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EX-32 - EXHIBIT 32 - Investors Heritage Capital Corpex32.htm

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

____________________________________________

  

FORM 10-Q

 ____________________________________________

 

QUARTERLY REPORT

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

 

For the quarterly period ended June 30, 2014

____________________________________________

 

000-01999

(Commission file number)

 

INVESTORS HERITAGE CAPITAL CORPORATION

(Exact Name of Registrant as Specified in its Charter)

 

KENTUCKY

 

61-6030333

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification Number)

 

200 Capital Avenue,

Frankfort, Kentucky 40602

(Address of principal executive offices)

 

(502) 223-2361

(Registrant’s telephone number, including area code)

____________________________________________

 

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 ☒   No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes ☒    No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ☐

Accelerated filer                    ☐

Non-accelerated filer     ☐ (Do not check if a smaller reporting company)

Smaller reporting company  

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes ☐   No ☒

 

 
1

 

 

Securities registered pursuant to Section 12(g) of the Act:

 

Common Capital Stock par value $1.00 per share

(Title of Class)

 

Number of outstanding shares as of August 14, 2014 - 1,125,413.451

 

 
2

 

 

CONTENTS

 

 

 

PART I – FINANCIAL INFORMATION

 
   

Page

ITEM 1.

Condensed Consolidated Financial Statements

4

ITEM 2.

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

27

ITEM 4.

Controls and Procedures

37

     
     
     
 

PART II – OTHER INFORMATION

 
     

ITEM 1.

Legal Proceedings

38

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

38

ITEM 3.

Defaults Upon Senior Securities

38

ITEM 4.

Mine Safety Disclosures

38

ITEM 5.

Other Information

38

ITEM 6.

Exhibits

38

     
     

SIGNATURES

 

39

     

EXHIBIT 31.1

 

40

EXHIBIT 31.2

 

41

EXHIBIT 32

 

42

 

 
3

 

 

 

 PART I - FINANCIAL INFORMATION

 

 

 

ITEM 1. Condensed Consolidated Financial Statements

 

INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Balance Sheets (Unaudited)

 

   

June 30,

   

December 31,

 

ASSETS

 

2014

   

2013

 

Investments:

               

Securities available-for-sale, at fair value:

               

Fixed maturities (amortized cost: $405,328,455 and $402,396,191)

  $ 434,742,762     $ 417,909,105  

Equity securities (cost: $6,066,855 and $5,888,361)

    6,672,308       5,818,333  

Mortgage loans on real estate

    19,104,706       18,601,722  

Policy loans

    6,681,655       6,674,887  

State-guaranteed receivables

    7,938,601       8,085,107  

Other invested assets

    3,327,871       3,181,182  

Total investments

    478,467,903       460,270,336  

Cash and cash equivalents

    4,133,711       4,143,291  

Accrued investment income

    5,289,921       5,191,253  

Due premiums

    3,383,749       3,368,008  

Deferred acquisition costs

    18,190,751       18,822,481  

Value of business acquired

    343,862       386,056  

Leased property under capital leases

    776,198       1,005,523  

Property and equipment

    1,142,643       1,042,748  

Cash value of company-owned life insurance

    11,603,169       11,808,248  

Other assets

    1,824,414       1,901,946  

Amounts recoverable from reinsurers

    55,326,178       55,669,088  

Total assets

  $ 580,482,499     $ 563,608,978  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               

LIABILITIES

               

Policy liabilities:

               

Benefit reserves

  $ 483,631,491     $ 480,151,818  

Unearned premium reserves

    8,083,202       8,189,640  

Policy claims

    2,925,685       3,672,474  

Liability for deposit-type contracts

    3,326,787       3,283,960  

Reserves for dividends and endowments and other

    424,231       408,555  

Total policy liabilities

    498,391,396       495,706,447  

Deferred federal income tax liability

    9,439,030       4,604,891  

Obligations under capital leases

    712,053       943,488  

Notes payable

    2,971,485       3,031,942  

Accrued pension liability

    2,361,534       2,887,843  

Other liabilities

    3,576,839       2,787,099  

Total liabilities

    517,452,337       509,961,710  
                 

STOCKHOLDERS' EQUITY

               

Common stock (shares issued: 1,125,413 and 1,128,583)

    1,125,413       1,128,583  

Paid-in surplus

    8,908,243       8,908,243  

Accumulated other comprehensive income

    16,251,739       6,751,991  

Retained earnings

    36,744,767       36,858,451  

Total stockholders' equity

    63,030,162       53,647,268  

Total liabilities and stockholders' equity

  $ 580,482,499     $ 563,608,978  

 

See notes to condensed consolidated financial statements.

 

 
4

 

 

INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Income Statements (Unaudited)

 

   

Quarter Ended June 30,

   

Six Months Ended June 30,

 
   

2014

   

2013

   

2014

   

2013

 

REVENUE

                               

Premiums and other considerations

  $ 14,610,152     $ 19,008,321     $ 29,842,638     $ 36,903,377  

Premiums ceded

    (2,829,466 )     (3,573,782 )     (6,185,116 )     (7,581,075 )

Net premiums

    11,780,686       15,434,539       23,657,522       29,322,302  
                                 

Investment income, net of expenses

    5,174,624       5,269,708       10,253,606       10,530,999  

Net realized gains (losses) on investments

    72,665       (24,716 )     68,859       63,251  

Other income

    536,987       365,806       874,859       746,777  

Total revenue

    17,564,962       21,045,337       34,854,846       40,663,329  
                                 

BENEFITS AND EXPENSES

                               

Death and other benefits

    10,282,489       12,048,971       21,303,533       23,179,512  

Guaranteed annual endowments

    119,928       128,264       223,738       237,748  

Dividends to policyholders

    105,299       128,183       188,682       229,001  

Increase in benefit reserves and unearned premiums

    2,569,701       5,697,008       4,548,392       9,243,812  

Acquisition costs deferred

    (1,563,362 )     (2,472,881 )     (3,315,343 )     (4,651,602 )

Amortization of deferred acquisition costs

    1,780,950       2,057,154       3,568,551       3,800,031  

Commissions

    1,139,201       1,925,656       2,446,061       3,668,129  

Other general and administrative expenses

    2,837,816       3,048,012       5,665,997       6,049,875  

Total benefits and expenses

    17,272,022       22,560,367       34,629,611       41,756,506  
                                 

INCOME (LOSS) BEFORE FEDERAL INCOME TAXES

    292,940       (1,515,030 )     225,235       (1,093,177 )
                                 

PROVISION (BENEFIT) FOR FEDERAL INCOME TAXES

                               

Current

    78,131       (509,115 )     104,718       (466,574 )

Deferred

    (19,543 )     54,606       (59,671 )     138,621  

Total federal income taxes

    58,588       (454,509 )     45,047       (327,953 )
                                 

NET INCOME (LOSS)

  $ 234,352     $ (1,060,521 )   $ 180,188     $ (765,224 )
                                 

BASIC AND DILUTED NET INCOME (LOSS) PER SHARE

  $ 0.21     $ (0.93 )   $ 0.16     $ (0.67 )
                                 

DIVIDENDS PER SHARE

  $ -     $ -     $ 0.20     $ 0.25  

 

See notes to condensed consolidated financial statements.

 

 
5

 

  

INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

 

   

Quarter Ended June 30,

   

Six Months Ended June 30,

 
   

2014

   

2013

   

2014

   

2013

 
                                 

NET INCOME (LOSS)

  $ 234,352     $ (1,060,521 )   $ 180,188     $ (765,224 )
                                 

OTHER COMPREHENSIVE INCOME (LOSS):

                               

Change in net unrealized gains (losses) on available-for-sale securities:

                               

Unrealized holding gains (losses) arising during period

    7,477,538       (18,973,830 )     14,645,733       (21,794,920 )

Reclassification adjustment for losses (gains) included in income

    (72,665 )     10,710       (68,859 )     (77,257 )

Adjustment for effects of deferred acquisition costs

    (187,378 )     557,230       (378,522 )     670,593  

Net unrealized gains (losses) on investments

    7,217,495       (18,405,890 )     14,198,352       (21,201,584 )

Change in defined benefit pension plan:

                               

Amortization of actuarial net loss in net periodic pension cost

    97,603       193,162       195,206       386,324  
                                 

Other comprehensive income (loss) before income taxes

    7,315,098       (18,212,728 )     14,393,558       (20,815,260 )
                                 

Income tax expense (benefit)

    2,487,134       (6,203,004 )     4,893,810       (7,087,652 )
                                 

OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAXES

    4,827,964       (12,009,724 )     9,499,748       (13,727,608 )
                                 

COMPREHENSIVE INCOME (LOSS)

  $ 5,062,316     $ (13,070,245 )   $ 9,679,936     $ (14,492,832 )

 

See notes to condensed consolidated financial statements.

 

 
6

 

 

INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Statements of Stockholders' Equity (Unaudited)

 

                   

Accumulated

                 
                   

Other

           

Total

 
   

Common

   

Paid-in

   

Comprehensive

   

Retained

   

Stockholders'

 
   

Stock

   

Surplus

   

Income

   

Earnings

   

Equity

 
                                         

BALANCE, JANUARY 1, 2013

  $ 1,141,886     $ 8,908,243     $ 22,539,724     $ 35,642,931     $ 68,232,784  
                                         

Net loss

    -       -       -       (765,224 )     (765,224 )

Other comprehensive loss, net

    -       -       (13,727,608 )     -       (13,727,608 )

Cash dividends

    -       -       -       (285,471 )     (285,471 )

Repurchases of common stock, net

    (5,154 )     -       -       (113,404 )     (118,558 )

BALANCE, JUNE 30, 2013

  $ 1,136,732     $ 8,908,243     $ 8,812,116     $ 34,478,832     $ 53,335,923  
                                         

BALANCE, JANUARY 1, 2014

  $ 1,128,583     $ 8,908,243     $ 6,751,991     $ 36,858,451     $ 53,647,268  
                                         

Net income

    -       -       -       180,188       180,188  

Other comprehensive income, net

    -       -       9,499,748       -       9,499,748  

Cash dividends

    -       -       -       (225,717 )     (225,717 )

Repurchases of common stock, net

    (3,170 )     -       -       (68,155 )     (71,325 )

BALANCE, JUNE 30, 2014

  $ 1,125,413     $ 8,908,243     $ 16,251,739     $ 36,744,767     $ 63,030,162  

 

See notes to condensed consolidated financial statements.

 

 
7

 

 

INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Statements of Cash Flows (Unaudited)

 

   

Six Months Ended June 30,

 
   

2014

   

2013

 
                 

NET CASH PROVIDED BY OPERATING ACTIVITIES

  $ 5,516,252     $ 7,623,348  
                 

INVESTING ACTIVITIES

               

Purchases of available-for-sale securities

    (20,568,659 )     (36,098,086 )

Sales of available-for-sale securities

    4,047,573       908,149  

Maturities of available-for-sale securities

    13,181,406       27,756,207  

Acquisitions of mortgage loans on real estate

    (2,554,413 )     (505,800 )

Payments of mortgage loans on real estate

    2,061,777       715,685  

Payments of state-guaranteed receivables

    431,020       301,020  

Net reductions (additions) of other investments

    (153,457 )     39,832  

Net additions to property and equipment

    (208,576 )     (66,817 )

NET CASH USED IN INVESTING ACTIVITIES

    (3,763,329 )     (6,949,810 )
                 

FINANCING ACTIVITIES

               

Policyholder account deposits

    2,411,877       2,715,340  

Policyholder account withdrawals

    (3,816,881 )     (4,973,942 )

Payments on notes payable

    (1,619,716 )     (2,088,646 )

Proceeds from notes payable

    1,559,259       2,041,172  

Dividends paid

    (225,717 )     (285,471 )

Repurchases of common stock, net

    (71,325 )     (118,558 )

NET CASH USED IN FINANCING ACTIVITIES

    (1,762,503 )     (2,710,105 )
                 

DECREASE IN CASH AND CASH EQUIVALENTS

    (9,580 )     (2,036,567 )

Cash and cash equivalents at beginning of period

    4,143,291       6,009,905  

CASH AND CASH EQUIVALENTS AT END OF PERIOD

  $ 4,133,711     $ 3,973,338  

 

See notes to condensed consolidated financial statements.

 

 
8

 

 

INVESTORS HERITAGE CAPITAL CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2014

(Unaudited)

 

NOTE 1 - Nature of Operations

Investors Heritage Capital Corporation 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; 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; and is the sole member of Heritage Funding, LLC, a limited liability company that invests in various business ventures. These entities are collectively hereinafter referred to as the “Company”. In excess of 99% of Investors Heritage Capital’s consolidated revenue is generated by Investors Heritage Life.

 

Our principal operations involve the sale and administration of various insurance and annuity products, including, but not limited to, participating and non-participating whole life, limited pay life, universal life, annuity contracts, credit life, credit accident and health and group insurance policies. The principal markets for the Company’s products are in Kentucky, North Carolina, Georgia, Indiana, Michigan, Ohio, Pennsylvania, South Carolina, Tennessee, Texas and Virginia.

 

NOTE 2 - Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles 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 U.S. generally accepted accounting principles 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 quarter and six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2013, as included in our Annual Report on Form 10-K.

 

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

 

Management has evaluated all events subsequent to June 30, 2014 through the date that these financial statements have been issued.

 

NOTE 3 – New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued guidance regarding accounting for revenue recognition that identifies the accounting treatment for an entity’s contracts with customers. Certain contracts, including insurance contracts, are specifically excluded from this guidance. This guidance is effective for public entities for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period.  The Company has not yet adopted this guidance, but it is not expected to have a material impact on our Company’s financial position, cash flows or results of operations.

 

All other new accounting standards and updates of existing standards issued through the date of this filing were considered by management and did not relate to accounting policies and procedures pertinent to the Company at this time or were not expected to have a material impact to the consolidated financial statements.

 

 
9

 

 

NOTE 4 – Investments

Investments in available-for-sale securities are summarized as follows:

 

           

Gross

   

Gross

         

June 30, 2014

 

Amortized

   

Unrealized

   

Unrealized

   

Fair

 
   

Cost

   

Gains

   

Losses

   

Value

 

Fixed maturity securities:

                               

U.S. government obligations

  $ 32,299,152     $ 938,164     $ 90,810     $ 33,146,506  

States and political subdivisions

    38,679,485       4,988,285       -       43,667,770  

Corporate

    218,381,654       17,968,264       289,245       236,060,673  

Foreign

    63,810,146       3,516,199       135,140       67,191,205  

Asset-backed securities

    1,580,807       62,516       -       1,643,323  

Mortgage-backed securities (MBS):

                               

Commercial MBS

    7,347,396       222,740       38       7,570,098  

Residential MBS

    43,229,815       2,233,372       -       45,463,187  

Total fixed maturity securities

    405,328,455       29,929,540       515,233       434,742,762  

Equity securities:

                               

U.S. agencies

    707,900       -       -       707,900  

Mutual funds

    318,284       38,341       -       356,625  

Corporate common stock

    5,040,671       699,065       131,953       5,607,783  

Total equity securities

    6,066,855       737,406       131,953       6,672,308  

Total

  $ 411,395,310     $ 30,666,946     $ 647,186     $ 441,415,070  

 

           

Gross

   

Gross

         

December 31, 2013

 

Amortized

   

Unrealized

   

Unrealized

   

Fair

 
   

Cost

   

Gains

   

Losses

   

Value

 

Fixed maturity securities:

                               

U.S. government obligations

  $ 34,485,660     $ 793,701     $ 703,570     $ 34,575,791  

States and political subdivisions

    39,910,030       3,145,632       60,898       42,994,764  

Corporate

    217,659,449       12,535,411       2,251,886       227,942,974  

Foreign

    56,960,366       2,081,436       1,395,450       57,646,352  

Asset-backed securities

    2,677,953       109,417       -       2,787,370  

Mortgage-backed securities (MBS):

                               

Commercial MBS

    4,252,765       160,955       -       4,413,720  

Residential MBS

    46,449,968       1,443,228       345,062       47,548,134  

Total fixed maturity securities

    402,396,191       20,269,780       4,756,866       417,909,105  

Equity securities:

                               

U.S. agencies

    687,000       -       -       687,000  

Mutual funds

    318,283       1,356       -       319,639  

Corporate common stock

    4,883,078       422,880       494,264       4,811,694  

Total equity securities

    5,888,361       424,236       494,264       5,818,333  

Total

  $ 408,284,552     $ 20,694,016     $ 5,251,130     $ 423,727,438  

 

 
10

 

 

The following table summarizes, for all securities in an unrealized loss position as of the balance sheet dates, the estimated fair value, pre-tax gross unrealized loss and number of securities by length of time that those securities have been continuously in an unrealized loss position.

 

   

June 30, 2014

   

December 31, 2013

 
           

Gross

   

Number

           

Gross

   

Number

 
   

Estimated

   

Unrealized

   

of

   

Estimated

   

Unrealized

   

of

 
   

Fair Value

   

Loss

   

Securities

   

Fair Value

   

Loss

   

Securities

 

Fixed Maturities:

                                               

Less than 12 months:

                                               

U.S. government obligations

  $ -     $ -       -     $ 17,401,555     $ 703,570       3  

States and political subdivisions

    -       -       -       1,239,103       60,898       2  

Corporate

    2,000,636       7,167       1       56,249,758       2,076,123       37  

Foreign

    4,363,294       18,539       3       26,858,417       1,395,450       15  

Commercial MBS

    64,371       38       1       -       -       -  

Residential MBS

    -       -       -       18,187,588       345,062       4  

Greater than 12 months:

                                               

U.S. government obligations

    7,681,258       90,810       1       -       -       -  

Corporate

    4,394,471       282,078       4       1,072,341       175,763       1  

Foreign

    7,036,987       116,601       3       -       -       -  

Total fixed maturities

    25,541,017       515,233       13       121,008,762       4,756,866       62  
                                                 

Equities:

                                               

Less than 12 months:

                                               

Corporate common stock

    275,396       16,003       6       2,806,072       494,264       24  

Greater than 12 months:

                                               

Corporate common stock

    1,341,361       115,950       11       -       -       -  

Total equities

    1,616,757       131,953       17       2,806,072       494,264       24  
                                                 

Total

  $ 27,157,774     $ 647,186       30     $ 123,814,834     $ 5,251,130       86  

 

As of June 30, 2014, all of the above fixed maturity securities individually had a fair value to cost ratio equal to or greater than 88% and the equity securities had a fair value to cost ratio equal to or exceeding 82%. As of December 31, 2013, all of the above fixed maturity securities had a fair value to cost ratio equal to or greater than 84% and the equity securities noted above had a fair value to cost ratio equal to or greater than 70%.

 

The Company’s decision to record an impairment loss is primarily based on whether the security’s fair value is likely to remain significantly below its book value in light of all the factors considered. Factors that are considered include the length of time the security’s fair value has been below its carrying amount, the severity of the decline in value, the credit worthiness of the issuer, and the coupon and/or dividend payment history of the issuer. The Company also assesses whether it intends to sell or whether it is more likely than not that it may be required to sell the security prior to its recovery in value. For any fixed maturity securities that are other-than-temporarily impaired, the Company determines the portion of the other-than-temporary impairment that is credit-related and the portion that is related to other factors. The credit-related portion is the difference between the expected future cash flows and the amortized cost basis of the fixed maturity security, and that difference is charged to earnings. The non-credit-related portion representing the remaining difference to fair value is recognized in other comprehensive income (loss). Only in the case of a credit-related impairment where management has the intent to sell the security, or it is more likely than not that it will be required to sell the security before recovery of its cost basis, is a fixed maturity security adjusted to fair value and the resulting losses recognized in realized gains (losses) in the consolidated statements of income. Any other-than-temporary impairments on equity securities are recorded in the consolidated statements of income in the periods incurred as the difference between fair value and cost. Based on our review, the Company experienced no other-than-temporary impairments during the quarters or six months ended June 30, 2014 or 2013.

 

 
11

 

 

Management believes that the Company will fully recover its cost basis in the securities held at June 30, 2014, and management does not have the intent to sell nor is it more likely than not that the Company will be required to sell such securities until they recover or mature. The temporary impairments shown herein are primarily the result of the current interest rate environment rather than credit factors that would imply other-than-temporary impairment.

 

Net unrealized gains for investments classified as available-for-sale are presented below, net of the effect on deferred income taxes and deferred acquisition costs assuming that the appreciation (depreciation) had been realized.

  

   

June 30,

   

December 31,

 
   

2014

   

2013

 

Net unrealized appreciation on available-for sale securities

  $ 30,019,760     $ 15,442,886  

Adjustment to deferred acquisition costs

    (796,941 )     (418,419 )

Deferred income taxes

    (9,935,759 )     (5,108,319 )

Net unrealized appreciation on available-for sale securities

  $ 19,287,060     $ 9,916,148  

 

The amortized cost and fair value of fixed maturity securities at June 30, 2014, by contractual maturity, are presented 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.

  

   

Available-for-Sale

 
   

Amortized

   

Fair

 
   

Cost

   

Value

 

Due in one year or less

  $ 4,563,723     $ 4,680,629  

Due after one year through five years

    75,557,902       83,659,927  

Due after five years through ten years

    194,689,572       207,057,787  

Due after ten years

    49,881,996       55,616,632  

Due at multiple maturity dates

    80,635,262       83,727,787  

Total

  $ 405,328,455     $ 434,742,762  

 

Proceeds for the quarters and six months ended June 30, 2014 and 2013 from sales and maturities of investments in available-for-sale securities, as well as gross gains and gross losses realized, are presented below.

  

   

Quarter Ended June 30,

   

Six Months Ended June 30,

 
   

2014

   

2013

   

2014

   

2013

 

Proceeds from sales and maturities

  $ 10,078,931     $ 16,566,630     $ 17,228,979     $ 28,664,356  

Gross realized gains

    152,138       5,719       173,810       108,383  

Gross realized losses

    (79,473 )     (16,429 )     (104,951 )     (31,126 )

 

 
12

 

 

The table below shows the change in net unrealized investment gains (losses) and the amount of realized investment gains (losses) on fixed maturities and equity securities for the quarters and six months ended June 30, 2014 and 2013.

 

   

Quarter Ended June 30,

   

Six Months Ended June 30,

 
   

2014

   

2013

   

2014

   

2013

 

Change in unrealized investment gains (losses):

                               

Available-for-sale:

                               

Fixed maturities

  $ 7,041,196     $ (18,548,532 )   $ 13,901,393     $ (21,480,323 )

Equity securities

    363,677       (414,588 )     675,481       (391,854 )

Realized investment gains (losses):

                               

Available-for-sale:

                               

Fixed maturities

  $ 68,188     $ 1,680     $ 68,188     $ 89,647  

Equity securities

    4,477       (12,390 )     671       (12,390 )

 

The Company is required to hold assets on deposit for the benefit of policyholders in accordance with statutory rules and regulations. At June 30, 2014 and December 31, 2013, these required deposits had a total fair value of $24,446,501 and $25,209,390, respectively.

 

The Company also engages in commercial and residential mortgage lending. As of June 30, 2014 and December 31, 2013, 69.5% and 83.2%, respectively, of these investments were in commercial properties. All commercial mortgage loans are either originated in-house or through two mortgage brokers, are secured by first mortgages on the real estate and generally carry personal guarantees by the borrowers. Loan to value ratios of 80% or less and debt service coverage from existing cash flows of 115% or higher are generally required. We minimize credit risk in our mortgage loan portfolio through various methods, including stringently underwriting the loan request, maintaining small average loan balances, and reviewing larger mortgage loans on an annual basis. As of June 30, 2014 and December 31, 2013, there were no non-performing loans, loans on nonaccrual status, loans 90 days past due or more, loans in process of foreclosure, or restructured loans. The Company experienced no mortgage loan defaults during the quarters or six months ended June 30, 2014 and 2013.

 

During 2013, we began evaluating and purchasing residential mortgage loans through the secondary market. We review each mortgage loan opportunity individually, considering both the value of the underlying property and the credit worthiness of the borrower. During the quarter and six months ended June 30, 2014, we purchased residential mortgages through the secondary market totaling approximately $1,522,000 and $2,254,000, respectively. During the year ended December 31, 2013, we purchased residential mortgages through the secondary market totaling approximately $2,116,000. We are utilizing a third party servicer to administer these loans.

 

 
13

 

 

 

The Company owns certain investments in state-guaranteed receivables. These investments represent an assignment of the future rights to cash flows from lottery winners purchased at a discounted price. Payments on these investments are made by state run lotteries and guaranteed by the states. The state-guaranteed receivables are carried at their amortized cost basis on the balance sheet. At June 30, 2014, the amortized cost and estimated fair value of state-guaranteed receivables, by contractual maturity, are summarized as follows:

 

   

Amortized

   

Fair

 
   

Cost

   

Value

 

Due in one year or less

  $ 701,042     $ 710,324  

Due after one year through five years

    2,466,328       2,678,524  

Due after five years through ten years

    2,926,813       3,592,598  

Due after ten years

    1,844,418       2,581,021  

Total

  $ 7,938,601     $ 9,562,467  

 

The amortized cost of state-guaranteed receivables, by state, is summarized as follows:

 

   

June 30,

   

December 31,

 
   

2014

   

2013

 

New York

  $ 3,746,128     $ 3,880,368  

Massachusetts

    1,918,175       1,927,350  

Georgia

    1,510,514       1,500,719  

Pennsylvania

    294,809       284,756  

Texas

    220,048       212,447  

California

    181,928       195,593  

Ohio

    66,999       83,874  

Total

  $ 7,938,601     $ 8,085,107  

 

 

Prior to the third quarter of 2013, the Company owned a $3,000,000 position in a Morgan Stanley market-indexed note, which paid 1% interest annually and matured in six years from the issue date. At maturity, the Company would have participated at 110% of any increase in the Dow Jones Industrial Average since the purchase date, but were guaranteed against market-related downside risk. Accordingly, a portion of the investment was classified as a derivative and bifurcated for reporting purposes. The derivative portion, having a cost basis of $645,000 calculated at 21.5% of the total value of the purchase price of the note, was reported as an investment in derivative on the balance sheet. The remaining non-derivative portion of the note was reported within fixed maturities on the balance sheet. This derivative was marked-to-market through the income statement, with the change in value reported as a component of investment income on the income statement. This investment was sold during the third quarter of 2013 for $3,918,083, generating a realized gain of $918,083. This realized gain was partially offset by the reduction in investment income previously recognized that was associated with the removal of the mark-to-market adjustment.

 

 
14

 

 

Major categories of net investment income are summarized as follows:

 

   

Quarter Ended June 30,

   

Six Months Ended June 30,

 
   

2014

   

2013

   

2014

   

2013

 

Fixed maturities

  $ 4,729,760     $ 4,798,389     $ 9,438,841     $ 9,605,911  

Equity securities

    75,841       35,836       127,478       49,731  

Mortgage loans on real estate

    352,824       274,334       656,700       552,398  

Policy loans

    118,448       117,978       235,377       236,090  

State-guaranteed receivables

    140,719       143,622       284,514       289,876  

Gain on investment in derivative

    -       121,500       -       243,000  

Other

    60,429       60,559       117,486       119,013  

Gross investment income

    5,478,021       5,552,218       10,860,396       11,096,019  

Investment expenses

    303,397       282,510       606,790       565,020  

Net investment income

  $ 5,174,624     $ 5,269,708     $ 10,253,606     $ 10,530,999  

 

 

NOTE 5 – Fair Values of Financial Instruments

The fair value of a financial instrument is the estimated amount at which the instrument could be exchanged in an orderly transaction between knowledgeable, unrelated, willing parties, i.e., not in a forced transaction.  The estimated fair value of a financial instrument may differ from the amount that could be realized if the security was sold in an immediate sale, e.g., a forced transaction.  Additionally, the valuation of investments is more subjective when markets are less liquid due to the lack of market based inputs, which may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction would occur.

 

The Company holds fixed maturities and equity securities that are measured and reported at fair market value on the balance sheet. The Company is also required to disclose fair value estimates for other financial instruments not required to be carried at market value on the balance sheet. The Company determines the fair market values of its financial instruments based on the fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value, as follows:

 

Level 1 - Quoted prices in active markets for identical assets or liabilities.

 

Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. The unobservable inputs reflect the Company’s own assumptions about the inputs that market participants would use.

 

The Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into the three-level fair value hierarchy. If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the valuation inputs, or their ability to be observed, may result in a reclassification for certain financial assets or liabilities. Reclassifications impacting Level 3 of the fair value hierarchy are reported as transfers in/out of the Level 3 category as of the beginning of the period in which the reclassifications occur.

 

 
15

 

 

Valuation of Investments Reported at Fair Value in Financial Statements

 

The Company’s Level 1 investments include equity securities that are traded in an active exchange market, as well as one U.S. agency equity security whose value is set by government statute.

 

The Company’s Level 2 investments include fixed maturities with quoted prices that are traded less frequently than exchange-traded instruments or instruments whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes the majority of our fixed maturities, where fair values are obtained from a nationally recognized, third-party pricing service.

 

The Company’s Level 3 investments include financial instruments whose value cannot be obtained through a pricing service and must be determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. This category currently includes one private equity investment where independent pricing inputs were not able to be obtained. For the fixed maturities that may fall within this level, the Company utilizes the assistance of its third-party investment advisor to estimate the fair value based on non-binding broker quotes and internal models using unobservable assumptions about market participants. For the private equity investment, the Company establishes fair value based on the most recent trading activity as well as a review of the underlying financial statements of the entity. The Company’s Level 3 segment also included the investment in derivative related to the bifurcated equity-indexed portion of a market-indexed note prior to its sale during the third quarter of 2013. The value of the derivative portion of this investment was derived from an option pricing model that utilizes the Dow Jones Industrial Average as of the measurement date compared to the strike price in the note, along with various other market assumptions including those regarding volatility and dividend yields.

 

 
16

 

 

The following table presents the Company’s fair value hierarchy for those financial instruments measured and reported at fair value on a recurring basis as of June 30, 2014 and December 31, 2013.

 

   

June 30, 2014

 
   

Level 1

   

Level 2

   

Level 3

   

Total

 

Fixed maturities:

                               

U.S. government obligations

  $ -     $ 33,146,506     $ -     $ 33,146,506  

States and political subdivisions

    -       43,667,770       -       43,667,770  

Corporate

    -       236,060,673       -       236,060,673  

Foreign

    -       67,191,205       -       67,191,205  

Asset-backed securities

    -       1,643,323       -       1,643,323  

Mortgage-backed securities:

                               

Commercial MBS

    -       7,570,098       -       7,570,098  

Residential MBS

    -       45,463,187       -       45,463,187  

Total fixed maturities

  $ -     $ 434,742,762     $ -     $ 434,742,762  
                                 

Equity securities:

                               

U.S. agencies

  $ 707,900     $ -     $ -     $ 707,900  

Mutual funds

    356,625       -       -       356,625  

Corporate common stock

    5,223,783       -       384,000       5,607,783  

Total equity securities

  $ 6,288,308     $ -     $ 384,000     $ 6,672,308  
                                 

 

   

December 31, 2013

 
   

Level 1

   

Level 2

   

Level 3

   

Total

 

Fixed maturities:

                               

U.S. government obligations

  $ -     $ 34,575,791     $ -     $ 34,575,791  

States and political subdivisions

    -       42,994,764       -       42,994,764  

Corporate

    -       227,942,974       -       227,942,974  

Foreign

    -       57,646,352       -       57,646,352  

Asset-backed securities

    -       2,787,370       -       2,787,370  

Mortgage-backed securities:

                               

Commercial MBS

    -       4,413,720       -       4,413,720  

Residential MBS

    -       47,548,134       -       47,548,134  

Total fixed maturities

  $ -     $ 417,909,105     $ -     $ 417,909,105  
                                 

Equity securities:

                               

U.S. agencies

  $ 687,000     $ -     $ -     $ 687,000  

Mutual funds

    319,639       -       -       319,639  

Corporate common stock

    4,427,694       -       384,000       4,811,694  

Total equity securities

  $ 5,434,333     $ -     $ 384,000     $ 5,818,333  

 

 
17

 

 

The following table provides a summary of changes in fair value of our Level 3 financial instruments reported at fair value for the quarters and six months ended June 30, 2014 and 2013.

  

   

Quarter Ended June 30, 2014

 
                   

Corporate

   

Investment

         
                   

Common

   

in

         
   

Corporate

   

Foreign

   

Stock

   

Derivative

   

Total

 

Beginning balance

  $ -     $ -     $ 384,000     $ -     $ 384,000  

Transfers into Level 3

    -       -       -       -       -  

Transfers out of Level 3

    -       -       -       -       -  

Purchases

    -       -       -       -       -  

Sales

    -       -       -       -       -  

Total gains or losses:

                                       

Included in earnings

    -       -       -       -       -  

Included in other comprehensive income

    -       -       -       -       -  

Ending balance

  $ -     $ -     $ 384,000     $ -     $ 384,000  
                                         
                                         

 

   

Quarter Ended June 30, 2013

 
                   

Corporate

   

Investment

         
                   

Common

   

in

         
   

Corporate

   

Foreign

   

Stock

   

Derivative

   

Total

 

Beginning balance

  $ 2,033,750     $ -     $ 384,000     $ 764,100     $ 3,181,850  

Transfers into Level 3

    -       -       -       -       -  

Transfers out of Level 3

    -       -       -       -       -  

Purchases

    -       2,025,000       -       -       2,025,000  

Sales

    -       (335 )     -       -       (335 )

Total gains or losses:

                                       

Included in earnings

    -       -       -       121,500       121,500  

Included in other comprehensive income

    (143,750 )     (29,665 )     -       -       (173,415 )

Ending balance

  $ 1,890,000     $ 1,995,000     $ 384,000     $ 885,600     $ 5,154,600  

 

 
18

 

 

   

Six Months Ended June 30, 2014

 
                   

Corporate

   

Investment

         
                   

Common

   

in

         
   

Corporate

   

Foreign

   

Stock

   

Derivative

   

Total

 

Beginning balance

  $ -     $ -     $ 384,000     $ -     $ 384,000  

Transfers into Level 3

    -       -       -       -       -  

Transfers out of Level 3

    -       -       -       -       -  

Purchases

    -       -       -       -       -  

Sales

    -       -       -       -       -  

Total gains or losses:

                                       

Included in earnings

    -       -       -       -       -  

Included in other comprehensive loss

    -       -       -       -       -  

Ending balance

  $ -     $ -     $ 384,000     $ -     $ 384,000  

 

   

Six Months Ended June 30, 2013

 
                   

Corporate

   

Investment

         
                   

Common

   

in

         
   

Corporate

   

Foreign

   

Stock

   

Derivative

   

Total

 

Beginning balance

  $ 3,834,470     $ -     $ 384,000     $ 642,600     $ 4,861,070  

Transfers into Level 3

    -       -       -       -       -  

Transfers out of Level 3

    (3,834,470 )     -       -       -       (3,834,470 )

Purchases

    2,000,000       2,025,000       -       -       4,025,000  

Sales

    -       (335 )     -       -       (335 )

Total gains or losses:

                                       

Included in earnings

    -       -       -       243,000       243,000  

Included in other comprehensive income

    (110,000 )     (29,665 )     -       -       (139,665 )

Ending balance

  $ 1,890,000     $ 1,995,000     $ 384,000     $ 885,600     $ 5,154,600  

 

The Company experienced no transfers between Level 1 and Level 2 during the quarters or six months ended June 30, 2014 or 2013. The Company experienced no transfers between Level 2 and Level 3 during the quarter or six months ended June 30, 2014. The Company experienced no transfers between Level 2 and Level 3 during the quarter ended June 30, 2013. The Company had four corporate fixed maturities that transferred from Level 3 to Level 2 during the six months ended June 30, 2013. Transfers in and/or out of Level 3 are primarily attributable to changes in the availability of market observable information and re-evaluation of the observability of pricing inputs.

 

The unrealized gains (losses) on Level 3 investments, other than the investment in derivative, are recorded as a component of accumulated other comprehensive income (loss), net of tax, in accordance with required accounting for our available-for-sale portfolio. The unrealized gains (losses) on the investment in derivative are reported in earnings as a component of investment income.

 

Financial Instruments Disclosed, but not Carried, at Fair Value

 

The following disclosure presents the carrying values and estimated fair values of the Company’s financial instruments disclosed, but not carried, at fair value as of June 30, 2014 and December 31, 2013, and the level within the fair value hierarchy at which such assets and liabilities are measured on a recurring basis. The fair values for insurance contracts other than investment-type contracts are not required to be disclosed. The estimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, considerable judgment was required to interpret market data to develop these estimates. Accordingly, the estimates are not necessarily indicative of the amounts which could be realized in a current market exchange. The use of different market assumptions or estimation methodologies may have a material effect on the fair value amounts.

 

 
19

 

 

   

June 30, 2014

 
   

Carrying

   

Fair

                         
   

Amount

   

Value

   

Level 1

   

Level 2

   

Level 3

 

Assets:

                                       

Mortgage loans on real estate:

                                       

Commercial

  $ 13,283,850     $ 14,101,357     $ -     $ -     $ 14,101,357  

Residential

    5,820,856       6,347,380       -       -       6,347,380  

Policy loans

    6,681,655       6,681,655       -       -       6,681,655  

State-guaranteed receivables

    7,938,601       9,562,467       -       9,562,467       -  

Other invested assets

    3,327,871       3,327,871       -       -       3,327,871  

Cash and cash equivalents

    4,133,711       4,133,711       4,133,711       -       -  

Accrued investment income

    5,289,921       5,289,921       -       -       5,289,921  

Cash value of company-owned life insurance

    11,603,169       11,603,169       -       -       11,603,169  
                                         

Liabilities:

                                       

Policyholder deposits (Investment-type contracts)

    53,589,733       54,436,078       -       -       54,436,078  

Policy claims

    2,925,685       2,925,685       -       -       2,925,685  

Obligations under capital leases

    712,053       712,053       -       -       712,053  

Notes payable

    2,971,485       2,971,924       -       -       2,971,924  
                                         
                                         

 

   

December 31, 2013

 
   

Carrying

   

Fair

                         
   

Amount

   

Value

   

Level 1

   

Level 2

   

Level 3

 

Assets:

                                       

Mortgage loans on real estate:

                                       

Commercial

  $ 15,478,188     $ 16,128,845     $ -     $ 16,128,845     $ -  

Residential

    3,123,534       3,273,306       -       3,273,306       -  

Policy loans

    6,674,887       6,674,887       -       -       6,674,887  

State-guaranteed receivables

    8,085,107       9,392,660       -       9,392,660       -  

Other invested assets

    3,181,182       3,181,182       -       -       3,181,182  

Cash and cash equivalents

    4,143,291       4,143,291       4,143,291       -       -  

Accrued investment income

    5,191,253       5,191,253       -       -       5,191,253  

Cash value of company-owned life insurance

    11,808,248       11,808,248       -       -       11,808,248  
                                         

Liabilities:

                                       

Policyholder deposits (Investment-type contracts)

    53,476,853       53,396,538       -       -       53,396,538  

Policy claims

    3,672,474       3,672,474       -       -       3,672,474  

Obligations under capital leases

    943,488       943,488       -       -       943,488  

Notes payable

    3,031,942       3,033,122       -       -       3,033,122  

 

 
20

 

 

The following methods and assumptions were used in estimating the fair value disclosures for financial instruments in the accompanying financial statements and notes thereto:

 

Mortgage loans on real estate: The fair values for mortgage loans are estimated using discounted cash flow analyses. For commercial mortgage loans, the discount rate was assumed to be the interest rate of the last commercial mortgage acquired by the Company. For residential mortgage loans, the discount rate was assumed to be the average yield on recent purchases less an expense factor. These investment fair values were moved from Level 2 to Level 3 in the fair value hierarchy during the second quarter of 2014 given the expansion of our residential mortgage loans and the unobservable inputs used to determine those fair values.

 

State-guaranteed receivables: The fair values for state-guaranteed receivables are estimated using discounted cash flow analyses, using the average Citigroup Pension Liability Index in effect at the end of each period.

 

Cash and cash equivalents: The carrying amounts reported for these financial instruments approximate their fair values given the highly liquid nature of the instruments.

 

Cash value of company-owned life insurance: The carrying values and fair values for these policies are based on the current cash surrender values of the policies.

 

Investment-type contracts: The fair value for liabilities under investment-type insurance contracts (accumulation annuities) is calculated using a discounted cash flow approach. Cash flows are projected using actuarial assumptions and discounted to the valuation date using risk-free rates adjusted for credit risk and the nonperformance risk of the liabilities.

 

Notes payable: The fair values for notes payable on commercial loans with fixed interest rates are estimated using discounted cash flow analyses, assuming current interest rate assumptions for similar borrowings based on information gathered from market loan brokers. The fair value for notes payable with floating interest rates and promissory notes approximate the unpaid principal balances on such notes.

 

Policy loans, other invested assets, accrued investment income, policy claims and obligations under capital leases: The carrying values of these instruments approximate their fair values and are disclosed in Level 3 of the hierarchy.

 

NOTE 6 - Earnings per Share

Earnings per share of common stock were computed based on the weighted average number of common shares outstanding during each period. The weighted average number of shares outstanding for the quarters ended June 30, 2014 and 2013 were 1,127,225 and 1,140,116, respectively. The weighted average number of shares outstanding for the six months ended June 30, 2014 and 2013 were 1,127,900 and 1,140,996, respectively.

 

 
21

 

 

NOTE 7 - Segment Data

The Company operates in four segments as shown in the following table. All segments include both individual and group insurance. Identifiable revenues, expenses and assets are assigned directly to the applicable segment. Net investment income, realized gains and losses, and invested assets are generally allocated to the insurance and the corporate segments in proportion to policy liabilities and stockholders' equity, respectively. Certain assets, such as property and equipment and leased property under capital leases, are allocated between the administrative and financial services segment and the corporate and other segment. Investors Heritage Financial revenue and income associated with credit administrative services is assigned to the administrative and financial services segment, along with fees relative to third party administrative services. Any remaining revenue and income is assigned to the corporate and other segment. Results for the parent company, Investors Heritage Printing, At Need Funding and Heritage Funding, after elimination of intercompany amounts, are allocated to the corporate and other segment.

 

   

Quarter Ended June 30,

   

Six Months Ended June 30,

 
   

2014

   

2013

   

2014

   

2013

 
                                 

Revenue:

                               

Preneed and burial products

  $ 12,378,694     $ 12,906,857     $ 23,591,408     $ 25,261,222  

Traditional and universal life products

    4,499,730       7,531,626       10,097,262       14,129,925  

Administrative and financial services

    348,573       315,948       626,009       643,512  

Corporate and other

    337,965       290,906       540,167       628,670  

Total revenue

  $ 17,564,962     $ 21,045,337     $ 34,854,846     $ 40,663,329  
                                 

Pre-tax income (loss) from operations:

                               

Preneed and burial products

  $ (50,136 )   $ 72,185     $ (358,714 )   $ 7,210  

Traditional and universal life products

    88,686       (1,694,923 )     281,177       (1,399,579 )

Administrative and financial services

    67,678       55,259       113,909       128,818  

Corporate and other

    186,712       52,449       188,863       170,374  

Total pre-tax income (loss)

  $ 292,940     $ (1,515,030 )   $ 225,235     $ (1,093,177 )

 

 

Included in the Corporate and other revenue and pre-tax income above and as a component of other income in the consolidated income statement for the quarter and six months ended June 30, 2014 is $141,907 of net life insurance proceeds received under a company-owned life insurance policy upon the death of a former board member.

 

At June 30, 2013, the Company’s death and other benefits included an additional amount totaling $2,029,462 relative to a comparison of our life insurance policies against the Social Security Death Master File. This comparison was performed in compliance with a recently enacted Kentucky state law which follows a model law adopted by the National Conference of Insurance Legislators. This amount primarily affects the traditional and universal life segment, along with a much smaller impact on the final expense portion of the preneed and burial segment. The Company is in the process of researching the potential matches to determine that a valid claim exists, to locate beneficiaries and to pay benefits accordingly.

 

NOTE 8 – Federal Income Taxes

The provision for federal income taxes is based on the estimated 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 dividends-received deduction; the 404(k) dividend deduction; the small life insurance company tax deduction; and non-taxable effects of company-owned life insurance premiums, cash value growth, and death benefit proceeds.

 

 
22

 

 

We file U.S. federal income tax returns and income tax returns in various state jurisdictions. Our 2010 through 2013 U.S. federal tax years remain subject to income tax examination by tax authorities. We have no known uncertain tax benefits within our provision for income taxes. In addition, we do not believe the Company will be subject to any penalties or interest relative to any open tax years and, therefore, have not accrued any such amounts. However, should such a circumstance arise, it is our policy to classify any interest and penalties (if applicable) as income tax expense in the financial statements.

 

NOTE 9 – Other Comprehensive Income (Loss)

The following tables present the pretax components of the Company’s other comprehensive income (loss), and the related income tax expense (benefit) for each component, for the quarters and six months ended June 30, 2014 and 2013.

  

   

Quarter Ended June 30, 2014

 
           

Income Tax

         
           

Expense

         
   

Pretax

   

(Benefit)

   

Net of Tax

 

Other comprehensive income:

                       

Change in net unrealized gains on available-for-sale securities:

                       

Unrealized holding gains arising during period

  $ 7,477,538     $ 2,532,191     $ 4,945,347  

Reclassification adjustment for gains included in income

    (72,665 )     (14,533 )     (58,132 )

Adjustment for effect of deferred acquisition costs

    (187,378 )     (63,709 )     (123,669 )

Net unrealized gains on investments

    7,217,495       2,453,949       4,763,546  

Change in defined benefit pension plan:

                       

Amortization of actuarial net loss in net periodic pension cost

    97,603       33,185       64,418  
                         

Total other comprehensive income

  $ 7,315,098     $ 2,487,134     $ 4,827,964  
                         

 

   

Quarter Ended June 30, 2013

 
           

Income Tax

         
           

Expense

         
   

Pretax

   

(Benefit)

   

Net of Tax

 

Other comprehensive loss:

                       

Change in net unrealized gains on available-for-sale securities:

                       

Unrealized holding losses arising during period

  $ (18,973,830 )   $ (6,455,742 )   $ (12,518,088 )

Reclassification adjustment for losses included in income

    10,710       (2,394 )     13,104  

Adjustment for effect of deferred acquisition costs

    557,230       189,457       367,773  

Net unrealized losses on investments

    (18,405,890 )     (6,268,679 )     (12,137,211 )

Change in defined benefit pension plan:

                       

Amortization of actuarial net loss in net periodic pension cost

    193,162       65,675       127,487  
                         

Total other comprehensive loss

  $ (18,212,728 )   $ (6,203,004 )   $ (12,009,724 )

  

 

 
23

 

 

   

Six Months Ended June 30, 2014

 
           

Income Tax

         
           

Expense

         
   

Pretax

   

(Benefit)

   

Net of Tax

 

Other comprehensive income:

                       

Change in net unrealized gains on available-for-sale securities:

                       

Unrealized holding gains arising during period

  $ 14,645,733     $ 4,969,909     $ 9,675,824  

Reclassification adjustment for gains included in income

    (68,859 )     (13,772 )     (55,087 )

Adjustment for effect of deferred acquisition costs

    (378,522 )     (128,697 )     (249,825 )

Net unrealized gains on investments

    14,198,352       4,827,440       9,370,912  

Change in defined benefit pension plan:

                       

Amortization of actuarial net loss in net periodic pension cost

    195,206       66,370       128,836  
                         

Total other comprehensive income

  $ 14,393,558     $ 4,893,810     $ 9,499,748  
                         

 

   

Six Months Ended June 30, 2013

 
           

Income Tax

         
           

Expense

         
   

Pretax

   

(Benefit)

   

Net of Tax

 

Other comprehensive loss:

                       

Change in net unrealized gains on available-for-sale securities:

                       

Unrealized holding losses arising during period

  $ (21,794,920 )   $ (7,414,784 )   $ (14,380,136 )

Reclassification adjustment for gains included in income

    (77,257 )     (32,218 )     (45,039 )

Adjustment for effect of deferred acquisition costs

    670,593       228,000       442,593  

Net unrealized losses on investments

    (21,201,584 )     (7,219,002 )     (13,982,582 )

Change in defined benefit pension plan:

                       

Amortization of actuarial net loss in net periodic pension cost

    386,324       131,350       254,974  
                         

Total other comprehensive loss

  $ (20,815,260 )   $ (7,087,652 )   $ (13,727,608 )

 

Realized gains and losses on the sales of investments are determined based upon the specific identification method and include provisions for other-than-temporary impairments where appropriate.

 

 
24

 

 

The change in the components of the Company’s accumulated other comprehensive income, net of tax, for the six months ended June 30, 2014 and 2013 are as follows:

 

   

Unrealized Gains

   

Defined

   

Accumulated

 
   

(Losses) on

   

Benefit

   

Other

 
   

Available-For-Sale

   

Pension

   

Comprehensive

 
   

Securities

   

Plan

   

Income

 

For the six months ended June 30, 2014:

                       

Beginning balance

  $ 9,916,148     $ (3,164,157 )   $ 6,751,991  

Other comprehensive income before reclassifications

    9,425,999       -       9,425,999  

Amounts reclassified from accumulated other comprehensive income

    (55,087 )     128,836       73,749  

Net current period other comprehensive income

    9,370,912       128,836       9,499,748  

Ending balance

  $ 19,287,060     $ (3,035,321 )   $ 16,251,739  
                         

For the six months ended June 30, 2013:

                       

Beginning balance

  $ 28,088,103     $ (5,548,379 )   $ 22,539,724  

Other comprehensive loss before reclassifications

    (13,937,543 )     -       (13,937,543 )

Amounts reclassified from accumulated other comprehensive income

    (45,039 )     254,974       209,935  

Net current period other comprehensive income (loss)

    (13,982,582 )     254,974       (13,727,608 )

Ending balance

  $ 14,105,521     $ (5,293,405 )   $ 8,812,116  

 

 

The following table presents the pretax and the related income tax components of the amounts reclassified from the Company’s accumulated other comprehensive income to the Company’s consolidated statement of income for the quarters and six months ended June 30, 2014 and 2013.

 

   

Quarter Ended June 30,

   

Six Months Ended June 30,

 

Reclassification Adjustments

 

2014

   

2013

   

2014

   

2013

 

Unrealized gains on available-for-sale securities:

                               

Realized gains (losses) on sale of securities (a)

  $ 72,665     $ (10,710 )   $ 68,859     $ 77,257  

Income tax benefit (expense) (c)

    (14,533 )     (2,394 )     (13,772 )     (32,218 )

Net of tax

    58,132       (13,104 )     55,087       45,039  
                                 

Defined benefit pension plan:

                               

Amortization of actuarial net loss (b)

    (97,603 )     (193,162 )     (195,206 )     (386,324 )

Income tax benefit (c)

    33,185       65,675       66,370       131,350  

Net of tax

    (64,418 )     (127,487 )     (128,836 )     (254,974 )
                                 

Total reclassifications for the period

  $ (6,286 )   $ (140,591 )   $ (73,749 )   $ (209,935 )

 

(a) These items appear within net realized gains (losses) on investments in the consolidated income statements.

(b) These items are included in the computation of net periodic pension cost (see Note 10).

(c) These items appear within federal income taxes in the consolidated income statements.

 

 
25

 

 

NOTE 10 – Employee Benefit Plans

Investors Heritage Capital Corporation sponsors a noncontributory defined benefit pension plan. Benefits under this plan were curtailed for covered employees effective as of June 30, 2012, and no further benefits are being earned under this plan. The following table provides the components of our net periodic benefit cost:

  

   

Quarter Ended June 30,

   

Six Months Ended June 30,

 
   

2014

   

2013

   

2014

   

2013

 
                                 

Service cost

  $ -     $ -     $ -     $ -  

Interest cost

    261,264       167,180       522,528       334,360  

Expected return on plan assets

    (299,419 )     (298,146 )     (598,837 )     (596,292 )

Recognized actuarial net loss

    97,603       193,162       195,206       386,324  

Net periodic pension cost

  $ 59,448     $ 62,196     $ 118,897     $ 124,392  

 

We previously disclosed in our financial statements for the year ended December 31, 2013 that the Company expected to contribute $900,000 to our defined benefit pension plan during 2014. As of June 30, 2014, the Company had contributed $450,000 to the plan.

 

 
26

 

 

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

 

 

GENERAL

 

Investors Heritage Capital Corporation 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. Investors Heritage Capital also wholly owns Investors Heritage Financial Services Group, Inc., a Kentucky insurance marketing company; Investors Heritage Printing, Inc., a Kentucky printing company that provides printing to Investors Heritage Life and other unaffiliated parties; 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; and is the sole member of Heritage Funding, LLC, a limited liability company that was formed to invest in various business ventures but is currently dormant.

 

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, policies sold in the senior wealth transfer market, final expense insurance, credit life and credit disability insurance, group term insurance sold through associations, and term life and reducing term life sold through financial institutions.

 

In our preneed and burial product segment, we currently market the Legacy Gold and Heritage FX Final Expense products. The Legacy Gold life insurance and annuity product series is sold in the preneed market in conjunction with prearranged funerals. The Legacy Gold series includes both single premium and multi-pay policies, and both underwritten and guaranteed issue options are available. The Heritage FX Final Expense product was introduced during the third quarter of 2013 as a replacement for the Heritage Final Expense II product. The Heritage FX product is a non-participating whole life insurance product with simplified underwriting, sold in the final expense product. The Heritage FX product is structured to allow increased production while mitigating surplus strain through the use of reinsurance.

 

We also marketed our Heritage Advantage final expense product through a third party national master general agent distribution system with an established record and extensive experience in this market. However, in late-2013, we ceased marketing this product in order to limit the production volume to effectively manage the initial surplus strain associated with the product.

 

Within our traditional and universal life products segment, we currently market two products geared toward wealth preservation in the senior market – the Heritage Solution, a single premium life policy, and the Heritage Provider, a ten pay whole life and single premium immediate annuity combination. These products are currently being sold exclusively through our partnership with Puritan Financial Group and are being underwritten and issued using a third party underwriter with significant experience in that market. Prior to January 1, 2013, this business was being reinsured under a 50% coinsurance arrangement with a life insurance company affiliated with Puritan Financial Group. Effective January 1, 2013, this coinsurance agreement was amended to reinsure 25% of new business with that life insurance company. Additionally, these products were re-priced effective January 1, 2013 to account for lower required valuation rates and the current economic environment.

 

During 2013, Investors Heritage Life began assuming 75% of the risks on policies sold by affiliated life insurance companies of Puritan Financial Group. The products being assumed are identical to the Heritage Solution and Heritage Provider products currently being written by Investors Heritage Life. However, these reinsurance arrangements allow us to participate in the profitability of these products in certain states where we are not currently marketing.

 

 
27

 

 

Our traditional and universal life products also include the HLW Choice Whole Life product and the Heritage Protector IV product. The HLW Choice Whole Life product is designed with numerous options and with flexibility to achieve our customers’ goals. The Heritage Protector IV product is a term product marketed primarily by banks and other financial institutions in conjunction with consumer credit.

 

We introduced an association group term product during the second half of 2013. This product provides a monthly renewable term benefit and is being marketed to various association groups.

 

We also market the Heritage Youth Protector, which is a combination term/whole life plan marketed to parents and grandparents, with issue ages of 0-22. The policy is a term policy until age 25 at which time it automatically converts to a whole life policy with increased premium. Waiver of premium and guaranteed insurability option riders are also available. Initial coverage may be purchased in $5,000 increments from $5,000 to $20,000 per child, with single or annual payment options to age 25. At age 25, the policy becomes an annual pay plan.

 

Investors Heritage Financial markets traditional insurance products through banks and other financial institutions. Investors Heritage Financial markets Investors Heritage Life products and continues to expand the portfolio of products available to our regular ordinary insurance agents by offering products of other unaffiliated companies. For a number of years, we have provided outlets for our agents with substandard business that Investors Heritage Life will not accept. Investors Heritage Financial has provided “second to die” policies, substandard life policies, larger term policies and health insurance products through other unaffiliated insurance companies. Investors Heritage Financial receives a fee for providing those services.

 

We utilize a combination of yearly renewable term reinsurance and coinsurance to cede life insurance coverage in excess of our desired retention limits, which in most cases is $25,000 per life. Most of our business is written in the smaller face amount markets and, in the past, claims on larger-case ordinary business caused income fluctuations. This lower retention level has stabilized earnings fluctuations. The lowered retention was achieved by maintaining the established reinsurance treaties and adding additional yearly renewable term treaties for amounts between our desired net amount at risk and the previous retention of $100,000.

 

Investors Heritage Life continues to market its third party administrative (“TPA”) services as an additional revenue source. These agreements, for various levels of administrative services on behalf of each company, generate fee income for Investors Heritage Life. We currently have six TPA clients for which we provide tailored services to meet each client’s individual business needs. We have been able to perform our TPA services using our existing in-house resources.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. Preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We evaluate our estimates continually, including those related to investments, deferred acquisition costs, value of business acquired, policy liabilities, income taxes, employee benefit plans, regulatory requirements, contingencies and litigation. We base 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. We believe the following accounting policies, judgments and estimates are the most critical to the preparation of our consolidated financial statements.

 

 
28

 

 

Investments in Fixed Maturities, Equity Securities, Mortgage Loans and State-Guaranteed Receivables

We hold fixed maturities and equity interests in a variety of companies. Additionally, we originate, underwrite and manage commercial mortgage loans, and we purchase residential mortgage loans through the secondary market. We also own certain investments in state-guaranteed receivables consisting of the future cash flow rights from lottery prize winners. We continuously evaluate all of our investments based on current economic conditions, credit loss experience and other developments. We evaluate the difference between the cost/amortized cost and estimated fair value of our investments to determine whether any decline in fair value is 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 recognized in other comprehensive income (loss) within stockholders’ equity. If a decline in a security’s fair value is considered to be other-than-temporary, we then determine the proper treatment for the other-than-temporary impairment. For fixed maturities, the amount of any other-than-temporary impairment related to a credit loss is recognized in earnings and reflected as a reduction in the cost basis of the security; and the amount of any other-than-temporary impairment related to other factors is recognized in other comprehensive income (loss) with no change to the cost basis of the security.  For equity securities, the amount of any other-than-temporary impairment is recognized in earnings and reflected as a reduction in the cost basis of the security.

 

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. Likewise, if a change occurs in our intent to sell temporarily impaired securities prior to maturity or recovery in value, or if it becomes more likely than not that we will be required to sell such securities prior to recovery in value or maturity, a future impairment charge could result.

 

If an other-than-temporary impairment related to a credit loss occurs with respect to a bond, we amortize the reduced book value back to the security’s expected recovery value over the remaining term of the bond. We continue to review the security for further impairment that would prompt another write-down in the book value.

 

We classify our fixed maturities and equity securities as available-for-sale and carry them at fair value on the balance sheet, with unrealized appreciation (depreciation) relating to temporary market value changes recorded as an adjustment to other comprehensive income (loss), net of adjustments to deferred acquisition costs and federal income taxes. Fair value for these investments is determined using Accounting Standards Codification principles covering Level 1, Level 2 and Level 3 instruments as further discussed in Note 5 to the consolidated financial statements.

 

The majority of our fixed maturities are Level 2 instruments, for which the fair value is derived from readily available pricing services utilizing recent trades and broker information. Certain liquid equity securities are considered Level 1 instruments and are valued based on publicly available market quotes in an active market. We hold approximately $384,000 in Level 3 financial instruments, comprising 0.1% of our total investments carried at fair value. Fair value for these instruments is derived from unobservable inputs such as non-binding broker quotes and internal models using unobservable assumptions about market participants.

 

 
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Deferred Acquisition Costs

The recovery of deferred acquisition costs is dependent on the future profitability of the underlying business for which acquisition costs were incurred. Each reporting period, we evaluate the recoverability of the unamortized balance of 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 revision to these assumptions may impact future financial results.

 

Deferred acquisition costs related to annuities and universal life insurance products are deferred to the extent deemed recoverable and amortized in relation to the present value of actual and expected gross profits on the policies. To the extent that realized gains and losses on securities result in adjustments to deferred acquisition costs related to annuities, such adjustments are reflected as a component of the amortization of deferred acquisition costs.

 

Deferred acquisition costs related to annuities are also adjusted, net of tax, for the change in amortization that would have been recorded if the unrealized gains (losses) from securities had actually been realized. This adjustment is included in the change in net unrealized appreciation (depreciation) on available-for-sale securities, a component of "Accumulated Other Comprehensive Income (Loss)" in the stockholders' equity section of the balance sheet.

 

Policy Liabilities 

Estimating liabilities for our long-duration insurance contracts requires management to make various assumptions, including policyholder persistency, mortality rates, investment yields, discretionary benefit increases, new business pricing, and operating expense levels. We evaluate 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 judgment is required. Actual experience may emerge differently from that originally estimated. Any such difference would be recognized in the current year’s consolidated statement of income. We utilize in-house actuaries in developing our actuarial assumptions and estimates and in monitoring such assumptions and estimates against actual experience.

 

Income Taxes

We evaluate our deferred income tax assets, which partially offset our deferred tax liabilities, for any necessary valuation allowances. In doing so, we consider our ability and potential for recovering income taxes associated with such assets, which involve significant judgment. Revisions to the assumptions associated with any necessary valuation allowances would be recognized in the consolidated financial statements in the period in which such revisions are made.

 

Employee Benefit Plans

We maintain a defined benefit retirement plan on behalf of our employees. Measurement of the future benefit obligations associated with this plan involves significant judgment, particularly in regard to the expected long-term rate of return on plan assets and the current discount rate used to calculate the present value of future obligations. The long-term rate of return for plan assets is determined based on an analysis of historical returns on invested assets, anticipated future fixed income, equity investment markets, and diversification needs. Long term trends are evaluated relative to current market factors such as inflation, interest rates and investment strategies, including risk management, in order to assess the assumptions as applied to the plan. The discount rate utilized is determined based on reviews of market indices commonly used to measure such liabilities in the industry. Changes in our assumptions can significantly impact the accrued pension liability and net periodic benefit cost recorded in the consolidated financial statements. Additionally, funding of plan liabilities is sensitive to changes in investment returns as well as regulatory changes, which can significantly impact our consolidated financial statements.

 

 
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During 2012, the Company restructured its employee benefit plans. Effective June 30, 2012, the Company ceased all future benefit accruals and compensation increases under the IHCC Employee Retirement Plan, although participants can continue to earn vesting credit towards their plan benefit subsequent to June 30, 2012. We continually monitor the performance of plan assets and growth in liabilities and funding necessities, utilizing independent and experienced consultants to assist in plan management.

 

The Company also amended the IHCC Retirement Savings Plan and Trust (the “Old 401(k) Plan”), under which, effective June 30, 2012, participants in the Old 401(k) Plan are no longer eligible to elect to defer and contribute compensation earned to the Old 401(k) Plan; the Company will not make any matching contributions to the Old 401(k) Plan; and the Old 401(k) Plan will not accept rollover contributions.

 

The Company adopted a new traditional 401(k) retirement plan, the IHCC 401(k) Retirement Plan (the “Retirement Plan”). Employees are eligible to participate in the Retirement Plan on the first day of employment. Under the Retirement Plan, the Company matches employee contributions dollar for dollar up to 4% of employee compensation deferrals. Employees who have met certain employment criteria may also be eligible to receive an additional allocation after the end of each plan year. The Retirement Plan became effective January 1, 2012.

 

We expect these changes in our employee benefit plans to mitigate future uncertainty with respect to defined benefit pension plans while also maintaining a competitive benefit package for our employees.

 

We previously disclosed in our financial statements for the year ended December 31, 2013 that we expected to contribute $900,000 to our defined benefit pension plan during 2014. As of June 30, 2014, the Company had contributed $450,000 to the plan.

 

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board issued guidance regarding accounting for revenue recognition that identifies the accounting treatment for an entity’s contracts with customers. Certain contracts, including insurance contracts, are specifically excluded from this guidance. This guidance is effective for public entities for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. We have not yet adopted this guidance, but it is not expected to have a material impact on our financial position, cash flows or results of operations.

 

All other new accounting standards and updates of existing standards issued through the date of this filing were considered by management and did not relate to accounting policies and procedures pertinent to the Company at this time or were not expected to have a material impact to the consolidated financial statements.

 

INVESTMENTS, LIQUIDITY AND CAPITAL RESOURCES

 

Investments

Investors Heritage Life maintains a sound, conservative investment strategy. At June 30, 2014 and December 31, 2013, 90.9% and 90.8%, respectively, of invested assets consisted of fixed income securities. At June 30, 2014 and December 31, 2013, Investors Heritage Life’s fixed income investments were 96.8% and 96.0% investment grade, respectively, as rated by Standard & Poor’s.

 

We have reviewed our investment portfolio and do not believe that there are any securities that are other-than-temporarily impaired at June 30, 2014. 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. We recorded no other-than-temporary impairment charges in the consolidated statements of income during the quarters or six months ended June 30, 2014 or 2013.

 

We continuously monitor the investment risk within our portfolio, including the risk associated with subprime lending with our CMO investments. As of June 30, 2014, we have only one CMO, with a fair value of approximately $2,700, which has any level of direct subprime exposure. Based on our analysis, we expect no losses as a result of subprime concerns. Additionally, we have no Alt-A bond exposure within our current holdings.

 

 
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During the second quarter of 2013, we entered into an investment advisory agreement to purchase common and preferred stocks in stable areas within the real estate sector. The investment advisor has a history of strong performance within these markets. The majority of these funds have been invested in a diversified assortment of regularly traded, exchange listed common stocks. As of June 30, 2014, the largest individual stock position within this group is approximately $307,000. We believe the unrealized losses associated with our common stocks are temporary in nature given the credit quality of the issuers. We believe that these investments will generate positive future results by providing a slightly increased and fully managed exposure to equity markets.

 

Additionally, Investors Heritage Life engages in commercial and residential mortgage lending. As of June 30, 2014, 69.5% of these investments were in commercial properties. Our commercial mortgage loans and certain residential mortgage loans are either originated in-house or through two mortgage brokers, are secured by first mortgages on the real estate and generally carry personal guarantees by the borrowers. Loan to value ratios of 80% or less and debt service coverage from existing cash flows of 115% or higher are generally required. We minimize credit risk in our mortgage loan portfolio through various methods, including stringently underwriting the loan request, maintaining small average loan balances, and reviewing larger mortgage loans on an annual basis.

 

During the third quarter of 2013, we began evaluating and purchasing residential mortgage loans through the secondary market. We review each mortgage loan opportunity individually, considering both the value of the underlying property and the credit worthiness of the borrower. These loans are typically purchased at a discount to their unpaid principal balance. During the quarter and six months ended June 30, 2014, we purchased residential mortgages through the secondary market totaling approximately $1,522,000 and $2,254,000, respectively. We are utilizing a third party servicer to administer these loans. We currently anticipate evaluating and making additional residential mortgage loan investments assuming they meet our investment goals and criteria.

 

At June 30, 2014 and December 31, 2013, 4.0% of invested assets consisted of mortgage loans. As of June 30, 2014, Investors Heritage Life had no non-performing mortgage loans, which would include loans past due 180 days or more, loans in process of foreclosure, restructured loans and real estate acquired through foreclosure.

 

We own certain investments in state-guaranteed receivables. These investments represent an assignment of the future rights to cash flows from lottery winners purchased at a discounted price. Payments on these investments are made by state run lotteries and guaranteed by the states. As these payment streams are secured by the states themselves, a key function of our due diligence is the assessment of the states’ ability to meet these obligations. Additionally, each state generally withholds income tax from each payment for which we must file for reimbursement of such tax annually. We carry the state-guaranteed receivables at their amortized cost basis on the balance sheet. As of June 30, 2014, we held approximately $7,939,000 in state-guaranteed receivables, with the largest concentrations in the states of New York, Massachusetts and Georgia totaling approximately $3,746,000, $1,918,000 and $1,511,000, respectively. At June 30, 2014 and December 31, 2013, 1.7% and 1.8%, respectively, of invested assets consisted of state-guaranteed receivables.

 

Liquidity and Capital Resources

Investors Heritage Life’s principal sources of cash flow used to meet short-term and long-term cash requirements are insurance premiums, which include mortality and expense charges, investment income, and administrative service fees.

 

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.

 

 
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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. We believe these assumptions will produce revenues sufficient to meet our future contractual benefit obligations and operating expenses, and provide an adequate profit margin.

 

Investors Heritage Capital’s principal sources of cash flow are rental income and dividends from its subsidiaries. Investors Heritage Capital’s principal long-term obligations are payments on long-term debt.

 

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.

 

We assess our compliance with prescribed debt covenant requirements as outlined in the terms of each debt agreement at least annually, if not otherwise required in the debt agreement. Management has assessed our position and as of June 30, 2014, we are in compliance with all debt covenant requirements.

 

We are not aware of any commitments or unusual events that could materially affect capital resources. We have the option to prepay certain notes payable at our discretion prior to their maturity dates.

 

We will continue to explore various opportunities including mergers and acquisitions and purchasing blocks of business from other companies, which may dictate a need for either long-term or short-term debt. There are no restrictions as to use of funds except the restriction on Investors Heritage Life as to the payment of cash dividends to Investors Heritage Capital.

 

RESULTS OF OPERATIONS

 

Overview

Premiums earned (net of reinsurance) were $11,780,686 for the second quarter of 2014 (a decrease of 23.7% compared to the second quarter of 2013) and $23,657,522 for the six months ended June 30, 2014 (a decrease of 19.3% compared to the corresponding period in 2013). These decreases are primarily due to unanticipated weather-related impacts that hampered new sales across all segments during the first quarter of 2014 in addition to lower sales of the Puritan product offerings as compared to the prior year.

  

Net investment income was $5,174,624 for the second quarter of 2014 (a decrease of 1.8% compared to the second quarter of 2013) and $10,253,606 for the six months ended June 30, 2014 (a decrease of 2.6% compared to the corresponding period in 2013). These decreases are primarily driven by the reversal of previously recorded mark-to-market adjustments relative to our investment in derivative, which flows through investment income. This investment was sold during the third quarter of 2013. Low new fixed maturity investment yields continue to put downward pressure on our investment income. We continue to seek high quality investments while considering alternative investments that can be used to enhance future investment income.

 

Net realized gains (losses) on investments were $72,665 and $68,859 for the quarter and six months ended June 30, 2014, respectively, compared to ($24,716) and $63,251 for the quarter and six months ended June 30, 2013, respectively. Other than a realized loss of $14,006 relative to the demolition of a Company-owned building during the quarter and six months ended June 30, 2013, the activity during each of these periods was in the normal course of business. We experienced no other-than-temporary impairments during the quarters or six months ended June 30, 2014 or 2013.

 

Other income was $536,987 for the second quarter of 2014 (an increase of 46.8% compared to the second quarter of 2013) and $874,859 for the six months ended June 30, 2014 (an increase of 17.2% compared to the corresponding period in 2013). These increases are principally due to $141,907 of net life insurance proceeds received under a company-owned life insurance policy upon the death of a former board member during the second quarter of 2014.

 

 
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Total benefits and expenses were $17,272,022 for the second quarter of 2014 (a decrease of 23.4% compared to the second quarter of 2013) and $34,629,611 for the six months ended June 30, 2014 (a decrease of 17.1% compared to the corresponding period in 2013). These decreases are primarily driven by lower reserve increases and reduced commissions relative to the lower sales volume in the first six months of 2014. Additionally, for the quarter and six months ended June 30, 2013, death and other benefits included an additional amount totaling $2,029,462 relative to a comparison of our life insurance policies against the Social Security Death Master File. This comparison was performed in compliance with a recently enacted Kentucky state law which follows a model law adopted by the National Conference of Insurance Legislators. This amount primarily affects the traditional and universal life segment, along with a much smaller impact on the final expense portion of the preneed and burial segment. We are in the process of researching the potential matches to determine that a valid claim exists, to locate beneficiaries and to pay benefits accordingly.

 

After providing for federal income taxes, our net income was $234,352 with net income per share of $0.21 for the second quarter of 2014 compared to a net loss of $1,060,521 with a net loss per share of $0.93 for the second quarter of 2013. Our net income was $180,188 with net income per share of $0.16 for the six months ended June 30, 2014 compared to a net loss of $765,224 with a net loss per share of $0.67 for the six months ended June 30, 2013.

 

We declared a dividend of $0.20 per share on February 13, 2014 to shareholders of record on March 14, 2014. This dividend was paid on April 7, 2014.

 

Business Segments 

FASB guidance requires a "management approach" in the presentation of business segments based on how management internally evaluates the operating performance of business units. The discussion of segment operating results that follows is being provided based on segment data prepared using this methodology.

 

Preneed & Burial Products

Preneed and burial Products include both life and annuity products sold by funeral directors or affiliated agents to fund prearranged funerals. Revenues for this segment were $12,378,694 for the second quarter of 2014 (a decrease of 4.1% compared to the second quarter of 2013) and $23,591,408 for the six months ended June 30, 2014 (a decrease of 6.6% compared to the corresponding period in 2013). These decreases are predominantly due to the previously mentioned unanticipated weather-related impacts that affected new sales of our preneed products during the first quarter of 2014. Additionally, revenue was impacted by the discontinuation of our Heritage Advantage product sold through the national master general agent distribution system. Low investment yields on new fixed maturity investments also continue to negatively affect our revenue.

 

Pre-tax loss from operations was $50,136 and $358,714 for the quarter and six months ended June 30, 2014, respectively, compared to pre-tax income of $72,185 and $7,210 for the quarter and six months ended June 30, 2013, respectively. These increases in the pre-tax loss were driven primarily by the previously mentioned reductions in sales volume and reduced net investment income within the segment given the current interest rate environment.

 

Traditional & Universal Life Products

Traditional and universal life products include traditional life and group life insurance products, certain annuities and universal life products. Revenues for this segment were $4,499,730 for the second quarter of 2014 (a decrease of 40.3% compared to the second quarter of 2013) and $10,097,262 for the six months ended June 30, 2014 (a decrease of 28.5% compared to the corresponding period in 2013). These decreases are primarily due to lower sales of the Puritan product offerings in comparison to the corresponding period in the prior year. Reduced investment income due to the previously discussed yield pressures has also affected revenue.

 

 
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Pre-tax income from operations was $88,686 and $281,177 for the quarter and six months ended June 30, 2014, respectively, compared to a pre-tax loss of $1,694,923 and $1,399,579 for the quarter and six months ended June 30, 2013, respectively. These improvements in pre-tax income are primarily a reflection of the impact of the additional claims liability established in the corresponding periods in 2013 relative to a comparison of our life insurance policies against the Social Security Death Master File, as previously discussed.

 

Administrative & Financial Services

Administrative and financial services include the administration of credit life and credit accident and health insurance products. We reinsure 100% of the related underwriting risk on credit products currently produced within this segment. Accordingly, credit product revenue is generated primarily from initiation fees as well as fees for servicing and administering the credit business for our reinsurers. Because the credit product revenue is fee-based, performance is in direct relation to new premium production coupled with fees generated as premiums are earned. Premium production within this segment is also significantly affected by economic conditions within our credit markets, particularly Kentucky.

 

In addition to credit administration, this segment includes fees generated relative to our third party administrative relationships. We currently provide tailored administrative services for six unaffiliated companies, comprised of four life insurance companies and two holding companies. Services provided to each company vary based on their needs and can include some or all aspects of back-office accounting, actuarial services and policy administration.

 

Revenues for this segment were $348,573 for the second quarter of 2014 (an increase of 10.3% compared to the second quarter of 2013) and $626,009 for the six months ended June 30, 2014 (a decrease of 2.7% compared to the corresponding period in 2013). Pre-tax income from operations was $67,678 and $113,909 for the quarter and six months ended June 30, 2014, respectively, compared to pre-tax income of $55,259 and $128,818 for the quarter and six months ended June 30, 2013. The revenue and pre-tax income changes are primarily related to the amount and timing of service fees generated from our third party administration relationships compared to the prior period. While revenue and pre-tax income for the six months ended June 30, 2014 are slightly lower than in the corresponding period of the prior year, amounts for the quarter ended June 30, 2014 are increased over the prior year due to additional special services being performed for certain clients as well as the addition of a new client during the current period.

 

Corporate & Other

Corporate and other consists of corporate accounts measured primarily by stockholders’ paid-in capital, contributed surplus, earned surplus, property and equipment, corporate-owned life insurance and other minor business lines which include group annuities and group and individual accident and health products. Revenues for this segment were $337,965 and $540,167 for the quarter and six months ended June 30, 2014, respectively, compared to $290,906 and $628,670 for the quarter and six months ended June 30, 2013, respectively. Pre-tax income from operations was $186,712 and $188,863 for the quarter and six months ended June 30, 2014, respectively, compared to pre-tax income from operations of $52,449 and $170,374 for the quarter and six months ended June 30, 2013. Results for the quarter and six months ended June 30, 2014 include $141,907 of net life insurance proceeds received under a company-owned life insurance policy upon the death of a former board member. Additionally, 2013 segment results were impacted by the changes associated with mark-to-market adjustments relative to our previously owned investment in derivative. This adjustment was completely reversed during the third quarter of 2013 in conjunction with the sale of the market-linked note.

 

 
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While we continue to expand the operations of Investors Heritage Financial, Investors Heritage Printing, At Need Funding and Heritage Funding, less than 1% of our consolidated revenues were generated by those subsidiaries. During the six months ended June 30, 2014, Investors Heritage Capital received dividends of $55,000 and $10,000 from Investors Heritage Financial and Investors Heritage Printing, respectively. Investors Heritage Capital received no distributions from At Need Funding. Additionally, Investors Heritage Capital received dividends of $275,000 from Investors Heritage Life. The potential exists for dividend payments and distributions over the remainder of 2014 as any needs arise.

 

Federal Income Taxes 

The provision (benefit) for federal income taxes is based on the estimated 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 dividends-received deduction; the 404(k) dividend deduction; the small life insurance company tax deduction; and non-taxable effects of company-owned life insurance premiums, cash value growth and death benefit proceeds. Our effective tax rate was 20.0% for the quarter and six months ended June 30, 2014 compared to 30.0% for the quarter and six months ended June 30, 2013.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

We have no off-balance sheet arrangements as of June 30, 2014.

 

FORWARD LOOKING INFORMATION 

 

We caution readers regarding certain forward-looking statements contained in this report and in any other statements made by us or on our behalf, 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 our beliefs concerning future levels of sales and redemptions of Investors Heritage Life’s products, investment spreads and yields, or our earnings and profitability.

 

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 our 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 us or on our behalf. 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 financial institutions operating in our market area and elsewhere. Others may relate to us specifically, such as credit, volatility and other risks associated with our investment portfolio. We caution that such factors are not exclusive. We disclaim any obligation to update forward-looking information. 

 

 
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ITEM 4. Controls and Procedures

 

As of the end of the period covered by this Form 10-Q, we performed an evaluation, under the supervision and with the participation of management, including our Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our 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 our 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 changes in our internal control over financial reporting identified by that evaluation that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during this most recent quarter or subsequent to the date we carried out our evaluation.

 

 

 
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 PART II – OTHER INFORMATION

 

 

 

 

ITEM 1. Legal Proceedings

 

Investors Heritage Capital 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 August 14, 2014, 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 our 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 original stockholders under our right of first refusal or by employees as part of our 401(k) plan. 

 

ITEM 3. Defaults Upon Senior Securities

 

None 

 

ITEM 4. Mine Safety Disclosures

 

None 

 

ITEM 5. Other Information

 

None 

 

ITEM 6. Exhibits

   

31.1 & 

31.2  

Certifications pursuant to Securities and Exchange Act Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.

   

32.1 

Certifications Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

101.INS** XBRL Instance

101.SCH**

XBRL Taxonomy Extension Schema

101.CAL** XBRL Taxonomy Extension Calculation
101.DEF** XBRL Taxonomy Extension Definition
101.LAB** XBRL Taxonomy Extension Labels
101.PRE** XBRL Taxonomy Extension Presentation

 

**

XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

 
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SIGNATURES

 

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

 

 

 

INVESTORS HERITAGE CAPITAL CORPORATION

 

 

 

BY: /s/Harry Lee Waterfield II

 

Harry Lee Waterfield II

DATE: August 14, 2014

President

 

 

 

BY: /s/Larry Johnson

 

Larry Johnson

DATE: August 14, 2014

Vice President - Chief Financial Officer