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MIDWEST HOLDING INC. FORM 10 TABLE OF CONTENTS
MIDWEST HOLDING INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Amendment No. 3
to
FORM 10
GENERAL FORM FOR REGISTRATION OF SECURITIES
Pursuant to Section 12(b) or (g) of The Securities Exchange Act of 1934
Midwest Holding Inc.
(Exact name of registrant as specified in its charter)
| Nebraska (State or other jurisdiction of incorporation or organization) |
20-0362426 (I.R.S. Employer Identification No.) |
|
8101 "O" Street, Suite S111, Lincoln, Nebraska (Address of principal executive offices) |
68510 (Zip Code) |
Registrant's telephone number, including area code : (402) 489-8266
Securities to be registered pursuant to Section 12(b) of the Act: None
Securities to be registered pursuant to Section 12(g) of the Act:
| |
Voting Common Stock, $0.001 par value | |
||
|---|---|---|---|---|
| (Title of class) |
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer o | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company ý |
MIDWEST HOLDING INC.
FORM 10
TABLE OF CONTENTS
Special Note Regarding Forward-Looking Statements
Certain statements in this Form 10 constitute forward-looking statements. These statements are based on management's expectations, estimates, projections and assumptions. In some cases, you can identify forward-looking statements by terminology including "could," "may," "will," "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential," "intend," or "continue," the negative of these terms, or other comparable terminology used in connection with any discussion of future operating results or financial performance. These statements are only predictions, and reflect our management's present expectation of future events and are subject to a number of important factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.
General Information
Midwest Holding Inc. (we, us, our, Midwest, the Company or the Registrant) was formed on October 31, 2003 for the primary purpose of becoming a financial services holding company. Midwest presently conducts its business through its wholly owned subsidiary, American Life & Security Corp. (American Life). Capital Reserve Life Insurance Company of Jefferson City, Missouri (Capital Reserve) is a dormant, wholly owned subsidiary of American Life. Security Capital Corporation is a 60% owned subsidiary of Midwest. Midwest is a Nebraska Corporation, American Life is an Arizona corporation, and Capital Reserve is a Missouri corporation. The principal executive offices at 8101 "O" Street, Suite S111, Lincoln, Nebraska 68510. The phone number for the companies is (402) 489-8266.
Development of the Business
From our inception through July 2006, we raised approximately $6.5 million through the sale of shares of voting common stock in several private placements. Between June 2007 and May 2009, we raised approximately $11.0 million through an intrastate public offering of voting common stock in the State of Nebraska. Each of these sales of stock was intended to provide capital for our financial services operations.
American Life was incorporated on May 7, 2009. On September 1, 2009, American Life was issued a certificate of authority to conduct life insurance business in the State of Nebraska. Immediately following the issuance of the certificate of authority, American Life began to offer the American Accumulator and Future Cornhusker products in the state of Nebraska. Prior to our acquisition of American Life, the Company did not offer any products. Initial capital and surplus contributed to American Life was approximately $3.5 million, which was increased to approximately $5.5 million on September 1, 2009. In its first four months of operation, between September 1, 2009 and December 31, 2009, American Life generated $354,352 in premium revenue. In 2010, American Life generated $1.9 million in premium revenue. For the nine months ended September 30, 2011, American Life generated $1.6 million in premium revenue.
On June 20, 2010, American Life acquired Capital Reserve in exchange for a cash payment of approximately $1.9 million. This transaction added approximately a like amount of assets to American Life. Further, with the insurance charters acquired from Capital Reserve, we obtained access to additional markets in Missouri, Kansas and Iowa.
In connection with the acquisition of Capital Reserve, American Life also coinsured a block of life insurance business from Capital Reserve's parent corporation in a separate transaction. The purchase price for this block of business was approximately $375,000. This transaction added more than $70,000 in annual revenues to American Life's operations, as well as approximately $3.5 million of new assets to
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our balance sheet, while American Life assumed approximately $3.65 million in policy reserves on the block of business.
In July 2010, we commenced the private sale of 74,159 shares of our Series A Preferred Stock to certain qualified investors in Latin America. This offering was completed in January 2011. The net proceeds of this sale, after expenses, were approximately $415,750. These proceeds were used to further capitalize our insurance operations, for working capital and for other general corporate purposes.
On July 12, 2010, in order to provide additional capital to support our continued growth, we commenced an offering of up to 2,000,000 additional shares of voting common stock to existing shareholders who were residents of the State of Nebraska. This offering was completed on February 28, 2011, and a total of 1,554,326 additional shares of voting common stock were sold. The gross proceeds of this sale, after expenses, were approximately $7.7 million. These proceeds will be used to further capitalize our insurance operations, for working capital and for other general corporate purposes, including funding the acquisition of Old Reliance Insurance Company (Old Reliance) as described below.
On November 8, 2010, the Company and American Life entered into an agreement to acquire all of the issued and outstanding capital stock of Old Reliance, an Arizona-domiciled life insurance company. The plan provided for American Life to merge into Old Reliance following the purchase, with the survivor changing its name to American Life & Security Corp. and domiciled in Arizona. In the transaction, the sole shareholder of Old Reliance received: (i) approximately $1.6 million in cash, (ii) $500,000 in the form of a surplus debenture issued by American Life, and (iii) 150,000 shares of voting common stock of the Company. On November 8, 2010, prior to signing the stock purchase agreement with American Life, Old Reliance had assets of approximately $19 million and for the period from January 1, 2010 through November 8, 2010, income of approximately $1.4 million, and expenses of approximately $1.7 million. The transaction including the merger, was consummated on August 3, 2011.
The Company was a development stage company until American Life commenced its insurance operations in 2009. We have incurred significant net losses since inception totaling approximately $9.4 million through September 30, 2011. These losses have resulted primarily from costs incurred while raising capital and establishing American Life. We expect to continue to incur operating losses until we achieve a volume of in-force life insurance policies that provides premiums that are sufficient to cover our operating expenses.
American Life
General
Our insurance company, as it exists today, is the product of the August 2011 merger of Old Reliance and American Life. Organized in 1960, Old Reliance primarily focused on the sale of final expense or burial products which typically are small face amount policies with limited underwriting. American Life historically did not offer similar products and instead focused on the sale of its American Accumulator product (a multi-benefit life insurance policy) and its Future Cornhusker Plan (a single premium term life product for children), as described below. The final expense and burial products have been offered by Old Reliance through a small network of independent agents in the Southwest United States. Sales over the past five years have been nominal as the Company lacked the capital and surplus to support broad sales of the products. During 2010, approximately 24% of premiums were first year premiums compared to 76% of premiums being renewal premiums. Following the acquisition by American Life and merger, these products were withdrawn due to concerns regarding persistency and potential claims.
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Management does not expect the historical block of Old Reliance business to be unprofitable due to the profitability loaded into the products. New ordinary life products are being developed that will incorporate more underwriting to serve as replacements to the final expense and burial products previously offered by Old Reliance. It is expected that these products will be similar to those that have been offered in the past by American Life.
On November 8, 2010, prior to signing the stock purchase agreement with American Life, Old Reliance had assets of approximately $19 million and for the period from January 1, 2010 through November 8, 2010, income of approximately $1.4 million and expenses of approximately $1.7 million.
American Life underwrites and markets life insurance products within the State of Nebraska. After completing the merger with Old Reliance, we are licensed in fourteen states. Because American Life is domiciled in Arizona following the merger, it is required to comply with the insurance laws of that state. Management is evaluating the pros and cons of domesticating American Life in Nebraska; however no decision has been made as of the current date. Old Reliance had eliminated marketing in several states prior to the acquisition. Management's assessment of Old Reliance's activities is that the business lacked adequate profit. As such, an on-going review is underway to evaluate market potential and appropriate products; such decision is expected in early 2012. With the acquisition of Capital Reserve, we also obtained access to additional markets in Missouri, Kansas and Iowa, although our sales efforts remain focused on Nebraska at the present time. Over time, we may apply with other state insurance departments in order to obtain certificates of authority to market life insurance products in those states.
Additionally, we intend to explore the international market for U.S. dollar denominated ordinary life policies.
Some of the agents who were engaged by us to sell shares of voting common stock in the 2007-09 intrastate public offering were cross-trained by American Life to act as agents for its insurance business. The recruiting, training and hiring of captive agents (agents who sell only American Life's products) will be a continuous process for American Life.
Type of Policies
American Life sells two insurance products, the "American Accumulator", which is a multi-benefit life insurance policy that combines cash value life insurance with a tax deferred annuity, and the "Future Cornhusker Plan", which is a single premium term life product offered for children aged three months to 15 years. The Future Cornhusker is available in annual premium amounts of $125 or $250 and carries an initial face amount of $5,000 or $10,000. The American Accumulator is sold in annual premium units of $2,000. The average annual premium is approximately $2,000 with an average face amount of $64,000. Premiums may be higher based upon the age and health of the insured.
It is anticipated that, over time, American Life will market other traditional life insurance products as well, which may include:
American Life will, in all likelihood, offer limited pay whole life, term and decreasing term life and single and flexible premium annuities. The potential profitability of any product, including the cost involved to market and administer it, will be a significant factor in the decision to offer that product. Currently, the Company's consulting actuary is working with management to design these products.
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Management expects to introduce a limited pay whole life and term product during the summer of 2012.
Product Pricing
None of the insurance products to be marketed by American Life, other than the two initial products described above, have been developed or filed with the Arizona Department of Insurance and the Nebraska Department of Insurance for approval. These products will be developed with a pricing structure designed to accomplish the following primary objectives:
All products will be developed by using the services of an independent qualified consulting actuary, Miller and Newberg of Kansas City, Missouri. In addition to product development, Miller and Newberg serves as American Life's Valuation Actuary. The total fees paid to Miller and Newberg in 2011 were $39,199.
Underwriting Standards
Underwriting guidelines will have a direct impact on American Life's operating results. If the underwriting standards that are established are not adequate, desired operating results will not be realized. Generally, when underwriting standards are less restrictive, more mortality claims will result and vice versa. Underwriting standards have a direct impact on the pricing structure of a product. The less restrictive the underwriting standards, the higher the product needs to be priced in order to allow for a higher incident of mortality. This higher incident of mortality is also reflected in greater policy reserves being established.
American Life has established underwriting guidelines consistent with its product's pricing structure. The Company utilizes information from the application and, in some cases, telephone interviews with applicants, inspection reports, doctors' statements and/or medical examinations to determine whether a policy should be issued in accordance with the application, with a different rating, with a rider, with reduced coverage or rejected. In addition to an applicant's medical history, the Company also considers other factors such as financial profile, foreign travel, vocations and alcohol, drug and tobacco use. Depending upon age of the insured and the face amount of the policy, we may rely solely on the information contained within an application to determine whether or not to underwrite a policy, and a medical examination or other information may not be required. Generally, we will only issue a policy based solely on the information contained within an application to individuals less than 55 years of age and for a face amount less than $55,000. Requests for coverage are reviewed on their merits and generally a policy is not issued unless the particular risk has been examined and approved by our underwriters. American Life's consulting actuary assists the insurance subsidiary in establishing its underwriting standards.
Marketing
New agents are recruited through referrals from shareholders, newspaper advertisements, and solicitation through the use of on-line job sites. Each potential candidate must go through a three interview process. If hired to sell insurance, the candidate must complete a 40 hour training course conducted by a third party as well as pass the state examination. Once licensed, they must complete a week long product and sales training class. Following course completion, they will have a training week
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where their manager will work side by side making sales calls with them. The average turnover rate of our agents is approximately 15% per year.
The products developed by American Life have been marketed initially by those agents cross-trained to market insurance products after selling shares of stock in our intrastate public offering. When agents were recruited to sell stock in connection with our earlier intrastate public offering, they were required to complete a similar company training program and compliance course. They also were required to be licensed by the Nebraska Department of Banking & Finance, Securities Bureau, under applicable securities laws and were required to spend time in the field with their managers prior to engaging in any sales activity on their own. During the period in which our intrastate offering was on-going, the average turnover rate of our agents was approximately 10% per year.
Additionally, the recruiting, hiring and training process is continuous for American Life going forward. These captive agents will market only the life insurance subsidiary's products. The American Accumulator pays total first year commissions to our marketing agents of 72% and renewal commissions total 15%. Total commissions may be split between multiple agents involved in the sale, with the writing agent receiving the bulk of the commission and others receiving portions of the commission as overrides. The Future Cornhusker pays a first year commission to our marketing agents of 20% and no renewal commission.
The insurance products are marketed using the same face-to-face marketing concept that was used by us to sell shares of stock in our intrastate public offering that utilized in person sales meetings with prospective shareholders. When the intrastate offering was being conducted, the shares were only offered to individuals who had been referred by another shareholder. There was no cold calling or other similar activity. The sale of stock was not allowed to be conducted in any area where insurance sales were ongoing. The intrastate offering was completed in 2010. Since then, our insurance agents have used our shareholder base and their referrals as potential clients for our life insurance products.
American Life also intends to pursue the U.S. Dollar-denominated life insurance market in Latin America. The products that will be offered are ordinary whole life that are designed specifically for that market.
If, and when, American Life enters the interest-sensitive and universal life markets, it would not use its captive agents to market such products. Generally, these are sophisticated products which require a unique ability to market. Accordingly, if American Life chooses to enter this market, it would develop an independent agent distribution system using independent marketing agencies that have the experience and ability to market these products. However, American Life would not enter this market segment unless it could do so profitably.
Operating Results
There are certain factors unique to the life insurance business, which may have an adverse effect on the operating results of American Life. One such factor is that the cost of putting a new policy in force is usually greater than the first year's policy premium, and, accordingly, in the early years of a new life insurance company, these initial costs and the required provisions for reserves often have an adverse effect on operating results. American Life, as is common among new or inactive life insurance companies, probably will continue to operate at a loss for a number of years because of the substantial costs of writing new life insurance. The aggregate cost of writing new life insurance includes such significant, nonrecurring items as first year commissions, medical and investigation expenses, and other expenses incidental to the issuance of new policies, together with the initial reserves required to be established. For the American Accumulator product, the costs to cover expenses and the policyholder liability that must be set up at policy issuance exceed the first year premium by approximately 39%, while there is no excess of costs to cover expenses and the policyholder liability for the Future Cornhusker product. Accordingly, it is generally recognized that the cost of putting a new policy in
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force is substantially greater than the first year premium. As a result, a new life insurance company can be expected to sustain losses for a number of years, during which time earnings are not available for dividends. However, in accordance with accounting principles generally accepted in the United States of America (GAAP), incremental direct costs that result directly from and are essential to the contract acquisition transaction and would not have been incurred by the Company had the contract acquisition not occurred, are capitalized and amortized over the life of the premiums produced.
Additionally, the Company has a large portion of its business as first year business. Therefore, the overhead of the Company is not yet supported by renewal business and premium growth.
Our operating results are reported in accordance with accounting principles generally accepted in the United States of America (GAAP) for stock life companies; although the Company's life insurance subsidiaries will also prepare financial statements in accordance with accounting practices prescribed or permitted by their respective state of domicile (statutory basis of accounting) for the purpose of reporting to insurance regulatory authorities. Under the GAAP method of reporting, certain costs, which are expensed immediately under the statutory basis of accounting, will be charged to operations over the period in which premiums are earned, thereby reducing the adverse effect of these costs on operating results. In addition, under the GAAP method of reporting, assumptions used in calculating reserves are less conservative than those used under the statutory basis, thereby further reducing adverse effects on operating results.
Administration
The policies written or acquired by American Life have historically been administered through a contract with a third-party administrator (TPA). The TPA is a company that is not related to American Life which is in the business of performing policy administration. Such administration was performed through a TPA until January 31, 2012. Policy administration includes the issuance of policies, billing, preparation of commission and production statements, posting of premium payments and servicing of policyholders. Following the acquisition of Old Reliance, which owned a policy administration and accounting system, management gave notice of cancellation to American Life's TPA and brought all administration in house on February 1, 2012.
Investments
American Life has adopted an investment policy in compliance with the insurance laws of the State of Arizona. The type and amount of investments which can be made by a life insurance company domiciled in the State of Arizona are specifically controlled by applicable Arizona statutes and rules and regulations of the Arizona Department of Insurance.
It is critical that an insurer invest its assets wisely and conservatively as investment income ultimately (as a new company grows, investment income will increase as a percent of total income due to investment of policy reserves) will be a significant component of total revenue. Accordingly, American Life has developed a conservative investment policy in an effort to minimize its investment risk. An independent professional investment advisor who specializes in the insurance industry assists American Life with its investments.
Reinsurance
American Life and Capital Reserve reinsure with other companies (reinsurers) portions of the life insurance risks they underwrite and occasionally will reinsure portions of life insurance risks underwritten by other (ceding) companies. The primary purpose of reinsurance is to allow a company to reduce the amount of its risk on any particular policy. The effect of reinsurance is to transfer a portion of the risk to the reinsurers. However, American Life and Capital Reserve remain contingently liable for the risk in the event the reinsurers are not able to meet their obligations under the
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reinsurance agreements. Further, when life insurance risks are ceded to another insurer, the ceding company must pay a reinsurance premium to the reinsurance company as consideration for the risk being transferred. The payment of this reinsurance premium to the reinsurer represents a reduction of the premium income received by American Life or Capital Reserve. This reduction in premium income has a direct impact on the profitability of the ceding company (American Life and Capital Reserve).
The average face amount of our life insurance policies in force is $63,000. With respect to such policies, the Company retains $40,000 of risk on any one life. Approximately 62% of the gross outstanding life insurance policies in force are reinsured with third parties. The Company cedes approximately $8.57, or .857%, of premium per year for each $1,000 of life insurance in force and reinsured per year. All accidental death benefits are reinsured.
Reserves
American Life establishes as liabilities actuarially computed reserves to meet the obligations on the policies it writes, in accordance with the insurance laws and the regulations of the Arizona Department of Insurance for statutory accounting and GAAP for financial reporting to shareholders. These reserves are the amounts which, with additions from premiums to be received and with interest on such reserves, compounded annually at certain assumed rates, in the future are sufficient according to accepted actuarial principles to meet American Life's policy obligations as they mature. The various actuarial factors are determined from mortality tables and interest rates in effect when the policies are issued and are applied against policy in force amounts.
Competition
The life insurance industry is fiercely competitive. Many of the life insurance companies authorized to do business in states that we conduct business in are well-established companies with fine reputations, offering a broader line of insurance policies, having larger selling organizations, and possessing greater financial resources than American Life. American Life is not rated by industry analysts at the present time and likely will not be rated for a period of three to five years. This will have a negative impact on American Life's ability to compete with rated insurance companies. There is also considerable competition among insurance companies in obtaining qualified sales agents, which might require the Company to pay higher commissions to attract such agents.
Possible Acquisition of Other Companies
Subject to the regulation and supervision of the Arizona Department of Insurance and other regulators, we may acquire one or more life insurance or insurance-related companies in the future. Our acquisition strategy, should this avenue be pursued, will be to identify one or more established insurance companies which have developed viable marketing networks for their products and which are or could be managed from a Lincoln, Nebraska administrative office. In selecting target insurance companies which constitute suitable acquisition candidates, we will consider factors such as, but not limited to, the target company's financial statements and operating history (including surplus adequacy and underwriting standards); the price and features of insurance products sold and the markets serviced; the competency and loyalty of its agents; certain income tax considerations; and the purchase price therefore.
We also may seek to acquire insurance-related companies such as: (i) third-party administrators; (ii) existing marketing agencies; (iii) actuarial services companies; (iv) reinsurance brokerage companies and (v) life and health insurance data processing servicers.
The primary reasons we may acquire an existing life insurance company or insurance-related company are: (i) the placement of administrative, accounting and data processing systems that would allow the company to expand; (ii) provide additional revenue streams to us through additional
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marketing expansion or ancillary services; and (iii) provide additional profits through more effective cost management of an existing company as many companies within the insurance industry have excessive administrative cost levels relative to premium income.
On August 4, 2011, the Company acquired Old Reliance Life Insurance Company, an Arizona domiciled life insurer and simultaneously merged American Life with and into it, changing the survivors name to American Life and Security Corporation. This acquisition added 14 new states, annual premium income of approximately $1.7 million, annual expenses of approximately $2 million, and total assets of approximately $19 million. At the time of the acquisition, Old Reliance had 35 independent agents under contract. Currently, all 35 remain under contract.
On December 27, 2011, American Life reached an agreement to acquire all of the outstanding shares of Preferred Security Life Insurance Company (Preferred Security), a Texas domiciled stipulated premium life insurance company, in exchange for $225,000 in cash. Management anticipates the deal to close during the second quarter of 2012. The acquisition will add approximately $3 million in assets and $60,000 of annual revenues to the Company's consolidated financial statements.
No additional acquisition agreements have been signed as of March 20, 2012. However, we will continue to evaluate and consider appropriate candidates.
Prior Acquisitions and Investments
In 2006, we acquired 1,627,500 shares of Western States Alliance Corporation (Western States) for $0.46 a share for an aggregate investment of $748,650. This investment gave us majority ownership of Western States. Western States was subsequently dissolved, with the majority of its assets transferred to us, effective December 31, 2009.
In 2005, we acquired 1,410,000 shares of capital stock of Security Capital Corporation (Security Capital), an Arkansas corporation formerly known as Arkansas Security Capital Corporation, for $0.10 per share, or $141,000 in the aggregate. At the time, such shares constituted 47% of the outstanding capital stock of Security Capital. Starting in 2007, Security Capital began issuing additional capital stock, reducing our ownership to approximately 40%. In 2010 and 2011, we acquired additional shares bringing our ownership to over 60%. During the third quarter of 2011, the Company began consolidating Security Capital.
In July 2009, we acquired 350,000 shares of capital stock of First Wyoming Capital Corporation (First Wyoming) for $0.10 per share for an aggregate investment of $35,000 and funding of $20,000 of pre-incorporation expenses. First Wyoming's insurance subsidiary received its Certificate of Authority to operate in Wyoming July 1, 2011. As of September 30, 2011, our ownership constituted approximately 12.8% of the issued and outstanding capital stock of First Wyoming.
In April 2010, we acquired 340,000 shares of capital stock of Rocky Mountain Capital Corporation, a Colorado corporation (Rocky Mountain) for $0.10 per share for an aggregate investment of $34,000. As of September 30, 2011, our ownership constituted approximately 11.07% of the issued and outstanding capital stock of Rocky Mountain.
In April 2010, we acquired 600,000 shares of non-voting capital stock of Northstar Financial Corp. (Northstar) for $0.10 per share for an aggregate investment of $60,000. As of September 30, 2011, our ownership constituted approximately 25.8% of all issued and outstanding capital stock of Northstar.
In June 2010, we acquired 366,500 shares of capital stock of Great Plains Financial Corporation, a South Dakota corporation (Great Plains), for $1.65 per share for an aggregate investment of $604,725. Great Plains has a life insurance subsidiary licensed to do business in South Dakota. As of September 30, 2011, our ownership constituted approximately 9.0% of the issued and outstanding capital stock of Great Plains.
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In August 2011, we acquired 2,500,000 shares of capital stock of Hot Dot, Inc., a Nebraska corporation (Hot Dot), for $.02 per share for an aggregate investment of $50,000. Hot Dot was organized to develop, manufacture, and market the Alert Patch. The Alert Patch is an adhesive-backed cloth patch that is used to detect increases in body temperature that pose a risk of heat exhaustion or heat stroke. As of September 30, 2011, the Company's ownership constituted approximately 42.7% of the issued and outstanding capital stock of Hot Dot. In addition, Rick Meyer, Chairman of our Board of Directors, is Chairman and a member of the original Board of Directors of Hot Dot. Rick Meyer owns 300,000 shares of voting capital stock of Hot Dot. Mark A. Oliver, our Secretary/Treasurer and a member of our Board of Directors, is Treasurer and a member of the original Board of Directors of Hot Dot. Mr. Oliver owns 300,000 shares of voting capital stock of Hot Dot. Travis Meyer, our president and a member of our Board of Directors, is President and a member of the original Board of Directors of Hot Dot. Travis Meyer owns 300,000 shares of voting capital stock of Hot Dot. Todd C. Boeve, an employee of ours, is Secretary and a member of the original Board of Directors of Hot Dot. Mr. Boeve owns 50,000 shares of voting capital stock of Hot Dot.
In September 2011, we acquired 797,500 shares of non-voting capital stock of Pacific Northwest Capital Corp., an Idaho corporation (Pacific Northwest), for $0.10 per share for an aggregate investment of $79,750. On the date of the investment, our initial ownership constituted approximately 33.2% of the issued and outstanding capital stock.
Certain Relationships and Affiliations with Similar Businesses
The Company and certain of its directors and officers have current or past relationships and affiliations with businesses that operate, or once operated, in the life insurance industry and that have conducted public and private stock offerings in connection with their operations. Additional information on these relationships and affiliations, organized by company, is as follows:
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2010. He owns 25,000 shares of capital stock of First Wyoming. First Wyoming has raised approximately $4 million of an anticipated $7.5 million offering and received its certificate of authority in July 2011.
Most of these entities have business plans similar to that of the Company. Each entity operates under a separate Board of Directors. There are no plans to merge any of the entities above as of the present date.
Regulation
American Life, as well as any other life insurance subsidiary that we may acquire or form, is (or will be) subject to the regulation and supervision of the Arizona Department of Insurance and/or other state insurance regulators. Such regulation is primarily for the benefit of policyholders rather than
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shareholders. These regulators possess broad administrative powers. These powers include the authority to grant and revoke licenses to transact business, to approve the form of insurance contracts, to regulate capital requirements, to regulate the character of permitted investments, and to require deposits for the protection of investments. Arizona insurance law requires the filing of a detailed annual report with the Department of Insurance, as do other states' laws. Thus, the business and financial accounts of American Life will be subject to examination by the Arizona Department of Insurance, as well as insurance departments of any other states in which it may do business.
There can be no assurance that American Life, Capital Reserve, or any other life insurance subsidiary that we may acquire or form will be able to satisfy the regulatory requirements of the Arizona or Missouri Department of Insurance or a similar department in any other state in which it may wish to transact business.
As the holder of a controlling interest in an Arizona insurance company, the Company also is subject to regulation as an insurance holding company system under Arizona law. The provisions of this law generally provide for restrictions on a change in control of the insurance holding company, require the filing of certain reports with the Department of Insurance, and limit the amount of dividends which may be received by the holding company from American Life.
On July 21, 2010, President Obama signed into law financial regulatory reform legislation, known as the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Reform Act"). The Reform Act reshapes financial regulations in the United States by creating new regulators, regulating new markets and firms, and providing new enforcement powers to regulators. Virtually all major areas of the Reform Act will be subject to regulatory interpretation and implementation rules requiring rulemaking that may take several years to complete. Although the ultimate outcome of the regulatory rulemaking proceedings cannot be predicted with certainty, we do not believe that the provisions of the Reform Act will have a material impact on our consolidated financial results or financial condition.
Employees and Agents
As of September 30, 2011, we have 20 full-time employees and 2 part-time employees, as well as 22 insurance agents who operate as independent contractors.
An investment in our voting common stock involves a high degree of risk. Investors should carefully consider the risks described below and the other information in this Form 10 before investing in our voting common stock. If any of the following risks occur, our business, operating results and financial condition could be seriously harmed.
Risks Related to Our Business
The Company has a limited operating history and owns a limited amount of assets.
The Company was formed in October 2003 and was in the development stage until the insurance operations of American Life commenced in September 2009. We have a limited operating history and, until recently, we have generated no revenues other than interest and investment income. The start-up costs we have incurred have created a history of operating losses. We have all of the risks inherent in establishing a new business, including limited capital, uncertain markets, lack of revenues and potential competition from better capitalized companies. We have no control over general economic conditions, competitors' products, competitive pricing, customer demand and costs of marketing or advertising to build and expand our business. Moreover, we anticipate that we will continue to incur net operating losses well into the future as we establish a revenue stream from our operating subsidiaries. There is no assurance that our activities will be successful or result in any revenues or profits to the Company and,
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the likelihood of any success must be considered in light of our early stage of development. These risks and our lack of substantial operating history make it difficult to predict the Company's future revenues or results of operations. As a result, our financial results may fluctuate widely and fall below our expectations or the expectations of our shareholders. This could cause the value of our voting common stock to decline.
Ownership of shares of our voting common stock involves substantial risk, and the entire value of those shares may be lost.
Shares of our voting common stock constitute a high-risk investment in a developing business. No assurance or guaranty can be given that any of the potential benefits envisioned by our business plan will prove to be available, nor can any assurance or guaranty be given as to the actual amount of financial return, if any, which may result from ownership of our shares. The entire value of shares of our voting common stock may be lost.
Our insurance marketing efforts are key to our success.
We market our insurance products through the services of licensed insurance agents. New agents are recruited through referrals from shareholders, newspaper advertisements, and solicitation through use of on-line job sites. Each potential candidate must go through a three interview process. If hired to sell insurance, the candidate must complete a 40 hour training course conducted by a third party as well as pass the state examination. Once licensed, they must complete a week long product and sales training class. Following course completion, they will have a training week where their manager will work side by side making sales calls with them. The average turnover rate of our agents is approximately 15% per year.
The insurance products are marketed using the same face-to-face marketing concept that was used by us to sell shares of stock in our intrastate public offering that utilized in person sales meetings with prospective shareholders. When the intrastate offering was being conducted, the shares were only offered to individuals who had been referred by another shareholder. There was no cold calling or other similar activity. The sale of stock was not allowed to be conducted in any area where insurance sales were ongoing. The intrastate offering was completed in 2010. Since then, our insurance agents have used our shareholder base and their referrals as potential clients for our life insurance products.
Many of these agents have no prior insurance product selling experience and, accordingly, this lack of experience may have a negative impact on the amount of premium volume we write. The extent of this negative impact on the premium volume written will depend primarily on our ability to timely and adequately train these agents to sell our insurance products and the effectiveness of our face-to-face marketing concept.
Our existing insurance subsidiaries, American Life and Capital Reserve, may fail as a result of being inadequately capitalized.
American Life was granted a certificate of authority by the Nebraska Department of Insurance based on initial capital and surplus of approximately $3.5 million, which was increased to approximately $5.5 million on September 1, 2009. Following the merger of American Life with Old Reliance, American Life had approximately $4,942,301 in capital and surplus at September 30, 2011. The Arizona Department of Insurance may require American Life to add additional amounts of capital and surplus to support its business going forward, just as the Missouri Department of Insurance may require additional capitalization of Capital Reserve. Capital Reserve had capital and surplus of $1.4 million as of September 30, 2011. The amount of capital and surplus ultimately required will be based on certain "risk-based capital" standards established by statute and regulation and administered by the Arizona and Missouri Departments of Insurance and other regulators. The "risk-based capital" system
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establishes a framework for evaluating the adequacy of the minimum amount of capital and surplus, calculated in accordance with statutory accounting principles, necessary for an insurance company to support its overall business operations. It identifies insurers that may be inadequately capitalized by looking at certain inherent risks of each insurer's assets and liabilities and its mix of net premiums written. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action, including supervision, rehabilitation, or liquidation. If American Life or Capital Reserve fails to maintain required capital levels in accordance with the "risk-based capital" system, each company's ability to maintain the regulatory authority necessary to conduct business would be compromised.
We expect to suffer operating losses for a number of years.
We expect to sustain losses for a number of years. American Life, as is common among new or inactive life insurance companies, likely will operate at a loss for a number of years because of the substantial costs of writing new life insurance. We have incurred significant net losses since inception totaling approximately $9.4 million through September 30, 2011.
The aggregate cost of writing new life insurance includes such significant, nonrecurring items as first year commissions, medical and investigation expenses, and other expenses incidental to the issuance of new policies, together with the initial reserves required to be established. For the American Accumulator product, the costs to cover expenses and the policyholder liability that must be set up at policy issuance exceed the first year premium by approximately 39%, while there is no excess of costs to cover expenses and the policyholder liability for the Future Cornhusker product. Accordingly, it is generally recognized that the cost of putting a new policy in force is substantially greater than the first year premium. As a result, a new life insurance company can be expected to sustain losses for a number of years, during which time earnings are not available for dividends. However, in accordance with accounting principles generally accepted in the United States of America (GAAP), incremental direct costs that result directly from and are essential to the contract acquisition transaction and would not have been incurred by the Company had the contract acquisition not occurred, are capitalized and amortized over the life of the premiums produced.
Additionally, the Company has a large portion of its business as first year business. Therefore, the overhead of the Company is not yet supported by renewal business and premium growth.
The insurance industry is subject to numerous laws and regulations, and compliance costs and/or changes in the regulatory environment could adversely affect our business.
We are subject to government regulation in each of the states in which we conduct business. Such regulatory authority is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including rates, policy forms, and capital adequacy, and is concerned primarily with the protection of policyholders rather than shareholders. During the past several years, increased scrutiny has been placed upon the insurance regulatory framework, and certain state legislatures have considered or enacted laws that alter, and in many cases increase, state authority to regulate insurance companies and insurance holding company systems. The National Association of Insurance Commissioners (the NAIC) and state insurance regulators are reexamining existing laws and regulations, specifically focusing on insurance company investments and solvency issues, risk-based capital guidelines, interpretations of existing laws, the development of new laws, the implementation of non-statutory guidelines and the circumstances under which dividends may be paid. Current NAIC initiatives, and other regulatory changes, could have a material adverse impact on our business. There can be no assurance that our life insurance subsidiaries or any other life insurance subsidiary that we may acquire or form will be able to satisfy the regulatory requirements of the Departments of Insurance of their respective state of domicile or a similar department in any other state in which it may wish to transact business.
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Individual state guaranty associations assess insurance companies to pay benefits to policyholders of insolvent or failed insurance companies. The impact of such assessments may be partly offset by credits against future state premium taxes. We cannot predict the amount of any future assessments, nor have we attempted to estimate the amount of assessments to be made from known insolvencies.
We operate in a highly competitive industry, and our business will suffer if we are unable to compete effectively.
The operating results of companies in the insurance industry are subject to significant fluctuations due to competition, economic conditions, interest rates, investment performance, maintenance of insurance ratings from rating agencies such as A.M. Best and other factors. Our ability to compete with other insurance companies is dependent upon, among other things, our ability to attract and retain agents to market our insurance products, our ability to develop competitive and profitable products and our ability to obtain high ratings. In connection with the development and sale of products, we and our operating subsidiaries encounter significant competition from other insurance companies, many of whom have financial resources substantially greater than the Company, as well as competition from other investment alternatives available to our customers. We do not anticipate that American Life will be rated by industry analysts for a period of three to five years. This will have a negative impact on American Life's ability to compete with rated insurance companies. Accordingly, competition for new life insurance policies will be significant which may have a negative impact on our ability to operate profitably.
We are highly dependent upon our key personnel, and the loss of any of our key personnel could materially and adversely affect our business.
Our ability to operate successfully is dependent primarily upon the efforts of our President, Travis Meyer, and our Secretary/Treasurer and Chief Executive Officer of American Life, Mark Oliver, as well as other key personnel. The loss of the services of any of these officers and employees could have a material adverse effect on our ability to operate successfully.
Development of life insurance products involves the use of certain assumptions, and the inaccuracy of these assumptions could adversely affect our profitability.
We must make certain assumptions as to expected mortality, lapse rates and other factors in developing the pricing and other terms of our life insurance products. These assumptions are based on industry experience and are reviewed and revised regularly so as to reflect actual experience on a current basis. However, variation of actual experience from that assumed in developing such terms may affect a product's profitability.
If we underestimate our liability for future policy benefits, our results of operations could suffer.
The liability established for future life insurance policy benefits is based upon a number of factors, including certain assumptions, such as mortality, morbidity, lapse rate and crediting rate. If we underestimate future policy benefits, we would incur additional expenses at the time we becomes aware of the inadequacy. As a result, our profitability could suffer.
American Life may not be able to obtain a favorable insurance rating.
Insurance ratings have become an increasingly important factor in establishing the competitive position of insurance companies. Ratings reflect the rating agencies' opinion of an insurance company's financial strength, operating performance and ability to meet its obligations to policyholders. American Life will not receive a rating until it has maintained operations for a minimum of three to five years. There can be no assurance that American Life will be rated by a rating agency or that any rating, if
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and when received, will be favorable to the insurance subsidiary. The lack of a rating could impact the Company's ability to make sales in the broad insurance marketplace. For example, customers may choose not to purchase a policy from an unrated company, or we may be required to charge lower rates and offer discounts to attract business. Capital Reserve also has no rating at the present time; however it is currently not marketing products.
Fluctuations in interest rates could adversely affect our business and profitability.
Interest rate fluctuations could impair the ability to pay policyholder benefits with operating and investment cash flows, cash on hand and other cash sources. Our annuity product has an interest rate guarantee that exposes us to the risk that changes in interest rates will reduce our spread, or the difference between the amounts that we are required to pay under the contracts and the amounts we are able to earn on our investments intended to support our obligations under the contracts. Our spread is a key component of our net income.
To the extent that interest rates credited are less than those generally available in the marketplace, policyholder lapses, policy loans and surrenders, and withdrawals of life insurance policies and annuity contracts may increase as contract holders seek to buy products with perceived higher returns. This process may result in cash outflows requiring that we sell investments at a time when the prices of those investments are adversely affected by the increase in market interest rates, which may result in realized investment losses.
Increases in market interest rates may also negatively affect our profitability. In periods of increasing interest rates, the Company may not be able to replace invested assets with higher yielding assets needed to fund the higher crediting rates that may be necessary to keep interest sensitive products competitive. We therefore may have to accept a lower spread and thus lower profitability or face a decline in sales and greater loss of existing contracts.
Changes in the tax laws could adversely affect our business.
Congress has from time to time considered possible legislation that would eliminate the deferral of taxation on the accretion of value within certain annuities and life insurance products. This and similar legislation, including a simplified "flat tax" income tax structure with an exemption from taxation for investment income, could adversely affect the sale of life insurance compared with other financial products if such legislation were to be enacted. There can be no assurance as to whether such legislation will be enacted or, if enacted, whether such legislation would contain provisions with possible adverse effects on any annuity and life insurance products that we and our operating subsidiaries develop.
We may not be able to successfully execute our acquisition strategy, which could cause our business and future growth prospects to suffer.
One component of our business plan is to pursue strategic acquisitions of companies that meet our acquisition criteria. However, suitable acquisition candidates may not be available on terms and conditions that we find acceptable. In pursuing acquisitions, we compete with other companies, many of which have greater financial and other resources than the Company. If we are unable to secure sufficient funding for potential acquisitions, it may not be able to complete strategic acquisitions that it otherwise finds desirable. Further, if we succeed in consummating strategic acquisitions, our business, financial condition and results of operations may be negatively affected because:
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We may be required to raise additional capital through sales of our voting common stock, which could dilute the ownership interests of our existing shareholders.
In order to continue to operate, to fund the capital and surplus required for its insurance subsidiaries and to grow in accordance with our business plan, we may require additional capital. This capital may be raised through the issuance of additional shares of our voting common stock. If additional shares are issued, the ownership interests of existing shareholders will be diluted.
Certain of our directors and officers have relationships with businesses similar to the Company's, which could present a potential conflict of interest if we were to expand into those states or if those other insurance holding companies were to offer life insurance products in our territory.
As described in more detail in Item 1, under the heading "Certain Relationships and Affiliations with Similar Businesses," some of our officers and directors have past or present relationships with other businesses operating in the insurance industry. Should we plan to enter the life insurance markets in the states where these other businesses operate, or should those other businesses enter the life insurance markets in our territory, a potential conflict of interest could exist. We will attempt to eliminate or minimize any conflicts of interest, should they arise. We expect that these efforts will include the required recusal of interested parties from (a) any decision relating to competition in a state in which another company with whom he or she is associated is operating, (b) any other decision involving a conflict of interest with respect to such companies. However, the efforts to eliminate or minimize potential conflicts of interest may not be successful.
Shares of our voting common stock are an illiquid investment.
There is no public market for shares of our voting common stock, and there is no assurance that one will develop. Therefore, the shares will have limited marketability for an indefinite period of time. There is not currently, and may never be, an active market in our securities, and there is no assurance that any of our securities will ever become publicly traded or that an active trading market will develop or be sustained. Consequently, shareholders may not be able to liquidate their investment in the event of an emergency or for any other reason. We do not meet the requirements for our stock to be quoted on the New York Stock Exchange, NASDAQ, the New York Stock Exchange Alternext Exchange (formerly, AMEX), the OTC Bulletin Board or any other exchange.
We do not intend to declare dividends on shares of our voting common stock in the foreseeable future.
We have not paid cash dividends on our stock in the past and do not anticipate paying such dividends in the foreseeable future. We intend to retain available funds to be used in the expansion of our operations. Future dividend policy will depend on our earnings, capital requirements, financial condition and other relevant factors. Moreover, the Company is a holding company without independent operations. We expect a source of cash will be dividends on the stock of our operating subsidiaries, including American Life. The payment of dividends to the Company by our operating subsidiaries is subject to limitations imposed by applicable insurance laws. For example, with respect to
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American Life, "extraordinary" dividends may not be paid without permission of the Arizona Department of Insurance. An "extraordinary" dividend is defined, in general, as any dividend or distribution of cash or other property whose fair market value, compared with that of other dividends or distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the policyholders surplus (total statutory capital stock and surplus) as of December 31 of the proceeding year or (ii) the statutory net gain from operations excluding realized gains on investments) of the insurer for the twelve month period ending December 31 of the preceding year. Arizona insurance laws also require that dividends on capital stock must be paid out of surplus, which is calculated after reserving a sum equal to all liabilities of the insurance company and may include all or part of surplus arising from unrealized capital gains or revaluation of assets
Because we do not intend to pay dividends in the foreseeable future, shareholders will benefit from an investment in our voting common stock only if it appreciates in value and becomes liquid.
Because we do not expect to pay any cash dividends in the foreseeable future, the success of any investment in our stock will depend upon any future appreciation in their value. We cannot guarantee that our stock will appreciate in value or even achieve or maintain a value equal to the price at which shares were purchased. Further, a market may never develop to sell shares of our stock even if they appreciate in value based on an increase in book value or other valuation criteria.
Our business and future growth prospects may suffer if the acquisition and merger of Old Reliance with American Life does not achieve expected results.
Our business, financial condition and results of operations may be negatively affected if: (i) the acquired business does not achieve anticipated revenues, earnings or cash flows; (ii) we assume liabilities that were not disclosed or exceed estimates; (iii) we are unable to integrate the acquired business successfully and realize anticipated economic, operational and other benefits in a timely manner; (iv) the acquisition itself disrupts our on-going business, distracts management or diverts resources from other more beneficial uses; (v) we experience difficulties operating in markets in which we have no or only limited direct experience; or (vi) there is a loss of customers and key employees of the acquired company.
ITEM 2. FINANCIAL INFORMATION.
Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes appearing elsewhere in this Form 10. In addition to historical information, this discussion and analysis may contain forward-looking statements that involve risk, uncertainties and assumptions. Actual results may differ materially from those anticipated in these forward-looking statements.
Overview
Midwest was formed on October 31, 2003 for the primary purpose of becoming a financial services holding company. Midwest presently conducts its business through its wholly owned subsidiary, American Life & Security Corp.
From our inception through July 2006, we raised approximately $6.5 million through the sale of shares of voting common stock in several private placements. Between June 2007 and May 2009, we raised approximately $11.0 million through an intrastate public offering of voting common stock in the State of Nebraska.
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American Life was incorporated on May 7, 2009. On September 1, 2009, American Life was issued a certificate of authority to conduct life insurance business in the State of Nebraska. Immediately following the issuance of the certificate of authority, American Life began to offer the American Accumulator and Future Cornhusker products in the state of Nebraska. Prior to our acquisition of American Life, the Company did not offer any products. Initial capital and surplus contributed to American Life was approximately $3.5 million, which was increased to approximately $5.5 million on September 1, 2009. In its first four months of operation, between September 1, 2009 and December 31, 2009, American Life generated $354,352 in premium revenue. In 2010, American Life generated $1.9 million in premium revenue. For the nine months ended September 30, 2011, American Life generated $1.6 million in premium revenue.
On June 20, 2010, American Life acquired Capital Reserve Life Insurance Company of Jefferson City, Missouri in exchange for a cash payment of approximately $1.9 million. This transaction added approximately $1.6 million in assets to the Company. Further, with the insurance charters acquired from Capital Reserve, we obtained access to additional markets in Missouri, Kansas and Iowa.
In connection with the acquisition of Capital Reserve, American Life also coinsured a block of life insurance business from Capital Reserve's parent corporation in a separate transaction. The purchase price for this block of business was approximately $375,000. This transaction added more than $70,000 in annual revenues to American Life's operations, as well as approximately $3.5 million of new assets and $3.2 million of policy liabilities to our balance sheet.
In January 2011, we completed the private sale of 74,159 shares of our Series A Preferred Stock to certain qualified investors. The net proceeds of this sale, after expenses, were approximately $415,750. These proceeds were used to further capitalize our insurance operations, for working capital and for other general corporate purposes.
On July 12, 2010, in order to provide additional capital to support our continued growth, we commenced an offering of up to 2,000,000 additional shares of voting common stock to existing shareholders who were residents of the State of Nebraska. This offering was completed on February 28, 2011 and a total of 1,554,326 additional shares of voting common stock were sold. The gross proceeds of this sale were approximately $7.7 million. These proceeds will be used to further capitalize our insurance operations, for working capital and for other general corporate purposes, including funding the acquisition of Old Reliance Insurance Company as described below.
On November 8, 2010, the Company and American Life entered into an agreement to acquire all of the issued and outstanding capital stock of Old Reliance. American Life merged into Old Reliance following the purchase, with the survivor changing its name to American Life & Security Corp. In the transaction, the sole shareholder of Old Reliance received: (i) approximately $1.6 million in cash, (ii) $500,000 in the form of a surplus debenture and (iii) 150,000 shares of voting common stock of the Company. On November 8, 2010, prior to signing the stock purchase agreement with American Life, Old Reliance had assets of approximately $19 million and for the period from January 1, 2010 through November 8, 2010, income of approximately $1.4 million, and expenses of approximately $1.7 million. As of September 30, 2011 and December 31, 2010, it had total capital and surplus of approximately $1.3 million and $1.7 million, respectively. The transaction, including the merger, was consummated on August 3, 2011.
The Company was a development stage company until American Life commenced its insurance operations in 2009. We have incurred significant net losses since inception totaling approximately $9.4 million through September 30, 2011. These losses have resulted primarily from costs incurred while raising capital and establishing American Life. We expect to continue to incur operating losses until we achieve a volume of in-force life insurance policies that provides premiums that are sufficient to cover its operating expenses.
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During the 3rd quarter of 2011, control was attained on a previous noncontrolling interest in Security Capital Corporation. The previously held interest was remeasured at fair value and a gain of $182,200 was recognized. The acquisition of Security Capital added cash and cash equivalents of $21,471 and investments in equity securities of $434,000 to the consolidated balance sheets.
Critical Accounting Policies and Estimates
The accounting and reporting policies of the Company are 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. The following is an explanation of the Company's accounting policies and the estimates considered most significant by management. These accounting policies inherently require significant judgment and assumptions and actual operating results could differ significantly from management's estimates determined using these policies. We believe the following accounting policies, judgments and estimates are the most critical to the understanding of the results of operations and financial position. A detailed discussion of significant accounting policies is provided in Note 1—Nature of Operations and Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements.
Valuation of Investments
The Company's principal investments are in fixed maturity securities. Fixed maturity securities, which are classified as available for sale, are carried at their fair value in the consolidated balance sheets, with unrealized gains or losses recorded in accumulated other comprehensive income (loss). The Company's fair value of fixed maturity securities are derived from external brokers. The valuation of the investment portfolio involves a variety of assumptions and estimates.
The Company has a policy and process in place to identify securities that could potentially have an impairment that is other-than-temporary. The assessment of whether impairments have occurred is based on a case-by-case evaluation of underlying reasons for the decline in fair value. We consider severity of impairment, duration of impairment, forecasted recovery period, industry outlook, financial condition of the issuer, projected cash flows, issuer credit ratings and the intent and ability of the Company to hold the investment until the recovery of the cost.
The recognition of other-than-temporary impairment losses on debt securities is dependent on the facts and circumstances related to the specific security. If the Company intends to sell a security or it is more likely than not that the Company would be required to sell a security prior to recovery of the amortized cost, the difference between amortized cost and fair value is recognized in the income statement as an other-than-temporary impairment. If the Company does not expect to recover the amortized basis, does not plan to sell the security and if it is not more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, the recognition of the other-than-temporary impairment is bifurcated. The Company recognizes the credit loss portion in the income statement and the noncredit loss portion in accumulated other comprehensive loss. The credit component of an other-than-temporary impairment is determined by comparing the net present value of projected cash flows with the amortized cost basis of the debt security. The net present value is calculated by discounting the Company's best estimate of projected future cash flows at the effective interest rate implicit in the fixed income security at the date of acquisition. Cash flow estimates are driven by assumptions regarding probability of default, including changes in credit ratings, and estimates regarding timing and amount of recoveries associated with a default.
Deferred Acquisition Costs
Incremental direct costs that result directly from and are essential to the contract acquisition transaction and would not have been incurred by the Company had the contract acquisition not occurred, are capitalized and amortized over the life of the premiums produced. Recoverability of
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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.
Value of Business Acquired
Value of business acquired (VOBA) represents the estimated value assigned to purchased companies or insurance in force of the assumed policy obligations at the date of acquisition of a block of policies. At least annually, a review is performed of the models and the assumptions used to develop expected future profits, based upon management's current view of future events. VOBA is reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts. Management's view primarily reflects Company experience but can also reflect emerging trends within the industry. Short-term deviations in experience affect the amortization of VOBA in the period, but do not necessarily indicate that a change to the long-term assumptions of future experience is warranted. If it is determined that it is appropriate to change the assumptions related to future experience, then an unlocking adjustment is recognized for the block of business being evaluated. Certain assumptions, such as interest spreads and surrender rates, may be interrelated. As such, unlocking adjustments often reflect revisions to multiple assumptions. The VOBA balance is immediately impacted by any assumption changes, with the change reflected through the income statement as an unlocking adjustment in the amount of VOBA amortized. These adjustments can be positive or negative with adjustments reducing amortization limited to amounts previously deferred plus interest accrued through the date of the adjustment.
In addition, the Company may consider refinements in estimates due to improved capabilities resulting from administrative or actuarial system upgrades. The Company considers such enhancements to determine whether and to what extent they are associated with prior periods or simply improvements in the projection of future expected gross profits due to improved functionality. To the extent they represent such improvements, these items are applied to the appropriate financial statement line items in a manner similar to unlocking adjustments.
VOBA is also reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts. If it is determined from emerging experience that the premium margins or gross profits are insufficient to amortize deferred acquisition costs, then the asset will be adjusted downward with the adjustment recorded as an expense in the current period.
Goodwill and Intangibles
Goodwill represents the excess of the amounts paid to acquire subsidiaries and other businesses over the fair value of their net assets at the date of acquisition. Goodwill is tested for impairment at least annually in the fourth quarter or more frequently if events or circumstances change that would indicate that a triggering event has occurred.
In September 2011, the FASB issued ASU 2011-08 which amends the rules for testing goodwill for impairment. Under the new rules, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. We early adopted ASU 2011-08 for our December 31, 2011 annual goodwill impairment test.
In assessing the qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we assess relevant events and circumstances that may impact the fair value and the carrying amount of the reporting unit. The identification of relevant events and circumstances and how these may impact a reporting units' fair value or carrying
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amount involve significant judgments and assumptions. The judgment and assumptions include the identification of macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, specific events and share price trends and making the assessment on whether each relevant factor will impact the impairment test positively or negatively and the magnitude of any such impact.
The Company assesses the recoverability of intangible assets at least annually or whenever events or circumstances suggest that the carrying value of an identifiable intangible asset may exceed the sum of the undiscounted cash flows expected to result from its use and eventual disposition. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset.
Reinsurance
In the normal course of business, the Company seeks to limit aggregate and single exposure to losses on large risks by purchasing reinsurance. The amounts reported in the consolidated balance sheets as reinsurance recoverable include amounts billed to reinsurers on losses paid as well as estimates of amounts expected to be recovered from reinsurers on insurance liabilities that have not yet been paid. Reinsurance recoverable on unpaid losses are estimated based upon assumptions consistent with those used in establishing the liabilities related to the underlying reinsured contracts. Insurance liabilities are reported gross of reinsurance recoverable. Management believes the recoverables are appropriately established. The Company generally strives to diversify its credit risks related to reinsurance ceded. Reinsurance premiums are generally reflected in income in a manner consistent with the recognition of premiums on the reinsured contracts. Reinsurance does not extinguish the Company's primary liability under the policies written. Therefore, the Company regularly evaluates the financial condition of its reinsurers including their activities with respect to claim settlement practices and commutations, and establishes allowances for uncollectible reinsurance recoverable as appropriate.
Future Policy Benefits
The Company establishes liabilities for amounts payable under insurance policies, including traditional life insurance and annuities. Generally, amounts are payable over an extended period of time. Liabilities for future policy benefits of traditional life insurance have been computed by a net level premium method based upon estimates at the time of issue for investment yields, mortality and withdrawals. These estimates include provisions for experience less favorable than initially expected. Mortality assumptions are based on industry experience expressed as a percentage of standard mortality tables.
Income Taxes
Deferred tax assets are recorded based on the differences between the financial statement and tax basis of assets and liabilities at the enacted tax rates. The principal assets and liabilities giving rise to such differences are investments, insurance reserves, unearned premiums, and deferred acquisition costs. A deferred tax asset valuation allowance is established when there is uncertainty that such assets would be realized. The Company has no uncertain tax positions that they believe are more-likely-than not that the benefit will not to be realized.
Recognition of Revenues
Revenues on traditional life insurance products consist of direct and assumed premiums reported as earned when due.
Amounts received as payment for non-traditional contracts such as interest sensitive whole life contracts, single payment endowment contracts, single payment juvenile contracts and other contracts without life contingencies are recognized as deposits to policyholder account balances and included in future insurance policy benefits. Revenues from these contracts are comprised of fees earned for
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administrative and contract-holder services, which are recognized over the period of the contracts, and included in revenue. Deposits are shown as a financing activity in the Consolidated Statements of Cash Flows.
Income
Our income prior to commencing insurance operations in 2009 came from our investments, which were nominal due to the need to maintain liquidity. When American Life commenced operations in September 2009, we also began to receive premium income from the sales of life insurance. Capital Reserve, acquired in 2010 had little impact on 2010 operations as it had no premium income or related expenses. Management expects the premium writings in American Life to increase substantially in the next few years, and as assets and policy reserves grow, expect investment income to grow also. An evaluation of the best use of the assets obtained in the acquisition of Capital Reserve is ongoing.
Results of Operations
Comparison of nine months ended September 30, 2011 with the nine months ended September 30, 2010.
Revenue: Total revenues were $2,301,381 for the nine months ended September 30, 2011, a decrease of $2,796,772 from $5,098,153 for the nine months ended September 30, 2010. The decrease reflects the realization in the 2010 period of $3,729,599 in consideration for the reinsurance assumed from Security National. The consideration for reinsurance assumed is a non-recurring revenue that did not reoccur in 2011. Excluding the effects of this non-recurring event, total revenues increased from $1,368,554 in the 2010 period to $2,301,381 in the 2011 period. Premium revenue in the nine months ended September 30, 2011 was $1,852,132, up $596,773 from $1,255,359 in the nine months ended September 30, 2010. In addition, realized gains (losses) on investments were $15,127 in the 2011 period compared to ($15,452) in the 2010 period. Investment and miscellaneous income was $434,122 for the nine months ended September 30, 2011 compared to $128,647 in the nine months ended September 30, 2010, which was largely due to the gain recognized from writing up the Company's previously held interest in Security Capital.
Expenses: Total expenses were $4,950,933 for the nine months ended September 30, 2011, a decrease of $2,120,924 from $7,071,857 for the nine months ended September 30, 2010. The decrease reflects the significant one-time increase in benefit reserves of $4,248,409 which was required in the 2010 period as a result of the assumption of insurance from Security National. This increase in benefit reserves was a non-recurring event that was not repeated in 2011. Excluding the effects of this non-recurring event, total recurring expenses increased from $2,823,448 in the nine months ended September 30, 2010 to $4,950,933 in the nine months ended September 30, 2011. Death and other policy benefits decreased from $302,108 in the 2010 period to $188,580 in the 2011 period. Insurance commission expense decreased from $1,025,246 in the 2010 period to $934,007 in the 2011 period, while salaries and benefits increased from $848,500 in the 2010 period to $1,676,109 in the 2011 period. Further, comparing the 2010 period to the 2011 period, travel and entertainment expense increased from $125,102 to $218,882, rent expense increased from $63,190 to $80,818 and other operating expenses increased from $335,589 to $626,248, while professional and administrative fees increased from $949,088 to $961,712.
Net Loss: Our net loss was ($2,649,552) for the nine months ended September 30, 2011, compared to a net loss of ($1,973,704) for the nine months ended September 30, 2010. The increase in the net loss was primarily attributable to the fact that the overall increase in recurring expenses described above more than offset the overall increase in recurring revenue. We expect our losses to continue and increase in the future as we incur increased cost to grow our life insurance business.
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Comparison of year ended December 31, 2010 with the year ended December 31, 2009.
Revenue: Total revenues were $5,831,841 for the year ended December 31, 2010, an increase of $5,387,563 from $444,278 for the year ended December 31, 2009. This increase is primarily attributable to the fact that American Life conducted insurance operations for a full year in 2010 and only operated for approximately four months in 2009. As a result, American Life generated premium revenue of $1,910,562 in 2010, compared to only $354,352 in 2009. In addition, realized gains (losses) on investments were ($71) in 2010, compared to $0 in 2009. Investment and miscellaneous income was $191,751 in 2010 compared to $89,926 in 2009. Consideration for the reinsurance assumed from Security National in 2010 was $3,729,599. The consideration for reinsurance assumed is a non-recurring revenue; therefore total revenues can be expected to decline in 2011, even though management expects premium income to increase.
Expenses: Total expenses were $8,055,046 for the year ended December 31, 2010, an increase of $6,534,403 from $1,520,643 for the year ended December 31, 2009. This increase is primarily attributable to the fact that American Life operated for a full year in 2010 and only operated for approximately four months in 2009, plus the fact that the assumption of insurance from Security National in 2010 caused a significant increase in benefit reserves which largely offset the consideration described above, as well as adding death benefits and other policy-related expenses. As a result, death and other policy benefits increased from $4,890 in 2009 to $162,099 in 2010, policyholder benefit reserves increased from $182,781 in 2009 to $4,650,227 in 2010, and insurance commission expense increased from $255,659 in 2009 to $1,251,817 in 2010. Also contributing to the overall increase in expenses between 2009 and 2010 were an increase of $304,292 in salaries and wages from $655,862 to $960,154 and an increase of $1,450,140 in other operating expenses from $634,829 to $2,084,969. Again, these increased expenses related primarily to the operation of American Life's insurance business for a full year in 2010. We expect most of these expenses to continue to increase in the future as a result of an increased payroll and other office and administrative expenses necessary for the management of the anticipated growth of our life insurance business, although management intends to pursue opportunities to forge partnerships with other companies of similar size in order to achieve better economies of scale.
Capitalized deferred policy acquisition costs were $1,375,155 in 2010, compared to $283,370 in 2009. In accordance with accounting principles generally accepted in the United States of America (GAAP), these costs, which relate to the first year expenses of putting new life insurance premiums on the books of the Company, are capitalized and amortized over the life of the premiums produced. Amortization of such costs was $320,935 in 2010, compared to $69,992 in 2009
Net Loss: Our net loss was ($2,223,205) for the year ended December 31, 2010, compared to a net loss of ($1,076,365) for the year ended December 31, 2009. The increase in the net loss was primarily attributable to the increase in expenses described above. We expect our losses to continue and increase in the future as we incur increased cost to grow our life insurance business.
One of the steps management is taking to mitigate the size of future losses is to look for opportunities for Midwest to earn revenues from complementary businesses. Currently, other than a nominal amount of investment income, Midwest has no revenue source (other than the revenues generated by American Life). Management believes there are opportunities for Midwest to generate income as a stand-alone company to add to the revenues generated by American Life and ultimately lead to profitability.
Liquidity and Capital Resources
Since inception, our operations have been financed primarily through the sale of voting common stock and preferred stock. As a result of delays in obtaining the Certificate of Authority for American Life, our operations have not been profitable and have generated significant operating losses since the Company was incorporated in 2003.
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In the nine months ended September 30, 2011, net cash used in operating activities was ($2,682,551) compared to cash provided by operating activities of $1,420,506 in the nine months ended September 30, 2010. The cash provided by operating activities in 2010 was largely due to the effects of the non-recurring transaction with Security National, and the net cash used in operating activities in the 2011 period largely reflects our operating losses. In the 2011 period, net cash used in investing activities was ($2,106,573) compared to ($1,879,521) in the 2010 period. The increase in cash flow used in investing activities is a result of the Company's acquisition of Old Reliance. In the 2011 period, net cash provided by financing activities was $2,355,875 compared to $2,811,812 in the 2010 period. The decrease in positive cash flow from financing activities can be attributed to the decrease in proceeds from the sale of shares of voting common stock to existing shareholders in Nebraska in the first half of 2011.
For the year ended December 31, 2010, net cash provided in operating activities was $667,993 compared to cash used of ($827,065) in 2009. The improvement in cash flow can be attributed to the effects of the one-time transaction with Security National as well as to the revenues generated by American Life for a full-year in 2010 compared to approximately four months in 2009. For the year ended December 31, 2010, net cash used in investing activities was ($2,501,251) compared to ($4,966,329) in 2009. For the year ended December 31, 2010, net cash provided by financing activities was $5,599,612 compared to $4,640,650 in 2009. The increase in positive cash flow from financing activities can be attributed to the proceeds of our sale of additional shares of voting common stock to existing shareholders in Nebraska as well as the sale of non-voting convertible preferred shares to foreign residents, both of which primarily occurred in the second half of 2010.
At September 30, 2011, we had cash and cash equivalents totaling $2,817,219. We believe that our existing cash and cash equivalents will be sufficient to fund our anticipated operating expenses and capital expenditures for at least twelve months. We have based this estimate upon assumptions that may prove to be wrong and we could use our capital resources sooner than we currently expect. The growth of American Life is uncertain and will require additional capital if it continues to grow.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
The Company and American Life currently lease office space at 8101 "O" Street, Suite S111, Lincoln, Nebraska 68510. This lease was executed August 28, 2009, amended on January 21, 2011, and expires on January 31, 2014. As part of the acquisition of Old Reliance, the Company assumed a lease for the headquarters of Old Reliance in Colorado Springs, CO that expires on December 31, 2012. Rent expense for the years ended December 31, 2010 and 2009 was $93,369 and $41,762, respectively. Rent expense for the nine month period ended September 30, 2011 was $80,818. Future minimum payments for the remainder of 2011, 2012, 2013 and 2014 are $24,806, $145,076, $128,240 and $10,687, respectively.
ITEM 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table sets forth information as of September 30, 2011, regarding the number and percentage of outstanding shares of our voting common stock beneficially owned by each person known by us to beneficially own more than five percent (5%) of such stock, by each of our directors, director nominees and executive officers, and by all of our directors, director nominees and executive officers as
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a group. As of September 30, 2011, there were 8,670,146 shares of voting common stock issued and outstanding.
Name and Business Address of Beneficial Owner(1)
|
Amount and Nature of Beneficial Ownership |
Percent of Class |
|||||
|---|---|---|---|---|---|---|---|
Five percent shareholders: |
|||||||
None |
— | — | |||||
Directors and executive officers: |
|||||||
Rick D. Meyer(2) |
324,480 | 3.7 | % | ||||
Travis Meyer |
270,400 | 3.1 | % | ||||
Les Meyer |
54,080 | * | |||||
John R. Perkins |
54,080 | * | |||||
Douglas R. Clark |
43,264 | * | |||||
John C. Osborne |
56,909 | * | |||||
Milton Tenopir |
43,264 | * | |||||
Mark A. Oliver |
43,264 | * | |||||
Jim Ballard |
— | * | |||||
All directors and executive officers as a group |
889,741 | 10.3 | % | ||||
ITEM 5. DIRECTORS AND EXECUTIVE OFFICERS.
The table below sets forth information concerning our directors and executive officers.
Name
|
Age | Position with Company | |||
|---|---|---|---|---|---|
Travis Meyer |
38 | President and Director | |||
Mark A. Oliver |
53 | Secretary/Treasurer and Director | |||
Douglas R. Clark |
51 | Director | |||
John R. Perkins |
58 | Director | |||
Jim Ballard |
46 | Director | |||
Rick D. Meyer |
60 | Chairman of the Board and Director | |||
Les Meyer |
59 | Director | |||
John C. Osborne |
70 | Director | |||
Milton Tenopir |
69 | Director | |||
Travis Meyer has served as our President and a Director of the Company since 2003. He also serves as a Board member of American Life. Mr. Meyer began his career in 1997 as an agent for First American Capital Corporation ("First American") in Topeka, Kansas, and later served as Regional Director of Sales, Executive Sales Director, Agency Director, and Assistant to the President. Mr. Meyer was drafted by the Los Angeles Dodgers in 1995, and played professional baseball from 1995 until 1997. Mr. Meyer is the son of Rick Meyer. He also serves as a Director of Great Plains Financial Corp., a South Dakota holding company, and as President, Chief Executive Officer, Co-Chairman and a Director of Pacific Northwest Financial Corp., an Idaho holding company.
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Mark A. Oliver has been employed by the Company since July 2009 and presently serves as the Company's Secretary/Treasurer. He was elected to the Board of Directors in June 2010. Mr. Oliver serves as CEO and Board member of American Life. Mr. Oliver was recruited from Texas Life Insurance Company in 1984 by Citizens, Inc. Mr. Oliver assumed responsibility as Controller. He later became Chief Financial Officer, Vice President and Treasurer. He ultimately was promoted to President in 1997. During his 24-year tenure with Citizens, he managed, oversaw or chaired most aspects of the business, including operations, finance & accounting, investments, legal, administration and strategic planning. Mr. Oliver has significant knowledge of statutory, GAAP and SEC accounting for life insurance companies and had managed/overseen all SEC matters for that company. In addition, he completed 17 merger and acquisition transactions while at Citizens. As President, he was a key driver behind Citizens' asset growth from $15 million to $880 million and revenue expansion from $3 million to more than $170 million since 1984. He serves as Secretary/Treasurer and a Director of Rocky Mountain, a recently formed Colorado holding company that intends to form a Colorado life insurance subsidiary, and as President/Treasurer and a Director of Northstar, a recently formed Minnesota holding company that intends to form a Minnesota life insurance subsidiary. He also serves as CFO and EVP on the Board of Great Plains Financial Corp. and Great Plains Life Assurance, a South Dakota life insurance company. He also serves as Treasurer and a Director of Pacific Northwest Capital Corp., an Idaho holding company.
Douglas R. Clark has served as a Director of the Company since 2003 and has served as Chairman of the Board from September 2009 until June 2011. He also serves as Chairman of the Board and a Director of American Life. He has been President of the Metropolitan Utilities District in Omaha, Nebraska since January 2011. Previously, he served as Vice President of Governmental Affairs and Marketing for the Metropolitan Utilities District from 2002 through 2010. From 1994 to 2002, he was the Government Relations Director for Aquila Energy Company, and from 1992 to 1994, Mr. Clark served as Policy Advisor to Governor Ben Nelson. Mr. Clark graduated from the University of Nebraska.
John R. Perkins has served as a Director of the Company since 2003, and he previously served as the Company's Secretary and compliance officer from 2003 to 2010. He also serves as a Board member of American Life. Mr. Perkins is currently Chairman of the Board and COO of First Wyoming Capital Corp., a Wyoming holding company. He is also a member of the Board of Directors of First Trinity Financial Corporation, an Oklahoma life insurance holding company ("First Trinity"). Previously, he served as President of First Trinity. He also has served as President of Mid-American Alliance Corporation, a Missouri life insurance holding company ("Mid-American"), and Mid-American Century Life Company ("Mid-American Century") from January 1, 2003 to January 1, 2004. He served on the Board of Directors of Mid-American and Mid-American Century from 1998 till 2004. Mr. Perkins previously owned Perkins Law Office in Jefferson City, Missouri from 1995 to 2003, where he specialized in securities law. He is a graduate of Southern Methodist University Law School and has an undergraduate degree in Public Administration from the University of Missouri. From 1983 to 1995 he was the Commissioner of Securities for the State of Missouri, having previously served as its Chief of Enforcement for two years. He was an Assistant Attorney General in the Consumer Protection Division of the Missouri Attorney General's Office. He also served on the Board of Directors of the North American Securities Administrators Associations for five years, and as its President in 1991. Mr. Perkins was the first Chairman of SRD Inc. and was a Board member of that organization for two years. In 1989 he received his first "Blue Sky Cube," the highest honor bestowed by the North American Securities Administrators Association. In 1991, he became the first person to receive a second "Blue Sky Cube."
Jim Ballard has served as a Director of the Company since June 2010. Mr. Ballard is part-owner and award-winning winemaker of James Arthur Vineyards. He has both his undergraduate and Master's degrees in Broadcast Journalism from the University of Nebraska-Lincoln. Mr. Ballard is a
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Past-President of the Nebraska Winery and Grape Growers Association, where he also serves as chair of the legislative committee. He serves as Chair of the Board for WineAmerica, the only National Association for American Wineries and is also a Board Member for the National Wine and Grape Initiative. Closer to home, he is a Board Member for Keep Nebraska Beautiful as well as Bright Lights and serves as the School Board President for Parkview Christian School in Lincoln. He is also a member of Senator Mike Johanns' Agricultural Advisory Committee. Jim is a graduate of Leadership Lincoln and class XXVI of the Nebraska LEAD Program
Rick D. Meyer has served as a Director of the Company since 2003 and is currently Chairman. He is President of Bison Capital Corp., a company that provides consulting services to the Company. Mr. Meyer was a founder of the Company and served as our Chief Executive Officer and Chairman of the Board of Directors from 2003 to September 2009. From May 1982 to October 1984, Mr. Meyer was a life insurance agent, District Director, and Executive Sales Director with Liberty American Assurance Company ("Liberty American") of Lincoln, Nebraska. In October of 1984, Mr. Meyer transferred to an affiliated company to become Agency Director. In 1985, Mr. Meyer left Liberty American to become an organizer and Zone Sales Director for United Trust, Inc., in Springfield, Illinois. In January 1988, Mr. Meyer transferred to Columbus, Ohio, to assist in the organization of United Income, Inc. ("United") and served as Zone Sales Manager. While with United, he was promoted to Training Director in 1991 and to Agency Director in 1993. Mr. Meyer left United in 1996 to form First American. He served as President and promoter of that company until 2003. Mr. Meyer has served as Co-Chairman of the Board of Arkansas Security Capital Corporation from 2001 to 2003. Mr. Meyer is the father of Travis Meyer. He serves as Chairman and a Director of Rocky Mountain, a recently formed Colorado holding company that intends to form a Colorado life insurance subsidiary, and as Chairman and a Director of Northstar, a recently formed Minnesota holding company that intends to form a Minnesota life insurance subsidiary. He is a member of the Board of Directors of Great Plains Financial Corp., a South Dakota holding company, and Co-Chairman of Pacific Northwest Capital Corp., an Idaho holding company.
Les Meyer has served on the Company's Board of Directors since June 2009. He also serves as a Board member of American Life. As a young man, Mr. Meyer was a professional boxer. He fought out of Dodge City, Kansas as a heavyweight. He retired from professional boxing undefeated. He worked for over 35 years representing utility companies, serving as Director of media relations, government relations, and customer relations. In that role, he served as the liaison between the utility company and the public service commissions. Mr. Meyer was the author of several key pieces of legislation that govern the utility industry in Nebraska. Currently he is CEO of Knockout Partners, a real estate business serving the Front Range of Colorado. He also serves on the Board of Directors of First Wyoming Capital Corporation, a recently formed Wyoming holding company that intends to form a Wyoming life insurance subsidiary. He serves as CEO and a Director of Rocky Mountain, a recently formed Colorado holding company that intends to form a Colorado life insurance subsidiary.
John C. Osborne has served as a Director of the Company since 2003. He also is a Board member of American Life. Mr. Osborne is President of Industrial-Irrigation Services, a Hastings, Nebraska company at which he has been employed for over 30 years. Mr. Osborne serves on several foundation and corporate boards in central Nebraska, including Hastings Irrigation Pipe, Hastings Community Foundation, Heritage Bank Holding Co., and Mary Lanning Hospital Trust. He is also a Board member of Great Plains Financial Corp., a South Dakota holding company.
Milton Tenopir has served as a Director of the Company since 2003. He also is a Board member of American Life. Mr. Tenopir served for twenty-nine years as a member of the University of Nebraska football coaching staff, including 24 years under Coach Tom Osborne, and five years under Coach Frank Solich. Mr. Tenopir retired from the Cornhusker program in January of 2003. Prior to his college coaching career, Mr. Tenopir taught high school math and science. He also serves as a Director of
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Northstar. He is also a Board member of Great Plains Financial Corp., a South Dakota holding company.
ITEM 6. EXECUTIVE COMPENSATION.
Summary Compensation
The following table sets forth the compensation paid or accrued by us to our current President, our current Chairman, and our current Secretary/Treasurer. None of our other officers had compensation that exceeded $100,000 for the last completed fiscal year.
Name and Principal Position |
Year | Salary | Bonus | All Other Compensation |
Total | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Travis Meyer, |
2011 | $ | 162,550 | $ | 20,250 | $ | 455,442 | $ | 638,242 | |||||||
President(2) |
2010 | $ | 155,000 | $ | 32,500 | $ | 355,972 | $ | 543,472 | |||||||
Rick D. Meyer, |
2011 |
$ |
16,798 |
$ |
— |
$ |
208,551 |
$ |
225,349 |
|||||||
Chairman(3) |
2010 | $ | — | $ | — | $ | 336,140 | $ | 336,140 | |||||||
Mark A. Oliver, |
2011 |
$ |
163,300 |
$ |
45,250 |
$ |
— |
$ |
208,550 |
|||||||
Secretary/Treasurer and CEO of American Life |
2010 | $ | 170,000 | $ | 32,500 | $ | — | $ | 202,500 | |||||||
Outstanding Equity Awards at Fiscal Year End
We have not established any equity compensation plans or granted any equity awards under such plans to our named executive officers. As a result, none of our named executive officers had any unexercised options, unvested stock or equity incentive plan awards outstanding as of the end of our last completed fiscal year.
Our Board of Directors approved the issuance to Mark Oliver of 40,000 shares of voting common stock on March 7, 2010. The shares were issued for $1.15 per share, which was the approximate book
29
value of the shares as of December 31, 2009. The purchase price was paid by Mr. Oliver through delivery of a five-year promissory note secured by a pledge of the shares purchased.
Employment Agreements
We have entered into Employment Agreements with Travis Meyer, our President and Mark Oliver, our Secretary/Treasurer and Chief Executive Officer of American Life. Each of these Employment Agreement was effective on June 8, 2011 and is for a three year term, subject to termination upon notice. Pursuant to these Employment Agreements, each of Mr. Meyer and Mr. Oliver is entitled to receive:
We have entered into an Employment Agreement with Rick Meyer, the Chairman of our Board of Directors. The Employment Agreement was effective on December 1, 2011 and is for a three year term, subject to termination upon notice. Pursuant to this Employment Agreement, Mr. Meyer is entitled to receive:
If we terminate Travis Meyer, Mark Oliver, or Rick Meyer without cause as defined in the Employment Agreements, we will be required to pay such person his base salary and provide certain benefits for the duration of the remaining term of the Employment Agreement or 6 months, whichever is greater. This payment would be made in exchange for an agreement not to engage in certain competitive activities during that period.
In addition to the compensation payable to Mr. Oliver under his Employment Agreement, our Board of Directors approved the issuance to Mr. Oliver of 40,000 shares of voting common stock on March 1, 2010. The shares were issued for $1.15 per share, which was the book value of the shares as of December 31, 2009. The purchase price was paid by Mr. Oliver through delivery of a five-year promissory note secured by a pledge of the shares purchased.
Director Compensation
Directors who are not employees currently receive an annual fee of $1,000, plus $500 for each meeting of the Board of Directors they attend in person. Directors also are reimbursed for certain expenses related to their attendance at meetings. Directors receive $350 for each telephonic meeting. In addition, Douglas R. Clark, who served as our non-employee Chairman until June 2011, received an annual fee of $50,000 while he served in that position.
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The following table sets forth the compensation paid or accrued by us to our directors, other than directors who are also named executive officers, for the last completed fiscal year.
Name
|
Year | Fees Earned or Paid in Cash |
All Other Compensation |
Total | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Jim Ballard |
2011 | 2,200 | — | 2,200 | |||||||||
Douglas R. Clark(2) |
2011 |
36,458 |
— |
36,458 |
|||||||||
Les Meyer |
2011 |
5,200 |
— |
5,200 |
|||||||||
John C. Osborne |
2011 |
1,350 |
— |
1,350 |
|||||||||
John R. Perkins |
2011 |
2,200 |
— |
2,200 |
|||||||||
Milton Tenopir(3) |
2011 |
31,550 |
— |
31,550 |
|||||||||
Compensation Committee Interlocks and Insider Participation
Our Board of Directors does not maintain any standing committees at the present time. As a result, we do not have a compensation committee and all functions of a compensation committee are performed by our Board of Directors as a whole. Travis Meyer and Mark A. Oliver are members of our Board of Directors who also are executive officers and employees of the Company. Rick Meyer is a member of our Board of Directors who is a former executive officer and employee of the Company. Directors who also serve as officers of the Company do not participate in any deliberations of the Board of Directors concerning executive officer compensation. The Board intends to form an audit committee in the coming year.
Rick Meyer, our Chairman and a member of our Board of Directors, also serves as a member of the Boards of Directors of Northstar, Rocky Mountain and Pacific Northwest, which Boards of Directors perform the functions of a compensation committee for these companies. Rick Meyer is Chairman and Chief Executive Officer of Northstar, Chairman of Rocky Mountain and Co-Chairman of Pacific Northwest. Mark A. Oliver, our Treasurer and a member of our Board of Directors, also serves as a member of the Boards of Directors of Northstar, Rocky Mountain, and Pacific Northwest. Mr. Oliver is the President, Chief Operating Officer, Treasurer and Chief Financial Officer of Northstar, the Secretary/Treasurer of Rocky Mountain, the Treasurer of First Wyoming and the Treasurer of Pacific Northwest. Les Meyer, a member of our Board of Directors, also serves as a member of the Board of Directors of Rocky Mountain and First Wyoming. Les Meyer is the President and Chief Executive Officer of Rocky Mountain. Milton Tenopir, a member of our Board of Directors, also serves as a member of the Board of Directors of Northstar. John R. Perkins, a member of our Board of Directors, also serves as a member of the Board of Directors of Rocky Mountain and as Chairman of First Wyoming.
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Additional information concerning transactions between us and entities affiliated with members of our Board of Directors is included in Item 7 of this Form 10.
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
Related Party Transactions
In September 2009, we entered into a Consulting and Advisory Agreement with Bison Capital, a corporation owned by Rick Meyer and his wife. Rick Meyer is a member of our Board of Directors and our former Chief Executive Officer and Chairman. Under the Consulting and Advisory Agreement, we agreed to pay Bison Capital $190,000 per year for a period of four years. In exchange, Bison Capital agreed to provide us with certain services, including assistance with strategic planning, implementation of capital-raising strategies, product development, market research and public relations. In addition to the consulting fee, we agreed to reimburse Bison Capital for reasonable and necessary business expenses. During the years ended December 31, 2009 and December 31, 2010, we paid Bison Capital $63,333 and $332,215, respectively, under the terms of the Consulting and Advisory Agreement. The Consulting and Advisory Agreement was terminated in December 2011.
In September 2009, we entered into a general agency agreement with Great American Marketing, a corporation controlled by Travis Meyer. Travis Meyer is our President and a member of our Board of Directors. Under the agreement, Great American is responsible for training, recruiting and oversight of American Life marketing associates, including assuming responsibility for conventions, contests, prizes and awards. In exchange, Great American receives an override on all first-year premiums written. Great American has no underwriting or claims management authority. During the years ended December 31, 2009 and December 31, 2010, we paid Great American Marketing $43,621 and $355,972, respectively, under the terms of the agency agreement. The general agency agreement with Great American Marketing was terminated in October 2011.
Potential Conflicts of Interest Involving Our Officers and Directors
As described in more detail in Item 1, under the heading "Certain Relationships and Affiliations with Similar Businesses", some of our officers and directors have past or present relationships with other businesses operating in the insurance industry in states other than Nebraska. These relationships could result in a potential conflict of interest should we decide to offer life insurance products in any of the states in which these other companies do business to the extent that a relationship with the other companies is on-going. In addition, a potential conflict of interest could arise if any of those companies chose to do business in Nebraska to the extent that a relationship with the other companies is on-going. For that reason, any decision relating to such business will be made by the disinterested members of the Board of Directors and any member of the Board having an interest in another company will recuse himself or herself from voting or discussing the matter.
Director Independence
Presently, we are not required to comply with the director independence requirements of any securities exchange. In determining whether our directors are independent, however, we intend to comply with the rules of the New York Stock Exchange Alternext Exchange (the "AMEX"). The AMEX listing standards define an "independent director" generally as a person, other than an officer of a company, who does not have a relationship with the company that would interfere with the director's exercise of independent judgment.
The AMEX listing requirements state that a majority of a company's board of directors must be independent. Presently, our Board of Directors includes five independent directors, namely Douglas R. Clark, Jim Ballard, John R. Perkins, John C. ("Jack") Osborne and Milton Tenopir. These five independent directors constitute a majority of the Board of Directors.
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Because we are not listed on any securities exchange, we are not subject to any listing requirements mandating the establishment of any particular committees. As a result, we do not presently have any standing committees. All functions of a nominating committee, audit committee and compensation committee presently are performed by our Board of Directors as a whole.
We are involved in litigation incidental to our operations from time to time. We are not presently a party to any legal proceedings other than litigation arising in the ordinary course of our business, and we are not aware of any claims that could materially affect our financial position or results of operations.
ITEM 9. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Market Information
There is no established public trading market for our voting common stock. Our securities are not listed for trading on any national securities exchange nor are bid or asked quotations reported in any over-the-counter quotation service.
On September 30, 2011, the Company had issued and outstanding 8,670,146 shares of voting common stock. No other voting securities of the Company are outstanding.
Pursuant to our 2010 offering to existing shareholders in the State of Nebraska, no resales or transfers of the shares sold in the offering were permitted for nine months after the completion of that intrastate offering except to residents of the State of Nebraska. There were 1,808,894 shares issued in our 2010 offering that are subject to this restriction. The 2010 offering was completed on May 16, 2010 and the shares became transferable on February 17, 2011 to non-Nebraska residents.
All issued and outstanding shares of our voting common stock other than those issued in our 2010 offering to existing shareholders, consisting of 6,991,928 shares, are "restricted securities" and will be eligible for resale in compliance with Rule 144 of the Securities Act of 1933, as amended (the "Securities Act"), following the effectiveness of this Form 10, subject to the requirements described below. "Restricted Securities," as defined under Rule 144, were issued and sold by us in reliance on exemptions from the registration requirements of the Securities Act. These shares may be sold in the public market only if registered or if they qualify for an exemption from registration, such as Rule 144, which rule is summarized below. These shares will generally become available for sale ninety (90) days after the effectiveness of this Form 10, subject to the holding period, volume, manner of sale and other limitations, where required, under Rule 144.
Rule 144
Below is a summary of the requirements for sales of our voting common stock pursuant to Rule 144, as in effect on the date of this Form 10, after the effectiveness of this Form 10:
Affiliates
Affiliates will be able to sell their shares under Rule 144 beginning ninety (90) days after the effectiveness of this Form 10, subject to all other requirements of Rule 144. In general, under Rule 144, an affiliate would be entitled to sell within any three-month period a number of shares that does not exceed one percent of the number of shares of our common stock then outstanding. Sales under Rule 144 are also subject to manner of sale provisions and notice requirements and to the availability of current public information about us. Persons who may be deemed to be our affiliates generally
33
include individuals or entities that control, or are controlled by, or are under common control with, our company and may include our directors and officers, as well as our significant shareholders.
Non-Affiliates
For a person who has not been deemed to have been one of our affiliates at any time during the ninety (90) days preceding a sale, sales of our shares of voting common stock held longer than six months, but less than one year, will be subject only to the current public information requirement and can be sold under Rule 144 beginning ninety (90) days after the effectiveness of this Form 10. A person who is not deemed to have been one of our affiliates at any time during the ninety (90) days preceding a sale, and who has beneficially owned the shares proposed to be sold for at least one year, is entitled to sell the shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144 upon the effectiveness of this Form 10.
Holders of Record
As of February 3, 2012, there were approximately 5,500 holders of record of our voting common stock.
Dividends
We have not paid cash dividends on our voting common stock and do not anticipate paying cash dividends in the foreseeable future. Instead, we intend to retain any future earnings for reinvestment in our business. Any future determination to pay cash dividends will be at the discretion of the Board of Directors and will be dependent upon our financial condition, results of operations, capital requirements and such other factors as the Board of Directors deems relevant.
ITEM 10. RECENT SALES OF UNREGISTERED SECURITIES.
During the last three fiscal years, we sold securities in reliance on exemptions from registration permitted by the Securities Act and the rules and regulations thereunder.
Between June 2007 and May 2009, we issued 2,193,678 shares of voting common stock at a price of $5.00 per share for gross proceeds of $10,968,390 in an intrastate public offering to bona fide residents of the State of Nebraska. This offering was registered with the Nebraska Department of Banking & Finance under the Nebraska Securities Act and sold through issuer-agents licensed by the Nebraska Department of Banking & Finance. Total commissions paid on the sales did not exceed ten percent (10%) of the gross proceeds of the offering. There was no underwriter involved in the offering. The securities offered in this intrastate public offering were not registered under the Securities Act in reliance on Rule 147 thereunder, which exempts securities offered and sold on a wholly intrastate basis. A condition of the exemption was that during the period which the securities that were a part of the issue were being offered and sold by the issuer, and for a period of nine months from the date of the last sale by the issuer of such securities, all resales of any part of the issue, by any person, could be made only to persons resident within the State of Nebraska.
On March 1, 2010, we issued 40,000 shares of voting common stock to Mark Oliver in connection with his employment as the Treasurer of the Company and as the President and Chief Executive Officer of American Life. The shares were issued for $1.15 per share, or $46,000 in the aggregate. Such amount was equal to the book value of the shares as of December 31, 2009. The purchase price was paid by Mr. Oliver through delivery of a five-year promissory note secured by a pledge of the shares purchased. The shares were issued to Mr. Oliver based on the exemption provided by Section 4(2) of the Securities Act. The facts supporting the exemption are that the shares were issued only to one individual who was an executive officer of both the Company and its operating subsidiary, American Life. There was no general advertising or general solicitation. Mr. Oliver had access, by virtue of his
34
management position, to obtain all material information about the Company, American Life and his prospective investment.
On December 16, 2010, our Board of Directors authorized the payment of a four percent (4%) stock dividend to all shareholders of record on March 1, 2010. A total of 266,209 shares were issued. As a result of this stock dividend, each owner of one hundred (100) shares of our voting common stock, for example, became entitled to receive an additional four (4) shares of voting common stock.
On December 31, 2010, we issued 74,159 shares of our Series A Preferred Stock at a price of $6.00 per share for gross proceeds of approximately $445,000. These shares were issued outside of the United States to investors who were not "U.S. persons" pursuant to Regulation S under the Securities Act.
Between July 2010 and February 28 2011, we issued 1,808,894 shares of voting common stock at a price of $5.00 per share for gross proceeds of $7.7 million in an offering to existing shareholders who were bona fide residents of the State of Nebraska. This offering was exempt from the registration requirements of the Nebraska Securities Act, and no commissions were paid in connection with the sales of securities. There was no underwriter involved in the offering. The securities offered in this transaction were not registered under the Securities Act in reliance on Rule 147 thereunder, which exempts securities offered and sold on a wholly intrastate basis. A condition of the exemption was that during the period which the securities that were a part of the issue were being offered and sold by the issuer, and for a period of nine months from the date of the last sale by the issuer of such securities, all resales of any part of the issue, by any person, can be made only to persons resident within the State of Nebraska.
On April 29, 2011, the Company paid a four percent (4%) stock dividend to holders as of March 31, 2011. A total of 341,047 shares were issued.
ITEM 11. DESCRIPTION OF REGISTRANT'S SECURITIES TO BE REGISTERED.
The capital stock authorized by our Amended and Restated Articles of Incorporation consists of 120,000,000 shares of voting common stock, $0.001 par value per share, 20,000,000 shares of nonvoting common stock, $0.001 par value per share, and 10,000,000 shares of preferred stock, $0.001 par value per share. Of the 10,000,000 shares of preferred stock that are authorized, 2,000,000 shares have been designated as "Series A Preferred Stock". The balance of shares of preferred stock may be designated and issued by our Board of Directors in the future in one or more additional series.
As of September 30, 2011, 8,670,146 shares of voting common stock were issued and outstanding and 74,159 shares of Series A Preferred Stock were issued and outstanding. No shares of nonvoting common stock were issued and outstanding.
Description of Voting Common Stock
In the event of liquidation, holders of the shares of voting common stock are entitled to participate equally per share in all of our assets, if any, remaining after the payment of all liabilities and any liquidation preference on our preferred stock if any is outstanding. Holders of the shares of voting common stock are entitled to such dividends as the Board of Directors, in its discretion, may declare out of funds available therefor, subject to any preference in favor of outstanding shares of preferred stock, if any.
The holders of shares of voting common stock are entitled to one vote for each share held of record in each matter submitted to a vote of shareholders. Cumulative voting is mandatory in the election of directors. A majority of the outstanding shares of stock entitled to vote constitutes a quorum at any shareholder meeting. There are no preemptive or other subscription rights, conversion rights, registration or redemption provisions with respect to any shares of voting common stock.
35
The rights, preferences, and privileges of holders of voting common stock are subject to, and may be adversely affected by, the rights of the owners of any series of preferred stock that issued and outstanding, including the Series A Preferred Stock and any other preferred stock which we may designate and issue in the future.
Description of Nonvoting Common Stock
Except with respect to voting rights, our authorized nonvoting common stock is identical in all respects to our voting common stock. Thus, if shares of nonvoting common stock are issued in the future, holders of that nonvoting common stock would participate equally per share with holders of voting common stock in the distribution of assets upon liquidation and in the payment of dividends and other non-liquidating distributions.
Holders of shares of nonvoting common stock have no voting rights, except as otherwise required by the Business Corporation Act of the State of Nebraska. There are no preemptive or other subscription rights, conversion rights, registration or redemption provisions with respect to any shares of nonvoting common stock.
Description of Series A Preferred Stock
The Board of Directors is authorized by our Amended and Restated Articles of Incorporation to issue up to 10,000,000 shares of preferred stock in one or more series. Of the total authorized shares, 2,000,000 shares have been designated as "Series A Preferred Stock."
In the event of liquidation, the Series A Preferred Stock is entitled to a liquidation preference of $6.00 per share, as adjusted to reflect future stock splits, stock dividends and other like events. The Series A Preferred Stock is not preferred as to dividends and will participate equally per share with the voting common stock and nonvoting common stock (if any) in any dividends or other non-liquidating distributions.
The holders of shares of Series A Preferred Stock have no voting rights, except as otherwise required by the Business Corporation Act of the State of Nebraska. There are no preemptive or other subscription rights, registration or redemption provisions with respect to the shares of Series A Preferred Stock. Commencing on May 10, 2015, the Series A Preferred Stock will be convertible at the option of either the Company or the holder of such Series A Preferred Stock, into shares of voting common stock. Each share of Series A Preferred Stock will be convertible into 1.30 shares of voting common stock, with the conversion rate adjusted to reflect future stock splits, stock dividends and other like events.
Description of Other "Blank Check" Preferred Stock
With only 2,000,000 shares of our authorized preferred stock designated as Series A Preferred Stock, an additional 8,000,000 shares of preferred stock remain available for future designation. Our Board of Directors, without further action by the shareholders, may issue these undesignated shares of preferred stock and may fix or alter the voting rights, redemption provisions (including sinking fund provisions), dividend rights, dividend rates, liquidation preferences, conversion rights, and the designation of a number of shares constituting any wholly unissued series of preferred stock.
The actual effect of the authorization of additional series of preferred stock upon your rights as holders of voting common stock is unknown until our Board of Directors determines the specific rights of owners of any such series of preferred stock. Depending upon the rights granted to any such series of preferred stock, your voting power, liquidation preference, or other rights could be adversely affected.
36
Transfer Agent and Registrar
We have retained Computershare, Inc., 250 Royal Street, Canton, Massachusetts 02021 as our transfer agent and registrar for our voting common stock.
ITEM 12. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
In our Amended and Restated Articles of Incorporation, we have agreed to indemnify our directors and officers to the fullest extent permitted by Nebraska law. Under this indemnification provision, we are generally required to indemnify each of our directors and officers against any reasonable expenses actually incurred in the defense of any action, suit or proceeding to which the director or officer is a party by reason of his or her service to our company. We also may advance expenses incurred by a director or officer in defending such an action, suit or proceeding upon receipt of an undertaking by that director or officer to repay those advances if a court establishes that his or her acts or omissions involved conduct which precludes indemnification under Nebraska law.
Consistent with Nebraska law, our Amended and Restated Articles of Incorporation provide that a director will not be personally liable to the corporation or its shareholders for monetary damages for any action taken, or any failure to take action as a director, except for liability (i) for the amount of a financial benefit received by a director to which he or she is not entitled; (ii) for intentional infliction of harm on the corporation or its shareholders; (iii) for a violation of Neb. Rev. Stat. § 21-2096; and (iv) for an intentional violation of criminal law.
ITEM 13. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statement information required by this Item 13 is set forth at the end of this Form 10 beginning on page F-1 and is hereby incorporated into this Item 13 by reference
ITEM 14. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
On December 3, 2009, we dismissed Dana F. Cole & Company, LLP ("Dana Cole") as our auditor. At that time, we anticipated that we would be required to file this Form 10 pursuant to Section 12(g) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the rules and regulations thereunder. Dana Cole was not registered with the Public Company Accounting Oversight Board and could not audit our financial statements for the purposes of including them in this Form 10. Thus, Dana Cole was not engaged to audit our financial statements for the year ended December 31, 2009, even though it had audited our financial statements in prior years. Our Board of Directors approved the dismissal of Dana Cole. None of the prior reports of Dana Cole on our financial statements contained an adverse opinion or disclaimer of opinion, or was qualified or modified as to uncertainty, audit scope or accounting principles. We did not have any disagreements with Dana Cole regarding any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure.
On December 3, 2009, we engaged McGladrey & Pullen, LLP ("McGladrey") as our auditor. Prior to the engagement of McGladrey, we did not consult with McGladrey regarding (1) the application of accounting principles to specified transactions, (2) the type of audit opinion that might be rendered on our financial statements, (3) written or oral advice that would be an important factor considered by us in reaching a decision as to an accounting, auditing or financial reporting issues, or (4) any matter that was the subject of a disagreement between our company and its predecessor auditor as described in Item 304(a)(1)(iv) or a reportable event as described in Item 304(a)(1)(v) of Regulation S-K. The decision to engage McGladrey was approved by our Board of Directors.
37
ITEM 15. FINANCIAL STATEMENTS AND EXHIBITS.
The list of financial statements filed as part of this registration statement is provided on page F-1.
| EXHIBIT NUMBER |
DESCRIPTION | ||
|---|---|---|---|
| 2.1 | Stock Purchase Agreement, dated January 20, 2009, by and between American Life & Security Corp. and Security National Life Insurance Company. (Incorporated by reference to Exhibit 2.1 to the Company's Form 10 Registration Statement, filed December 12, 2011.) | ||
2.2 |
Stock Purchase Agreement, dated November 8, 2010, by and among Midwest Holding Inc., American Life & Security Corp., Old Reliance Insurance Company and David G. Elmore. (Incorporated by reference to Exhibit 2.2 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
2.3 |
Amendment I to Stock Purchase Agreement, dated May 20, 2011, by and among Midwest Holding Inc., American Life & Security Corp., Old Reliance Insurance Company and David G. Elmore. (Incorporated by reference to Exhibit 2.3 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) |
||
2.4 |
Amendment II to Stock Purchase Agreement, dated August 2, 2011, by and among Midwest Holding Inc., American Life & Security Corp., Old Reliance Insurance Company and David G. Elmore. (Incorporated by reference to Exhibit 2.4 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) |
||
3.1 |
Amended and Restated Articles of Incorporation, dated March 29, 2010. (Incorporated by reference to Exhibit 3.1 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
3.2 |
Articles of Amendment to the Amended and Restated Articles of Incorporation, dated May 6, 2010. (Incorporated by reference to Exhibit 3.2 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
3.3 |
Amended and Restated Bylaws. (Incorporated by reference to Exhibit 3.3 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
3.4 |
American Life & Security Corp. State of Nebraska Department of Insurance Amended Certificate of Authority, issued August 3, 2011. (Incorporated by reference to Exhibit 3.4 to the Company's Amendment No. 2 to Form 10 Registration Statement, filed March 20, 2012.) |
||
10.1 |
† |
Employment Agreement, dated July 1, 2011, by and between Midwest Holding Inc. and Travis Meyer. (Incorporated by reference to Exhibit 10.1 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
|
10.2 |
† |
Employment Agreement, dated July 1, 2011, by and between Midwest Holding Inc. and Mark Oliver. (Incorporated by reference to Exhibit 10.2 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
|
10.3 |
† |
Consulting and Advisory Agreement, dated September 1, 2009, by and between Midwest Holding Inc. and Bison Capital Corp. (f/k/a Corporate Development Inc.). (Incorporated by reference to Exhibit 1032 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
|
38
| EXHIBIT NUMBER |
DESCRIPTION | ||
|---|---|---|---|
| 10.4 | Administrative Services Agreement, dated August 17, 2009, by and between American Life & Security Corp. and Investors Heritage Life Insurance Company. (Incorporated by reference to Exhibit 10.4 to the Company's Form 10 Registration Statement, filed December 12, 2011.) | ||
10.5 |
Administrative Services Agreement, dated August 17, 2009, by and between Midwest Holding Inc. and Investors Heritage Life Insurance Company. (Incorporated by reference to Exhibit 10.5 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.6 |
Automatic Reinsurance Agreement, dated August 1, 2009, by and between American Life & Security Corp. and Optimum Re Insurance Company. (Incorporated by reference to Exhibit 10.6 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.7 |
Amendment Number One to Automatic Reinsurance Agreement, dated August 1, 2009, by and between American Life & Security Corp. and Optimum Re Insurance Company. (Incorporated by reference to Exhibit 10.7 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.8 |
Amendment Number Two to Automatic Reinsurance Agreement, dated August 1, 2009, by and between American Life & Security Corp. and Optimum Re Insurance Company. (Incorporated by reference to Exhibit 10.8 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.9 |
Bulk Reinsurance Agreement, dated September 1, 2009, by and between American Life & Security Corp. and Optimum Re Insurance Company. (Incorporated by reference to Exhibit 10.9 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.10 |
Amendment to all Reinsurance Agreements, dated August 4, 2011, by and between American Life & Security Corp. and Optimum Re Insurance Company. (Incorporated by reference to Exhibit 10.10 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.11 |
Automatic Reinsurance Agreement, dated August 1, 2009, by and between American Life & Security Corp. and Investors Heritage Life Insurance Company. (Incorporated by reference to Exhibit 10.11 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.12 |
Reinsurance Agreement, dated January 1, 2010, by and between American Life & Security Corp. and Security National Life Insurance Company. (Incorporated by reference to Exhibit 10.12 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.13 |
Master Reinsurance Agreement, dated December 20, 1999, by and between Old Reliance Insurance Company and American Founders Life Insurance Company. (Incorporated by reference to Exhibit 10.13 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) |
||
10.14 |
Amendment Number One to Master Reinsurance Agreement, dated December 20, 1999, by and between Old Reliance Insurance Company and American Founders Life Insurance Company. (Incorporated by reference to Exhibit 10.14 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) |
||
10.15 |
Reinsurance Agreement Number One, dated December 31, 1999, by and between Old Reliance Insurance Company and American Founders Life Insurance Company. (Incorporated by reference to Exhibit 10.15 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) |
||
39
| EXHIBIT NUMBER |
DESCRIPTION | ||
|---|---|---|---|
| 10.16 | Amendment Number One to Reinsurance Agreement Number One dated December 31, 1999, by and between Old Reliance Insurance Company and American Founders Life Insurance Company. (Incorporated by reference to Exhibit 10.16 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) | ||
10.17 |
Master Reinsurance Agreement, dated April 1, 2000, by and between Old Reliance Insurance Company and American Founders Life Insurance Company. (Incorporated by reference to Exhibit 10.17 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) |
||
10.18 |
Reinsurance Agreement Number One, dated April 1, 2000, by and between Old Reliance Insurance Company and American Founders Life Insurance Company. (Incorporated by reference to Exhibit 10.18 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) |
||
10.19 |
† |
Agency Agreement, dated September 1, 2009, by and between American Life & Security Corp. and Great American Marketing, Inc. (Incorporated by reference to Exhibit 10.19 to the Company's Amendment No. 2 to Form 10 Registration Statement, filed March 20, 2012.) |
|
10.20 |
† |
Employment Agreement, dated December 1, 2011, by and between Midwest Holding Inc. and Rick Meyer. (Incorporated by reference to Exhibit 10.20 to the Company's Amendment No. 2 to Form 10 Registration Statement, filed March 20, 2012.) |
|
21.1 |
List of Subsidiaries. (Incorporated by reference to Exhibit 21.1 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
99.1 |
Disclaimer of Control by Rick D. Meyer, dated September 26, 2010. (Incorporated by reference to Exhibit 99.1 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
40
MIDWEST HOLDING INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
To
the Board of Directors and Stockholders
Midwest Holding Inc. and Subsidiaries
We have reviewed the accompanying consolidated balance sheet of Midwest Holding Inc. and Subsidiaries (the Company) as of September 30, 2011, and the related consolidated statements of operations, and stockholders' equity for the three- and nine-month periods ended September 30, 2011 and 2010, and the related consolidated statements of cash flows for the nine-month periods ended September 30, 2011 and 2010. These consolidated financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited in accordance with the standards of the Public Company Accounting Oversight Board, the consolidated balance sheet of Midwest Holding Inc. and Subsidiaries as of December 31, 2010 and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended; and in our report dated June 10, 2011, we expressed an unqualified opinion on those financial statements.
/s/ McGladrey & Pullen, LLP
Omaha, Nebraska
February 3, 2012
F-1
Midwest Holding Inc. and Subsidiaries
Consolidated Balance Sheets
September 30, 2011 and December 31, 2010
| |
(Unaudited) September 30, 2011 |
December 31, 2010 | |||||
|---|---|---|---|---|---|---|---|
Assets |
|||||||
Investments, available for sale, at fair value |
|||||||
Fixed maturities |
$ | 9,364,120 | $ | 6,398,133 | |||
Equity securities |
1,687,847 | 1,110,725 | |||||
Mortgage loans on real estate |
685,465 | — | |||||
Real estate |
590,010 | — | |||||
Policy loans |
329,422 | 94,272 | |||||
Note receivable |
257,383 | 200,000 | |||||
Short-term investments |
515,725 | 500,000 | |||||
Total investments |
13,429,972 | 8,303,130 | |||||
Cash and cash equivalents |
2,817,219 | 5,250,468 | |||||
Amounts recoverable from reinsurers |
34,323,877 | 20,914,194 | |||||
Interest and dividends due and accrued |
165,916 | 82,388 | |||||
Due premiums |
138,876 | 78,270 | |||||
Deferred acquisition costs, net |
1,889,815 | 1,267,598 | |||||
Value of business acquired, net |
1,175,898 | 417,902 | |||||
Intangible assets |
700,000 | — | |||||
Goodwill |
555,237 | — | |||||
Property and equipment, net |
471,579 | 138,262 | |||||
Other assets |
390,150 | 58,116 | |||||
Total assets |
$ | 56,058,539 | $ | 36,510,328 | |||
Liabilities and Stockholders' Equity |
|||||||
Liabilities: |
|||||||
Benefit reserves |
$ | 31,666,037 | $ | 13,903,783 | |||
Policy claims |
522,565 | 183,706 | |||||
Deposit-type contracts |
11,404,524 | 11,692,181 | |||||
Advance premiums |
98,540 | 717 | |||||
Total policy liabilities |
43,691,666 | 25,780,387 | |||||
Accounts payable and accrued expenses |
799,275 | 360,147 | |||||
Surplus notes |
950,000 | — | |||||
Total liabilities |
45,440,941 | 26,140,534 | |||||
Stockholders' Equity: |
|||||||
Preferred stock, Series A, $0.001 par value. Authorized 2,000,000 shares; issued and outstanding 74,159 shares as of September 30, 2011 and December 31, 2010 |
74 | 74 | |||||
Common stock, $0.001 par value. Authorized 120,000,000 shares; issued and outstanding 8,670,146 shares as of September 30, 2011 and 8,182,761 shares as of December 31, 2010 |
8,670 | 8,183 | |||||
Additional paid-in capital |
23,902,188 | 19,498,839 | |||||
Accumulated deficit |
(13,106,684 | ) | (8,751,897 | ) | |||
Accumulated other comprehensive loss |
(368,850 | ) | (385,405 | ) | |||
Total Midwest Holding Inc.'s stockholders' equity |
10,435,398 | 10,369,794 | |||||
Noncontrolling interests |
182,200 | — | |||||
Total stockholders' equity |
10,617,598 | 10,369,794 | |||||
Total liabilities and stockholders' equity |
$ | 56,058,539 | $ | 36,510,328 | |||
See Notes to Interim Consolidated Financial Statements.
F-2
Midwest Holding Inc. and Subsidiaries
Consolidated Statements of Operations
Quarter and Nine Months Ended September 30, 2011 and 2010
(Unaudited)
| |
Quarter Ended September 30, |
Nine Months Ended September 30, |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
2011 | 2010 | 2011 | 2010 | |||||||||
Income: |
|||||||||||||
Premiums |
$ | 875,036 | $ | 386,187 | $ | 1,852,132 | $ | 1,255,359 | |||||
Consideration on reinsurance assumed |
— | 26,990 | — | 3,729,599 | |||||||||
Investment income, net of expenses |
86,343 | 50,809 | 218,224 | 113,509 | |||||||||
Realized gain (loss) on investments |
29,254 | 54,751 | 15,127 | (15,452 | ) | ||||||||
Miscellaneous income |
188,210 | 15,038 | 215,898 | 15,138 | |||||||||
|
1,178,843 | 533,775 | 2,301,381 | 5,098,153 | |||||||||
Expenses: |
|||||||||||||
Death and other benefits |
147,260 | 94,537 | 188,580 | 302,108 | |||||||||
Increase in benefit reserves |
381,336 | 152,581 | 776,515 | 4,248,409 | |||||||||
Acquisition costs deferred |
(389,311 | ) | (326,616 | ) | (996,927 | ) | (1,117,864 | ) | |||||
Amortization of deferred acquisition costs |
102,412 | 47,335 | 374,710 | 202,645 | |||||||||
Salaries and benefits |
632,460 | 356,983 | 1,676,109 | 848,500 | |||||||||
Commission |
387,506 | 321,546 | 934,007 | 1,025,246 | |||||||||
Professional and administrative fees |
434,745 | 359,646 | 961,712 | 949,088 | |||||||||
Travel and entertainment |
90,162 | 77,445 | 218,882 | 125,102 | |||||||||
Rent |
34,378 | 19,442 | 80,818 | 63,190 | |||||||||
Depreciation and amortization of value of business acquired |
66,176 | 52,794 | 110,279 | 89,844 | |||||||||
Operating expenses |
245,631 | 105,680 | 626,248 | 335,589 | |||||||||
|
2,132,755 | 1,261,373 | 4,950,933 | 7,071,857 | |||||||||
Loss before income tax expense |
(953,912 | ) | (727,598 | ) | (2,649,552 | ) | (1,973,704 | ) | |||||
Income tax expense |
— |
— |
— |
— |
|||||||||
Net loss |
(953,912 | ) | (727,598 | ) | (2,649,552 | ) | (1,973,704 | ) | |||||
Less: Loss attributable to noncontrolling interests |
— | — | — | — | |||||||||
Net loss attributable to Midwest Holding, Inc. |
$ | (953,912 | ) | $ | (727,598 | ) | $ | (2,649,552 | ) | $ | (1,973,704 | ) | |
Net loss attributable to Midwest Holding, Inc. per common share |
$ | (0.11 | ) | $ | (0.10 | ) | $ | (0.31 | ) | $ | (0.26 | ) | |
See Notes to Interim Consolidated Financial Statements.
F-3
Midwest Holding Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
Periods Ended September 30, 2011 (unaudited) and December 31, 2010
| |
Preferred Stock |
Common Stock |
Additional Paid-In Capital |
Accumulated Deficit |
Accumulated Other Comprehensive Loss |
Total Midwest Holding, Inc.'s Stockholders' Equity |
Noncontrolling Interests |
Total Equity |
|||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Balance, December 31, 2009 |
$ | — | $ | 6,600 | $ | 12,820,538 | $ | (5,197,647 | ) | $ | (104,515 | ) | $ | 7,524,976 | $ | — | $ | 7,524,976 | |||||||
Issuances of preferred stock, net of capital raising expenses |
74 | — | 415,676 | — | — | 415,750 | — | 415,750 | |||||||||||||||||
Issuances of common stock, net of capital raising expenses |
— | 1,317 | 4,931,846 | — | — | 4,933,163 | — | 4,933,163 | |||||||||||||||||
Net loss |
— | — | — | (2,223,205 | ) | — | (2,223,205 | ) | — | (2,223,205 | ) | ||||||||||||||
Unrealized losses on investments arising during period |
— | — | — | — | (280,961 | ) | (280,961 | ) | — | (280,961 | ) | ||||||||||||||
Realized losses on investments |
— | — | — | — | 71 | 71 | — | 71 | |||||||||||||||||
Net unrealized losses on investments, net of tax |
— | — | — | — | (280,890 | ) | (280,890 | ) | — | (280,890 | ) | ||||||||||||||
Total comprehensive loss |
(2,504,095 | ) | (2,504,095 | ) | |||||||||||||||||||||
Stock dividend |
— | 266 | 1,330,779 | (1,331,045 | ) | — | — | — | — | ||||||||||||||||
Balance, December 31, 2010 |
74 | 8,183 | 19,498,839 | (8,751,897 | ) | (385,405 | ) | 10,369,794 | — | 10,369,794 | |||||||||||||||
Issuances of common stock, net of capital raising expenses |
— | 277 | 1,979,392 | — | — | 1,979,669 | — | 1,979,669 | |||||||||||||||||
Repurchases of common stock |
— | (281 | ) | (27,787 | ) | — | — | (28,068 | ) | — | (28,068 | ) | |||||||||||||
Changes in equity of noncontrolling interests |
— | — | (3,000 | ) | — | — | (3,000 | ) | 182,200 | 179,200 | |||||||||||||||
Net loss |
— | — | — | (2,649,552 | ) | — | (2,649,552 | ) | — | (2,649,552 | ) | ||||||||||||||
Unrealized gains on investments arising during period |
— | — | — | — | 31,682 | 31,682 | — | 31,682 | |||||||||||||||||
Realized gains on investments |
— | — | — | — | (15,127 | ) | (15,127 | ) | — | (15,127 | ) | ||||||||||||||
Net unrealized gains on investments, net of tax |
— | — | — | — | 16,555 | 16,555 | — | 16,555 | |||||||||||||||||
Total comprehensive loss |
(2,632,997 | ) | (2,632,997 | ) | |||||||||||||||||||||
Acquisition of Old Reliance |
— | 150 | 749,850 | — | — | 750,000 | — | 750,000 | |||||||||||||||||
Stock dividend |
— | 341 | 1,704,894 | (1,705,235 | ) | — | — | — | — | ||||||||||||||||
Balance, September 30, 2011 |
$ | 74 | $ | 8,670 | $ | 23,902,188 | $ | (13,106,684 | ) | $ | (368,850 | ) | $ | 10,435,398 | $ | 182,200 | $ | 10,617,598 | |||||||
See Notes to Interim Consolidated Financial Statements.
F-4
Midwest Holding Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2011 and 2010
(Unaudited)
| |
Nine Months Ended September 30, |
||||||
|---|---|---|---|---|---|---|---|
| |
2011 | 2010 | |||||
Cash Flows from Operating Activities: |
|||||||
Net loss |
$ | (2,649,552 | ) | $ | (1,973,704 | ) | |
Adjustments to reconcile net loss to net cash and cash equivalents (used in) provided by operating activities: |
|||||||
Net adjustment for premium and discount on investments |
43,763 | 36,617 | |||||
Depreciation and amortization |
110,279 | 89,844 | |||||
Deferral of acquisition costs |
(996,927 | ) | (1,117,864 | ) | |||
Amortization of deferred acquisition costs |
374,710 | 202,645 | |||||
Realized (gain) loss on investments |
(15,127 | ) | 15,452 | ||||
Gain from fair value remeasurement of previously held interest in Security Capital |
(182,000 | ) | — | ||||
Changes in operating assets and liabilities: |
|||||||
Amounts recoverable from reinsurers |
983,619 | 779,646 | |||||
Interest and dividends due and accrued |
(31,303 | ) | (44,308 | ) | |||
Due premiums |
(47,733 | ) | 8,984 | ||||
Policy liabilities |
(351,762 | ) | 3,008,506 | ||||
Other assets and liabilities |
79,682 | 414,688 | |||||
Net cash (used in) provided by operating activities |
(2,682,551 | ) | 1,420,506 | ||||
Cash Flows from Investing Activities: |
|||||||
Securities available for sale: |
|||||||
Purchases |
(3,605,156 | ) | (6,861,376 | ) | |||
Sales |
3,150,880 | 5,107,147 | |||||
Net change in policy loans |
6,826 | (112,039 | ) | ||||
Net change in note receivable |
(57,383 | ) | (200,000 | ) | |||
Net change in short-term investments |
43,377 | 1,006,665 | |||||
Net purchases of property and equipment |
(46,688 | ) | (56,840 | ) | |||
Purchases of businesses, net of cash and cash equivalents acquired |
(1,598,429 | ) | (763,078 | ) | |||
Net cash used in investing activities |
(2,106,573 | ) | (1,879,521 | ) | |||
Cash Flows from Financing Activities: |
|||||||
Net proceeds from sale of common stock |
1,951,601 | 2,367,700 | |||||
Net proceeds from sale of preferred stock |
— | 365,750 | |||||
Receipts on deposit type contracts |
430,348 | 87,043 | |||||
Withdrawals on deposit type contracts |
(26,074 | ) | (8,681 | ) | |||
Net cash provided by financing activities |
2,355,875 | 2,811,812 | |||||
Net (decrease) increase in cash and cash equivalents |
(2,433,249 | ) | 2,352,797 | ||||
Cash and cash equivalents: |
|||||||
Beginning |
5,250,468 | 1,484,114 | |||||
Ending |
$ | 2,817,219 | $ | 3,836,911 | |||
See Notes to Interim Consolidated Financial Statements.
F-5
Midwest Holding Inc. and Subsidiaries
Supplemental Cash Flow Information
Nine Months Ended September 30, 2011 and 2010
| |
Nine Months Ended September 30, |
||||||
|---|---|---|---|---|---|---|---|
| |
2011 | 2010 | |||||
Supplemental Disclosure of Non-Cash Information: |
|||||||
Stock dividend |
$ | 1,705,235 | $ | 1,331,045 | |||
Acquisition of Old Reliance Insurance Company: |
|||||||
Investments |
$ | 4,316,067 | $ | — | |||
Amounts recoverable from reinsurers |
14,393,302 | — | |||||
Value of business acquired |
824,485 | — | |||||
Intangible assets |
700,000 | — | |||||
Excess cost over fair value of net assets acquired (goodwill) |
555,237 | — | |||||
Property and equipment |
330,419 | — | |||||
Other assets |
171,556 | — | |||||
Benefit reserves |
(17,329,944 | ) | — | ||||
Policy claims |
(282,567 | ) | — | ||||
Deposit-type contracts |
(153,068 | ) | — | ||||
Other liabilities |
(227,058 | ) | — | ||||
Surplus notes assumed |
(450,000 | ) | — | ||||
Surplus notes issued |
(500,000 | ) | — | ||||
Surplus note liability |
(950,000 | ) | — | ||||
Issuance of stock |
(750,000 | ) | — | ||||
|
$ | 1,598,429 | $ | — | |||
Acquisition of Capital Reserve Life Insurance Company: |
|||||||
Value of business acquired |
$ | — | $ | 116,326 | |||
Investments in fixed maturities acquired |
— | 646,752 | |||||
Amounts recoverable from reinsurers acquired |
— | 21,885,247 | |||||
Policy claims assumed |
— | (154,413 | ) | ||||
Benefit reserves assumed |
— | (11,979,023 | ) | ||||
Deposit-type contracts assumed |
— | (9,751,811 | ) | ||||
|
$ | — | $ | 763,078 | |||
Purchases of businesses, net of cash and cash equivalents acquired |
$ | 1,598,429 | $ | 763,078 | |||
See Notes to Interim Consolidated Financial Statements.
F-6
Note 1. Nature of Operations and Summary of Significant Accounting Policies
Nature of operations: Midwest Holding Inc. (Midwest) was incorporated in Nebraska on October 31, 2003 for the primary purpose of organizing a life insurance subsidiary. From 2003 to May, 2009, Midwest was focused on raising capital, first through private placements and finally through an intra-state offering of 2,000,000 common shares at $5.00 per share. These offerings sold out, including a 10% oversale on the Final Offering. Midwest became operational during the year ended December 31, 2009. Upon capitalizing American Life & Security Corporation (ALSC or American Life) and acquiring Capital Reserve Life Insurance Company (CRLIC), as described below, Midwest deemed it prudent to raise additional capital to fund primarily the expansion of the life insurance operation. Beginning in 2009, ALSC, a wholly-owned subsidiary of Midwest, was authorized to do business in the State of Nebraska. ALSC was also granted a certificate of authority to write insurance in the State of Nebraska on September 1, 2009. ALSC is engaged in the business of underwriting, selling, and servicing life insurance and annuity policies.
During the second quarter of 2010, ALSC completed the purchase of a 100% ownership interest in CRLIC, an insurance company domiciled in Missouri. The purchase was effective as of January 1, 2010. ALSC purchased CRLIC for its statutory capital and surplus plus $116,326. CRLIC is licensed to issue business in the states of Kansas and Missouri. Currently, 100% of the business issued by CRLIC is reinsured to an unaffiliated reinsurer.
In August, 2010, Midwest began an exempt offering of shares to existing holders in the state of Nebraska at $5.00 per share. As of September 30, 2011, Midwest had raised approximately $7,400,000 before capital raising expenses through this offering. Additionally, Midwest offered a newly-created class of preferred shares to residents of Latin America. The preferred shares are non-voting and convert to common shares in 2015 at the rate of 1.3 common shares for each preferred share. The shares were sold at $6.00 per share and a total of 74,159 were sold in 2010. No preferred shares were sold in 2011.
On November 8, 2010, the Company and American Life entered into an agreement to acquire all of the issued and outstanding capital stock of Old Reliance, an Arizona-domiciled life insurance company. The plan provided for Amercian Life to merge into Old Reliance following the purchase, with the survivor changing its name to American Life & Security Corp. In the transaction, the sole shareholder of Old Reliance received: (i) Approximately $1.6 million in cash, (ii) $500,000 in the form of a surplus debenture issued by American Life, and (iii) 150,000 shares of voting common stock of the Company. The transaction including the merger, was consummated on August 3, 2011.
Basis of presentation: The accompanying consolidated financial statements include the accounts of Midwest, its wholly-owned subsidiary ALSC, ALSC's wholly-owned subsidiary CRLIC., and Midwest's 60% owned subsidiary, Security Capital Corporation, which was acquired during the third quarter of 2011. Hereafter, entities are collectively referred to as the "Company."
These interim consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Management believes that the disclosures are adequate to make the information presented not misleading, and all normal and recurring adjustments necessary to present fairly the financial position as of September 30, 2011 and the results of operations for all periods presented have been made. The results of operations for any interim period are not necessarily indicative of the Company's operating results for a full year. All intercompany accounts and transactions have been eliminated in consolidation.
Investments: All fixed maturities and equity securities owned by the Company are considered available-for-sale and are included in the financial statements at their fair value as of the financial statement date. Bond premiums and discounts are amortized using the scientific-yield method over the
F-7
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
term of the bonds. Realized gains and losses on securities sold during the year are determined using the specific identification method. Unrealized holding gains and losses, net of applicable income taxes, are included in accumulated other comprehensive loss.
Declines in the fair value of available for sale securities below their amortized cost are evaluated to assess whether any other-than-temporary impairment loss should be recorded. In determining if these losses are expected to be other-than-temporary, the Company considers severity of impairment, duration of impairment, forecasted recovery period, industry outlook, financial condition of the issuer, projected cash flows, issuer credit ratings and the intent and ability of the Company to hold the investment until the recovery of the cost.
The recognition of other-than-temporary impairment losses on debt securities is dependent on the facts and circumstances related to the specific security. If the Company intends to sell a security or it is more likely than not that the Company would be required to sell a security prior to recovery of the amortized cost, the difference between amortized cost and fair value is recognized in the income statement as an other-than-temporary impairment. If the Company does not expect to recover the amortized basis, does not plan to sell the security and if it is not more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, the recognition of the other-than-temporary impairment is bifurcated. The Company recognizes the credit loss portion in the income statement and the noncredit loss portion in accumulated other comprehensive loss. The credit component of an other-than-temporary impairment is determined by comparing the net present value of projected cash flows with the amortized cost basis of the debt security. The net present value is calculated by discounting the Company's best estimate of projected future cash flows at the effective interest rate implicit in the fixed income security at the date of acquisition. Cash flow estimates are driven by assumptions regarding probability of default, including changes in credit ratings, and estimates regarding timing and amount of recoveries associated with a default. No other-than-temporary write-downs were recognized during the quarter or nine months ended September 30, 2011.
Included within the Company's equity securities are certain privately placed common stocks for several recently formed holding companies organized for the purpose of forming life insurance subsidiaries. Given the nature of these investments, the cost basis of these investments approximates their fair value.
Investment income consists primarily of interest, which is recognized on an accrual basis.
Mortgage loans on real estate: Mortgage loans on real estate are carried at unpaid principal balances. Interest income on mortgage loans on real estate is recognized in net investment income at the contract interest rate when earned. A mortgage loan is considered to be impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the mortgage agreement. Valuation allowances on mortgage loans are established based upon losses expected by management to be realized in connection with future dispositions or settlement of mortgage loans, including foreclosures. The Company establishes valuation allowances for estimated impairments on an individual loan basis as of the balance sheet date. Such valuation allowances are based on the excess carrying value of the loan over the present value of expected future cash flows discounted at the loan's original effective interest rate. These evaluations are revised as conditions change and new information becomes available. No valuation allowance was established for mortgage loans on real estate as of September 30, 2011, primarily as a result of the seller's guaranteed performance of the mortgage loans acquired as part of the Old Reliance transaction.
F-8
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
Policy loans: Policy loans are carried at unpaid principal balances. Interest income on policy loans is recognized in net investment income at the contract interest rate when earned. No valuation allowance is established for these policy loans as the amount of the loan is fully secured by the death benefit of the policy and cash surrender value.
Notes receivable: Notes receivable are stated at their outstanding principal amount. Outstanding notes accrue interest based on the terms of the respective note agreements.
Short-term investments: Short-term investments are stated at cost and consist of certificates of deposit. At September 30, 2011 and December 31, 2010, the cost of these investments approximates fair value due to the short duration to maturity.
Real Estate Owned: Real estate owned is comprised of ten condominiums in Hawaii. Real estate is carried at depreciated cost. Depreciation on residential real estate is computed on a straight-line basis over 50 years.
Cash and cash equivalents: The Company considers all liquid investments with original maturities of three months or less to be cash equivalents. At September 30, 2011 and December 31, 2010, cash equivalents consisted primarily of money market accounts. The Company has cash on deposit with financial institutions which at times may exceed the Federal Deposit Insurance Corporation insurance limits. The Company has not suffered any losses in the past and does not believe it is exposed to any significant credit risk in these balances.
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 "revenue recognition and related 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. The Company determined that all deferred acquisition costs were recoverable.
Value of business acquired: Value of business acquired represents the estimated value assigned to purchased companies or insurance in force of the assumed policy obligations at the date of acquisition of a block of policies. As previously discussed, ALSC purchased CRLIC during 2010, resulting in an initial capitalized asset for value of business acquired of $116,326. This asset is being amortized on a straight-line basis over ten years, resulting in annual amortization of $11,633. Amortization recognized during the quarter and nine months ended September 30, 2011 and 2010 relative to this transaction totaled $2,908 and $8,724, respectively.
Additionally, ALSC entered into a coinsurance agreement with Security National Life Insurance Company (SNL), effective January 1, 2010, to reinsure a block of traditional whole life policies and a block of deferred annuities of SNL. Under the terms of the agreement, SNL ceded to ALSC a block of deferred annuities in the amount of $2,678,931 and a block of whole life policies in the amount of $1,048,134, together with net due and deferred premiums in the amount of $12,305, advance premiums in the amount of $353, claims liabilities in the amount of $14,486, and net policy loans in the amount of $128,487.
On the effective date of the reinsurance contract, ALSC assumed the immediate obligation for performance related to the underlying policies covered by the agreement. In other words, SNL transferred its risk to us. As part of the contract, SNL agreed to pay ALSC an amount equal to the adjusted net reserves on the effective date of the agreement with respect to the liabilities reinsured as
F-9
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
of such date. In accordance with FASB ASC 944-605-25-3, "Financial Services—Insurance, Revenue Recognition, Long-Duration Contracts," the assumed premiums paid to ALSC by SNL, along with the Company's estimate of losses incurred, were immediately recognized into earnings. The Company recorded income of $3,729,599 that was offset by the assumption of the reserve liability, which was recorded as an increase in benefit reserve expense. The Company concluded gross reporting was appropriate because the Company obtained immediate risk and rewards of ownership.
Additionally, the Company paid an upfront ceding commission of $375,000. An initial asset was established for the value of this business acquired totaling $348,010, representing primarily the ceding commission. This asset is being amortized on a straight-line basis over ten years, resulting in annual amortization of $34,801. The Company recognized amortization expense of $8,700 for each of the quarters ended September 30, 2011 and 2010 and $26,101 for each of the nine month periods ended September 30, 2011 and 2010 relative to this transaction. The agreement has an automatic renewal provision unless the Company notifies SNL of its intention not to renew, no less than 180 days prior to the expiration of the then current agreement. Each automatic renewal period is for one year.
Additionally, ALSC purchased Old Reliance in August 2011, resulting in an initial capitalized asset for value of business acquired of $824,485. This asset is being amortized over the life of the related policies (refer to "revenue recognition and related expenses" discussed later regarding amortization methods). Amortization recognized during the quarter and nine months ended September 30, 2011 totaled $31,664.
Goodwill and Other Intangible Assets: Goodwill represents the excess of the amounts paid to acquire subsidiaries and other businesses over the fair value of their net assets at the date of acquisition. Goodwill is tested for impairment at least annually in the fourth quarter or more frequently if events or circumstances change that would indicate that a triggering event has occurred.
The Company assesses the recoverability of intangible assets at least annually or whenever events or circumstances suggest that the carrying value of an identifiable intangible asset may exceed the sum of the undiscounted cash flows expected to result from its use and eventual disposition. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset.
Property and equipment: Property and equipment are stated at cost net of accumulated depreciation. Annual depreciation is primarily computed using straight-line methods for financial reporting and straight-line and accelerated methods for tax purposes. The accumulated depreciation totaled $160,667 and $66,063 as of September 30, 2011 and December 31, 2010, respectively.
Maintenance and repairs are expensed as incurred. Replacements and improvements which extend the useful life of the asset are capitalized. The net book value of assets sold or retired are removed from the accounts, and any resulting gain or loss is reflected in earnings.
Long-lived assets are reviewed annually for impairment. An impairment loss is recognized if the carrying amount of an asset may not be recoverable and exceeds estimated future undiscounted cash flows of the asset. A recognized impairment loss reduces the carrying amount of the asset to its fair value. For the quarter and nine months ended September 30, 2011 and 2010, no impairment loss of long-lived assets has been recognized.
Reinsurance: In the normal course of business, the Company seeks to limit aggregate and single exposure to losses on large risks by purchasing reinsurance. The amounts reported in the consolidated balance sheets as reinsurance recoverable include amounts billed to reinsurers on losses paid as well as estimates of amounts expected to be recovered from reinsurers on insurance liabilities that have not yet
F-10
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
been paid. Reinsurance recoverable on unpaid losses are estimated based upon assumptions consistent with those used in establishing the liabilities related to the underlying reinsured contracts. Insurance liabilities are reported gross of reinsurance recoverable. Management believes the recoverables are appropriately established. The Company generally strives to diversify its credit risks related to reinsurance ceded. Reinsurance premiums are generally reflected in income in a manner consistent with the recognition of premiums on the reinsured contracts. Reinsurance does not extinguish the Company's primary liability under the policies written. Therefore, the Company regularly evaluates the financial condition of its reinsurers including their activities with respect to claim settlement practices and commutations, and establishes allowances for uncollectible reinsurance recoverable as appropriate. There were no allowances as of September 30, 2011 or December 31, 2010.
Benefit reserves: The Company establishes liabilities for amounts payable under insurance policies, including traditional life insurance and annuities. Generally, amounts are payable over an extended period of time. Liabilities for future policy benefits of traditional life insurance have been computed by a net level premium method based upon estimates at the time of issue for investment yields, mortality and withdrawals. These estimates include provisions for experience less favorable than initially expected. Mortality assumptions are based on industry experience expressed as a percentage of standard mortality tables.
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.
Deposit-type contracts: Deposit-type contracts consist of amounts on deposit associated with deferred annuity riders, premium deposit funds and supplemental contracts without life contingencies.
Income taxes: The Company is subject to income taxes in the U.S. federal and various state jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. With few exceptions, the Company is no longer subject to U.S. federal, state or local tax examinations by tax authorities for the years before 2007. The provision for income taxes is based on income as reported in the financial statements. The income tax provision is calculated under the asset and liability method. Deferred tax assets are recorded based on the differences between the financial statement and tax basis of assets and liabilities at the enacted tax rates. The principal assets and liabilities giving rise to such differences are investments, insurance reserves, unearned premiums, and deferred acquisition costs. A deferred tax asset valuation allowance is established when there is uncertainty that such assets would be realized. The Company has no uncertain tax positions that they believe are more-likely-than not that the benefit will not to be realized. When applicable, the Company recognizes interest accrued related to unrecognized tax benefits and penalties in income tax expense. The Company had no accruals for payments of interest and penalties at September 30, 2011 or December 31, 2010.
Revenue recognition and related expenses: Revenues on traditional life insurance products consist of direct and assumed premiums reported as earned when due.
Amounts received as payment for annuities and/or non-traditional contracts such as interest sensitive whole life contracts, single payment endowment contracts, single payment juvenile contracts and other contracts without life contingencies are recognized as deposits to policyholder account balances and included in future insurance policy benefits. Revenues from these contracts are comprised of fees earned for administrative and contract-holder services, which are recognized over the period of the contracts, and included in revenue. Deposits are shown as a financing activity in the Consolidated Statements of Cash Flows.
F-11
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
Amounts received under our multi-benefit policy form are allocated to the life insurance portion of the multi-benefit life insurance arrangement and the annuity portion based upon amounts included in the signed policy.
Liabilities for future policy benefits 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, which generally remain in force for the lifetime of the insured.
We measure our sales or new business production with two components: new premiums recorded and new deposits received. New premiums and deposits are measures of sales or new business production.
Comprehensive loss: Comprehensive loss is comprised of net loss and other comprehensive loss. Accumulated other comprehensive loss includes unrealized gains and losses from marketable securities classified as available for sale. Accumulated other comprehensive loss and comprehensive loss are displayed separately in the consolidated statements of stockholders' equity.
Common and preferred stock and earnings (loss) per share: The par value per common share is $0.001 with 120,000,000 shares authorized. At September 30, 2011, the Company had 8,670,146 common shares issued and outstanding. At December 31, 2010, the Company had 8,182,761 common shares issued and outstanding.
The Class A preferred shares are non-cumulative, non-voting and convertible to common shares after five years at a rate of 1.3 common shares for each preferred share. The par value per preferred share is $0.001 with 2,000,000 shares authorized. At September 30, 2011, the Company had 74,159 preferred shares issued and outstanding. At December 31, 2010, the Company had 74,159 preferred shares issued and outstanding.
Stock repurchases: During the third quarter of 2011, the company repurchased 280,676 shares from one of its original shareholders at the same price that said shares were originally sold. The repurchase was not part of a formal buyback but occurred because Management was presented with an opportunity to buy-back shares at a substantial discount to book value and current market value. Earnings (loss) per share attributable to the Company's common stockholders were computed based on the weighted average number of shares outstanding during each year. The weighted average number of shares outstanding during the quarters ended September 30, 2011 and 2010 were 8,706,887 and 7,626,943 shares, respectively. The weighted average number of shares outstanding during the nine months ended September 30, 2011 and 2010 were 8,573,082 and 7,666,943 shares, respectively. The Company paid no cash dividends during the quarters or nine month periods ended September 30, 2011 or 2010. During the first quarter of 2010, the Company issued a 4% stock dividend to shareholders of record on March 1, 2010, with fractional shares rounded up to the next whole share. A total of 266,209 shares were issued under this stock dividend at a value of $5 per share, resulting in an increase in common stock and additional paid-in capital, and a corresponding charge to accumulated deficit, totaling $1,331,045. On April 29, 2011, the Company issued another 4% stock dividend to shareholders of record on March 31, 2011, with fractional shares rounded up to the next whole share. A total of 341,047 shares were issued under this stock dividend at a value of $5 per share, resulting in an increase in common stock and additional paid-in capital, and a corresponding charge to accumulated deficit, totaling $1,705,235. The weighted average shares outstanding for the quarters and nine month periods ended September 30, 2011 and 2010 have been computed including the pro-forma effect of both 4% dividends for comparative purposes.
F-12
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
Risk and uncertainties: Certain risks and uncertainties are inherent in the Company's day-to-day operations and in the process of preparing its consolidated financial statements. The more significant of those risks and uncertainties, as well as the Company's method for mitigating the risks, are presented below and throughout the notes to the consolidated financial statements.
New Accounting Standards: In October 2010, the FASB issued authoritative guidance to address diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. Under the new guidance, acquisition costs are to include only those costs that are directly related to the acquisition or renewal of insurance contracts by applying a model similar to the accounting for loan origination costs. An entity may defer incremental direct costs of contract acquisition that are incurred in transactions with independent third parties or employees as well as the portion of employee compensation and other costs directly related to underwriting, policy issuance and processing, medical inspection, and contract selling for successfully negotiated contracts. Additionally, an entity may capitalize as a deferred acquisition cost only those advertising costs meeting the capitalization criteria for direct-response advertising. This change is effective for fiscal years beginning after December 15, 2011 and interim periods within those years. Early adoption as of the beginning of a fiscal year is permitted. The guidance is to be applied
F-13
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
prospectively upon the date of adoption, with retrospective application permitted, but not required. The Company adopted this new guidance on January 1, 2012 with no material impact to the consolidated financial statements.
In May 2011, the FASB issued new guidance concerning fair value measurements and disclosure. The new guidance is the result of joint efforts by the FASB and the International Accounting Standards Board to develop a single, converged fair value framework on how to measure fair value and the necessary disclosures concerning fair value measurements. The guidance is effective for interim and annual periods beginning after December 15, 2011 and no early adoption is permitted. The Company adopted this new guidance on January 1, 2012 with no material impact to the consolidated financial statements.
In June 2011, the FASB issued updated guidance to increase the prominence of items reported in other comprehensive income by eliminating the option of presenting components of comprehensive income as part of the statement of changes in stockholders' equity. The updated guidance requires that all non-owner changes in stockholders' equity be presented either as a single continuous statement of comprehensive income or in two separate but consecutive statements. The updated guidance is to be applied retrospectively and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted. The updated guidance will result in a change in the presentation of the Company's financial statements but will not have any impact on the Company's results of operations, financial position or liquidity.
In September 2011, the FASB issued new guidance on goodwill impairment testing. The new guidance is intended to reduce complexity and costs by allowing an entity the option to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether it should calculate the fair value of a reporting unit. Only if an entity determines, based on qualitative assessment, that it is more likely than not that a reporting unit's fair value is less than its carrying value will it be required to calculate the fair value of the reporting unit. The guidance is effective for calendar years beginning after December 15, 2011. Early adoption is permitted. The Company early adopted this new guidance beginning in the fourth quarter of 2011 when we performed our annual impairment test. The adoption did not have a material impact on our consolidated financial statements.
All other new accounting standards and updates of existing standards issued during 2011 and 2010 did not relate to accounting policies and procedures pertinent to the Company at this time.
Note 2. Business Acquisitions
On November 8, 2010, the Company and American Life entered into an agreement to acquire all of the issued and outstanding capital stock of Old Reliance, an Arizona-domiciled life insurance company. The plan provided for American Life to merge into Old Reliance following the purchase, with the survivor changing its name to American Life & Security Corp. In the transaction, the sole shareholder of Old Reliance received: (i) approximately $1.6 million in cash, (ii) $500,000 in the form of a surplus debenture issued by American Life, and (iii) 150,000 shares of voting common stock of the Company. The acquisition of Old Reliance was accounted for under purchase accounting and the results of operations have been included in the consolidated financial statements from August 3, 2011, the effective date of the acquisitions. This acquisition was pursued because it fit the Company's desire to expand its geographic footprint and it also allowed for the acquisition of a policy administration and accounting system.
F-14
Note 2. Business Acquisitions (Continued)
The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of acquisition:
Investments, available for sale, fixed maturities |
2,289,846 | |||
Investments, available for sale, equity securities |
449,668 | |||
Mortgage loans on real estate |
685,465 | |||
Real estate |
590,010 | |||
Policy loans |
241,976 | |||
Cash and cash equivalents |
29,334 | |||
Amounts recoverable from reinsurers |
14,393,302 | |||
Value of business acquired |
824,485 | |||
Intangible assets |
700,000 | |||
Property and equipment |
330,419 | |||
Other assets |
230,659 | |||
Excess cost over fair value of net assets aquired (goodwill) |
555,237 | |||
Benefit reserves |
(17,329,944 | ) | ||
Policy claims |
(282,567 | ) | ||
Deposit-type contracts |
(153,068 | ) | ||
Surplus note liability |
(450,000 | ) | ||
Other liabilities |
(227,058 | ) | ||
Total purchase price |
$ | 2,877,764 | ||
A $700,000 intangible asset was assigned to fourteen (14) state licenses with an indefinite useful life.
The $555,237 of goodwill recognized as a result of the acquisition is not expected to be deductible for tax purposes. The goodwill recorded as part of the acquisition includes the expected synergies and other benefits that management believes will result from combining the operations of Old Reliance with the operations of American Life.
The operating results of Old Reliance from the acquisition date of August 3, 2011 through September 30, 2011 are included in the consolidated statements of income. From the acquisition date through September 30, 2011, Old Reliance had operating revenues of $281,149 and operating expenses of $500,846.
During the quarter ended September 30, 2011 control was attained on a previous noncontrolling interest in Security Capital Corporation. The previously held interest was remeasured at a fair value of $182,200 and a gain of $182,200 was recognized and recorded under miscellaneous income in the consolidated statements of income. The previously held interest had been reduced to $0 in 2009 as a result of the recognition of an impairment expense on the investment due to a lack of projected cash flows. Subsequent to the recognized impairment, an investment in a development stage entity held by Security Capital increased in value. Additionally, management purchased additional shares of Security Capital, which triggered the need for consolidation and revaluation of the entire holding of Security Capital. Management determined that the carrying value approximated the fair value of Security Capital as the assets held by Security Capital consisted of cash and cash equivalents and financial instruments whose carrying value approximated fair value. Security Capital has no liabilities or non-controlling interests as of the acquisition date. The entity is a development stage company that has not conducted operations apart from raising capital. Management's policy is to record these investments at the cost of our investment until such time as the entities commence active operations or when events dictate that our investment will not be recovered. As Security Capital begins operations, there will be
F-15
Note 2. Business Acquisitions (Continued)
significant unobservable inputs into valuing Security Capital including: material non-public financial information, management judgment, estimation of future earnings and cash flows, and liquidity assumptions. The acquisition of Security Capital Corporation added cash and cash equivalents of $21,471 and investments in equity securities of $434,000 to the consolidated balance sheets. Security Capital Corporation had no revenue or earnings for the quarter or nine months ended September 30, 2011.
The following unaudited pro forma information presents the combined results of the Company as though the 2011 business acquisitions of Old Reliance and Security Capital Corporation occurred on January 1, 2010. The pro forma financial information does not necessarily reflect the results of operations if the acquisitions had been in effect at the beginning of the period or that may be attained in the future.
| |
Nine Months Ended September 30, |
||||||
|---|---|---|---|---|---|---|---|
| |
2011 | 2010 | |||||
Premiums |
$ | 2,757,071 | $ | 2,841,923 | |||
Other income |
565,925 | 3,996,427 | |||||
Expenses |
6,178,305 | 9,126,670 | |||||
Net loss |
(2,855,309 | ) | (2,288,320 | ) | |||
Net loss attributable to Midwest Holding, Inc. per common share |
$ | (0.33 | ) | $ | (0.30 | ) | |
Note 3. Commitments and Contingencies
Legal Proceedings: We are involved in litigation incidental to our operations from time to time. We are not presently a party to any legal proceedings other than litigation arising in the ordinary course of our business, and we are not aware of any claims that could materially affect our financial position or results of operations.
Regulatory Matters: State regulatory bodies, the SEC, and other regulatory bodies regularly make inquiries and conduct examinations or investigations concerning the Company's compliance with laws in relation to, but not limited to, insurance and securities. The issues involved in information requests and regulatory matters vary widely. The Company cooperates in these inquiries.
In accordance with U.S. GAAP, the Company establishes an accrued liability for litigation and regulatory matters when the future event is probable and its impact can be reasonably estimated. The initial reserve reflects management's best estimate of the probable cost of ultimate resolution of the matter and is revised accordingly as facts and circumstances change and, ultimately, when the matter is brought to closure.
The Company leases office space under an agreement executed August 28, 2009 and amended on January 21, 2011 that expires on January 31, 2014. As part of the acquisition of Old Reliance, the Company assumed a lease for the headquarters of Old Reliance in Colorado Springs, CO that expires on December 31, 2012. Rent expense for the quarters ended September 30, 2011 and 2010 was $34,378 and $19,442, respectively. Rent expense for the nine months ended September 30, 2011 and 2010 was $80,818 and $63,190, respectively. Future minimum lease payments for the remaining portion of 2011, 2012, 2013 and 2014 are $24,806, $145,076, $128,240 and $10,687, respectively.
F-16
Note 4. Investments
The amortized cost and estimated fair value of investments classified as available-for-sale as of September 30, 2011 and December 31, 2010 are as follows:
| |
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Estimated Fair Value |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
September 30, 2011: |
|||||||||||||
Fixed maturities: |
|||||||||||||
U.S. government obligations |
$ | 3,426,026 | $ | 53,780 | $ | 13,359 | $ | 3,466,447 | |||||
States and political subdivisions—general obligations |
1,278,702 | 36,290 | 4,635 | 1,310,357 | |||||||||
States and political subdivisions—special revenue |
845,209 | 11,902 | 1,341 | 855,770 | |||||||||
Corporate |
4,140,663 | 4,890 | 414,007 | 3,731,546 | |||||||||
Total fixed maturities |
9,690,600 | 106,862 | 433,342 | 9,364,120 | |||||||||
Equity securities: |
|||||||||||||
Common corporate stock |
152,662 | — | 38,080 | 114,582 | |||||||||
Preferred corporate stock |
168,205 | — | 4,290 | 163,915 | |||||||||
Private placement common stock |
1,409,350 | — | — | 1,409,350 | |||||||||
Total equity securities |
1,730,217 | — | 42,370 | 1,687,847 | |||||||||
Total |
$ | 11,420,817 | $ | 106,862 | $ | 475,712 | $ | 11,051,967 | |||||
December 31, 2010: |
|||||||||||||
Fixed maturities: |
|||||||||||||
U.S. government obligations |
$ | 3,357,871 | $ | 6,406 | $ | 160,542 | $ | 3,203,735 | |||||
States and political subdivisions—general obligations |
831,075 | — | 88,772 | 742,303 | |||||||||
States and political subdivisions—special revenue |
267,127 | — | 24,601 | 242,526 | |||||||||
Corporate |
2,327,465 | — | 117,896 | 2,209,569 | |||||||||
Total fixed maturities |
6,783,538 | 6,406 | 391,811 | 6,398,133 | |||||||||
Equity securities: |
|||||||||||||
Preferred corporate stock |
200,000 | — | — | 200,000 | |||||||||
Private placement common stock |
910,725 | — | — | 910,725 | |||||||||
Total equity securities |
1,110,725 | — | — | 1,110,725 | |||||||||
Total |
$ | 7,894,263 | $ | 6,406 | $ | 391,811 | $ | 7,508,858 | |||||
F-17
Note 4. Investments (Continued)
The Company has three securities that individually exceed 10% of the total of the state and political general and special revenue categories as of September 30, 2011. The amortized cost, fair value, number of securities, and credit ratings of these investments are as follows:
| |
September 30, 2011 | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Amortized Cost |
Estimated Fair Value |
Number of Securities |
Credit Ratings |
|||||||||
Fixed Maturities: |
|||||||||||||
States and political subdivisions—general obligations |
$ | 503,128 | $ | 516,803 | 2 | AA+ to A+ | |||||||
States and political subdivisions—special revenue |
319,132 | 323,022 | 1 | A | |||||||||
Total |
$ | 822,260 | $ | 839,825 | 3 | AA+ to A | |||||||
The following table summarizes, for all securities in an unrealized loss position at September 30, 2011 and December 31, 2010, the estimated fair value, pre-tax gross unrealized loss and number of securities by length of time that those securities have been continuously in an unrealized loss position.
| |
September 30, 2011 | December 31, 2010 | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Estimated Fair Value |
Gross Unrealized Loss |
Number of Securities |
Estimated Fair Value |
Gross Unrealized Loss |
Number of Securities |
|||||||||||||
Fixed Maturities: |
|||||||||||||||||||
Less than 12 months: |
|||||||||||||||||||
U.S. government obligations |
$ | 543,961 | $ | 10,368 | 4 | $ | 2,552,276 | $ | 160,542 | 14 | |||||||||
States and political subdivisions—general obligations |
218,944 | 4,635 | 2 | 742,303 | 88,772 | 3 | |||||||||||||
States and political subdivisions—special revenue |
264,111 | 1,341 | 2 | 242,526 | 24,601 | 2 | |||||||||||||
Corporate |
2,545,467 | 247,780 | 22 | 2,209,569 | 117,896 | 16 | |||||||||||||
Greater than 12 months: |
|||||||||||||||||||
U.S. government obligations |
175,023 | 2,991 | 1 | — | — | — | |||||||||||||
Corporate |
891,837 | 166,227 | 6 | — | — | — | |||||||||||||
Total fixed maturities |
$ | 4,639,343 | $ | 433,342 | 37 | $ | 5,746,674 | $ | 391,811 | 35 | |||||||||
Equity Securities: |
|||||||||||||||||||
Less than 12 months: |
|||||||||||||||||||
Common corporate stock |
114,582 | 38,080 | 3 | — | — | — | |||||||||||||
Preferred corporate stock |
63,915 | 4,290 | 2 | — | — | — | |||||||||||||
Total equity securities |
178,487 | 42,370 | 5 | — | — | — | |||||||||||||
Total |
4,817,830 | 475,712 | 42 | — | — | — | |||||||||||||
Based on our review of the securities in an unrealized loss position at September 30, 2011 and December 31, 2010, no other-than-temporary impairments were deemed necessary. Management believes that the Company will fully recover its cost basis in the securities held at September 30, 2011, 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. As of September 30, 2011, there were no individual fixed maturity securities that had a fair value to amortized cost ratio below 79%. The temporary impairments shown herein are primarily the result of the current interest rate environment rather than credit factors that would imply other-than-temporary impairment.
F-18
Note 4. Investments (Continued)
The amortized cost and estimated fair value of fixed maturity securities at September 30, 2011, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
| |
Amortized Cost |
Estimated Fair Value |
|||||
|---|---|---|---|---|---|---|---|
Due in one year or less |
$ | 464,031 | $ | 464,696 | |||
Due after one year through five years |
1,558,188 | 1,534,652 | |||||
Due after five years through ten years |
5,131,149 | 4,864,720 | |||||
Due after ten years |
2,537,232 | 2,500,052 | |||||
|
$ | 9,690,600 | $ | 9,364,120 | |||
The Company is required to hold assets on deposit for the benefit of policyholders in accordance with statutory rules and regulations. At September 30, 2011 and December 31, 2010, these required deposits had a total amortized cost of $2,775,769 and $740,649, respectively.
The components of net investment income for the quarters and nine months ended September 30, 2011 and 2010 are as follows:
| |
Quarter Ended September 30, |
Nine Months Ended September 30, |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
2011 | 2010 | 2011 | 2010 | |||||||||
Fixed maturities |
$ | 89,938 | $ | 59,346 | $ | 226,108 | $ | 109,854 | |||||
Equity securities |
746 | 560 | 1,061 | 624 | |||||||||
Cash and short-term investments |
1,047 | 2,543 | 2,822 | 14,292 | |||||||||
Other |
2,352 | 1,086 | 10,672 | 4,950 | |||||||||
|
94,083 | 63,535 | 240,663 | 129,720 | |||||||||
Less investment expenses |
(7,740 | ) | (12,726 | ) | (22,439 | ) | (16,211 | ) | |||||
|
$ | 86,343 | $ | 50,809 | $ | 218,224 | $ | 113,509 | |||||
Proceeds for the quarters ended September 30, 2011 and 2010 from sales of investments classified as available-for-sale were $1,611,225 and $2,357,611, respectively. Gross gains of $29,254 and $56,862 and gross losses of $0 and $2,111 were realized on those sales during the quarters ended September 30, 2011 and 2010, respectively. Proceeds for the nine months ended September 30, 2011 and 2010 from sales of investments classified as available-for-sale were $3,150,880 and $5,107,147, respectively. Gross gains of $35,380 and $59,606 and gross losses of $20,253 and $75,058 were realized on those sales during the nine months ended September 30, 2011 and 2010, respectively.
During the quarter ended September 30, 2011, control was attained on a previous noncontrolling interest in Security Capital Corporation. The previously held interest was remeasured at fair value and a gain of $182,200 was recognized and recorded under miscellaneous income in the consolidated statements of income.
F-19
Note 5. Fair Values of Financial Instruments
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Accounting standards require the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, accounting standards establish a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
A description of the valuation methodologies used for assets measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
Securities available for sale: The fair values for fixed maturities and preferred corporate stock are determined using Level 2 inputs, which are derived from significant observable pricing information. The fair values for private placement common stock are determined using Level 3 inputs. The fair value for these securities is set equal to their cost basis, given the nature of the companies and their operations as well as the limited trading involved. The fair value of marketable equity securities is based on Level 1 inputs, which are unadjusted quoted prices in active markets for identical assets.
F-20
Note 5. Fair Values of Financial Instruments (Continued)
The following table presents the Company's fair value hierarchy for those financial instruments measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010.
| |
Quoted in Active Markets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
Estimated Fair Value |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
September 30, 2011 |
|||||||||||||
Fixed maturities: |
|||||||||||||
U.S. government obligations |
$ | — | $ | 3,466,447 | $ | — | $ | 3,466,447 | |||||
States and political subdivisions—general obligations |
— | 1,310,357 | — | 1,310,357 | |||||||||
States and political subdivisions—special revenue |
— | 855,770 | — | 855,770 | |||||||||
Corporate |
— | 3,731,546 | — | 3,731,546 | |||||||||
Total fixed maturities |
— | 9,364,120 | — | 9,364,120 | |||||||||
Equity securities: |
|||||||||||||
Common corporate stock |
114,582 | — | — | 114,582 | |||||||||
Preferred corporate stock |
63,915 | 100,000 | — | 163,915 | |||||||||
Private placement common stock |
— | — | 1,409,350 | 1,409,350 | |||||||||
Total equity securities |
178,497 | 100,000 | 1,409,350 | 1,687,847 | |||||||||
Total |
$ | 178,497 | $ | 9,464,120 | $ | 1,409,350 | $ | 11,051,967 | |||||
December 31, 2010 |
|||||||||||||
Fixed maturities: |
|||||||||||||
U.S. government obligations |
$ | — | $ | 3,203,735 | $ | — | $ | 3,203,735 | |||||
States and political subdivisions—general obligations |
— | 742,303 | — | 742,303 | |||||||||
States and political subdivisions—special revenue |
— | 242,526 | — | 242,526 | |||||||||
Corporate |
— | 2,209,569 | — | 2,209,569 | |||||||||
Total fixed maturities |
— | 6,398,133 | — | 6,398,133 | |||||||||
Equity securities: |
|||||||||||||
Preferred corporate stock |
— | 200,000 | — | 200,000 | |||||||||
Private placement common stock |
— | — | 910,725 | 910,725 | |||||||||
Total equity securities |
— | 200,000 | 910,725 | 1,110,725 | |||||||||
Total |
$ | — | $ | 6,598,133 | $ | 910,725 | $ | 7,508,858 | |||||
F-21
Note 5. Fair Values of Financial Instruments (Continued)
The table below sets forth a summary of changes in the fair value of the Company's Level 3 financial instruments for the quarters and nine months ended September 30, 2011 and 2010, respectively:
| |
Quarter Ended September 30, | Nine Months Ended September 30, | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
2011 | 2010 | 2011 | 2010 | |||||||||
| |
Private Placement Common Stock |
Private Placement Common Stock |
Private Placement Common Stock |
Private Placement Common Stock |
|||||||||
Balance, beginning of period |
$ | 922,850 | $ | 753,725 | $ | 910,725 | $ | 55,000 | |||||
Purchases |
486,500 | 66,500 | 498,625 | 765,225 | |||||||||
Balance, end of period |
$ | 1,409,350 | $ | 820,225 | $ | 1,409,350 | $ | 820,225 | |||||
Accounting standards require disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring basis are discussed above. There were no financial assets or financial liabilities measured at fair value on a non-recurring basis.
Fixed maturity securities: Fixed maturity securities are recorded at fair value on a recurring basis utilizing a third-party pricing source. The valuations are reviewed and validated quarterly through random testing by comparisons to separate pricing models or other third party pricing services. For the period ended December 31, 2011, there were no material changes to the valuation methods or assumptions used to determine fair values, and no broker or third party prices were changed from the values received. Securities with prices based on validated quotes from pricing services are reflected within Level 2.
Equity securities: Equity securities consist principally of common stock of publicly and privately traded companies and preferred stock of publicly traded companies. The fair values of publicly traded equity securities are based on quoted market prices in active markets for identical assets and are classified within Level 1 in the fair value hierarchy. The fair values of a portion of our preferred equity securities are based on prices obtained from independent pricing services and these securities are generally classified within Level 2 in the fair value hierarchy. The fair values of Level 3 equity securities approximate cost and are predominately invested in developmental stage companies that have not conducted operations apart from raising capital. Management's policy is to record these investments at the cost of our investment until such time as the entities commence active operations or when events dictate that our investment will not be recovered. As these companies begin operations, there will be significant unobservable inputs into valuing these securities including: material non-public financial information, management judgment, estimation of future earnings and cash flows, and liquidity assumptions. These inputs are usually considered unobservable, as not all market participants will have access to this data, and therefore are classified within Level 3 in the fair value hierarchy.
Cash and cash equivalents and short-term investments: The carrying value of cash and cash equivalents and short-term investments approximate the fair value because of the short maturity of the investments.
Policy loans: Policy loans are stated at unpaid principal balances. As these loans are fully collateralized by the cash surrender value of the underlying insurance policies, the carrying value of the policy loans approximates their fair value.
F-22
Note 5. Fair Values of Financial Instruments (Continued)
Notes Receivable: Fair values for short-term notes receivable approximate carrying value. The carrying amount is a reasonable estimate of the fair value because of the relatively short time between the origination of the loan and its expected repayment.
Mortgage loans: The fair values of mortgage loans are estimated by discounting scheduled cash flows through the scheduled maturities of the loans, using interest rates currently being offered for similar loans to borrowers with similar credit ratings.
Investment-type contracts: The fair value for direct and assumed 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 nonperformance risk of the liabilities. Liabilities under investment-type insurance contracts that are wholly ceded by CRLIC to a non-affiliated reinsurer are carried at cash surrender value which approximates fair value. The fair values for insurance contracts other than investment-type contracts are not required to be disclosed.
Surplus notes: The fair value for surplus notes is calculated using a discounted cash flow approach. Cash flows are projected utilizing scheduled repayments and discounted to the valuation date using market rates currently available for debt with similar remaining maturities.
The following disclosure contains the estimated fair values of financial assets and financial liabilities as of September 30, 2011 and December 31, 2010:
| |
September 30, 2011 | December 31, 2010 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Carrying Amount |
Fair Value |
Carrying Amount |
Fair Value |
|||||||||
Assets: |
|||||||||||||
Fixed maturities |
$ | 9,364,120 | $ | 9,364,120 | $ | 6,398,133 | $ | 6,398,133 | |||||
Equity securities |
1,687,847 | 1,687,847 | 1,110,725 | 1,110,725 | |||||||||
Mortgage loans on real estate |
685,465 | 685,465 | — | — | |||||||||
Policy loans |
329,422 | 329,422 | 94,272 | 94,272 | |||||||||
Notes receivable |
257,383 | 257,383 | 200,000 | 200,000 | |||||||||
Short-term investments |
515,725 | 515,725 | 500,000 | 500,000 | |||||||||
Cash and cash equivalents |
2,817,219 | 2,817,219 | 5,250,468 | 5,250,468 | |||||||||
Liabilities: |
|||||||||||||
Policyholder deposits |
11,404,524 | 11,610,764 | 11,692,181 | 11,759,019 | |||||||||
Surplus Notes |
950,000 | 1,059,195 | — | — | |||||||||
F-23
Note 6. Income Tax Matters
Significant components of the Company's deferred tax assets and liabilities as of September 30, 2011 and December 31, 2010 are as follows:
| |
September 30, 2011 |
December 31, 2010 |
|||||
|---|---|---|---|---|---|---|---|
Deferred tax assets: |
|||||||
Loss carryforwards |
$ | 3,631,575 | $ | 1,727,972 | |||
Capitalized costs |
975,231 | — | |||||
Unrealized losses on investments |
125,409 | 131,038 | |||||
Benefit reserves |
498,049 | 131,868 | |||||
Total deferred tax assets |
5,230,264 | 1,990,878 | |||||
Less valuation allowance |
(4,019,978 | ) | (1,553,381 | ) | |||
Total deferred tax assets, net of valuation allowance |
1,210,286 | 437,497 | |||||
Deferred tax liabilities: |
|||||||
Policy acquisition costs |
426,663 | 383,548 | |||||
Due premiums |
47,218 | 26,612 | |||||
Value of business acquired |
399,805 | 27,337 | |||||
Intangible assets |
238,000 | — | |||||
Property and equipment |
98,600 | — | |||||
Total deferred tax liabilities |
1,210,286 | 437,497 | |||||
Net deferred tax assets |
$ | — | $ | — | |||
At September 30, 2011 and December 31, 2010, the Company recorded a valuation allowance of $4,019,978 and $1,553,381, respectively, on the deferred tax assets to reduce the total to an amount that management believes will ultimately be realized. Realization of deferred tax assets is dependent upon sufficient future taxable income during the period that deductible temporary differences and carryforwards are expected to be available to reduce taxable income. As part of the valuation allowance of $1,553,381 recorded at December 31, 2010, the Company included $379,542 as a valuation allowance against loss carryforwards within CRLIC as of the purchase date of January 1, 2010. As part of the valuation allowance of $4,019,978 recorded at September 30, 2011, the Company included $705,456 as a valuation allowance against loss carryforwards within Old Reliance as of the purchase date of August 3, 2011.
In connection with its acquisition of Old Reliance Insurance Company, the Company acquired net deferred tax assets of $1,203,492. The Company determined that a valuation allowance for the entire amount was necessary. This acquisition of these net deferred tax assets and the related valuation did not impact the Company's income tax expense during the period.
Loss carryforwards for tax purposes as of September 30, 2011, have expiration dates that range from 2024 through 2026.
F-24
Note 6. Income Tax Matters (Continued)
There was no income tax expense for the quarters or nine months ended September 30, 2011 and 2010. This differed from the amounts computed by applying the statutory U.S. federal income tax rate of 34% to pretax income, as a result of the following:
| |
Quarter Ended September 30, |
Nine Months Ended September 30, |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
2011 | 2010 | 2011 | 2010 | |||||||||
Computed expected income tax benefit |
$ | (324,330 | ) | $ | (247,383 | ) | $ | (900,848 | ) | $ | (671,059 | ) | |
Increase (reduction) in income taxes resulting from: |
|||||||||||||
Meals, entertainment and political contributions |
9,464 | 2,259 | 14,361 | 4,119 | |||||||||
Dividends received deduction |
(186 | ) | — | (261 | ) | — | |||||||
Value of business acquired |
280,325 | — | 280,325 | 39,551 | |||||||||
Intangible assets acquired |
238,000 | — | 238,000 | — | |||||||||
Property and equipment acquired and remeasured at fair value |
98,600 | — | 98,600 | — | |||||||||
True-up of provision to actual |
(18,051 | ) | 1,481 | (18,051 | ) | 1,481 | |||||||
Start-up costs amortized for tax purposes |
(975,231 | ) | — | (975,231 | ) | — | |||||||
Other |
17 | — | — | (5,323 | ) | ||||||||
|
(367,062 | ) | 3,740 | (362,257 | ) | 39,828 | |||||||
Tax benefit before valuation allowance |
(691,392 | ) | (243,643 | ) | (1,263,105 | ) | (631,231 | ) | |||||
Change in valuation allowance |
691,392 | 243,643 | 1,263,105 | 631,231 | |||||||||
Net income tax expense |
$ | — | $ | — | $ | — | $ | — | |||||
Note 7. Reinsurance
A summary of significant reinsurance amounts affecting the accompanying interim consolidated financial statements as of September 30, 2011 and December 31, 2010, and for the quarters and nine months ended September 30, 2011 and 2010 is as follows:
| |
September 30, 2011 | December 31, 2010 | |||||
|---|---|---|---|---|---|---|---|
Balance sheets: |
|||||||
Benefit and claim reserves assumed |
$ | 3,287,916 | $ | 3,395,026 | |||
Benefit and claim reserves ceded |
34,323,877 | 20,914,194 | |||||
| |
Quarter Ended September 30, |
Nine Months Ended September 30, |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
2011 | 2010 | 2011 | 2010 | |||||||||
Statements of income: |
|||||||||||||
Premiums assumed |
$ | 8,475 | $ | 1,338 | $ | 25,994 | $ | 29,168 | |||||
Premiums ceded |
103,647 | 124,383 | 323,415 | 393,083 | |||||||||
Consideration on reinsurance assumed |
— | 26,990 | — | 3,729,599 | |||||||||
Benefits assumed |
10,198 | 72,813 | 48,281 | 256,515 | |||||||||
Benefits ceded |
226,995 | 160,024 | 692,488 | 563,166 | |||||||||
Commissions assumed |
15 | 27,011 | 37 | 27,048 | |||||||||
Commissions ceded |
5,238 | 7,533 | 15,590 | 23,249 | |||||||||
F-25
Note 7. Reinsurance (Continued)
The following table provides a summary of the significant reinsurance balances recoverable on paid and unpaid policy claims by reinsurer along with the A.M. Best credit rating as of September 30, 2011:
Reinsurer
|
AM Best Rating |
Recoverable on Paid Losses |
Recoverable on Unpaid Losses |
Recoverable on Benefit Reserves/ Deposit-Type Contracts |
Total Amount Recoverable from Reinsurer |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Security National Life Insurance Company |
NR | $ | — | $ | 131,706 | $ | 19,723,474 | $ | 19,855,180 | ||||||
Optimum Re Insurance Company |
A- | — | 40,565 | 7,516 | 48,081 | ||||||||||
Investors Heritage Life Insurance Company |
B+ | — | 23,006 | 4,308 | 27,314 | ||||||||||
Sagicor Life Insurance Company |
A- | — | 258,227 | 14,135,075 | 14,393,302 | ||||||||||
|
$ | 453,504 | $ | 33,870,373 | $ | 34,323,877 | |||||||||
CRLIC has a 100% coinsurance agreement with SNL whereby 100% of the business written by CRLIC is ceded to SNL. At September 30, 2011 and December 31, 2010, total benefit reserves, policy claims and deposit-type contracts ceded by CRLIC to SNL were $19,855,180 and $20,887,037, respectively. CRLIC remains contingently liable on this ceded reinsurance should SNL be unable to meet their obligations.
During 1999, Old Reliance entered into a 75% coinsurance agreement with Sagicor Life (Sagicor) whereby 75% of the business written by Old Reliance is ceded to Sagicor. During 2000, Old Reliance coinsured the remaining 25% with Sagicor. At September 30, 2011, total benefit reserves, policy claims and deposit-type contracts ceded by Old Reliance to Sagicor were $14,393,302. Old Reliance remains contingently liable on this ceded reinsurance should Sagicor be unable to meet their obligations.
The use of reinsurance does not relieve the Company of its primary liability to pay the full amount of the insurance benefit in the event of the failure of a reinsurer to honor its contractual obligation. Consequently, the Company avoids concentrating reinsurance risk with any one reinsurer and only participates in reinsurance treaties with reputable carriers. No reinsurer of business ceded by the Company has failed to pay policy claims (individually or in the aggregate) with respect to our ceded business.
At September 30, 2011, the Company had over 99% of its reinsurance recoverable amounts concentrated with two reinsurers, Sagicor and SNL. $20 million of reinsurance recoverable amounts are from SNL, who is not rated by A.M. Best.
The Company monitors several factors that it considers relevant to satisfy itself as to the ongoing ability of a reinsurer to meet all obligations of the reinsurance agreements. These factors include the credit rating of the reinsurer, the financial strength of the reinsurer, significant changes or events of the reinsurer, and any other relevant factors. If the Company believes that any reinsurer would not be able to satisfy its obligations with the Company, a separate contingency reserve may be established. At December 31, 2011 and 2010, no contingency reserve was established.
Note 8. Deposit-Type Contracts
The Company's deposit-type contracts represent the contract value that has accrued to the benefit of the policyholder as of the balance sheet date. This liability is equal to the accumulated account
F-26
Note 8. Deposit-Type Contracts (Continued)
deposits, plus interest credited, and less policyholder withdrawals. The following table provides information about deposit-type contracts at September 30, 2011 and December 31, 2010:
| |
Nine Months Ended September 30, 2011 |
Year Ended December 31, 2010 |
|||||
|---|---|---|---|---|---|---|---|
Beginning balance |
$ | 11,692,181 | $ | 97,464 | |||
Change in deposit-type contracts from Old Reliance acquisition |
153,109 | — | |||||
Change in deposit-type contracts assumed from SNL |
(95,393 | ) | 2,415,310 | ||||
Change in deposit-type contracts fully ceded by CRLIC |
(768,808 | ) | 8,923,395 | ||||
Deposits received |
430,348 | 271,143 | |||||
Investment earnings |
19,161 | 5,313 | |||||
Withdrawals |
(26,074 | ) | (20,444 | ) | |||
Ending balance |
$ | 11,404,524 | $ | 11,692,181 | |||
Under the terms of ALSC's coinsurance agreement with SNL, ALSC assumes certain deposit-type contract obligations, as shown in the table above. Additionally, CRLIC cedes 100% of its direct business to SNL. Accordingly, this amount is presented within the corresponding single line above. The remaining deposits, withdrawals and interest credited represent those for ALSC's direct business.
Note 9. Statutory Net Income and Surplus
ALSC is required to prepare statutory financial statements in accordance with statutory accounting practices prescribed or permitted by the Arizona Department of Insurance. Likewise, CRLIC is required to prepare statutory financial statements in accordance with statutory accounting practices prescribed or permitted by the Missouri Department of Insurance. Statutory practices primarily differ from GAAP by charging policy acquisition costs to expense as incurred, establishing future policy benefit liabilities using different actuarial assumptions as well as valuing investments and certain assets and accounting for deferred taxes on a different basis. The statutory net loss of ALSC amounted to $1,311,890 for the nine months ended September 30, 2011 and $1,202,940 for the nine months ended September 30, 2010. Statutory capital and surplus of ALSC amounted to $4,942,302 and $5,636,925 at September 30, 2011 and December 31, 2010, respectively. The statutory net loss of CRLIC was $82,839 for the nine months ended September 30, 2011 and $41,230 for the nine months ended September 30, 2010. Statutory capital and surplus of CRLIC totaled $1,376,468 and $1,584,780 at September 30, 2011 and December 31, 2010, respectively.
Note 10. Surplus Notes
Old Reliance executed two surplus notes during 2006 to First American Capital Corporation (First American), a Maryland Corporation, totaling $250,000. The notes are at 7% interest per annum and mature in September 2016. Old Reliance executed one surplus note during 2008 to David G. Elmore, in the amount of $200,000 at 7% interest per annum maturing in December 2011. As part of the Old Reliance acquisition, the Company executed a second surplus note to David G. Elmore, in the amount of $500,000 at 5% interest per annum maturing in August 2016. Any payments and/or repayments must be approved by the Arizona Department of Insurance (ADOI). No interest or principal repayments have been made as of September 30, 2011.
F-27
Note 11. Related Party Transactions
The Company has a consulting agreement with a corporation owned by a Board member. The agreement, approved by the Board of Directors, provides for consulting services related to capital raising and special projects and runs through 2012. Total payments made by the Company during the quarter and nine months ended September 30, 2011 amounted to $48,925 and $158,880, respectively. Total payments made by the Company during the quarter and nine months ended September 30, 2010 amounted to $79,545 and $199,595, respectively.
ALSC has a general agent contract with a corporation owned by an officer of Midwest. The agreement, which was approved by the Board of Directors of Midwest and ALSC, specifies that the corporation, a licensed insurance agency, shall receive an override on business written in exchange for managing the Company's marketing. In addition, the agency must pay for all sales conventions, contests, prizes, awards and training seminars. Total payments made by ALSC during the quarter and nine months ended September 30, 2011 were $98,535 and $311,133, respectively. Total payments made by ALSC during the quarter and nine months ended September 30, 2010 were $99,745 and $268,523, respectively. This agreement was terminated in October 2011.
Note 12. Subsequent Events
All of the effects of subsequent events that provide additional evidence about conditions that existed at September 30, 2011, including the estimates inherent in the process of preparing consolidated financial statements, are recognized in the consolidated financial statements. The Company does not recognize subsequent events that provide evidence about conditions that did not exist at the date of the interim consolidated financial statements but arose after, but before the interim consolidated financial statements were available to be issued. In some cases, non recognized subsequent events are disclosed to keep the interim consolidated financial statements from being misleading.
The Company has evaluated subsequent events through the date that the interim consolidated financial statements were issued.
F-28
Report of Independent Registered Public Accounting Firm
To
the Board of Directors
Midwest Holding Inc. and Subsidiaries
Lincoln, Nebraska
We have audited the accompanying consolidated balance sheets of Midwest Holding Inc. and Subsidiaries (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in stockholder's 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 financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public 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 audits included consideration of internal control over financial reporting as a basis 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 financial position of Midwest Holding Inc. and Subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.
/s/ McGladrey & Pullen, LLP
Omaha,
Nebraska
June 10, 2011
F-29
Midwest Holding Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 2010 and 2009
| |
2010 | 2009 | |||||
|---|---|---|---|---|---|---|---|
Assets |
|||||||
Investments, available for sale, at fair value |
|||||||
Fixed maturities |
$ | 6,398,133 | $ | 4,721,332 | |||
Equity securities |
1,110,725 | 55,000 | |||||
Policy loans |
94,272 | — | |||||
Note receivable |
200,000 | — | |||||
Short-term investments |
500,000 | 1,506,665 | |||||
Total investments |
8,303,130 | 6,282,997 | |||||
Cash and cash equivalents |
5,250,468 | 1,484,114 | |||||
Amounts recoverable from reinsurers |
20,914,194 | 3,987 | |||||
Interest and dividends due and accrued |
82,388 | 39,352 | |||||
Premiums receivable |
78,270 | 9,892 | |||||
Deferred acquisition costs, net |
1,267,598 | 213,378 | |||||
Value of business acquired, net |
417,902 | — | |||||
Property and equipment, net |
138,262 | 128,746 | |||||
Other assets |
58,116 | 27,651 | |||||
Total assets |
$ | 36,510,328 | $ | 8,190,117 | |||
Liabilities and Stockholders' Equity |
|||||||
Liabilities: |
|||||||
Benefit reserves |
$ | 13,903,783 | $ | 183,784 | |||
Policy claims |
183,706 | 7,347 | |||||
Deposit-type contracts |
11,692,181 | 97,464 | |||||
Advance premiums |
717 | — | |||||
Total policy liabilities |
25,780,387 | 288,595 | |||||
Accounts payable and accrued expenses |
360,147 | 376,546 | |||||
Total liabilities |
26,140,534 | 665,141 | |||||
Stockholders' Equity: |
|||||||
Preferred stock |
74 | — | |||||
Common stock |
8,183 | 6,600 | |||||
Additional paid-in capital |
19,498,839 | 12,820,538 | |||||
Accumulated deficit |
(8,751,897 | ) | (5,197,647 | ) | |||
Accumulated other comprehensive loss |
(385,405 | ) | (104,515 | ) | |||
Total stockholders' equity |
10,369,794 | 7,524,976 | |||||
Total liabilities and stockholders' equity |
$ | 36,510,328 | $ | 8,190,117 | |||
See Notes to Consolidated Financial Statements.
F-30
Midwest Holding Inc. and Subsidiaries
Consolidated Statements of Operations
Years Ended December 31, 2010 and 2009
| |
2010 | 2009 | |||||
|---|---|---|---|---|---|---|---|
Income: |
|||||||
Premiums |
$ | 1,910,562 | $ | 354,352 | |||
Consideration on reinsurance assumed |
3,729,599 | — | |||||
Investment income, net of expenses |
167,613 | 89,926 | |||||
Realized loss on investments |
(71 | ) | — | ||||
Miscellaneous income |
24,138 | — | |||||
|
5,831,841 | 444,278 | |||||
Expenses: |
|||||||
Death and other benefits |
162,099 | 4,890 | |||||
Increase in benefit reserves |
4,650,227 | 182,781 | |||||
Acquisition costs deferred |
(1,375,155 | ) | (283,370 | ) | |||
Amortization of deferred acquisition costs |
320,935 | 69,992 | |||||
Salaries and benefits |
960,154 | 655,862 | |||||
Commission |
1,251,817 | 255,659 | |||||
Professional and administrative fees |
1,174,714 | 233,324 | |||||
Travel and entertainment |
139,072 | 79,877 | |||||
Rent |
93,369 | 41,762 | |||||
Depreciation and amortization of value of business acquired |
74,307 | 14,205 | |||||
Other operating expenses |
603,507 | 265,661 | |||||
|
8,055,046 | 1,520,643 | |||||
Loss before income tax expense |
(2,223,205 | ) | (1,076,365 | ) | |||
Income tax expense |
— |
— |
|||||
Net loss |
$ | (2,223,205 | ) | $ | (1,076,365 | ) | |
Net loss per common share |
$ | (0.32 | ) | $ | (0.17 | ) | |
See Notes to Consolidated Financial Statements.
F-31
Midwest Holding Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 2010 and 2009
| |
Preferred Stock |
Common Stock |
Additional Paid-In Capital |
Accumulated Deficit |
Noncontrolling Interest |
Accumulated Other Comprehensive Loss |
Total | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Balance, December 31, 2008 |
$ | — | $ | 5,639 | $ | 8,277,786 | $ | (3,487,825 | ) | $ | (633,457 | ) | $ | — | $ | 4,162,143 | ||||||
Dissolution of subsidiary (See Note 9) |
— |
— |
— |
(633,457 |
) |
633,457 |
— |
— |
||||||||||||||
Issuance of 961,380 shares at $5.00 per share net of capital raising expenses |
— |
961 |
4,542,752 |
— |
— |
— |
4,543,713 |
|||||||||||||||
Net loss |
— |
— |
— |
(1,076,365 |
) |
— |
— |
(1,076,365 |
) |
|||||||||||||
Unrealized loss on investments |
— |
— |
— |
— |
— |
(104,515 |
) |
(104,515 |
) |
|||||||||||||
Total comprehensive loss |
(1,180,880 | ) | ||||||||||||||||||||
Balance, December 31, 2009 |
— | 6,600 | 12,820,538 | (5,197,647 | ) | — | (104,515 | ) | 7,524,976 | |||||||||||||
Sale of 74,159 shares at $6.00 per share net of capital raising expenses |
74 |
— |
415,676 |
— |
— |
— |
415,750 |
|||||||||||||||
Sale of 1,317,512 shares at $5.00 per share net of capital raising expenses |
— |
1,317 |
4,931,846 |
— |
— |
— |
4,933,163 |
|||||||||||||||
Net loss |
— |
— |
— |
(2,223,205 |
) |
— |
— |
(2,223,205 |
) |
|||||||||||||
Unrealized loss on investments |
— |
— |
— |
— |
— |
(280,890 |
) |
(280,890 |
) |
|||||||||||||
Total comprehensive loss |
(2,504,095 | ) | ||||||||||||||||||||
Stock dividend |
— |
266 |
1,330,779 |
(1,331,045 |
) |
— |
— |
— |
||||||||||||||
Balance, December 31, 2010 |
$ | 74 | $ | 8,183 | $ | 19,498,839 | $ | (8,751,897 | ) | $ | — | $ | (385,405 | ) | $ | 10,369,794 | ||||||
See Notes to Consolidated Financial Statements.
F-32
Midwest Holding Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2010 and 2009
| |
2010 | 2009 | |||||
|---|---|---|---|---|---|---|---|
Cash Flows from Operating Activities: |
|||||||
Net loss |
$ | (2,223,205 | ) | $ | (1,076,365 | ) | |
Adjustments to reconcile net loss to net cash and cash equivalents used in operating activities: |
|||||||
Net adjustment for premium and discount on investments |
52,614 | 12,525 | |||||
Depreciation and amortization |
74,307 | 14,205 | |||||
Deferral of acquisition costs |
(1,375,155 | ) | (283,370 | ) | |||
Amortization of deferred acquisition costs |
320,935 | 69,992 | |||||
Realized loss on investments |
71 | — | |||||
Changes in operating assets and liabilities: |
|||||||
Amounts recoverable from reinsurers |
975,040 | (3,987 | ) | ||||
Interest and dividends due and accrued |
(43,036 | ) | (32,446 | ) | |||
Due premiums |
(68,378 | ) | (9,892 | ) | |||
Policy liabilities |
3,007,836 | 191,658 | |||||
Other assets and liabilities |
(53,036 | ) | 290,615 | ||||
Net cash provided by (used in) operating activities |
667,993 | (827,065 | ) | ||||
Cash Flows from Investing Activities: |
|||||||
Securities available for sale: |
|||||||
Purchases |
(9,747,740 | ) | (4,838,783 | ) | |||
Sales and maturities |
7,334,563 | 1,506,970 | |||||
Net change in policy loans |
(94,272 | ) | — | ||||
Acquisition of notes receivable |
(200,000 | ) | — | ||||
Net change in short-term investments |
1,006,665 | (1,506,665 | ) | ||||
Net purchases of property and equipment |
(37,389 | ) | (127,851 | ) | |||
Purchase of Capital Reserve Life Insurance Company, net of cash and cash equivalents |
(763,078 | ) | — | ||||
Net cash used in investing activities |
(2,501,251 | ) | (4,966,329 | ) | |||
Cash Flows from Financing Activities: |
|||||||
Net proceeds from sale of common stock |
4,933,163 | 4,543,713 | |||||
Net proceeds from sale of preferred stock |
415,750 | — | |||||
Receipts on deposit type contracts |
271,143 | 109,387 | |||||
Withdrawals on deposit type contracts |
(20,444 | ) | (12,450 | ) | |||
Net cash provided by financing activities |
5,599,612 | 4,640,650 | |||||
Net increase (decrease) in cash and cash equivalents |
3,766,354 | (1,152,744 | ) | ||||
Cash and cash equivalents: |
|||||||
Beginning |
1,484,114 | 2,636,858 | |||||
Ending |
$ | 5,250,468 | $ | 1,484,114 | |||
Supplemental Disclosure of Non-Cash Information: |
|||||||
Stock dividend |
$ | 1,331,045 | $ | — | |||
Dissolution of subsidiary in exchange for stock |
— | 633,457 | |||||
Acquisition of Capital Reserve Life Insurance Company: |
|||||||
Value of business acquired |
$ | 116,326 | $ | — | |||
Investments in fixed maturities acquired |
646,752 | — | |||||
Amounts recoverable from reinsurers acquired |
21,885,247 | — | |||||
Policy claims assumed |
(154,413 | ) | — | ||||
Benefit Reserves assumed |
(11,979,023 | ) | — | ||||
Deposit-type contracts assumed |
(9,751,811 | ) | — | ||||
|
$ | 763,078 | $ | — | |||
See Notes to Consolidated Financial Statements.
F-33
Note 1. Nature of Operations and Summary of Significant Accounting Policies
Nature of operations: Midwest Holding Inc. (Midwest) was incorporated in Nebraska on October 31, 2003 for the primary purpose of organizing a life insurance subsidiary. From 2003 to May, 2009, Midwest was focused on raising capital, first through private placements and finally through an intra-state offering of 2,000,000 common shares at $5.00 per share. These offerings sold out, including a 10% oversale on the Final Offering. Midwest became operational during the year ended December 31, 2009. Upon capitalizing American Life & Security Corporation (ALSC) and acquiring Capital Reserve Life Insurance Company (CRLIC), as described below, Midwest deemed it prudent to raise additional capital to fund primarily the expansion of the life insurance operation.
In August, 2010, Midwest began an exempt offering of shares to existing holders in the state of Nebraska. As of December 31, 2010, Midwest had raised approximately $5,300,000 through this offering. Additionally, Midwest offered a newly-created class of preferred shares to residents of Latin America. The preferred shares are non-voting and convert to common shares in 2015 at the rate of 1.3 common shares per each preferred share. The shares were sold at $6.00 per share and a total of 74,159 were sold as of December 31, 2010.
On May 7, 2009, ALSC, a wholly-owned subsidiary of Midwest, was authorized to do business in the State of Nebraska. ALSC was also granted a certificate of authority to write insurance in the State of Nebraska on September 1, 2009. ALSC is engaged in the business of underwriting, selling, and servicing life insurance and annuity policies.
During the second quarter of 2010, ALSC completed the purchase of a 100% ownership interest in CRLIC, an insurance company domiciled in Missouri. The purchase was effective as of January 1, 2010. ALSC purchased CRLIC for its statutory capital and surplus plus $116,326. CRLIC is licensed to issue business in the states of Iowa, Kansas and Missouri. Currently, 100% of the business issued by CRLIC is reinsured to an unaffiliated reinsurer.
Hereafter, entities are collectively referred to as the "Company."
Basis of presentation: The accompanying consolidated financial statements include the accounts of Midwest, its wholly-owned subsidiary ALSC, and ALSC's wholly-owned subsidiary CRLIC.
These consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). All intercompany accounts and transactions have been eliminated in consolidation.
Reclassifications: Certain reclassifications have been made in the prior year financial statements to conform to current year presentation. These reclassifications had no effect on previously reported net income or stockholders' equity.
Investments: All fixed maturities and equity securities owned by the Company are considered available-for-sale and are included in the financial statements at their fair value as of the statement date. Bond premiums and discounts are amortized using the scientific-yield method over the term of the bonds. Realized gains and losses on securities sold during the year are determined using the specific identification method. Unrealized holding gains and losses, net of applicable income taxes, are included in accumulated other comprehensive loss.
Declines in the fair value of available-for-sale securities below their amortized cost are evaluated to assess whether any other-than-temporary impairment loss should be recorded. In determining if these losses are expected to be other-than-temporary, the Company considers severity of impairment, duration of impairment, forecasted recovery period, industry outlook, financial condition of the issuer,
F-34
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
projected cash flows, issuer credit ratings and the intent and ability of the Company to hold the investment until the recovery of the cost.
The recognition method of the other-than-temporary impairment losses on debt securities is dependent on the facts and circumstances related to the specific security. If the Company intends to sell a security or it is more likely than not that the Company would be required to sell a security prior to recovery of the amortized cost, the difference between amortized cost and fair value is recognized in the income statement as an other-than-temporary impairment. If the Company does not expect to recover the amortized basis, does not plan to sell the security and if it is not more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, less any current period credit loss, the recognition of the other-than-temporary impairment is bifurcated. The Company recognizes the credit loss portion in the income statement and the noncredit loss portion in accumulated other comprehensive loss. The credit component of an other-than-temporary impairment is determined by comparing the net present value of projected cash flows with the amortized cost basis of the debt security. The net present value is calculated by discounting the Company's best estimate of projected future cash flows at the effective interest rate implicit in the fixed income security at the date of acquisition. Cash flow estimates are driven by assumptions regarding probability of default, including changes in credit ratings, and estimates regarding timing and amount of recoveries associated with a default. No other-than-temporary write-downs were recognized in 2010 or 2009.
The Company's equity securities are investments in private placement common stocks for several recently formed holding companies organized for the purpose of forming life insurance subsidiaries. These companies are not yet operational as they are currently in the process of raising capital. Given the nature of these investments, the cost basis of these investments approximates their fair value.
Investment income consists primarily of interest, which is recognized on an accrual basis.
Policy loans: Policy loans are carried at unpaid principal balances. Interest income on policy loans is recognized in net investment income at the contract interest rate when earned.
Notes receivable: Notes receivable are stated at their outstanding principal amount. Outstanding notes accrue interest based on the terms of the respective note agreements. Notes past due over 90 days are evaluated for impairment. As of December 31, 2010, there were no notes over 90 days past due.
Short-term investments: Short-term investments are stated at cost and consist of certificates of deposit, with maturities of greater than 90 days. At December 31, 2010 and 2009, the cost of these investments approximates fair value.
Cash and cash equivalents: The Company considers all liquid investments with original maturities of three months or less when purchased to be cash equivalents. At December 31, 2010 and 2009, cash equivalents consisted primarily of money market accounts. The Company has cash on deposit with financial institutions which at times may exceed the Federal Deposit Insurance Corporation insurance limits. The Company has not suffered any losses in the past and does not believe it is exposed to any significant credit risk in these balances.
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. 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.
F-35
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
Value of business acquired: Value of business acquired (VOBA) represents the estimated value assigned to purchased companies or insurance in force of the assumed policy obligations at the date of acquisition of a block of policies. ALSC purchased CRLIC during 2010, resulting in an initial capitalized asset for value of business acquired of $116,326. This asset is being amortized over and estimated life of ten years, resulting in amortization in 2010 of $11,633. Estimated annual amortization over the remaining nine years is $11,633 per year.
Additionally, ALSC entered into a coinsurance agreement with Security National Life Insurance Company (SNL), effective January 1, 2010, to reinsure a block of traditional whole life policies and a block of deferred annuities of SNL. Under the terms of the agreement, SNL ceded to ALSC a block of deferred annuities in the amount of $2,678,931 and a block of whole life policies in the amount of $1,048,134, together with net due and deferred premiums in the amount of $12,305, advance premiums in the amount of $353, claims liabilities in the amount of $14,486, and net policy loans in the amount of $128,487. This asset is being amortized over and estimated life of ten years, resulting in amortization in 2010 of $34,801. Estimated annual amortization over the remaining nine years is $34,801 per year.
On the effective date of the reinsurance contract, ALSC assumed the immediate obligation for performance related to the underlying policies covered by the agreement. In other words, SNL transferred its risk to us. As part of the contract, SNL agreed to pay ALSC an amount equal to the adjusted net reserves on the effective date of the agreement with respect to the liabilities reinsured as of such date. In accordance with FASB ASC 944-605-25-3, "Financial Services—Insurance, Revenue Recognition, Long-Duration Contracts," the assumed premiums paid to ALSC by SNL, along with the Company's estimate of losses incurred, were immediately recognized into earnings. The Company recorded income of $3,729,599 that was offset by the assumption of the reserve liability, which was recorded as an increase in benefit reserve expense. The Company concluded gross reporting was appropriate because the Company obtained immediate risk and rewards of ownership.
Additionally, the Company paid an upfront ceding commission of $375,000. An initial asset was established for the value of this business acquired totaling $348,010, representing primarily the ceding commission. This asset is being amortized over and estimated life of ten years, resulting in amortization in 2010 of $34,801. Estimated annual amortization over the remaining nine years is $34,801 per year. The agreement has an automatic renewal provision unless the Company notifies SNL of its intention not to renew, no less than 180 days prior to the expiration of the then current agreement. Each automatic renewal period is for one year.
At least annually, a review is performed of the models and the assumptions used to develop expected future profits, based upon management's current view of future events. VOBA is reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts. Management's view primarily reflects Company experience but can also reflect emerging trends within the industry. Short-term deviations in experience affect the amortization of VOBA in the period, but do not necessarily indicate that a change to the long-term assumptions of future experience is warranted. If it is determined that it is appropriate to change the assumptions related to future experience, then an unlocking adjustment is recognized for the block of business being evaluated. Certain assumptions, such as interest spreads and surrender rates, may be interrelated. As such, unlocking adjustments often reflect revisions to multiple assumptions. The VOBA balance is immediately impacted by any assumption changes, with the change reflected through the income statement as an unlocking adjustment in the amount of VOBA amortized. These adjustments can be positive or negative with adjustments reducing amortization limited to amounts previously deferred plus interest accrued through the date of the adjustment.
F-36
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
In addition, the Company may consider refinements in estimates due to improved capabilities resulting from administrative or actuarial system upgrades. The Company considers such enhancements to determine whether and to what extent they are associated with prior periods or simply improvements in the projection of future expected gross profits due to improved functionality. To the extent they represent such improvements, these items are applied to the appropriate financial statement line items in a manner similar to unlocking adjustments.
VOBA is also reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts. If it is determined from emerging experience that the premium margins or gross profits are insufficient to amortize deferred acquisition costs, then the asset will be adjusted downward with the adjustment recorded as an expense in the current period. No impairment adjustments have been recorded in the years presented.
Property and equipment: Property and equipment are stated at cost net of accumulated depreciation. Annual depreciation is primarily computed using straight-line methods for financial reporting and straight-line and accelerated methods for tax purposes. For the years ending December 31, 2010 and 2009, accumulated depreciation was $66,063 and $38,190, respectively.
Maintenance and repairs are expensed as incurred. Replacements and improvements which extend the useful life of the asset are capitalized. The net book value of assets sold or retired are removed from the accounts, and any resulting gain or loss is reflected in earnings.
Long-lived assets are reviewed annually for impairment. An impairment loss is recognized if the carrying amount of an asset may not be recoverable and exceeds estimated future undiscounted cash flows of the asset. A recognized impairment loss reduces the carrying amount of the asset to its fair value. For the years ending December 31, 2010 and 2009, no impairment loss of long-lived assets has been recognized.
Reinsurance: In the normal course of business, the Company seeks to limit aggregate and single exposure to losses on large risks by purchasing reinsurance. The amounts reported in the consolidated balance sheets as reinsurance recoverable include amounts billed to reinsurers on losses paid as well as estimates of amounts expected to be recovered from reinsurers on insurance liabilities that have not yet been paid. Reinsurance recoverable on unpaid losses are estimated based upon assumptions consistent with those used in establishing the liabilities related to the underlying reinsured contracts. Insurance liabilities are reported gross of reinsurance recoverable. Management believes the recoverables are appropriately established. The Company generally strives to diversify its credit risks related to reinsurance ceded. Reinsurance premiums are generally reflected in income in a manner consistent with the recognition of premiums on the reinsured contracts. Reinsurance does not extinguish the Company's primary liability under the policies written. Therefore, the Company regularly evaluates the financial condition of its reinsurers including their activities with respect to claim settlement practices and commutations, and establishes allowances for uncollectible reinsurance recoverable as appropriate. There were no allowances as of December 31, 2010 or 2009.
Benefit reserves: The Company establishes liabilities for amounts payable under insurance policies, including traditional life insurance and annuities. Generally, amounts are payable over an extended period of time. Liabilities for future policy benefits of traditional life insurance have been computed by a net level premium method based upon estimates at the time of issue for investment yields, mortality and withdrawals. These estimates include provisions for experience less favorable than initially expected. Mortality assumptions are based on industry experience expressed as a percentage of standard mortality tables.
F-37
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
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.
Deposit-type contracts: The Company's liability for deposit-type contracts represents the contract value that has accrued to the benefit of the policyholder as of the balance sheet date. This liability is equal to the accumulated account deposits, plus interest credited, less policyholder withdrawals and other charges assessed against the account balance. These policyholders' account balances also include provision for benefits under non-life contingent payout annuities and certain unearned revenues.
Income taxes: The Company is subject to income taxes in the U.S. federal and various state jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. With few exceptions, the Company is no longer subject to U.S. federal, state or local tax examinations by tax authorities for the years before 2007. The provision for income taxes is based on income as reported in the financial statements. The income tax provision is calculated under the asset and liability method. Deferred tax assets are recorded based on the differences between the financial statement and tax basis of assets and liabilities at the enacted tax rates. The principal assets and liabilities giving rise to such differences are investments, insurance reserves, unearned premiums, and deferred acquisition costs. A deferred tax asset valuation allowance is established when there is uncertainty that such assets would be realized. The Company has no uncertain tax positions that they believe are more-likely-than not that the benefit will not to be realized. When applicable, the Company recognizes interest accrued related to unrecognized tax benefits and penalties in income tax expense. The Company had no accruals for payments of interest and penalties at December 31, 2010 and 2009.
Revenue recognition and related expenses: Revenues on traditional life insurance products consist of direct and assumed premiums reported as earned when due.
Amounts received as payment for annuities and/or non-traditional contracts such as interest sensitive whole life contracts, single payment endowment contracts, single payment juvenile contracts and other contracts without life contingencies are recognized as deposits to policyholder account balances and included in future insurance policy benefits. Revenues from these contracts are comprised of fees earned for administrative and contract-holder services, which are recognized over the period of the contracts, and included in revenue. Deposits are shown as a financing activity in the Consolidated Statements of Cash Flows.
Amounts received under our multi-benefit policy form are allocated to the life insurance portion of the multi-benefit life insurance arrangement and the annuity portion based upon amounts included in the signed policy.
Liabilities for future policy benefits 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, which generally remain in force for the lifetime of the insured.
We measure our sales or new business production with two components: new premiums recorded and new deposits received. New premiums and deposits are measures of sales or new business production.
Advertising costs: Advertising expense included in Company operations for the years ended December 31, 2010 and December 31, 2009 was $10,235 and $13,654, respectively.
F-38
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
Comprehensive loss: Comprehensive loss is comprised of net loss and other comprehensive loss. Accumulated other comprehensive loss includes unrealized gains and losses from marketable securities classified as available for sale. Accumulated other comprehensive loss and comprehensive loss are displayed separately in the consolidated statements of stockholders' equity.
Common and preferred stock and earnings per share: The par value per common share is $0.001 with 120,000,000 shares authorized. At December 31, 2010 and 2009, the Company had 8,182,761 and 6,599,040 common shares issued and outstanding, respectively.
The Class A preferred shares are non-cumulative, non-voting and convertible only to common shares after five years at a rate of 1.3 common shares for each preferred share. The par value per preferred share is $0.001 with 20,000,000 shares authorized. At December 31, 2010, the Company had 74,159 preferred shares issued and outstanding. The Company had no preferred shares outstanding at December 31, 2009.
Earnings per share of common stock were computed based on the weighted average number of shares outstanding during each year. The weighted average number of shares outstanding during 2010 and 2009 were 6,779,865 and 6,514,535 shares, respectively. The Company paid no cash dividends during 2010 or 2009. During 2010, the Company issued a 4% stock dividend to shareholders of record on March 1, 2010, with fractional shares rounded up to the next whole share. A total of 266,209 shares were issued under this stock dividend at a value of $5 per share, resulting in an increase in common stock and additional paid-in capital, and a corresponding charge to accumulated deficit, totaling $1,331,045. Subsequent to December 31, 2010, the Company issued another 4% stock dividend to shareholders of record on March 31, 2011, with fractional shares rounded up to the next whole share. A total of 341,047 shares were issued under this stock dividend at a value of $5 per share. The weighted average shares outstanding for 2010 and 2009 have been recomputed to show the pro-forma effect of both 4% dividends for comparative purposes.
Risk and uncertainties: Certain risks and uncertainties are inherent in the Company's day-to-day operations and in the process of preparing its consolidated financial statements. The more significant of those risks and uncertainties, as well as the Company's method for mitigating the risks, are presented below and throughout the notes to the consolidated financial statements.
F-39
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
New Accounting Standards: In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2010-06, Improving Disclosures about Fair Value Measurements (ASU 2010-06). The new guidance requires entities to separately disclose information relative to transfers in and out of Levels 1 and 2 in the fair value hierarchy. Additionally, ASU 2010-06 requires separate presentation of transfers in, transfers out, purchases, sales, issuances and settlements of Level 3 investments in the tabular reconciliation of Level 3 activity. ASU 2010-06 also clarifies the level of disaggregation for which fair value measurements should be disclosed and requires that information about input and valuation techniques be disclosed for Level 2 and Level 3 assets and liabilities. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the rollforward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company has included all necessary disclosures as a result of this guidance within its 2010 consolidated financial statements.
In October 2010, the FASB issued authoritative guidance to address diversity in practice regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. Under the new guidance, acquisition costs are to include only those costs that are directly related to the acquisition or renewal of insurance contracts by applying a model similar to the accounting for loan origination costs. An entity may defer incremental direct costs of contract acquisition that are incurred in transactions with independent third parties or employees as well as the portion of employee compensation and other costs directly related to underwriting, policy issuance and processing, medical inspection, and contract selling for successfully negotiated contracts. Additionally, an entity may capitalize as a deferred acquisition cost only those advertising costs meeting the capitalization criteria for direct-response advertising. This change is effective for fiscal years beginning after December 15, 2011 and interim periods within those years. Early adoption as of the beginning of a fiscal year is permitted. The guidance is to be applied prospectively upon the date of adoption, with retrospective application permitted, but not required. The Company adopted this new guidance on January 1, 2012 with no material impact to the consolidated financial statements.
All other new accounting standards and updates of existing standards issued during 2010 did not relate to accounting policies and procedures pertinent to the Company at this time.
Note 2. Commitments and Contingencies
Legal Proceedings: We are involved in litigation incidental to our operations from time to time. We are not presently a party to any legal proceedings other than litigation arising in the ordinary course of our business, and we are not aware of any claims that could materially affect our financial position or results of operations.
F-40
Note 3. Investments
Regulatory Matters: State regulatory bodies, the SEC, and other regulatory bodies regularly make inquiries and conduct examinations or investigations concerning the Company's compliance with laws in relation to, but not limited to, insurance and securities. The issues involved in information requests and regulatory matters vary widely. The Company cooperates in these inquiries.
In accordance with U.S. GAAP, the Company establishes an accrued liability for litigation and regulatory matters when the future event is probable and its impact can be reasonably estimated. The initial reserve reflects management's best estimate of the probable cost of ultimate resolution of the matter and is revised accordingly as facts and circumstances change and, ultimately, when the matter is brought to closure.
The Company leases office space under a lease executed August 28, 2009 and amended on January 21, 2011 that expires on January 31, 2014. Rent expense for the years ended December 31, 2010 and 2009 was $93,369 and $41,762, respectively. Future minimum lease payments for 2011, 2012, 2013 and 2014 are $94,242, $117,308, $128,240 and $10,687, respectively.
The amortized cost and estimated fair value of investments in fixed maturities as of December 31, 2010 and 2009 are as follows:
| |
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Estimated Fair Value |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
December 31, 2010: |
|||||||||||||
Fixed maturities: |
|||||||||||||
U.S. government obligations |
$ | 3,357,871 | $ | 6,406 | $ | 160,542 | $ | 3,203,735 | |||||
States and political subdivisions |
1,098,202 | — | 113,373 | 984,829 | |||||||||
Corporate bonds |
2,327,465 | — | 117,896 | 2,209,569 | |||||||||
Total fixed maturities |
6,783,538 | 6,406 | 391,811 | 6,398,133 | |||||||||
Equity securities: |
|||||||||||||
Preferred corporate stock |
200,000 | — | — | 200,000 | |||||||||
Private placement common stock |
910,725 | — | — | 910,725 | |||||||||
Total equity securities |
1,110,725 | — | — | 1,110,725 | |||||||||
Total |
$ | 7,894,263 | $ | 6,406 | $ | 391,811 | $ | 7,508,858 | |||||
December 31, 2009: |
|||||||||||||
Fixed maturities: |
|||||||||||||
U.S. government obligations |
$ | 4,825,847 | $ | — | $ | 104,515 | $ | 4,721,332 | |||||
Total fixed maturities |
4,825,847 | — | 104,515 | 4,721,332 | |||||||||
Equity securities: |
|||||||||||||
Private placement common stock |
55,000 | — | — | 55,000 | |||||||||
Total equity securities |
55,000 | — | — | 55,000 | |||||||||
Total |
$ | 4,880,847 | $ | — | $ | 104,515 | $ | 4,776,332 | |||||
F-41
Note 3. Investments (Continued)
The following table summarizes, for all securities in an unrealized loss position at December 31, 2010 and 2009, 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, 2010 | December 31, 2009 | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Estimated Fair Value |
Gross Unrealized Loss |
Number of Securities |
Estimated Fair Value |
Gross Unrealized Loss |
Number of Securities |
|||||||||||||
Fixed Maturities: |
|||||||||||||||||||
Less than 12 months: |
|||||||||||||||||||
U.S. government obligations |
$ | 2,552,276 | $ | 160,542 | 14 | $ | 4,721,332 | $ | 104,515 | 41 | |||||||||
States and political subdivisions |
984,829 | 113,373 | 5 | — | — | — | |||||||||||||
Corporate |
2,209,569 | 117,896 | 16 | — | — | — | |||||||||||||
Total fixed maturities |
$ | 5,746,674 | $ | 391,811 | 35 | $ | 4,721,332 | $ | 104,515 | 41 | |||||||||
Based on our review of the securities in an unrealized loss position at December 31, 2010 and 2009, no other-than-temporary impairments were deemed necessary. Management believes that the Company will fully recover its cost basis in the securities held at December 31, 2010, 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. As of December 31, 2010, all of the above fixed maturities had a fair value to cost ratio equal to or greater than 87%. The temporary impairments shown herein are primarily the result of the current interest rate environment rather than credit factors that would imply other-than-temporary impairment.
The amortized cost and estimated fair value of debt securities at December 31, 2010, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
| |
Amortized Cost |
Estimated Fair Value |
|||||
|---|---|---|---|---|---|---|---|
Due in one year or less |
$ | — | $ | — | |||
Due after one year through five years |
645,055 | 651,461 | |||||
Due after five years through ten years |
3,785,919 | 3,582,921 | |||||
Due after ten years |
2,352,564 | 2,163,751 | |||||
|
$ | 6,783,538 | $ | 6,398,133 | |||
The Company is required to hold assets on deposit for the benefit of policyholders in accordance with statutory rules and regulations. At December 31, 2010 and 2009, these required deposits had a total amortized cost of $740,649 and $99,279, respectively.
F-42
Note 3. Investments (Continued)
The components of net investment income for the years ended December 31, 2010 and 2009 are as follows:
| |
2010 | 2009 | |||||
|---|---|---|---|---|---|---|---|
Fixed maturities |
$ | 167,346 | $ | 43,551 | |||
Equity securities |
1,171 | — | |||||
Cash and short-term investments |
15,773 | 49,877 | |||||
Other |
7,887 | — | |||||
|
192,177 | 93,428 | |||||
Less investment expenses |
(24,564 |
) |
(3,502 |
) |
|||
|
$ | 167,613 | $ | 89,926 | |||
Note 4. Fair Values of Financial Instruments
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Accounting standards require the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity's own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, accounting standards establish fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Level 1: |
Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. | |
Level 2: |
Significant other 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. |
|
Level 3: |
Significant unobservable inputs that reflect a reporting entity's own assumptions about the assumptions that market participants would use in pricing an asset or liability. |
A description of the valuation methodologies used for assets measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
Securities available for sale: The fair value of the Company's securities available for sale is determined using Level 2 inputs, which are derived from quoted prices for similar assets.
Preferred corporate stock: The fair value of the Company's preferred corporate stock is determined using Level 2 inputs, which are derived from quoted prices for similar assets.
Private placement common stock: The fair value of the Company's private placement common stock is determined using Level 3 inputs, which for these investments is equal to their cost basis, given the nature of the companies and their operations.
F-43
Note 4. Fair Values of Financial Instruments (Continued)
The following table presents the Company's fair value hierarchy for those financial instruments measured at fair value on a recurring basis as of December 31, 2010 and 2009.
| |
Quoted in Active Markets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
Estimated Fair Value |
|||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
December 31, 2010 |
|||||||||||||
Fixed maturities: |
|||||||||||||
U.S. government obligations |
$ | — | $ | 3,203,735 | $ | — | $ | 3,203,735 | |||||
States and political subdivisions |
— | 984,829 | — | 984,829 | |||||||||
Corporate |
— | 2,209,569 | — | 2,209,569 | |||||||||
Total fixed maturities |
— | 6,398,133 | — | 6,398,133 | |||||||||
Equity securities: |
|||||||||||||
Preferred corporate stock |
— | 200,000 | — | 200,000 | |||||||||
Private placement common stock |
— | — | 910,725 | 910,725 | |||||||||
Total equity securities |
— | 200,000 | 910,725 | 1,110,725 | |||||||||
Total |
$ | — | $ | 6,598,133 | $ | 910,725 | $ | 7,508,858 | |||||
December 31, 2009 |
|||||||||||||
Fixed maturities: |
|||||||||||||
U.S. government obligations |
$ | — | $ | 4,721,332 | $ | — | $ | 4,721,332 | |||||
Total fixed maturities |
— | 4,721,332 | — | 4,721,332 | |||||||||
Equity securities: |
|||||||||||||
Private placement common stock |
— | — | 55,000 | 55,000 | |||||||||
Total equity securities |
— | — | 55,000 | 55,000 | |||||||||
Total |
$ | — | $ | 4,721,332 | $ | 55,000 | $ | 4,776,332 | |||||
At December 31, 2010 and 2009, Level 3 financial instruments consisted of private placement common stock, where trading is limited. The fair value for these investments is equal to their cost basis, given the nature of the companies and their operations. The only activity within this group in 2010 or 2009 has been additional purchases. There have been no sales or transfers in or out of Level 3 relative to these assets.
The table below sets forth a summary of changes in the fair value of the Company's Level 3 financial instruments for the years ended December 31, 2010 and 2009, respectively:
| |
Years Ended December 31, | ||||||
|---|---|---|---|---|---|---|---|
| |
2010 | 2009 | |||||
| |
Private Placement Common Stock |
Private Placement Common Stock |
|||||
Balance, beginning of year |
$ | 55,000 | $ | — | |||
Purchases |
855,725 | 55,000 | |||||
Balance, end of year |
$ | 910,725 | $ | 55,000 | |||
F-44
Note 4. Fair Values of Financial Instruments (Continued)
Accounting standards require disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring basis or non-recurring basis are discussed above.
Fixed maturity securities: Fixed maturity securities are recorded at fair value on a recurring basis utilizing a third-party pricing source. The valuations are reviewed and validated quarterly through random testing by comparisons to separate pricing models or other third party pricing services. For the period ended December 31, 2010, there were no material changes to the valuation methods or assumptions used to determine fair values, and no broker or third party prices were changed from the values received. Securities with prices based on validated quotes from pricing services are reflected within Level 2.
Equity securities: Equity securities consist principally of common stock of publicly and privately traded companies and preferred stock of publicly traded companies. The fair values of publicly traded equity securities are based on quoted market prices in active markets for identical assets and are classified within Level 1 in the fair value hierarchy. The fair values of a portion of our preferred equity securities are based on prices obtained from independent pricing services and these securities are generally classified within Level 2 in the fair value hierarchy. The fair values of Level 3 equity securities approximate cost and are predominately invested in developmental stage companies that have not conducted operations apart from raising capital. Management's policy is to record these investments at the cost of our investment until such time as the entities commence active operations or when events dictate that our investment will not be recovered. As these companies begin operations, there will be significant unobservable inputs into valuing these securities including: material non-public financial information, management judgment, estimation of future earnings and cash flows, and liquidity assumptions. These inputs are usually considered unobservable, as not all market participants will have access to this data, and therefore are classified within Level 3 in the fair value hierarchy.
Cash and cash equivalents and short-term investments: The carrying value of cash and cash equivalents and short-term investments approximate the fair value because of the short maturity of the investments.
Policy loans: Policy loans are stated at unpaid principal balances. As these loans are fully collateralized by the cash surrender value of the underlying insurance policies, the carrying value of the policy loans approximates their fair value.
Notes Receivable: Fair values for short-term notes receivable approximate carrying value. The carrying amount is a reasonable estimate of the fair value because of the relatively short time between the origination of the loan and its expected repayment.
Investment-type contracts: The fair value for direct and assumed 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 nonperformance risk of the liabilities. Liabilities under investment-type insurance contracts that are wholly ceded by CRLIC to a non-affiliated reinsurer are carried at cash surrender value which approximates fair value. The fair values for insurance contracts other than investment-type contracts are not required to be disclosed.
F-45
Note 4. Fair Values of Financial Instruments (Continued)
Policy claims: The carrying amounts reported for these liabilities approximate their fair value.
| |
2010 | 2009 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| |
Carrying Amount |
Fair Value |
Carrying Amount |
Fair Value |
|||||||||
Assets: |
|||||||||||||
Fixed maturities |
$ | 6,398,133 | $ | 6,398,133 | $ | 4,721,332 | $ | 4,721,332 | |||||
Equity securities |
1,110,725 | 1,110,725 | 55,000 | 55,000 | |||||||||
Policy loans |
94,272 | 94,272 | — | — | |||||||||
Notes receivable |
200,000 | 200,000 | — | — | |||||||||
Short-term investments |
500,000 | 500,000 | 1,506,665 | 1,506,665 | |||||||||
Cash and cash equivalents |
5,250,468 | 5,250,468 | 1,484,114 | 1,484,114 | |||||||||
Liabilities: |
|||||||||||||
Policyholder deposits |
|||||||||||||
(Investment-type contracts) |
11,692,181 | 11,759,019 | 97,464 | 97,464 | |||||||||
Policy claims |
183,706 | 183,706 | 7,347 | 7,347 | |||||||||
Note 5. Income Tax Matters
Significant components of the Company's deferred tax assets and liabilities as of December 31, 2010 and 2009 are as follows:
| |
2010 | 2009 | |||||
|---|---|---|---|---|---|---|---|
Deferred tax assets: |
|||||||
Loss carryforwards |
$ | 1,727,972 | $ | 430,109 | |||
Unrealized losses on investments |
131,038 | 35,535 | |||||
Benefit reserves |
131,868 | — | |||||
Total deferred tax assets |
1,990,878 | 465,644 | |||||
Less valuation allowance |
(1,553,381 | ) | (465,644 | ) | |||
Total deferred tax assets, net of valuation allowance |
437,497 | — | |||||
Deferred tax liabilities: |
|||||||
Policy acquisition costs |
383,548 | — | |||||
Due premiums |
26,612 | — | |||||
Value of business acquired |
27,337 | — | |||||
Total deferred tax liabilities |
437,497 | — | |||||
Net deferred tax assets |
$ | — | $ | — | |||
During the year ended December 31, 2010 and 2009, the Company recorded a valuation allowance of $1,553,381 and $465,644, respectively, on the deferred tax assets to reduce the total to an amount that management believes will ultimately be realized. Realization of deferred tax assets is dependent upon sufficient future taxable income during the period that deductible temporary differences and carryforwards are expected to be available to reduce taxable income. As part of the valuation allowance of $1,553,381 recorded at December 31, 2010, the Company included $379,542 as a valuation allowance against loss carryforwards within CRLIC as of the purchase date of January 1, 2010.
Loss carryforwards for tax purposes as of December 31, 2010, have expiration dates that range from 2024 through 2025.
F-46
Note 5. Income Tax Matters (Continued)
There was no income tax expense for the years ended December 31, 2010 and 2009. This differed from the amounts computed by applying the statutory U.S. federal income tax rate of 34% to pretax income, as a result of the following:
| |
2010 | 2009 | |||||
|---|---|---|---|---|---|---|---|
Computed expected income tax benefit |
$ | (755,890 | ) | $ | (365,964 | ) | |
Increase (reduction) in income taxes resulting from: |
|||||||
Meals, entertainment and political contributions |
6,982 | 3,299 | |||||
Dividends received deduction |
(261 | ) | — | ||||
Value of business acquired |
39,551 | — | |||||
True-up of provision to actual |
1,481 | — | |||||
Other |
(58 | ) | — | ||||
|
47,695 | 3,299 | |||||
Tax benefit before valuation allowance |
(708,195 | ) | (362,665 | ) | |||
Change in valuation allowance |
708,195 | 362,665 | |||||
Net income tax expense |
$ | — | $ | — | |||
Note 6. Reinsurance
A summary of significant reinsurance amounts affecting the accompanying consolidated financial statements as of and for the years ended December 31, 2010 and 2009 is as follows:
| |
2010 | 2009 | |||||
|---|---|---|---|---|---|---|---|
Balance sheets: |
|||||||
Benefit and claim reserves assumed |
$ | 3,395,026 | $ | — | |||
Benefit and claim reserves ceded |
20,914,194 | 3,987 | |||||
Statements of income: |
|||||||
Premiums assumed |
37,103 | — | |||||
Premiums ceded |
645,635 | 1,619 | |||||
Consideration on reinsurance assumed |
3,729,599 | — | |||||
Benefits assumed |
323,133 | ||||||
Benefits ceded |
2,039,786 | — | |||||
Commissions assumed |
27,068 | — | |||||
Commissions ceded |
29,820 | — | |||||
F-47
Note 6. Reinsurance (Continued)
The following table provides a summary of the significant reinsurance balances recoverable on paid and unpaid policy claims by reinsurer along with the A.M. Best credit rating as of December 31, 2010:
Reinsurer
|
AM Best Rating |
Recoverable on Paid Losses |
Recoverable on Unpaid Losses |
Recoverable on Benefit Reserves/ Deposit-type contracts |
Total Amount Recoverable from Reinsurers |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Security National Life Insurance Company |
NR-5 | $ | — | $ | 113,013 | $ | 20,774,024 | $ | 20,887,037 | |||||||
Optimum Re Insurance Company |
A- | — | 12,069 | 5,288 | 17,357 | |||||||||||
Investors Heritage Life Insurance Company |
B+ | — | 7,335 | 2,465 | 9,800 | |||||||||||
|
$ | 132,417 | $ | 20,781,777 | $ | 20,914,194 | ||||||||||
CRLIC has a 100% coinsurance agreement with SNL whereby 100% of the business written by CRLIC is ceded to SNL. At December 31, 2010, total benefit reserves, policy claims and deposit-type contracts ceded by CRLIC to SNL were $20,887,037. CRLIC remains contingently liable on this ceded reinsurance should SNL be unable to meet their obligations.
The use of reinsurance does not relieve the Company of its primary liability to pay the full amount of the insurance benefit in the event of the failure of a reinsurer to honor its contractual obligation. Consequently, the Company avoids concentrating reinsurance risk with any one reinsurer and only participates in reinsurance treaties with reputable carriers. No reinsurer of business ceded by the Company has failed to pay policy claims (individually or in the aggregate) with respect to our ceded business.
At December 31, 2010, the Company had over 99% of its reinsurance recoverable amounts concentrated with one reinsurer, SNL. SNL is not rated by A.M. Best.
The Company monitors several factors that it considers relevant to satisfy itself as to the ongoing ability of a reinsurer to meet all obligations of the reinsurance agreements. These factors include the credit rating of the reinsurer, the financial strength of the reinsurer, significant changes or events of the reinsurer, and any other relevant factors. If the Company believes that any reinsurer would not be able to satisfy its obligations with the Company, a separate contingency reserve may be established. At December 31, 2010 and 2009, no contingency reserve was established.
Note 7. Deposit-Type Contracts
The Company's deposit-type contracts represent the contract value that has accrued to the benefit of the policyholder as of the balance sheet date. This liability is equal to the accumulated account
F-48
Note 7. Deposit-Type Contracts (Continued)
deposits, plus interest credited, and less policyholder withdrawals. The following table provides information about deposit-type contracts at December 31, 2010 and 2009:
| |
2010 | 2009 | |||||
|---|---|---|---|---|---|---|---|
Beginning balance |
$ | 97,464 | $ | — | |||
Deposit-type contracts assumed from SNL |
2,415,310 | — | |||||
Deposit-type contracts fully ceded by CRLIC |
8,923,395 | — | |||||
Deposits received |
271,143 | 109,387 | |||||
Investment earnings |
5,313 | 527 | |||||
Withdrawals |
(20,444 | ) | (12,450 | ) | |||
Ending balance |
$ | 11,692,181 | $ | 97,464 | |||
Under the terms of ALSC's coinsurance agreement with SNL, ALSC assumes certain deposit-type contract obligations, as shown in the table above. Additionally, CRLIC cedes 100% of its direct business to an external reinsurer. Accordingly, this amount is presented within the corresponding single line above. The remaining deposits, withdrawals and interest credited represent those for ALSC's direct business.
Note 8. Statutory Net Income and Surplus
ALSC is required to prepare statutory financial statements in accordance with statutory accounting practices prescribed or permitted by the Nebraska Department of Insurance. Likewise, CRLIC is required to prepare statutory financial statements in accordance with statutory accounting practices prescribed or permitted by the Missouri Department of Insurance. Statutory practices primarily differ from GAAP by charging policy acquisition costs to expense as incurred, establishing future policy benefit liabilities using different actuarial assumptions as well as valuing investments and certain assets and accounting for deferred taxes on a different basis. The statutory net loss of ALSC amounted to $1,433,555 and $256,206 for the years ended December 31, 2010 and 2009, respectively. Statutory capital and surplus of ALSC amounted to $5,636,925 and $5,198,499 at December 31, 2010 and 2009, respectively. The statutory net income (loss) of CRLIC was ($89,279) and $16,512 for the years ended December 31, 2010 and 2009, respectively. Statutory capital and surplus of CRLIC totaled $1,584,780 and $1,681,250 at December 31, 2010 and 2009, respectively.
Note 9. Dissolution of Subsidiary
On December 31, 2009 Western States Alliance Corp. (WSA), a subsidiary of the Company, was dissolved. As of December 31, 2009 the only asset held by WSA was its own investment in the Company. When WSA was dissolved each of the WSA shareholders received a pro rata interest in the Company.
Note 10. Related Party Transactions
Midwest and ALSC operate under a cost sharing agreement that provides for the allocation of certain common expenses. The expenses are settled on a direct cost basis. The amount of total payments in 2010 and 2009 were $908,653 and $211,800, respectively.
The Company has a consulting agreement with a corporation owned by a Board member. The agreement, approved by the Board of Directors, provides for consulting services related to capital raising and special projects and runs through 2012. Total payments made by the Company in 2010 and 2009 amounted to $332,215 and $63,333, respectively.
F-49
Note 10. Related Party Transactions (Continued)
ALSC has a general agent contract with a corporation owned by an officer of Midwest. The agreement, which was approved by the Board of Directors of Midwest and ALSC, specifies that the corporation, a licensed insurance agency, shall receive an override on business written in exchange for managing the Company's marketing. In addition, the agency must pay for all sales conventions, contests, prizes, awards and training seminars. Total payments made by ALSC in 2010 and 2009 were $355,972 and $43,621, respectively.
Note 11. Subsequent Events
The Company has reached an agreement to acquire all of the outstanding shares of Old Reliance Insurance Company (Old Reliance), an Arizona domiciled life insurance company licensed in 14 states, in exchange for approximately $3,000,000 comprised of a combination of cash from ALSC, issuance of a surplus note by ALSC, and shares of Midwest common stock. The agreement calls for ALSC and CRLIC to be merged with and into Old Reliance. The merged company will change its name to American Life and Security Corp. This transaction is subject to and awaiting regulatory approval.
All of the effects of subsequent events that provide additional evidence about conditions that existed at December 31, 2009, including the estimates inherent in the process of preparing financial statements, are recognized in the financial statements. The Company does not recognize subsequent events that provide evidence about conditions that did not exist at the date of the financial statements but arose after, but before the financial statements were available to be issued. In some cases, non recognized subsequent events are disclosed to keep the financial statements from being misleading.
On April 29, 2011, Midwest paid a 4% stock dividend to shareholder of record on March 31, 2011. A total of 341,047 common shares were issued under this stock dividend at a value of $5 per share.
The Company has evaluated subsequent events through June 10, 2011, the date that the financial statements were issued.
F-50
Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized.
| MIDWEST HOLDING INC. | ||||
Date: April 13, 2012 |
By: |
/s/ TRAVIS MEYER Travis Meyer, President |
||
| EXHIBIT NUMBER |
DESCRIPTION | ||
|---|---|---|---|
| 2.1 | Stock Purchase Agreement, dated January 20, 2009, by and between American Life & Security Corp. and Security National Life Insurance Company. (Incorporated by reference to Exhibit 2.1 to the Company's Form 10 Registration Statement, filed December 12, 2011.) | ||
2.2 |
Stock Purchase Agreement, dated November 8, 2010, by and among Midwest Holding Inc., American Life & Security Corp., Old Reliance Insurance Company and David G. Elmore. (Incorporated by reference to Exhibit 2.2 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
2.3 |
Amendment I to Stock Purchase Agreement, dated May 20, 2011, by and among Midwest Holding Inc., American Life & Security Corp., Old Reliance Insurance Company and David G. Elmore. (Incorporated by reference to Exhibit 2.3 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) |
||
2.4 |
Amendment II to Stock Purchase Agreement, dated August 2, 2011, by and among Midwest Holding Inc., American Life & Security Corp., Old Reliance Insurance Company and David G. Elmore. (Incorporated by reference to Exhibit 2.4 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) |
||
3.1 |
Amended and Restated Articles of Incorporation, dated March 29, 2010. (Incorporated by reference to Exhibit 3.1 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
3.2 |
Articles of Amendment to the Amended and Restated Articles of Incorporation, dated May 6, 2010. (Incorporated by reference to Exhibit 3.2 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
3.3 |
Amended and Restated Bylaws. (Incorporated by reference to Exhibit 3.3 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
3.4 |
American Life & Security Corp. State of Nebraska Department of Insurance Amended Certificate of Authority, issued August 3, 2011. (Incorporated by reference to Exhibit 3.4 to the Company's Amendment No. 2 to Form 10 Registration Statement, filed March 20, 2012.) |
||
10.1 |
† |
Employment Agreement, dated July 1, 2011, by and between Midwest Holding Inc. and Travis Meyer. (Incorporated by reference to Exhibit 10.1 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
|
10.2 |
† |
Employment Agreement, dated July 1, 2011, by and between Midwest Holding Inc. and Mark Oliver. (Incorporated by reference to Exhibit 10.2 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
|
10.3 |
† |
Consulting and Advisory Agreement, dated September 1, 2009, by and between Midwest Holding Inc. and Bison Capital Corp. (f/k/a Corporate Development Inc.). (Incorporated by reference to Exhibit 1032 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
|
10.4 |
Administrative Services Agreement, dated August 17, 2009, by and between American Life & Security Corp. and Investors Heritage Life Insurance Company. (Incorporated by reference to Exhibit 10.4 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.5 |
Administrative Services Agreement, dated August 17, 2009, by and between Midwest Holding Inc. and Investors Heritage Life Insurance Company. (Incorporated by reference to Exhibit 10.5 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
| EXHIBIT NUMBER |
DESCRIPTION | ||
|---|---|---|---|
| 10.6 | Automatic Reinsurance Agreement, dated August 1, 2009, by and between American Life & Security Corp. and Optimum Re Insurance Company. (Incorporated by reference to Exhibit 10.6 to the Company's Form 10 Registration Statement, filed December 12, 2011.) | ||
10.7 |
Amendment Number One to Automatic Reinsurance Agreement, dated August 1, 2009, by and between American Life & Security Corp. and Optimum Re Insurance Company. (Incorporated by reference to Exhibit 10.7 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.8 |
Amendment Number Two to Automatic Reinsurance Agreement, dated August 1, 2009, by and between American Life & Security Corp. and Optimum Re Insurance Company. (Incorporated by reference to Exhibit 10.8 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.9 |
Bulk Reinsurance Agreement, dated September 1, 2009, by and between American Life & Security Corp. and Optimum Re Insurance Company. (Incorporated by reference to Exhibit 10.9 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.10 |
Amendment to all Reinsurance Agreements, dated August 4, 2011, by and between American Life & Security Corp. and Optimum Re Insurance Company. (Incorporated by reference to Exhibit 10.10 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.11 |
Automatic Reinsurance Agreement, dated August 1, 2009, by and between American Life & Security Corp. and Investors Heritage Life Insurance Company. (Incorporated by reference to Exhibit 10.11 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.12 |
Reinsurance Agreement, dated January 1, 2010, by and between American Life & Security Corp. and Security National Life Insurance Company. (Incorporated by reference to Exhibit 10.12 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
10.13 |
Master Reinsurance Agreement, dated December 20, 1999, by and between Old Reliance Insurance Company and American Founders Life Insurance Company. (Incorporated by reference to Exhibit 10.13 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) |
||
10.14 |
Amendment Number One to Master Reinsurance Agreement, dated December 20, 1999, by and between Old Reliance Insurance Company and American Founders Life Insurance Company. (Incorporated by reference to Exhibit 10.14 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) |
||
10.15 |
Reinsurance Agreement Number One, dated December 31, 1999, by and between Old Reliance Insurance Company and American Founders Life Insurance Company. (Incorporated by reference to Exhibit 10.15 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) |
||
10.16 |
Amendment Number One to Reinsurance Agreement Number One dated December 31, 1999, by and between Old Reliance Insurance Company and American Founders Life Insurance Company. (Incorporated by reference to Exhibit 10.16 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) |
||
10.17 |
Master Reinsurance Agreement, dated April 1, 2000, by and between Old Reliance Insurance Company and American Founders Life Insurance Company. (Incorporated by reference to Exhibit 10.17 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) |
||
| EXHIBIT NUMBER |
DESCRIPTION | ||
|---|---|---|---|
| 10.18 | Reinsurance Agreement Number One, dated April 1, 2000, by and between Old Reliance Insurance Company and American Founders Life Insurance Company. (Incorporated by reference to Exhibit 10.18 to the Company's Amendment No. 1 to Form 10 Registration Statement, filed February 3, 2012.) | ||
10.19 |
† |
Agency Agreement, dated September 1, 2009, by and between American Life & Security Corp. and Great American Marketing, Inc. (Incorporated by reference to Exhibit 10.19 to the Company's Amendment No. 2 to Form 10 Registration Statement, filed March 20, 2012.) |
|
10.20 |
† |
Employment Agreement, dated December 1, 2011, by and between Midwest Holding Inc. and Rick Meyer. (Incorporated by reference to Exhibit 10.20 to the Company's Amendment No. 2 to Form 10 Registration Statement, filed March 20, 2012.) |
|
21.1 |
List of Subsidiaries. (Incorporated by reference to Exhibit 21.1 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
99.1 |
Disclaimer of Control by Rick D. Meyer, dated September 26, 2010. (Incorporated by reference to Exhibit 99.1 to the Company's Form 10 Registration Statement, filed December 12, 2011.) |
||
Jeffrey Riedler, Assistant Director
Securities and Exchange Commission
April 13, 2012
|
|
April 13, 2012 |
VIA EDGAR CORRESPONDENCE
Securities and Exchange Commission
Division of Corporate Finance
Attn: Jeffrey Riedler, Assistant Director
100 F Street, N.E.
Washington, D.C. 20549
Re: Midwest Holding Inc.
Amendment No. 2 to Registration Statement on Form 10-12G Filed March 20, 2012
File No. 000-10685
Dear Mr. Riedler:
On behalf of Midwest Holding Inc. (the “Company”), submitted below are the Company’s responses to the comments of the Staff (the “Staff”) of the Securities and Exchange Commission (the “Commission”) set forth in the letter dated March 30, 2012 in connection with the above-referenced filing. For your convenience, the responses set forth below have been placed in the order in which the Staff presented the Comments and the text of each Comment is presented in bold italics before each response. The Company is also filing herewith Amendment Number 3 to the Form 10 (“Amendment No. 3”).
Item 1. Business
American Life, page 2
1. We note your response to our prior comment 7. Please include American Life & Security Corp.’s year of incorporation and state when it began to offer the American Accumulator Plan and the Future Cornhusker Plan, respectively. Please affirmatively state whether or not you offered any products prior to your acquisition of American Life.
We have revised our disclosure as follows in response to this comment on pages 2 and 19 of Amendment No. 3.
“American Life was incorporated on May 7, 2009. On September 1, 2009, American Life was issued a certificate of authority to conduct life insurance business in the State of Nebraska. Immediately following the issuance of the certificate of authority, American Life began to offer the American Accumulator and Future Cornhusker products in the state of Nebraska. Prior to our acquisition of American Life, the Company did not offer any products.”
2. You state that Old Reliance’s sales over the past five years had been nominal but you then note that in 2010 it generated income of approximately $1.4 million. Please explain how this level of income could be generated while sales were nominal.
We inform you supplementally that the income of Old Reliance was primarily driven off of renewal premiums as opposed to first year premiums. First year premiums are a key indicator of sales. Accordingly, we have revised our disclosure as follows in response to this comment on page 3 of Amendment No. 3.
“During 2010, approximately 24% of premiums were first year premiums compared to 76% of premiums being renewal premiums.”
3. We note your response to our prior comment 12. Please describe how your agents’ first- year commission is determined according to the 42%-72% range you cite.
We inform you supplementally that, as is customary in the insurance industry, individual agents have individual commission schedules that depend on the agent’s experience and seniority. Thus, an individual agent’s commission may vary from 42% to 72%. However, overrides also are paid within the commission structure. So, for example, an individual writing agent will be paid a commission of 42%, but override commissions paid to other agents involved in the sale will bring the total commission paid to 72%. Our prior response focused on what individual agents may receive; however, we now believe the most relevant information is the total amount paid to writing agents and all others involved in the sale. Accordingly, we have revised our disclosure as follows in response to this comment on page 6 of Amendment No. 3.
“The American Accumulator pays total first year commissions to our marketing agents of 72% and renewal commissions total 15%. Total commissions may be split between multiple agents involved in the sale, with the writing agent receiving the bulk of the commission and others receiving portions of the commission as overrides.”
4. We note your response to our prior comment 14. Please clarify that you may opt to rely solely on the information contained within an application in determining whether or not to underwrite a policy, and that a medical examination or other information is not mandatory in certain instances.
We have revised our disclosure as follows in response to this comment on page 5 of Amendment No. 3.
“Depending upon age of the insured and the face amount of the policy, we may rely solely on the information contained within an application to determine whether or not to underwrite a policy, and a medical examination or other information may not be required. Generally, we will only issue a policy based solely on the information contained within an application to individuals less than 55 years of age and for a face amount less than $55,000.”
Consolidated Financial Statements for the Period Ended September 30, 2011
Note 2. Business Acquisitions, page F-14
5. Refer to your response to our previous comment 32. Please disclose when your previous investment in Security Capital Corporation was reduced to zero and describe how the assumptions changed from prior years in determining the fair value of your previously held equity interest of Security Capital at the acquisition date. Disclose how you determined that carrying value was equal to the acquisition date fair value of the identifiable assets acquired, the liabilities assumed and the non-controlling interests.
We have revised our disclosure as follows in response to this comment on page F-15 of Amendment No. 3.
“The previously held interest had been reduced to $0 in 2009 as a result of the recognition of an impairment expense on the investment due to a lack of projected cash flows. Subsequent to the recognized impairment, an investment in a development stage entity held by Security Capital increased in value. Additionally, management purchased additional shares of Security Capital, which triggered the need for consolidation and revaluation of the entire holding of Security Capital. Management determined that the carrying value approximated the fair value of Security Capital as the assets held by Security Capital consisted of cash and cash equivalents and financial instruments whose carrying value approximated fair value. Security Capital had no liabilities or non-controlling interests as of the acquisition date. The entity is a development stage company that has not conducted operations apart from raising capital. Management’s policy is to record these investments at the cost of our investment until such time as the entities commence active operations or when events dictate that our investment will not be recovered. As Security Capital begins operations, there will be significant unobservable inputs into valuing Security Capital including: material non-public financial information, management judgment, estimation of future earnings and cash flows, and liquidity assumptions.”
Note 4. Investments, page F-16
6. It appears that your revised disclosure did not provide all of the information requested in prior comment 33. Please revise to include the following disclosures as originally requested:
· A further break-down of the securities issued by the states and political subdivisions for those that comprise more than 10% of the total category, showing the fair value and amortized cost and credit rating with and without any third party guarantees; and
· For the special revenue bonds category, also provide a break-down by nature of activity supporting these securities for any activity comprising more than 10% of this category.
We have revised our disclosure as follows in response to this comment on page F-18 of Amendment No. 3.
“The Company has three securities that individually exceed 10% of the total of the state and political general and special revenue categories as of September 30, 2011. The amortized cost, fair value, number of securities, and credit ratings of these investments are as follows:
|
|
|
September 30, 2011 |
| ||||||||
|
|
|
Amortized |
|
Estimated Fair |
|
Number |
|
Credit Ratings |
| ||
|
Fixed Maturities: |
|
|
|
|
|
|
|
|
| ||
|
States and political subdivisions — general obligations |
|
$ |
503,128 |
|
$ |
516,803 |
|
2 |
|
AA+ to A+ |
|
|
States and political subdivisions — special revenue |
|
319,132 |
|
323,022 |
|
1 |
|
A |
| ||
|
Total |
|
$ |
822,260 |
|
$ |
839,825 |
|
3 |
|
AA+ to A |
|
Consolidated Financial Statements for the Period Ended December 31, 2010
Note 1. Nature of Operations and Summary of Significant Accounting Policies
Revenue Recognition and Related Expenses, page F-35
7. Please revise your disclosure that was provided in response to comment 36 to explain how you allocate the amounts received in a multi-benefit life insurance arrangement.
We have revised our disclosure as follows in response to this comment on pages F-11, F-12, and F-38 of Amendment No. 3.
“Amounts received as payment for annuities and/or non-traditional contracts such as interest sensitive whole life contracts, single payment endowment contracts, single payment juvenile contracts and other contracts without life contingencies are recognized as deposits to policyholder account balances and included in future insurance policy benefits. Revenues from these contracts are comprised of fees earned for administrative and contract-holder services, which are recognized over the period of the contracts, and included in revenue. Deposits are shown as a financing activity in the Consolidated Statements of Cash Flows.
Amounts received under our multi-benefit policy form are allocated to the life insurance portion of the multi-benefit life insurance arrangement and the annuity portion based upon amounts included in the signed policy.”
Note 4. Fair Values of Financial Instruments, page F-42
8. Please refer to your revised disclosure in response to comment 38. Revise your disclosure to explain how you determined that cost at each balance sheet date approximates fair value for private placement common stock considering these investments are primarily in development stage companies.
We have revised our disclosure as follows in response to this comment on pages F-22 and F-45 of Amendment No. 3.
“The fair values of Level 3 equity securities approximate cost and are predominately invested in developmental stage companies that have not conducted operations apart from raising capital. Management’s policy is to record these investments at the cost of our investment until such time as the entities commence active operations or when events dictate that our investment will not be recovered. As these companies begin operations, there will be significant unobservable inputs into valuing these securities including: material non-public financial information, management judgment, estimation of future earnings and cash flows, and liquidity assumptions. These inputs are usually considered unobservable, as not all market participants will have access to this data, and therefore are classified within Level 3 in the fair value hierarchy.”
9. Refer to your revised disclosure in response to comment 39 that you avoid concentrating reinsurance risk with any one reinsurer and only participate in reinsurance treaties with reputable carriers. Please revise your disclosure in the financial statements to describe your current vulnerability due to a concentration of reinsurance recoverable amounts with one reinsurer at December 31, 2010 and two reinsurers at September 30, 2011. Highlight to investors that you have material amounts with a reinsurer that has not been assigned a rating with A.M. Best.
We have revised our disclosure as follows in response to this comment on page F-26 of Amendment No. 3.
“At September 30, 2011, the Company had over 99% of its reinsurance recoverable amounts concentrated with two reinsurers, Sagicor and SNL. $20 million of reinsurance recoverable amounts are from SNL, who is not rated by A.M. Best.”
We have revised our disclosure as follows in response to this comment on page F-48 of Amendment No. 3.
“At December 31, 2010, the Company had over 99% of its reinsurance recoverable amounts concentrated with one reinsurer, SNL. SNL is not rated by A.M. Best.”
10. Please refer to your revised disclosure in response to comment 40. Revise your disclosure to describe the types of life insurance and individual annuity polices reinsured by you under the coinsurance agreement. Disclose other material terms of the agreement, such as the length of the agreement and the termination provisions. Provide a breakdown of the consideration by life insurance or annuities and disclose the amounts accounted for as reinsurance or deposits. Also as previously requested, please revise your disclosure to explain your basis for recognizing the total amount of cash consideration as income in 2010. Tell us the applicable authoritative literature to support your accounting.
We have revised our disclosure as follows in response to this comment on pages F-9 and F-36 of Amendment No. 3.
“Additionally, ALSC entered into a coinsurance agreement with Security National Life Insurance Company (SNL), effective January 1, 2010, to reinsure a block of traditional whole life policies and a block of deferred annuities of SNL. Under the terms of the agreement, SNL ceded to ALSC a block of deferred annuities in the amount of $2,678,931 and a block of whole life policies in the amount of $1,048,134, together with net due and deferred premiums in the amount of $12,305, advance premiums in the amount of $353, claims liabilities in the amount of $14,486, and net policy loans in the amount of $128,487.
On the effective date of the reinsurance contract, ALSC assumed the immediate obligation for performance related to the underlying policies covered by the agreement. In other words, SNL transferred its risk to us. As part of the contract, SNL agreed to pay ALSC an amount equal to the adjusted net reserves on the effective date of the agreement with respect to the liabilities reinsured as of such date. In accordance with FASB ASC 944-605-25-3, “Financial Services — Insurance, Revenue Recognition, Long-Duration Contracts,” the assumed premiums paid to ALSC by SNL, along with the Company’s estimate of losses incurred, were immediately recognized into earnings. The Company recorded income of $3,729,599 that was offset by the assumption of the reserve liability, which was recorded as an increase in benefit reserve expense. The Company concluded gross reporting was appropriate because the Company obtained immediate risk and rewards of ownership.
Additionally, the Company paid an upfront ceding commission of $375,000. An initial asset was established for the value of this business acquired totaling $348,010, representing primarily the ceding commission…The agreement has an automatic renewal provision unless the Company notifies SNL of its intention not to renew, no less than 180 days prior to the expiration of the then current agreement. Each automatic renewal period is for one year.”
On behalf of the Company, the undersigned acknowledges that:
· the company is responsible for the adequacy and accuracy of the disclosure in the filing;
· staff comments or changes to disclosure in response to staff comments do not foreclose the Commission from taking any action with respect to the filing; and
· the company may not assert staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States.
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Sincerely, |
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/s/ Mark Oliver |
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Mark Oliver |
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Secretary/Treasurer |
cc: David J. Routh, Esq.
Cline Williams Wright Johnson & Oldfather, L.L.P.
233 South 13th Street -1900 U.S. Bank Building
Lincoln, Nebraska 68508