premium income (net of reinsurance) for the third quarter 2004 decreased 14.7% when compared to the third quarter of 2003 and decreased 11.2% for the first nine months of 2004 when compared to the same period in 2003. The decrease was primarily due to lower sales in the pre-need segment. Net investment income increased 5.9% for the third quarter 2004 compared to the third quarter of 2003 and increased 0.5% for the first nine months of 2004 when compared to the same period in 2003. The increase is primarily due to a larger asset base, however lower yield rates on new asset purchases have impacted the rate of return on our investment portfolio. Overall revenue for the third quarter 2004 decreased 10.4% when compared to the third quarter of 2003 and decreased 8.5% for the first nine months of 2004 when compared to the same period in 2003.

Total Benefits and Expenses were 16.6% lower in the third quarter of 2004 when compared to the same quarter of 2003 and 11.4% lower for the first nine months of 2004 when compared to the same period of 2003, primarily due to lower premium production in pre-need sales and the implementation of several cost containment measures. After providing for federal income taxes, the Company's Net Income was $1,443,138 with Earnings per share of $1.27 for the first nine months of 2004 as compared to Net Income of $265,396 and Earnings per share of $0.23 for the same period in 2003.

A dividend of $0.38 per share was paid April 14, 2004, to shareholders of record on March 26, 2004.

Business Segments

Management internally evaluates the performance of Investors Heritage Life operations by the following business segments:

Preneed & Burial Products include both life and annuity products sold by funeral directors or affiliated agents to fund prearranged funerals. Revenues for this segment were 11.5% lower for the third quarter of 2004 when compared to the same period of 2003 and 9.4% lower in the first nine months of 2004 when compared to the same period of 2003. The decrease is due primarily to increased competition in the marketplace and an uncertain economic environment. Pre-Tax Income (Loss) from Operations for the third quarter 2004 was $602,617 compared to $(397,587) for the same period for 2003 and $331,158 for the first nine months of 2004 compared to $(713,445) for the same period for 2003. The implementation of several cost containment measures have resulted in lower general expenses. Also, the Company's new product series introduced in 2003 has improved product profitability and has helped to offset the losses resulting on our previously sold preneed products. Investors Heritage Life plans to continue its expansion of territory and recruitment of agents in the Preneed and Burial insurance market.

Traditional & Universal Life Products include traditional life and group life insurance products, annuities (primarily qualified) and universal life products. Revenues for this segment were 4.1% higher for the third quarter of 2004 when compared to the third quarter of 2003 and 2.4% lower for the first nine months of 2004 when compared to the same period in 2003. Revenues on this segment are primarily derived from the sales of term insurance products through banks, which has been lower during 2004 due to less loan demand. Sales have also slowed due to new federal banking guidelines regarding predatory lending and the sale of credit insurance in conjunction with a real estate mortgage. In addition, several states, including Kentucky, have enacted or are considering predatory lending laws that prohibit the financing of single premium credit insurance as part of a real estate mortgage transaction. Pre-Tax Income from Operations for the first nine months of 2004 was $604,287 compared to $199,748 for the same period for 2003 primarily because of general insurance expense savings and better than anticipated mortality. Effective January 1, 2004, the Company lowered its maximum retention level from $100,000 to $25,000 per life. This new retention level has already helped to stabilize earnings fluctuations in this segment.

Credit Insurance Products and Administrative Services include the marketing and administration of credit life and credit accident & health insurance products. Revenues were $45,086 for the third quarter of 2004 compared to $78,474 for the same period for 2003 and $133,211 for the first nine months of 2004 compared to $235,343 for the same period in 2003. Pre-Tax Income from Operations was $10,947 for the third quarter of 2004 compared to $6,218 for the third quarter of 2003 and $36,195 for the first nine months of 2004 compared to $22,542 for the same period in 2003. The revenues and income on the credit insurance line have been affected by the same factors that affect the Traditional & Universal Life products discussed above including consumer loan demand, new federal banking guidelines enacted or being considered by states, and expense savings within the Company. Overall income is higher for the nine month period because of the increased service fees gener ated on earned premiums. All of the related underwriting risk currently produced is being reinsured 100% with highly-rated life companies.

Corporate & Other consists of corporate accounts measured primarily by stockholders' paid-in capital, contributed surplus, earned surplus, property and equipment, and other minor business lines which include group annuities and group and individual accident and health products. Revenues were 37.9% lower and Pre-Tax Income from Operations was 118.2% lower for the third quarter of 2004 when compared to the third quarter 2003. Revenues were 13.4% lower for the first nine months of 2004 compared to the same period in 2003 and Pre-Tax Income from Operations was 13.7% lower for the first nine months of 2004 when compared to the same period in 2003. The decreases in revenue and pre-tax income for the third quarter in 2004 are primarily due to lower realized gains from the sale of investments in 2004 as compared to 2003.

Federal Income Taxes

Current taxes are provided based on estimates of the projected effective annual tax rate. Deferred taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The effective tax rate was 15.0% for the nine months ended September 30, 2004 compared to 24.3% for the nine months ended September 30, 2003. The decrease in the effective tax rate is due primarily to the differences between book and tax reserve bases arising from the Company's section 807(f) tax election. In addition, there were permanent differences in the current tax resulting from the death benefit received by the Company on a company owned life policy, a reduction in stock compensation cost for a decline in the value of Company stock options, as well as the release of the Company's previously non taxable self insurance reserve.

Forward Looking Information

The Company cautions readers regarding certain forward-looking statements contained in this report and in any other statements made by, or on behalf of, the Company, whether or not in future filings with the Securities and Exchange Commission. Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, or other developments. Statements using verbs such as "expect", "anticipate", "believe" or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements which represent the Company's beliefs concerning future levels of sales and redemptions of Investors Heritage Life's products, investment spreads and yields, or the earnings and profitability of the Company's or Investors Heritage Life's activities.

Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company's control and many of which are subject to change. These uncertainties and contingencies could cause actual results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable factors and developments. Some of these may be national in scope, such as general economic conditions, changes in tax law and changes in interest rates. Some may be related to the insurance industry generally, such as pricing competition, regulatory developments, industry consolidation and the effects of competition in the insurance business from other insurance companies and other finan cial institutions operating in the Company's market area and elsewhere. Others may relate to the Company specifically, such as credit, volatility and other risks associated with the Company's investment portfolio. The Company cautions that such factors are not exclusive. The Company disclaims any obligation to update forward-looking information.

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

There have been no significant or material changes in the Company's market risks since December 31, 2003. Measuring market risk is a key function of our asset/liability management process. To test financial risk and investment strategy, the Company performs an asset adequacy analysis each year. Dynamic models of both assets and liabilities are created to project financial results under several shifts in the current interest rate environment. Results show that the Company's exposure to a relative 10% increase or decrease in the interest rates prevalent at December 31, 2003 is a net loss of less than $500,000. This analysis is not performed on a quarterly basis.

Items taken into account on the asset side include prepayment and liquidity risks, asset diversification and quality considerations. On the liability side, interest crediting strategies and policyholder and agent behavior (lapses, loans, withdrawals and premium flow) are dynamically modeled in relationship to the particular interest rate environment tested. Although the Company is careful to ensure that these assumptions are consistent with the best available data, interest-sensitive cash flows cannot be forecast with certainty and can deviate significantly from the assumptions made.

Because asset and liability durations are continually changing as new policyholder contracts are issued and as new investments are added to the portfolio, the Company manages its balance sheet on an ongoing basis and its net exposure to changes in interest rates may vary over time. Although the asset adequacy analysis is not performed on a quarterly basis, management believes that the Company's asset base is sufficient to cover the minimal increases or decreases that would be expected to occur during any particular year.

In addition to these dynamic modeling techniques, the Company closely monitors its own business segments with respect to product performance and agent behavior. To that end, during 2002 we implemented a new system to assist in monitoring these areas. This new tool allows management to quickly isolate areas of strength and weakness and to take appropriate and timely action to exploit the strengths and improve the weaknesses.

ITEM 4. Controls and Procedures

As of the end of the period covered by this Form 10-Q, the Company performed an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in this Quarterly Report on Form 10-Q. There have been no significant changes in the Company's internal controls or in other factors which could significantly affect internal controls over financial reporting during this most recent quarter or subs equent to the date the Company carried out its evaluation.

PART II - OTHER INFORMATION

ITEM 1. Legal Proceedings

The Company is not involved in any legal proceedings. From time to time Investors Heritage Life is involved in litigation relating to claims arising out of its operations in the normal course of business. As of November 11, 2004, Investors Heritage Life is not a party to any legal proceedings, the adverse outcome of which, in management's opinion, individually or in the aggregate, would have a material adverse effect on Investors Heritage Life's or the Company's financial condition or results of operations. 

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

No share repurchases were made pursuant to a publicly announced plan or program. All share repurchases were shares tendered by employees as part of the Company's 401(k) plan.

ITEM 3. Defaults Upon Senior Securities

None

ITEM 4. Submission of Matters to a Vote of Security Holders

None

ITEM 5. Other Information

None

ITEM 6. Exhibits and Reports on Form 8-K

a) Exhibits

No exhibits were filed for the quarter ended September 30, 2004.

b) Reports on form 8-K

None

SIGNATURES
 

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

KENTUCKY INVESTORS, INC.

BY: /s/

Harry Lee Waterfield II

DATE: November 11, 2004

President

BY: /s/

Raymond L. Carr

DATE: November 11, 2004

Vice President - Chief Financial Officer