Investors Heritage Capital Corp - FORM 10-K - EX-13 - EXHIBIT 13 - March 22, 2017

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EX-32.1 - EXHIBIT 32.1 - Investors Heritage Capital Corpex32-1.htm
EX-31.2 - EXHIBIT 31.2 - Investors Heritage Capital Corpex31-2.htm
EX-31.1 - EXHIBIT 31.1 - Investors Heritage Capital Corpex31-1.htm
EX-23 - EXHIBIT 23 - Investors Heritage Capital Corpex23.htm
10-K - FORM 10-K - Investors Heritage Capital Corpihrc20161231_10k.htm

Exhibit 13

 

 

     

Investors Heritage 

     

Capital Corporation

       
     

2016 Annual Review

       
       
       
       
       
     

table of contents

  
       
       

2

    

Letter To Our Stockholders

       

4

    

management’s discussion and analysis

       

21

    

management’s report on internal control over financial reporting

       

22

    

report of independent registered public accounting firm

       

23

    

consolidated financial statements

       

28

    

notes to consolidated financial statements

       

58

    

corporate information

       

 

 
 
 

 

LETTER

TO OUR STOCKHOLDERS

 

Last year was a productive and busy year for our companies. All of this led to positive financial gains from operations for both Investors Heritage Capital Corporation (IHCC) and its wholly owned subsidiary, Investors Heritage Life Insurance Company (Investors Heritage Life). Net income for IHCC was $2,660,801 for 2016 compared to $1,036,716 in 2015. Investors Heritage Life had statutory net income of $2,073,521 in 2016 compared to $1,267,672 in 2015. IHCC stockholders’ equity increased approximately $7,000,000 to $56,184,945 and Investors Heritage Life’s statutory capital and surplus increased 22% to $25,958,039. A dividend of $0.25 per share was declared by the Board of Directors on March 16, 2017 to be paid to stockholders on April 7, 2017. These are just some of the financial highlights and I encourage you to read Management’s Discussion and Analysis.

 

Our primary sales segments, preneed sales through funeral homes and sales of final expense life insurance, increased 10.8% in 2016 following an increase of 4.5% in 2015. We are very encouraged by the activity, results and direction of our preneed and final expense sales.

 

In February 2016, we introduced a new target marketing cooperative program for our funeral home clients. This program allows us to provide our clients with customizable direct mail campaigns, lead and sales tracking information, as well as return on investment reports. This program contributed to the preneed sales increase we experienced in 2016.

 

In January 2017, Investors Heritage Life was endorsed as the “Preferred Preneed Provider” by the Tennessee Funeral Security, Inc. and the Tennessee Funeral Directors Association (TFSI / TFDA). Creative thinking by our Company, our Tennessee field managers and the TFSI / TFDA led to a plan structured to benefit all by increasing preneed sales in Tennessee. Sales in Tennessee have grown substantially over the past two years and we hope this endorsement will lead to new and productive relationships with additional funeral homes.

 

Our Third Party Administration (TPA) of non-affiliated companies continues to be a strong revenue source, with income growth of 8.4% in 2016. This would not be possible without an outstanding home office staff and strong administrative systems. Jim Smith was hired in April, 2004 to find non-affiliated clients and oversee the TPA program. Jim is also a key in many of our investment programs. He was promoted to Vice President, Corporate Development in 2016.

 

We had several additional personnel changes during the year including retirements and promotions. Lewis Rogers, Vice President, Information Services retired after 29 years with the Company. Lewis’ leadership of the Information Services Department kept our systems running and our Company in a position to provide great service to our clients. We wish Lewis and his wife, Valerie, all the best in their retirement to the lakes area of Western Kentucky. The department continues in good hands under the leadership of Andrew Moore. Andrew has been with us since June, 2004 and was promoted from Assistant Vice President to Vice President upon Lewis’ retirement. Andrew has been an integral part of the development and success of the department.

 

Jeff Crippen joined the Company in January 2013 as Vice President, Agency. We appreciate Jeff’s work, bringing new ideas and markets to us. He helped us to increase sales in our primary markets and gain access to a market new to us, association group life. We value all Jeff brought to us and wish him and Charlotte the best in the future.

 

Jeff was succeeded as Vice President, Agency by my son, Garth Waterfield. Garth has grown up in this Company, particularly the sales side of the organization. Garth joined Investors Heritage Life as a full-time employee in July 2011 after several years in the thoroughbred horse industry. In preparation to lead the Agency Department he served as Agency Support from 2011 – 2012, Assistant to the President from 2012-2013 and as Director of Agency Sales and Support under Jeff.

 

 
2
 

 

LETTER

TO OUR STOCKHOLDERS

 

Two excellent department heads were promoted in 2016. Robin Bowman was promoted from Director to Vice President, Benefit Payments Department. Robin has been an invaluable member of our organization since joining the Company in January 1983. Robin and her department are a critical part of our customer service, providing careful and thoughtful service and prompt payments of benefits to policy beneficiaries.

 

Kate Andry Montgomery had a special 2016. She was promoted to Vice President, Policyholder Services, and also became a mother. Kate has been an outstanding employee since joining us in October 2004. The Policyholder Service department has the most direct contact with our policyholders and I am proud to say they consistently provide a high level of professional and compassionate service.

 

Our longtime manager for the western half of North Carolina, Joe Beeson, passed away on June 10, 2016 at age 88. Joe joined us in 1976 after we assumed a block of business from a company he had represented. Joe and his wife, Louise, have two sons, a daughter and several loving grandchildren and great-grandchildren. Joe was a true gentlemen and Louise is equally gracious and elegant. We were blessed to be able to work with Joe for so many years. Our best always to Louise and her family.

 

Our people are the reason for our success. The hard work and dedication of our sales personnel in the field and our home office administration and staff is sincerely appreciated. Our Board of Directors is diligent in carrying out their duty of providing oversight and advising management in operation of the Company. All associated with our organization take our obligation to our stakeholders seriously and pledge to continue to run a well managed organization for all of our stockholders, clients, employees and sales personnel.

 

 

 

Respectfully submitted,

     

Harry Lee Waterfield II

Chairman, Chief Executive Officer

 

 
3
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

EXECUTIVE OVERVIEW

 

The following discussion highlights significant factors impacting the consolidated operating results and financial condition of Investors Heritage Capital Corporation (“Investors Heritage Capital”) and its subsidiaries (collectively referred to as “we”, “us”, “our” or the “Company”) as of and for the year ended December 31, 2016, as compared with the year ended December 31, 2015. This supplementary financial information should be read in conjunction with the consolidated financial statements and related notes, all of which are integral parts of the following analysis of our results of operations and financial position.

 

Investors Heritage Capital is the parent company of Investors Heritage Life Insurance Company (“Investors Heritage Life”), Investors Heritage Financial Services Group, Inc. (“Investors Heritage Financial”), Investors Heritage Printing, Inc., and is the sole member of At Need Funding, LLC and Heritage Funding, LLC. Investors Heritage Capital and each subsidiary are domiciled in the Commonwealth of Kentucky. In excess of 99% of Investors Heritage Capital’s consolidated revenue is generated by Investors Heritage Life.

 

MAJOR MARKETS AND AFFILIATIONS

 

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. We continue to actively develop new products and diversify distribution systems in order to broaden our marketing base.

 

We focus significant sales efforts in the preneed funeral market. We have established a strong marketing base allowing us to maintain solid premium production in our core market.

 

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 through our partnership with Puritan Financial Group and are being underwritten and issued using a third party underwriter with significant experience in that market. Premiums are generated through a combination of direct sales of these products in addition to reinsurance assumed through sales by Puritan Life Insurance Company of America and Sterling Investors Life Insurance Company of identical products in certain states where we are not currently marketing. Prior to July 31, 2015, we ceded 25% of new business generated under our marketing agreement to Puritan Life Insurance Company of America, and we assumed 75% of the risks associated with sales by both Puritan Life Insurance Company of America and Sterling Investors Life Insurance Company. These reinsurance agreements were terminated with respect to new business effective July 31, 2015, after which time we retain 100% of the direct new business produced under our marketing agreement.

 

We continue to actively market an association group term product. This product provides a monthly renewable term benefit and is being marketed to various association groups.

 

Effective September 30, 2016, we entered into a 100% coinsurance agreement with Southland National Insurance Corporation (“SNIC”) whereby we ceded an existing block of deferred fixed annuities to SNIC. The total liabilities reinsured as of September 30, 2016 were approximately $44,024,000 and deferred acquisition costs associated with this block were approximately $329,000. We transferred cash to SNIC under the agreement totaling approximately $41,921,000. In order to generate cash, we sold fixed maturity securities generating pre-tax net realized capital gains totaling approximately $880,000. In accordance with GAAP guidance, the initial ceding commission received on this transaction was deferred and will be recognized into income over the expected life of the reinsurance contract, which is 20 years. The initial ceding commission, net of tax, was $1,471,858 and is presented separately on the balance sheet as deferred revenue on reinsurance ceded. We recognized $40,211 of income associated with the amortization of the deferred revenue during 2016. Under the terms of the reinsurance agreement, we will continue to administer this business and will be paid administrative fees by SNIC. SNIC will also maintain a trust account further securing the statutory liabilities ceded.

 

 
4
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

Investors Heritage Financial operates under marketing agreements with Investors Heritage Life. These arrangements have enabled Investors Heritage Financial and Investors Heritage Life to utilize their expertise in the marketing and administration of credit insurance products. Further, Investors Heritage Financial enables Investors Heritage Life to offer mortgage protection and ordinary life insurance products through financial institutions.

 

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 five TPA clients, which includes the addition of one new life insurance company client during September 2016, for which we provide tailored services to meet each client’s individual business needs. Two life insurance holding company clients terminated their agreements effective October 1, 2015 in order to begin performing that work in-house. We have been able to perform our TPA services using 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.

 

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.

 

 
5
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

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 3 to the consolidated financial statements.

 

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 $448,000 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.

 

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.

 

 
6
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

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.

 

Under current tax law, we are allowed to utilize the small life insurance company tax deduction to limit the federal taxable income associated with Investors Heritage Life annually. Changes in tax law or the growth of the Company’s tax basis assets to an amount greater than $500 million could limit our ability to utilize this deduction in future years, which could give rise to higher current federal income tax expense.

 

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. 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.

 

 
7
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

During 2014, the Society of Actuaries released new mortality tables and a new mortality improvement scale for consideration with respect to defined benefit plan liability measurement. Effective December 31, 2015, our plan began utilizing new mortality tables and improvement scales, developed by plan consulting actuaries utilizing the principles underlying the guidance from the Society of Actuaries along with allowable adjustments where warranted.

 

At December 31, 2016, our unfunded status with respect to our defined benefit pension plan was $6,021,264, compared to an unfunded status of $6,075,376 at December 31, 2015. This improvement in the funded status is due primarily to the performance of plan assets for the year ended December 31, 2016. The estimated net loss that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost in 2017 is approximately $677,000. We currently expect to contribute $360,000 to our plan during 2017, although this contribution is subject to change based on the results of current year funding analyses to be performed by plan actuaries.

 

New Accounting Pronouncements

In July 2015, the FASB issued guidance regarding employee benefit accounting. The guidance is divided into three parts. First, the guidance requires a pension plan to use contract value as the only required measure for fully benefit-responsive investment contracts. Second, the guidance simplifies and increases the effectiveness of the investment disclosure requirements for employee benefit plans. Third, the guidance provides benefit plans with a measurement date practical expedient. This guidance is effective for fiscal years beginning after December 15, 2015. The adoption of this guidance did not have a material impact on our consolidated financial statements.

 

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.  However, certain other types of contracts may impact the financial statements of insurance providers. In August 2015, the FASB deferred the effective date of this guidance for public entities to annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. We are currently evaluating this guidance, but we do not expect it to have a material impact on our consolidated financial statements.

 

In January 2016, the FASB issued guidance regarding the recognition and measurement of financial assets and liabilities. This guidance intends to enhance reporting for financial instruments and addresses certain aspects of recognition and measurement of investments in equity securities and the presentation in the balance sheet of financial assets and liabilities measured at fair value. It also amends certain disclosure requirements associated with the fair value of financial instruments. This guidance is effective for fiscal years beginning after December 15, 2017. The recognition and measurement provisions of this guidance will be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption and early adoption is not permitted. We are in the process of evaluating this guidance, but we expect its primary impact on the Company will be the recognition of all unrealized gains and losses on available-for-sale equity securities in net income. Currently, all unrealized gains and losses on available-for-sale equity securities are recognized in other comprehensive income (loss).  Refer to Note 2 for details of unrealized gains and losses on available-for-sale equity securities held by the Company.

 

 
8
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

In February 2016, the FASB issued updated lease accounting guidance that provides new requirements for leases to be recognized in the financial statements. In general, the guidance requires the lessee to recognize liabilities on the balance sheet for the obligation to make lease payments and an asset for the right to use the underlying assets for the lease term.  There is a differentiation between finance leases and operating leases for the lessee in the statements of operations and cash flows.  Finance leases recognize interest on the lease liability separately from the right to use the asset whereas an operating lease recognizes a single lease cost allocated over the lease term on a generally straight-line basis.  All cash payments are within operating activities in the statement of cash flows except finance leases classify repayments of the principal portion of the lease liability within financing activities. The updated guidance is to be applied using a modified retrospective approach effective for annual and interim periods beginning after December 15, 2018.  Early adoption is permitted.  The adoption of this guidance is not expected to have a material effect on our consolidated financial statements.

 

In June 2016, the FASB issued new guidance for the accounting for credit losses on financial instruments. A new model, referred to as the current expected credit losses model, requires an entity to determine credit-related impairment losses for financial instruments held at amortized cost and to estimate these expected credit losses over the life of an exposure (or pool of exposures). The estimate of expected credit losses should consider historical and current information, reasonable and supportable forecasts, as well as estimates of prepayments. The estimated credit losses, and subsequent adjustment to loss estimates, will be recorded through an allowance account which is deducted from the amortized cost of the financial instrument, with the offset recorded in current earnings. The guidance also modifies the impairment model for available-for-sale debt securities. The new model will require an estimate of expected credit losses only when the fair value is below the amortized cost of the asset, thus the length of time the fair value of an available-for-sale debt security has been below the amortized cost will no longer affect the determination of whether a credit loss exists. In addition, credit losses on available-for-sale debt securities will be limited to the difference between the security’s amortized cost basis and its fair value. The updated guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for periods beginning after December 15, 2018. We are currently evaluating the impact of the adoption of this guidance on our financial position and results of operations.

 

In August 2016, the FASB issued new guidance that clarifies the classification of certain cash receipts and payments in the statement of cash flows under eight different scenarios including, but not limited to: (i) debt prepayment or debt extinguishment costs; (ii) proceeds from the settlement of corporate-owned life insurance policies including bank-owned life insurance policies; (iii) distributions received from equity method investees; and (iv) separately identifiable cash flows and application of the predominance principle. This guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the impact of this guidance on our statement of cash flows.

 

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

 

 
9
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

  

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. Accordingly, our business segments are as follows:

 

 

■

Preneed and Burial Products segment includes both life and annuity products sold by funeral directors or affiliated agents to fund prearranged funerals or to provide for the insured’s final expenses.

 

 

■

Traditional and Universal Life Products segment includes senior wealth transfer products, traditional life, group life, certain annuities and universal life products.

 

 

■

Administrative and Financial Services segment includes the administration of credit life and credit accident and health insurance products as well as the fees generated from our third party administrative relationships.

 

 

■

Corporate and Other segment consists of corporate accounts primarily including stockholders' paid-in capital, earned surplus, property and equipment, company-owned life insurance and other minor business lines which include group annuities and group and individual accident and health products.

 

Please see Note 9 to the consolidated financial statements for additional information regarding segment data.

 

OPERATING RESULTS

Consolidated Operations

Consolidated revenues decreased approximately $2,616,000 during 2016. This decrease was primarily driven by a decrease in net premiums of approximately $3,441,000, or 7.8%, during 2016. The decrease was due to lower direct and assumed premiums relative to the senior wealth transfer product offerings compared to the prior period.

 

Net investment income increased approximately $171,000, or 0.8%, during 2016 due primarily to increased investment income generated by our investments in residential mortgage loans and state-guaranteed receivables, which were partially offset by a reduction in income associated with fixed maturities. The reduction in investment income from fixed maturities resulted from the sale of approximately $41,779,000 in fixed maturities near the end of the third quarter of 2016 to fund the new annuity reinsurance agreement with SNIC. Our mortgage loan portfolio and investments in state-guaranteed receivables both provide greater investment yields than the current fixed maturity market. New fixed maturity investments with lower 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 were $1,556,122 and $818,705 during 2016 and 2015, respectively. The 2016 net realized gains resulted from a combination of the capital gains attributable to the strategic sale of certain bonds to fund the SNIC reinsurance agreement, capital gains generated earlier in 2016 as a result of an effort to reduce single issuer exposure levels, and realized gains on the real estate common stock portfolio. The 2015 realized gains primarily resulted from capital gains taken on common stocks. During 2016, we recognized one other-than-temporary impairment totaling $118,267 on a real estate common stock which we continue to hold. We experienced no other-than-temporary impairments during the year ended December 31, 2015.

 

 
10
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

Other income decreased approximately $83,000, or 4.7%, during 2016. This decrease is primarily due to the fact that we received net life insurance proceeds on one of our company-owned life insurance policies totaling approximately $203,000 during 2015. During 2016, we received no life insurance proceeds under such policies. This reduction was partially offset by increased third party administrative fees based on increased policy counts and service needs for our life insurance company clients as well as the addition of a new life insurance company client during September 2016.

 

Total benefits and expenses decreased approximately $4,704,000, or 7.0%, during 2016. This decrease is primarily driven by reduced death benefits due to more favorable mortality experience in comparison to the prior period, a reduction in the increase in reserves and commissions associated with our lower new premium volume as well as cost savings generated in our general and administrative expenses.

 

After providing for federal income taxes, our net income was $2,660,801 with net income per share of $2.39 for 2016 as compared to net income of $1,036,716 and net income per share of $0.93 for 2015.

 

We declared a dividend of $0.21 per share on February 11, 2016 to shareholders of record on March 18, 2016. This dividend was paid on April 7, 2016. We declared a dividend of $0.21 per share on February 12, 2015 to shareholders of record on March 20, 2015. This dividend was paid on April 7, 2015.

 

Preneed & Burial Products

Revenues for the preneed and burial products business segment increased approximately $3,351,000, or 6.9%, in 2016 compared to 2015. This increase was predominantly due to stronger sales of our preneed products driven both by sales within existing relationships as well as new agent relationships coupled with increased investment income and realized gains in comparison to the prior period. Our pre-tax income increased approximately $2,478,000 in 2016, resulting in pre-tax income of approximately $1,982,000. This increase was primarily due to the previously mentioned revenue increases along with more favorable mortality experience in comparison to the prior period.

 

The table below provides the detail of premiums for the top ten producing states for this segment:

 

Preneed Premium Production

First Year and Single

Year Ended December 31

 

 

   

2016

    

2015

  

Kentucky

   $ 8,412,558     $ 7,172,554  

North Carolina

     6,836,499       6,861,083  

Tennessee

     5,255,623       4,465,024  

Georgia

     2,136,317       2,355,569  

Virginia

     1,956,036       1,769,661  

Ohio

     1,666,521       1,570,985  

Indiana

     1,316,455       1,033,919  

Illinois

     607,064       417,525  

Michigan

     566,674       479,093  

South Carolina

     547,206       548,890  

All Other States

     818,550       916,187  

TOTAL

   $ 30,119,503     $ 27,590,490  

 

 
11
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

We currently market the Legacy Gold and Heritage Final Expense products within this segment. 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 Final Expense product is a non-participating whole life insurance product with simplified underwriting, sold in the final expense market.

 

Traditional & Universal Life Products

Revenues for 2016 decreased approximately $5,690,000, or 34.0%, while pre-tax income decreased approximately $238,000. The decrease in revenue and pre-tax income was primarily due to the reduction in direct and assumed premiums generated from the senior wealth preservation product offerings in comparison to the prior year, as further discussed below.

 

Within this 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 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. This reinsurance agreement was terminated with respect to new business effective July 31, 2015, after which time we now retain 100% of new business being produced under the marketing agreement. The statutory reserves ceded under this agreement are secured by a trust account located within the Commonwealth of Kentucky. Premiums generated during the years ended December 31, 2016 and 2015 from this partnership totaled approximately $3,421,000 and $8,933,000, respectively.

 

Investors Heritage Life assumed 75% of the risks on certain 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. These reinsurance agreements were also terminated with respect to new business effective July 31, 2015. Premiums assumed under these agreements totaled approximately $447,000 and $753,000 for the years ended December 31, 2016 and 2015, respectively.

 

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.

 

 
12
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

We utilize a combination of yearly renewable term reinsurance and coinsurance to cede life insurance coverage in excess of our desired retention limits. In recent years, we have maintained our retention limits in most cases at $25,000 per life, utilizing a combination of established product specific reinsurance treaties along with yearly renewable term treaties for policies where we had previously maintained more than this limit. At the end of the second quarter of 2016, we approved an increase in our individual life retention to $50,000 per life where allowable under our reinsurance agreements. We are in the process of evaluating and either replacing or modifying our existing individual life yearly renewable term reinsurance agreements in order to effect this increase in retention. We anticipate that this change will better align our retention with our current capital, reduce reinsurance costs and allow for us to retain a greater share of the anticipated profitability of our products.

 

Administrative & Financial Services

This segment includes 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 five unaffiliated life insurance companies, which includes a new client added in September 2016. 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. Two former life insurance holding company clients terminated their agreements effective October 1, 2015 in order to begin performing that work in-house.

 

Revenues for this segment increased approximately $112,000, or 8.3%, in 2016 while pre-tax income increased approximately $119,000. The increases in revenues and pre-tax income were primarily due to the addition of the one new client and the fact that our existing life insurance company clients experienced increased policy counts and additional service needs which resulted in an increase in our monthly fees. We were able to perform this additional work using in-house resources.

 

Corporate & Other

Corporate & 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 from this segment decreased approximately $389,000, or 33.0%, in 2016, while pre-tax income decreased $271,000. The decreases in revenues and pre-tax income were primarily due to the mark-to-market adjustment on our investments in convertible options and decrease in net life insurance proceeds received under company-owned life insurance policies upon the death of covered employees and board members. For the years ended December 31, 2016 and 2015, the Company recognized income (loss) of approximately ($10,000) and $102,000, respectively, associated with the mark-to-market adjustment on our investments in convertible options. Additionally, the net life insurance proceeds received under company-owned life insurance policies totaled approximately $203,000 during 2015. We received no proceeds on these policies during 2016.

 

 
13
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

During 2016, Investors Heritage Financial's revenues were approximately $148,000, up $8,000 compared to 2015. Investors Heritage Financial paid dividends to Investors Heritage Capital totaling $60,000 during 2016. Revenues from At Need Funding were approximately $65,000 in 2016, down $49,000 compared to 2015. At Need Funding paid no distributions to Investors Heritage Capital during 2016. Due to the retirement of a key employee at the end of 2015 and shifts in print demand, the Company had no ongoing operations within Investors Heritage Printing in 2016. Revenues from Investors Heritage Printing were approximately $122,000 in 2015. Investors Heritage Printing paid no dividends to Investors Heritage Capital during 2016. Revenues from all non-Investors Heritage Life sources constituted less than 1% of total consolidated revenues in 2016. Management continues to focus on the growth and profitability of Investors Heritage Financial and At Need Funding.

 

INVESTMENTS, LIQUIDITY AND CAPITAL RESOURCES

 

 

Investments

Together with our outside investment advisors and portfolio manager, we manage the fixed income investment portfolio to achieve the Company’s investment goals, which include the diversification of credit risk, the maintenance of adequate portfolio liquidity, the management of interest rate risk and the maximization of investment returns. The primary investment objectives are to maintain the quality and integrity of the fixed income portfolio while improving the total return on investments.

 

We maintain a sound, conservative investment strategy. As of December 31, 2016, 83.8% of our total invested assets consisted of fixed income securities, compared to 87.5% at December 31, 2015. At December 31, 2016 and 2015, our fixed income investments were 97.7% and 97.5% investment grade, respectively, as rated by Standard & Poor's. The Standard & Poor's average quality rating of our fixed income portfolio holdings as of December 31, 2016 was A. None of our fixed income investments are in default.

 

The fixed income portfolio is diversified among asset classes and industry sectors. At December 31, 2016 and 2015, the fixed income portfolio was allocated as follows:

 

 

   

December 31

  
   

2016

    

2015

  

U.S. corporate securities

     57.8 %     57.5 %

Foreign government and corporate securities

     14.3 %     15.2 %

Mortgage-backed securities

     11.0 %     11.2 %

States and political subdivisions

     10.8 %     10.1 %

U.S. government obligations

     6.1 %     5.9 %

Asset-backed securities

     0.0 %     0.1 %

 

 

The fixed maturities and equity securities within our portfolio were in a net unrealized gain position of approximately $16,827,000 at December 31, 2016 compared to a net unrealized gain position of approximately $9,785,000 at December 31, 2015. Please see Note 3 to the consolidated financial statements for additional information regarding these fair values.

 

 
14
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

At December 31, 2016, 100% of our fixed maturity portfolio had a fair value to amortized cost ratio of greater than 80%, and 94.0% of our equity securities portfolio had a fair value to cost ratio of greater than 80%. At December 31, 2015, 97.4% of our fixed maturity portfolio had a fair value to amortized cost ratio of greater than 80%, and 93.4% of our equity securities portfolio had a fair value to cost ratio of greater than 80%. The improvements in these measures relative to fixed maturities is primarily due to rebounding commodity prices and economic environments particularly within the metals/mining and energy sectors. The improvement relative to equity securities is primarily due to market conditions within our real estate sector stocks.

 

During 2016, we recognized an other-than-temporary impairment on one real estate common stock totaling $118,267. While we continue to hold this security, there was no evidence to suggest that the security would recover in the near-term based on the financial outlook for the stock, the significance of the reduction in market value and the length of time that the stock has traded below its book value. We experienced no additional other-than-temporary impairments during 2016 or 2015.

 

The fixed income portfolio includes approximately $40,223,000 (at fair value) of non-U.S. Government mortgage-backed securities ("MBS"). MBS have historically added value to the portfolio and our outside investment advisor has provided the expertise to purchase MBS with confidence that the credit ratings have been properly analyzed and that the investment properly suits our asset and liability needs.

 

There have been concerns expressed by rating agencies, various regulators and other constituencies regarding investments in MBS by insurers and other financial institutions. Although these highly rated securities provide excellent credit quality, their liquidity risk must be monitored. Except for six commercial-backed mortgages totaling approximately $6,916,000, all of the collateral of the MBS owned are guaranteed by the Government National Mortgage Association ("GNMA"), Federal National Mortgage Association ("FNMA") or Federal Home Loan Mortgage Corporation ("FHLMC").

 

The FNMA and FHLMC securities are structured either as publicly traded collateralized mortgage obligations ("CMO") or pass-throughs. Unlike most corporate or real estate debt, the primary concern with MBS is the uncertainty of timing of cash flows due to prepayment assumptions rather than the possibility of loss of principal.

 

CMO holdings represent approximately 31% of the total MBS portfolio. In accordance with relevant accounting guidance, when these securities are purchased at a discount or premium, the income yield will vary with changes in prepayment speeds due to the change in accretion of discount or amortization of premium, as well as the timing of the basic principal and interest cash flows. The overall impact of the CMO’s variability in yields on the portfolio has not been significant in relation to the yield and cash flows of the total invested assets. More importantly, the investment portfolio has no exposure to more volatile, high-risk CMO’s, such as those structured to share in residual cash flows. Except for two sequential pay CMO’s totaling approximately $5,244,000, the CMO’s held are either planned amortization class bonds or support class bonds, both of which are structured to provide more certain cash flows to the investor and therefore have reduced prepayment risk. Based on our analysis of the investment portfolio, there are no impairment issues with respect to our CMO’s.

 

Pass-throughs comprise the remainder of MBS owned, representing approximately 69% of the total MBS portfolio. Pass-throughs are FNMA or FHLMC guaranteed MBS that, simply stated, pass through interest and principal payments to the investors in accordance with their respective ownership percentage.

 

We continuously monitor the investment risk within our portfolio, including the risk associated with subprime lending with our CMO investments. As of December 31, 2016, we have no investments with any level of direct subprime exposure. Additionally, we have no Alt-A bond exposure within our current holdings.

 

 
15
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

We have an investment advisory agreement with an independent third-party investment advisor 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 December 31, 2016, the largest individual stock position within this sector had a fair value of approximately $440,000. We believe the unrealized losses in our common stock portfolio 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 December 31, 2016 and 2015, investments in commercial mortgage loans comprised 26.2% and 37.4%, respectively, of our mortgage portfolio. Our 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 December 31, 2016 and 2015, investments in residential mortgage loans comprised 73.8% and 62.6%, respectively, of our mortgage portfolio. We purchase single family residential mortgage loans through the secondary market. Each mortgage loan opportunity is reviewed individually, considering both the value of the underlying property and the credit worthiness of the borrower. We utilize third party servicers to administer these loans.

 

As of December 31, 2016, our average loan balance is $157,643 and the average loan-to-value is 61%. The largest loan currently held has a balance of $903,326. Our mortgage loans are spread across properties located in 26 states. At December 31, 2016 and 2015, 9.4% and 7.1% of invested assets consisted of mortgage loans, respectively.

 

The mortgage loan portfolio consists of the following property types:

 

 

   

December 31

 
   

2016

    

2015

  

Residential

     73.8 %     62.6 %

Retail

     17.9 %     26.9 %

Apartments

     4.9 %     5.3 %

Office

    1.2 %     1.8 %

Medical

     1.1 %     1.5 %

Industrial

     0.6 %     1.2 %

Other

     0.5 %     0.7 %

 

We are familiar with our mortgage loan markets and given our low loan-to-value ratios, we do not believe that there is a significant risk of loss on our mortgage loan portfolio. We have been successful in adding value to the total investment portfolio through mortgage loan originations and secondary market purchases due to the fact that yields realized from the mortgage loan portfolio are generally higher than yields realized from fixed income investments. Value has also been added because the mortgage loan portfolio has consistently performed well. As of December 31, 2016 and 2015, we had no non-performing mortgage loans, loans on nonaccrual status, loans past due 90 days or more, loans in process of foreclosure, or restructured loans.

 

 
16
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

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 where allowable by law. We carry the state-guaranteed receivables at their amortized cost basis on the balance sheet. As of December 31, 2016, we held approximately $11,585,000 in state-guaranteed receivables, with the largest concentrations in the states of New York, Massachusetts and Georgia totaling approximately $3,446,000, $3,126,000 and $2,013,000, respectively. At December 31, 2016 and 2015, 2.6% and 1.6% of invested assets consisted of state-guaranteed receivables, respectively.

 

During the third quarter of 2015, with the assistance and under the active management of our external third party investment advisor, we began purchasing investments in convertible fixed maturity securities. Convertible securities feature an option allowing for a portion of the security to be converted into an equity position of the underlying issuer in exchange for a lower coupon rate. In accordance with FASB accounting guidance, this convertible feature must be bifurcated and reported separately on the balance sheet at fair value, with adjustments in fair value recognized in the income statement. Accordingly, the convertible options within our portfolio are reported as investments in convertible options on the balance sheet, and the mark-to-market adjustment associated with the changes in fair value of the convertible options are reported as gains (losses) on investments in convertible options as a component of net investment income. As of December 31, 2016 and 2015, the total fair value of our investments in convertible options was $983,950 and $957,405, respectively. For the years ended December 31, 2016 and 2015, we recognized gains (losses) on our investments in convertible options of ($9,850) and $102,342, respectively, relative to the mark-to-market adjustment. Additionally, we recognized net realized investment gains during 2016 and 2015 of $47,940 and $7,223, respectively, upon the exchange of convertible securities.

 

Liquidity and Capital Resources

The quality of our investment portfolio and the current level of stockholders' equity continue to provide a sound financial base as we strive to expand our marketing system and to offer competitive, quality products. Our investment portfolio continues to provide financial stability. It is management's opinion that we have adequate cash flows both on a long-term and short-term basis as evidenced by the net cash flows provided by operating activities in the consolidated statements of cash flows. Investors Heritage Life’s primary sources of cash flows 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.

 

 
17
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

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, dividends from its subsidiaries and proceeds received under company-owned life insurance policies. Investors Heritage Capital’s principal long-term obligations are payments on long-term debt and stock purchased under the put option through the IHCC Retirement Savings Plan and Trust, which is now frozen with respect to new contributions.

 

Our conservative approach to product development and the strength and stability of our fixed income and mortgage loan portfolios provide adequate liquidity both in the short-term and the long-term. Liquidity is also managed by laddering maturities of our fixed income portfolio. The average duration of our fixed income investments is 5.1 years with approximately $11,454,000 due within twelve months and approximately $106,475,000 due within the following four years. One of the responsibilities of our independent portfolio manager is to constantly monitor the credit rating of our fixed income investments to determine if rating changes of any investment requires action by management. As explained in detail in Note 1 to the consolidated financial statements, all fixed income securities and all marketable equity securities are classified as available-for-sale and are carried at fair value.

 

Effective November 25, 2016, Investors Heritage Capital renewed a line of credit agreement designated for the purpose of funding the purchase of agent debit balance receivables from Investors Heritage Life. These agent debit balance receivables may be purchased by Investors Heritage Capital at a discount with servicing retained by Investors Heritage Life. Borrowings under the line of credit are collateralized by the agent debit balances. The renewal reduces the line of credit to $1,000,000 with a new maturity date of November 25, 2018. This line of credit requires interest to be paid monthly at the prime rate, with a floor of 3.50%. We have not yet borrowed any amounts under this line of credit.

 

During the first quarter of 2015, we renewed the Investors Heritage Capital Corporation operating line of credit and the At Need Funding line of credit. The Investors Heritage Capital Corporation line of credit is for $150,000 with a maturity date of March 24, 2017. Interest is paid on this note monthly at the prime rate, with a floor of 3.25%. The At Need Funding line of credit is for $1,500,000 with a maturity date of March 24, 2017. Interest is paid on this note monthly at the prime rate, which is currently 3.75%. This line of credit is used for the purpose of funding at-need funerals secured by the assignment of verified, incontestable life insurance policies. At December 31, 2016, the outstanding principal balance on the At Need Funding line of credit was $133,878. At December 31, 2016, there was no amount outstanding on the Investors Heritage Capital Corporation operating line of credit.

 

On November 5, 2012, we entered into a loan agreement to borrow $2,000,000 in order to fund a credit agreement to Puritan Financial Companies, Inc. On November 25, 2014, this note was amended to extend the maturity date to November 25, 2019 to correlate with an amendment to the Puritan promissory note and marketing agreement, as discussed further below. The amended loan agreement calls for interest to be paid quarterly at a rate of 0.25% under the prime rate. The note requires monthly principal payments of at least $15,000 beginning December 5, 2014 with a balloon payment upon maturity. There is no penalty for prepayment. This note is collateralized with 55,000 shares of Investors Heritage Life Insurance Company common stock. At December 31, 2016, the outstanding principal balance on the bank note was $837,973.

 

 
18
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

The borrowed funds were utilized to fund a credit agreement to Puritan Financial Companies, Inc. for $2,000,000, with interest at a rate of 1.75% above the prime rate. The promissory note and the marketing agreement with Puritan Financial Group were amended on August 28, 2014 to extend the maturity date to August 28, 2019. These amendments allow the Company to withhold 15% of Puritan Financial’s earned commissions on certain products to pay down the note. Additionally, the amended note calls for quarterly payments of principal and interest and requires Puritan Financial to pay at least $400,000 annually toward the outstanding balance of the note from 2015 until the balance is paid in full. Any unpaid principal balance together with all accrued interest shall be due and payable with a balloon payment upon maturity. Under this credit agreement, Puritan Financial Companies, Inc. and its wholly-owned subsidiary Puritan Financial Group have committed to an increased level of new business production on behalf of the Company. Additionally, Puritan Financial Companies, Inc. has issued warrants for 2,000,000 shares of common stock to the Company in exchange for this funding. This note is further collateralized by all the stock and other assets of Puritan Financial Companies, Inc. and each of its affiliated companies. The outstanding balance on this note receivable, which is included within other invested assets on the balance sheet, was $893,915 and $1,450,830 at December 31, 2016 and 2015, respectively.

 

We are a member of the Federal Home Loan Bank of Cincinnati, Ohio by way of our investment in shares of their common stock. As a member, we have access to both short-term and long-term borrowings at below market rates. Borrowings under this program are collateralized by securities within our investment portfolio. To this point, we have not needed to access this borrowing capacity.

 

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 as of December 31, 2016, and we are in compliance with all debt covenant requirements.

 

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

 

Other than anticipated increases in federal and state regulatory reporting requirements which generally increase administrative expenses, management is not aware of any current recommendations by any regulatory authority which, if implemented, would have any material effect on our liquidity, capital resources or operations.

 

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 shareholders that is discussed in more detail in Note 7 to the consolidated financial statements.

 

 
19
 

 

MANAGEMENT’S

DISCUSSION & ANALYSIS

 

REGULATORY MATTERS

 

The statutory capital and surplus of Investors Heritage Life increased approximately $4,756,000 in 2016. The increase in statutory capital and surplus in 2016 is due primarily to net income, the statutory unamortized ceding commission totaling $1,732,130 generated as a result of the reinsurance agreement with SNIC, and an increase in unrealized gains on our common stock portfolio. Investors Heritage Life produced statutory net income of approximately $2,074,000 and $1,268,000 in 2016 and 2015, respectively. For additional discussion on statutory accounting practices refer to Note 8 to the consolidated financial statements.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

We have no off-balance sheet arrangements as of December 31, 2016.

 

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 our products, investment spreads and yields or the earnings and profitability of our activities.

 

Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond 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 laws 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.

 

 
20
 

 

MANAGEMENT’S report on internal

control over financial reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is designed to provide reasonable assurances regarding the reliability of financial reporting and the preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles. Our accounting policies and internal controls over financial reporting, established and maintained by management, are under the general oversight of our Audit Committee.

 

Our internal control over financial reporting includes those policies and procedures that:

 

 

■

pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;

 

 

■

provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

 

 

■

provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management has assessed our internal control over financial reporting as of December 31, 2016. The standard measures adopted by management in making its evaluation are the measures in the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

Based upon its assessment, management has concluded that our internal control over financial reporting is effective at December 31, 2016, and that there were no material weaknesses in our internal control over financial reporting as of that date.

 

This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.

 

 
21
 

 

REPORT OF INDEPENDENT

REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders

Investors Heritage Capital Corporation

 

We have audited the accompanying consolidated balance sheets of Investors Heritage Capital Corporation (“the Company”) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income (loss), stockholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Investors Heritage Capital Corporation as of December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

 

 

 

/s/ Mountjoy Chilton Medley LLP

Louisville, Kentucky 

March 22, 2017

 

 
22
 

 

 INVESTORS HERITAGE CAPITAL CORPORATION

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 2016 AND 2015

 

   

2016

    

2015

  
ASSETS                

Investments:

                

Securities available-for-sale, at fair value:

                

Fixed maturities (amortized cost: 2016 - $350,585,324; 2015 - $399,525,617)

   $ 366,347,999     $ 409,146,807  

Equity securities (cost: 2016 - $7,691,597; 2015 - $7,452,666)

     8,756,068       7,616,789  

Mortgage loans on real estate

     41,302,392       33,174,131  

Policy loans

     6,336,277       6,702,911  

State-guaranteed receivables

     11,584,681       7,692,959  

Investments in convertible options

     983,950       957,405  

Other invested assets

     1,951,830       2,379,451  

Total investments

     437,263,197       467,670,453  

Cash and cash equivalents

     3,297,917       3,619,663  

Accrued investment income

     4,433,680       5,149,612  

Due premiums

     2,768,774       2,946,218  

Deferred acquisition costs

     15,712,181       17,237,522  

Value of business acquired

     155,264       225,276  

Leased property under capital leases

     75,841       381,432  

Property and equipment

     915,494       909,151  

Cash value of company-owned life insurance

     13,855,560       13,191,773  

Other assets

     2,435,867       2,374,292  

Amounts recoverable from reinsurers

     98,444,173       56,332,692  

Total assets

   $ 579,357,948     $ 570,038,084  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

                

LIABILITIES

                

Policy liabilities:

                

Benefit reserves

   $ 492,963,963     $ 493,369,378  

Unearned premium reserves

     8,100,042       8,119,385  

Policy claims

     2,637,220       2,584,088  

Liability for deposit-type contracts

     3,351,107       3,400,836  

Reserves for dividends and endowments and other

    384,401       388,193  

Total policy liabilities

     507,436,733       507,861,880  

Deferred federal income tax liability

     3,256,943       1,105,776  

Obligations under capital leases

     72,209       377,259  

Notes payable

     971,851       1,433,448  

Accrued pension liability

    6,021,264       6,075,376  

Deferred revenue on reinsurance ceded

    1,431,647       -  

Other liabilities

     3,982,356       3,933,343  

Total liabilities

     523,173,003       520,787,082  
                 

STOCKHOLDERS' EQUITY

                

Common stock (shares issued: 2016 - 1,106,351; 2015 - 1,117,647)

     1,106,351       1,117,647  

Paid-in surplus

     8,913,360       8,913,360  

Accumulated other comprehensive income

     5,493,892       757,161  

Retained earnings

     40,671,342       38,462,834  

Total stockholders' equity

     56,184,945       49,251,002  

Total liabilities and stockholders' equity

   $ 579,357,948     $ 570,038,084  

 

See Notes to Consolidated Financial Statements.

 

 
23
 

 

INVESTORS HERITAGE CAPITAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015

 

   

2016

    

2015

  
                 

REVENUE

                

Premiums and other considerations

   $ 51,715,510     $ 56,864,702  

Premiums ceded

     (10,803,281 )     (12,511,080 )

Net premiums

     40,912,229       44,353,622  
                 

Investment income, net of expenses

     21,408,232       21,237,313  

Net realized gains (losses) on investments:

                

Other-than-temporary impairment losses

     (118,267 )     -  

Other net realized investment gains

     1,674,389       818,705  

Total net realized gains on investments

     1,556,122       818,705  

Other income

     1,684,255       1,767,071  

Total revenue

     65,560,838       68,176,711  
                 

BENEFITS AND EXPENSES

                

Death and other benefits

     42,767,646       44,305,739  

Guaranteed annual endowments

     392,142       404,466  

Dividends to policyholders

     293,563       332,063  

Increase in benefit reserves and unearned premiums

     4,235,260       6,739,357  

Acquisition costs deferred

     (4,923,682 )     (6,030,513 )

Amortization of deferred acquisition costs

     5,907,926       7,103,147  

Commissions

     3,091,836       3,537,009  

Other general and administrative expenses

     10,804,013       10,881,337  

Total benefits and expenses

     62,568,704       67,272,605  
                 

INCOME BEFORE FEDERAL INCOME TAXES

     2,992,134       904,106  
                 

PROVISION (BENEFIT) FOR FEDERAL INCOME TAXES

                

Current

     620,300       392,468  

Deferred

     (288,967 )     (525,078 )

Total federal income taxes

     331,333       (132,610 )
                 
                 

NET INCOME

   $ 2,660,801     $ 1,036,716  
                 
                 

BASIC AND DILUTED NET EARNINGS PER SHARE

   $ 2.39     $ 0.93  

 

See Notes to Consolidated Financial Statements.

 

 
24
 

 

INVESTORS HERITAGE CAPITAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015

 

   

2016

    

2015

  
                 

NET INCOME

   $ 2,660,801     $ 1,036,716  
                 

OTHER COMPREHENSIVE INCOME (LOSS):

                

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

                

Unrealized holding gains (losses) arising during period

     8,550,015       (17,074,720 )

Reclassification adjustment for gains included in income

     (1,508,182 )     (735,567 )

Adjustment for effects of deferred acquisition costs

     (211,683 )     462,249  

Net unrealized gains (losses) on investments

     6,830,150       (17,348,038 )

Change in defined benefit pension plan:

                

Actuarial net loss on pension plan

     (390,459 )     (1,515,949 )

Amortization of actuarial net loss in net periodic pension cost

     737,174       762,233  

Net change in defined benefit pension plan

     346,715       (753,716 )
                 

Other comprehensive income (loss) before income taxes

     7,176,865       (18,101,754 )
                 

Income tax expense (benefit)

     2,440,134       (6,154,596 )
                 

OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAXES

     4,736,731       (11,947,158 )
                 

COMPREHENSIVE INCOME (LOSS)

   $ 7,397,532     $ (10,910,442 )

 

See Notes to Consolidated Financial Statements.

 

 
25
 

 

INVESTORS HERITAGE CAPITAL CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015

 

                   

Accumulated

                  
                   

Other

            

Total

  
   

Common

    

Paid-in

    

Comprehensive

    

Retained

    

Stockholders'

  
   

Stock

    

Surplus

    

Income

    

Earnings

    

Equity

  
                                         

BALANCE, JANUARY 1, 2015

   $ 1,123,980     $ 8,908,243     $ 12,704,319     $ 37,799,944     $ 60,536,486  
                                         

Net income

     -       -       -       1,036,716       1,036,716  

Other comprehensive loss, net

     -       -       (11,947,158 )     -       (11,947,158 )

Cash dividends

     -       -       -       (236,035 )     (236,035 )

Repurchases of common stock, net

     (6,333 )     5,117       -       (137,791 )     (139,007 )

BALANCE, DECEMBER 31, 2015

   $ 1,117,647     $ 8,913,360     $ 757,161     $ 38,462,834     $ 49,251,002  
                                         

Net income

     -       -       -       2,660,801       2,660,801  

Other comprehensive income, net

     -       -       4,736,731       -       4,736,731  

Cash dividends

     -       -       -       (234,706 )     (234,706 )

Repurchases of common stock, net

     (11,296 )     -       -       (217,587 )     (228,883 )

BALANCE, DECEMBER 31, 2016

   $ 1,106,351     $ 8,913,360     $ 5,493,892     $ 40,671,342     $ 56,184,945  

 

See Notes to Consolidated Financial Statements.

 

 
26
 

 

INVESTORS HERITAGE CAPITAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015

 

   

2016

    

2015

  

OPERATING ACTIVITIES

                

Net income

   $ 2,660,801     $ 1,036,716  

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

                

Net realized gains on investments

     (1,556,122 )     (818,705 )

Deferred federal income tax benefit

     (288,967 )     (525,078 )

Amortization of deferred acquisition costs

     5,907,926       7,103,147  

Acquisition costs deferred

     (4,923,682 )     (6,030,513 )

Net adjustment for premium and discount on investments

     (1,032,323 )     (185,671 )

Depreciation and other amortization

     446,431       599,638  

Change in value of convertible options

     9,850       (102,342 )

Changes in operating assets and liabilities:

                

Accrued investment income

     715,932       41,128  

Due premiums

     177,444       270,918  

Cash value of company-owned life insurance

     (663,787 )     (749,940 )

Amounts recoverable from reinsurers

     (42,111,481 )     (421,699 )

Benefit reserves

     2,441,015       7,126,305  

Policy claims

     53,132       (237,018 )

Liability for deposit-type contracts

     (49,729 )     (31,957 )

Reserves for dividends and endowments and other

     (3,792 )     (3,246 )

Deferred revenue on reinsurance ceded

     1,801,272       -  

Other assets and other liabilities

     (7,760 )     (498,817 )

NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES

     (36,423,840 )     6,572,866  

INVESTING ACTIVITIES

                

Purchases of available-for-sale securities

     (30,622,950 )     (33,893,271 )

Sales of available-for-sale securities

     55,905,616       8,115,128  

Maturities of available-for-sale securities

     25,394,796       29,085,575  

Acquisitions of mortgage loans on real estate

     (20,695,767 )     (12,240,031 )

Payments of mortgage loans on real estate

     12,470,604       8,619,349  

Purchases of state-guaranteed receivables

     (4,193,203 )     -  

Payments of state-guaranteed receivables

     962,790       769,540  

Purchases of convertible options

     (124,882 )     (1,016,251 )

Sales and exchanges of convertible options

     136,426       168,415  

Net change in receivable for securities

     (17,250 )     -  

Net reductions in other investments

     794,255       853,979  

Net additions to property and equipment

     (117,382 )     (259,089 )

NET CASH PROVIDED BY INVESTING ACTIVITIES

     39,893,053       203,344  

FINANCING ACTIVITIES

                

Policyholder account deposits

     3,926,994       4,486,920  

Policyholder account withdrawals

     (6,792,767 )     (8,064,164 )

Payments on notes payable

     (2,808,654 )     (3,877,673 )

Proceeds from notes payable

     2,347,057       2,802,545  

Dividends paid

     (234,706 )     (236,035 )

Repurchases of common stock, net

     (228,883 )     (139,007 )

NET CASH USED IN FINANCING ACTIVITIES

     (3,790,959 )     (5,027,414 )

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     (321,746 )     1,748,796  

Cash and cash equivalents at beginning of year

     3,619,663       1,870,867  

CASH AND CASH EQUIVALENTS AT END OF YEAR

   $ 3,297,917     $ 3,619,663  
                 

SUPPLEMENTAL INFORMATION

                

Cash paid during year for federal income taxes

   $ 567,698     $ 213,671  

 

See Notes to Consolidated Financial Statements.

 

 
27
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

NOTE 1 - Nature of Operations and Accounting Policies

 

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.

 

The Company's 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. Investors Heritage Life is currently licensed in 35 states. The principal markets for the Company's products are in Kentucky, North Carolina, Tennessee, Georgia, Ohio, Virginia, Indiana, Michigan, Texas, South Carolina, Pennsylvania and Illinois.

 

Basis of Presentation: The accompanying consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”).

 

Principles of Consolidation: The consolidated financial statements include the accounts of the wholly-owned subsidiaries of Investors Heritage Capital, which are Investors Heritage Life and its subsidiary, Investors Underwriters, Inc., Investors Heritage Printing, Investors Heritage Financial, At Need Funding and Heritage Funding. Intercompany transactions are eliminated in the Company's consolidated financial statements.

 

Use of Estimates: The preparation of financial statements requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

 

Investments: The Company classifies all fixed maturities and equity securities as available-for-sale. Securities classified as available-for-sale are carried at fair value 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.

 

Premiums and discounts on fixed maturity investments are amortized into income using the interest method. Anticipated prepayments on mortgage-backed securities are considered in the determination of the effective yield on such securities. If a difference arises between anticipated prepayments and actual prepayments, the carrying amounts of the investments are adjusted with a corresponding charge or credit to interest income.

 

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, as discussed in further detail in Note 2 to the consolidated financial statements.

 

If an other-than-temporary impairment occurs with respect to a bond, the reduced book value is amortized back to the security’s expected recovery value over the remaining term of the bond. The Company continues to review the security for further impairment that would prompt another write-down in the value.

 

Mortgage loans are carried at their aggregate principal balance, adjusted for any unamortized premium or discount.

 

 
28
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

Policy loans are carried at their aggregate principal balance.

 

State-guaranteed receivables 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.

 

Investments in convertible options represent the bifurcated equity derivative portion of convertible security investments. These investments are recorded at their market value with changes in the market value recorded as a component of net investment income on the income statement.

 

Other invested assets include real estate investments and notes receivable. Real estate investments are carried at cost less accumulated depreciation. Notes receivable are carried at their aggregate principal balance.

 

Short-term investments represent securities with maturity dates within one year but exceeding three months. These securities are carried at amortized cost, which approximates fair value.

 

Cash equivalents include money market funds on deposit at various financial institutions with contractual maturity dates within three months at the time of purchase.

 

Deferred Acquisition Costs: Commissions and other acquisition costs, which vary with and are primarily related to the production of new business, are deferred and amortized over the life of the related policies (refer to Revenues and Expenses discussed later regarding amortization methods). Recoverability of deferred acquisition costs is evaluated periodically by comparing the current estimate of the present value of expected pretax future profits to the unamortized asset balance. If this current estimate is less than the existing balance, the difference is charged to expense.

 

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 fixed income 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 and universal life insurance products 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" in the stockholders' equity section of the balance sheet.

 

Value of Business Acquired: Value of business acquired represents the estimated value assigned to the insurance in force of the assumed policy obligations at the date of acquisition of a block of policies. Amortization of value of business acquired recognized in 2016 and 2015 totaled $70,012 and $75,761, respectively. Accumulated amortization was $766,092 and $696,080 at December 31, 2016 and 2015, respectively. Estimated annual amortization will be approximately $63,000, $44,000, $13,000, $8,000, and $7,000 in 2017 through 2021, respectively.

 

Property and Equipment: Property and equipment is carried at cost less accumulated depreciation, using principally the straight-line method. Accumulated depreciation on property and equipment was $4,072,622 and $3,991,112 at December 31, 2016 and 2015, respectively.

 

Capital Leases: During 2016, the Company entered into no new capital leases. During 2015, the Company entered into one new capital lease totaling $184,100 at inception. Total lease payments for 2016 and 2015 relating to previously existing capital leases were $319,762 and $395,024, respectively. Future minimum lease payments for 2017 and 2018 are $74,034 and $6,259, respectively. The present value of net minimum lease payments at December 31, 2016 was $72,209, which is equal to the total future minimum lease payments of $80,292 less imputed interest of $8,083. Accumulated amortization on the leased property was $895,570 and $745,601 at December 31, 2016 and 2015, respectively.

 

 
29
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

Cash Value of Company-Owned Life Insurance: The Company holds life insurance policies on key members of the organization. These policies are reported at the current cash surrender values of the policies.

 

Benefit Reserves and Policyholder Deposits: Reserves on traditional life and accident and health insurance products are calculated using the net level premium method based upon estimated future investment yields, mortality, withdrawals and other assumptions, including dividends on participating policies. The assumptions used for prior year issues are locked in. Current year policies issued are reserved using updated assumptions determined by reviewing the Company's past experience and include a provision for possible unfavorable deviation.

 

Benefit reserves and policyholder deposits on universal life and investment-type products are determined by using the retrospective deposit method and represent the policy account value before consideration of surrender charges. In addition, unearned revenues are included as a part of the benefit reserve.

 

The mortality assumptions for regular ordinary business are based on the 1955-60 Basic Table, Select and Ultimate, for plans issued prior to 1982; the 1965-70 Basic Table, Select and Ultimate, for plans issued in 1982 through 1984; the 1975-80 Basic Table, Select and Ultimate, for plans issued after 1984; the 2001 Valuation Basic Table, Select and Ultimate, for plans issued after 2008; and on the Company's experience for final expense and preneed plans.

 

Reinsurance: The Company assumes and cedes reinsurance under various agreements providing greater diversification of business, allowing management to control exposure to potential losses arising from large risks, and providing additional capacity for growth. Amounts recoverable from reinsurers are estimated in a manner consistent with the related liabilities associated with the reinsured policies. At December 31, 2016 and 2015, amounts recoverable from reinsurers were $98,444,173 and $56,332,692, respectively. These amounts included reserves ceded to reinsurers of $97,514,013 and $55,510,620 at December 31, 2016 and 2015, respectively. Please refer to Note 10 for further information on the Company’s significant reinsurance agreements.

 

Unearned Premium Reserves: Credit life unearned premium reserves are calculated for level and reducing coverage certificates using the monthly pro rata and Rule of 78's methods, respectively. Credit accident and health unearned premium reserves are determined based upon the Rule of 78's.

 

Policy Claims: Policy claims are based on reported claims plus estimated incurred but not reported claims developed from trends of historical data applied to current exposure.

 

At December 31, 2016 and 2015, the Company’s policy claims liability includes an estimate of $600,226 and $721,592, respectively, for outstanding claims 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.

 

 
30
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

Liability for Deposit-Type Contracts: Liability for deposit-type contracts consists of supplemental contracts without life contingencies, premium deposit funds and dividends and endowments left on deposit at interest.

 

Participating Policies: Participating business approximates 14% and 15% of ordinary life insurance in force at December 31, 2016 and 2015, respectively. Premiums relative to participating business comprised approximately 3% of net premiums for the years ended December 31, 2016 and 2015. Participating dividends are accrued as declared by the Board of Directors of Investors Heritage Life. For participating policies that are not a part of the Texas Memorial Life or Memorial Service Life policy acquisitions, the liability for future policy benefits for participating policies was determined based on the Net Level Premium Reserve Method, 3% interest, and the 1941 CSO Mortality and 1958 CSO Mortality tables. All guaranteed benefits were considered in calculating these reserves. Deferred acquisition costs are amortized in proportion to expected gross profits.

 

The liability for future policy benefits of the Texas Memorial Life and Memorial Service Life blocks of participating business was determined based on the 2001 CSO and 1980 CSO Mortality tables, respectively. While these policies are participating, no future dividends are anticipated on this block of policies.

 

The average assumed investment yields used in determining expected gross profits ranged from 3.56% to 9.17% (for the current and all future years, an assumed investment yield of 4.50% was utilized).

 

Deferred Revenue on Reinsurance Ceded: The Company established this liability relative to the initial ceding commission received on a reinsurance agreement with Southland National Insurance Corporation, as further discussed in Note 10. This amount is being recognized into income over the expected life of the reinsurance contract, which is 20 years. The initial ceding commission, net of tax, was $1,471,858. The Company recognized $40,211 of income associated with the amortization of the deferred revenue during 2016.

 

Federal Income Taxes: The Company utilizes the liability method to account for income taxes. Under such method, deferred tax assets and liabilities are determined based on differences between the financial reporting and the tax bases of assets and liabilities and are measured using the enacted tax rates.

 

Revenues and Expenses: Revenues on traditional life and accident and health insurance products consist of direct and assumed premiums reported as earned when due. Liabilities for future policy benefits, including unearned premium reserves on accident and health policies and unreleased profits on limited-pay life policies, are provided and acquisition costs are amortized by associating benefits and expenses with earned premiums to recognize related profits over the life of the contracts. Acquisition costs are amortized over the premium paying period using the net level premium method. Traditional life insurance products are treated as long duration contracts since they are ordinary whole life insurance products, which generally remain in force for the lifetime of the insured. The accident and health insurance products are treated as long duration contracts because they are non-cancelable.

 

Revenues for universal life and investment-type products consist of investment income and policy charges for the cost of insurance and policy initiation and administrative fees. Expenses include interest credited to policy account balances, actual administrative expenses and benefit payments in excess of policy account balances.

 

Other income consists principally of third party administrative service fees along with servicing and administration fees relative to credit insurance administered for our reinsurers.

 

 
31
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

Common Stock and Earnings per Share: The par value per share is $1.00 with 4,000,000 shares authorized. Earnings per share of common stock were computed based on the weighted average number of common shares outstanding during each year. The weighted average number of shares outstanding during 2016 and 2015 were 1,111,660 and 1,120,306 shares, respectively. The Company paid cash dividends per share of $0.21 in both 2016 and 2015.

 

Subsequent Events: Management has evaluated all events subsequent to December 31, 2016 through the date that these consolidated financial statements were available to be issued.

 

New Accounting Standards: In July 2015, the Financial Accounting Standards Board (“FASB”) issued guidance regarding employee benefit accounting. The guidance is divided into three parts. First, the guidance requires a pension plan to use contract value as the only required measure for fully benefit-responsive investment contracts. Second, the guidance simplifies and increases the effectiveness of the investment disclosure requirements for employee benefit plans. Third, the guidance provides benefit plans with a measurement date practical expedient. This guidance is effective for fiscal years beginning after December 15, 2015. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

 

In May 2014, the 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.  However, certain other types of contracts may impact the financial statements of insurance providers. In August 2015, the FASB deferred the effective date of this guidance for public entities to annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The Company is currently evaluating this guidance, but it is not currently expected to have a material impact on its consolidated financial statements.

 

In January 2016, the FASB issued guidance regarding the recognition and measurement of financial assets and liabilities. This guidance intends to enhance reporting for financial instruments and addresses certain aspects of recognition and measurement of investments in equity securities and the presentation in the balance sheet of financial assets and liabilities measured at fair value. It also amends certain disclosure requirements associated with the fair value of financial instruments. This guidance is effective for fiscal years beginning after December 15, 2017. The recognition and measurement provisions of this guidance will be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption and early adoption is not permitted. The Company is in the process of evaluating this guidance, but the primary impact on the Company is expected to be the recognition of all unrealized gains and losses on available-for-sale equity securities in net income. Currently, all unrealized gains and losses on available-for-sale equity securities are recognized in other comprehensive income (loss).  Refer to Note 2 for details of unrealized gains and losses on available-for-sale equity securities held by the Company.

 

In February 2016, the FASB issued updated lease accounting guidance that provides new requirements for leases to be recognized in the financial statements. In general, the guidance requires the lessee to recognize liabilities on the balance sheet for the obligation to make lease payments and an asset for the right to use the underlying assets for the lease term.  There is a differentiation between finance leases and operating leases for the lessee in the statements of operations and cash flows.  Finance leases recognize interest on the lease liability separately from the right to use the asset whereas an operating lease recognizes a single lease cost allocated over the lease term on a generally straight-line basis.  All cash payments are within operating activities in the statement of cash flows except finance leases classify repayments of the principal portion of the lease liability within financing activities. The updated guidance is to be applied using a modified retrospective approach effective for annual and interim periods beginning after December 15, 2018.  Early adoption is permitted.  The adoption of this guidance is not expected to have a material effect on the Company’s consolidated financial statements.

 

 
32
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

In June 2016, the FASB issued new guidance for the accounting for credit losses on financial instruments. A new model, referred to as the current expected credit losses model, requires an entity to determine credit-related impairment losses for financial instruments held at amortized cost and to estimate these expected credit losses over the life of an exposure (or pool of exposures). The estimate of expected credit losses should consider historical and current information, reasonable and supportable forecasts, as well as estimates of prepayments. The estimated credit losses, and subsequent adjustment to loss estimates, will be recorded through an allowance account which is deducted from the amortized cost of the financial instrument, with the offset recorded in current earnings. The guidance also modifies the impairment model for available-for-sale debt securities. The new model will require an estimate of expected credit losses only when the fair value is below the amortized cost of the asset, thus the length of time the fair value of an available-for-sale debt security has been below the amortized cost will no longer affect the determination of whether a credit loss exists. In addition, credit losses on available-for-sale debt securities will be limited to the difference between the security’s amortized cost basis and its fair value. The updated guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for periods beginning after December 15, 2018. The Company is currently evaluating the impact of the adoption of this guidance on its financial position and results of operations.

 

In August 2016, the FASB issued new guidance that clarifies the classification of certain cash receipts and payments in the statement of cash flows under eight different scenarios including, but not limited to: (i) debt prepayment or debt extinguishment costs; (ii) proceeds from the settlement of corporate-owned life insurance policies including bank-owned life insurance policies; (iii) distributions received from equity method investees; and (iv) separately identifiable cash flows and application of the predominance principle. This guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact of this guidance on its statement of cash flows.

 

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.

 

 
33
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

  

NOTE 2 - Investments

 

The Company limits credit risk by investing primarily in investment grade securities and by diversifying its investment portfolio among government and corporate bonds and mortgage loans. The Company manages its fixed income portfolio to diversify between and within industry sectors. Investments in available-for-sale securities are summarized as follows:

 

 

December 31, 2016

  

Amortized

     Gross Unrealized     Gross Unrealized    

Fair

  
   

Cost

     Gains     Losses    

Value

  

Available-for-sale securities:

                                

Fixed maturities:

                                

U.S. government obligations

   $ 21,882,312     $ 360,723     $ 9,416     $ 22,233,619  

States and political subdivisions

     35,403,214       4,153,294       31,260       39,525,248  

Corporate

     202,578,595       9,355,481       953,527       210,980,549  

Foreign

     51,081,850       1,731,092       283,363       52,529,579  

Mortgage-backed securities (MBS):

                                

Commercial MBS

     6,717,214       198,857       -       6,916,071  

Residential MBS

     32,065,365       1,314,373       72,741       33,306,997  

Corporate redeemable preferred stock

     856,774       24,314       25,152       855,936  

Total fixed maturity securities

     350,585,324       17,138,134       1,375,459       366,347,999  

Equity securities:

                                

U.S. agencies

     707,900       -       -       707,900  

Mutual funds

     318,284       28,840       -       347,124  

Corporate common stock

     6,665,413       1,370,651       335,020       7,701,044  

Total equity securities

     7,691,597       1,399,491       335,020       8,756,068  

Total

   $ 358,276,921     $ 18,537,625     $ 1,710,479     $ 375,104,067  

 

December 31, 2015

  

Amortized

     Gross Unrealized      Gross Unrealized    

Fair

  
   

Cost

     Gains     Losses    

Value

  

Available-for-sale securities:

                                

Fixed maturities:

                                

U.S. government obligations

   $ 23,373,714     $ 642,038     $ -     $ 24,015,752  

States and political subdivisions

     36,830,198       4,511,826       136,585       41,205,439  

Corporate

     229,425,035       10,338,999       4,587,896       235,176,138  

Foreign

     65,010,084       1,731,076       4,682,638       62,058,522  

Asset-backed securities

     143,552       457       -       144,009  

Mortgage-backed securities (MBS):

                                

Commercial MBS

     6,830,520       148,314       15,592       6,963,242  

Residential MBS

     37,200,599       1,776,233       62,255       38,914,577  

Corporate redeemable preferred stock

     711,915       -       42,787       669,128  

Total fixed maturity securities

     399,525,617       19,148,943       9,527,753       409,146,807  

Equity securities:

                                

U.S. agencies

     707,900       -       -       707,900  

Mutual funds

     318,284       -       14,253       304,031  

Corporate common stock

     6,426,482       702,497       524,121       6,604,858  

Total equity securities

     7,452,666       702,497       538,374       7,616,789  

Total

   $ 406,978,283     $ 19,851,440     $ 10,066,127     $ 416,763,596  

 

 
34
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

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.

 

   

December 31, 2016

    

December 31, 2015

  
           

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

   $ 7,892,992     $ 9,416       2     $ -     $ -       -  

States and political subdivisions

     968,740       31,260       1       1,613,415       136,585       2  

Corporate

     30,370,227       753,570       27       55,039,213       3,873,158       52  

Foreign

     10,215,322       283,355       11       24,154,510       1,418,143       20  

Commercial MBS

     -       -       -       1,447,694       15,592       2  

Residential MBS

     3,003,214       72,741       2       3,320,890       62,255       2  

Corporate redeemable preferred stock

     17,488       493       1       669,128       42,787       2  

Greater than 12 months:

                                                

Corporate

     2,997,784       199,957       2       5,533,581       714,738       4  

Foreign

     197,700       8       1       6,007,156       3,264,495       4  

Corporate redeemable preferred stock

     205,423       24,659       1       -       -       -  

Total fixed maturities

     55,868,890       1,375,459       48       97,785,587       9,527,753       88  
                                                 

Equity securities:

                                                

Less than 12 months:

                                                

Mutual funds

     -       -       -       304,031       14,253       1  

Corporate common stock

     1,004,821       136,117       6       2,449,672       473,551       15  

Greater than 12 months:

                                                

Corporate common stock

     873,083       198,903       7       183,960       50,570       3  

Total equities

     1,877,904       335,020       13       2,937,663       538,374       19  
                                                 

Total

   $ 57,746,794     $ 1,710,479       61     $ 100,723,250     $ 10,066,127       107  

 

At December 31, 2016, 100% of the fixed maturity portfolio had a fair value to amortized cost ratio of greater than 80%, and 94.0% of the equity securities portfolio had a fair value to cost ratio of greater than 80%. At December 31, 2015, 97.4% of the fixed maturity portfolio had a fair value to amortized cost ratio of greater than 80%, and 93.4% of the equity securities portfolio had a fair value to cost ratio of greater than 80%. The improvements in these measures relative to fixed maturities is primarily due to rebounding commodity prices and economic environments particularly within the metals/mining and energy sectors. The improvement relative to equity securities is primarily due to market conditions within our real estate sector stocks.

 

During 2016, the Company recognized an other-than-temporary impairment on one real estate common stock totaling $118,267. While the Company continues to hold this security, there was no evidence to suggest that the security would recover in the near-term based on the financial outlook for the stock, the significance of the reduction in market value and the length of time that the stock has traded below its book value. The Company experienced no additional other-than-temporary impairments during 2016 or 2015.

 

 
35
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

  

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.

 

Management believes that the Company will fully recover its cost basis in the securities held at December 31, 2016, 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 and economic 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 had been realized.

 

   

December 31,

  
   

2016

    

2015

  

Net unrealized appreciation on available-for sale securities

   $ 16,827,146     $ 9,785,313  

Adjustment to deferred acquisition costs

     (461,084 )     (249,401 )

Deferred income taxes

     (5,564,461 )     (3,242,210 )

Net unrealized appreciation on available-for sale securities

   $ 10,801,601     $ 6,293,702  

 

The amortized cost and fair value of debt securities at December 31, 2016, 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

   $ 11,282,653     $ 11,454,020  

Due after one year through five years

     100,288,408       106,474,899  

Due after five years through ten years

     131,988,499       135,072,291  

Due after ten years

     48,697,265       53,377,415  

Due at multiple maturity dates

     58,328,499       59,969,374  

Total

   $ 350,585,324     $ 366,347,999  

 

 
36
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

Proceeds from sales and maturities of investments in available-for-sale securities, as well as gross gains and gross losses realized, are presented below.

 

   

Year Ended December 31,

  
   

2016

    

2015

  

Proceeds from sales and maturities

   $ 81,300,412     $ 37,200,703  

Gross realized gains

     2,360,747       939,423  

Gross realized losses

     (734,298 )     (203,856 )

Other-than-temporary impairment loss

     (118,267 )     -  

 

 

The table below presents the change in net unrealized investment gains (losses) and the amount of realized investment gains (losses) by investment type.

 

   

Year Ended December 31,

  
   

2016

    

2015

  

Change in net unrealized investment gains (losses):

                

Securities available-for-sale:

                

Fixed maturities

   $ 6,141,485     $ (16,900,027 )

Equity securities

     900,348       (910,260 )

Net realized investment gains (losses):

                

Securities available-for-sale:

                

Fixed maturities

   $ 1,460,321     $ 91,141  

Equity securities

     166,128       644,426  

Other-than-temporary impairment loss

     (118,267 )     -  

Mortgage loans on real estate

     -       75,915  

Investments in convertible options

     47,940       7,223  

 

 

The Company is required to hold assets on deposit for the benefit of policyholders in accordance with statutory rules and regulations. At December 31, 2016 and 2015, these required deposits had a total fair value of $22,724,783 and $22,899,132, respectively.

 

The Company also engages in commercial and residential mortgage lending. As of December 31, 2016, investments in commercial and residential properties comprised 26.2% and 73.8%, respectively, of the Company’s mortgage portfolio. At December 31, 2015, investments in commercial and residential properties comprised 37.4% and 62.6%, respectively, of the Company’s mortgage portfolio.

 

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.

 

The Company purchases single family residential mortgage loans through the secondary market. Each mortgage loan opportunity is reviewed individually, considering both the value of the underlying property and the credit worthiness of the borrower. We utilize third party servicers to administer these loans.

 

As of December 31, 2016 and 2015, there were no non-performing mortgage 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 2016 or 2015.

 

 
37
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

The Company’s investments in mortgage loans, by state, are as follows:

 

   

December 31,

  
   

2016

    

2015

  

Florida

   $ 5,253,110     $ 3,906,034  

Texas

     5,191,186       5,694,612  

Illinois

     4,787,454       6,046,408  

California

     3,591,584       3,366,434  

Georgia

     3,487,991       2,671,788  

Missouri

     3,107,289       1,342,845  

Ohio

     3,083,440       1,692,354  

Kentucky

     2,402,800       3,241,793  

Arizona

     1,490,538       774,060  

New Jersey

     1,196,156       247,723  

Colorado

     1,190,873       222,364  

Tennessee

     1,048,452       895,607  

Indiana

     893,431       759,139  

Virginia

     800,635       -  

North Carolina

     757,004       353,275  

Oregon

     487,824       -  

Pennsylvania

     479,720       370,323  

Nevada

     479,182       373,359  

Utah

     343,533       77,939  

Washington

     231,939       -  

West Virginia

     225,578       412,250  

South Carolina

     199,101       225,881  

Massachusetts

     169,681       205,469  

Idaho

     142,745       159,073  

Kansas

     134,396       135,401  

Michigan

     126,750       -  

Total

   $ 41,302,392     $ 33,174,131  

 

 

At December 31, 2016, the Company held various real estate investments for the production of income totaling $1,126,649, which is reported net of accumulated depreciation of $612,194. At December 31, 2015, the Company’s real estate investments totaled $1,126,649, net of accumulated depreciation of $586,762.

 

 
38
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

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. At December 31, 2016, the amortized cost and estimated fair value of state-guaranteed receivables, by contractual maturity, are summarized as follows:

 

   

State-Guaranteed Receivables

  
   

Amortized

    

Fair

  
   

Cost

    

Value

  

Due in one year or less

   $ 1,094,070     $ 1,106,879  

Due after one year through five years

     4,065,183       4,418,206  

Due after five years through ten years

     4,334,493       5,210,810  

Due after ten years

     2,090,935       3,202,929  

Total

   $ 11,584,681     $ 13,938,824  

 

The outstanding balance of state-guaranteed receivables, by state, is summarized as follows:

 

   

December 31,

  
   

2016

    

2015

  

New York

   $ 3,446,349     $ 3,496,115  

Massachusetts

     3,126,011       1,991,601  

Georgia

     2,012,845       1,432,022  

Washington

     653,235       -  

Indiana

     417,811       -  

Pennsylvania

     318,019       294,968  

Texas

     261,396       243,939  

California

     171,590       180,143  

Ohio

     1,177,425       54,171  

Total

   $ 11,584,681     $ 7,692,959  

 

 

During the third quarter of 2015, the Company began purchasing investments in convertible fixed maturity securities. Convertible securities feature an option allowing for a portion of the security to be converted into an equity position of the underlying issuer in exchange for a lower coupon rate. In accordance with FASB accounting guidance, this convertible feature must be bifurcated and reported separately on the balance sheet at fair value, with adjustments in fair value recognized in the income statement. Accordingly, the convertible options within our portfolio are reported as investments in convertible options on the balance sheet, and the mark-to-market adjustment associated with the changes in fair value of the convertible options are reported as gains (losses) on investments in convertible options as a component of net investment income. As of December 31, 2016 and 2015, the total fair value of our investments in convertible options was $983,950 and $957,405, respectively. For the years ended December 31, 2016 and 2015, we recognized gains (losses) on our investments in convertible options of ($9,850) and $102,342, respectively, relative to the mark-to-market adjustment. Additionally, we recognized net realized investment gains during 2016 and 2015 of $47,940 and $7,223, respectively, upon the exchange of convertible securities.

 

 
39
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

Major categories of net investment income are summarized as follows:

 

   

Year Ended December 31,

  
   

2016

   

2015

 

Fixed maturities

   $ 18,135,421     $ 18,296,411  

Equity securities

     316,238       295,368  

Mortgage loans on real estate

     2,654,165       2,316,721  

Policy loans

     481,912       494,299  

State-guaranteed receivables

     661,309       545,120  

Gain (loss) on investments in convertible options

     (9,850 )     102,342  

Other

     221,067       219,037  

Gross investment income

     22,460,262       22,269,298  

Investment expenses

     1,052,030       1,031,985  

Net investment income

   $ 21,408,232     $ 21,237,313  

 

NOTE 3 - 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.

 

 
40
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

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 as well as our investments in convertible options. These options are bifurcated from the underlying fixed maturity investments and are also valued using observable market data 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 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.

 

 
41
 

 

The following table presents the Company’s fair value hierarchy for those financial instruments measured and reported at fair value on a recurring basis.

 

   

December 31, 2016

 
   

Level 1

   

Level 2

   

Level 3

   

Total

 
                                 

U.S. government obligations

   $ -     $ 22,233,619     $ -     $ 22,233,619  

States and political subdivisions

     -       39,525,248       -       39,525,248  

Corporate

     -       210,980,549       -       210,980,549  

Foreign

     -       52,529,579       -       52,529,579  

Mortgage-backed securities:

                                

Commercial MBS

     -       6,916,071       -       6,916,071  

Residential MBS

     -       33,306,997       -       33,306,997  

Corporate redeemable preferred stock

     -       855,936       -       855,936  

Total fixed maturities

   $ -     $ 366,347,999     $ -     $ 366,347,999  
                                 
                                 

U.S. agencies

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

Mutual funds

     347,124       -       -       347,124  

Corporate common stock

     7,253,044       -       448,000       7,701,044  

Total equity securities

   $ 8,308,068     $ -     $ 448,000     $ 8,756,068  
                                 

Investments in convertible options

   $ -     $ 983,950     $ -     $ 983,950  

 

   

December 31, 2015

 
   

Level 1

   

Level 2

   

Level 3

   

Total

 
                                 

U.S. government obligations

   $ -     $ 24,015,752     $ -     $ 24,015,752  

States and political subdivisions

     -       41,205,439       -       41,205,439  

Corporate

     -       235,176,138       -       235,176,138  

Foreign

     -       62,058,522       -       62,058,522  

Asset-backed securities

     -       144,009       -       144,009  

Mortgage-backed securities:

                                

Commercial MBS

     -       6,963,242       -       6,963,242  

Residential MBS

     -       38,914,577       -       38,914,577  

Corporate redeemable preferred stock

     -       669,128       -       669,128  

Total fixed maturities

   $ -     $ 409,146,807     $ -     $ 409,146,807  
                                 
                                 

U.S. agencies

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

Mutual funds

     304,031       -       -       304,031  

Corporate common stock

     6,252,858       -       352,000       6,604,858  

Total equity securities

   $ 7,264,789     $ -     $ 352,000     $ 7,616,789  
                                 

Investments in convertible options

   $ -     $ 957,405     $ -     $ 957,405  

 

 
42
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

  

The following table provides a summary of changes in fair value of our Level 3 financial instruments reported at fair value.

 

   

Year Ended December 31,

  
   

2016

    

2015

  

Corporate common stock:

                

Beginning balance

   $ 352,000     $ 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 (loss)

     96,000       (32,000 )

Ending balance

   $ 448,000     $ 352,000  

 

The Company experienced no transfers between Level 1 and Level 2 during the years ended December 31, 2016 or 2015. The Company experienced no transfers between Level 2 and Level 3 during the years ended December 31, 2016 or 2015. 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 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.

 

 
43
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

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 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.

 

   

December 31, 2016

  
   

Carrying

    

Fair

                          
   

Amount

    

Value

    

Level 1

    

Level 2

    

Level 3

  

Assets:

                                        

Mortgage loans on real estate:

                                        

Commercial

   $ 10,819,996     $ 11,084,097     $ -     $ -     $ 11,084,097  

Residential

     30,482,396       33,992,592       -       -       33,992,592  

Policy loans

     6,336,277       6,336,277       -       -       6,336,277  

State-guaranteed receivables

     11,584,681       13,938,824       -       13,938,824       -  

Other invested assets

     1,951,830       1,951,830       -       -       1,951,830  

Cash and cash equivalents

     3,297,917       3,297,917       3,297,917       -       -  

Accrued investment income

     4,433,680       4,433,680       -       -       4,433,680  

Cash value of company-owned life insurance

     13,855,560       13,855,560       -       -       13,855,560  
                                         

Liabilities:

                                        

Policyholder deposits (Investment-type contracts)

     51,870,288       51,304,889       -       -       51,304,889  

Policy claims

     2,637,220       2,637,220       -       -       2,637,220  

Obligations under capital leases

     72,209       72,209       -       -       72,209  

Notes payable

     971,851       971,851       -       -       971,851  

 

   

December 31, 2015

  
   

Carrying

    

Fair

                          
   

Amount

    

Value

    

Level 1

    

Level 2

    

Level 3

  

Assets:

                                        

Mortgage loans on real estate:

                                        

Commercial

   $ 12,419,443     $ 12,895,965     $ -     $ -     $ 12,895,965  

Residential

     20,754,688       23,032,713       -       -       23,032,713  

Policy loans

     6,702,911       6,702,911       -       -       6,702,911  

State-guaranteed receivables

     7,692,959       9,094,934       -       9,094,934       -  

Other invested assets

     2,379,451       2,379,451       -       -       2,379,451  

Cash and cash equivalents

     3,619,663       3,619,663       3,619,663       -       -  

Accrued investment income

     5,149,612       5,149,612       -       -       5,149,612  

Cash value of company-owned life insurance

     13,191,773       13,191,773       -       -       13,191,773  
                                         

Liabilities:

                                        

Policyholder deposits (Investment-type contracts)

     52,694,746       53,880,242       -       -       53,880,242  

Policy claims

     2,584,088       2,584,088       -       -       2,584,088  

Obligations under capital leases

     377,259       377,259       -       -       377,259  

Notes payable

     1,433,448       1,433,448       -       -       1,433,448  

 

The following methods and assumptions were used in estimating the fair value disclosures for financial instruments in the accompanying consolidated 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.

 

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.

 

 
44
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

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 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 4 - Federal Income Taxes

 

Deferred income 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. Significant components of the Company’s deferred tax liabilities and assets are as follows:

 

   

December 31,

  
   

2016

    

2015

  

Deferred tax liabilities:

                

Policy acquisition costs

   $ 2,427,869     $ 2,675,908  

Net unrealized gain on available-for-sale securities

     5,564,461       3,242,210  

Due premiums

     922,868       957,825  

Other

     768,852       695,201  

Total deferred tax liabilities

     9,684,050       7,571,144  
                 

Deferred tax assets:

                

Benefit reserves, net of reinsurance

     2,626,693       3,137,466  

Other policyholder funds

     337,333       363,106  

AMT credit carryforwards

     656,087       565,828  

Accrued pension liability

     2,047,230       2,065,628  

Deferred revenue on reinsurance ceded

     486,760       -  

Other-than-temporary impairments

     40,211       -  

Other

     232,793       333,340  

Total deferred tax assets

     6,427,107       6,465,368  

Net deferred tax liabilities

   $ 3,256,943     $ 1,105,776  

 

 

The Company periodically reviews its gross deferred tax assets for recoverability. At December 31, 2016 and 2015, the Company is able to demonstrate that the benefit of its gross deferred tax assets is fully recoverable.

 

 
45
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

  

The reconciliation of income tax attributable to operations computed at the federal statutory tax rate to income tax expense is as follows:

 

   

Year Ended December 31,

  
   

2016

    

2015

  
                 

Statutory federal income tax rate

     34.0

%

     34.0

%

Small life insurance company deduction

     (17.2 )     (19.2 )

Dividends-received deduction

     (0.9 )     (2.7 )

Defined contribution plan dividend

     (0.7 )     (2.3 )

Nondeductible COLI expense

     (5.2 )     (16.3 )

Nontaxable COLI life insurance proceeds

     -       (7.7 )

Nondeductible travel & meals expense

     0.6       2.5  

True-up of provision to actual

     0.1       1.7  

Other

     0.4       (4.7 )
                 

Effective income tax rate

     11.1

%

     (14.7

)%

 

We file U.S. federal income tax returns and income tax returns in various state jurisdictions. Our 2013 through 2016 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 consolidated financial statements.

 

NOTE 5 - Notes Payable

 

Effective November 25, 2016, Investors Heritage Capital renewed a line of credit agreement designated for the purpose of funding the purchase of agent debit balance receivables from Investors Heritage Life. These agent debit balance receivables may be purchased by Investors Heritage Capital at a discount with servicing retained by Investors Heritage Life. Borrowings under the line of credit are collateralized by the agent debit balances. The renewal reduces the line of credit to $1,000,000 with a new maturity date of November 25, 2018. This line of credit requires interest to be paid monthly at the prime rate, with a floor of 3.50%. We have not yet borrowed any amounts under this line of credit.

 

During the first quarter of 2015, the Company renewed the Investors Heritage Capital Corporation operating line of credit and the At Need Funding line of credit. The Investors Heritage Capital Corporation line of credit is for $150,000 with a maturity date of March 24, 2017. Interest is paid on this note monthly at the prime rate, with a floor of 3.25%. The At Need Funding line of credit is for $1,500,000 with a maturity date of March 24, 2017. Interest is paid on this note monthly at the prime rate, which is currently 3.75%. This line of credit is used for the purpose of funding at-need funerals secured by the assignment of verified, incontestable life insurance policies.

 

On November 5, 2012, the Company entered into a loan agreement to borrow $2,000,000 in order to fund a credit agreement to Puritan Financial Companies, Inc. On November 25, 2014, this note was amended to extend the maturity date to November 25, 2019 to correlate with an amendment to the Puritan promissory note and marketing agreement, as discussed further below. The amended loan agreement calls for interest to be paid quarterly at a rate of 0.25% under the prime rate. The note requires monthly principal payments of at least $15,000 beginning December 5, 2014 with a balloon payment upon maturity. There is no penalty for prepayment. This note is collateralized with 55,000 shares of Investors Heritage Life Insurance Company common stock.

 

 
46
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

The borrowed funds were utilized to fund a credit agreement to Puritan Financial Companies, Inc. for $2,000,000, with interest at a rate of 1.75% above the prime rate. The promissory note and the marketing agreement with Puritan Financial Group were amended on August 28, 2014 to extend the maturity date to August 28, 2019. These amendments allow the Company to withhold 15% of Puritan Financial’s earned commissions on certain products to pay down the note. Additionally, the amended note calls for quarterly payments of principal and interest and requires Puritan Financial to pay at least $400,000 annually toward the outstanding balance of the note from 2015 until the balance is paid in full. Any unpaid principal balance together with all accrued interest shall be due and payable with a balloon payment upon maturity. Under this credit agreement, Puritan Financial Companies, Inc. and its wholly-owned subsidiary Puritan Financial Group have committed to an increased level of new business production on behalf of the Company. Additionally, Puritan Financial Companies, Inc. has issued warrants for 2,000,000 shares of common stock to the Company in exchange for this funding. This note is further collateralized by all the stock and other assets of Puritan Financial Companies, Inc. and each of its affiliated companies. The outstanding balance on this note receivable, which is included within other invested assets on the balance sheet, was $893,915 and $1,450,830 at December 31, 2016 and 2015, respectively.

 

Information relative to the Company’s outstanding notes payable is as follows:

 

December 31, 2016

  

Outstanding

    

Current

  

Maturity

  

Interest

   

Interest

  
   

Principal

    

Interest Rate

  

Date

  

Expense

    

Paid

  

At Need Funding line of credit

   $ 133,878       3.75%  

3/24/2017

   $ 7,343     $ 6,734  

Bank note

     837,973       3.50%  

11/25/2019

     44,101       48,961  

 

December 31, 2015

  

Outstanding

    

Current

  

Maturity

  

Interest

   

Interest

  
   

Principal

    

Interest Rate

  

Date

  

Expense

    

Paid

  

At Need Funding line of credit

   $ 59,484       3.50%  

3/24/2017

   $ 19,301     $ 20,002  

Bank note

     1,373,964       3.25%  

11/25/2019

     32,186       35,194  

 

 

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 as of December 31, 2016, and we are in compliance with all debt covenant requirements.

 

NOTE 6 - Employee Benefit Plans

 

The Company sponsors the IHCC Employee Retirement Plan (the “Pension Plan”), which is a noncontributory defined benefit pension plan that was frozen in 2012 with respect to new benefit accruals. Participants in the plan at the time it was frozen may still continue to earn vesting credit towards their Pension Plan benefit.

 

 
47
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

The following table provides information relative to the Company’s Pension Plan.

 

   

December 31,

  
   

2016

    

2015

  

Change in projected benefit obligation:

                

Benefit obligation at beginning of year

   $ 24,691,877     $ 24,975,342  

Service cost

     -       -  

Interest cost

     990,439       890,263  

Actuarial (gain) loss

     627,361       (5,930 )

Benefits paid

     (1,320,617 )     (1,167,798 )

Benefit obligation at end of year

     24,989,060       24,691,877  
                 

Change in plan assets:

                

Fair value of plan assets at beginning of year

     18,616,501       19,833,900  

Actual return on plan assets

     1,338,912       (349,601 )

Employer contributions

     333,000       300,000  

Benefits paid

     (1,320,617 )     (1,167,798 )

Fair value of plan assets at end of year

     18,967,796       18,616,501  
                 

Funded status

     (6,021,264 )     (6,075,376 )

Unrecognized net actuarial loss

     8,041,983       8,388,698  

Net amount recognized as prepaid benefit cost

   $ 2,020,719     $ 2,313,322  
                 

Accumulated benefit obligation

   $ 24,989,060     $ 24,691,877  

 

   

Year Ended December 31,

  
   

2016

    

2015

  

Components of net periodic benefit cost:

                

Service cost

   $ -     $ -  

Interest cost

     990,439       890,263  

Expected return on plan assets

     (1,102,010 )     (1,172,278 )

Amortization of net (gain) loss

     737,174       762,233  

Net periodic benefit cost

   $ 625,603     $ 480,218  

 

 

The portion of the accrued pension liability included in accumulated other comprehensive income at December 31, 2016 is $8,041,983, which has been recorded net of related tax of $2,734,274. The portion of the accrued pension liability included in accumulated other comprehensive income at December 31, 2015 is $8,388,698, which has been recorded net of related tax of $2,852,157. These amounts are solely the result of unamortized actuarial net losses not yet amortized into income.

 

The estimated net actuarial loss that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost during 2017 is $676,810.

 

 
48
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

Actuarial assumptions used to determine benefit obligations and net periodic benefit cost are as follows:

  

   

December 31,

  
   

2016

    

2015

  

Discount rate

     3.95%       4.20%  

Expected return on plan assets

     6.25%       6.25%  

  

 

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 Company employs a conservative investment strategy whereby the majority of invested assets are held in appropriate investments for defined benefit pension plans, including a small portion of plan assets held in common stock of the Company. The Company uses an independent third party to administer its retirement plan. Plan assets are held in a trust account and include a diversified assortment of pooled separate accounts as well as Company common stock. The fair value of the plan assets are as follows:

 

   

December 31,

  
   

2016

    

2015

  
                 

Pooled separate accounts

   $ 18,471,796     $ 18,029,051  

Company common stock - 31,000 shares

     496,000       587,450  

 

 

Pooled separate accounts held by the Pension Plan at December 31, 2016 and 2015 are valued at the net asset value (“NAV”) of units held by the Pension Plan at year end. The NAV is determined by dividing the net assets, at fair value, of the fund by the number of units outstanding on the day of valuation.  Pooled separate accounts are comprised, primarily, of shares of registered investment companies held through subaccounts of a separate account of an insurance company. The NAV as adjusted (for mutual fund dividends, mutual fund splits and administrative maintenance charges and other items) and reported by the insurance company approximates fair value of the investments. The investments are redeemable at the adjusted NAV under agreements with the insurance company.  However, it is possible that the redemption rights may be restricted or eliminated in the future. Due to the nature of the investments, changes in the market conditions, liquidity requirements, and the economic environment may significantly affect the NAV of the registered investment companies and, consequently, the fair value of the Pension Plan's investments.

 

Shares of Company common stock held by the plan at December 31, 2016 and 2015 are considered Level 2 assets and are valued based on observable inputs, such as quoted prices in markets with limited activity. Dividends of $6,510 and $6,510 were paid to the plan in both 2016 and 2015 on the Company common stock. The plan made no purchases or sales of Company common stock during 2016 or 2015.

 

 
49
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

A summary of the allocation of plan assets by investment type is as follows:

 

 

   

December 31,

  
   

2016

    

2015

  

Fixed income pooled separate accounts

     64 %     68 %

Equity pooled separate accounts

     33 %     29 %

Company common stock

     3 %     3 %

 

 

The Company expects to contribute approximately $360,000 to its pension plan in 2017.

 

The following estimated future benefit payments are expected to be paid:

 

     

Pension Benefits

  
           

2017

     $ 2,550,000  

2018

       1,450,000  

2019

       1,440,000  

2020

       1,780,000  

2021

       1,790,000  
2022-2026       8,430,000  

 

 

The Company sponsors a 401(k) defined contribution plan known as the IHCC Retirement Savings Plan and Trust (the “Old 401(k) Plan”), which was frozen in 2012 relative to allowable new contributions. The only remaining investments held within the Old 401(k) Plan consist of Company stock. Upon distribution of the Company stock by the Old 401(k) Plan, the participant has the right to hold the stock, sell the stock on the open market, subject to a right of first refusal in favor of the Company, or sell the stock back to the Company under an elective put option at its then fair market value as determined by an independent appraiser.  Under the put option, the Company has the right to purchase the stock in substantially equal annual installments over a period not exceeding five years.

 

The Company also sponsors a 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.

 

 
50
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

Information relative to the assets within both the Old 401(k) Plan and the Retirement Plan, along with employer contributions expensed and dividends paid on Company stock, are as follows:

  

   

December 31,

  
   

2016

    

2015

  
                 

Old 401(k) Plan

                

Company common stock:

                

Shares held

     265,294       276,590  

Fair value

   $ 4,244,701     $ 5,241,377  
                 

Retirement Plan

                

Mutual funds - fair value

   $ 3,671,794     $ 2,979,588  

 

   

Year Ended December 31,

  
   

2016

    

2015

  
                 

Old 401(k) Plan

                

Employer contributions

   $ -     $ -  

Dividends on Company stock

     58,084       61,838  
                 

Retirement Plan

                

Employer contributions

   $ 457,815     $ 453,576  

 

In addition, the Company sponsors a deferred compensation plan for selected executive officers. Information relative to the assets within the deferred compensation plan, along with employer contributions expensed and dividends paid on Company stock, are as follows:

 

   

December 31,

  
   

2016

    

2015

  
                 

Company common stock:

                

Shares held

     30,100       27,350  

Fair value

   $ 481,608     $ 518,292  

Mutual funds - fair value

     157,436       80,666  

Cash and cash equivalents

     6,471       6,227  

 

   

Year Ended December 31,

  
   

2016

    

2015

  
                 

Employer contributions

   $ 55,970     $ 50,263  

Dividends on Company stock

     5,744       4,340  

 

 

NOTE 7 - Stockholders' Equity and Dividend Restrictions

 

Statutory restrictions limit the amount of dividends which may be paid by Investors Heritage Life. Generally, dividends during any year may not be paid, without prior regulatory approval, in excess of the lesser of (a) 10 percent of statutory surplus as of the preceding December 31, or (b) statutory net gain from operations for the preceding year. For 2017, the maximum dividend that Investors Heritage Life can pay to Investors Heritage Capital without regulatory approval is $1,819,285.

 

 
51
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

  

NOTE 8 - Statutory Accounting Practices

 

Investors Heritage Life's statutory-basis capital and surplus was $25,958,039 and $21,202,435 at December 31, 2016 and 2015, respectively. Statutory-basis net income was $2,073,521 and $1,267,672 for 2016 and 2015, respectively.

 

Principal adjustments to statutory amounts to derive GAAP amounts include: a) costs of acquiring new policies are deferred and amortized; b) benefit reserves are calculated using different investment, mortality and withdrawal assumptions; c) changes in deferred taxes associated with timing differences are recorded in net income rather than directly to equity; d) value of business acquired and goodwill established for acquired companies differ from admitted statutory goodwill; e) accounting for certain investments in debt securities is at fair value with unrealized gains and losses reported as a separate component of equity; f) statutory asset valuation reserves and interest maintenance reserves are eliminated; g) convertible option components of certain fixed maturities are bifurcated and recorded at market value with changes in market value recorded in the income statement; and h) the unamortized ceding commission relative to reinsured in-force blocks of business is calculated based on GAAP principles rather than statutory amounts, is recorded as a liability rather than as surplus, and follows a different amortization pattern into income.

 

NOTE 9 - Segment Data

 

The Company operates in four segments. 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.

 

 
52
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

Information relative to our operating segments as of and for the years ended December 31, 2016 and 2015 is as follows:

 

   

2016

    

2015

  
   

(000's omitted)

  

Revenue:

                

Preneed and burial products

   $ 52,245     $ 48,894  

Traditional and universal life products

     11,056       16,746  

Administrative and financial services

     1,469       1,357  

Corporate and other

     791       1,180  

Total

   $ 65,561     $ 68,177  
                 

Pre-tax income (loss) from operations:

                

Preneed and burial products

   $ 1,982     $ (496 )

Traditional and universal life products

     504       742  

Administrative and financial services

     393       274  

Corporate and other

     113       384  

Total

   $ 2,992     $ 904  
                 

Assets:

                

Preneed and burial products

   $ 376,687     $ 374,793  

Traditional and universal life products

     123,000       123,823  

Administrative and financial services

     9,687       9,706  

Corporate and other

     69,984       61,716  

Total

   $ 579,358     $ 570,038  
                 

Amortization and depreciation expense:

                

Preneed and burial products

   $ 5,226     $ 5,641  

Traditional and universal life products

     752       1,538  

Administrative and financial services

     161       214  

Corporate and other

     256       310  

Total

   $ 6,395     $ 7,703  

 

 

Included in the corporate and other revenue and pre-tax income above and as a component of other income in the consolidated statement of income for the year ended December 31, 2015 is $203,451 of net life insurance proceeds received under a company-owned life insurance policy upon the death of a former employee and former board member. No such proceeds were received during 2016.

 

NOTE 10 - Reinsurance

 

Effective September 30, 2016, the Company entered into a 100% coinsurance agreement with Southland National Insurance Corporation (“SNIC”) whereby the Company ceded an existing block of deferred fixed annuities to SNIC. The total liabilities reinsured as of September 30, 2016 were $44,023,892 and deferred acquisition costs associated with this block were $329,414. The Company transferred cash to SNIC under the agreement totaling $41,921,155. In order to generate cash, we sold fixed maturity securities generating pre-tax net realized capital gains totaling $880,055. In accordance with GAAP guidance, the initial ceding commission received on this transaction was deferred and will be recognized into income over the expected life of the reinsurance contract, which is 20 years. The initial ceding commission, net of tax, was $1,471,858 and is presented separately on the balance sheet as deferred revenue on reinsurance ceded. The Company recognized $40,211 of income associated with the amortization of the deferred revenue during 2016. Under the terms of the reinsurance agreement, the Company will continue to administer this business and will be paid administrative fees by SNIC. SNIC also maintains a trust account further securing the statutory liabilities ceded by the Company. Benefit reserves ceded to SNIC and included in the amounts recoverable from reinsurers approximated $43,179,000 at December 31, 2016.

 

 
53
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

The Company ceded 100% of the risks associated with its credit life and accident insurance written during 2016 and 2015 through coinsurance agreements with various companies. The Company administers the ceded credit life and accident insurance for an agreed-upon fee. During 2016 and 2015, the Company received $228,369 and $223,994, respectively, of fee income associated with these reinsurance arrangements, which is recognized in the administrative and financial services segment in the preceding table in Note 9. Ceded claim reserves associated with these reinsurance arrangements at December 31, 2016 and 2015 were $1,441,190 and $1,396,448, respectively. Additionally, unearned premium reserves were reduced by $8,098,452 and $8,117,461 at December 31, 2016 and 2015, respectively, for credit-related reinsurance transactions. The Company utilizes yearly renewable term reinsurance to cede life insurance coverage in excess of its retention limit.

 

Investors Heritage Life cedes 85% of life and annuity policy obligations assumed from Franklin American Life Insurance Company to Scottish Annuity and Life Insurance Company (Cayman) Ltd. Benefit reserves ceded to Scottish and included in the amounts recoverable from reinsurers approximated $17,466,000 and $18,522,000 at December 31, 2016 and 2015, respectively. An escrow account has been established by Scottish to secure Investors Heritage Life's ceded benefit obligations.

 

Investors Heritage Life coinsures policy obligations written through its relationship with Puritan Financial Group to Puritan Life Insurance Company of America (“Puritan”). This reinsurance agreement was terminated with respect to new business effective July 31, 2015, after which time the Company now retains 100% of direct new business produced under the marketing agreement. Benefit reserves ceded to Puritan and included in the amounts recoverable from reinsurers approximated $17,967,000 and $18,261,000 at December 31, 2016 and 2015, respectively. Puritan maintains a trust account in Kentucky to secure Investors Heritage Life's ceded benefit obligations.

 

Investors Heritage Life assumed 75% of the risks on certain policies sold by Puritan 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. These reinsurance agreements were also terminated with respect to new business effective July 31, 2015. Premiums assumed under these agreements totaled approximately $447,000 and $753,000 for the years ended December 31, 2016 and 2015, respectively. Benefit reserves assumed under these agreements totaled approximately $10,933,000 and $11,267,000 at December 31, 2016 and 2015, respectively.

 

Reinsurance ceded and assumed amounts included in the consolidated statements of income are as follows:

 

   

Year Ended December 31,

  
   

2016

    

2015

  
                 

Premiums ceded

   $ 10,803,281     $ 12,511,080  

Premiums assumed

     465,962       781,863  

Commission and expense allowances

     4,171,811       4,457,058  

Benefit recoveries

     8,736,272       8,414,608  

 

 

The Company remains contingently liable on all ceded insurance should any reinsurer be unable to meet their obligations.

 

 
54
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

NOTE 11 – Other Comprehensive Income

 

The following tables present the pretax components of the Company’s other comprehensive income, and the related income tax expense (benefit) for each component.

 

   

Year Ended December 31, 2016

 
           

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

   $ 8,550,015     $ 2,907,005     $ 5,643,010  

Reclassification adjustment for gains included in income

     (1,508,182 )     (512,782 )     (995,400 )

Adjustment for effect of deferred acquisition costs

     (211,683 )     (71,972 )     (139,711 )

Net unrealized gains on investments

     6,830,150       2,322,251       4,507,899  

Change in defined benefit pension plan:

                        

Actuarial net loss on pension plan

     (390,459 )     (132,756 )     (257,703 )

Amortization of actuarial net loss in net periodic pension cost

     737,174       250,639       486,535  

Net change in defined benefit pension plan

     346,715       117,883       228,832  
                         

Total other comprehensive income

   $ 7,176,865     $ 2,440,134     $ 4,736,731  

 

   

Year Ended December 31, 2015

 
           

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

   $ (17,074,720 )   $ (5,805,405 )   $ (11,269,315 )

Reclassification adjustment for gains included in income

     (735,567 )     (250,093 )     (485,474 )

Adjustment for effect of deferred acquisition costs

     462,249       157,165       305,084  

Net unrealized losses on investments

     (17,348,038 )     (5,898,333 )     (11,449,705 )

Change in defined benefit pension plan:

                        

Actuarial net loss on pension plan

     (1,515,949 )     (515,422 )     (1,000,527 )

Amortization of actuarial net loss in net periodic pension cost

     762,233       259,159       503,074  

Net change in defined benefit pension plan

     (753,716 )     (256,263 )     (497,453 )
                         

Total other comprehensive loss

   $ (18,101,754 )   $ (6,154,596 )   $ (11,947,158 )

 

 

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.

 

 
55
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

 

 The change in the components of the Company’s accumulated other comprehensive income, net of tax, are as follows:

 

   

Unrealized Gains

    

Defined

   

Accumulated

  
   

(Losses) on

    

Benefit

    

Other

  
   

Available-For-Sale

    

Pension

    

Comprehensive

  
   

Securities

    

Plans

    

Income

  

For the year ended December 31, 2016:

                        

Beginning balance

   $ 6,293,702     $ (5,536,541 )   $ 757,161  

Other comprehensive income (loss) before reclassifications

     5,503,299       (257,703 )     5,245,596  

Amounts reclassified from accumulated other comprehensive income

     (995,400 )     486,535       (508,865 )

Net current period other comprehensive income

     4,507,899       228,832       4,736,731  

Ending balance

   $ 10,801,601     $ (5,307,709 )   $ 5,493,892  
                         

For the year ended December 31, 2015:

                        

Beginning balance

   $ 17,743,407     $ (5,039,088 )   $ 12,704,319  

Other comprehensive loss before reclassifications

     (10,964,231 )     (1,000,527 )     (11,964,758 )

Amounts reclassified from accumulated other comprehensive income

     (485,474 )     503,074       17,600  

Net current period other comprehensive loss

     (11,449,705 )     (497,453 )     (11,947,158 )

Ending balance

   $ 6,293,702     $ (5,536,541 )   $ 757,161  

  

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.

 

   

Year Ended December 31,

 

Reclassification Adjustments

  

2016

    

2015

  

Unrealized gains on available-for-sale securities:

                

Realized gains on securities (a)

   $ 1,508,182     $ 735,567  

Income tax expense (c)

     (512,782 )     (250,093 )

Net of tax

     995,400       485,474  
                 

Defined benefit pension plans:

                

Amortization of actuarial net loss (b)

     (737,174 )     (762,233 )

Income tax benefit (c)

     250,639       259,159  

Net of tax

     (486,535 )     (503,074 )
                 

Total reclassifications for the period

   $ 508,865     $ (17,600 )

 

 

(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 benefit cost (see Note 6).

 

(c)

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

 

 
56
 

 

NOTES TO CONSOLIDATED

FINANCIAL STATEMENTS

NOTE 12 - Contingent Liabilities

 

In most of the states in which the Company is licensed to do business, guaranty fund assessments may be taken as a credit against premium taxes over a five-year period. These assessments, brought about by the insolvency of life and health insurers, are levied at the discretion of the various state guaranty fund associations to cover association obligations. It is management's opinion that the effect of any future assessments would not be material to the financial position or results of operations of the Company because of the use of premium tax offsets.

 

The Company is not currently named as a defendant in any legal actions.

 

 
57
 

 

BOARD OF DIRECTORS

 

HARRY LEE

WATERFIELD II

    

Chairman of the Board

President

Chief Executive Officer

Executive Committee

Finance Committee

Nominating Committee

Frankfort, Kentucky

 

GEORGE R.

BURGESS, JR.

    

Executive Committee

Nominating Committee

Frankfort, Kentucky

 

ROBERT M. HARDY, JR.

    

Executive Vice President, General Counsel

Executive Committee

Finance Committee

Frankfort, Kentucky

                 

HAROLD G.

DORAN, JR.

    

Audit Committee

Executive Committee

Finance Committee

Murray, Kentucky 

  

DAVID W.

REED

   

Audit Committee

Nominating Committee

Gilbertsville, Kentucky

                 

GORDON C.

DUKE

    

Audit Committee

Finance Committee

Frankfort, Kentucky

  

HELEN S.

WAGNER

    

Executive Committee

Nominating Committee

Daniel Island, South Carolina

                 

MICHAEL F.

DUDGEON, JR.

    

Finance Committee

Frankfort, Kentucky

          
                 

 

 

CORPORATE OFFICERS

 

RAYMOND L.

CARR

    

Executive Vice President,

Chief Operating Officer

Frankfort, Kentucky

JANE S.

JACKSON

    

Corporate Secretary

Frankfort, Kentucky 

               

LARRY J. JOHNSON II,

CPA

    

Vice President,

Chief Financial Officer

Frankfort, Kentucky

SHANE S.

MITCHELL,

CPA

    

Treasurer

Frankfort, Kentucky

 

MOUNTJOY

CHILTON

MEDLEY LLP

    

Independent Registered Public Accounting Firm

Louisville, Kentucky

       

ANNUAL

MEETING

    

The 2017 annual meeting of shareholders of Investors Heritage Capital Corporation is scheduled for 11:00 a.m. on May 11, 2017 at the Company auditorium, Second and Shelby Streets, Frankfort, Kentucky.

       

FORM 10-K

    

A copy of the Form 10-K Annual Report to the Securities and Exchange Commission for the Company can be obtained at www.investorsheritage.com or upon request to the Secretary.

       

TRANSFER

AGENT

    

Investors Heritage Life Insurance Company

Stock Transfer Department

P.O. Box 717

Frankfort, KY 40602-0717

Phone: 800.422.2011 502.209.1009

 

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