Attached files

file filename
EXCEL - IDEA: XBRL DOCUMENT - Investors Heritage Capital CorpFinancial_Report.xls
EX-31 - EXHIBIT 31.2 - Investors Heritage Capital Corpex31-2.htm
EX-32 - EXHIBIT 32.1 - Investors Heritage Capital Corpex32-1.htm
EX-31 - EXHIBIT 31.1 - Investors Heritage Capital Corpex31-1.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 September 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 November 13, 2014 - 1,124,335.588

 

 
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

42

EXHIBIT 32

44

  

 
3

 

 

 

PART I – FINANCIAL INFORMATION

 

 

ITEM 1. Condensed Consolidated Financial Statements

 

 

INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Balance Sheets (Unaudited)

 

   

September 30,

   

December 31,

 

 

 

2014

   

2013

 
ASSETS            

Investments:

               

Securities available-for-sale, at fair value:

               

Fixed maturities (amortized cost: $397,288,212 and $402,396,191)

  $ 422,523,511     $ 417,909,105  

Equity securities (cost: $6,272,097 and $5,888,361)

    6,793,227       5,818,333  

Mortgage loans on real estate

    24,633,072       18,601,722  

Policy loans

    6,660,986       6,674,887  

State-guaranteed receivables

    7,896,230       8,085,107  

Other invested assets

    3,311,580       3,181,182  

Total investments

    471,818,606       460,270,336  

Cash and cash equivalents

    11,743,411       4,143,291  

Accrued investment income

    4,391,287       5,191,253  

Due premiums

    3,371,600       3,368,008  

Deferred acquisition costs

    18,159,217       18,822,481  

Value of business acquired

    323,506       386,056  

Leased property under capital leases

    662,645       1,005,523  

Property and equipment

    1,187,691       1,042,748  

Cash value of company-owned life insurance

    12,166,351       11,808,248  

Other assets

    1,796,238       1,901,946  

Amounts recoverable from reinsurers

    55,648,802       55,669,088  

Total assets

  $ 581,269,354     $ 563,608,978  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               

LIABILITIES

               

Policy liabilities:

               

Benefit reserves

  $ 486,856,684     $ 480,151,818  

Unearned premium reserves

    8,290,064       8,189,640  

Policy claims

    2,811,794       3,672,474  

Liability for deposit-type contracts

    3,364,738       3,283,960  

Reserves for dividends and endowments and other

    419,315       408,555  

Total policy liabilities

    501,742,595       495,706,447  

Deferred federal income tax liability

    8,296,641       4,604,891  

Obligations under capital leases

    647,265       943,488  

Notes payable

    2,665,507       3,031,942  

Accrued pension liability

    2,098,379       2,887,843  

Other liabilities

    4,604,851       2,787,099  

Total liabilities

    520,055,238       509,961,710  
                 

STOCKHOLDERS' EQUITY

               

Common stock (shares issued: 1,124,911 and 1,128,583)

    1,124,911       1,128,583  

Paid-in surplus

    8,908,243       8,908,243  

Accumulated other comprehensive income

    13,585,613       6,751,991  

Retained earnings

    37,595,349       36,858,451  

Total stockholders' equity

    61,214,116       53,647,268  

Total liabilities and stockholders' equity

  $ 581,269,354     $ 563,608,978  

 

See notes to condensed consolidated financial statements.

 

 
4

 

 

INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Income Statements (Unaudited)

 

   

Quarter Ended September 30,

   

Nine Months Ended September 30,

 
   

2014

   

2013

   

2014

   

2013

 

REVENUE

                               

Premiums and other considerations

  $ 16,072,480     $ 18,740,917     $ 45,915,118     $ 55,644,294  

Premiums ceded

    (3,681,935 )     (3,792,363 )     (9,867,051 )     (11,373,438 )

Net premiums

    12,390,545       14,948,554       36,048,067       44,270,856  
                                 

Investment income, net of expenses

    5,393,294       4,985,998       15,646,900       15,516,997  

Net realized gains on investments

    593,272       2,418,806       662,131       2,482,057  

Other income

    327,621       325,180       1,202,480       1,071,957  

Total revenue

    18,704,732       22,678,538       53,559,578       63,341,867  
                                 

BENEFITS AND EXPENSES

                               

Death and other benefits

    10,142,835       9,746,027       31,446,368       32,925,539  

Guaranteed annual endowments

    102,357       94,771       326,095       332,519  

Dividends to policyholders

    81,426       85,824       270,108       314,825  

Increase in benefit reserves and unearned premiums

    3,443,824       5,784,708       7,992,216       15,028,520  

Acquisition costs deferred

    (1,700,281 )     (2,279,348 )     (5,015,624 )     (6,930,950 )

Amortization of deferred acquisition costs

    1,857,955       2,030,109       5,426,506       5,830,140  

Commissions

    1,110,624       1,956,328       3,556,685       5,624,457  

Other general and administrative expenses

    2,403,260       2,476,130       8,069,257       8,526,005  

Total benefits and expenses

    17,442,000       19,894,549       52,071,611       61,651,055  
                                 

INCOME BEFORE FEDERAL INCOME TAXES

    1,262,732       2,783,989       1,487,967       1,690,812  
                                 

PROVISION (BENEFIT) FOR FEDERAL INCOME TAXES

                               

Current

    170,271       896,769       274,989       430,195  

Deferred

    231,072       (61,573 )     171,401       77,048  

Total federal income taxes

    401,343       835,196       446,390       507,243  
                                 

NET INCOME

  $ 861,389     $ 1,948,793     $ 1,041,577     $ 1,183,569  
                                 

BASIC AND DILUTED NET INCOME PER SHARE

  $ 0.77     $ 1.72     $ 0.92     $ 1.04  
                                 

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 September 30,

   

Nine Months Ended September 30,

 
   

2014

   

2013

   

2014

   

2013

 
                                 

NET INCOME

  $ 861,389     $ 1,948,793     $ 1,041,577     $ 1,183,569  
                                 

OTHER COMPREHENSIVE INCOME (LOSS):

                               

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

                               

Unrealized holding gains (losses) arising during period

    (3,670,059 )     (1,357,536 )     10,975,674       (23,152,456 )

Reclassification adjustment for gains included in income

    (593,272 )     (2,418,806 )     (662,131 )     (2,496,063 )

Adjustment for effects of deferred acquisition costs

    126,140       128,198       (252,382 )     798,791  

Net unrealized gains (losses) on investments

    (4,137,191 )     (3,648,144 )     10,061,161       (24,849,728 )

Change in defined benefit pension plan:

                               

Amortization of actuarial net loss in net periodic pension cost

    97,604       193,161       292,810       579,485  
                                 

Other comprehensive income (loss) before income taxes

    (4,039,587 )     (3,454,983 )     10,353,971       (24,270,243 )
                                 

Income tax expense (benefit)

    (1,373,461 )     (1,215,383 )     3,520,349       (8,303,035 )
                                 

OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAXES

    (2,666,126 )     (2,239,600 )     6,833,622       (15,967,208 )
                                 

COMPREHENSIVE INCOME (LOSS)

  $ (1,804,737 )   $ (290,807 )   $ 7,875,199     $ (14,783,639 )

 

 

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 income

    -       -       -       1,183,569       1,183,569  

Other comprehensive loss, net

    -       -       (15,967,208 )     -       (15,967,208 )

Cash dividends

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

Repurchases of common stock, net

    (8,724 )     -       -       (192,628 )     (201,352 )

BALANCE, SEPTEMBER 30, 2013

  $ 1,133,162     $ 8,908,243     $ 6,572,516     $ 36,348,401     $ 52,962,322  
                                         

BALANCE, JANUARY 1, 2014

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

Net income

    -       -       -       1,041,577       1,041,577  

Other comprehensive income, net

    -       -       6,833,622       -       6,833,622  

Cash dividends

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

Repurchases of common stock, net

    (3,672 )     -       -       (78,962 )     (82,634 )

BALANCE, SEPTEMBER 30, 2014

  $ 1,124,911     $ 8,908,243     $ 13,585,613     $ 37,595,349     $ 61,214,116  

 

See notes to condensed consolidated financial statements.

 

 
7

 

 

INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Statements of Cash Flows (Unaudited)

 

 

   

Nine Months Ended September 30,

 
   

2014

   

2013

 
                 

NET CASH PROVIDED BY OPERATING ACTIVITIES

  $ 11,052,080     $ 12,964,120  
                 

INVESTING ACTIVITIES

               

Purchases of available-for-sale securities

    (31,220,765 )     (89,724,430 )

Sales of available-for-sale securities

    13,981,335       35,306,604  

Maturities of available-for-sale securities

    22,442,467       40,899,144  

Acquisitions of mortgage loans on real estate

    (8,997,660 )     (1,102,901 )

Payments of mortgage loans on real estate

    2,983,174       1,371,915  

Payments of state-guaranteed receivables

    611,280       481,280  

Sale of investment in derivative

    -       645,000  

Net change in payable (receivable) for securities

    -       219,158  

Net reductions (additions) of other investments

    (116,497 )     230,853  

Net additions to property and equipment

    (299,123 )     (76,139 )

NET CASH USED IN INVESTING ACTIVITIES

    (615,789 )     (11,749,516 )

FINANCING ACTIVITIES

               

Policyholder account deposits

    3,908,096       4,002,096  

Policyholder account withdrawals

    (6,069,481 )     (7,008,323 )

Payments on notes payable

    (2,602,402 )     (3,060,944 )

Proceeds from notes payable

    2,235,967       2,764,381  

Dividends paid

    (225,717 )     (285,471 )

Repurchases of common stock, net

    (82,634 )     (201,352 )

NET CASH USED IN FINANCING ACTIVITIES

    (2,836,171 )     (3,789,613 )

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

    7,600,120       (2,575,009 )

Cash and cash equivalents at beginning of period

    4,143,291       6,009,905  

CASH AND CASH EQUIVALENTS AT END OF PERIOD

  $ 11,743,411     $ 3,434,896  

 

See notes to condensed consolidated financial statements.

  

 
8

 

 

INVESTORS HERITAGE CAPITAL CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 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 nine months ended September 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 September 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.

  

 
9

 

 

In August 2014, the FASB issued guidance that requires management to evaluate whether there are concerns or events that raise substantial doubt about the entity's ability to continue as a going concern within one year after the date the financial statements are issued. Disclosures are required when certain criteria are met. This guidance is effective for annual periods ending after December 15, 2016 and for annual periods and interim periods thereafter. The Company has not yet adopted this guidance, but it is not expected to have a material impact on the consolidated financial statements.

 

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.

 

NOTE 4 – Investments

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

 

September 30, 2014  

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair

Value

 

Fixed maturity securities:

                               

U.S. government obligations

  $ 30,092,949     $ 727,407     $ 120,452     $ 30,699,904  

States and political subdivisions

    38,668,814       5,225,745       -       43,894,559  

Corporate

    214,418,857       15,226,956       707,197       228,938,616  

Foreign

    62,843,899       2,845,038       185,737       65,503,200  

Asset-backed securities

    1,580,807       48,185       -       1,628,992  

Mortgage-backed securities (MBS):

                               

Commercial MBS

    8,067,540       166,218       11,595       8,222,163  

Residential MBS

    41,615,346       2,020,731       -       43,636,077  

Total fixed maturity securities

    397,288,212       26,260,280       1,024,981       422,523,511  

Equity securities:

                               

U.S. agencies

    707,900       -       -       707,900  

Mutual funds

    318,284       24,769       -       343,053  

Corporate common stock

    5,245,913       711,358       214,997       5,742,274  

Total equity securities

    6,272,097       736,127       214,997       6,793,227  

Total

  $ 403,560,309     $ 26,996,407     $ 1,239,978     $ 429,316,738  

 

December 31, 2013  

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Fair

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.

 

   

September 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

  $ 5,145,508     $ 7,751       1     $ 17,401,555     $ 703,570       3  

States and political subdivisions

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

Corporate

    13,298,157       158,362       7       56,249,758       2,076,123       37  

Foreign

    6,444,469       59,121       5       26,858,417       1,395,450       15  

Commercial MBS

    837,794       11,595       1       -       -       -  

Residential MBS

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

Greater than 12 months:

                                               

U.S. government obligations

    7,649,750       112,701       1       -       -       -  

Corporate

    4,127,143       548,835       4       1,072,341       175,763       1  

Foreign

    5,045,046       126,616       2       -       -       -  

Total fixed maturities

    42,547,867       1,024,981       21       121,008,762       4,756,866       62  
                                                 

Equities:

                                               

Less than 12 months:

                                               

Corporate common stock

    1,508,444       106,781       16       2,806,072       494,264       24  

Greater than 12 months:

                                               

Corporate common stock

    722,942       108,216       7       -       -       -  

Total equities

    2,231,386       214,997       23       2,806,072       494,264       24  
                                                 

Total

  $ 44,779,253     $ 1,239,978       44     $ 123,814,834     $ 5,251,130       86  

 

 

As of September 30, 2014, all of the above fixed maturity securities individually had a fair value to cost ratio equal to or greater than 76% 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 nine months ended September 30, 2014 or 2013.

  

 
11

 

 

Management believes that the Company will fully recover its cost basis in the securities held at September 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.

 

   

September 30,

   

December 31,

 
   

2014

   

2013

 

Net unrealized appreciation on available-for sale securities

  $ 25,756,429     $ 15,442,886  

Adjustment to deferred acquisition costs

    (670,801 )     (418,419 )

Deferred income taxes

    (8,529,113 )     (5,108,319 )

Net unrealized appreciation on available-for sale securities

  $ 16,556,515     $ 9,916,148  

 

The amortized cost and fair value of fixed maturity securities at September 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

  $ 7,709,530     $ 7,913,431  

Due after one year through five years

    72,936,246       80,068,136  

Due after five years through ten years

    187,219,859       196,520,895  

Due after ten years

    51,734,836       57,745,070  

Due at multiple maturity dates

    77,687,741       80,275,979  

Total

  $ 397,288,212     $ 422,523,511  

 

 

Proceeds for the quarters and nine months ended September 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 September 30,

   

Nine Months Ended September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Proceeds from sales and maturities

  $ 19,194,823     $ 47,541,392     $ 36,423,802     $ 76,205,748  

Gross realized gains

    611,566       2,436,585       785,376       2,544,968  

Gross realized losses

    (18,294 )     (17,779 )     (123,245 )     (48,905 )

 

 
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 nine months ended September 30, 2014 and 2013.

 

   

Quarter Ended September 30,

   

Nine Months Ended September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Change in unrealized investment gains (losses):

                               

Available-for-sale:

                               

Fixed maturities

  $ (4,179,008 )   $ (3,668,612 )   $ 9,722,385     $ (25,148,935 )

Equity securities

    (84,323 )     (107,730 )     591,158       (499,584 )

Realized investment gains (losses):

                               

Available-for-sale:

                               

Fixed maturities

  $ 593,895     $ 2,383,513     $ 662,083     $ 2,473,160  

Equity securities

    (623 )     35,293       48       22,903  

 

 

The Company is required to hold assets on deposit for the benefit of policyholders in accordance with statutory rules and regulations. At September 30, 2014 and December 31, 2013, these required deposits had a total fair value of $24,157,419 and $25,209,390, respectively.

 

The Company also engages in commercial and residential mortgage lending. As of September 30, 2014 and December 31, 2013, 51.2% 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 September 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 nine months ended September 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 nine months ended September 30, 2014, we purchased residential mortgages through the secondary market totaling approximately $6,444,000 and $8,698,000, 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 September 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

  $ 700,932     $ 710,359  

Due after one year through five years

    2,441,132       2,643,090  

Due after five years through ten years

    3,031,845       3,723,780  

Due after ten years

    1,722,321       2,429,809  

Total

  $ 7,896,230     $ 9,507,038  

 

 

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

 

   

September 30,

   

December 31,

 
   

2014

   

2013

 

New York

  $ 3,678,700     $ 3,880,368  

Massachusetts

    1,950,887       1,927,350  

Georgia

    1,489,630       1,500,719  

Pennsylvania

    299,835       284,756  

Texas

    223,849       212,447  

California

    185,030       195,593  

Ohio

    68,299       83,874  

Total

  $ 7,896,230     $ 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 September 30,

   

Nine Months Ended September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Fixed maturities

  $ 4,930,579     $ 4,874,638     $ 14,369,420     $ 14,480,549  

Equity securities

    58,733       50,970       186,211       100,701  

Mortgage loans on real estate

    391,596       264,056       1,048,296       816,454  

Policy loans

    121,585       121,699       356,962       357,789  

State-guaranteed receivables

    137,889       140,790       422,403       430,666  

Gain (loss) on investment in derivative

    -       (240,600 )     -       2,400  

Other

    56,486       57,099       173,972       176,112  

Gross investment income

    5,696,868       5,268,652       16,557,264       16,364,671  

Investment expenses

    303,574       282,654       910,364       847,674  

Net investment income

  $ 5,393,294     $ 4,985,998     $ 15,646,900     $ 15,516,997  

 

 

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 September 30, 2014 and December 31, 2013.

 

   

September 30, 2014

 
   

Level 1

   

Level 2

   

Level 3

   

Total

 

Fixed maturities:

                               

U.S. government obligations

  $ -     $ 30,699,904     $ -     $ 30,699,904  

States and political subdivisions

    -       43,894,559       -       43,894,559  

Corporate

    -       228,938,616       -       228,938,616  

Foreign

    -       65,503,200       -       65,503,200  

Asset-backed securities

    -       1,628,992       -       1,628,992  

Mortgage-backed securities:

                               

Commercial MBS

    -       8,222,163       -       8,222,163  

Residential MBS

    -       43,636,077       -       43,636,077  

Total fixed maturities

  $ -     $ 422,523,511     $ -     $ 422,523,511  
                                 

Equity securities:

                               

U.S. agencies

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

Mutual funds

    343,053       -       -       343,053  

Corporate common stock

    5,358,274       -       384,000       5,742,274  

Total equity securities

  $ 6,409,227     $ -     $ 384,000     $ 6,793,227  

 

   

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 nine months ended September 30, 2014 and 2013.

 

   

Quarter Ended September 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 September 30, 2013

 
                   

Corporate

   

Investment

         
                   

Common

   

in

         
   

Corporate

   

Foreign

   

Stock

   

Derivative

   

Total

 

Beginning balance

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

Transfers into Level 3

    -       -       -       -       -  

Transfers out of Level 3

    (1,887,820 )     -       -       -       (1,887,820 )

Purchases

    2,001,500       -       -       -       2,001,500  

Sales

    (13 )     (475 )     -       (645,000 )     (645,488 )

Total gains or losses:

                                       

Included in earnings

    -       -       -       (240,600 )     (240,600 )

Included in other comprehensive income

    (48,667 )     (112,025 )     -       -       (160,692 )

Ending balance

  $ 1,955,000     $ 1,882,500     $ 384,000     $ -     $ 4,221,500  

 

 
18

 

 

   

Nine Months Ended September 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  

 

   

Nine Months Ended September 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

    (5,722,290 )     -       -       -       (5,722,290 )

Purchases

    4,001,500       2,025,000       -       -       6,026,500  

Sales

    (13 )     (810 )     -       (645,000 )     (645,823 )

Total gains or losses:

                                       

Included in earnings

    -       -       -       2,400       2,400  

Included in other comprehensive income

    (158,667 )     (141,690 )     -       -       (300,357 )

Ending balance

  $ 1,955,000     $ 1,882,500     $ 384,000     $ -     $ 4,221,500  

 

 

The Company experienced no transfers between Level 1 and Level 2 during the quarters or nine months ended September 30, 2014 or 2013. The Company experienced no transfers between Level 2 and Level 3 during the quarter or nine months ended September 30, 2014. The Company experienced one transfer of a corporate fixed maturity from Level 3 to Level 2 during the quarter ended September 30, 2013. The Company had five corporate fixed maturities that transferred from Level 3 to Level 2 during the nine months ended September 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 September 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

 

 

   

September 30, 2014

 
   

Carrying

   

Fair

                         
   

Amount

   

Value

   

Level 1

   

Level 2

   

Level 3

 

Assets:

                                       

Mortgage loans on real estate:

                                       

Commercial

  $ 12,614,183     $ 13,375,610     $ -     $ -     $ 13,375,610  

Residential

    12,018,889       14,349,457       -       -       14,349,457  

Policy loans

    6,660,986       6,660,986       -       -       6,660,986  

State-guaranteed receivables

    7,896,230       9,507,038       -       9,507,038       -  

Other invested assets

    3,311,580       3,311,580       -       -       3,311,580  

Cash and cash equivalents

    11,743,411       11,743,411       11,743,411       -       -  

Accrued investment income

    4,391,287       4,391,287       -       -       4,391,287  

Cash value of company-owned life insurance

    12,166,351       12,166,351       -       -       12,166,351  
                                         

Liabilities:

                                       

Policyholder deposits (Investment-type contracts)

    53,599,935       53,898,216       -       -       53,898,216  

Policy claims

    2,811,794       2,811,794       -       -       2,811,794  

Obligations under capital leases

    647,265       647,265       -       -       647,265  

Notes payable

    2,665,507       2,665,711       -       -       2,665,711  

 

   

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 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 September 30, 2014 and 2013 were 1,125,247 and 1,135,559, respectively. The weighted average number of shares outstanding for the nine months ended September 30, 2014 and 2013 were 1,127,006 and 1,139,164, 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 September 30,

   

Nine Months Ended September 30,

 
   

2014

   

2013

   

2014

   

2013

 
                                 

Revenue:

                               

Preneed and burial products

  $ 12,737,829     $ 13,121,547     $ 36,329,237     $ 38,382,769  

Traditional and universal life products

    5,456,879       9,318,715       15,554,141       23,448,640  

Administrative and financial services

    275,076       282,157       901,085       925,669  

Corporate and other

    234,948       (43,881 )     775,115       584,789  

Total revenue

  $ 18,704,732     $ 22,678,538     $ 53,559,578     $ 63,341,867  
                                 

Pre-tax income (loss) from operations:

                               

Preneed and burial products

  $ 487,638     $ 555,869     $ 128,924     $ 563,079  

Traditional and universal life products

    687,998       2,353,229       969,175       953,650  

Administrative and financial services

    90,797       95,649       204,706       224,467  

Corporate and other

    (3,701 )     (220,758 )     185,162       (50,384 )

Total pre-tax income (loss)

  $ 1,262,732     $ 2,783,989     $ 1,487,967     $ 1,690,812  

 

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 nine months ended September 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 September 30, 2013, the Company’s death and other benefits included an additional amount totaling $2,069,169 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 2011 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 nine months ended September 30, 2014 and 2013.

 

   

Quarter Ended September 30, 2014

 
           

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

  $ (3,670,059 )   $ (1,366,178 )   $ (2,303,881 )

Reclassification adjustment for gains included in income

    (593,272 )     (83,355 )     (509,917 )

Adjustment for effect of deferred acquisition costs

    126,140       42,887       83,253  

Net unrealized losses on investments

    (4,137,191 )     (1,406,646 )     (2,730,545 )

Change in defined benefit pension plan:

                       

Amortization of actuarial net loss in net periodic pension cost

    97,604       33,185       64,419  
                         

Total other comprehensive loss

  $ (4,039,587 )   $ (1,373,461 )   $ (2,666,126 )

 

   

Quarter Ended September 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

  $ (1,357,536 )   $ (856,681 )   $ (500,855 )

Reclassification adjustment for gains included in income

    (2,418,806 )     (467,966 )     (1,950,840 )

Adjustment for effect of deferred acquisition costs

    128,198       43,589       84,609  

Net unrealized losses on investments

    (3,648,144 )     (1,281,058 )     (2,367,086 )

Change in defined benefit pension plan:

                       

Amortization of actuarial net loss in net periodic pension cost

    193,161       65,675       127,486  
                         

Total other comprehensive loss

  $ (3,454,983 )   $ (1,215,383 )   $ (2,239,600 )

 

 
23

 

 

   

Nine Months Ended September 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

  $ 10,975,674     $ 3,603,731     $ 7,371,943  

Reclassification adjustment for gains included in income

    (662,131 )     (97,127 )     (565,004 )

Adjustment for effect of deferred acquisition costs

    (252,382 )     (85,810 )     (166,572 )

Net unrealized gains on investments

    10,061,161       3,420,794       6,640,367  

Change in defined benefit pension plan:

                       

Amortization of actuarial net loss in net periodic pension cost

    292,810       99,555       193,255  
                         

Total other comprehensive income

  $ 10,353,971     $ 3,520,349     $ 6,833,622  

 

   

Nine Months Ended September 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

  $ (23,152,456 )   $ (8,271,465 )   $ (14,880,991 )

Reclassification adjustment for gains included in income

    (2,496,063 )     (500,184 )     (1,995,879 )

Adjustment for effect of deferred acquisition costs

    798,791       271,589       527,202  

Net unrealized losses on investments

    (24,849,728 )     (8,500,060 )     (16,349,668 )

Change in defined benefit pension plan:

                       

Amortization of actuarial net loss in net periodic pension cost

    579,485       197,025       382,460  
                         

Total other comprehensive loss

  $ (24,270,243 )   $ (8,303,035 )   $ (15,967,208 )

 

 

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 nine months ended September 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 nine months ended September 30, 2014:

                       

Beginning balance

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

Other comprehensive income before reclassifications

    7,205,371       -       7,205,371  

Amounts reclassified from accumulated other comprehensive income

    (565,004 )     193,255       (371,749 )

Net current period other comprehensive income

    6,640,367       193,255       6,833,622  

Ending balance

  $ 16,556,515     $ (2,970,902 )   $ 13,585,613  
                         

For the nine months ended September 30, 2013:

                       

Beginning balance

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

Other comprehensive loss before reclassifications

    (14,353,789 )     -       (14,353,789 )

Amounts reclassified from accumulated other comprehensive income

    (1,995,879 )     382,460       (1,613,419 )

Net current period other comprehensive income (loss)

    (16,349,668 )     382,460       (15,967,208 )

Ending balance

  $ 11,738,435     $ (5,165,919 )   $ 6,572,516  

 

 

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 nine months ended September 30, 2014 and 2013.

 

   

Quarter Ended September 30,

   

Nine Months Ended September 30,

 

Reclassification Adjustments

 

2014

   

2013

   

2014

   

2013

 

Unrealized gains on available-for-sale securities:

                               

Realized gains on sale of securities (a)

  $ 593,272     $ 2,418,806     $ 662,131     $ 2,496,063  

Income tax expense (c)

    (83,355 )     (467,966 )     (97,127 )     (500,184 )

Net of tax

    509,917       1,950,840       565,004       1,995,879  
                                 

Defined benefit pension plan:

                               

Amortization of actuarial net loss (b)

    (97,604 )     (193,161 )     (292,810 )     (579,485 )

Income tax benefit (c)

    33,185       65,675       99,555       197,025  

Net of tax

    (64,419 )     (127,486 )     (193,255 )     (382,460 )
                                 

Total reclassifications for the period

  $ 445,498     $ 1,823,354     $ 371,749     $ 1,613,419  

 

 

(a)

These items appear within net realized gains 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 September 30,

   

Nine Months Ended September 30,

 
   

2014

   

2013

   

2014

   

2013

 
                                 

Service cost

  $ -     $ -     $ -     $ -  

Interest cost

    261,263       167,180       783,791       501,540  

Expected return on plan assets

    (299,418 )     (298,146 )     (898,255 )     (894,438 )

Recognized actuarial net loss

    97,604       193,161       292,810       579,485  

Net periodic pension cost

  $ 59,449     $ 62,195     $ 178,346     $ 186,587  

 

 

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 September 30, 2014, the Company had contributed $675,000 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 Puritan Life Insurance Company of America. Effective January 1, 2013, this coinsurance agreement was amended to reinsure 25% of new business. 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 Puritan Life Insurance Company of America and Sterling Investors Life Insurance Company. 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.

 

 
29

 

 

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.

  

 
30

 

 

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 September 30, 2014, the Company had contributed $675,000 to the plan.

 

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.  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.

 

In August 2014, the FASB issued guidance that requires management to evaluate whether there are concerns or events that raise substantial doubt about the entity's ability to continue as a going concern within one year after the date the financial statements are issued. Disclosures are required when certain criteria are met. This guidance is effective for annual periods ending after December 15, 2016 and for annual periods and interim periods thereafter. We have not yet adopted this guidance, but it is not expected to have a material impact on the consolidated financial statements.

 

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 September 30, 2014 and December 31, 2013, 89.6% and 90.8%, respectively, of invested assets consisted of fixed income securities. At September 30, 2014 and December 31, 2013, Investors Heritage Life’s fixed income investments were 99.0% and 96.0% investment grade, respectively, as rated by Standard & Poor’s.

  

 
31

 

 

We have reviewed our investment portfolio and do not believe that there are any securities that are other-than-temporarily impaired at September 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 nine months ended September 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 September 30, 2014, we have no assets that have direct subprime exposure. Additionally, we have no Alt-A bond exposure within our current holdings.

 

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 September 30, 2014, the largest individual stock position within this group is approximately $262,000. 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 September 30, 2014, 51.2% 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 nine months ended September 30, 2014, we purchased residential mortgages through the secondary market totaling approximately $6,444,000 and $8,698,000, 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 September 30, 2014 and December 31, 2013, mortgage loans comprised 5.2% and 4.0%, respectively, of invested assets. As of September 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 September 30, 2014, we held approximately $7,896,000 in state-guaranteed receivables, with the largest concentrations in the states of New York, Massachusetts and Georgia totaling approximately $3,679,000, $1,951,000 and $1,490,000, respectively. At September 30, 2014 and December 31, 2013, state-guaranteed receivables comprised 1.7% and 1.8%, respectively, of invested assets.

  

 
32

 

 

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.

 

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 September 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 $12,390,545 for the third quarter of 2014 (a decrease of 17.1% compared to the third quarter of 2013) and $36,048,067 for the nine months ended September 30, 2014 (a decrease of 18.6% compared to the corresponding period in 2013). These decreases were primarily due to unanticipated weather-related impacts that hampered new sales across all segments during the first quarter of 2014, lower direct and assumed premiums from the Puritan product offerings as compared to the prior year, and the discontinuation of our Heritage Advantage product sold through the national master general agent distribution system.

   

 
33

 

 

Net investment income was $5,393,294 for the third quarter of 2014 (an increase of 8.2% compared to the third quarter of 2013) and $15,646,900 for the nine months ended September 30, 2014 (an increase of 0.8% compared to the corresponding period in 2013). These increases were primarily driven by an increase in mortgage loan income due to the growth in our residential mortgage loan portfolio, which provides greater investment yields than the current fixed maturity market. Our net investment income was negatively affected during the third quarter of 2013 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 on investments were $593,272 and $662,131 for the quarter and nine months ended September 30, 2014, respectively, compared to $2,418,806 and $2,482,057 for the quarter and nine months ended September 30, 2013, respectively. The realized gains recognized during the third quarter of 2014 primarily resulted from an effort to reduce our exposure to certain high-yield bonds given market uncertainty. The realized gains recognized during the quarter ended September 30, 2013 included those gains that we earmarked as part of our strategic initiative to take certain unrealized gains into operations. We also recognized a realized loss of $14,006 relative to the demolition of a Company-owned building during the nine months ended September 30, 2013. We experienced no other-than-temporary impairments during the quarters or nine months ended September 30, 2014 or 2013.

 

Other income was $327,621 for the third quarter of 2014 (an increase of 0.8% compared to the third quarter of 2013) and $1,202,480 for the nine months ended September 30, 2014 (an increase of 12.2% compared to the corresponding period in 2013). The increase for the current year was 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.

 

Total benefits and expenses were $17,442,000 for the third quarter of 2014 (a decrease of 12.3% compared to the third quarter of 2013) and $52,071,611 for the nine months ended September 30, 2014 (a decrease of 15.5% compared to the corresponding period in 2013). These decreases were primarily driven by lower reserve increases and reduced commissions relative to the lower sales volume in the first nine months of 2014. Additionally, for the nine months ended September 30, 2013, death and other benefits included an additional amount totaling $2,069,169 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 $861,389 with net income per share of $0.77 for the third quarter of 2014 compared to net income of $1,948,793 with net income per share of $1.72 for the third quarter of 2013. Our net income was $1,041,577 with net income per share of $0.92 for the nine months ended September 30, 2014 compared to net income of $1,183,569 with net income per share of $1.04 for the nine months ended September 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.

  

 
34

 

  

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 $12,737,829 for the third quarter of 2014 (a decrease of 2.9% compared to the third quarter of 2013) and $36,329,237 for the nine months ended September 30, 2014 (a decrease of 5.4% compared to the corresponding period in 2013). These decreases were 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 income from operations was $487,638 and $128,924 for the quarter and nine months ended September 30, 2014, respectively, compared to pre-tax income of $555,869 and $563,079 for the quarter and nine months ended September 30, 2013, respectively. These decreases in pre-tax income 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 $5,456,879 for the third quarter of 2014 (a decrease of 41.4% compared to the third quarter of 2013) and $15,554,141 for the nine months ended September 30, 2014 (a decrease of 33.7% compared to the corresponding period in 2013). These decreases were primarily due to lower direct and assumed premiums received from the Puritan product offerings in comparison to the corresponding period in the prior year. Revenue was also impacted by the reduction in realized investment gains due to the 2013 strategic sales effort of certain fixed maturities in order to realize capital gains.

 

Pre-tax income from operations was $687,998 and $969,175 for the quarter and nine months ended September 30, 2014, respectively, compared to pre-tax income of $2,353,229 and $953,650 for the quarter and nine months ended September 30, 2013, respectively. The reduction in pre-tax income for the quarter was primarily due to the 2013 strategic sales effort of certain fixed maturities in order to realize capital gains. The increase in pre-tax income for the nine month period was primarily due to stronger net investment income associated with our residential mortgage loan portfolio.

 

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 $275,076 for the third quarter of 2014 (a decrease of 2.5% compared to the third quarter of 2013) and $901,085 for the nine months ended September 30, 2014 (a decrease of 2.7% compared to the corresponding period in 2013). Pre-tax income from operations was $90,797 and $204,706 for the quarter and nine months ended September 30, 2014, respectively, compared to pre-tax income of $95,649 and $224,467 for the quarter and nine months ended September 30, 2013. The revenue and pre-tax income changes were primarily related to a reduction in fees generated from servicing and administering credit business compared to prior periods.

  

 
35

 

 

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 $234,948 and $775,115 for the quarter and nine months ended September 30, 2014, respectively, compared to ($43,881) and $584,789 for the quarter and nine months ended September 30, 2013, respectively. Pre-tax income (loss) from operations was ($3,701) and $185,162 for the quarter and nine months ended September 30, 2014, respectively, compared to a pre-tax loss from operations of $220,758 and $50,384 for the quarter and nine months ended September 30, 2013. Results for the nine months ended September 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.

 

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 nine months ended September 30, 2014, Investors Heritage Capital received dividends of $85,000 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 31.8% and 30.0%, respectively, for the quarter and nine months ended September 30, 2014 compared to 30.0% for the quarter and nine months ended September 30, 2013.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

We have no off-balance sheet arrangements as of September 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.

  

 
36

 

 

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. 

 

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.

  

 
37

 

 

 

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 November 13, 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.

  

 
38

 

 

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: November 13, 2014

President

 

 

 

BY: /s/Larry Johnson

 

Larry Johnson

DATE: November 13, 2014

Vice President - Chief Financial Officer

 

 

39