-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ow8cppWiwA79dyqucFk32XeDvvb2KwnHPlUlCmjND9Z/P0y636C/CM3ix2nlP3Tf kLkD4EZs2zmjl7f8bTHlnw== 0000832480-98-000014.txt : 19980603 0000832480-98-000014.hdr.sgml : 19980603 ACCESSION NUMBER: 0000832480-98-000014 CONFORMED SUBMISSION TYPE: S-4/A PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 19980602 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: UNITED TRUST INC /IL/ CENTRAL INDEX KEY: 0000832480 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 371172848 STATE OF INCORPORATION: IL FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-4/A SEC ACT: SEC FILE NUMBER: 333-44269 FILM NUMBER: 98640679 BUSINESS ADDRESS: STREET 1: 5250 SOUTH SIXTH STREET STREET 2: PO BOX 5147 CITY: SPRINGFIELD STATE: IL ZIP: 62703 BUSINESS PHONE: 2172416300 MAIL ADDRESS: STREET 1: PO BOX 5147 STREET 2: 5250 SOUTH SIXTH STREET ROAD CITY: SPRINGFIELD STATE: IL ZIP: 62705 S-4/A 1 AMENDMENT 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 1, 1998 Registration No. 333-44269 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM S-4/A REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 UNITED TRUST, INC. (Exact name of registrant as specified in its charter) ILLINOIS 6711 (State or other jurisdiction of (Primary Standard Industrial incorporation or organization) Classification Code Number) 37-1172848 (I.R.S. EMPLOYER IDENTIFICATION NO.) 5250 SOUTH SIXTH STREET ROAD SPRINGFIELD, ILLINOIS 62703 (217) 241-6300 (Address, including ZIP code, and telephone number, including area code, of registrant's principal executive offices) JAMES E. MELVILLE PRESIDENT AND CHIEF OPERATING OFFICER 5250 SOUTH SIXTH STREET ROAD SPRINGFIELD, ILLINOIS 62703 (217) 241-6300 (Names, address, including ZIP code, and telephone number, including area code, of agent for service) Approximate date of commencement of proposed sale of the securities to the public: UPON COMPLETION OF THE MERGER AS DESCRIBED IN THIS REGISTRATION STATEMENT If the securities being registered on this Form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box: If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. CALCULATION OF REGISTRATION FEE Title of each Proposed class of Proposed maximum Amount of securities Amount to be maximum aggregate registration to be registered offering offering fee(2) registered (1) price price per unit (2) Common Stock, 826,153 9.33 7,708,007 2,273.86 no par value (1) Represents the approximate number of shares issuable upon the merger of United Income, Inc. into the registrant. (2) Pursuant to Rule 457(f), the registration fee is based upon the book value of UTI at March 31, 1998. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. 2 UNITED TRUST, INC. CROSS REFERENCE SHEET Pursuant to Item 501(b) of Regulation S-K, showing the location in the Prospectus of the answers to the items in Part I of Form S-4. Item No. and Caption Location in Prospectus 1. Forepart of the Registration Statement and Outside Front Cover Page of Prospectus Facing page; Cross-reference Sheet; Outside Front Cover Page of Prospectus 2. Inside Front and Outside Back Cover Pages of Prospectus Inside Front and Outside Back Cover Pages of Prospectus; Table of Contents; Available Information 3. Risk Factors, Ratio of Earnings to Fixed Charges and Other Information Proxy Statement Summary 4. Terms of the Transaction Information Regarding the Proposed Merger; Description of UTI and UII Capital Stock 5. Pro Forma Financial Information UTI and UII Pro Forma Consolidated Condensed Financial Information - Unaudited 6. Material Contracts with the Company Being Acquired The UTI Holding Company System; Business or UTI; Business of UII: Certain Relationships and Related Transactions 7. Additional Information Required for Reoffering By Persons and Parties Deemed to be Underwriters * 8. Interests of Named Experts and Counsel * 9. Disclosure of Commission Position on Indemnification for Securities Act Liabilities * 10. Information with Respect to S-3 Registrants * 11. Incorporation of Certain Information by Reference * 12. Information with Respect to S-2 or S-3 Registrants * 13. Incorporation of Certain Information by Reference * 14. Information with Respect to Registrants Other Than S-2 or S-3 Registrants Selected Financial Data of UTI; Business of UTI; Market Prices and Dividends; UTI Management's Discussion and Analysis of UTI's Financial Condition and Results of Operations; Potential Conflicts of Interest; Index to Financial Statements 15. Information with Respect to S-3 Companies * 16. Information with Respect to S-2 or S-3 Companies * 17. Information with Respect to Companies Other Than S-2 or S-3 Companies Selected Financial Data of UII; Business Of UII; Market Prices and Dividends; UII Management's Discussion and Analysis Of UII's Financial Condition and Results Of Operations; Relationship with Independent Public Accountants; Index to Exhibits; Index to Financial Statements 3 18. Information if Proxies, Consents or Authorizations are to be Solicited Solicitations and Revocability of UTI and UII Proxies; Principal Stockholders and Stock Ownership of Management; Dissenters' Appraisal Rights; Information Regarding the Proposed Merger; Management of UTI 19. Information if Proxies, Consents or Authorizations are not to be Solicited or in an Exchange Offer * ________ * Not applicable or answer thereto is negative 4 UNITED INCOME, INC. NOTICE OF SPECIAL MEETING OF STOCKHOLDERS TO BE HELD ON JUNE 25, 1998 To the Stockholders of United Income, Inc.: NOTICE IS HEREBY GIVEN that a Special Meeting of the Stockholders of United Income, Inc. ("UII") will be held on June 25, 1998 at 1:00 p.m. at the Holiday Inn Select Airport, 2501 South High School Road, Indianapolis, Indiana 46241 for the following purposes: 1. To consider and act upon a proposal to approve and adopt an Agreement and Plan of Reorganization by and between UII and United Trust, Inc., an Illinois corporation ("UTI"), which provides for the merger of UII into UTI, the conversion of each outstanding share of UII Common Stock, no par value into one share of UTI Common Stock, no par value. Upon the Effective date of the Merger the corporate name of United Trust, Inc. shall be changed to United Trust Group, Inc. Stockholders of UII who dissent from approval of this proposal have the right to obtain payment for the fair value of their shares pursuant to statutory procedures under Ohio state law, a copy of the relevant provisions of which is attached as Appendix B to the Proxy Statement; and 2. To transact such other business as may properly come before the meeting. The Board of Directors has fixed the close of business on May 26, 1998 as the record date for the determination of stockholders entitled to notice of and to vote at the Special Meeting. Whether or not you plan to attend the Special Meeting, you are urged to mark, date, and sign the enclosed proxy and return it promptly so that your vote can be recorded. If you are present at the meeting and desire to do so, you may revoke your proxy and vote in person. By Order of the Board of Directors, GEORGE E. FRANCIS, Secretary Dated: June 1, 1998 YOUR VOTE IS IMPORTANT. PLEASE COMPLETE, DATE, SIGN AND PROMPTLY RETURN YOUR PROXY IN THE ENCLOSED ENVELOPE, WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING IN PERSON. 5 UNITED TRUST, INC. NOTICE OF SPECIAL MEETING OF STOCKHOLDERS TO BE HELD ON JUNE 25, 1998 To the Stockholders of United Trust, Inc.: NOTICE IS HEREBY GIVEN that a Special Meeting of Stockholders of United Trust, Inc. ("UTI") will be held on June 25, 1998 at 1:00 p.m. at the Holiday Inn Select Airport, 2501 South High School Road, Indianapolis, Indiana 46241 for the following purposes: 1. To consider and act upon a proposal to approve and adopt an Agreement and Plan of Reorganization by and between UTI and United Income, Inc., an Ohio corporation ("UII"), which provides for the merger of UII into UTI and the conversion of each outstanding share of UII Common Stock, no par value, into one share of UTI Common Stock, no par value. If the proposed merger is approved, UTI will issue 826,153 shares of its Common Stock, no par value to UII shareholders which will represent 33.3% of its then issued and outstanding Common Stock, net of treasury shares. Upon the Effective date of the Merger, the corporate name of United Trust, Inc. shall be changed to United Trust Group, Inc. Stockholders of UTI who dissent from approval of this proposal have the right to obtain payment for the fair value of their shares pursuant to statutory procedures under Illinois state law, a copy of the relevant provisions of which is attached as Appendix C to the Proxy Statement; and 2. To consider and act upon a proposal to approve an amendment to UTI's Articles of Incorporation increasing the amount of authorized Common Stock, no par value from 3,500,000 shares to 7,000,000 shares; and 3. To transact such other business as may properly come before the meeting. The Board of Directors has fixed the close of business on May 26, 1998 as the record date for the determination of stockholders entitled to notice of and to vote at the Special Meeting. Whether or not you plan to attend the Special Meeting, you are urged to mark, date and sign the enclosed proxy and return it promptly so that your vote can be recorded. If you are present at the meeting and desire to do so, you may revoke your proxy and vote in person. By Order of the Board of Directors, GEORGE E. FRANCIS, Secretary Dated: June 1, 1998 YOUR VOTE IS IMPORTANT. PLEASE COMPLETE, DATE, SIGN AND PROMPTLY RETURN YOUR PROXY IN THE ENCLOSED ENVELOPE, WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING IN PERSON. 6 PRELIMINARY PROSPECTUS/PROXY STATEMENT DATED MAY 15, 1998 PROSPECTUS RELATING TO 826,153 SHARES OF COMMON STOCK OF UNITED TRUST, INC. JOINT PROXY STATEMENT RELATING TO SPECIAL MEETINGS OF THE SHAREHOLDERS OF UNITED TRUST, INC. AND UNITED INCOME, INC. BOTH TO BE HELD JUNE 25, 1998 This Prospectus relates to 826,123 shares of Common Stock of United Trust, Inc., an Illinois corporation ("UTI") to be issued in connection with an Agreement and Plan of Reorganization dated as of March 31, 1998, a copy of which is attached hereto as Appendix A ("the Merger Agreement"), pursuant to which UTI would be the surviving company to a merger ("the Merger"), with United Income, Inc., an Ohio corporation ("UII"). If the Merger is approved (See "INFORMATION REGARDING THE PROPOSED MERGER" and "RISK FACTORS") each one share of UII Common Stock, no par value ("the UII Common Stock"), excluding those held by UII as treasury shares will be converted ("the Conversion") into one share of UTI Common Stock, no par value ("the UTI Common Stock"). Simultaneously with the Conversion, the corporate name of UTI will be changed to United Trust Group, Inc. The 826,125 shares of UTI Common Stock issued to the UII Shareholders will represent 33.3% of UTI's then issued and outstanding Common Stock, net of treasury shares and will be issued at an aggregate value of $7,708,007. This Prospectus also serves as a Proxy Statement for Special Meetings of Shareholders of each of UTI and UII both of which will be held on June 25, 1998. The close of business on May 26, 1998 has been fixed as the record date for the determination of Stockholders entitled to notice of and to vote at the Special Meetings of Shareholders. Each share of both the UTI Common Stock and UII Common Stock is entitled to one vote. Abstentions, shares not voted for any reason and broker non votes will have the same effect as a negative vote. The holders of a majority of the outstanding shares of both the UTI Common Stock and UTI Common Stock entitled to vote represented in person or by proxy shall constitute a quorum for consideration of such matters placed before the Shareholders. On May 4, 1998, the high bid for the UTI Common Stock traded on the NASDAQ Small Cap exchange was $9.50. The UII Common Stock is not listed or actively traded, therefore no quote is available. THE DATE OF THIS JOINT PROXY STATEMENT/PROSPECTUS IS JUNE 1, 1998. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION. NEITHER THE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS PASSED UPON THE ACCURACY OR ADEQUACY OF THE INFORMATION CONTAINED IN THIS JOINT PROXY STATEMENT/PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL. NO PERSONS HAVE BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS JOINT PROXY STATEMENT/PROSPECTUS IN CONNECTION WITH THE SOLICITATION OF PROXIES HEREBY AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY UTI, UII OR ANY OTHER PERSON. THIS JOINT PROXY STATEMENT/PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO PURCHASE ANY SECURITIES OTHER THAN THE 7 SHARES OF UTI OR UII HOLDINGS TO WHICH IT RELATES, OR AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO PURCHASE ANY SECURITIES COVERED BY THIS JOINT PROXY STATEMENT/PROSPECTUS OR THE SOLICITATION OF A PROXY IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS JOINT PROXY STATEMENT/PROSPECTUS NOR ANY DISTRIBUTION OF SUCH SHARES SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF UTI OR UII SINCE THE DATE HEREOF, OR THE DATE AS OF WHICH CERTAIN INFORMATION IS SET FORTH HEREIN. AVAILABLE INFORMATION UTI is subject to the informational requirements of the Securities Exchange Act of 1934 and in accordance therewith files reports and other information with the Securities and Exchange Commission. The reports, proxy statements distributed to stockholders of UTI, and other information filed by UTI can be inspected and copied at the public reference facilities maintained by the Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. and at the Commission's Regional Offices located at Seven World Trade Center, New York, New York 10048, and Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such materials can also be obtained from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. Additionally, the Commission maintains a Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. Said information may be obtained via the Internet at (http://www.sec.gov). This Prospectus does not contain all of the information set forth in the Registration Statement (of which this Prospectus is a part) and exhibits thereto which UTI has filed with the Securities and Exchange Commission in Washington, D.C. For further information, reference is made to the Registration Statement including the exhibits filed or incorporated as a part of it. 8 PRELIMINARY PROXY MATERIAL DATED MAY 15, 1998 UNITED INCOME, INC. 5250 SOUTH SIXTH STREET ROAD SPRINGFIELD, ILLINOIS 62703 SOLICITATION AND REVOCABILITY OF UII PROXIES This Proxy Statement is furnished in connection with the solicitation by UII's Board of Directors of proxies to be voted at a Special Meeting of Stockholders, or any adjournment thereof, to be held on June 25, 1998 at 1:00 p.m. at the Holiday Inn Select Airport, 2501 South High School Road, Indianapolis, Indiana 46201. The purpose of the Special Meeting of Stockholders, as set forth in the accompanying notice, is (i) to vote on the proposal for the merger of UII into UTI, pursuant to the terms of an Agreement and Plan of Reorganization (the "Merger Agreement"), and (ii) to conduct such other business as may properly come before the meeting or any adjournment thereof. The Proxy Statement and accompanying proxy are being mailed to stockholders on or about June 1, 1998. Any proxy may be revoked by the person giving it at any time before it is voted by delivering to the Secretary of UII a written notice of revocation or a duly executed proxy bearing a later date. Shares represented by a proxy, properly executed and returned to UII and not revoked, will be voted at the Special Meeting. Shares will be voted in accordance with the directions of the stockholder as specified on the proxy. In the absence of directions, the proxy will be voted FOR the approval of the Merger Agreement. Any other matters that may properly come before the meeting will be acted upon by the persons named in the accompanying proxy in accordance with their discretion. The close of business on May 26, 1998 has been fixed as the record date (the "Record Date") for the determination of stockholders entitled to notice of and to vote at the Special Meeting and any adjournment thereof. As of the Record Date, UII had 1,391,919 shares of Common Stock, no par value, outstanding and entitled to vote. No other voting securities of UII are outstanding. There are no cumulative voting rights. The cost of soliciting proxies will be borne by UII. UII may reimburse brokers and other persons for their reasonable expenses in forwarding proxy material to the beneficial owners of UII Common Stock. Solicitations may be made by telephone, by telegram or by personal calls. A copy of the Merger Agreement is included as Appendix A to this Proxy Statement. The description of the Merger contained in this Proxy Statement, including the summary of the terms of the Merger Agreement, is qualified in its entirety by reference to the full text of the Merger Agreement which is incorporated herein by reference. THE DATE OF THIS PROXY STATEMENT IS JUNE 1, 1998. 9 PRELIMINARY PROXY MATERIAL DATED MAY 15, 1998 UNITED TRUST, INC. 5250 SOUTH SIXTH STREET ROAD SPRINGFIELD, ILLINOIS 62703 PROXY STATEMENT SOLICITATION AND REVOCABILITY OF UTI PROXIES This Proxy Statement is furnished in connection with the solicitation by the Board of Directors of UTI of proxies to be voted at a Special Meeting of Stockholders, or at any adjournment thereof, to be held on June 25, 1998, at 1:00 p.m. at the Holiday Inn Select Airport, 2501 South High School Road, Indianapolis, Indiana 46201. The purpose of the Special Meeting of Stockholders as set forth in the accompanying notice is (i) to vote on the proposal for the merger of UII into UTI, pursuant to the terms of an Agreement and Plan of Reorganization ("the Merger Agreement"); (ii) to vote on a proposal to amend UTI's Articles of Incorporation to increase the amount of authorized Common Stock from 3,500,000 shares to 7,000,000 shares; and (iii) to conduct such other business as may properly come before the meeting or any adjournment thereof. The Proxy Statement and accompanying proxy are being mailed to stockholders on or about June 1, 1998. Any proxy may be revoked by the person giving it at any time before it is voted by delivering to the Secretary of UTI a written notice of revocation or a duly executed proxy bearing a later date. Shares represented by a proxy, properly executed and returned to UTI and not revoked, will be voted at the Special Meeting. Shares will be voted in accordance with the directions of the stockholder as specified on the proxy. In the absence of directions, the proxy will be voted FOR the approval of the proposals described above. Any other matters that may properly come before the meeting will be acted upon by the persons named in the accompanying proxy in accordance with their discretion. The close of business on May 26, 1998 has been fixed as the record date (the "Record Date") for the determination of stockholders entitled to notice of and to vote at the Special Meeting and any adjournment thereof. As of the Record Date, UTI had 1,655,200 shares of Common Stock, no par value, outstanding and entitled to vote. No other voting securities of UTI are outstanding. There are no cumulative voting rights. The cost of soliciting proxies will be borne by UTI. UTI may reimburse brokers and other persons for their reasonable expenses in forwarding proxy material to the beneficial owners of UTI Common Stock. Solicitations may be made by telephone, by telegram or by personal calls. A copy of the Merger Agreement is included as Appendix A to this Proxy Statement. The description of the Merger contained in this Proxy Statement, including the summary of the terms of the Merger Agreement, is qualified in its entirety by reference to the full text of the Merger Agreement which is incorporated herein by reference. THE DATE OF THIS PROXY STATEMENT IS JUNE 1, 1998. 10 TABLE OF CONTENTS Page PROXY STATEMENT SUMMARY 12 RISK FACTORS 15 INTRODUCTION 18 THE UTI HOLDING COMPANY SYSTEM 18 PRINCIPAL STOCKHOLDERS AND STOCK OWNERSHIP OF MANAGEMENT 20 INFORMATION REGARDING THE PROPOSED MERGER 22 DISSENTERS' RIGHTS 27 SELECTED FINANCIAL DATA OF UII 31 UII MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 32 SELECTED FINANCIAL DATA OF UTI 47 UTI MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 48 FEDERAL INCOME TAXES 66 CAPITALIZATION OF UTI AND UII 66 UTI AND UII PRO FORMA CONSOLIDATED CONDENSED FINANCIAL INFORMANTION - UNAUDITED 67 MARKET PRICES AND DIVIDENDS 74 BUSINESS OF UII 75 BUSINESS OF UTI 83 DIRECTORS AND EXECUTIVE OFFICERS OF UII 95 BENEFICIAL OWNERS AND MANAGEMENT OF UII 102 DIRECTORS AND EXECUTIVE OFFICERS OF UTI 104 BENEFICIAL OWNERS AND MANAGEMENT OF UTI 111 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 113 POTENTIAL CONFLICTS OF INTEREST 114 YEAR 2000 ISSUE 114 RECENT DEVELOPMENT 115 DESCRIPTION OF UTI AND UII CAPITAL STOCK 115 PROPOSED INCREASE IN THE AUTHORIZED COMMON STOCK OF UTI 118 RELATIONSHIP WITH INDEPENDENT PUBLIC ACCOUNTANTS 119 OTHER MATTERS TO COME BEFORE THE MEETING 119 SIGNATURES 120 INDEX TO EXHIBITS 121 INDEX TO FINANCIAL STATEMENTS OF UTI AND UII 125 Appendix A Agreement and Plan of Reorganization 234 Appendix B Rights of Dissenting Stockholders of United Income, Inc. 252 Appendix C Rights of Dissenting Stockholders of United Trust, Inc. 256 Appendix D Proposed Amendment to Articles of Incorporation of UTI 259 11 PROXY STATEMENT SUMMARY The following summary is qualified in its entirety by the more detailed information and financial statements appearing elsewhere in the Proxy Statement and by the full text of the Agreement and Plan of Reorganization (the "Merger Agreement") which is attached hereto as Appendix A and incorporated herein by reference. DATE OF SPECIAL MEETINGS OF UTI AND UII STOCKHOLDERS June 25, 1998 RECORD DATE March 26, 1998 EFFECTIVE DATE The closing of the transactions ("the Effective Date") contemplated by the Merger Agreement shall take place at the executive offices of UII beginning at 2:00 p.m. on the first business day following the day upon which the UTI and UII stockholders meetings to approve the Merger were held. SHARES OF UTI AND UII UTI Common Stock outstanding 1,655,200 UII Common Stock outstanding 1,391,919 UII Common Stock owned by UTI 565,766 UTI Shares to be issued to UII Shareholders 826,153 PROPOSALS 1. UII will be merged into UTI pursuant to the merger agreement. 2. The number of authorized Common Stock of UTI will be increased from 3,500,000 to 7,000,000. NAME CHANGE Upon the Effective Date of the Merger, the corporate name of United Trust, Inc. will change to United Trust Group, Inc. REASONS FOR THE MERGERThe Board of Directors of each UTI and UII has concluded that the Merger will benefit the business operations of UTI and UII and their respective stockholders by creating a larger, more viable life insurance holding group with lower administrative costs, a simplified corporate structure, and more readily marketable securities. UTI and UII have no operations of its own other than its holding companies and investment activities. The Merger will have no effect on the administration of UTI's and UII's subsidiary insurance company operations. The commonalty of ownership among UTI and UTI's officers and directors (See "Vote Required") conflict in terms of their voting authority and resulting differences in their percentage of ownership from the merger. (See "RISK FACTORS - Change in Ownership Interest") The close of business on May 26, 1998 has been fixed as the record date for the determination of stockholders entitled to notice of and to vote on the proposals. Regulatory approval is not required from the States in which its' life insurance subsidiaries are authorized to do business and that UTI and UII are proceeding in accordance with the provisions of the Illinois Business Corporation Act and the Ohio General Corporation Law, respectively. 12 INCREASE IN UTI The Board of Directors of UTI has declared AUTHORIZED advisable to increase UTI's COMMON STOCK authorized capital stock from 3,500,000 shares to 7,000,000 shares. The purpose is to provide UTI with the flexibility to engage in future transactions that UTI's Board of Directors deem necessary or desirable (See "Proposed Increase in the Authorized Common Stock of UTI"). UTI has sufficient unissued authorized stock to complete the proposed Merger of UTI and UII without the proposed increase in authorized capital stock. CONVERSION RATIO One share of UII Common Stock, excluding shares held by UII as treasury shares and shares as to which dissenter's appraisal rights shall have been perfected, will be converted into one share of UTI Common Stock. VOTE REQUIRED UTI The affirmative votes of the holders of two- thirds of the outstanding UTI Common Stock are required for approval of the proposals 1. and 2. The executive officers and directors of UTI beneficially own 42.6% of the outstanding Common Stock of UTI and they intend to vote in favor of proposals 1. and 2. UII The affirmative vote of the holders of a majority of the outstanding UII Common Stock is required for approval of the Merger by UII. The executive officers and directors of UII beneficially own 5.5% of the outstanding Common Stock of UII. Additionally, UTI owns 40.6% of the outstanding Common Stock of UTI. Both the officers and directors of UII and the Board of Directors of UTI (collectively owning 46.1% of the Common Stock of UII) intend to vote in favor of the UII merger TAX CONSEQUENCES The Merger will qualify as a tax-free reorganization for federal income tax purposes. No gain or loss will be recognized by UTI or UII, or stockholders of UTI or UII, except that gain or loss will be recognized to the extent of cash received by a dissenting stockholder. BOARD OF DIRECTORS The Board of Directors of each of UTI and UII recommends approval of the proposals. DISSENTERS' UTI and UII stockholders who dissent from APPRAISAL RIGHTS approval of the Merger pursuant to certain procedures under Illinois and Ohio state laws have the right to obtain payment for the fair value of their shares. (See DISSENTERS' APPRAISAL RIGHTS".) BUSINESS OF UTI UTI is a holding company owning 53% of the AND UII outstanding capital stock of UTG. Additionally, UTI owns 40.6% of UII, also a holding company, which in turn owns the remaining 47% of the outstanding capital stock of UTG. UTG is a holding company formed in 1992 as a vehicle to acquire Commonwealth Industries Corporation (See "THE UTI HOLDING COMPANY SYSTEM"). UTG owns directly a majority of the outstanding capital stock of First Commonwealth Corporation ("FCC"). FCC in turn owns 100% of Universal Guaranty Life Insurance Company ("UG"). UG in turn owns 100% of United Security Assurance Company ("USA"), and USA in turns owns 84% of Appalachian Life Insurance Company ("APPL"). Finally, APPL owns 100% of Abraham Lincoln Insurance Company ("ABE"). The companies main business is the solicitation and acquisition of life insurance. 13 POTENTIAL CONFLICTS The directors and officers of UTI OF INTEREST beneficially own 42.6% of the outstanding Common Stock of UTI. UTI owns 40.6% of the issued and outstanding Common Stock of UII. A conflict exists with regard to their corresponding percentage of ownership after the merger. The directors and officers of UII beneficially own 5.5% for which a similar conflict exists. If the Merger is approved the directors and officers of UTI will own a smaller percentage of UTI and the directors and officers of UII will own a smaller percentage of a larger company. Because of the existence of minority interests in the holding companies within the UTI holding company system, potential conflicts of interest exist with respect to intercompany transactions. (See "POTENTIAL CONFLICTS OF INTEREST".) RELATED TRANSACTIONS See "THE UTI HOLDING COMPANY SYSTEM" and "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS". EQUITY INVESTMENT On April 30, 1998, UTI and First Southern Funding, IN UTI a Kentucky corporation ("FSF"), signed a Definitive Agreement ("the FSF Agreement") whereby FSF will make an equity investment in UTI. Under the terms of the FSF Agreement, FSF will buy 473,523 authorized but unissued shares of UTI common stock for $15.00 a share and will also buy 389,715 shares of UTI common stock that UTI purchased during the last year in private transactions at the average price UTI paid for such stock, plus interest, or approximately $10.00 per share. FSF will also purchase 66,667 shares of UTI common stock and $2,560,000 of face amount convertible bonds which are due and payable on any change in control of UTI, in private transactions, primarily from officers of UTI. In addition, FSF will be granted a three year option to purchase up to 1,450,000 shares of UTI common stock for $15.00 per share. (See "RECENT DEVELOPMENT") 14 RISK FACTORS DEPENDENCE ON DISTRIBUTIONS FROM AFFILIATES UTI is a holding company owning 53% of the outstanding capital stock of UTG. Additionally, UTI owns 40.6% of UII, also a holding company, which in turn owns the remaining 47% of the outstanding capital stock of UTG. UTG is a holding company formed in 1992 as a vehicle to acquire Commonwealth Industries Corporation (See "THE UTI HOLDING COMPANY SYSTEM"). UTG owns directly a majority of the outstanding capital stock of First Commonwealth Corporation ("FCC"). FCC in turn owns 100% of Universal Guaranty Life Insurance Company ("UG"). UG in turn owns 100% of United Security Assurance Company ("USA"), and USA in turn owns 84% of Appalachian Life Insurance Company ("APPL"). Finally, APPL owns 100% of Abraham Lincoln Insurance Company ("ABE"). UTI has no operations of its own other than its holding companies and investment activities. Sources of funds available to UTI are its investment assets and the income, if any, from such assets, and service fees and dividends from its operating affiliates. The fair market value of the UTI's cash and cash equivalents and investment assets on March 31, 1998 was approximately $297,000. UTI's investment income for the three months ended March 31, 1998 totaled $44,000. UII has a service agreement with USA which states that USA is to pay UII monthly fees equal to 22% of the amount of collected first year premiums, 20% in second year and 6% of the renewal premiums in years three and after. UII has a subcontract agreement with UTI which states that UII is to pay UTI monthly fees equal to 60% of collected service fees from USA as stated above. USA paid $989,295, $1,567,891 and $2,015,325 under their agreement with UII for 1997, 1996 and 1995, respectively. UII paid $593,577, $940,734 and $1,209,195 under their agreement with UTI for 1997, 1996 and 1995, respectively. Should the proposed Merger be approved the service fees received by UII from USA would continue to be paid to UTI. The payment of dividends to UTI from UTG will be dependent upon UTG's receipt for dividends from FCC, directly and indirectly through the holding company system. Should the Merger be approved the dividends from FCC, if any, would be paid directly to UTI. Such dividends in turn depend upon FCC's receipt of dividends from UG and UG's receipt of dividends from its subsidiaries. The payment of dividends by life insurance companies is regulated by state insurance laws, and generally dividends in any year are limited to the net statutory earnings (earnings determined in accordance with accounting rules required or permitted by applicable state insurance laws and regulations) of the life insurance company. CONTROL BY UTI UTI owns 40.6% of the Common Stock of UII. Together, UTI and UII own 100% of the Common Stock of UTG. As a result of its equity ownership, UTI is able to exercise substantial control over the Company's affairs. UTI may effectively control the election of the directors and operations of both UTG and UII. Additionally, UTI may effectively control the approval or disapproval of any matters submitted for stockholder approval and it may prevent a change of management or an acquisition or takeover of UII. The Board of Directors of both UTI and UII intend to vote in favor of the proposed Merger. CHANGE IN OWNERSHIP INTEREST If the Merger is approved, a shareholder of UTI will own a smaller percentage of UTI's equity as a result of the additional 826,153 shares of UTI Common Stock issued to the UII shareholders; however, the additional shares being issued will also cause an increase in UTI's equity (See "UTI AND UII PROFORMA CONSOLIDATED FINANCIAL INFORMATION"). POTENTIAL CONFLICTS OF INTEREST Because of the existence of minority interest in certain holding companies within the UTI holding company system potential conflicts of interest may arise with respect to intercompany transactions. Such transactions may include mergers and allocation of expenses among the companies in the UTI holding company system. UTI has taken a number of steps to reduce potential conflicts of interest by increasing the commonality of ownership interest in the subsidiaries. One of the reasons for the proposed Merger is to increase the commonality of ownership among UTI and UII. 15 NO DIVIDENDS UTI has not paid any cash dividends on its Common Stock and currently intends to retain any earnings for the future development of its business. COMPARATIVE MARKET VALUE OF SECURITIES On March 24, 1997, the date prior to the day the agreement of the proposed merger was entered into, UTI's common stock had a closing bid price of $5.31 as quoted on NASDAQ. There is no established public trading market for UII's common stock. UII's common stock is not listed on any exchange. Therefore, no market quote was available. 16 SELECTED FINANCIAL INFORMATION PROPOSED MERGER OF UTI AND UII (000's omitted except on per share data) Three Months Year Ended Ended December 31, March 31, 1998 1997 1997 1996 1995 UTI - HISTORICAL Revenues $ 11,227 $ 11,966 $ 43,992 $ 46,976 $ 49,869 Net Income (loss) $ 114 $ 47 $ (559) $ (938) $ (3,001) Per common share: Income (loss) $ .07 $ .03 $ (0.32) $ (0.50) $ (1.61) Cash dividends $ 0 $ 0 $ 0 $ 0 $ 0 Balance sheet data: Assets $ 350,023 $ 349,300 $ 355,474 $ 356,305 Common stockholders equity: Total $ 15,189 $ 15,357 $ 18,014 $ 19,022 Per Share $ 9.33 $ 9.39 $ 9.63 $ 10.19 UII - HISTORICAL Revenues $ 287 $ 343 $ 1,186 $ 1,791 $ 2,234 Net Income (loss) $ 105 $ 56 $ (79) $ (319) $ (2,148) Per common share: Income (loss) $ .08 $ .04 $ (0.06) $ (0.23) $ (1.54) Cash dividends $ 0 $ 0 $ 0 $ 0 $ 0 Balance sheet data: Assets $ 12,815 $ 12,840 $ 12,881 $ 13,386 Common Stockholders equity: Total $ 11,902 $ 11,936 $ 11,977 $ 12,355 Per common $ 8.55 $ 8.58 $ 8.60 $ 8.87 share UTI AND UII - PRO FORMA: Revenues $ 11,114 $ 43,363 Net Income (loss) $ 177 $ (615) Per common share: Income (loss) $ 0.07 $ (0.25) Cash dividends $ 0 $ 0 Balance sheet data: Assets $ 341,669 Common stockholders equity: Total $ 22,864 Per Share $ 9.33
17 PROXY STATEMENT FOR SPECIAL MEETINGS OF STOCKHOLDERS OF UNITED TRUST, INC. AND UNITED INCOME, INC. INTRODUCTION This Proxy Statement is being provided to stockholders of United Trust, Inc. an Illinois corporation ("UTI"), and to stockholders of United Income, Inc. an Ohio corporation ("UII"), in connection with the solicitation of proxies by and on behalf of the management of UTI and UII, respectively, to be used in voting at the Special Meetings of Stockholders of UTI and UII, respectively, in accordance with the foregoing Notices of Special Meetings of UTI and UII. The mailing address and telephone number of each UTI and UII is 5250 South Sixth Street, Springfield, Illinois 62703 and (217) 241-6300. THE UTI HOLDING COMPANY SYSTEM UTI and UII are members of an insurance holding company system of which UTI is the ultimate parent company. The following is the current organizational chart for the companies that are members of the Company's insurance holding company system and affiliates of the Company, and the acronyms that will be used herein to reference the companies: ORGANIZATIONAL CHART AS OF MARCH 31, 1998 United Trust, Inc. ("UTI") is the ultimate controlling company. UTI owns 53% of United Trust Group ("UTG") and 41% of United Income, Inc. ("UII"). UII owns 47% of UTG. UTG owns 79% of First Commonwealth Corporation ("FCC") and 100% of Roosevelt Equity Corporation ("REC"). FCC owns 100% of Universal Guaranty Life Insurance Company ("UG"). UG owns 100% of United Security Assurance Company ("USA"). USA owns 84% of Appalachian Life Insurance Company ("APPL") and APPL owns 100% of Abraham Lincoln Insurance Company ("ABE"). 18 For purposes of this proxy statement, the term "affiliate life insurance companies" shall mean UG, USA, APPL and ABE, and the term "non- insurance affiliate companies" shall mean the affiliated companies other than UG, USA, APPL and ABE. All of these companies, either directly or through subsidiaries operate principally in the individual life insurance business. The primary business of the companies has been the servicing of existing insurance business in force, the solicitation of new insurance business, and the acquisition of other companies in similar lines of business. UTI was incorporated December 14, 1984, as an Illinois corporation. During the next two and a half years, UTI was engaged in an intrastate public offering of its securities, raising over $12,000,000 net of offering costs. In 1986, UTI formed a life insurance subsidiary and by 1987 began selling life insurance products. UII was incorporated on November 2, 1987, as an Ohio corporation. Between March 1988 and August 1990, UII raised a total of approximately $15,000,000 in an intrastate public offering in Ohio. During 1990, UII formed a life insurance subsidiary and began selling life insurance products. UTI currently owns 40.6% of the outstanding common stock of UII and accounts for its investment in UII using the equity method. In 1987, UTI made an initial investment in UII of approximately one third of the public offering. On February 20, 1992, UTI and UII, formed a joint venture, United Trust Group, Inc. On June 16, 1992, UTI contributed $2.7 million in cash, an $840,000 promissory note and 100% of the common stock of its wholly owned life insurance subsidiary. UII contributed $7.6 million in cash and 100% of its life insurance subsidiary to UTG. After the contributions of cash, subsidiaries, and the note, UII owns 47% and UTI owns 53% of UTG. On June 16, 1992, UTG acquired 67% of the outstanding common stock of the now dissolved Commonwealth Industries Corporation ("CIC"), for a purchase price of $15,567,000. Following the acquisition, UTI controlled eleven life insurance subsidiaries. UTI and UII have taken several steps to streamline and simplify the corporate structure following the acquisitions. On December 28, 1992, Universal Guaranty Life Insurance Company was the surviving company of a merger with Roosevelt National Life Insurance Company, United Trust Assurance Company, Cimarron Life Insurance and Home Security Life Insurance Company. On June 30, 1993, Alliance Life Insurance Company, a subsidiary of UG, was merged into UG. On March 30, 1994, Farmers and Ranchers Life Insurance Company ("F&R) was sold to an unrelated third party. F&R was a small life insurance company which did not significantly contribute to the operations of the group. F&R primarily represented a marketing opportunity. Management determined it would not be able to allocate the time and resources necessary to properly develop the opportunity, due to continued focus and emphasis on certain other agency forces of the Company. On July 31, 1994, Investors Trust Assurance Company was merged into Abraham Lincoln Insurance Company. On August 15, 1995, the shareholders of CIC, Investors Trust, Inc., and Universal Guaranty Investment Company, all intermediate holding companies within the UTI group, voted to voluntarily liquidate each of the companies and distribute the assets to the shareholders (consisting solely of common stock of their respective subsidiary). As a result, the shareholders of the liquidated companies became shareholders of FCC. The proposed merger described in the Proxy Statement/Prospectus is a further step in the consolidation and restructuring of the UTI holding company system. 19 PRINCIPAL STOCKHOLDERS AND STOCK OWNERSHIP OF MANAGEMENT The following table shows with respect to any person who is known to be the beneficial owner of more than 5% of the UTI Common Stock or UII Common Stock and shows for each: (i) the total number of shares of such stock beneficially owned as of January 5, 1998, and the nature of such ownership; and (ii) the percent of the issued and outstanding shares of Common Stock so owned as of the same date. Title Number of Shares Percent Of Name and Address and Nature of of Class of Beneficial Owner Beneficial Ownership Class UII Common United Trust, Inc 565,766 40.6% Stock, 5250 South Sixth Street Springfield, IL 62703 UTI Common Larry E. Ryherd 562,431 (1) 33.9% Stock, 12 Red Bud Lane Springfield, IL 62707 (1) Larry E. Ryherd owns 230,621 shares of UTI's Common Stock in his own name. Includes; (i) 150,050 shares of UTI's Common Stock in the name of Dorothy LouVae Ryherd, his wife; (ii) 150,000 shares of UTI's Common Stock which are held beneficially in trust for the three children of Larry E. Ryherd and Dorothy LouVae Ryherd, namely Shari Lynette Serr, Derek Scott Ryherd and Jarad John Ryherd; (iii) 14,800 shares of UTI's Common Stock , 6,700 shares of which are in the name of Shari Lynette Serr, 1,200 shares of which are held in the name of Derek Scott Ryherd and 6,900 shares of which are in the name of Jarad John Ryherd; (iv) 500 shares of UTI's Common Stock held in the name of Larry E. Ryherd as custodian for Charity Lynn Newby, his niece; (v) 500 shares held in the name of Larry E. Ryherd as custodian for Lesley Carol Newby, his niece; (vi) 2,000 shares held by Dorothy LouVae Ryherd, his wife as custodian for granddaughter; 160 shares held by Larry E. Ryherd as custodian for granddaughter; and (viii) 13,800 shares which may be acquired by Larry E. Ryherd upon the exercise of outstanding stock options. The following table shows with respect to each of the directors of UTI and UII and with respect to the named executive officers and directors of UTI and UII as a group, (i) the total number of shares of common stock of UTI and UII beneficially owned as of January 5, 1998 and the nature of such ownership; (ii) the percent of such classes of common stock so owned as of the same date. Title Directors, Named Executive Number of Shares Percent of Officers, & All Directors & and Nature of of Class Executive Officers as a Group Ownership Class UII Common Vincent T. Aveni 7,716 (1) * Stock Marvin W. Berschet 7,161 (2) * George E. Francis 0 * James E. Melville 0 * Charlie E. Nash 7,052 * Larry E. Ryherd 47,250 (3)(5) 3.4% Robert W. Teater 7,380 (4) * All directors and executive officers as a group 76,559 5.5% (eight in number) 20 Title Directors, Named Executive Number of Shares Percent of Officers, & All Directors & and Nature of of Class Executive Officers as a Group Ownership Class UTI John S. Albin 10,503 (6) * Common William F. Cellini 1,000 * Stock, Robert E. Cook 10,199 * Larry R. Dowell 10,142 * George E. Francis 4,600 (7) * Donald G. Geary 1,200 * Raymond L. Larson 4,400 (8) * Dale E. McKee 11,122 (9) * James E. Melville 52,500 (10) 3.2% Thomas F. Morrow 40,555 (11) 2.4% Larry E. Ryherd 562,431 (12) 33.9% All directors and 715,808 42.6% Executive officers as a Group (eleven in number) (1) Includes 272 shares owned directly by Mr. Aveni's brother and 210 shares owned directly by Mr. Aveni's son. (2) Includes 42 shares owned directly by each of Mr. Berschet's two sons and 77 shares owned directly by Mr. Berschet's daughter, a total of 161 shares. (3) Includes 47,250 shares beneficially in trust for the three children of Larry E. Ryherd and Dorothy LouVae Ryherd, namely Shari Lynette Serr, Derek Scott Ryherd and Jarad John Ryherd. (4) Includes 210 shares owned directly by Mr. Teater's spouse. (5) In addition, Mr. Ryherd is a director and officer of UTI, which owns 565,766 shares (40.6%) of UII. Mr. Ryherd disclaims any beneficial interest in the 416,185 shares of UII owned by UTI as the board of directors controls the voting and investment decisions regarding such shares. (6) Includes 392 shares owned directly by Mr. Ablin's spouse. (7) Includes 4,600 shares which may be acquired upon the exercise of outstanding stock options. (8) Includes 375 shares owned directly by Mr. Larson's spouse. (9) Includes 778 shares owned jointly with his spouse. (10) James E. Melville owns 2,500 shares individually and 14,000 shares jointly with his spouse. Includes; (i) 3,000 shares of UII's Common Stock which are held beneficially in trust for his daughter, namely Bonnie J. Melville; (ii) 3,000 shares of UII's Common Stock, 750 shares of which are in the name of Matthew C. Hartman, his nephew; 750 shares of which are in the name of Zachary T. Hartman, his nephew; 750 shares of which are in the name of Elizabeth A. Hartman, his niece; and 750 shares which are in the name of Margaret M. Hartman, his niece; and (iii) 30,000 shares which may be acquired by James E. Melville upon the exercise of outstanding stock options. (11) Thomas F. Morrow owns 21,855 shares individually. Includes (i) 1,500 shares held in the name of Thomas F. Morrow as custodian for his grandchildren, and (ii) 17,200 shares which may be acquired by Thomas F. Morrow upon the exercise of outstanding stock options. (12) See footnote 1 under "Principal Stockholders". * Less than 1%. Except as indicated above, the foregoing persons hold sole voting and investment power. 21 INFORMATION REGARDING THE PROPOSED MERGER On March 25, 1997, the Board of Directors of each UTI and UII unanimously approved an Agreement and Plan of Reorganization (the "Merger Agreement") providing for the merger of UII into UTI. UTI and UII jointly own 100% of the outstanding capital stock of UTG. Simultaneously at closing, UTG shall be liquidated and UTI's name will be changed to United Trust Group, Inc. A summary of all material provisions of the Merger Agreement is set forth below and is qualified in its entirety by reference to the full text of the Merger Agreement dated as of March 30, 1998 which is attached hereto as Appendix A to this Proxy Statement. THE PROPOSED MERGER The Merger Agreement provides that, if approved, UII will be merged into UTI. UTI will continue in existence as the surviving company ("Surviving Company"), its name will be changed to United Trust Group, Inc. and will be governed by the State of Illinois. The separate existence of UII will cease, but its business will be continued by the Surviving Company. No change in the present business of UII is now contemplated. The Surviving Company will succeed to ownership of all of UII's assets and will assume all of UII's liabilities. The directors of UII in office on the effective date of the Merger will continue in office as directors of the Surviving Company, until the next annual meeting of UTI stockholders or until their successors are duly elected and qualified. The officers of UTI and UII are the same individuals. The certificate of incorporation of UTI, as amended, will continue to be the certificate of incorporation of the Surviving Company following the Effective Date of the Merger (as hereinafter defined), and is not amended by the Merger Agreement. The by-laws of UTI will continue as the by-laws of the Surviving Company until altered, amended or repealed. REASONS FOR THE MERGER In 1992, UTI and its subsidiary UII combined assets to form UTG as a vehicle to acquire Commonwealth Industries Corporation. (See "UTI Holding Company System). The acquisition increased the company's business by more than ten fold. The organization at that time consisted of six separate holding companies and eleven separate life insurance companies. The companies long and short goals have been to realize operating efficiencies through restructuring and simplification of the organization. To that extent over the past years the companies managed to liquidate three of its holding companies and merge seven of its life insurance companies yielding the current organization as shown under the "UTI Holding Company System" section. UTI is traded on the NASDAQ Small Cap exchange. In 1997, UTI completed a 1 for 10 reverse stock split to enable the company to meet new NASDAQ requirements regarding market value per share of its Common Stock to remain listed on the NASDAQ exchange and to increase the market value per share to a level where more brokers will look at UTI and its stock. In keeping with its goals both long term and short term, of simplifying the organization the Board of Directors had previously considered the possible merger with UII. UII also perfected 1 for 14.2 reverse stock split in 1997. The split in effect, placed the book value per share of the UII shares and UTI shares on the same basis. The exchange ratio of one share of UII Common Stock for one share of UTI Common Stock was arrived at based upon a review of a number of factors, including (1) the relationship of the current number of shares of UTI and UII common stock outstanding and the percentage ownership of each company of their common affiliate, United Trust Group, Inc. and (2) the relative historical and projected earnings per share, the relative historical book value per share, and the relative historical market value per share of each of UTI and UII. Taking all these factors into account, the Board of Directors of UTI determined that the exchange ratio would be fair to the stockholders of UTI and UII respectively. 22 The Board of Directors considered the beneficial ownership of UTI Common Stock by its members and executive officers (See "Potential Conflicts of Interest") and the resulting decrease in percentage of ownership if the Merger is approved. The Board of Directors of UTI consisting of eight independent members who also are not members of UII's board, and two members (Mssrs Ryherd and Melville) who are executive officers of UTI and UII considered all the above factors at its board meeting on March 25, 1997 and concluded that the Merger will benefit the business operations of UTI and UII and their respective stockholders. The Merger if approved, will provide the following benefits. * A simplified and more viable holding company system. * Lower administrative costs. * More readily marketable securities. * The UII shareholders will have shares that are traded on an exchange. REASONS FOR THE MERGER UII In 1992, UII and its parent UTI combined assets to form UTG as a vehicle to acquire Commonwealth Industries Corporation. (See "UTI Holding Company System"). The combination increased the operations in size by approximately ten fold. As with its parent, the company's long and short term goals have included a focus on restructuring and simplification of the organization to realize operating efficiencies. UII's Common Stock is not traded on an exchange. The Board of Directors long term plans have been to obtain a greater visibility of its stock by becoming a member of the NASDAQ Small Cap exchange. The Board of Directors has considered since 1992 the possibilities of a merger with its parent UTI. It also was aware of the new NASDAQ requirements that UTI needed to meet concerning the market value of its Common Stock and UTI's board actions to split its stock to satisfy the requirement (See "Reason for the Merger UTI). The Board of Directors of UII consisting of four independent members who also were not members of UTI's board and two members (Mssrs Ryherd and Melville) who are executive officers of UTI and UII considered the above factors and determined that an opportunity existed to accomplish both the merger and provide the UII shareholders with a security that is listed on an exchange. Accordingly, UII also perfected a stock split (See "Reason for the Merger UTI") as a step towards merging the companies. The exchange ratio was arrived at based upon a review of a number of factors, including (1) the relationship of the current number of shares of UTI and UII common stock outstanding and the percentage ownership of each company of their common affiliate, United Trust Group, Inc. and (2) the relative historical and projected earnings per share, the relative historical book value per share, and the relative historical market value per share of each of UTI and UII. Taking all these factors into account, the Board of Directors of UII determined that the exchange ratio of each (one) share of UII Common Stock for one share of UTI Common Stock would be fair to the stockholders of UTI and UII respectively. The above matters were the main substance of the Board of Directors meeting on March 25, 1997 and the Directors concluded that the Merger will benefit the business operations of UII and their stockholders. The Merger if approved, will provide the following benefits. * The UII shareholders will have shares that are traded on an exchange. * More readily marketable securities. * A simplified and more viable holding company system. * Lower administrative costs. 23 EFFECTIVE DATE The Merger would become effective after the adoption of the Merger Agreement by the required two thirds affirmative vote of the UTI Common Stock entitled to vote thereon and the required majority affirmative vote of the UII Common Stock, the filing of the merger Agreement and Articles of Merger with the Secretary of State of Illinois and the Secretary of State of Ohio, and the issuance by the Secretary of State of Ohio, a certificate of merger (the "Effective Date"). The closing of the transaction contemplated by the merger Agreement shall take place at the executive offices of UTI beginning at 2:00 P.M. on the first business day following the day upon which the UTI and UII stockholder meetings to approve the merger were held. It is anticipated that the Merger will occur on June 26, 1998. CONVERSION OF UII SHARES AND DETERMINATION OF MERGER EXCHANGE RATIOS The terms of the Merger Agreement provide that on the Effective Date, each (one) issued and outstanding share of UII Common Stock, excluding shares of UII capital stock held as treasury shares by UII or as to which dissenters' rights have been perfected, shall immediately, without any further action by UII, UTI or UII stockholders, be converted into one share of UTI Common Stock. On the Effective Date of the Merger, all further sales or transfers of UII shares will cease. All shares of UII Common Stock held as treasury shares will be cancelled and no consideration issued with respect thereto. The exchange ratio was arrived at based upon a review of a number of factors, including (1) the relationship of the current number of shares of UTI and UII common stock outstanding and the percentage ownership of each company of their common affiliate, United Trust Group, Inc. and (2) the relative historical and projected earnings per share, the relative historical book value per share, and the relative historical market value per share of each of UTI and UII. Taking all these factors into account, the Board of Directors of each UTI and UII determined that the exchange ratio of each (one) share of UII Common Stock for one share of UTI Common Stock would be fair to the stockholders of UTI and UII respectively. INCREASE IN AUTHORIZED UTI COMMON STOCK The merger will require the issuance of almost all of the remaining authorized but unissued shares of UTI. In order to provide UTI with flexibility regarding future merger options, the raising of additional capital or the granting of stock options, a proposal to amend UTI's Certificate of Incorporation to increase the number of shares of UTI's authorized Common Stock from 3,500,000 shares to 7,000,000 shares will be voted upon by UTI's stockholders at the same special meeting on March 2, 1998 at which the proposed Merger will be voted upon by UTI stockholders. UTI has no pending arrangements or plans for these additional authorized shares at this time. The purpose of the Amendment is to provide UTI with the flexibility to engage in future transactions that UTI's Board of Directors may deem necessary or desirable without further shareholder action. (See PROPOSED INCREASE IN THE AUTHORIZED COMMON STOCK OF UII) EFFECT ON CURRENT STOCKHOLDERS The Merger will have no effect on the rights and privileges of current stockholders of UTI. The name of the company will be changed to United Trust Group, Inc. and the shares of UTI Common Stock will be converted to the new shares of United Trust Group, Inc. After the Merger, assuming no stockholders execute their dissenters' rights, the former UII stockholders would receive 826,153 New Shares which would constitute 33.7% of the then issued and outstanding shares. As soon as practicable after the closing of the Merger, UTG will mail a letter of instruction and a new stock certificate of UTG Common Stock ("the New Shares") to each UTI and UII shareholder replacing their UTI Common Stock certificate and UII Common Stock certificate ("the Old Shares"). The Old Shares will be considered null and void. SHAREHOLDERS SHOULD NOT FORWARD THEIR CERTIFICATES REPRESENTING THE OLD SHARES BEFORE RECEIVING THEIR INSTRUCTIONS. 24 After the Merger, assuming no stockholders execute their dissenters' rights, UTI will have issued 826,153 New Shares which would constitute 33.3% of the then issued and outstanding shares of UTI Common Stock. EXPENSES Each of UTI and UII will bear its respective expenses relating to the Merger. TERMINATION AND AMENDMENT The Merger Agreement may be terminated at any time before the Merger becomes effective; (i) by mutual consent of the Boards of Directors of UTI and UII; (ii) by the Board of Directors of either UTI or UII if the merger is for any reason not consummated on or before December 31, 1998; or (iii) by the Board of Directors of either UTI or UII if any of the conditions for closing described below at "INFORMATION REGARDING THE PROPOSED MERGER - Other Provisions" has not been met. No material changes may be made to the terms of the Merger Agreement either before or after the Special Meeting of Stockholders of UII and the Special Meeting of Stockholders of UTI without the written agreement of the Board of Directors of each of UTI and UII. Additionally, should the Merger Agreement be approved by a vote of UTI and UII stockholders at their respective Special Meetings, no amendment or modification that would materially affect the rights of UTI or UII stockholders may be made to the terms of the Merger Agreement. If any such change were made, UTI would amend its registration statement and UTI and UII stockholders would be notified and a resolicitation of the stockholders made. OTHER PROVISIONS The Merger Agreement contains certain representations and warranties of each of UTI and UII. In the Merger Agreement, UTI and UII each represent and warrant regarding their current organization and standing; the existence of subsidiaries; their current respective capitalizations; the accuracy and completeness of financial statements delivered in connection with the Merger; the absence of undisclosed liabilities; the absence of certain materially adverse changes, events or conditions; the absence of litigation or proceedings affecting each company or its properties; the compliance by each company with all licensing and regulatory laws and requirements; the accuracy and completeness of information supplied by the respective company for this Proxy Statement; the absence of conflicts between the Merger Agreement and any other contract or document or any judgment or decree; the authority of the respective company to execute, deliver and perform the Merger Agreement; the absence of material undisclosed tax liabilities; and the absence of material undisclosed liens against or encumbrances of each company's respective assets. The Merger Agreement also contains certain covenants by each of UTI and UII. In the Merger Agreement, each of UTI and UII covenants to conduct its business in the ordinary course; to refrain from materially amending any employment contract, pension or retirement plan, or charter documents and by-laws; to refrain from issuing securities or declaring or paying any dividends; to refrain from incurring additional significant debt; to provide access to the other company to properties, books and records of the company; and to attempt to obtain all necessary consents for consummation of the Merger including a favorable vote of stockholders. Additionally, the Merger Agreement contains several conditions to the obligation of each of UTI and UII to close the Merger Agreement and consummate the Merger. Neither UTI nor UII is required to close the Merger Agreement and consummate the Merger if any representation or warranty of the other company is untrue; if any covenant is unfulfilled; if approval of the other company's stockholders has not been obtained; if the Registration Statement pertaining to the Merger is not fully effective; if all necessary governmental approvals have not been obtained; if statements made in this Proxy Statement are inaccurate or incomplete; if an action or proceedings exist against any party or its officers or directors seeking to restrain or prohibit or obtain damages or other relief in connection with the Merger; or if all necessary third party consents have not been obtained. 25 ACCOUNTING TREATMENT The Merger will be accounted for as a purchase of UII by UTI at a cost of $7,708,007. TAX CONSEQUENCES The Merger will constitute a statutory merger under the applicable laws of Illinois and Ohio and will qualify for treatment as a reorganization within the meaning of section 368(a)(1)(A) of the Internal Revenue Code of 1986 as amended. A tax ruling will not be requested. The Merger will result in the following federal income tax effects: (a) no gain or loss will be recognized by UTI or UII. (b) the basis of assets acquired by UTI in the Merger will be the same as UII's basis in such assets; (c) no gain or loss will be recognized by UII stockholders upon receipt of UTI Common Stock; (d) the basis of UTI Common Stock received by an UII stockholder will be the same as that stockholder's basis in the stock held by him immediately prior to the Merger; (e) the holding period of UTI Common Stock received by an UII stockholder will include that stockholder's holding period for the stock previously held by him, provided that the stock was a capital asset in the stockholder's hands at the time of the Merger; (f) no gain or loss will be recognized by current stockholders of UTI, and no change in the basis of their shares will occur. Stockholders should consult their own tax advisors as to the effects on them of the Merger under federal, state and local tax laws. COMPARATIVE RIGHTS UTI AND UII SHAREHOLDERS If the merger is consummated, all holders of UII Common Stock will become shareholders of UTI. The rights of holders of common stock of both UTI and UII are governed by Illinois and Ohio law, respectively. In addition, the rights and obligations of shareholders are also governed by the Articles of Incorporation and Code of Regulation of the respective companies. Because both UTI and UII Articles of Incorporation and Codes of Regulations are substantially the same, there will be no change the relative rights and obligations of holders of common stock of UII when they become holders of common stock of UTI. With regard to the State laws, the following summary is intended to highlight some substantive differences in stockholders' rights under Ohio and Illinois law, but does not purport to be an exhaustive discussion of all distinctions. There are no consequential effects of any differences on the UII shareholders. Stockholder Approval of Significant Corporate Changes Under Ohio law, amendment of the Articles of Incorporation requires approval of the holders of two-thirds of the outstanding capital stock entitled to vote. Similarly, a merger consolidation, acquisition by exchange of shares or sale of substantially all of the assets of an Ohio corporation requires the approval of the holders of two-thirds of the outstanding capital stock entitled to vote. The articles of incorporation of an Ohio corporation may modify this statutory two- thirds vote requirement. UII has modified its articles of incorporation requiring the affirmative vote of holders of the majority of the outstanding shares. Thus, a majority of the outstanding shares of UII entitled to vote will be required to merge UII into UTI. Under Illinois law, the vote of shareholders of the surviving corporation to a merger is required if the authorized but unissued common stock of the surviving corporation which is to be issued in the merger exceeds 20% of the common stock of such corporation outstanding immediately prior to the effective date of such merger. Because the number of shares to be issued in the merger exceeds the 20% threshold amount, the merger of UII into UTI must receive the affirmative vote of holders of at least two-thirds of the outstanding common stock of UTI. 26 Stockholder Voting in General Under Ohio and Illinois laws, voting for directors is cumulative; however, the articles of incorporation, may be amended to eliminate cumulative voting. Both UTI and UII have amended their articles of incorporation to eliminate cumulative voting. Under Ohio and Illinois laws, proxies for stock are valid for 11 months unless a different period is stated in the proxy. Dissenting Stockholders' Rights Under the Illinois Law, each shareholder of UTI may, in lieu of receiving the consideration set forth in the Merger Agreement, seek the fair value of his or her shares of UTI common stock and, if the Merger is consummated, receive payment of such fair value in cash from UTI. To receive such payment, a dissenting shareholder must follow the procedures set forth in Section 11.70 of the Illinois Law, a copy of which Is attached hereto as Appendix C. Failure to follow such procedures shall result in the loss of such shareholder's dissenters' rights. Any UTI shareholder who returns a blank executed proxy card will be deemed to have approved the Merger Agreement and to have waived any dissenters' rights he or she may have. See `DISSENTERS' RIGHTS OF SHAREHOLDERS OF UTI". Pursuant to Section 1701.84 of the Ohio Revised Code, UII Shareholders entitled to vote on the Merger who follow the procedures set forth in Section 1701.85 of the Ohio Revised Code have the right to demand payment of the "fair cash value" of their shares of UII Common Stock if the Merger is consummated. See "DISSENTERS' RIGHTS OF SHAREHOLDERS OF UII," Section 1701.85 of the Ohio Revised Code is attached as Appendix B to this Proxy Statement/Prospectus. Stockholder Rights to Inspect Books and Records A shareholder of a corporation in both Illinois and Ohio may examine the books and records of the corporation or have an agent examine such books only for a proper purpose. Removal of Directors Both Ohio and Illinois allow stockholders to remove directors with or without cause. Such action requires the affirmative vote of holders of a majority of the voting power then entitled to vote in the election of directors. MANAGEMENT RECOMMENDATIONS The board of directors of each UTI and UII has unanimously approved the Merger Agreement and recommends to the stockholders of UTI and UII that they vote for approval of the Merger Agreement. (See "INFORMATION REGARDING PROPOSED MERGER - Reasons for the Merger"). Management of each UTI and UII believes that the Merger is fair and equitable to its stockholders. UTI intends to vote its shares of UII in favor of the Merger and Merger Agreement. DISSENTERS' RIGHTS OF SHAREHOLDERS OF UII Section 1701.84 of the Ohio Revised Code provides that each shareholder of UII Common Stock who is entitled to vote on the Merger may dissent from the Merger. The following is a summary of the principal steps a dissenting shareholder must take to perfect his or her dissenters' rights under Section 1701.85 of the Ohio Revised Code. This summary does not purport to be complete and is qualified in its entirety by reference to Section 1701.85 of the Ohio Revised Code, a copy of which is attached as Appendix B to this Proxy Statement/Prospectus. To perfect his or her dissenters' rights, a dissenting UII Shareholder must vote his proxy and must not vote in favor of the Merger and must deliver to UII, within ten days after the vote on the Merger is taken, a written demand for payment of the fair cash value of his or her shares of UII Common Stock. A proxy that is returned signed but on which no voting preference is indicated will be voted in favor of the Merger and will constitute a waiver of dissenters' rights. A dissenting shareholder's written demand for payment of the fair cash value of his or her shares should be delivered to UII, 5250 South Sixth Street, Springfield, Illinois 62703, Attention: Corporate Secretary. Voting against the Merger will not by itself constitute a written demand. 27 The written demand for payment must identify the name and address of the holder of record of such shareholder's UII Common Stock, the number of shares of UII common stock held by such shareholder, and the amount claimed by such shareholder as the fair cash value of his or her shares. A beneficial owner of shares of UII common stock must, in all cases, have the record holder of such shares deliver the written demand for payment. The written demand for payment must be signed by the shareholder of record (or by the duly authorized representative of the shareholder) exactly as the shareholder's name appears on the shareholder records of UII. A written demand for payment with respect to shares of common stock of UII owned jointly by more than one person must identify and be signed by all of the shareholders of record. Any person signing a written demand for payment on behalf of a partnership or corporation or in any other representative capacity (such as an attorney-in-fact, executor, administrator, trustee or guardian) must indicate the nature of the representative capacity and, if requested, must furnish written proof of this capacity and such person's authority to sign such written demand. Because only shareholders of record on the Record Date may exercise dissenters' rights, any person who beneficially owns shares that are held of record by a broker, fiduciary, nominee or other holder and who wishes to exercise dissenters' rights must instruct the record holder of shares to satisfy the condition outlined above. If a record holder does not satisfy, in a timely manner, all of the conditions outlined in this section entitled "Rights of Dissenting Shareholders," the dissenters' rights for all of the shares held by that shareholder will be lost. Unless UII and the dissenting shareholder reach an agreement on the fair cash value of the shares of UII Common Stock held by the dissenting shareholder, the dissenting shareholder of UII may, within three months after the dissenting shareholder has delivered his or her written demand for payment to UII, file a complaint in the Court of Common Pleas of Franklin County, Ohio (the "Common Pleas Court"), or join or be joined in an action similarly brought by another dissenting UII shareholder, for a judicial determination of the fair cash value (as defined below) of the shares of UII Common Stock held by the dissenting shareholder. Upon motion of the complainant, the Common Pleas Court will hold a hearing to determine whether the dissenting UII shareholder is entitled to be paid the fair cash value of his or her shares of UII Common Stock. If the Common Pleas Court finds that the dissenting shareholder is so entitled, it may appoint one or more appraisers to receive evidence and recommend a decision on the amount of the fair cash value of the shares of UII Common Stock held by such shareholder. The Common Pleas Court is required to make a finding as to the fair cash value of the shares of UII common stock and to render judgment against UII for the payment thereof, with interest at such rate and from such date as the Common Pleas Court considers equitable. Costs of the proceedings, including reasonable compensation to the appraiser or appraisers to be fixed by the Common Pleas Court, are to be apportioned or assessed as the Common Pleas Court considers equitable. Payment of the fair cash value of the shares of UII common stock held by the dissenting shareholder is required to be made within 30 days after the date of final determination of such value or the date on which the Merger is consummated, whichever is later, only upon surrender to UII of the certificates representing such shares. Under the Ohio Revised Code, "fair cash value" is the amount that a willing seller, under no compulsion to sell, would be willing to accept, and that a willing buyer, under no compulsion to buy, would be willing to pay. The fair cash value is to be determined as of the date prior to the day of the vote on the Merger, and, in computing the fair cash value, any appreciation or depreciation in market value resulting from the Merger shall be excluded from the computation. In no event may the fair cash value exceed the amount specified in the written demand for payment delivered to UII by a dissenting shareholder. Under the Ohio Revised Code, a shareholder's dissenters' rights will terminate if among other things, the dissenting shareholder has not complied with Section 1701.85 of the Ohio Revised Code (unless the Board of Directors of UII waives compliance), the Merger is abandoned or otherwise not carried out or the dissenting shareholder, upon obtaining the consent of the Board of Directors of UII, withdraws his or her written demand for payment, or no agreement is reached between UII and the dissenting shareholder with respect to the fair cash value of his or her shares of UII Common Stock and no complaint is timely filed in the Common Pleas Court. 28 FAILURE TO COMPLY STRICTLY WITH THE FOREGOING PROCEDURES SHALL CAUSE A SHAREHOLDER TO LOSE HIS OR HER DESSENTERS' RIGHTS. ANY SHAREHOLDER WHO WISHES TO EXERCISE HIS OR HER DISSENTERS' RIGHTS IS URGED TO CONSULT LEGAL COUNSEL BEFORE ATTEMPTING TO EXERCISE SUCH RIGHTS. DISSENTERS' RIGHTS OF SHAREHOLDERS OF UTI Section 11.65 and 11.70 of the Illinois Act provides that each shareholder of UTI Common Stock who is entitled to vote on the Merger may dissent from the Merger. The following is a summary of the principal steps a dissenting shareholder must take to perfect his or her dissenters' rights under Section 11.65 and 11.70 of the Illinois Act. This summary does not purport to be complete and is qualified in its entirety by reference to Section 11.65 and 11.70 of the Illinois Act, a copy of which is attached as Appendix C to this Proxy Statement/Prospectus. To perfect his or her dissenters' rights, a dissenting UTI Shareholder must vote his or her proxy and must not vote in favor of the merger and must deliver to UTI, before the vote on the merger is taken, a written demand for payment of the fair value of his or her shares of UTI Common Stock. A proxy that is returned signed but on which no voting preference is indicated will be voted in favor of the Merger and will constitute a waiver of dissenters' rights. A dissenting shareholder's written demand for payment of the fair value of his or her shares should be delivered to UTI at 5250 South Sixth Street, Springfield, Illinois 62703, Attention: Corporate Secretary. Voting against the Merger will not by itself constitute a written demand. Within ten days after the date on which the Merger is effective or thirty days after the dissenting shareholder delivers to UTI a written demand for payment, whichever is later, UTI will send each shareholder who has delivered a written demand for payment a statement setting forth UTI's opinion as to the estimated fair value of the shares of UTI Common Stock, a copy of UTI's latest balance sheet as of the end of a fiscal year ending not earlier than sixteen months before the delivery of the foregoing statement, together with the statement of income for that year and the latest available interim financial statements, and a commitment to pay for the shares of the dissenting shareholder at the estimated fair value of such shares. A VOTE AGAINST THE MERGER, WHETHER BY PROXY OR IN PERSON WILL NOT, BY ITSELF, BE REGARDED AS A WRITTEN DEMAND FOR PAYMENT FOR PURPOSES OF ASSERTING DISSENTERS' RIGHTS. Upon consummation of the merger, UTI will pay to each dissenting shareholder who transmits to UTI the certificate or other evidence of ownership of the shares of UTI Common Stock the amount that UTI estimates to be the fair value of such shares, plus accrued interest, accompanied by a written explanation of how the interest was calculated. Under the Illinois Act, "fair value" means the value of shares of UTI Common Stock immediately before the consummation of the Merger, exclusive of any appreciation or depreciation of the value of such shares in anticipation of the merger, unless such exclusion would be inequitable. "Interest" means interest, at the average rate currently paid by UTI on its principal bank loans or, if none, at a rate that is fair and equitable under all the circumstances, from the effective date of the Merger until the date on which UTI pays to the dissenting shareholder the fair value of his or her shares. If the dissenting shareholder agrees with UTI's estimate as to the fair value of UTI common stock, upon consummation of the Merger and payment of the agreed fair value, the dissenting shareholder shall cease to have any interest in shares of UTI Common Stock. If a dissenting shareholder does not agree with the opinion of UTI as to the estimated fair value of the shares or the amount of interest due, such shareholder, within 30 days from the delivery of UTI's statement of fair value, must notify UTI in writing of his or her estimated fair value and amount of interest due and demand payment for the difference between his or her estimate of fair value and interest due and the amount of payment by UTI or the proceeds of sale by the shareholder, whichever is applicable. If, within 60 days from delivery to UTI of the shareholder's notification of estimate of fair value of the shares and interest due, UTI and the dissenting shareholder have not agreed in writing upon the fair value of the shares and interest due, UTI will either pay the difference in value demanded by the shareholder, with interest, or file a petition in the 29 circuit court of the county in which either the registered office of the principal office of UTI is located, asking such court to determine the fair value of the shares and interest due. If such a petition is filed, UTI will make all dissenting shareholders whose demands remain unsettled parties to the proceeding, whether or not such shareholders are residents of Illinois, and all such parties will be served with a copy of the petition. The "fair value" determined by the court may be more or less than the amount offered to UTI shareholders under the Merger Agreement. Any judgment entered by the court with respect to the fair value of the dissenting shareholders' shares will be payable only upon, and simultaneously with, the surrender to UTI of the certificate or certificates, or other evidence of ownership, representing shares of UTI Common Stock. Upon the payment of such judgment, the dissenting shareholders will cease to have any interest in shares of UTI common stock. FAILURE TO COMPLY STRICTLY WITH THE FOREGOING PROCEDURES SHALL CAUSE A SHAREHOLDER TO LOSE HIS OR HER DISSENTERS' RIGHTS. ANY SHAREHOLDER WHO WISHES TO EXERCISE HIS OR HER DISSENTERS' RIGHTS IS URGED TO CONSULT LEGAL COUNSEL BEFORE ATTEMPTING TO EXERCISE SUCH RIGHTS. 30 SELECTED FINANCIAL DATA OF UII THE FOLLOWING TABLE PROVIDES SELECTED FINANCIAL DATA FOR UII FOR THE PAST FIVE YEARS. FINANCIAL HIGHLIGHTS (000's omitted, except per share data) 1997 1996 1995 1994 1993 Net Operating Revenues $ 1,186 $ 1,791 $ 2,234 $ 1,667 $ 1,459 Operating Costs and Expenses $ 909 $ 1,414 $ 1,976 $ 1,627 $ 1,384 Income taxes $ 0 $ 0 $ 0 $ 0 $ 0 Equity in loss of investees $ (357) $ (696) $ (2,406) $ (384) $ (580) Net loss $ (79) $ (319) $ (2,148) $ (344) $ (505) Net loss per common share $ (0.06) $ (0.23) $ (1.54) $ (0.25) $ (0.36) Cash Dividend Declared per common share $ 0 $ 0 $ 0 $ 0 $ 0 Total Assets $ 12,840 $ 12,881 $ 13,386 $ 15,414 $ 14,919 Long Term Obligations $ 902 $ 902 $ 902 $ 902 $ 0
31 UII MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997 At December 31, 1997 and 1996, the balance sheet reflects the assets and liabilities of UII and its 47% equity interest in UTG. The statements of operations and statements of cash flows presented for 1997, 1996 and 1995 include the operating results of UII. RESULTS OF OPERATIONS 1997COMPARED TO 1996 (a) REVENUES The Company's source of revenues is derived from service fee income which is provided via a service agreement with USA. The service agreement between UII and USA is to provide USA with certain administrative services. Pursuant to the terms of the agreement, USA pays UII monthly fees equal to 22% of the amount of collected first year statutory premiums, 20% in second year and 6% of the renewal premiums in years three and after. The Company recognized service agreement income of $989,295, $1,567,891 and $2,015,325 in 1997, 1996 and 1995, respectively, based on statutory collected premiums in USA of $10,300,332, $13,298,597, and $14,128,199 in 1997,1996 and 1995, respectively. First year premium revenues of USA decreased 54% in 1997 from 1996. This decline is primarily related to the potential change in control of UTI over the last two years to two different parties. The possible changes and resulting uncertainties have hurt USA's ability to recruit and maintain sales agents. Management expects first year production to decline slightly in 1998, and then growth is anticipated in subsequent periods following the resolution of the change in control of UTI. The Company holds $864,100 of notes receivable from affiliates. The notes receivable from affiliates consists of three separate notes. The $700,000 note bears interest at the rate of 1% above the variable per annum rate of interest most recently published by the Wall Street Journal as the prime rate. Interest is payable quarterly with principal due at maturity on May 8, 2006. In February 1996, FCC borrowed an additional $150,000 from UII to provide additional cash for liquidity. The note bears interest at the rate of 1% over prime as published in the Wall Street Journal, with interest payments due quarterly and principal due upon maturity of the note on June 1, 1999. The remaining $14,100 are 20 year notes of UTG with interest at 8.5% payable semi-annually. At current interest levels, the notes will generate approximately $80,000 annually. (b) EXPENSES The Company has a sub-contract service agreement with United Trust, Inc. ("UTI") for certain administrative services. Through its facilities and personnel, UTI performs such services as may be mutually agreed upon between the parties. The fees are based on 60% of the fees paid to UII by USA. The Company has incurred $744,000, $1,241,000 and $1,809,000 in service fee expense in 1997, 1996, and 1995, respectively. Interest expense of $85,000, $84,000 and $89,000 was incurred in 1997, 1996 and 1995, respectively. The interest expense is directly attributable to the convertible debentures. The Debentures bear interest at a variable rate equal to one percentage point above the prime rate published in the Wall Street Journal from time to time. (c) EQUITY IN LOSS OF INVESTEES Equity in earnings of investees represents UII's 47% share of the net loss of UTG. Included with this filing as Exhibit 99(d) are audited financial statements of UTG. Following is a discussion of the results of operations of UTG: 32 Revenues of UTG Premiums and policy fee revenues, net of reinsurance premiums and policy fees, decreased 7% when comparing 1997 to 1996. UTG and its subsidiaries currently writes little new traditional business, consequently, traditional premiums will decrease as the amount of traditional business in-force decreases. Collected premiums on universal life and interest sensitive products is not reflected in premiums and policy revenues because Generally Accepted Accounting Principles ("GAAP") requires that premiums collected on these types of products be treated as deposit liabilities rather than revenue. Unless UTG and its subsidiaries' acquires a block of in-force business or marketing changes its focus to traditional business, premium revenue will continue to decline. Another cause for the decrease in premium revenues is related to the potential change in control of UTI over the last two years to two different parties. During September of 1996, it was announced that control of UTI would pass to an unrelated party, but the change in control did not materialize. At this writing, negotiations are progressing with a different unrelated party for the change in control of UTI. Please refer to the Notes to the Consolidated Financial Statements of UTG for additional information. The possible changes and resulting uncertainties have hurt the insurance companies' ability to recruit and maintain sales agents. New business production decreased significantly over the last two years. New business production decreased 43% or $3,935,000 when comparing 1997 to 1996. In recent years, the insurance industry as a whole has experienced a decline in the total number of agents who sell insurance products, therefore competition has intensified for top producing sales agents. The relatively small size of our companies, and the resulting limitations, have made it challenging to compete in this area. A positive impact on premium income is the improvement of persistency. Persistency is a measure of insurance in force retained in relation to the previous year. The average persistency rate for all policies in force for 1997 and 1996 has been approximately 89.4% and 87.9%, respectively. Net investment income decreased 6% when comparing 1997 to 1996. The decrease relates to the decrease in invested assets from a coinsurance agreement. UTG's insurance subsidiary UG entered into a coinsurance agreement with First International Life Insurance Company ("FILIC"), an unrelated party, as of September 30, 1996. During 1997, FILIC changed its name to Park Avenue Life Insurance Company ("PALIC"). Under the terms of the agreement, UG ceded to FILIC substantially all of its paid- up life insurance policies. Paid-up life insurance generally refers to non-premium paying life insurance policies. At closing of the transaction, UG received a coinsurance credit of $28,318,000 for policy liabilities covered under the agreement. UG transferred assets equal to the credit received. This transfer included policy loans of $2,855,000 associated with policies under the agreement and a net cash transfer of $19,088,000, after deducting the ceding commission due UG of $6,375,000. To provide the cash required to be transferred under the agreement, UG sold $18,737,000 of fixed maturity investments. The overall investment yields for 1997, 1996 and 1995, are 7.25%, 7.31% and 7.14%, respectively. Since 1995 investment yield improved due to the fixed maturity investments. Cash generated from the sales of universal life insurance products, has been invested primarily in our fixed maturity portfolio. The investments are generally managed to match related insurance and policyholder liabilities. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. The minimum interest spread between earned and credited rates is 1% on the "Century 2000" universal life insurance product, which currently is the primary sales product. UTG and its subsidiaries' monitor investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads. It is expected that monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on the insurance policies the Company currently has in force and will write in the future. 33 Realized investment losses were $279,000 and $466,000 in 1997 and 1996, respectively. UTG and its subsidiaries sold two foreclosed real estate properties that resulted in approximately $357,000 in realized losses in 1996. There were other gains and losses during the period that comprised the remaining amount reported but were immaterial in nature on an individual basis. Expenses of UTG Life benefits, net of reinsurance benefits and claims, decreased 11% in 1997 as compared to 1996. The decrease in premium revenues resulted in lower benefit reserve increases in 1997. In addition, policyholder benefits decreased due to a decrease in death benefit claims of $162,000. In 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by UTG and its subsidiaries' standards. These non- standard policies had a face amount of $22,700,000 and represented 1/2 of 1% of the insurance in-force in 1994. Management's initial analysis indicated that expected death claims on the business in-force was adequate in relation to mortality assumptions inherent in the calculation of statutory reserves. Nevertheless, management determined it was in the best interest of UTG and its subsidiaries' to repurchase as many of the non-standard policies as possible. Through December 31, 1996, the UTG and its subsidiaries' spent approximately $7,099,000 for the settlement of non-standard policies and for the legal defense of related litigation. In relation to settlement of non-standard policies UTG and its subsidiaries' incurred life benefit costs of $3,307,000, and $720,000 in 1996 and 1995, respectively. UTG and its subsidiaries' incurred legal costs of $906,000 and $687,000 in 1996 and 1995, respectively. All policies associated with this issue have been settled as of December 31, 1996. Therefore, expense reductions for 1997 would follow. Commissions and amortization of deferred policy acquisition costs decreased 14% in 1997 compared to 1996. The decrease is due primarily due to a reduction in commissions paid. Commissions decreased 19% in 1997 compared to 1996. The decrease in commissions was due to the decline in new business production. There is a direct relationship premium revenues and commission expense. First year premium production decreased 43% and first year commissions decreased 33% when comparing 1997 to 1996. Amortization of deferred policy acquisition costs decreased 6% in 1997 compared to 1996. Management would expect commissions and amortization of deferred policy acquisition costs to decrease in the future if premium revenues continue to decline. Amortization of cost of insurance acquired decreased 56% in 1997 compared to 1996. Cost of insurance acquired is amortized in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. UTG and its subsidiaries' did not have any charge-offs during the periods covered by this report. The decrease in amortization during the current period is a normal fluctuation due to the expected future profits. Amortization of cost of insurance acquired is particularly sensitive to changes in persistency of certain blocks of insurance in- force. The improvement of persistency during the year had a positive impact on amortization of cost of insurance acquired. Persistency is a measure of insurance in force retained in relation to the previous year. The average persistency rate for all policies in force for 1997 and 1996 has been approximately 89.4% and 87.9%, respectively. Operating expenses decreased 21% in 1997 compared to 1996. The decrease in operating expenses is directly related to settlement of certain litigation in December of 1996. UTG and its subsidiaries' incurred legal costs of $0, $906,000 and $687,000 in 1997, 1996 and 1995, respectively in relation to the settlement of the non-standard insurance policies. Interest expense decreased 4% in 1997 compared to 1996. Since December 31, 1996, notes payable decreased approximately $758,000. Average outstanding indebtedness was $19,461,000 with an average cost of 8.6% in 1997 compared to average outstanding indebtedness of 20,652,000 with an average cost of 8.5% in 1996. In March 1997, the base interest rate for most of the notes payable increased a quarter of a point. The base rate is defined as the floating daily, variable rate of interest determined and announced by First of America Bank. Please refer to Note 12 "Notes Payable" in the Notes to the Consolidated Financial Statements of UTG for more information. 34 Net loss of UTG UTG had a net loss of $923,000 in 1997 compared to a net loss of $1,661,000 in 1996. The improvement is directly related to the decrease in life benefits and operating expenses primarily associated with the 1996 settlement and other related costs of the non-standard life insurance policies. (d) NET LOSS The Company recorded a net loss of $79,000 for 1997 compared to $319,000 for the same period one year ago. The net loss is from the equity share of UTG's operating results. RESULTS OF OPERATIONS 1996 COMPARED TO 1995 (a) REVENUES The Company's source of revenues is derived from service fee income which is provided via a service agreement with USA. The service agreement between UII and USA is to provide USA with certain administrative services. The fees are based on a percentage of premium revenue of USA. The percentages are applied to both first year and renewal premiums at different rates. The Company holds $864,100 of notes receivable from affiliates. The notes receivable from affiliates consists of three separate notes. The $700,000 note bears interest at the rate of 1% above the variable per annum rate of interest most recently published by the Wall Street Journal as the prime rate. Interest is payable quarterly with principal due at maturity on May 8, 2006. In February 1996, FCC borrowed an additional $150,000 from UII to provide additional cash for liquidity. The note bears interest at the rate of 1% over prime as published in the Wall Street Journal, with interest payments due quarterly and principal due upon maturity of the note on June 1, 1999. The remaining $14,100 are 20 year notes of UTG with interest at 8.5% payable semi-annually. At current interest levels, the notes will generate approximately $80,000 annually. (b) EXPENSES The Company has a sub-contract service agreement with United Trust, Inc. ("UTI") for certain administrative services. Through its facilities and personnel, UTI performs such services as may be mutually agreed upon between the parties. The fees are based on a percentage of the fees paid to UII by USA. The Company has incurred $1,241,000, $1,809,000, and $1,210,000 in service fee expense in 1996, 1995, and 1994, respectively. Interest expense of $84,000, $89,000 and $59,000 was incurred in 1996, 1995 and 1994, respectively. The interest expense is directly attributable to the convertible debentures. The Debentures bear interest at a variable rate equal to one percentage point above the prime rate published in the Wall Street Journal from time to time. (c) EQUITY IN LOSS OF INVESTEES Equity in earnings of investees represents UII's 47% share of the net loss of UTG. Included with this filing as Exhibit 99(d) are audited financial statements of UTG. Following is a discussion of the results of operations of UTG: 35 Revenues of UTG Premium and policy fee revenues, net of reinsurance premium, decreased 7% when comparing 1996 to 1995. The decrease in premium income is primarily attributed to a 15% decrease in new business production. UTG and its subsidiaries' changed its marketing strategy from traditional life insurance products to universal life insurance products. Universal life and interest sensitive products contribute only the risk charge to premium income, however traditional insurance products contribute all monies received to premium income. UTG and its subsidiaries' changed its marketing strategy to remain competitive based on consumer demand. In addition, UTG and its subsidiaries' changed its focus from primarily a broker agency distribution system to a captive agent system. Business written by the broker agency force, in recent years, did not meet UTG and its subsidiaries' expectations. With the change in focus of distribution systems, most of the broker agents were terminated. (The termination of the broker agency force caused a non-recurring write down of the value of agency force asset in 1995, see discussion of amortization of agency force for further details.). The change in distribution systems effectively reduced the total number of agents representing and producing business. Broker agents sell insurance and related products for several companies. Captive agents sell for only one company. A positive impact on premium income is the improvement of persistency. Persistency is a measure of insurance in force retained in relation to the previous year. Average persistency rate for all policies in force for 1996 and 1995 has been approximately 87.9% and 87.3%, respectively. Net investment income increased 3% when comparing 1996 to 1995. The overall investment yields for 1996 and 1995 are 7.31% and 7.14%, respectively. The improvement in investment yield is primarily attributed to fixed maturity investments. Cash generated from the sales of universal life insurance products, has been invested primarily in our fixed investment portfolio. The investments are generally managed to match related insurance and policyholder liabilities. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. The minimum interest spread between earned and credited rates is 1% on the "Century 2000" universal life insurance product, which currently is the primary sales product. UTG and its subsidiaries' monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads. It is expected that monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on the insurance policies UTG and its subsidiaries' currently has in force and will write in the future. Realized investment losses were $466,000 and $114,000 in 1996 and 1995, respectively. UTG and its subsidiaries' sold two foreclosed real estate properties that resulted in approximately $357,000 in realized losses in 1996. There were other gains and losses during the period that comprised the remaining amount reported but were immaterial in nature on an individual basis. Expenses of UTG Life benefits, net of reinsurance benefits and claims, increased 2% compared to 1995. The increase in life benefits is due primarily to settlement expenses discussed in the following paragraph: In 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by UTG and its subsidiaries' standards. These non- standard policies had a face amount of $22,700,000 and represented 1/2 of 1% of the insurance in-force in 1994. Management's initial analysis indicated that expected death claims on the business in-force was adequate in relation to mortality assumptions inherent in the calculation of statutory reserves. Nevertheless, management determined it was in the best interest of UTG and its subsidiaries' to repurchase as many of the non-standard policies as possible. Through December 31, 1996, UTG and its subsidiaries' spent approximately $7,099,000 for the 36 settlement of non-standard policies and for the legal defense of related litigation. In relation to settlement of non-standard policies UTG and its subsidiaries incurred life benefits of $3,307,000 and $720,000 in 1996 and 1995, respectively. UTG and its subsidiaries' incurred legal costs of $906,000 and $687,000 in 1996 and 1995, respectively. All the policies associated with this issue have been settled as of December 31, 1996. UTG and its insurance subsidiaries' has approximately $3,742,000 of insurance in-force and $1,871,000 of reserves from the issuance of paid-up life insurance policies for settlement of matters related to the original non-standard policies. Management believes the reserves are adequate in relation to expected mortality on this block of in-force. Commissions and amortization of deferred policy acquisition costs decreased 14% in 1996 compared to 1995. The decrease is due to a decrease in commissions expense. Commissions decreased 15% in 1996 compared to 1995. The decrease in commissions was due to the decline in new business production. There is a direct relationship between premium revenues and commission expenses. First year premium production decreased 15% and first year commissions decreased 32% when comparing 1996 to 1995. Amortization of deferred policy acquisition costs decreased 12% in 1996 compared to 1995. Management expects commissions and amortization of deferred policy acquisition costs to decrease in the future if premium revenues continue to decline. Amortization of cost of insurance acquired increased 26% in 1996 compared to 1995. Cost of insurance acquired is amortized in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. UTG and its subsidiaries' did not have any charge-offs during the periods covered by this report. The increase in amortization during the current period is a normal fluctuation due to the expected future profits. Amortization of cost of insurance acquired is particularly sensitive to changes in persistency of certain blocks of insurance in- force. UTG and its subsidiaries' reported a non-recurring write down of value of agency force of $0 and $8,297,000 in 1996 and 1995, respectively. The write down was directly related to the change in distribution systems. UTG and its subsidiaries' changed its focus from primarily a broker agency distribution system to a captive agent system. Business produced by the broker agency force in recent years did not meet expectations. With the change in focus of distribution systems, most of the broker agents were terminated. The termination of most of the agents involved in the broker agency force caused management to re- evaluate and write-off the value of the agency force carried on the balance sheet. Operating expenses increased 6% in 1996 compared to 1995. The primary factor that caused the increase in operating expenses is directly related to increased legal costs and reserves established for litigation. The legal costs are due to the settlement of non-standard insurance policies as was discussed in the review of life benefits. UTG and its subsidiaries' incurred legal costs of $906,000 and $687,000 in 1996 and 1995, respectively in relation to the settlement of the non- standard insurance policies. Interest expense decreased 12% in 1996 compared to 1995. Since December 31, 1995, notes payable decreased approximately $1,623,000 that has directly attributed to the decrease in interest expense during 1996. Interest expense was also reduced, as a result of the refinancing of the senior debt under which the new interest rate is more favorable. Please refer to Note 12 "Notes Payable" of the Consolidated Notes to the Financial Statements of UTG for more information on this matter. Net loss of UTG UTG and its subsidiaries' had a net loss of $1,661,000 in 1996 compared to a net loss of $5,321,000 in 1995. The net loss in 1996 is attributed to the increase in life benefits net of reinsurance and operating expenses primarily associated with settlement and other related costs of the non-standard life insurance policies. 37 (d) NET LOSS The Company recorded a net loss of $319,000 for 1996 compared to a net loss of $2,148,000 for the same period one year ago. The net loss is from the equity share of UTG's operating results. FINANCIAL CONDITION The Company owns 47% equity interest in UTG which controls total assets of approximately $348,000,000. Audited financial statements of UTG are presented as Exhibit 99(d) of this filing. LIQUIDITY AND CAPITAL RESOURCES Since UII is a holding company, funds required to meet its debt service requirements and other expenses are primarily provided by its affiliates. UII's cash flow is dependent on revenues from a management agreement with USA and its earnings received on invested assets and cash balances. At December 31, 1997 and March 31, 1998, substantially all of the shareholders equity represents investment in affiliates. UII does not have significant day to day operations of its own. Cash requirements of UII primarily relate to the payment of interest on its convertible debentures and expenses related to maintaining the Company as a corporation in good standing with the various regulatory bodies which govern corporations in the jurisdictions where the Company does business. The payment of cash dividends to shareholders is not legally restricted. However, insurance company dividend payments are regulated by the state insurance department where the company is domiciled. UTI is the ultimate parent of UG through ownership of several intermediary holding companies. UG can not pay a dividend directly to UII due to the ownership structure. Please refer to Note 1 of the Notes to the Financial Statements. UG's dividend limitations are described below without effect of the ownership structure. Ohio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 1997, UG had a statutory gain from operations of $1,779,000. At December 31, 1997, UG statutory capital and surplus amounted to $10,997,000. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. At March 31, 1998, UII had $734,827 in cash and cash equivalents. The Company holds one mortgage loan. Operating activities of the Company produced cash flows of $324,097, $255,675 and $326,905 in 1997, 1996 and 1995, respectively. The Company had uses of cash from investing activities of $50,764, $180,402 and $192,801 in 1997, 1996 and 1995, respectively. Cash flows from financing activities were ($2,112), $33 and $0 in 1997, 1996 and 1995, respectively. UII produced cash of $29,635 from operating activities as of March 31, 1998 and had used of cash from investing activities of $5,705 for the same period. In early 1994, UII received $902,300 from the sale of Debentures. The Debentures were issued pursuant to an indenture between the Company and First of America Bank - Southeast Michigan, N.A., as trustee. The Debentures are general unsecured obligations of UII, subordinate in right of payment to any existing or future senior debt of UII. The Debentures are exchangeable and transferable, and are convertible at any time prior to March 31, 1999 into UII's Common Stock at a conversion price of $25 per share, subject to adjustment in certain events. The Debentures bear interest from March 31, 1994, payable quarterly, at a variable rate equal to one percentage point above the prime rate published in the Wall Street Journal from time to time. The prime rate was 8.25% during first quarter 1997, increasing to 8.5% April 1, 1997, and has remained unchanged. On or after March 31, 1999, the Debentures will be redeemable at UII's option, in whole or in part, at redemption prices declining from 103% of their principal amount. No sinking fund will be established to redeem the Debentures. The Debentures will mature on March 31, 2004. The Debentures are not listed on any national securities exchange or the NASDAQ National Market System. The Company is not aware of any litigation that will have a material adverse effect on the financial position of the Company. In addition, the Company does not believe that the regulatory initiatives currently under consideration by various regulatory agencies will have a material adverse impact on the Company. The Company is not aware of any material pending or threatened regulatory action with respect to the Company or any of its affiliates. The Company does not believe that any insurance guaranty fund assessments will be materially different from amounts already provided for in the financial statements. 38 Management believes that the overall sources of liquidity available to the Company will be more than sufficient to satisfy its financial obligations. REGULATORY ENVIRONMENT The Company's insurance affiliates are assessed contributions by life and health guaranty associations in almost all states to indemnify policyholders of failed companies. In several states the company may reduce premium taxes paid to recover a portion of assessments paid to the states' guaranty fund association. This right of "offset" may come under review by the various states, and the company cannot predict whether and to what extent legislative initiatives may affect this right to offset. Also, some state guaranty associations have adjusted the basis by which they assess the cost of insolvencies to individual companies. The Company believes that its reserve for future guaranty fund assessments is sufficient to provide for assessments related to known insolvencies. This reserve is based upon management's current expectation of the availability of this right of offset, known insolvencies and state guaranty fund assessment bases. However, changes in the basis whereby assessments are charged to individual companies and changes in the availability of the right to offset assessments against premium tax payments could materially affect the company's results. Currently, the Company's insurance affiliates are subject to government regulation in each of the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including the power to: (i) grant and revoke licenses to transact business; (ii) regulate and supervise trade practices and market conduct; (iii) establish guaranty associations; (iv) license agents; (v) approve policy forms; (vi) approve premium rates for some lines of business; (vii) establish reserve requirements; (viii) prescribe the form and content of required financial statements and reports; (ix) determine the reasonableness and adequacy of statutory capital and surplus; and (x) regulate the type and amount of permitted investments. Insurance regulation is concerned primarily with the protection of policyholders. The Company cannot predict the form of any future proposals or regulation. The Company's insurance affiliates, USA, UG, APPL and ABE are domiciled in the states of Ohio, Ohio, West Virginia and Illinois, respectively. The insurance regulatory framework continues to be scrutinized by various states, the federal government and the National Association of Insurance Commissioners ("NAIC"). The NAIC is an association whose membership consists of the insurance commissioners or their designees of the various states. The NAIC has no direct regulatory authority over insurance companies, however its primary purpose is to provide a more consistent method of regulation and reporting from state to state. This is accomplished through the issuance of model regulations, which can be adopted by individual states unmodified, modified to meet the state's own needs or requirements, or dismissed entirely. Most states also have insurance holding company statutes which require registration and periodic reporting by insurance companies controlled by other corporations licensed to transact business within their respective jurisdictions. The insurance affiliates are subject to such legislation and registered as controlled insurers in those jurisdictions in which such registration is required. Statutes vary from state to state but typically require periodic disclosure, concerning the corporation, that controls the registered insurers and all affiliates of such corporation. In addition, prior notice to, or approval by, the state insurance commission of material intercorporate transfers of assets, reinsurance agreements, management agreements (see Note 9 in the notes to the consolidated financial statements), and payment of dividends (see note 2 in the notes to the consolidated financial statements) in excess of specified amounts by the insurance subsidiary, within the holding company system, are required. Each year the NAIC calculates financial ratio results (commonly referred to as IRIS ratios) for each company. These ratios compare various financial information pertaining to the statutory balance sheet and income statement. The results are then compared to pre-established normal ranges determined by the NAIC. Results outside the range typically require explanation to the domiciliary insurance department. 39 At year-end 1997, the insurance companies had one ratio outside the normal range. The ratio is related to the decrease in premium income. The ratio fell outside the normal range the last three years. A primary cause for the decrease in premium revenues is related to the potential change in control of UTI over the last two years to two different parties. During September of 1996, it was announced that control of UTI would pass to an unrelated party, but the transaction did not materialize. At this writing, negotiations are progressing with a different unrelated party for the change in control of UTI. Please refer to the Notes to the Consolidated Financial Statements for additional information. The possible changes and resulting uncertainties have hurt the insurance companies' ability to recruit and maintain sales agents. The industry has experienced a downward trend in the total number of agents who sell insurance products, and competition for the top sales producers has intensified. As this trend appears to continue, the recruiting focus of the Company has been on introducing quality individuals to the insurance industry through an extensive internal training program. The Company feels this approach is conducive to the mutual success of our new recruits and the Company as these recruits market our products in a professional, company structured manner. The NAIC, in conjunction with state regulators, has been reviewing existing insurance laws and regulations. A committee of the NAIC proposed changes in the regulations governing insurance company investments and holding company investments in subsidiaries and affiliates which were adopted by the NAIC as model laws in 1996. The Company does not presently anticipate any material adverse change in its business as a result of these changes. Legislative and regulatory initiatives regarding changes in the regulation of banks and other financial services businesses and restructuring of the federal income tax system could, if adopted and depending on the form they take, have an adverse impact on the Company by altering the competitive environment for its products. The outcome and timing of any such changes cannot be anticipated at this time, but the Company will continue to monitor developments in order to respond to any opportunities or increased competition that may occur. The NAIC adopted the Life Illustration Model Regulation. Many states have adopted the regulation effective January 1, 1997. This regulation requires products which contain non-guaranteed elements, such as universal life and interest sensitive life, to comply with certain actuarially established tests. These tests are intended to target future performance and profitability of a product under various scenarios. The regulation does not prevent a company from selling a product that does not meet the various tests. The only implication is the way in which the product is marketed to the consumer. A product that does not pass the tests uses guaranteed assumptions rather than current assumptions in presenting future product performance to the consumer. The Company conducts an ongoing thorough review of its sales and marketing process and continues to emphasize its compliance efforts. A task force of the NAIC is currently undertaking a project to codify a comprehensive set of statutory insurance accounting rules and regulations. This project is not expected to be completed earlier than 1999. Specific recommendations have been set forth in papers issued by the NAIC for industry review. The Company is monitoring the process, but the potential impact of any changes in insurance accounting standards is not yet known. ACCOUNTING AND LEGAL DEVELOPMENTS The Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards (SFAS) No. 128 entitled Earnings per share, which is effective for financial statements for fiscal years beginning after December 15, 1997. SFAS No. 128 specifies the computation, presentation, and disclosure requirements for earnings per share (EPS) for entities with publicly held common stock or potential common stock. The Statement's objective is to simplify the computation of earnings per share, and to make the U.S. standard for computing EPS more compatible with the EPS standards of other countries. Under SFAS No. 128, primary EPS computed in accordance with previous opinions is replaced with a simpler calculation called basic EPS. Basic EPS is calculated by dividing income available to common stockholders (i.e., net income or loss adjusted for preferred stock dividends) by the weighted-average number of common shares outstanding. Thus, in the most significant change in current practice, options, warrants, and convertible securities are excluded from the basic EPS calculation. Further, contingently issuable shares are included in basic EPS only if all the necessary conditions for the issuance of such shares have been satisfied by the end of the period. 40 Fully diluted EPS has not changed significantly but has been renamed diluted EPS. Income available to common stockholders continues to be adjusted for assumed conversion of all potentially dilutive securities using the treasury stock method to calculate the dilutive effect of options and warrants. However, unlike the calculation of fully diluted EPS under previous opinions, a new treasury stock method is applied using the average market price or the ending market price. Further, prior opinion requirement to use the modified treasury stock method when the number of options or warrants outstanding is greater than 20% of the outstanding shares also has been eliminated. SFAS 128 also includes certain shares that are contingently issuable; however, the test for inclusion under the new rules is much more restrictive. SFAS No. 128 requires companies reporting discontinued operations, extraordinary items, or the cumulative effect of accounting changes are to use income from operations as the control number or benchmark to determine whether potential common shares are dilutive or antidilutive. Only dilutive securities are to be included in the calculation of diluted EPS. This statement was adopted for the 1997 Financial Statements. For all periods presented the Company reported a loss from continuing operations so any potential issuance of common shares would have an antidilutive effect on EPS. Consequently, the adoption of SFAS No. 128 did not have an impact on the Company's financial statement. The FASB has issued SFAS No. 130 entitled Reporting Comprehensive Income and SFAS No. 132 Employers' Disclosures about Pensions and Other Postretirement Benefits. Both of the above statements are effective for financial statements with fiscal years beginning after December 15, 1997. SFAS No. 130 defines how to report and display comprehensive income and its components in a full set of financial statements. The purpose of reporting comprehensive income is to report a measure of all changes in equity of an enterprise that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners. SFAS No. 132 addresses disclosure requirements for post-retirement benefits. The statement does not change post-retirement measurement or recognition issues. The Company will adopt both SFAS No. 130 and SFAS No. 132 for the 1998 financial statements. Management does not expect either adoption to have a material impact on the Company's financial statements. The Company is not aware of any litigation that will have a material adverse effect on the financial position of the Company. In addition, the Company does not believe that the regulatory initiatives currently under consideration by various regulatory agencies will have a material adverse impact on the Company. The Company is not aware of any material pending or threatened regulatory action with respect to the Company or any of its affiliates. The Company does not believe that any insurance guaranty fund assessments will be materially different from amounts already provided for in the financial statements. YEAR 2000 ISSUE The "Year 2000 Issue" is the inability of computers and computing technology to recognize correctly the Year 2000 date change. The problem results from a long-standing practice by programmers to save memory space by denoting Years using just two digits instead of four digits. Thus, systems that are not Year 2000 compliant may be unable to read dates correctly after the Year 1999 and can return incorrect or unpredictable results. This could have a significant effect on the Company's business/financial systems as well as products and services, if not corrected. The Company established a project to address year 2000 processing concerns in September of 1996. In 1997 the Company completed the review of the Company's internally and externally developed software, and made corrections to all year 2000 non-compliant processing. The Company also secured verification of current and future year 2000 compliance from all 41 major external software vendors. In December of 1997, a separate computer operating environment was established with the system dates advanced to December of 1999. A parallel model office was established with all dates in the data advanced to December of 1999. Parallel model office processing is being performed using dates from December of 1999 to January of 2001, to insure all year 2000 processing errors have been corrected. Testing should be completed by the end of the first quarter of 1998. After testing is completed, periodic regression testing will be performed to monitor continuing compliance. By addressing year 2000 compliance in a timely manner, compliance will be achieved using existing staff and without significant impact on the Company operationally or financially. PROPOSED MERGER On March 25, 1997, the Board of Directors of UTI and UII voted to recommend to the shareholders a merger of the two companies. Under the Plan of Merger, UTI would be the surviving entity with UTI issuing one share of its stock for each share held by UII shareholders. UTI owns 53% of United Trust Group, Inc., an insurance holding company, and UII owns 47% of United Trust Group, Inc. Neither UTI nor UII have any other significant holdings or business dealings. The Board of Directors of each company thus concluded a merger of the two companies would be in the best interests of the shareholders. The merger will result in certain cost savings, primarily related to costs associated with maintaining a corporation in good standing in the states in which it transacts business. A vote of the shareholders of UTI and UII regarding the proposed merger is anticipated to occur sometime during the third quarter of 1998. SUBSEQUENT EVENT On February 19, 1998, UTI signed a letter of intent with Jesse T. Correll, whereby Mr. Correll will personally or in combination with other individuals make an equity investment in UTI over a period of three years. Under the terms of the letter of intent Mr. Correll will buy 2,000,000 authorized but unissued shares of UTI common stock for $15.00 per share and will also buy 389,715 shares of UTI common stock, representing stock of UTI and UII, that UTI purchased during the last eight months in private transactions at the average price UTI paid for such stock, plus interest, or approximately $10.00 per share. Mr. Correll also will purchase 66,667 shares of UTI common stock and $2,560,000 of face amount of convertible bonds (which are due and payable on any change in control of UTI) in private transactions, primarily from officers of UTI. Upon completion of the transaction, Mr. Correll would be the largest shareholder of UTI. UTI intends to use the equity that is being contributed to expand their operations through the acquisition of other life insurance companies. The transaction is subject to negotiation of a definitive purchase agreement; completion of due diligence by Mr. Correll; the receipt of regulatory and other approvals; and the satisfaction of certain conditions. The transaction is not expected to be completed before June 30, 1998, and there can be no assurance that the transaction will be completed. 42 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF UII FOR THE PERIOD ENDED MARCH 31, 1998 At March 31, 1998 and December 31, 1997, the balance sheet reflects the assets and liabilities of UII and its 47% equity interest in UTG. The statements of operations and statements of cash flows presented include the operating results of UII. RESULTS OF OPERATIONS FIRST QUARTER 1998 COMPARED TO FIRST QUARTER 1997 (a) REVENUES The Company's source of revenues is derived from service fee income which is provided via a service agreement with USA. The service agreement between UII and USA is to provide USA with certain administrative services. The fees are based on a percentage of premium revenue of USA. The percentages are applied to both first year and renewal premiums at different rates. The Company holds $864,100 of notes receivable from affiliates. The notes receivable from affiliates consists of three separate notes. The $700,000 note bears interest at the rate of 1% above the variable per annum rate of interest most recently published by the Wall Street Journal as the prime rate. Interest is payable quarterly with principal due at maturity on May 8, 2006. In February 1996, FCC borrowed an additional $150,000 from UII to provide additional cash for liquidity. The note bears interest at the rate of 1% over prime as published in the Wall Street Journal, with interest payments due quarterly and principal due upon maturity of the note on June 1, 1999. The remaining $14,100 are 20 year notes of UTG with interest at 8.5% payable semi-annually. At current interest levels, the notes will generate approximately $80,000 annually. (b) EXPENSES The Company has a sub-contract service agreement with United Trust, Inc. ("UTI") for certain administrative services. Through its facilities and personnel, UTI performs such services as may be mutually agreed upon between the parties. The fees are based on a percentage of the fees paid to UII by USA. Interest expense of $21,430 and $20,866 was incurred in first quarter 1998 and 1997, respectively. The interest expense is directly attributable to the convertible debentures. The Debentures bear interest at a variable rate equal to one percentage point above the prime rate published in the Wall Street Journal from time to time. (c) EQUITY IN INCOME OF INVESTEES Equity in income of investees represents UII's 47% share of the net loss of UTG. Following is a discussion of the results of operations of UTG and its consolidated subsidiaries ("UTG"): Revenues of UTG Premiums and policy fee revenues, net of reinsurance premiums and policy fees, decreased 9% when comparing 1998 to 1997. UTG currently writes little new traditional business, consequently, traditional premiums will decrease as the amount of traditional business in-force decreases. Collected premiums on universal life and interest sensitive products is not reflected in premiums and policy revenues because Generally Accepted Accounting Procedures ("GAAP") requires that premiums collected on these types of products be treated as deposit liabilities rather than revenue. Unless UTG acquires a block of in-force business or marketing changes its focus to traditional business, premium revenue will continue to decline. 43 Another cause for the decrease in premium revenues is related to the potential change in control of UTI over the last two years to two different parties. During September of 1996, it was announced that control of UTI would pass to an unrelated party, but the change in control did not materialize. At this writing, negotiations are progressing with a different unrelated party for the change in control of UTI. Please refer to the Notes to the Consolidated Financial Statements for additional information. The possible changes and resulting uncertainties have hurt the insurance companies' ability to recruit and maintain sales agents. Net investment income decreased 3% when comparing 1998 to 1997. The decrease in net investment income is due to the decrease in invested assets. Although, net investment income decreased, overall investment yields increased from 7% in 1997 to 7.3% in 1998. During the first quarter of 1998, UTG had maturities of approximately $15,000,000 from the fixed maturity portfolio. Of these maturities, approximately $10,000,000 was reinvested in fixed maturities and the remaining funds were placed in interest bearing cash equivalent accounts. UTG's investment advisor is anticipating a favorable shift, in the near future, of fixed maturity yields. The increase in cash is a short- term fluctuation. UTG anticipates the purchase of additional long- term fixed maturities in the near future. The overall investment yields for 1998 and 1997, are 7.3% and 7%, respectively. UTG's investments are generally managed to match related insurance and policyholder liabilities. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. The minimum interest spread between earned and credited rates is 1% on the "Century 2000" universal life insurance product, which currently is UTG's primary sales product. UTG monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads. It is expected that monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on the insurance policies UTG currently has in force and will write in the future. UTG had realized investment gains of $92,248 in the first quarter of 1998, compared to a realized investment loss of $6,136 in the first quarter of 1997. The current quarter investment gain can be attributed to a sale of real estate property for a profit of $82,024. UTG had other gains and losses during the period that comprised the remaining amount reported but were immaterial in nature on an individual basis. Expenses of UTG Life benefits, net of reinsurance benefits and claims, decreased 12% in 1998 as compared to 1997. The decrease in premium revenues resulted in lower benefit reserve increases in 1998. In addition, policyholder benefits decreased due to a decrease in death benefit claims of $607,000 from the prior period. There is no single event that caused mortality to decrease. Policy claims vary from year to year and therefore, fluctuations in mortality are to be expected and are not considered unusual by management. Operating expenses decreased 10% in 1998 compared to 1997. The decrease in operating expenses is due to a decrease in salaries. The decrease in salaries is due to a 10% reduction in staff compared to the previous year, including the retirement of an executive officer. Net loss of UTG UTG had a net income of $31,311 in 1998 compared to a net loss of $(23,565) in 1997. The improvement is directly related to the decrease in life benefits and operating expenses. (d) NET INCOME The Company recorded net income of $105,177 for the first quarter of 1998 compared to $55,572 for the same period one year ago. The improvement in net income is the result of a combination of improved operating results of UII and improved earnings of UTG. 44 YEAR 2000 ISSUE The "Year 2000 Issue" is the inability of computers and computing technology to recognize correctly the Year 2000 date change. The problem results from a long-standing practice by programmers to save memory space by denoting Years using just two digits instead of four digits. Thus, systems that are not Year 2000 compliant may be unable to read dates correctly after the Year 1999 and can return incorrect or unpredictable results. This could have a significant effect on the Company's business/financial systems as well as products and services, if not corrected. The Company established a project to address year 2000 processing concerns in September of 1996. In 1997 the Company completed the review of the Company's internally and externally developed software, and made corrections to all year 2000 non-compliant processing. The Company also secured verification of current and future year 2000 compliance from all major external software vendors. In December of 1997, a separate computer operating environment was established with the system dates advanced to December of 1999. A parallel model office was established with all dates in the data advanced to December of 1999. Parallel model office processing is being performed using dates from December of 1999 to January of 2001, to insure all year 2000 processing errors have been corrected. Testing was completed by the end of the first quarter of 1998. Periodic regression testing will be performed to monitor continuing compliance. By addressing year 2000 compliance in a timely manner, compliance will be achieved using existing staff and without significant impact on the Company operationally or financially. PROPOSED MERGER On March 25, 1997, the Board of Directors of UTI and UII voted to recommend to the shareholders a merger of the two companies. Under the Plan of Merger, UTI would be the surviving entity with UTI issuing one share of its stock for each share held by UII shareholders. UTI owns 53% of United Trust Group, Inc., an insurance holding company, and UII owns 47% of United Trust Group, Inc. Neither UTI nor UII have any other significant holdings or business dealings. The Board of Directors of each company thus concluded a merger of the two companies would be in the best interests of the shareholders. The merger will result in certain cost savings, primarily related to costs associated with maintaining a corporation in good standing in the states in which it transacts business. A vote of the shareholders of UTI and UII regarding the proposed merger is anticipated to occur sometime during the third quarter of 1998. PENDING CHANGE IN CONTROL OF UNITED TRUST INC. On April 30, 1998, UTI and First Southern Funding, a Kentucky corporation ("FSF"), signed a Definitive Agreement ("the FSF Agreement") whereby FSF will make an equity investment in UTI. Under the terms of 0the FSF Agreement, FSF will buy 473,523 authorized but unissued shares of UTI common stock for $15.00 a share and will also buy 389,715 shares of UTI common stock that UTI purchased during the last year in private transactions at the average price UTI paid for such stock, plus interest, or approximately $10.00 per share. FSF will also purchase 66,667 shares of UTI common stock and $2,560,000 of face amount convertible bonds which are due and payable on any change in control of UTI, in private transactions, primarily from officers of UTI. In addition, FSF will be granted a three year option to purchase up to 1,450,000 shares of UTI common stock for $15.00 per share. Management of UTI intends to use the equity that is being contributed to expand their operations through the acquisition of other life insurance companies. The transaction is subject to the receipt of regulatory and other approvals; and the satisfaction of certain conditions. The transaction is not expected to be completed before July 31, 1998, and there can be no assurance that the transaction will be completed. FSF is an affiliate of First Southern Bancorp, Inc., a bank holding company that owns five banks that operate out of 14 locations in central Kentucky. 45 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS Any forward-looking statement contained herein or in any other oral or written statement by the company or any of its officers, directors or employees is qualified by the fact that actual results of the company may differ materially from any such statement due to the following important factors, among other risks and uncertainties inherent in the company's business: 1. Prevailing interest rate levels, which may affect the ability of the company to sell its products, the market value of the company's investments and the lapse ratio of the company's policies, notwithstanding product design features intended to enhance persistency of the company's products. 2. Changes in the federal income tax laws and regulations which may affect the relative tax advantages of the company's products. 3. Changes in the regulation of financial services, including bank sales and underwriting of insurance products, which may affect the competitive environment for the company's products. 4. Other factors affecting the performance of the company, including, but not limited to, market conduct claims, insurance industry insolvencies, stock market performance, and investment performance. 46 SELECTED FINANCIAL DATA OF UTI FINANCIAL HIGHLIGHTS (000's omitted, except per share data) 1997 1996 1995 1994 1993 Premium income net of reinsurance $ 28,639 $ 30,944 $ 33,099 $ 35,145 $ 33,530 Total revenues $ 43,992 $ 46,976 $ 49,869 $ 49,207 $ 48,541 Net loss* $ (559) $ (938) $ (3,001) $ (1,624) $ (862) Net loss per share $ (0.32) $ (0.50) $ (1.61) $ (0.90) $ (0.50) Total assets $ 349,300 $ 355,474 $ 356,305 $ 360,258 $ 375,755 Total long-term debt $ 21,460 $ 19,574 $ 21,447 $ 22,053 $ 24,359 Dividends paid per share NONE NONE NONE NONE NONE * Includes equity earnings of investees.
47 UTI MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997 The purpose of this section is to discuss and analyze the Company's consolidated results of operations, financial condition and liquidity and capital resources. This analysis should be read in conjunction with the consolidated financial statements and related notes which appear elsewhere in this report. The Company reports financial results on a consolidated basis. The consolidated financial statements include the accounts of UTI and its subsidiaries at December 31, 1997. RESULTS OF OPERATIONS 1997 COMPARED TO 1996 (a) REVENUES Premiums and policy fee revenues, net of reinsurance premiums and policy fees, decreased 7% when comparing 1997 to 1996. The Company currently writes little new traditional business, consequently, traditional premiums will decrease as the amount of traditional business in-force decreases. Collected premiums on universal life and interest sensitive products is not reflected in premiums and policy revenues because Generally Accepted Accounting Procedures ("GAAP") requires that premiums collected on these types of products be treated as deposit liabilities rather than revenue. Unless the Company acquires a block of in-force business or marketing changes its focus to traditional business, premium revenue will continue to decline at a rate consistent with prior experience.. Another cause for the decrease in premium revenues is related to the potential change in control of UTI over the last two years to two different parties. During September of 1996, it was announced that control of UTI would pass to an unrelated party, but the change in control did not materialize. At this writing, negotiations are progressing with a different unrelated party for the change in control of UTI. Please refer to the Notes to the Consolidated Financial Statements for additional information. The possible changes and resulting uncertainties have hurt the insurance companies' ability to recruit and maintain sales agents. New business production decreased significantly over the last two years. New business production decreased 43% or $3,935,000 when comparing 1997 to 1996. In recent years, the insurance industry as a whole has experienced a decline in the total number of agents who sell insurance products, therefore competition has intensified for top producing sales agents. The relatively small size of our companies, and the resulting limitations, have made it challenging to compete in this area. A positive impact on premium income is the improvement of persistency. Persistency is a measure of insurance in force retained in relation to the previous year. The Companies' average persistency rate for all policies in force for 1997 and 1996 has been approximately 89.4% and 87.9%, respectively. Net investment income decreased 6% when comparing 1997 to 1996. The decrease relates to the decrease in invested assets from a coinsurance agreement. The Company's insurance subsidiary UG entered into a coinsurance agreement with First International Life Insurance Company ("FILIC"), an unrelated party, as of September 30, 1996. During 1997, FILIC changed its name to Park Avenue Life Insurance Company ("PALIC"). Under the terms of the agreement, UG ceded to FILIC substantially all of its paid-up life insurance policies. Paid-up life insurance generally refers to non-premium paying life insurance policies. At closing of the transaction, UG received a coinsurance credit of $28,318,000 for policy liabilities covered under the agreement. UG transferred assets equal to the credit received. This transfer included policy loans of $2,855,000 associated with policies under the agreement and a net cash transfer of $19,088,000, after deducting the ceding commission due UG of $6,375,000. To provide the cash required to be transferred under the agreement, the Company sold $18,737,000 of fixed maturity investments. The overall investment yields for 1997, 1996 and 1995, are 7.24%, 7.29% and 7.12%, respectively. Since 1995, investment yield improved due to the fixed maturity investments. Cash generated from the sales of universal life insurance products, has been invested primarily in our fixed maturity portfolio. 48 The Company's investments are generally managed to match related insurance and policyholder liabilities. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. The minimum interest spread between earned and credited rates is 1% on the "Century 2000" universal life insurance product, which currently is the Company's primary sales product. The Company monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads. It is expected that monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on the insurance policies the Company currently has in force and will write in the future. Realized investment losses were $279,000 and $988,000 in 1997 and 1996, respectively. Approximately $522,000 of realized losses in 1996 are due to the charge-off of two specific investments. The Company realized a loss of $207,000 from a single loan and $315,000 from an investment in First Fidelity Mortgage Company ("FFMC"). The charge-off of the loan represented the entire loan balance at the time of the charge-off. Additionally, the Company sold two foreclosed real estate properties that resulted in approximately $357,000 in realized losses in 1996. The Company had other gains and losses during the period that comprised the remaining amount reported but were immaterial in nature on an individual basis. (b) EXPENSES Life benefits, net of reinsurance benefits and claims, decreased 11% in 1997 as compared to 1996. The decrease in premium revenues resulted in lower benefit reserve increases in 1997. In addition, policyholder benefits decreased due to a decrease in death benefit claims of $162,000. In 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by Company standards. These non-standard policies had a face amount of $22,700,000 and represented 1/2 of 1% of the insurance in-force in 1994. Management's initial analysis indicated that expected death claims on the business in-force was adequate in relation to mortality assumptions inherent in the calculation of statutory reserves. Nevertheless, management determined it was in the best interest of the Company to repurchase as many of the non-standard policies as possible. Through December 31, 1996, the Company spent approximately $7,099,000 for the settlement of non-standard policies and for the legal defense of related litigation. In relation to settlement of non-standard policies the Company incurred life benefit costs of $3,307,000, and $720,000 in 1996 and 1995, respectively. The Company incurred legal costs of $906,000 and $687,000 in 1996 and 1995, respectively. All policies associated with this issue have been settled as of December 31, 1996. Therefore, expense reductions for 1997 would follow. Commissions and amortization of deferred policy acquisition costs decreased 14% in 1997 compared to 1996. The decrease is due primarily due to a reduction in commissions paid. Commissions decreased 19% in 1997 compared to 1996. The decrease in commissions was due to the decline in new business production. There is a direct relationship between premium revenues and commission expense. First year premium production decreased 43% and first year commissions decreased 33% when comparing 1997 to 1996. Amortization of deferred policy acquisition costs decreased 6% in 1997 compared to 1996. Management would expect commissions and amortization of deferred policy acquisition costs to decrease in the future if premium revenues continue to decline. Amortization of cost of insurance acquired decreased 57% in 1997 compared to 1996. Cost of insurance acquired is amortized in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. The Company did not have any charge-offs during the periods covered by this report. The decrease in amortization during the current period is a normal fluctuation due to the expected future profits. Amortization of cost of insurance acquired is particularly sensitive to changes in persistency of certain blocks of insurance in-force. The improvement of persistency during the year had a positive impact on amortization of cost of insurance acquired. Persistency is a measure of insurance in force retained in relation to the previous year. The Company's average persistency rate for all policies in force for 1997 and 1996 has been approximately 89.4% and 87.9%, respectively. Operating expenses decreased 23% in 1997 compared to 1996. The decrease in operating expenses is directly related to settlement of certain litigation in December of 1996. The Company incurred legal costs of $0, $906,000 and $687,000 in 1997, 1996 and 1995, respectively in relation to the settlement of the non-standard insurance policies. 49 Interest expense increased 5% in 1997 compared to 1996. Since December 31, 1996, notes payable increased approximately $1,886,000. Average outstanding indebtedness was $20,517,000 with an average cost of 8.9% in 1997 compared to average outstanding indebtedness of 20,510,000 with an average cost of 8.5% in 1996. The increase in outstanding indebtedness was due to the issuance of convertible notes to seven individuals, all officers or employees of UTI. In March 1997, the base interest rate for most of the notes payable increased a quarter of a point. The base rate is defined as the floating daily, variable rate of interest determined and announced by First of America Bank. Please refer to Note 12 "Notes Payable" in the Consolidated Notes to the Financial Statements for more information. (c) NET LOSS The Company had a net loss of $559,000 in 1997 compared to a net loss of $938,000 in 1996. The improvement is directly related to the decrease in life benefits and operating expenses primarily associated with the 1996 settlement and other related costs of the non-standard life insurance policies. 1996 COMPARED TO 1995 (a) REVENUES Premium and policy fee revenues, net of reinsurance premium, decreased 7% when comparing 1996 to 1995. The decrease in premium income is primarily attributed to a 15% decrease in new business production. The Company changed its marketing strategy from traditional life insurance products to universal life insurance products. Universal life and interest sensitive products contribute only the risk charge to premium income, however traditional insurance products contribute all monies received to premium income. The Company changed its marketing strategy to remain competitive based on consumer demand. In addition, the Company changed its focus from primarily a broker agency distribution system to a captive agent system. Business written by the broker agency force, in recent years, did not meet Company expectations. With the change in focus of distribution systems, most of the broker agents were terminated. (The termination of the broker agency force caused a non- recurring write down of the value of agency force asset in 1995, see discussion of amortization of agency force for further details.). The change in distribution systems effectively reduced the total number of agents representing and producing business for the Company. Broker agents sell insurance and related products for several companies. Captive agents sell for only one company. A positive impact on premium income is the improvement of persistency. Persistency is a measure of insurance in force retained in relation to the previous year. The Companies' average persistency rate for all policies in force for 1996 and 1995 has been approximately 87.9% and 87.3%, respectively. Net investment income increased 3% when comparing 1996 to 1995. The overall investment yields for 1996 and 1995 are 7.29% and 7.12%, respectively. The improvement in investment yield is primarily attributed to fixed maturity investments. Cash generated from the sales of universal life insurance products, has been invested primarily in our fixed investment portfolio. The Company's investments are generally managed to match related insurance and policyholder liabilities. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. The minimum interest spread between earned and credited rates is 1% on the "Century 2000" universal life insurance product, which currently is the Company's primary sales product. The Company monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads. It is expected that monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on the insurance policies the Company currently has in force and will write in the future. 50 Realized investment losses were $988,000 and $124,000 in 1996 and 1995, respectively. Approximately $522,000 of realized losses in 1996 are due to the charge-off of two specific investments. The Company realized a loss of $207,000 from a single loan and $315,000 from an investment in First Fidelity Mortgage Company ("FFMC"). The charge-off of the loan represented the entire loan balance at the time of the charge-off. Additionally, the Company sold two foreclosed real estate properties that resulted in approximately $357,000 in realized losses in 1996. The Company had other gains and losses during the period that comprised the remaining amount reported but were immaterial in nature on an individual basis. (b) EXPENSES Life benefits, net of reinsurance benefits and claims, increased 2% compared to 1995. The increase in life benefits is due primarily to settlement expenses discussed in the following paragraph: In 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by Company standards. These non-standard policies had a face amount of $22,700,000 and represented 1/2 of 1% of the insurance in-force in 1994. Management's initial analysis indicated that expected death claims on the business in-force was adequate in relation to mortality assumptions inherent in the calculation of statutory reserves. Nevertheless, management determined it was in the best interest of the Company to repurchase as many of the non-standard policies as possible. Through December 31, 1996, the Company spent approximately $7,099,000 for the settlement of non-standard policies and for the legal defense of related litigation. In relation to settlement of non-standard policies the Company incurred life benefits of $3,307,000 and $720,000 in 1996 and 1995, respectively. The Company incurred legal costs of $906,000 and $687,000 in 1996 and 1995, respectively. All the policies associated with this issue have been settled as of December 31, 1996. The Company has approximately $3,742,000 of insurance in-force and $1,871,000 of reserves from the issuance of paid-up life insurance policies for settlement of matters related to the original non-standard policies. Management believes the reserves are adequate in relation to expected mortality on this block of in- force. Commissions and amortization of deferred policy acquisition costs decreased 14% in 1996 compared to 1995. The decrease is due to a decrease in commissions expense. Commissions decreased 15% in 1996 compared to 1995. The decrease in commissions was due to the decline in new business production. There is a direct relationship between premium revenues and commission expenses. First year premium production decreased 15% and first year commissions decreased 32% when comparing 1996 to 1995. Amortization of deferred policy acquisition costs decreased 12% in 1996 compared to 1995. Management expects commissions and amortization of deferred policy acquisition costs to decrease in the future if premium revenues continue to decline. Amortization of cost of insurance acquired increased 25% in 1996 compared to 1995. Cost of insurance acquired is amortized in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. The Company did not have any charge-offs during the periods covered by this report. The increase in amortization during the current period is a normal fluctuation due to the expected future profits. Amortization of cost of insurance acquired is particularly sensitive to changes in persistency of certain blocks of insurance in-force. The Company reported a non-recurring write down of value of agency force of $0 and $8,297,000 in 1996 and 1995, respectively. The write down was directly related to the Company's change in distribution systems. The Company changed its focus from primarily a broker agency distribution system to a captive agent system. Business produced by the broker agency force in recent years did not meet Company expectations. With the change in focus of distribution systems, most of the broker agents were terminated. The termination of most of the agents involved in the broker agency force caused management to re-evaluate and write-off the value of the agency force carried on the balance sheet. Operating expenses increased 4% in 1996 compared to 1995. The primary factor that caused the increase in operating expenses is directly related to increased legal costs and reserves established for litigation. The legal costs are due to the settlement of non-standard insurance policies as was discussed in the review of life benefits. The Company incurred legal costs of $906,000 and $687,000 in 1996 and 1995, respectively in relation to the settlement of the non-standard insurance policies. 51 Interest expense decreased 12% in 1996 compared to 1995. Since December 31, 1995, notes payable decreased approximately $1,873,000 that has directly attributed to the decrease in interest expense during 1996. Interest expense was also reduced, as a result of the refinancing of the senior debt under which the new interest rate is more favorable. Please refer to Note 11 "Notes Payable" of the Consolidated Notes to the Financial Statements for more information on this matter. (c) NET LOSS The Company had a net loss of $938,000 in 1996 compared to a net loss of $3,001,000 in 1995. The net loss in 1996 is attributed to the increase in life benefits net of reinsurance and operating expenses primarily associated with settlement and other related costs of the non-standard life insurance policies. FINANCIAL CONDITION (a) ASSETS Investments are the largest asset group of the Company. The Company's insurance subsidiaries are regulated by insurance statutes and regulations as to the type of investments that they are permitted to make and the amount of funds that may be used for any one type of investment. In light of these statutes and regulations, and the Company's business and investment strategy, the Company generally seeks to invest in United States government and government agency securities and corporate securities rated investment grade by established nationally recognized rating organizations. The liabilities are predominantly long-term in nature and therefore, the Company invests in long-term fixed maturity investments that are reported in the financial statements at their amortized cost. The Company has the ability and intent to hold these investments to maturity; consequently, the Company does not expect to realize any significant loss from these investments. The Company does not own any derivative investments or "junk bonds". As of December 31, 1997, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in the context of consolidated assets or shareholders' equity. The Company has identified securities it may sell and classified them as "investments held for sale". Investments held for sale are carried at market, with changes in market value charged directly to shareholders' equity. The following table summarizes the Company's fixed maturities distribution at December 31, 1997 and 1996 by ratings category as issued by Standard and Poor's, a leading ratings analyst. Fixed Maturities Rating % of Portfolio 1997 1996 Investment Grade AAA 31% 30% AA 14% 13% A 46% 46% BBB 9% 10% Below investment grade 0% 1% 100% 100% Mortgage loans decreased 14% in 1997 as compared to 1996. The Company is not actively seeking new mortgage loans, and the decrease is due to early pay-offs from mortgagee's seeking refinancing at lower interest rates. All mortgage loans held by the Company are first position loans. The Company has $298,227 in mortgage loans, net of a $10,000 reserve allowance, which are in default and in the process of foreclosure, this represents approximately 3% of the total portfolio. 52 Investment real estate and real estate acquired in satisfaction of debt decreased slightly in 1997 compared to 1996. Investment real estate holdings represent approximately 3% of the total assets of the Company. Total investment real estate is separated into three categories: Commercial 38%, Residential Development 47% and Foreclosed Properties 15%. Policy loans decreased 2% in 1997 compared to 1996. Industry experience for policy loans indicates few policy loans are ever repaid by the policyholder other than through termination of the policy. Policy loans are systematically reviewed to ensure that no individual policy loan exceeds the underlying cash value of the policy. Policy loans will generally increase due to new loans and interest compounding on existing policy loans. Deferred policy acquisition costs decreased 6% in 1997 compared to 1996. Deferred policy acquisition costs, which vary with, and are primarily related to producing new business, are referred to as ("DAC"). DAC consists primarily of commissions and certain costs of policy issuance and underwriting, net of fees charged to the policy in excess of ultimate fees charged. To the extent these costs are recoverable from future profits, the Company defers these costs and amortizes them with interest in relation to the present value of expected gross profits from the contracts, discounted using the interest rate credited by the policy. The Company had $586,000 in policy acquisition costs deferred, $425,000 in interest accretion and $1,735,636 in amortization in 1997. The Company did not recognize any impairment during the period. Cost of insurance acquired decreased 5% in 1997 compared to 1996. At December 31, 1997, cost of insurance acquired was $41,523,000 and amortization totaled $2,394,000 for the year. When an insurance company is acquired, the Company assigns a portion of its cost to the right to receive future cash flows from insurance contracts existing at the date of the acquisition. The cost of policies purchased represents the actuarially determined present value of the projected future cash flows from the acquired policies. Cost of Insurance Acquired is amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. (b) LIABILITIES Total liabilities increased slightly in 1997 compared to 1996. However, future policy benefits which represented 81% of total liabilities at December 31, 1997, decreased slightly in 1997. Policy claims and benefits payable decreased 35% in 1997 compared to 1996. There is no single event that caused this item to decrease. Policy claims vary from year to year and therefore, fluctuations in this liability are to be expected and are not considered unusual by management. Other policyholder funds decreased 12% in 1997 compared to 1996. The decrease can be attributed to a decrease in premium deposit funds. Premium deposit funds are funds deposited by the policyholder with the insurance company to accumulate interest and pay future policy premiums. The change in marketing from traditional insurance products to universal life insurance products is the primary reason for the decrease. Universal life insurance products do not have premium deposit funds. All premiums received from universal life insurance policyholders are credited to the life insurance policy and are reflected in future policy benefits. Dividend and endowment accumulations increased 7% in 1997 compared to 1996. The increase is attributed to the significant amount of participating business the Company has in force. Over 47% of all dividends paid were put on deposit with the Company to accumulate with interest. Management expects this liability to increase in the future. Income taxes payable and deferred income taxes payable increased 7% in 1997 compared to 1996. The change in deferred income taxes payable is attributable to temporary differences between Generally Accepted Accounting Principles ("GAAP") and tax basis accounting. Federal income taxes are discussed in more detail in Note 3 of the Consolidated Notes to the Financial Statements. Notes payable increased approximately $1,886,000 in 1997 compared to 1996. On July 31, 1997, United Trust Inc. issued convertible notes totaling $2,560,000 to seven individuals, all officers or employees of United Trust Inc. The notes bear interest at a rate of 1% over prime, with interest 53 payments due quarterly and principal due upon maturity of July 31, 2004. The conversion price of the notes are graded from $12.50 per share for the first three years, increasing to $15.00 per share for the next two years and increasing to $20.00 per share for the last two years. As of December 31, 1997, the notes were convertible into 204,800 shares of UTI common stock with no conversion privileges having been exercised. The Company's long-term debt is discussed in more detail in Note 12 of the Notes to the Financial Statements. (c) SHAREHOLDERS' EQUITY Total shareholders' equity decreased 15% in 1997 compared to 1996. The decrease is attributable to the Company's acquisition of treasury stock. As indicated in the notes payable paragraph above, on July 31, 1997 UTI issued convertible notes totaling $2,560,000. The notes were issued to provide UTI with additional funds to be used for the following purposes. A portion of the proceeds in combination with debt instruments were used to acquire approximately 16% of the Larry E. Ryherd and family stock holdings in UTI. This transaction reduced the largest shareholder's stock holdings for the purpose of making UTI stock more attractive to the investment community. Additionally, a portion of the proceeds in combination with debt instruments were used to acquire the stock holdings of Thomas F. Morrow and family in UTI and UII. Simultaneous to this stock acquisition Mr. Morrow retired as an executive officer of UTI. Mr. Morrow's retirement will provide an annual cost savings to the Company in excess of debt service on the new notes. The remaining proceeds of approximately $1,500,000, of the original $2,560,000, will be used to reduce the outstanding debt of the Company. LIQUIDITY AND CAPITAL RESOURCES The Company has three principal needs for cash - the insurance companies' contractual obligations to policyholders, the payment of operating expenses and the servicing of its long-term debt. Cash and cash equivalents as a percentage of total assets were 7% and 5% as of March 31, 1998, and December 31, 1997, respectively. Fixed maturities as a percentage of total invested assets were 82% as of March 31, 1998 and December 31, 1997. Future policy benefits are primarily long-term in nature and therefore, the Company's investments are predominantly in long-term fixed maturity investments such as bonds and mortgage loans which provide sufficient return to cover these obligations. The Company has the ability and intent to hold these investments to maturity; consequently, the Company's investment in long-term fixed maturities is reported in the financial statements at their amortized cost. Many of the Company's products contain surrender charges and other features which reward persistency and penalize the early withdrawal of funds. With respect to such products, surrender charges are generally sufficient to cover the Company's unamortized deferred policy acquisition costs with respect to the policy being surrendered. Cash provided by operating activities was $23,000, $3,140,000 and 486,000 in 1997, 1996 and 1995, respectively. The net cash provided by operating activities plus net policyholder contract deposits after the payment of policyholder withdrawals equaled $3,412,000 in 1997, $9,952,000 in 1996 and $9,499,000 in 1995. Cash provided by (used in) operating activities was $309,381 and ($504,803) at first quarter in 1998 and 1997, respectively. The net cash provided by (used in) operating activities plus net policyholder contract deposits after the payment of policyholder withdrawals equaled $1,891,265 in 1998 first quarter and $1,274,926 in 1997 first quarter. Management utilizes this measurement of cash flows as an indicator of the performance of the Company's insurance operations, since reporting regulations require cash inflows and outflows from universal life insurance products to be shown as financing activities when reporting on cash flows. 54 Cash provided by (used in) investing activities was ($2,989,000), $15,808,000 and ($8,063,000), for 1997, 1996 and 1995, respectively. The most significant aspect of cash provided by (used in) investing activities are the fixed maturity transactions. Fixed maturities account for 70%, 81% and 76% of the total cost of investments acquired in 1997, 1996 and 1995, respectively. The net cash provided by investing activities in 1996, is due to the fixed maturities sold in conjunction with the coinsurance agreement with FILIC. Cash provided by (used in) investing activities was $7,007,600 and ($2,799,588), for first quarter 1998 and 1997, respectively. The most significant aspect of cash provided by (used in) investing activities are the fixed maturity transactions. Fixed maturities account for 90% and 73% of the total cost of investments acquired in 1998 and 1997, respectively. The Company has not directed its investable funds to so- called "junk bonds" or derivative investments. Net cash provided by (used in) financing activities was $1,746,000, ($14,150,000) and $8,408,000 for 1997, 1996 and 1995, respectively. The change between 1997 and 1996 is due to a coinsurance agreement with FILIC as of September 30, 1996. At closing of the transaction, UG received a reinsurance credit of $28,318,000 for policy liabilities covered under the agreement. UG transferred assets equal to the credit received. This transfer included policy loans of $2,855,000 associated with policies under the agreement and a net cash transfer of $19,088,000 after deducting the ceding commission due UG of $6,375,000. Policyholder contract deposits decreased 20% in 1997 compared to 1996, and decreased 11% in 1996 when compared to 1995. Policyholder contract withdrawals has decreased 6% in 1997 compared to 1996, and decreased 4% in 1996 compared to 1995. Net cash provided by financing activities was $1,555,357 and $1,779,729 for first quarter 1998 and 1997, respectively. Policyholder contract deposits decreased 13% in 1998 compared to 1997. Policyholder contract withdrawals has decreased 14% in 1998 compared to 1997. The change in policyholder contract withdrawals is not attributable to any one significant event. Factors that influence policyholder contract withdrawals are fluctuation of interest rates, competition and other economic factors. At March 31, 1998, the Company had a total of $21,511,706 in long-term debt outstanding. Long-term debt principal reductions are approximately $1.5 million per year over the next several years. The senior debt is through First of America Bank - NA and is subject to a credit agreement. The debt bears interest to a rate equal to the "base rate" plus nine-sixteenths of one percent. The Base rate is defined as the floating daily, variable rate of interest determined and announced by First of America Bank from time to time as its "base lending rate". The base rate at issuance of the loan was 8.25%, until March of 1997, when it changed to 8.5%. The base rate has remained unchanged at 8.5% through the date of this filing. Interest is paid quarterly and principal payments of $1,000,000 are due in May of each year beginning in 1997, with a final payment due May 8, 2005. On November 8, 1997, the Company prepaid the $1,000,000 May 8,1998, principal payment. The subordinated debt was incurred June 16, 1992 as a part of an acquisition. The 10-year notes bear interest at the rate of 7 1/2% per annum, payable semi-annually beginning December 16, 1992. These notes except for one $840,000 note, provide for principal payments equal to 1/20th of the principal balance due with each interest installment beginning December 16, 1997, with a final payment due June 16, 2002. The $840,000 note provides for a lump sum principal payment due June 16, 2002. In June 1997, the Company refinanced $204,267 of its subordinated 10-year notes to subordinated 20-year notes bearing interest at the rate of 8.75%. The repayment terms of these notes are the same as the original subordinated 20 year notes. The 20-year notes bear interest at the rate of 8 1/2% per annum on $3,530,000 and 8.75% per annum on $505,000, payable semi-annually with a lump sum principal payment due June 16, 2012. On July 31, 1997, United Trust Inc. issued convertible notes totaling $2,560,000 to seven individuals, all officers or employees of United Trust Inc. The notes bear interest at a rate of 1% over prime, which has remained unchanged at 8.5%, with interest payments due quarterly and principal due upon maturity of July 31, 2004. The conversion price of the notes are graded from $12.50 per share for the first three years, increasing to $15.00 per share for the next two years and increasing to $20.00 per share for the last two years. As of December 31, 1997, the notes were convertible into 204,800 shares of UTI common stock with no conversion privileges having been exercised. As of March 31, 1998 the Company has a total $29,894,202 of cash and cash equivalents, short-term investments and investments held for sale in comparison to $21,511,706 of notes payable. UTI and FCC service this debt through existing cash balances and management fees received from the insurance subsidiaries. FCC is further able to service this debt through dividends it may receive from UG. 55 Since UTI is a holding company, funds required to meet its debt service requirements and other expenses are primarily provided by its subsidiaries. On a parent only basis, UTI's cash flow is dependent on revenues from a management agreement with UII and its earnings received on invested assets and cash balances. At March 31, 1998, substantially all of the consolidated shareholders equity represents net assets of its subsidiaries. Cash requirements of UTI primarily relate to servicing its long-term debt. The Company's insurance subsidiaries have maintained adequate statutory capital and surplus and have not used surplus relief or financial reinsurance, which have come under scrutiny by many state insurance departments. The payment of cash dividends to shareholders is not legally restricted. However, insurance company dividend payments are regulated by the state insurance department where the company is domiciled. UTI is the ultimate parent of UG through ownership of several intermediary holding companies. UG can not pay a dividend directly to UTI due to the ownership structure. Please refer to Note 1 of the Notes to the Consolidated Financial Statements. UG's dividend limitations are described below without effect of the ownership structure. Ohio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 1997, UG had a statutory gain from operations of $1,779,000. At December 31, 1997, UG's statutory capital and surplus amounted to $10,997,000. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. A life insurance company's statutory capital is computed according to rules prescribed by the National Association of Insurance Commissioners ("NAIC"), as modified by the insurance company's state of domicile. Statutory accounting rules are different from generally accepted accounting principles and are intended to reflect a more conservative view by, for example, requiring immediate expensing of policy acquisition costs. The achievement of long-term growth will require growth in the statutory capital of the Company's insurance subsidiaries. The subsidiaries may secure additional statutory capital through various sources, such as internally generated statutory earnings or equity contributions by the Company from funds generated through debt or equity offerings. The NAIC's risk-based capital requirements require insurance companies to calculate and report information under a risk-based capital formula. The risk-based capital formula measures the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching and other business factors. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio of the insurance company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Insurance companies below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action. The levels and ratios are as follows: Ratio of Total Adjusted Capital to Authorized Control Level RBC Regulatory Event (Less Than or Equal to) Company action level 2* Regulatory action level 1.5 Authorized control level 1 Mandatory control level 0.7 * Or, 2.5 with negative trend. 56 At December 31, 1997, each of the insurance subsidiaries has a Ratio that is in excess of 3, which is 300% of the authorized control level; accordingly the insurance subsidiaries meet the RBC requirements. The Company is not aware of any litigation that will have a material adverse effect on the financial position of the Company. In addition, the Company does not believe that the regulatory initiatives currently under consideration by various regulatory agencies will have a material adverse impact on the Company. The Company is not aware of any material pending or threatened regulatory action with respect to the Company or any of its subsidiaries. The Company does not believe that any insurance guaranty fund assessments will be materially different from amounts already provided for in the financial statements. Management believes the overall sources of liquidity available will be sufficient to satisfy its financial obligations. REGULATORY ENVIRONMENT The Company's insurance subsidiaries are assessed contributions by life and health guaranty associations in almost all states to indemnify policyholders of failed companies. In several states the company may reduce premium taxes paid to recover a portion of assessments paid to the states' guaranty fund association. This right of "offset" may come under review by the various states, and the company cannot predict whether and to what extent legislative initiatives may affect this right to offset. Also, some state guaranty associations have adjusted the basis by which they assess the cost of insolvencies to individual companies. The Company believes that its reserve for future guaranty fund assessments is sufficient to provide for assessments related to known insolvencies. This reserve is based upon management's current expectation of the availability of this right of offset, known insolvencies and state guaranty fund assessment bases. However, changes in the basis whereby assessments are charged to individual companies and changes in the availability of the right to offset assessments against premium tax payments could materially affect the company's results. Currently, the Company's insurance subsidiaries are subject to government regulation in each of the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including the power to: (i) grant and revoke licenses to transact business; (ii) regulate and supervise trade practices and market conduct; (iii) establish guaranty associations; (iv) license agents; (v) approve policy forms; (vi) approve premium rates for some lines of business; (vii) establish reserve requirements; (viii) prescribe the form and content of required financial statements and reports; (ix) determine the reasonableness and adequacy of statutory capital and surplus; and (x) regulate the type and amount of permitted investments. Insurance regulation is concerned primarily with the protection of policyholders. The Company cannot predict the form of any future proposals or regulation. The Company's insurance subsidiaries, USA, UG, APPL and ABE are domiciled in the states of Ohio, Ohio, West Virginia and Illinois, respectively. The insurance regulatory framework continues to be scrutinized by various states, the federal government and the National Association of Insurance Commissioners ("NAIC"). The NAIC is an association whose membership consists of the insurance commissioners or their designees of the various states. The NAIC has no direct regulatory authority over insurance companies, however its primary purpose is to provide a more consistent method of regulation and reporting from state to state. This is accomplished through the issuance of model regulations, which can be adopted by individual states unmodified, modified to meet the state's own needs or requirements, or dismissed entirely. Most states also have insurance holding company statutes which require registration and periodic reporting by insurance companies controlled by other corporations licensed to transact business within their respective jurisdictions. The insurance subsidiaries are subject to such legislation and registered as controlled insurers in those jurisdictions in which such registration is required. Statutes vary from state to state but typically require periodic disclosure, concerning the corporation, that controls the registered insurers and all subsidiaries of such corporation. In addition, prior notice to, or approval by, the state insurance commission of material intercorporate transfers of assets, reinsurance agreements, management agreements (see Note 9 in the notes to the consolidated financial statements), and payment of dividends (see note 2 in the notes to the consolidated financial statements) in excess of specified amounts by the insurance subsidiary, within the holding company system, are required. 57 Each year the NAIC calculates financial ratio results (commonly referred to as IRIS ratios) for each company. These ratios compare various financial information pertaining to the statutory balance sheet and income statement. The results are then compared to pre-established normal ranges determined by the NAIC. Results outside the range typically require explanation to the domiciliary insurance department. At year-end 1997, the insurance companies had one ratio outside the normal range. The ratio is related to the decrease in premium income. The ratio fell outside the normal range the last three years. A primary cause for the decrease in premium revenues is related to the potential change in control of UTI over the last two years to two different parties. During September of 1996, it was announced that control of UTI would pass to an unrelated party, but the transaction did not materialize. At this writing, negotiations are progressing with a different unrelated party for the change in control of UTI. . Please refer to the Notes to the Consolidated Financial Statements for additional information. The possible changes and resulting uncertainties have hurt the insurance companies' ability to recruit and maintain sales agents. The industry has experienced a downward trend in the total number of agents who sell insurance products, and competition for the top sales producers has intensified. As this trend appears to continue, the recruiting focus of the Company has been on introducing quality individuals to the insurance industry through an extensive internal training program. The Company feels this approach is conducive to the mutual success of our new recruits and the Company as these recruits market our products in a professional, company structured manner. The NAIC, in conjunction with state regulators, has been reviewing existing insurance laws and regulations. A committee of the NAIC proposed changes in the regulations governing insurance company investments and holding company investments in subsidiaries and affiliates which were adopted by the NAIC as model laws in 1996. The Company does not presently anticipate any material adverse change in its business as a result of these changes. Legislative and regulatory initiatives regarding changes in the regulation of banks and other financial services businesses and restructuring of the federal income tax system could, if adopted and depending on the form they take, have an adverse impact on the Company by altering the competitive environment for its products. The outcome and timing of any such changes cannot be anticipated at this time, but the Company will continue to monitor developments in order to respond to any opportunities or increased competition that may occur. The NAIC adopted the Life Illustration Model Regulation. Many states have adopted the regulation effective January 1, 1997. This regulation requires products which contain non-guaranteed elements, such as universal life and interest sensitive life, to comply with certain actuarially established tests. These tests are intended to target future performance and profitability of a product under various scenarios. The regulation does not prevent a company from selling a product that does not meet the various tests. The only implication is the way in which the product is marketed to the consumer. A product that does not pass the tests uses guaranteed assumptions rather than current assumptions in presenting future product performance to the consumer. The Company conducts an ongoing thorough review of its sales and marketing process and continues to emphasize its compliance efforts. A task force of the NAIC is currently undertaking a project to codify a comprehensive set of statutory insurance accounting rules and regulations. This project is not expected to be completed earlier than 1999. Specific recommendations have been set forth in papers issued by the NAIC for industry review. The Company is monitoring the process, but the potential impact of any changes in insurance accounting standards is not yet known. ACCOUNTING AND LEGAL DEVELOPMENTS The Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards (SFAS) No. 128 entitled Earnings per share, which is effective for financial statements for fiscal years beginning after December 15, 1997. SFAS No. 128 specifies the computation, presentation, and disclosure requirements for earnings per share (EPS) for entities with publicly held common stock or potential common stock. The Statement's objective is to simplify the computation of earnings per share, and to make the U.S. standard for computing EPS more compatible with the EPS standards of other countries. 58 Under SFAS No. 128, primary EPS computed in accordance with previous opinions is replaced with a simpler calculation called basic EPS. Basic EPS is calculated by dividing income available to common stockholders (i.e., net income or loss adjusted for preferred stock dividends) by the weighted-average number of common shares outstanding. Thus, in the most significant change in current practice, options, warrants, and convertible securities are excluded from the basic EPS calculation. Further, contingently issuable shares are included in basic EPS only if all the necessary conditions for the issuance of such shares have been satisfied by the end of the period. Fully diluted EPS has not changed significantly but has been renamed diluted EPS. Income available to common stockholders continues to be adjusted for assumed conversion of all potentially dilutive securities using the treasury stock method to calculate the dilutive effect of options and warrants. However, unlike the calculation of fully diluted EPS under previous opinions, a new treasury stock method is applied using the average market price or the ending market price. Further, prior opinion requirement to use the modified treasury stock method when the number of options or warrants outstanding is greater than 20% of the outstanding shares also has been eliminated. SFAS 128 also includes certain shares that are contingently issuable; however, the test for inclusion under the new rules is much more restrictive. SFAS No. 128 requires companies reporting discontinued operations, extraordinary items, or the cumulative effect of accounting changes are to use income from operations as the control number or benchmark to determine whether potential common shares are dilutive or antidilutive. Only dilutive securities are to be included in the calculation of diluted EPS. This statement was adopted for the 1997 Financial Statements. For all periods presented the Company reported a loss from continuing operations so any potential issuance of common shares would have an antidilutive effect on EPS. Consequently, the adoption of SFAS No. 128 did not have an impact on the Company's financial statement. The FASB has issued SFAS No. 130 entitled Reporting Comprehensive Income and SFAS No. 132 Employers' Disclosures about Pensions and Other Postretirement Benefits. Both of the above statements are effective for financial statements with fiscal years beginning after December 15, 1997. SFAS No. 130 defines how to report and display comprehensive income and its components in a full set of financial statements. The purpose of reporting comprehensive income is to report a measure of all changes in equity of an enterprise that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners. SFAS No. 132 addresses disclosure requirements for post-retirement benefits. The statement does not change post-retirement measurement or recognition issues. The Company will adopt both SFAS No. 130 and SFAS No. 132 for the 1998 financial statements. Management does not expect either adoption to have a material impact on the Company's financial statements. The Company is not aware of any litigation that will have a material adverse effect on the financial position of the Company. In addition, the Company does not believe that the regulatory initiatives currently under consideration by various regulatory agencies will have a material adverse impact on the Company. The Company is not aware of any material pending or threatened regulatory action with respect to the Company or any of its subsidiaries. The Company does not believe that any insurance guaranty fund assessments will be materially different from amounts already provided for in the financial statements. YEAR 2000 ISSUE The "Year 2000 Issue" is the inability of computers and computing technology to recognize correctly the Year 2000 date change. The problem results from a long-standing practice by programmers to save memory space by denoting Years using just two digits instead of four digits. Thus, systems that are not Year 2000 compliant may be unable to read dates correctly after the Year 1999 and can return incorrect or unpredictable results. This could have a significant effect on the Company's business/financial systems as well as products and services, if not corrected. 59 The Company established a project to address year 2000 processing concerns in September of 1996. In 1997 the Company completed the review of the Company's internally and externally developed software, and made corrections to all year 2000 non-compliant processing. The Company also secured verification of current and future year 2000 compliance from all major external software vendors. In December of 1997, a separate computer operating environment was established with the system dates advanced to December of 1999. A parallel model office was established with all dates in the data advanced to December of 1999. Parallel model office processing is being performed using dates from December of 1999 to January of 2001, to insure all year 2000 processing errors have been corrected. Testing should be completed by the end of the first quarter of 1998. After testing is completed, periodic regression testing will be performed to monitor continuing compliance. By addressing year 2000 compliance in a timely manner, compliance will be achieved using existing staff and without significant impact on the Company operationally or financially. PROPOSED MERGER On March 25, 1997, the Board of Directors of UTI and UII voted to recommend to the shareholders a merger of the two companies. Under the Plan of Merger, UTI would be the surviving entity with UTI issuing one share of its stock for each share held by UII shareholders. UTI owns 53% of United Trust Group, Inc., an insurance holding company, and UII owns 47% of United Trust Group, Inc. Neither UTI nor UII have any other significant holdings or business dealings. The Board of Directors of each company thus concluded a merger of the two companies would be in the best interests of the shareholders. The merger will result in certain cost savings, primarily related to costs associated with maintaining a corporation in good standing in the states in which it transacts business. A vote of the shareholders of UTI and UII regarding the proposed merger is anticipated to occur sometime during the third quarter of 1998. SUBSEQUENT EVENT On February 19, 1998, UTI signed a letter of intent with Jesse T. Correll, whereby Mr. Correll will personally or in combination with other individuals make an equity investment in UTI over a period of three years. Under the terms of the letter of intent Mr. Correll will buy 2,000,000 authorized but unissued shares of UTI common stock for $15.00 per share and will also buy 389,715 shares of UTI common stock, representing stock of UTI and UII, that UTI purchased during the last eight months in private transactions at the average price UTI paid for such stock, plus interest, or approximately $10.00 per share. Mr. Correll also will purchase 66,667 shares of UTI common stock and $2,560,000 of face amount of convertible bonds (which are due and payable on any change in control of UTI) in private transactions, primarily from officers of UTI. Upon completion of the transaction, Mr. Correll would be the largest shareholder of UTI. UTI intends to use the equity that is being contributed to expand their operations through the acquisition of other life insurance companies. The transaction is subject to negotiation of a definitive purchase agreement; completion of due diligence by Mr. Correll; the receipt of regulatory and other approvals; and the satisfaction of certain conditions. The transaction is not expected to be completed before June 30, 1998, and there can be no assurance that the transaction will be completed. 60 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS Any forward-looking statement contained herein or in any other oral or written statement by the company or any of its officers, directors or employees is qualified by the fact that actual results of the company may differ materially from any such statement due to the following important factors, among other risks and uncertainties inherent in the company's business: 1. Prevailing interest rate levels, which may affect the ability of the company to sell its products, the market value of the company's investments and the lapse ratio of the company's policies, notwithstanding product design features intended to enhance persistency of the company's products. 2. Changes in the federal income tax laws and regulations which may affect the relative tax advantages of the company's products. 3. Changes in the regulation of financial services, including bank sales and underwriting of insurance products, which may affect the competitive environment for the company's products. 4. Other factors affecting the performance of the company, including, but not limited to, market conduct claims, insurance industry insolvencies, stock market performance, and investment performance. 61 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF UTI FOR THE PERIOD ENDED MARCH 31, 1998 The purpose of this section is to discuss and analyze the Company's consolidated results of operations, financial condition and liquidity and capital resources. This analysis should be read in conjunction with the consolidated financial statements and related notes which appear elsewhere in this report. The Company reports financial results on a consolidated basis. The consolidated financial statements include the accounts of UTI and its subsidiaries at March 31, 1998. RESULTS OF OPERATIONS FIRST QUARTER 1998 COMPARED TO FIRST QUARTER 1997 (a) REVENUES Premiums and policy fee revenues, net of reinsurance premiums and policy fees, decreased 9% when comparing 1998 to 1997. The Company currently writes little new traditional business, consequently, traditional premiums will decrease as the amount of traditional business in-force decreases. Collected premiums on universal life and interest sensitive products is not reflected in premiums and policy revenues because Generally Accepted Accounting Procedures ("GAAP") requires that premiums collected on these types of products be treated as deposit liabilities rather than revenue. Unless the Company acquires a block of in-force business or marketing changes its focus to traditional business, premium revenue will continue to decline. Another cause for the decrease in premium revenues is related to the potential change in control of UTI over the last two years to two different parties. During September of 1996, it was announced that control of UTI would pass to an unrelated party, but the change in control did not materialize. At this writing, negotiations are progressing with a different unrelated party for the change in control of UTI. Please refer to the Notes to the Consolidated Financial Statements for additional information. The possible changes and resulting uncertainties have hurt the insurance companies' ability to recruit and maintain sales agents. Net investment income decreased 3% when comparing 1998 to 1997. The decrease in net investment income is due to the decrease in invested assets. Although, net investment income decreased, overall investment yields increased from 7% in 1997 to 7.3% in 1998. During the first quarter of 1998, the Company had maturities of approximately $15,000,000 from the fixed maturity portfolio. Of these maturities, approximately $10,000,000 was reinvested in fixed maturities and the remaining funds were placed in interest bearing cash equivalent accounts. The Company's investment advisor is anticipating a favorable shift, in the near future, of fixed maturity yields. The increase in cash is a short-term fluctuation. The Company anticipates the purchase of additional long-term fixed maturities in the near future. The overall investment yields for 1998 and 1997, are 7.3% and 7%, respectively. The Company's investments are generally managed to match related insurance and policyholder liabilities. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. The minimum interest spread between earned and credited rates is 1% on the "Century 2000" universal life insurance product, which currently is the Company's primary sales product. The Company monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads. It is expected that monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on the insurance policies the Company currently has in force and will write in the future. The Company had realized investment gains of $92,248 in the first quarter of 1998, compared to a realized investment loss of $6,136 in the first quarter of 1997. The current quarter investment gain can be attributed to a sale of real estate property for a profit of $82,024. The Company had other gains and losses during the period that comprised the remaining amount reported but were immaterial in nature on an individual basis. 62 (b) EXPENSES Life benefits, net of reinsurance benefits and claims, decreased 13% in 1998 as compared to 1997. The decrease in premium revenues resulted in lower benefit reserve increases in 1998. In addition, policyholder benefits decreased due to a decrease in death benefit claims of $607,000 from the prior period. There is no single event that caused mortality to decrease. Policy claims vary from year to year and therefore, fluctuations in mortality are to be expected and are not considered unusual by management. Operating expenses decreased 14% in 1998 compared to 1997. The decrease in operating expenses is due to the decrease in salaries. The decrease in salaries is due to a 10% reduction in staff compared to the previous year, including the retirement of an executive officer. Interest expense increased 18% in 1998 compared to 1997. Since March 31, 1997, notes payable increased approximately $1,938,000. The increase in outstanding indebtedness was due to the issuance of convertible notes to seven individuals, all officers or employees of UTI. In March 1997, the base interest rate for most of the notes payable increased a quarter of a point. The base rate is defined as the floating daily, variable rate of interest determined and announced by First of America Bank. Please refer to Note 3 "Notes Payable" in the Consolidated Notes to the Financial Statements for more information. (c) NET INCOME The Company had a net income of $114,441 in 1998 compared to $47,026 in 1997. The improvement is directly related to the decrease in life benefits and operating expenses. FINANCIAL CONDITION The financial condition of the Company has changed very little since December 31,1997. Total shareholder's equity decreased 1% as of March 31, 1998 compared to December 31, 1997. Investments represent approximately 61% and 64% of total assets at March 31, 1998 and December 31, 1997, respectively. Accordingly, investments are the largest asset group of the Company. The Company's insurance subsidiaries are regulated by insurance statutes and regulations as to the type of investments that they are permitted to make and the amount of funds that may be used for any one type of investment. In light of these statutes and regulations, and the Company's business and investment strategy, the Company generally seeks to invest in United States government and government agency securities and corporate securities rated investment grade by established nationally recognized rating organizations. The liabilities are predominantly long-term in nature and therefore, the Company invests in long-term fixed maturity investments that are reported in the financial statements at their amortized cost. The Company has the ability and intent to hold these investments to maturity; consequently, the Company does not expect to realize any significant loss from these investments. The Company does not own any derivative investments or "junk bonds". As of March 31, 1998, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in the context of consolidated assets or shareholders' equity. The Company has identified securities it may sell and classified them as "investments held for sale". Investments held for sale are carried at market, with changes in market value charged directly to shareholders' equity. YEAR 2000 ISSUE The "Year 2000 Issue" is the inability of computers and computing technology to recognize correctly the Year 2000 date change. The problem results from a long-standing practice by programmers to save memory space by denoting Years using just two digits instead of four digits. Thus, systems that are not Year 2000 compliant may be unable to read dates correctly after the Year 1999 and can return incorrect or unpredictable results. This could have a significant effect on the Company's business/financial systems as well as products and services, if not corrected. 63 The Company established a project to address year 2000 processing concerns in September of 1996. In 1997 the Company completed the review of the Company's internally and externally developed software, and made corrections to all year 2000 non-compliant processing. The Company also secured verification of current and future year 2000 compliance from all major external software vendors. In December of 1997, a separate computer operating environment was established with the system dates advanced to December of 1999. A parallel model office was established with all dates in the data advanced to December of 1999. Parallel model office processing is being performed using dates from December of 1999 to January of 2001, to insure all year 2000 processing errors have been corrected. Testing was completed by the end of the first quarter of 1998. Periodic regression testing will be performed to monitor continuing compliance. By addressing year 2000 compliance in a timely manner, compliance will be achieved using existing staff and without significant impact on the Company operationally or financially. PROPOSED MERGER OF UNITED TRUST, INC. AND UNITED INCOME, INC. On March 25, 1997, the Board of Directors of UTI and UII voted to recommend to the shareholders a merger of the two companies. Under the Plan of Merger, UTI would be the surviving entity with UTI issuing one share of its stock for each share held by UII shareholders. UTI owns 53% of United Trust Group, Inc., an insurance holding company, and UII owns 47% of United Trust Group, Inc. Neither UTI nor UII have any other significant holdings or business dealings. The Board of Directors of each company thus concluded a merger of the two companies would be in the best interests of the shareholders. The merger will result in certain cost savings, primarily related to costs associated with maintaining a corporation in good standing in the states in which it transacts business. A vote of the shareholders of UTI and UII regarding the proposed merger is anticipated to occur sometime during the third quarter of 1998. A vote of the shareholders of UTI and UII regarding the proposed merger is anticipated to occur sometime during the third quarter of 1998. PENDING CHANGE IN CONTROL OF UNITED TRUST, INC. On April 30, 1998, UTI and First Southern Funding, a Kentucky corporation ("FSF"), signed a Definitive Agreement ("the FSF Agreement") whereby FSF will make an equity investment in UTI. Under the terms of the FSF Agreement, FSF will buy 473,523 authorized but unissued shares of UTI common stock for $15.00 a share and will also buy 389,715 shares of UTI common stock that UTI purchased during the last year in private transactions at the average price UTI paid for such stock, plus interest, or approximately $10.00 per share. FSF will also purchase 66,667 shares of UTI common stock and $2,560,000 of face amount convertible bonds which are due and payable on any change in control of UTI, in private transactions, primarily from officers of UTI. In addition, FSF will be granted a three year option to purchase up to 1,450,000 shares of UTI common stock for $15.00 per share. Management of UTI intends to use the equity that is being contributed to expand their operations through the acquisition of other life insurance companies. The transaction is subject to the receipt of regulatory and other approvals; and the satisfaction of certain conditions. The transaction is not expected to be completed before July 31, 1998, and there can be no assurance that the transaction will be completed. FSF is an affiliate of First Southern Bancorp, Inc., a bank holding company that owns five banks that operate out of 14 locations in central Kentucky. 64 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS Any forward-looking statement contained herein or in any other oral or written statement by the company or any of its officers, directors or employees is qualified by the fact that actual results of the company may differ materially from any such statement due to the following important factors, among other risks and uncertainties inherent in the company's business: 1. Prevailing interest rate levels, which may affect the ability of the company to sell its products, the market value of the company's investments and the lapse ratio of the company's policies, notwithstanding product design features intended to enhance persistency of the company's products. 2. Changes in the federal income tax laws and regulations which may affect the relative tax advantages of the company's products. 3. Changes in the regulation of financial services, including bank sales and underwriting of insurance products, which may affect the competitive environment for the company's products. 4. Other factors affecting the performance of the company, including, but not limited to, market conduct claims, insurance industry insolvencies, stock market performance, and investment performance. 65 FEDERAL INCOME TAXES Under current federal income tax laws, qualifying life insurance companies are, subject to a phase out limitation, entitled to a "small life insurance company" deduction. This deduction is set at 60% of the life insurance company's tentative life insurance taxable income up to $3,000,000. For tentative life insurance taxable income in excess of $3,000,000, the amount of the deduction is equal to $1,800,000 (the maximum amount allowed to be deducted) less 15% of the excess of such income over $3,000,000. In general, the small life insurance company deduction is computed by treating all life insurance companies that are members of the same controlled group as one company, whether these companies join in the filing of a consolidated return or file separate returns. As a result, for the years 1994, 1995 and 1996, the effective tax rate on life insurance companies generally ranged from approximately 15% on companies with taxable income of $3,000,000 or less to approximately 35% on companies with taxable income of $15,000,000 or more. Effective in 1984, the provisions of the federal income tax law relating to the timing of the deduction for policy reserve increases were amended. This change had the effect of increasing the portion of gain from operations which is taxed currently. The Tax Reform Act of 1986 effected major changes in the basic structure of the federal income tax laws. The Act reduced the highest general corporate tax rates. As a result, after giving effect to the small life insurance company deduction, effective tax rates for life insurance companies generally range from approximately 14% for companies with taxable income of $3,000,000 or less to 35% for companies with taxable income of $15,000,000 or more. The Act also created a new alternative minimum tax on tax preference items of corporations (which includes as a tax preference item 75% of the excess of adjusted current earnings over alternative minimum taxable income). UTI and its subsidiaries have net operating loss carry forwards for federal income tax purposes totaling $1,493,000 for UTI, $2,135,000 for FCC, and $3,832,000 for UG expiring as set forth in Note 3 of Notes to Financial Statements of UTI. CAPITALIZATION OF UTI AND UII The following table sets forth the capitalizations on a GAAP basis of UTI and UII as of March 31, 1998 and UTI's capitalization on a pro forma combined basis at such date as if the proposed Merger had been consummated on that date, accounting for the Merger as a purchase of UII by UTI at a cost of $7,708,007. The pro forma combined capitalization is based on the exchange ratio of one share of UTI Common Stock for each share of UII Common Stock assumes that no stockholder dissents and exercises his rights of appraisal. The table should be read in conjunction with the financial statements and pro forma financial statements and related notes of UTI and UII. (* inapplicable). Outstanding at March 31, 1998 Pro Forma UTI UII Combined Short-term debt 0 0 0 Long-term debt, less current portion 21,512,000 902,000 21,550,000 Shareholders' equity: Common Stock: UTI, no par value (.02 stated value) 33,000 * 49,000 UII, no par value ($.033 stated value) * 46,000 * Paid-in Additional Capital 16,420,000 15,242,000 24,079,000 Unrealized Depreciation of Investments Held for Sale (243,000) (159,000) (243,000) Accumulated Deficit (1,021,000) (3,227,000) (1,021,000) Total Shareholders' Equity 15,189,000 11,902,000 22,864,000 Total Capitalization $15,189,000 $11,902,000 $22,864,000
66 UTI AND UII PRO FORMA CONSOLIDATED CONDENSED FINANCIAL INFORMATION - UNAUDITED The March 31, 1998 pro forma financial information included in this Proxy Statement is based on the exchange ratio of one share of UTI Common Stock for each one share of UII Common Stock and assumes that no stockholder dissents and exercises his rights of appraisal. The pro forma balance sheet assumes the transactions took place as of the balance sheet date and the pro forma statement of operations is prepared as if the transactions took place as of January 1. The pro forma financial information included in this Proxy Statement is not intended to reflect results of operations or the financial position that would have actually resulted had the Merger been effective on the dates indicated. The information shown is not necessarily indicative of the results of future operations. These statements should be read in conjunction with the financial statements of UTI and UII contained elsewhere herein. 67 UNITED TRUST, INC. UNITED INCOME, INC. PRO FORMA CONSOLIDATED BALANCE SHEET as of March 31, 1998 (Unaudited) UTI UII Merger ASSETS March 31 March 31 Adjustments Pro Forma Investments: Fixed maturities at amortized cost $175,588,738 $ 0 $ $ 175,588,738 Investments held for sale: Fixed maturities,at market 1,668,515 0 1,668,515 Equity securities, at market 2,619,571 0 2,619,571 Mortgage loans on real estate at amortized cost 9,314,870 121,165 9,436,035 Investment real estate, at cost, net of accumulated depreciation 9,137,807 0 9,137,807 Real estate acquired in satisfaction of debt 1,724,544 0 1,724,544 Policy loans 14,242,429 0 14,242,429 Short term investments 627,845 627,845 Other invested assets 66,212 0 66,212 214,990,531 121,165 0 215,111,696 Cash and cash equivalents 24,978,271 734,827 25,713,098 Investment in affiliates 5,622,841 10,959,408(1)(2)(16,582,249) 0 Accrued investment income 4,037,979 11,996 4,049,975 Reinsurance receivables: Future policy benefits 37,601,740 0 37,601,740 Policy claims and other benefits 3,576,509 0 3,576,509 Other accounts and notes receivable 903,254 864,100 (8) (864,100) 903,254 Cost of insurance acquired 40,912,005 0 (5) (3,636,736) 37,275,269 Deferred policy acquisition cost 10,283,427 0 10,283,427 Costs in excess of net assets purchased,net of accumulated amortization 2,718,102 0 2,718,102 Property and equipment, net of accumulated depreciation 3,390,147 808 3,390,955 Receivable from affiliate, net 0 85,476 (7) (85,476) 0 Other assets 1,007,870 37,004 1,044,874 Total assets $350,022,676 $12,814,784 $(21,168,561)$341,668,899 LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities and accruals: Future policy benefits $249,368,889 $ 0 $ $249,368,889 Policy claims and benefits payable 1,939,075 0 1,939,075 Other policyholder funds 2,519,118 0 2,519,118 Dividend and endowment accumulations 15,089,100 0 15,089,100 Income taxes payable: Current 10,662 0 10,662 Deferred 14,078,843 0 14,078,843 Notes payable 21,511,706 0 (8) (864,100) 20,647,606 Convertible debentures 0 902,300 902,300 Indebtedness to (from) affiliates, net 85,476 0 (7) (85,476) 0 Other liabilities 4,209,287 10,564 4,219,851 Total liabilities 308,812,156 912,864 (949,576) 308,775,444 Minority interests in consolidated subsidiaries 26,021,111 0 (3)(15,992,062) 10,029,049 Shareholders' equity: Common stock - no par value, stated value $.02 per share. 32,544 45,934(4)(6) (29,514) 48,964 Additional paid-in capital 16,420,442 15,242,365(4)(6)(7,583,788) 24,079,019 Unrealized depreciation of investments held for sale (242,692) (158,813) (4) 158,813 (242,692) Accumulated deficit (1,020,885) (3,227,566) (4) 3,227,566 (1,020,885) Total shareholders' equity 15,189,409 11,901,920 (4,226,923) 22,864,406 Total liabilities and shareholders' equity $350,022,676 $12,814,784 $(21,168,561)$341,668,899
68 UNITED TRUST, INC. UNITED INCOME, INC. PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS For the Three Months Ended March 31, 1998 (Unaudited) UTI UII Merger March 31 March 31 Adjustments Pro Forma Revenues: Premiums and policy fees $ 8,468,346 $ 0 $ $ 8,468,346 Reinsurance premiums and policy fees (1,236,865) 0 (1,236,865) Net investment income 3,727,002 32,039 (3) (20,488) 3,738,553 Realized investment gains and (losses), net 92,248 0 92,248 Other income 176,029 255,312 (1),(2)(379,773) 51,568 11,226,760 287,351 (400,261) 11,113,850 Benefits and other expenses: Benefits, claims and settlement expenses: Life 6,023,110 0 6,023,110 Reinsurance benefits and claims (589,874) 0 (589,874) Annuity 377,860 0 377,860 Dividends to policyholders 1,015,944 0 1,015,944 Commissions and amortization deferred policy acquisition costs 1,043,677 0 1,043,677 Amortization of cost of insurance acquired 610,883 0 610,883 Operating expenses 2,237,840 192,555 (1),(2)(379,773) 2,050,622 Interest expense 487,613 21,430 (3) (20,488) 488,555 11,207,053 213,985 (400,261) 11,020,777 Loss before income taxes, minority interest and equity in loss of investees 19,707 73,366 0 93,073 Income tax credit 85,031 0 85,031 Minority interest in loss (income) of consolidated subsidiaries (33,048) 0 (6) 31,811 (1,237) Equity in earnings of investees 42,751 31,811 (4),(5) (74,562) 0 Net income $ 114,441 $ 105,177 $ (42,751)$ 176,867 Basic earnings per share from continuing operations and net income $ 0 $ 0 $ 0 Diluted earnings per share from continuing operations and net income $ 0 $ 0 $ 0
69 UNITED TRUST, INC. UNITED INCOME, INC . PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS For the Year Ended December 31, 1997 Merger UTI UII Adjustments Pro Forma Revenues: Premiums and policy fees $ 33,373,950 $ 0 $ $ 33,373,950 Reinsurance premiums and policy fees (4,734,705) 0 (4,734,705 Net investment income 14,857,297 109,706 (3) (82,579) 14,884,424 Realized investment gains and (losses), net (279,096) 0 (279,096) Other income 774,884 1,076,416(1),(2) (1,732,872) 118,428 43,992,330 1,186,122 (1,815,451) 43,363,001 Benefits and other expenses: Benefits, claims and settlement expenses: Life 23,644,252 0 23,644,252 Reinsurance benefits and claims (2,078,982) 0 (2,078,982) Annuity 1,560,828 0 1,560,828 Dividends to policyholders 3,929,073 0 3,929,073 Commissions and amortization of deferred policy acquisition costs 3,616,365 0 3,616,365 Amortization of cost of insurance acquired 2,394,392 0 2,394,392 Operating expenses 9,222,913 823,750(1),(2)(1,732,872) 8,313,791 Interest expense 1,816,491 85,155 (3) (82,579) 1,819,067 44,105,332 908,905 (1,815,451) 43,198,786 Loss before income taxes, minority interest and equity in loss of investees (113,002) 277,217 0 164,215 Credit for income taxes (986,229) 0 (986,229) Minority interest in loss of consolidated subsididiaries 563,699 0 (6) (356,533) 207,166 Equity in loss of investees (23,716) (356,533)(4),(5) 380,249 0 Net loss $ (559,248)$ (79,316) $ 23,716 $ (614,848) Net loss per common share $ (0.32)$ (0.06) $ (0.25) Weighted average common shares outstanding 1,772,870 1,391,996 2,455,774
70 EXPLANATORY NOTES TO PRO FORMA FINANCIAL INFORMATION A. The pro forma consolidated balance sheet reflects the following adjustments: 1. Eliminate UII investment in UTG of $10,926,398 2. Eliminate UTI investment in UII of $5,622,841 3. Eliminate minority interest liability for UII ownership of UTG of $15,992,062 4. Eliminate UII equity accounts: Common stock $ 45,934 Additional paid in capital $15,242,365 Unrealized depreciation of investments held for sale $ (158,813) Accumulated deficit $(3,227,566) 5. Record amount for cost in excess of net assets received from UII of $(3,636,736) 6. Record as treasury shares 5,158 shares of UTI stock owned by UII Common stock 103 Additional paid in capital 32,907 7. Reclassify due to/due from affiliate of 85,476 8. Eliminate UII notes receivable from affiliates of $864,100 9. To record the issuance of 826,153 shares of UTI common stock to the shareholders of UII at a cost of $7,708,007. 71 UTI/UII PRO-FORMA MERGER INCOME STATEMENT ELIMINATION ENTRIES 03/31/98 B. The pro forma statement of operations for the three months ended March 31, 1998 reflects the following adjustments: 1. Eliminate management fee UII receives from USA of $237,358 2. Eliminate management fee UII pays to UTI Consolidated affiliates of $142,415 3. Eliminate intercompany interest paid to UII by UTI Consolidated affiliates of $20,488 4. Eliminate UTI equity in income of UII of $42,751 5. Eliminate UII equity in income of UTG of $31,811 6. Eliminate minority interest in income of UTG established for UII ownership of $31,811 72 UTI/UII PRO-FORMA MERGER INCOME STATEMENT ELIMINATION ENTRIES 12/31/97 C. The pro forma statement of operations for the year ended December 31, 1997 reflects the following adjustments: 1. Eliminate management fee UII receives from USA of $989,295 2. Eliminate management fee UII pays to UTI Consolidated affiliates of $743,577 3. Eliminate intercompany interest expense of $82,579 4. Eliminate UTI equity in loss of UII of $23,716 5. Eliminate UII equity in loss of UTG of $356,533 6. Eliminate minority interest in loss of UTG established for UII ownership of $356,533 73 MARKET FOR COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDERS MATTERS On June 18, 1990, UTI became a member of NASDAQ. Quotations began on that date under the symbol UTIN. The following table shows the high and low bid quotations for each quarterly period during the past two years, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. BID PERIOD LOW HIGH 1997 First quarter 3 3/4 5 5/8 Second quarter 4 5/8 5 1/4 Third quarter 9 1/4 9 1/2 Fourth quarter 8 8 BID PERIOD LOW HIGH 1996 First quarter 3 3/4 5 5/8 Second quarter 3 3/4 6 7/8 Third quarter 5 6 7/8 Fourth quarter 3 3/4 7 1/2 On May 13, 1997, UTI effected a 1 for 10 reverse stock split. Fractional shares received a cash payment on the basis of $1.00 for each old share. The reverse split was completed to enable UTI to meet new NASDAQ requirements regarding market value of stock to remain listed on the NASDAQ market and to increase the market value per share to a level where more brokers will look at UTI and its stock. Prior period numbers have been restated to give effect of the reverse split. CURRENT MARKET MAKERS ARE: M. H. Meyerson and Company 30 Montgomery Street Jersey City, NJ 07303 Herzog, Heine, Geduld, Inc. 26 Broadway, 1st Floor New York, NY 10004 As of December 31, 1997, no cash dividends had been declared on the common stock of UTI. See Note 2 in the accompanying consolidated financial statements for information regarding dividend restrictions. Number of Common Shareholders as of March 13, 1998 is 5,444. 74 BUSINESS OF UII The Registrant and its affiliates (the "Company") operate principally in the individual life insurance business. The primary business of the Company has been the servicing of existing insurance business in force, the solicitation of new insurance business, and the acquisition of other companies in similar lines of business. United Income, Inc. ("UII"), was incorporated on November 2, 1987, as an Ohio corporation. Between March 1988 and August 1990, UII raised a total of approximately $15,000,000 in an intrastate public offering in Ohio. During 1990, UII formed a life insurance subsidiary and began selling life insurance products. On February 20, 1992, UII and its affiliate, UTI, formed a joint venture, United Trust Group, Inc., ("UTG"). On June 16, 1992, UII contributed $7.6 million in cash and 100% of the common stock of its wholly owned life insurance subsidiary. UTI contributed $2.7 million in cash, an $840,000 promissory note and 100% of the common stock of its wholly owned life insurance subsidiary. After the contributions of cash, subsidiaries, and the note, UII owns 47% and UTI owns 53% of UTG. On June 16, 1992, UTG acquired 67% of the outstanding common stock of the now dissolved Commonwealth Industries Corporation, ("CIC") for a purchase price of $15,567,000. Following the acquisition, UTG controlled eleven life insurance subsidiaries. The Company has taken several steps to streamline and simplify the corporate structure following the acquisitions. On December 28, 1992, Universal Guaranty Life Insurance Company ("UG") was the surviving company of a merger with Roosevelt National Life Insurance Company ("RNLIC"), United Trust Assurance Company ("UTAC"), Cimarron Life Insurance Company ("CIM") and Home Security Life Insurance Company ("HSLIC"). On June 30, 1993, Alliance Life Insurance Company ("ALLI"), a subsidiary of UG, was merged into UG. On July 31, 1994, Investors Trust Assurance Company ("ITAC") was merged into Abraham Lincoln Insurance Company ("ABE"). On August 15, 1995, the shareholders of CIC, ITI, and UGIC voted to voluntarily liquidate each of the companies and distribute the assets to the shareholders (consisting solely of common stock of their respective subsidiary). As a result, the shareholders of the liquidated companies became shareholders of FCC. On March 25, 1997, the Board of Directors of UTI and UII voted to recommend to the shareholders a merger of the two companies. Under the Plan of Merger, UTI would be the surviving entity with UTI issuing one share of its stock for each share held by UII shareholders. Neither UTI nor UII have any other significant holdings or business dealings. The Board of Directors of each company thus concluded a merger of the two companies would be in the best interests of the shareholders. The merger will result in certain cost savings, primarily related to costs associated with maintaining a corporation in good standing in the states in which it transacts business. A vote of the shareholders of UTI and UII regarding the proposed merger is anticipated to occur sometime during the third quarter of 1998. The holding companies within the group, UTI, UII, UTG and FCC, are all life insurance holding companies. These companies became members of the same affiliated group through a history of acquisitions in which life insurance companies were involved. The focus of the holding companies is the acquisition of other companies in similar lines of business and management of the insurance subsidiaries. The companies have no activities outside the life insurance focus. The insurance companies of the group, UG, USA, APPL and ABE, all operate in the individual life insurance business. The primary focus of these companies has been the servicing of existing insurance business in force and the solicitation of new insurance business. On February 19, 1998, UTI signed a letter of intent with Jesse T. Correll, whereby Mr. Correll will personally or in combination with other individuals make an equity investment in UTI over a period of three years. Under the terms of the letter of intent, Mr. Correll will buy 2,000,000 authorized but unissued shares of UTI common stock for $15.00 per share and will also buy 389,715 shares of UTI common stock, representing stock of UTI and UII, that UTI purchased during the last eight months in private transactions at the average price UTI paid for such stock, plus interest, or approximately $10.00 per share. Mr. Correll also will purchase 66,667 shares of UTI common stock and $2,560,000 of face amount of convertible bonds (which are due and payable on any change in control of UTI) in private transactions, primarily from officers of UTI. 75 UTI intends to use the equity that is being contributed to expand their operations through the acquisition of other life insurance companies. The transaction is subject to negotiation of a definitive purchase agreement; completion of due diligence by Mr. Correll; the receipt of regulatory and other approvals; and the satisfaction of certain conditions. The transaction is not expected to be completed before June 30, 1998, and there can be no assurance that the transaction will be completed. PRODUCTS The Company's portfolio consists of two universal life insurance products. Universal life insurance is a form of permanent life insurance that is characterized by its flexible premiums, flexible face amounts, and unbundled pricing factors. The primary universal life insurance product is referred to as the "Century 2000". This product was introduced to the marketing force in 1993 and has become the cornerstone of current marketing. This product has a minimum face amount of $25,000 and currently credits 6% interest with a guaranteed rate of 4.5% in the first 20 years and 3% in years 21 and greater. The policy values are subject to a $4.50 monthly policy fee, an administrative load and a premium load of 6.5% in all years. The premium load is a general expense charge that is added to a policy's net premium to cover the insurer's cost of doing business. The administrative load and surrender charge are based on the issue age, sex and rating class of the policy. A surrender charge is effective for the first 14 policy years. In general, the surrender charge is very high in the first couple of years and then declines to zero at the end of 14 years.. Policy loans are available at 7% interest in advance. The policy's accumulated fund will be credited the guaranteed interest rate in relation to the amount of the policy loan. The second universal life product referred to as the "UL90A", has a minimum face amount of $25,000. The administrative load is based on the issue age, sex and rating class of the policy. Policy fees vary from $1 per month in the first year to $4 per month in the second and third years and $3 per month each year thereafter. The UL90A currently credits 5.5% interest with a 4.5% guaranteed interest rate. Partial withdrawals, subject to a remaining minimum $500 cash surrender value and a $25 fee, are allowed once a year after the first duration. Policy loans are available at 7% interest in advance. The policy's accumulated fund will be credited the guaranteed interest rate in relation to the amount of the policy loan. Surrender charges are based on a percentage of target premium starting at 120% for years 1-5 then grading downward to zero in year 15. This policy contains a guaranteed interest credit bonus for the long term policyholder. From years 10 through 20, additional interest bonuses are earned with a total in the twentieth year of 1.375%. The bonus is calculated from the policy issue date and is contractually guaranteed. The Company's actual experience for earned interest, persistency and mortality vary from the assumptions applied to pricing and for determining premiums. Accordingly, differences between the Company's actual experience and those assumptions applied may impact the profitability of the Company. The minimum interest spread between earned and credited rates is 1% on the "Century 2000" universal life insurance product. The Company monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads. Credited rates are reviewed and established by the Board of Directors of the respective life insurance affiliates. The premium rates are competitive with other insurers doing business in the states in which the Company is marketing its products. The Company markets other products, none of which is significant to operations. The Company has a variety of policies in force different from those which are currently being marketed. The previously defined Universal life and interest sensitive whole life, which is a type of indeterminate premium life insurance which provides that the policy's cash value may be greater than that guaranteed if changing assumptions warrant an increase, account for approximately 46% of the insurance in force. Approximately 29% of the insurance in force is participating business, which represents policies under which the policyowner shares in the insurance companies divisible surplus. The Company's average persistency rate for its policies in force for 1997 and 1996 has been 89.4% and 87.9%, respectively. The Company does not anticipate any material fluctuations in these rates in the future that may result from competition. 76 Interest-sensitive life insurance products have characteristics similar to annuities with respect to the crediting of a current rate of interest at or above a guaranteed minimum rate and the use of surrender charges to discourage premature withdrawal of cash values. Universal life insurance policies also involve variable premium charges against the policyholder's account balance for the cost of insurance and administrative expenses. Interest-sensitive whole life products generally have fixed premiums. Interest-sensitive life insurance products are designed with a combination of front-end loads, periodic variable charges, and back-end loads or surrender charges. Traditional life insurance products have premiums and benefits predetermined at issue; the premiums are set at levels that are designed to exceed expected policyholder benefits and Company expenses. Participating business is traditional life insurance with the added feature of an annual return of a portion of the premium paid by the policyholder through a policyholder dividend. This dividend is set annually by the Board of Directors of each insurance company and is completely discretionary. MARKETING The Company markets its products through separate and distinct agency forces. The Company has approximately 45 captive agents who actively write new business, and 15 independent agents who primarily service their existing customers. Captive agents work under an ordinary agency distribution system which relies on career agents to sell and service insurance and annuity policies of a single company. Independent agents work under a brokerage distribution system which relies on brokers to distribute the insurance and annuity policies of more than one company. Both captive and independent agents work on a contractual basis and are paid commissions on a percentage of premiums written. No individual sales agent accounted for over 10% of the Company's premium volume in 1997. The Company's sales agents do not have the power to bind the Company. Marketing is based on referrals from existing policyholders and new prospect lists obtained from newly recruited sales agents. Recruiting of sales agents is based on referrals from existing agents and the invitation to attend our Company's comprehensive training school. The industry has experienced a downward trend in the total number of agents who sell insurance products, and competition for the top sales producers has intensified. As this trend appears to continue, the recruiting focus of the Company has been on introducing quality individuals to the insurance industry through an extensive internal training program. The Company feels this approach is conducive to the mutual success of our new recruits and the Company as these recruits market our products in a professional, company structured manner. New sales are marketed by UG and USA through their agency forces using contemporary sales approaches with personal computer illustrations. Current marketing efforts are primarily focused on the Midwest region. USA is licensed in Illinois, Indiana and Ohio. During 1997, Ohio accounted for 99% of USA's direct premiums collected. ABE is licensed in Alabama, Arizona, Illinois, Indiana, Louisiana and Missouri. During 1997, Illinois and Indiana accounted for 46% and 32%, respectively of ABE's direct premiums collected. APPL is licensed in Alabama, Arizona, Arkansas, Colorado, Georgia, Illinois, Indiana, Kansas, Kentucky, Louisiana, Missouri, Montana, Nebraska, Ohio, Oklahoma, Pennsylvania, Tennessee, Utah, Virginia, West Virginia and Wyoming. During 1997, West Virginia accounted for 95% of APPL's direct premiums collected. UG is licensed in Alabama, Arizona, Arkansas, Colorado, Delaware, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, Washington, West Virginia and Wisconsin. During 1997, Illinois accounted for 33%, and Ohio accounted for 14% of direct premiums collected. No other state accounted for more than 7% of direct premiums collected in 1997. 77 In 1997 $38,471,452 of total direct premium was written by USA, ABE, APPL and UG. Ohio accounted for 35% , Illinois accounted for 21%, and West Virginia accounted for 10% of total direct premiums collected. New business production has decreased 15% from 1995 to 1996 and 43% from 1996 to 1997. Several factors have had a significant impact on new business production. Over the last two years there has been the possibility of a change in control of UTI. In September of 1996, an agreement was reached effecting a change in control of UTI to an unrelated party. The transaction did not materialize. At this writing negotiations are progressing with a different unrelated party for change in control of UTI. Please refer to the Notes to the Consolidated Financial Statements for additional information. The possible changes in control, and the uncertainty surrounding each potential event, have hurt the insurance Companies' ability to attract and maintain sales agents. In addition, increased competition for consumer dollars from other financial institutions, product Illustration guideline changes by State Insurance Departments, and a decrease in the total number of insurance sales agents in the industry, have all had an impact, given the relatively small size of the Company. Management recognizes the aforementioned challenges and is responding. The potential change in control of the Company is progressing, bringing the possibility for future growth, efforts are being made to introduce additional products, and the recruitment of quality individuals for intensive sales training, are directed at reversing current marketing trends. UNDERWRITING The underwriting procedures of the insurance affiliates are established by management. Insurance policies are issued by the Company based upon underwriting practices established for each market in which the Company operates. Most policies are individually underwritten. Applications for insurance are reviewed to determine additional information required to make an underwriting decision, which depends on the amount of insurance applied for and the applicant's age and medical history. Additional information may include inspection reports, medical examinations, statements from doctors who have treated the applicant in the past and, where indicated, special medical tests. After reviewing the information collected, the Company either issues the policy as applied for or with an extra premium charge because of unfavorable factors or rejects the application. Substandard risks may be referred to reinsurers for full or partial reinsurance of the substandard risk. The insurance affiliates require blood samples to be drawn with individual insurance applications for coverage over $45,000 (age 46 and above) or $95,000 (age 16-45). Blood samples are tested for a wide range of chemical values and are screened for antibodies to the HIV virus. Applications also contain questions permitted by law regarding the HIV virus which must be answered by the proposed insureds. RESERVES The applicable insurance laws under which the insurance affiliates operate require that each insurance company report policy reserves as liabilities to meet future obligations on the policies in force. These reserves are the amounts which, with the additional premiums to be received and interest thereon compounded annually at certain assumed rates, are calculated in accordance with applicable law to be sufficient to meet the various policy and contract obligations as they mature. These laws specify that the reserves shall not be less than reserves calculated using certain mortality tables and interest rates. Policy reserve liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method, where policy reserves are established on a consistent and uniform basis. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance affiliates' experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. The Company makes these assumptions at the time the contract is issued or, in the case of contracts acquired by purchase, at the purchase date. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. Current mortality rate assumptions are based on 1975-80 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or Linton C, which are industry standard actuarial tables for forecasting assumed policy lapse rates. 78 Benefit reserves for universal life insurance and interest sensitive life insurance products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims in excess of related policy account balances. Interest crediting rates for universal life and interest sensitive products range from 5.0% to 6.0% in each of the years 1997, 1996 and 1995. REINSURANCE As is customary in the insurance industry, the insurance affiliates cede insurance to other insurance companies under reinsurance agreements. Reinsurance agreements are intended to limit a life insurer's maximum loss on a large or unusually hazardous risk or to obtain a greater diversification of risk. The ceding insurance company remains contingently liable with respect to ceded insurance should any reinsurer be unable to meet the obligations assumed by it, however it is the practice of insurers to reduce their financial statement liabilities to the extent that they have been reinsured with other insurance companies. The Company sets a limit on the amount of insurance retained on the life of any one person. The Company will not retain more than $125,000, including accidental death benefits, on any one life. At December 31, 1997, the Company had insurance in force of $3.692 billion of which approximately $1.022 billion was ceded to reinsurers. The Company's reinsured business is ceded to numerous reinsurers. The Company believes the assuming companies are able to honor all contractual commitments, based on the Company's periodic reviews of their financial statements, insurance industry reports and reports filed with state insurance departments. Currently, the Company is utilizing reinsurance agreements with Business Men's Assurance Company, ("BMA") and Life Reassurance Corporation, ("LIFE RE") for new business. BMA and LIFE RE each hold an "A+" (Superior) rating from A.M. Best, an industry rating company. The reinsurance agreements were effective December 1, 1993, and cover all new business of the Company. The agreements are a yearly renewable term ("YRT") treaty where the Company cedes amounts above its retention limit of $100,000 with a minimum cession of $25,000. One of the Company's insurance subsidiaries (UG) entered into a coinsurance agreement with First International Life Insurance Company ("FILIC") as of September 30, 1996. Under the terms of the agreement, UG ceded to FILIC substantially all of its paid-up life insurance policies. Paid-up life insurance generally refers to non-premium paying life insurance policies. A.M. Best assigned FILIC a Financial Performance Rating (FPR) of 7 (Strong) on a scale of 1 to 9. A.M. Best assigned a Best's Rating of A++ (Superior) to The Guardian Life Insurance Company of America ("Guardian"), parent of FILIC, based on the consolidated financial condition and operating performance of the company and its life/health affiliates. During 1997, FILIC changed its name to Park Avenue Life Insurance Company ("PALIC"). The agreement with PALIC accounts for approximately 65% of the reinsurance receivables as of December 31, 1997. INVESTMENTS At December 31, 1997, substantially all of the assets of UII represent investments in or receivables from affiliates. UII does own one mortgage loan as of December 31, 1997. The mortgage loan is in good standing. Interest income was derived from mortgage loans and cash and cash equivalents. COMPETITION The insurance business is a highly competitive industry and there are a number of other companies, both stock and mutual, doing business in areas where the Company operates. Many of these competing insurers are larger, have more diversified lines of insurance coverage, have substantially greater financial resources and have a greater number of agents. Other significant competitive factors include policyholder benefits, service to policyholders, and premium rates. 79 The insurance industry is a mature industry. In recent years, the industry has experienced virtually no growth in life insurance sales, though the aging population has increased the demand for retirement savings products. The products offered (see Products) are similar to those offered by other major companies. The product features are regulated by the states and are subject to extensive competition among major insurance organizations. The Company believes a strong service commitment to policyholders, efficiency and flexibility of operations, timely service to the agency force and the expertise of its key executives help minimize the competitive pressures of the insurance industry. The industry has experienced a downward trend in the total number of agents who sell insurance products, and competition for the top sales producers has intensified. As this trend appears to continue, the recruiting focus of the Company has been on introducing quality individuals to the insurance industry through an extensive internal training program. The Company feels this approach is conducive to the mutual success of our new recruits and the Company as these recruits market our products in a professional, company structured manner. GOVERNMENT REGULATION The Company's insurance affiliates are assessed contributions by life and health guaranty associations in almost all states to indemnify policyholders of failed companies. In several states the company may reduce premium taxes paid to recover a portion of assessments paid to the states' guaranty fund association. This right of "offset" may come under review by the various states, and the company cannot predict whether and to what extent legislative initiatives may affect this right to offset. Also, some state guaranty associations have adjusted the basis by which they assess the cost of insolvencies to individual companies. The company believes that its reserve for future guaranty fund assessments is sufficient to provide for assessments related to known insolvencies. This reserve is based upon management's current expectation of the availability of this right of offset, known insolvencies and state guaranty fund assessment bases. However, changes in the basis whereby assessments are charged to individual companies and changes in the availability of the right to offset assessments against premium tax payments could materially affect the company's results. Currently, the Company's insurance affiliates are subject to government regulation in each of the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including the power to: (i) grant and revoke licenses to transact business; (ii) regulate and supervise trade practices and market conduct; (iii) establish guaranty associations; (iv) license agents; (v) approve policy forms; (vi) approve premium rates for some lines of business; (vii) establish reserve requirements; (viii) prescribe the form and content of required financial statements and reports; (ix) determine the reasonableness and adequacy of statutory capital and surplus; and (x) regulate the type and amount of permitted investments. Insurance regulation is concerned primarily with the protection of policyholders. The Company cannot predict the form of any future proposals or regulation. The Company's insurance affiliates, USA, UG, APPL and ABE are domiciled in the states of Ohio, Ohio, West Virginia and Illinois, respectively. The insurance regulatory framework continues to be scrutinized by various states, the federal government and the National Association of Insurance Commissioners ("NAIC"). The NAIC is an association whose membership consists of the insurance commissioners or their designees of the various states. The NAIC has no direct regulatory authority reporting from state to state. This is accomplished through the issuance of model regulations, which can be adopted by individual states unmodified, modified to meet the state's own needs or requirements, or dismissed entirely. Most states also have insurance holding company statutes which require registration and periodic reporting by insurance companies controlled by other corporations licensed to transact business within their respective jurisdictions. The insurance affiliates are subject to such legislation and registered as controlled insurers in those jurisdictions in which such registration is required. Statutes vary from state to state but typically require periodic disclosure concerning the corporation that controls the registered insurers and all subsidiaries of such corporation. In addition, prior notice to, or approval by, the state insurance commission of material intercorporate transfers of assets, reinsurance agreements, management agreements (see Note 9 of the Notes to the Financial Statements), and payment of dividends (see Note 2 of the Notes to the Financial Statements) in excess of specified amounts by the insurance subsidiary within the holding company system are required. 80 Each year the NAIC calculates financial ratio results (commonly referred to as IRIS ratios) for each company. These ratios compare various financial information pertaining to the statutory balance sheet and income statement. The results are then compared to pre-established normal ranges determined by the NAIC. Results outside the range typically require explanation to the domiciliary insurance department. At year end 1997, the insurance companies had one ratio outside the normal range. The ratio is related to the decrease in premium income. The ratio fell outside the normal range the last three years. The cause for the decrease in premium income is related to the possible change in control of UTI over the last two years to two different parties. At year end 1996 it was announced that UTI was to be acquired by an unrelated party, but the sale did not materialize. At this writing negotiations are progressing with a different unrelated party for the change in control of UTI. Please refer to the Notes to the Consolidated Financial Statements for additional information. The possible changes in control over the last two years have hurt the insurance companies' ability to recruit new agents. The active agents were apprehensive due to uncertainties in relation to the change in control of UTI. In recent years, the industry experienced a decline in the total number of agents selling insurance products and therefore competition has increased for quality agents. Accordingly, new business production decreased significantly over the last two years. A life insurance company's statutory capital is computed according to rules prescribed by the National Association of Insurance Commissioners ("NAIC"), as modified by the insurance company's state of domicile. Statutory accounting rules are different from generally accepted accounting principles and are intended to reflect a more conservative view by, for example, requiring immediate expensing of policy acquisition costs. The achievement of long-term growth will require growth in the statutory capital of the Company's insurance affiliates. The affiliates may secure additional statutory capital through various sources, such as internally generated statutory earnings or equity contributions by the Company from funds generated through debt or equity offerings. The NAIC's risk-based capital requirements require insurance companies to calculate and report information under a risk-based capital formula. The risk-based capital formula measures the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching and other business factors. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio of the insurance company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Insurance companies below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action. The levels and ratios are as follows: Ratio of Total Adjusted Capital to Authorized Control Level RBC Regulatory Event (Less Than or Equal to) Company action level 2* Regulatory action level 1.5 Authorized control level 1 Mandatory control level 0.7 * Or, 2.5 with negative trend. At December 31, 1997, each of the insurance subsidiaries has a Ratio that is in excess of 3, which is 300% of the authorized control level; accordingly the insurance subsidiaries meet the RBC requirements. The NAIC, in conjunction with state regulators, has been reviewing existing insurance laws and regulations. A committee of the NAIC proposed changes in the regulations governing insurance company investments and holding company investments in subsidiaries and affiliates which were adopted by the NAIC as model laws in 1996. The Company does not presently anticipate any material adverse change in its business as a result of these changes. 81 Legislative and regulatory initiatives regarding changes in the regulation of banks and other financial services businesses and restructuring of the federal income tax system could, if adopted and depending on the form they take, have an adverse impact on the company by altering the competitive environment for its products. The outcome and timing of any such changes cannot be anticipated at this time, but the company will continue to monitor developments in order to respond to any opportunities or increased competition that may occur. The NAIC adopted the Life Illustration Model Regulation. Many states have adopted the regulation effective January 1, 1997. This regulation requires products which contain non-guaranteed elements, such as universal life and interest sensitive life, to comply with certain actuarially established tests. These tests are intended to target future performance and profitability of a product under various scenarios. The regulation does not prevent a company from selling a product that does not meet the various tests. The only implication is the way in which the product is marketed to the consumer. A product that does not pass the tests uses guaranteed assumptions rather than current assumptions in presenting future product performance to the consumer. The Company conducts an ongoing thorough review of its sales and marketing process and continues to emphasize its compliance efforts. A task force of the NAIC is currently undertaking a project to codify a comprehensive set of statutory insurance accounting rules and regulations. This project is not expected to be completed earlier than 1999. Specific recommendations have been set forth in papers issued by the NAIC for industry review. The Company is monitoring the process, but the potential impact of any changes in insurance accounting standards is not yet known. EMPLOYEES UII has no employees of its own. There are approximately 90 persons who are employed by the Company's affiliates. PROPERTIES The Company leases approximately 1,951 square feet of office space at 2500 Corporate Exchange Drive, Suite 345, Columbus, Ohio 43231. The lease expires June 30, 1999 with annual lease rent of $23,000 unadjusted for additional rent for the Company's pro rata share of building taxes, operating expenses and management expenses. Under the current lease agreement, the Company will pay a minimum of $35,000 through the remaining term of the lease. The rent expense will be approximately $35,000 for 1998. The lease contains no renewal or purchase option clause. The leased space cannot be sublet without written approval of lessor. Rent expense for 1997, 1996 and 1995 was approximately $35,000, $61,000 and $69,000, respectively. LEGAL PROCEEDINGS The Company and its affiliates are named as defendants in a number of legal actions arising primarily from claims made under insurance policies. Those actions have been considered in establishing the Company's liabilities. Management and its legal counsel are of the opinion that the settlement of those actions will not have a material adverse effect on the Company's financial position or results of operations. 82 BUSINESS OF UTI The Registrant and its subsidiaries (the "Company") operate principally in the individual life insurance business. The primary business of the Company has been the servicing of existing insurance business in force, the solicitation of new insurance business, and the acquisition of other companies in similar lines of business. United Trust, Inc., ("UTI") was incorporated December 14, 1984, as an Illinois corporation. During the next two and a half years, UTI was engaged in an intrastate public offering of its securities, raising over $12,000,000 net of offering costs. In 1986, UTI formed a life insurance subsidiary, United Trust Assurance Company ("UTAC"), and by 1987 began selling life insurance products. United Income, Inc. ("UII"), an affiliated company, was incorporated on November 2, 1987, as an Ohio corporation. Between March 1988 and August 1990, UII raised a total of approximately $15,000,000 in an intrastate public offering in Ohio. During 1990, UII formed a life insurance subsidiary, United Security Assurance (USA), and began selling life insurance products. UTI currently owns 41% of the outstanding common stock of UII and accounts for its investment in UII using the equity method. On February 20, 1992, UTI and UII, formed a joint venture, United Trust Group, Inc., ("UTG"). On June 16, 1992, UTI contributed $2.7 million in cash, an $840,000 promissory note and 100% of the common stock of its wholly owned life insurance subsidiary, (UTAC). UII contributed $7.6 million in cash and 100% of its life insurance subsidiary, (USA), to UTG. After the contributions of cash, subsidiaries, and the note, UII owns 47% and UTI owns 53% of UTG. On June 16, 1992, UTG acquired 67% of the outstanding common stock of the now dissolved Commonwealth Industries Corporation, ("CIC") for a purchase price of $15,567,000. Following the acquisition UTI controlled eleven life insurance subsidiaries. The Company has taken several steps to streamline and simplify the corporate structure following the acquisitions. On December 28, 1992, Universal Guaranty Life Insurance Company ("UG") was the surviving company of a merger with Roosevelt National Life Insurance Company ("RNLIC"), United Trust Assurance Company ("UTAC"), Cimarron Life Insurance Company ("CIM") and Home Security Life Insurance Company ("HSLIC"). On June 30, 1993, Alliance Life Insurance Company ("ALLI"), a subsidiary of UG, was merged into UG. On July 31, 1994, Investors Trust Assurance Company ("ITAC") was merged into Abraham Lincoln Insurance Company ("ABE"). On August 15, 1995, the shareholders of CIC, Investors Trust, Inc., ("ITI"), and Universal Guaranty Investment Company, ("UGIC"), all intermediate holding companies within the UTI group, voted to voluntarily liquidate each of the companies and distribute the assets to the shareholders (consisting solely of common stock of their respective subsidiary). As a result, the shareholders of the liquidated companies became shareholders of FCC. On March 25, 1997, the Board of Directors of UTI and UII voted to recommend to the shareholders a merger of the two companies. Under the Plan of Merger, UTI would be the surviving entity with UTI issuing one share of its stock for each share held by UII shareholders. Neither UTI nor UII have any other significant holdings or business dealings. The Board of Directors of each company thus concluded a merger of the two companies would be in the best interests of the shareholders. The merger will result in certain cost savings, primarily related to costs associated with maintaining a corporation in good standing in the states in which it transacts business. A vote of the shareholders of UTI and UII regarding the proposed merger is anticipated to occur sometime during the third quarter of 1998. 83 The holding companies within the group, UTI, UII UTG and FCC, are all life insurance holding companies. These companies became members of the same affiliated group through a history of acquisitions in which life insurance companies were involved. The focus of the holding companies is the acquisition of other companies in similar lines of business and management of the insurance subsidiaries. The companies have no activities outside the life insurance focus. The insurance companies of the group, UG, USA, APPL and ABE, all operate in the individual life insurance business. The primary focus of these companies has been the servicing of existing insurance business in force and the solicitation of new insurance business. On February 19, 1998, UTI signed a letter of intent with Jesse T. Correll, whereby Mr. Correll will personally or in combination with other individuals make an equity investment in UTI over a period of three years. Under the terms of the letter of intent Mr. Correll will buy 2,000,000 authorized but unissued shares of UTI common stock for $15.00 per share and will also buy 389,715 shares of UTI common stock, representing stock of UTI and UII, that UTI purchased during the last eight months in private transactions at the average price UTI paid for such stock, plus interest, or approximately $10.00 per share. Mr. Correll also will purchase 66,667 shares of UTI common stock and $2,560,000 of face amount of convertible bonds (which are due and payable on any change in control of UTI) in private transactions, primarily from officers of UTI. UTI intends to use the equity that is being contributed to expand their operations through the acquisition of other life insurance companies. The transaction is subject to negotiation of a definitive purchase agreement; completion of due diligence by Mr. Correll; the receipt of regulatory and other approvals; and the satisfaction of certain conditions. The transaction is not expected to be completed before June 30, 1998, and there can be no assurance that the transaction will be completed. PRODUCTS The Company's portfolio consists of two universal life insurance products. Universal life insurance is a form of permanent life insurance that is characterized by its flexible premiums, flexible face amounts, and unbundled pricing factors. The primary universal life insurance product is referred to as the "Century 2000". This product was introduced to the marketing force in 1993 and has become the cornerstone of current marketing. This product has a minimum face amount of $25,000 and currently credits 6% interest with a guaranteed rate of 4.5% in the first 20 years and 3% in years 21 and greater. The policy values are subject to a $4.50 monthly policy fee, an administrative load and a premium load of 6.5% in all years. The premium load is a general expense charge which is added to a policy's net premium to cover the insurer's cost of doing business. The administrative load and surrender charge are based on the issue age, sex and rating class of the policy. A surrender charge is effective for the first 14 policy years. In general, the surrender charge is very high in the first couple of years and then declines to zero at the end of 14 years. Policy loans are available at 7% interest in advance. The policy's accumulated fund will be credited the guaranteed interest rate in relation to the amount of the policy loan. The second universal life product referred to as the "UL90A", has a minimum face amount of $25,000. The administrative load is based on the issue age, sex and rating class of the policy. Policy fees vary from $1 per month in the first year to $4 per month in the second and third years and $3 per month each year thereafter. The UL90A currently credits 5.5% interest with a 4.5% guaranteed interest rate. Partial withdrawals, subject to a remaining minimum $500 cash surrender value and a $25 fee, are allowed once a year after the first duration. Policy loans are available at 7% interest in advance. The policy's accumulated fund will be credited the guaranteed interest rate in relation to the amount of the policy loan. Surrender charges are based on a percentage of target premium starting at 120% for years 1-5 then grading downward to zero in year 15. This policy contains a guaranteed interest credit bonus for the long-term policyholder. From years 10 through 20, additional interest bonuses are earned with a total in the twentieth year of 1.375%. The bonus is calculated from the policy issue date and is contractually guaranteed. The Company's actual experience for earned interest, persistency and mortality vary from the assumptions applied to pricing and for determining premiums. Accordingly, differences between the Company's actual experience and those assumptions applied may impact the profitability of the Company. The minimum interest spread between earned and credited rates is 1% on the "Century 2000" universal life insurance product. The Company monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads. Credited rates are reviewed and established by the Board of Directors of the respective life insurance subsidiaries. 84 The premium rates are competitive with other insurers doing business in the states in which the Company is marketing its products. The Company markets other products, none of which is significant to operations. The Company has a variety of policies in force different from those which are currently being marketed. The previously defined Universal life and interest sensitive whole life, which is a type of indeterminate premium life insurance which provides that the policy's cash value may be greater than that guaranteed if changing assumptions warrant an increase, business account for approximately 46% of the insurance in force. Approximately 29% of the insurance in force is participating business, which represents policies under which the policyowner shares in the insurance companies divisible surplus. The Company's average persistency rate for its policies in force for 1997 and 1996 has been 89.4% and 87.9%, respectively. The Company does not anticipate any material fluctuations in these rates in the future that may result from competition. Interest-sensitive life insurance products have characteristics similar to annuities with respect to the crediting of a current rate of interest at or above a guaranteed minimum rate and the use of surrender charges to discourage premature withdrawal of cash values. Universal life insurance policies also involve variable premium charges against the policyholder's account balance for the cost of insurance and administrative expenses. Interest-sensitive whole life products generally have fixed premiums. Interest-sensitive life insurance products are designed with a combination of front-end loads, periodic variable charges, and back-end loads or surrender charges. Traditional life insurance products have premiums and benefits predetermined at issue; the premiums are set at levels that are designed to exceed expected policyholder benefits and Company expenses. Participating business is traditional life insurance with the added feature of an annual return of a portion of the premium paid by the policyholder through a policyholder dividend. This dividend is set annually by the Board of Directors of each insurance company and is completely discretionary. MARKETING The Company markets its products through separate and distinct agency forces. The Company has approximately 45 captive agents who actively write new business, and 15 independent agents who primarily service their existing customers. Captive agents work under an ordinary agency distribution system which relies on career agents to sell and service insurance and annuity policies of a single company. Independent agents work under a brokerage distribution system which relies on brokers to distribute the insurance and annuity policies of more than one company. Both captive and independent agents work on a contractual basis and are paid commissions on a percentage of premiums written. No individual sales agent accounted for over 10% of the Company's premium volume in 1997. The Company's sales agents do not have the power to bind the Company. Marketing is based on referrals from existing policyholders and new prospect lists obtained from newly recruited sales agents. Recruiting of sales agents is based on referrals from existing agents and the invitation to attend our Company's comprehensive training school. The industry has experienced a downward trend in the total number of agents who sell insurance products, and competition for the top sales producers has intensified. As this trend appears to continue, the recruiting focus of the Company has been on introducing quality individuals to the insurance industry through an extensive internal training program. The Company feels this approach is conducive to the mutual success of our new recruits and the Company as these recruits market our products in a professional, company structured manner. New sales are marketed by UG and USA through their agency forces using contemporary sales approaches with personal computer illustrations. Current marketing efforts are primarily focused on the Midwest region. USA is licensed in Illinois, Indiana and Ohio. During 1997, Ohio accounted for 99% of USA's direct premiums collected. ABE is licensed in Alabama, Arizona, Illinois, Indiana, Louisiana and Missouri. During 1997, Illinois and Indiana accounted for 46% and 32%, respectively of ABE's direct premiums collected. 85 APPL is licensed in Alabama, Arizona, Arkansas, Colorado, Georgia, Illinois, Indiana, Kansas, Kentucky, Louisiana, Missouri, Montana, Nebraska, Ohio, Oklahoma, Pennsylvania, Tennessee, Utah, Virginia, West Virginia and Wyoming. During 1997, West Virginia accounted for 95% of APPL's direct premiums collected. UG is licensed in Alabama, Arizona, Arkansas, Colorado, Delaware, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, Washington, West Virginia and Wisconsin. During 1997, Illinois accounted for 33%, and Ohio accounted for 14% of direct premiums collected. No other state accounted for more than 7% of direct premiums collected in 1997. In 1997 $38,471,452 of total direct premium was written by USA, ABE, APPL and UG. Ohio accounted for 35% , Illinois accounted for 21%, and West Virginia accounted for 10% of total direct premiums collected. New business production has decreased 15% from 1995 to 1996 and 43% from 1996 to 1997. Several factors have had a significant impact on new business production. Over the last two years there has been the possibility of a change in control of UTI. In September of 1996, an agreement was reached effecting a change in control of UTI to an unrelated party. The transaction did not materialize. At this writing negotiations are progressing with a different unrelated party for change in control of UTI. Please refer to note 17 in the Notes to the Consolidated Financial Statements for additional information. The possible changes in control, and the uncertainty surrounding each potential event, have hurt the insurance Companies' ability to attract and maintain sales agents. In addition, increased competition for consumer dollars from other financial institutions, product Illustration guideline changes by State Insurance Departments, and a decrease in the total number of insurance sales agents in the industry, have all had an impact, given the relatively small size of the Company. Management recognizes the aforementioned challenges and is responding. The potential change in control of the Company is progressing, bringing the possibility for future growth, efforts are being made to introduce additional products, and the recruitment of quality individuals for intensive sales training, are directed at reversing current marketing trends. UNDERWRITING The underwriting procedures of the insurance subsidiaries are established by management. Insurance policies are issued by the Company based upon underwriting practices established for each market in which the Company operates. Most policies are individually underwritten. Applications for insurance are reviewed to determine additional information required to make an underwriting decision, which depends on the amount of insurance applied for and the applicant's age and medical history. Additional information may include inspection reports, medical examinations, and statements from doctors who have treated the applicant in the past and, where indicated, special medical tests. After reviewing the information collected, the Company either issues the policy as applied for or with an extra premium charge because of unfavorable factors or rejects the application. Substandard risks may be referred to reinsurers for full or partial reinsurance of the substandard risk. The Company's insurance subsidiaries require blood samples to be drawn with individual insurance applications for coverage over $45,000 (age 46 and above) or $95,000 (ages 16-45). Blood samples are tested for a wide range of chemical values and are screened for antibodies to the HIV virus. Applications also contain questions permitted by law regarding the HIV virus which must be answered by the proposed insureds. RESERVES The applicable insurance laws under which the insurance subsidiaries operate require that each insurance company report policy reserves as liabilities to meet future obligations on the policies in force. These reserves are the amounts which, with the additional premiums to be received and interest thereon compounded annually at certain assumed rates, are calculated in accordance with applicable law to be sufficient to meet the various policy and contract obligations as they mature. These laws specify that the reserves shall not be less than reserves calculated using certain mortality tables and interest rates. 86 The liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance subsidiaries' experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. The Company makes these assumptions at the time the contract is issued or, in the case of contracts acquired by purchase, at the purchase date. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. Current mortality rate assumptions are based on 1975-80 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or Linton C, which are industry standard actuarial tables for forecasting assumed policy lapse rates. Benefit reserves for universal life insurance and interest sensitive life insurance products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims in excess of related policy account balances. Interest crediting rates for universal life and interest sensitive products range from 5.0% to 6.0% in each of the years 1997, 1996 and 1995. REINSURANCE As is customary in the insurance industry, the Company's insurance subsidiaries cede insurance to other insurance companies under reinsurance agreements. Reinsurance agreements are intended to limit a life insurer's maximum loss on a large or unusually hazardous risk or to obtain a greater diversification of risk. The ceding insurance company remains contingently liable with respect to ceded insurance should any reinsurer be unable to meet the obligations assumed by it, however it is the practice of insurers to reduce their financial statement liabilities to the extent that they have been reinsured with other insurance companies. The Company sets a limit on the amount of insurance retained on the life of any one person. The Company will not retain more than $125,000, including accidental death benefits, on any one life. At December 31, 1997, the Company had insurance in force of $3.692 billion of which approximately $1.022 billion was ceded to reinsurers. The Company's reinsured business is ceded to numerous reinsurers. The Company believes the assuming companies are able to honor all contractual commitments, based on the Company's periodic reviews of their financial statements, insurance industry reports and reports filed with state insurance departments. Currently, the Company is utilizing reinsurance agreements with Business Men's Assurance Company, ("BMA") and Life Reassurance Corporation, ("LIFE RE") for new business. BMA and LIFE RE each hold an "A+" (Superior) rating from A.M. Best, an industry rating company. The reinsurance agreements were effective December 1, 1993, and cover all new business of the Company. The agreements are a yearly renewable term ("YRT") treaty where the Company cedes amounts above its retention limit of $100,000 with a minimum cession of $25,000. One of the Company's insurance subsidiaries (UG) entered into a coinsurance agreement with First International Life Insurance Company ("FILIC") as of September 30, 1996. Under the terms of the agreement, UG ceded to FILIC substantially all of its paid-up life insurance policies. Paid-up life insurance generally refers to non-premium paying life insurance policies. A.M. Best assigned FILIC a Financial Performance Rating (FPR) of 7 (Strong) on a scale of 1 to 9. A.M. Best assigned a Best's Rating of A++ (Superior) to The Guardian Life Insurance Company of America ("Guardian"), parent of FILIC, based on the consolidated financial condition and operating performance of the company and its life/health subsidiaries. During 1997, FILIC changed its name to Park Avenue Life Insurance Company ("PALIC"). The agreement with PALIC accounts for approximately 65% of the reinsurance receivables as of December 31, 1997. 87 The Company does not have any short-duration reinsurance contracts. The effect of the Company's long-duration reinsurance contracts on premiums earned in 1997, 1996 and 1995 was as follows: Shown in thousands 1997 1996 1995 Premiums Premiums Premiums Earned Earned Earned Direct $ 33,374 $ 35,891 $ 38,482 Assumed 0 0 0 Ceded (4,735) (4,947) (5,383) Net premiums $ 28,639 $ 30,944 $ 33,099 INVESTMENTS The Company retains the services of a registered investment advisor to assist the Company in managing its investment portfolio. The Company may modify its present investment strategy at any time, provided its strategy continues to be in compliance with the limitations of state insurance department regulations. Investment income represents a significant portion of the Company's total income. Investments are subject to applicable state insurance laws and regulations which limit the concentration of investments in any one category or class and further limit the investment in any one issuer. Generally, these limitations are imposed as a percentage of statutory assets or percentage of statutory capital and surplus of each company. The following table reflects net investment income by type of investment. December 31, 1997 1996 1995 Fixed maturities and fixed maturities held for sale $ 12,677,348 $ 13,326,312 $ 13,190,121 Equity securities 87,211 88,661 52,445 Mortgage loans 802,123 1,047,461 1,257,189 Real estate 745,502 794,844 975,080 Policy loans 976,064 1,121,538 1,041,900 Short-term investments 70,624 21,423 21,295 Other 696,486 691,111 642,632 Total consolidated investment income 16,055,358 17,091,350 17,180,662 Investment expenses (1,198,061) (1,222,903) (1,724,438) Consolidated net investment income $ 14,857,297 $ 15,868,447 $ 15,456,224
At December 31, 1997, the Company had a total of $5,797,000 of investments, comprised of $3,848,000 in real estate and $1,949,000 in equity securities, which did not produce income during 1997. The following table summarizes the Company's fixed maturities distribution at December 31, 1997 and 1996 by ratings category as issued by Standard and Poor's, a leading ratings analyst. 88 Fixed Maturities Rating % of Portfolio 1997 1996 Investment Grade AAA 31% 30% AA 14% 13% A 46% 46% BBB 9% 10% Below investment grade 0% 1% 100% 100% The following table summarizes the Company's fixed maturities and fixed maturities held for sale by major classification. Carrying Value 1997 1996 U.S. government and government $ 29,701,879 $ 29,998,240 agencies States, municipalities and political subdivisions 22,814,301 14,561,203 Collateralized mortgage obligations 11,093,926 13,246,780 Public utilities 48,064,818 51,941,647 Corporate 70,964,039 72,140,081 $ 182,638,963 $ 181,887,951
The following table shows the composition and average maturity of the Company's investment portfolio at December 31, 1997. Carrying Average Average Investments Value Maturity Yield Fixed maturities and fixed maturities held for sale $182,638,963 4 years 6.95% Equity securities 3,001,744 not applicable 3.63% Mortgage loans 9,469,444 10 years 7.82% Investment real estate 11,485,276 not applicable 6.48% Policy loans 14,207,189 not applicable 6.81% Short-term investments 1,798,878 330 days 6.33% Total Investments $222,601,494 7.24%
At December 31, 1997, fixed maturities and fixed maturities held for sale have a combined market value of $186,451,198. Fixed maturities are carried at amortized cost. Management has the ability and intent to hold these securities until maturity. Fixed maturities held for sale are carried at market. The Company holds approximately $1,798,878 in short-term investments. Management monitors its investment maturities and in their opinion is sufficient to meet the Company's cash requirements. Fixed maturities of $15,107,100 mature in one year and $120,382,870 mature in two to five years. The Company holds approximately $9,469,444 in mortgage loans which represents 3% of the total assets. All mortgage loans are first position loans. Before a new loan is issued, the applicant is subject to certain criteria set forth by Company management to ensure quality control. These criteria include, but are not limited to, a credit report, personal financial information such as outstanding debt, sources of income, and personal equity. Loans issued are limited to no more than 80% of the appraised value of the property and must be first position against the collateral. 89 The Company has $298,000 of mortgage loans, net of a $10,000 reserve allowance, which are in default and in the process of foreclosure. These loans represent approximately 3% of the total portfolio. The Company has one loan of $3,404 which is under a repayment plan. Letters are sent to each mortgagee when the loan becomes 30 days or more delinquent. Loans 90 days or more delinquent are placed on a non-performing status and classified as delinquent loans. Reserves for loan losses are established based on management's analysis of the loan balances compared to the expected realizable value should foreclosure take place. Loans are placed on a non-accrual status based on a quarterly analysis of the likelihood of repayment. All delinquent and troubled loans held by the Company are loans which were held in portfolios by acquired companies at the time of acquisition. Management believes the current internal controls surrounding, the mortgage loan selection process provide a quality portfolio with minimal risk of foreclosure and/or negative financial impact. The Company has in place a monitoring system to provide management with information regarding potential troubled loans. Management is provided with a monthly listing of loans that are 30 days or more past due along with a brief description of what steps are being taken to resolve the delinquency. Quarterly, coinciding with external financial reporting, the Company determines how each delinquent loan should be classified. All loans 90 days or more past due are classified as delinquent. Each delinquent loan is reviewed to determine the classification and status the loan should be given. Interest accruals are analyzed based on the likelihood of repayment. In no event will interest continue to accrue when accrued interest along with the outstanding principal exceeds the net realizable value of the property. The Company does not utilize a specified number of days delinquent to cause an automatic non-accrual status. The mortgage loan reserve is established and adjusted based on management's quarterly analysis of the portfolio and any deterioration in value of the underlying property which would reduce the net realizable value of the property below its current carrying value. In addition, the Company also monitors that current and adequate insurance on the properties are being maintained. The Company requires proof of insurance on each loan and further requires to be shown as a lienholder on the policy so that any change in coverage status is reported to the Company. Proof of payment of real estate taxes is another monitoring technique utilized by the Company. Management believes a change in insurance status or non-payment of real estate taxes are indicators that a loan is potentially troubled. Correspondence with the mortgagee is performed to determine the reasons for either of these events occurring. The following table shows a distribution of mortgage loans by type. Mortgage Loans Amount % of Total FHA/VA $ 536,443 5% Commercial 1,565,643 17% Residential 7,367,358 78% 90 The following table shows a geographic distribution of the mortgage loan portfolio and real estate held. Mortgage Real Loans Estate New Mexico 3% 0% Illinois 10% 55% Kansas 13% 0% Louisiana 15% 14% Mississippi 0% 20% Missouri 2% 1% North Carolina 7% 6% Oklahoma 5% 1% Virginia 4% 0% West Virginia 38% 2% Other 3% 1% Total 100% 100% The following table summarizes delinquent mortgage loan holdings. Delinquent 31 Days or More 1997 1996 1995 Non-accrual $ 0 $ 0 $ 0 status Other 308,000 613,000 628,000 Reserve on delinquent (10,000) (10,000) (10,000) loans Total Delinquent $ 298,000 $ 603,000 $ 618,000 Interest income foregone (Delinquent $ 29,000 $ 29,000 $ 16,000 loans) In Process of Restructuring $ 0 $ 0 $ 0 Restructuring on other than market terms 0 0 0 Other potential problem loans 0 0 0 Total Problem $ 0 $ 0 $ 0 Loans Interest income foregone (Restructured loans) $ 0 $ 0 $ 0
See Item 2, Properties, for description of real estate holdings. COMPETITION The insurance business is a highly competitive industry and there are a number of other companies, both stock and mutual, doing business in areas where the Company operates. Many of these competing insurers are larger, have more diversified lines of insurance coverage, have substantially greater financial resources and have a greater number of agents. Other significant competitive factors include policyholder benefits, service to policyholders, and premium rates. 91 The insurance industry is a mature industry. In recent years, the industry has experienced virtually no growth in life insurance sales, though the aging population has increased the demand for retirement savings products. The products offered (see Products) are similar to those offered by other major companies. The product features are regulated by the states and are subject to extensive competition among major insurance organizations. The Company believes a strong service commitment to policyholders, efficiency and flexibility of operations, timely service to the agency force and the expertise of its key executives help minimize the competitive pressures of the insurance industry. The industry has experienced a downward trend in the total number of agents who sell insurance products, and competition for the top sales producers has intensified. As this trend appears to continue, the recruiting focus of the Company has been on introducing quality individuals to the insurance industry through an extensive internal training program. The Company feels this approach is conducive to the mutual success of our new recruits and the Company as these recruits market our products in a professional, company structured manner. GOVERNMENT REGULATION The Company's insurance subsidiaries are assessed contributions by life and health guaranty associations in almost all states to indemnify policyholders of failed companies. In several states the company may reduce premium taxes paid to recover a portion of assessments paid to the states' guaranty fund association. This right of "offset" may come under review by the various states, and the company cannot predict whether and to what extent legislative initiatives may affect this right to offset. Also, some state guaranty associations have adjusted the basis by which they assess the cost of insolvencies to individual companies. The company believes that its reserve for future guaranty fund assessments is sufficient to provide for assessments related to known insolvencies. This reserve is based upon management's current expectation of the availability of this right of offset, known insolvencies and state guaranty fund assessment bases. However, changes in the basis whereby assessments are charged to individual companies and changes in the availability of the right to offset assessments against premium tax payments could materially affect the company's results. Currently, the Company's insurance subsidiaries are subject to government regulation in each of the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including the power to: (i) grant and revoke licenses to transact business; (ii) regulate and supervise trade practices and market conduct; (iii) establish guaranty associations; (iv) license agents; (v) approve policy forms; (vi) approve premium rates for some lines of business; (vii) establish reserve requirements; (viii) prescribe the form and content of required financial statements and reports; (ix) determine the reasonableness and adequacy of statutory capital and surplus; and (x) regulate the type and amount of permitted investments. Insurance regulation is concerned primarily with the protection of policyholders. The Company cannot predict the form of any future proposals or regulation. The Company's insurance subsidiaries, USA, UG, APPL and ABE are domiciled in the states of Ohio, Ohio, West Virginia and Illinois, respectively. The insurance regulatory framework continues to be scrutinized by various states, the federal government and the National Association of Insurance Commissioners ("NAIC"). The NAIC is an association whose membership consists of the insurance commissioners or their designees of the various states. The NAIC has no direct regulatory authority over insurance companies, however its primary purpose is to provide a more consistent method of regulation and reporting from state to state. This is accomplished through the issuance of model regulations, which can be adopted by individual states unmodified, modified to meet the state's own needs or requirements, or dismissed entirely. Most states also have insurance holding company statutes which require registration and periodic reporting by insurance companies controlled by other corporations licensed to transact business within their respective jurisdictions. The insurance subsidiaries are subject to such legislation and registered as controlled insurers in those jurisdictions in which such registration is required. Statutes vary from state to state but typically require periodic disclosure concerning the corporation that controls the registered insurers and all subsidiaries of such corporation. In addition, prior notice to, or approval by, the state insurance commission of material intercorporate transfers of assets, reinsurance agreements, management agreements (see Note 9 of the Notes to the Consolidated Financial Statements), and payment of dividends (see Note 2 of the Notes to the Consolidated Financial Statements) in excess of specified amounts by the insurance subsidiary within the holding company system are required. 92 Each year the NAIC calculates financial ratio results (commonly referred to as IRIS ratios) for each company. These ratios compare various financial information pertaining to the statutory balance sheet and income statement. The results are then compared to pre-established normal ranges determined by the NAIC. Results outside the range typically require explanation to the domiciliary insurance department. At year end 1997, the insurance companies had one ratio outside the normal range. The ratio is related to the decrease in premium income. The ratio fell outside the normal range the last three years. The cause for the decrease in premium income is related to the possible change in control of UTI over the last two years to two different parties. At year end 1996 it was announced that UTI was to be acquired by an unrelated party, but the sale did not materialize. At this writing negotiations are progressing with a different unrelated party for the change in control of UTI. Please refer to the Notes to the Consolidated Financial Statements for additional information. The possible changes in control over the last two years have hurt the insurance companies' ability to recruit new agents. The active agents were apprehensive due to uncertainties in relation to the change in control of UTI. In recent years, the industry experienced a decline in the total number of agents selling insurance products and therefore competition has increased for quality agents. Accordingly, new business production decreased significantly over the last two years. A life insurance company's statutory capital is computed according to rules prescribed by the National Association of Insurance Commissioners ("NAIC"), as modified by the insurance company's state of domicile. Statutory accounting rules are different from generally accepted accounting principles and are intended to reflect a more conservative view by, for example, requiring immediate expensing of policy acquisition costs. The achievement of long-term growth will require growth in the statutory capital of the Company's insurance subsidiaries. The subsidiaries may secure additional statutory capital through various sources, such as internally generated statutory earnings or equity contributions by the Company from funds generated through debt or equity offerings. The NAIC's risk-based capital requirements require insurance companies to calculate and report information under a risk-based capital formula. The risk-based capital formula measures the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching and other business factors. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio of the insurance company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Insurance companies below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action. The levels and ratios are as follows: Ratio of Total Adjusted Capital to Authorized Control Level RBC Regulatory Event (Less Than or Equal to) Company action level 2* Regulatory action level 1.5 Authorized control level 1 Mandatory control level 0.7 * Or, 2.5 with negative trend. At December 31, 1997, each of the insurance subsidiaries has a Ratio that is in excess of 3, which is 300% of the authorized control level; accordingly the insurance subsidiaries meet the RBC requirements. 93 The NAIC, in conjunction with state regulators, has been reviewing existing insurance laws and regulations. A committee of the NAIC proposed changes in the regulations governing insurance company investments and holding company investments in subsidiaries and affiliates which were adopted by the NAIC as model laws in 1996. The Company does not presently anticipate any material adverse change in its business as a result of these changes. Legislative and regulatory initiatives regarding changes in the regulation of banks and other financial services businesses and restructuring of the federal income tax system could, if adopted and depending on the form they take, have an adverse impact on the company by altering the competitive environment for its products. The outcome and timing of any such changes cannot be anticipated at this time, but the company will continue to monitor developments in order to respond to any opportunities or increased competition that may occur. The NAIC has recently released the Life Illustration Model Regulation. Many states have adopted the regulation effective January 1, 1997. This regulation requires products which contain non-guaranteed elements, such as universal life and interest sensitive life, to comply with certain actuarially established tests. These tests are intended to target future performance and profitability of a product under various scenarios. The regulation does not prevent a company from selling a product that does not meet the various tests. The only implication is the way in which the product is marketed to the consumer. A product that does not pass the tests uses guaranteed assumptions rather than current assumptions in presenting future product performance to the consumer. The Company conducts an ongoing thorough review of its sales and marketing process and continues to emphasize its compliance efforts. A task force of the NAIC is currently undertaking a project to codify a comprehensive set of statutory insurance accounting rules and regulations. This project is not expected to be completed earlier than 1999. Specific recommendations have been set forth in papers issued by the NAIC for industry review. The Company is monitoring the process, but the potential impact of any changes in insurance accounting standards is not yet known. EMPLOYEES There are approximately 90 persons who are employed by the Company and its affiliates. PROPERTIES The following table shows a breakout of property, net of accumulated depreciation, owned and occupied by the Company and the distribution of real estate by type. Property owned Amount % of Total Home Office $ 2,815,241 20% Investment real estate Commercial $ 4,355,450 30% Residential development $ 5,405,282 38% Foreclosed real estate $ 1,724,544 12% $11,485,276 80% Grand total $14,300,517 100% Total investment real estate holdings represent approximately 3% of the total assets of the Company net of accumulated depreciation of $539,366 and $442,373 at year end 1997 and 1996 respectively. The Company owns an office complex in Springfield, Illinois, which houses the primary insurance operations. The office buildings contain 57,000 square feet of office and warehouse space. The properties are carried at approximately $2,394,360. In addition, an insurance subsidiary owns a home office building in Huntington, West Virginia. The building has 15,000 square feet and is carried at $165,882. The facilities occupied by the Company are adequate relative to the Company's present operations. 94 Commercial property consists primarily of former home office buildings of acquired companies no longer used in the operations of the Company. These properties are leased to various unaffiliated companies and organizations. Residential development property is primarily located in Springfield, Illinois, and entails several developments, each targeted for a different segment of the population. These targets include a development primarily for the first time home buyer, an upscale development for existing homeowners looking for a larger home, and duplex condominiums for those who desire maintenance free exteriors and surroundings. The Company's primary focus is on the development and sale of lots, with an occasional home construction to help stimulate interest. Springfield is the State Capital of Illinois. The City's economy is service oriented with the main employers being the State of Illinois, two major area hospitals and two large insurance companies. This provides for a very stable economy not as dramatically affected by economic conditions in other parts of the United States. Foreclosed property is carried at the unpaid loan principal balance plus accrued interest on the loan and other costs associated with the foreclosure process. The carrying value of foreclosed property does not exceed management's estimate of net realizable value. Management's estimate of net realizable value is based on significant internal real estate experience, local market experience, independent appraisals and evaluation of existing comparable property sales. LEGAL PROCEEDINGS The Company and its subsidiaries are named as defendants in a number of legal actions arising primarily from claims made under insurance policies. Those actions have been considered in establishing the Company's liabilities. Management and its legal counsel are of the opinion that the settlement of those actions will not have a material adverse effect on the Company's financial position or results of operations. DIRECTORS AND EXECUTIVE OFFICERS OF UII THE BOARD OF DIRECTORS In accordance with the laws of Ohio and the Certificate of Incorporation and Bylaws of the Company, as amended, the Company is managed by its executive officers under the direction of the Board of Directors. The Board elects executive officers, evaluates their performance, works with management in establishing business objectives and considers other fundamental corporate matters, such as the issuance of stock or other securities, the purchase or sale of a business and other significant corporate business transactions. In the fiscal year ended December 31, 1997, the Board met five times. All directors attended at least 75% of all meetings of the board except for Messers. Aveni and Teater. The Board of Directors has an Audit Committee consisting of Messrs. Berschet, Melville, and Mrs. Donahey. The Audit Committee reviews and acts or reports to the Board with respect to various auditing and accounting matters, the scope of the audit procedures and the results thereof, the internal accounting and control systems of the Company, the nature of services performed for the Company and the fees to be paid to the independent auditors, the performance of the Company's independent and internal auditors and the accounting practices of the Company. The Audit Committee also recommends to the full Board of Directors the auditors to be appointed by the Board. The Audit Committee met once in 1997. The Board of Directors has a Nominating Committee consisting of Messrs. Aveni, Nash and Teater. The Nominating Committee reviews, evaluates and recommends directors, officers and nominees for the Board of Directors. There is no formal mechanism by which shareholders of the Company can recommend nominees for the Board of Directors, although any recommendations by shareholders of the Company will be considered. Shareholders desiring to make nominations to the Board of Directors should submit their nominations in writing to the Chairman of the Board no later than February 1st of the year in which the nomination is to be made. The Committee did not meet in 1997. The compensation of the Company's executive officers is determined by the full Board of Directors (see report on Executive Compensation). 95 Under the Company's Certificate of Incorporation, the Board of Directors may be comprised of between five and twenty-one directors. The Board currently has a fixed number of directors at six. Shareholders elect Directors to serve for a period of one year at the Company's Annual Shareholders' meeting. The following information with respect to business experience of the Board of Directors has been furnished by the respective directors or obtained from the records of the Company. DIRECTORS NAME, AGE POSITION WITH THE COMPANY, BUSINESS EXPERIENCE AND OTHER DIRECTORSHIPS Vincent T. Aveni 71 Director of the Company since 1984; Chairman Emeritus of Realty One, Inc. and co-developer of the Three Village Condominium; currently serving the Ohio Association of Realtors as a trustee; past President of Ohio Association of Realtors; past Regional Vice President of the Ohio and Michigan National Association Marketing Institute, and Farm and Land Institute. Marvin W. Berschet 63 Director of the Company since 1984; self-employed since 1956; charter member of National Cattlemen's Association; Board member of Meat Export Federation for seven years and Chairman of Beef Council for three years; served on the National Livestock and Meat Board for 16 years; past President of Ohio Cattlemen's Association. James E. Melville 52 President and Chief Operating Officer since July 1997; Chief Financial Officer of the Company since 1993, Senior Executive ;Vice President of the Company since September 1992; President of certain Affiliate Companies from May 1989 until September 1991; Chief Operating Officer of FCC from 1989 to September 1991; Chief Operating Officer of certain Affiliate Companies from 1984 until September 1991; Senior Executive Vice President of certain Affiliate Companies from 1984 until September 1989; Consultant to UTI and UTG from March to September, 1992; President and Chief Operating Officer of certain affiliate life insurance companies and Senior Executive Vice President of non- insurance affiliate companies since 1992. Charlie E. Nash 70 Director of the Company since 1984; Executive Director and State President of the Ohio Farmers Union; serves on the Board of Directors for National Farmers Union Uniform Pension Committee and a member of its Investment Committee for pension funds; Chairman of the Putnam County Board of Elections; serves on the Board of Directors of Farmers Union Ventures, Inc., Green Thumb, Inc. and Farmers Education Foundation; he is a farm owner. Larry E. Ryherd 58 Chairman of the Board of Directors since 1987, CEO since 1992; President since 1993 and a Director since 1987; UTI Chairman of the Board of Directors and a Director since 1984, CEO since 1991; Chairman, CEO and Director of UTG since 1992; President, CEO and Director of certain affiliate companies since 1992. Mr. Ryherd has served has Chairman of the Board, .CEO, President and COO of certain affiliate life insurance companies since 1992 and 1993. He has also been a Director of the National Alliance of Life Companies since 1992 and is the 1994 Membership Committee Chairman; he is a member of the American Council of Life Companies and Advisory Board Member of its Forum 500 since 1992. Robert W. Teater 71 Director of the Company since 1984; Director of UTG and certain affiliate companies since 1992; member of Columbus School Board since 1991, President of Columbus School Board since 1992; President of Robert W. Teater and Associates, a comprehensive consulting firm in natural resources development and organization management since 1983. 96 EXECUTIVE OFFICERS OF THE COMPANY More detailed information on the following officers of the Company appears under "Election of Directors": Larry E.Ryherd Chairman of the Board and Chief Executive Officer James E. Melville President and Chief Operating Officer Other officers of the company are set forth below: NAME, AGE POSITION WITH THE COMPANY, BUSINESS EXPERIENCE AND OTHER DIRECTORSHIPS George E. Francis 53 Executive Vice President since July 1997; Secretary of the Company since February 1993; Director of certain Affiliate Companies since October 1992; Senior Vice President and Chief Administrative Officer of certain Affiliate Companies since 1989; Secretary of certain Affiliate Companies since March 1993; Treasurer and Chief Financial Officer of certain Affiliate Companies from 1984 until September 1992. Theodore C. Miller 35 Senior Vice President and Chief Financial Officer since July 1997; Vice President and Treasurer since October 1992; Vice President and Controller of certain Affiliate Companies from 1984 to 1992. Others not completing the current term: Thomas F. Morrow Formerly Director and President of the Company since 1992; retired effective July 31, 1997. John K. Cantrell Formerly Chairman of the Board of Directors since 1984; succumbed after a long illness in November 1997. Gertrude W. Donahey Formerly Director of the Company since 1984, resigned from the Board of Directors effective December 9, 1997. Mrs. Donahey stepped down due to scheduling reasons. EXECUTIVE COMPENSATION EXECUTIVE COMPENSATION TABLE The following table sets forth certain information regarding compensation paid to or earned by the Company's Chief Executive Officer and each of the Executive Officers of the Company whose salary plus bonus exceeded $100,000 during each of the Company's last three fiscal years. Compensation for services provided by the named executive officers to the Company and its affiliates is paid by FCC as set forth in their employment agreements. (See Employment Contracts). SUMMARY COMPENSATION TABLE Annual Compensation (1) Other Annual Name and Compensation (2) Principal Position Salary($) $ Larry E. Ryherd 1997 400,000 18,863 Chairman of the Board 1996 400,000 17,681 Chief Executive Officer 1995 400,000 13,324 97 James E. Melville 1997 237,000 29,538 President, Chief 1996 237,000 27,537 Operating Officer 1995 237,000 38,206(3) George E. Francis 1997 122,000 8,187 Executive Vice 1996 119,000 7,348 President, Secretary 1995 119,000 4,441 (1) Compensation deferred at the election of named officers is included in this section. (2) Other annual compensation consists of interest earned on deferred compensation amounts pursuant to their employment agreements and the Company's matching contribution to the First Commonwealth Corporation Employee Savings Trust 401(k) Plan. (3) Includes $16,000 for the value of personal perquisites owing Mr. Melville. AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES The following table summarizes for fiscal year ending, December 31, 1997, the number of shares subject to unexercised options and the value of unexercised options of the Common Stock of UTI held by the named executive officers. The values shown were determined by multiplying the applicable number of unexercised share options by the difference between the per share market price on December 31, 1997 and the applicable per share exercise price. There were no options granted to the named executive officers for the past three fiscal years. Number of Shares Number of Securities Underlying Acquired on Value Unexercised Options/SARs Exercise (#) Realized ($) at FY-End(# Name Exercisable Unexercisable Larry E. Ryherd - - 13,800 - James E. Melville - - 30,000 - George E. Francis - - 4,600 - Value of Unexercised In the Money Options/SARs at FY-End ($) Exercisable Unexercisable - - - - - - COMPENSATION OF DIRECTORS The Company's standard arrangement for the compensation of directors provide that each director shall receive an annual retainer of $2,400, plus $300 for each meeting attended and reimbursement for reasonable travel expenses. The Company's director compensation policy also provides that directors who are employees of the Company do not receive any compensation for their services as directors except for reimbursement for reasonable travel expenses for attending each meeting. EMPLOYMENT CONTRACTS On July 31, 1997, Larry E. Ryherd entered into an employment agreement with FCC. Formerly, Mr. Ryherd had served as Chairman of the Board and Chief Executive Officer of the Company and its affiliates. Pursuant to the agreement, Mr. Ryherd agreed to serve as Chairman of the Board and Chief Executive Officer of the Company and in addition, to serve in other positions of the affiliated companies if appointed or elected. The agreement provides for an annual salary of $400,000 as determined by the Board of Directors. The term of the agreement is for a period of five years. Mr. Ryherd has deferred portions of his income under a plan entitling him to a deferred compensation payment on January 2, 2000 in the amount of $240,000 which includes interest at the rate of approximately 8.5% per year. Additionally, Mr. Ryherd was granted an option to purchase up to 13,800 of the Common Stock of UTI at $17.50 per share. The option is immediately exercisable and transferable. The option will expire December 31, 2000. 98 FCC entered into an employment agreement dated July 31, 1997 with James E. Melville pursuant to which Mr. Melville is employed as President and Chief Operating Officer and in addition, to serve in other positions of the affiliated companies if appointed or elected at an annual salary of $238,200. The term of the agreement expires July 31, 2002. Mr. Melville has deferred portions of his income under a plan entitling him to a deferred compensation payment on January 2, 2000 of $400,000 which includes interest at the rate of approximately 8.5% annually. Additionally, Mr. Melville was granted an option to purchase up to 30,000 shares of the Common Stock of UTI at $17.50 per share. The option is immediately exercisable and transferable. The option will expire December 31, 2000. FCC entered into an employment agreement with George E. Francis on July 31, 1997. Under the terms of the agreement, Mr. Francis is employed as Executive Vice President of the Company at an annual salary of $126,200. Mr. Francis also agreed to serve in other positions if appointed or elected to such positions without additional compensation. The term of the agreement expires July 31, 2000. Mr. Francis has deferred portions of his income under a plan entitling him to a deferred compensation payment on January 2, 2000 of $80,000 which includes interest at the rate of approximately 8.5% per year. Additionally, Mr. Francis was granted an option to purchase up to 4,600 shares of the Common Stock of UTI at $17.50 per share. The option is immediately exercisable and transferable. This option will expire on December 31, 2000. REPORT ON EXECUTIVE COMPENSATION INTRODUCTION The compensation of the Company's executive officers is determined by the full Board of Directors. The Board of Directors strongly believes that the Company's executive officers directly impact the short-term and long-term performance of the Company. With this belief and the corresponding objective of making decisions that are in the best interest of the Company's shareholders, the Board of Directors places significant emphasis on the design and administration of the Company's executive compensation plans. EXECUTIVE COMPENSATION PLAN ELEMENTS BASE SALARY. The Board of Directors establishes base salaries each year at a level intended to be within the competitive market range of comparable companies. In addition to the competitive market range, many factors are considered in determining base salaries, including the responsibilities assumed by the executive, the scope of the executive's position, experience, length of service, individual performance and internal equity considerations. During the last three fiscal years, there were no material changes in the base salaries of the named executive officers. STOCK OPTIONS. One of the Company's priorities is for the executive officers to be significant shareholders so that the interest of the executives are closely aligned with the interests of the Company's other shareholders. The Board of Directors believes that this strategy motivates executives to remain focused on the overall long-term performance of the Company. Stock options are granted at the discretion of the Board of Directors and are intended to be granted at levels within the competitive market range of comparable companies. During 1993, each of the named executive officers were granted options under their employment agreements for the Company's Common Stock as described in the Employment Contracts section. There were no options granted to the named executive officers during the last three fiscal years. DEFERRED COMPENSATION. A very significant component of overall Executive Compensation Plans is found in the flexibility afforded to participating officers in the receipt of their compensation. The availability, on a voluntary basis, of the deferred compensation arrangements as described in the Employment Contracts section may prove to be critical to certain officers, depending upon their particular financial circumstance. 99 CHIEF EXECUTIVE OFFICER Larry E. Ryherd has been Chairman of the Board and Chief Executive Officer since 1988 and Chairman of the Board of the Company's parent, FCC, since 1984. The Board of Directors used the same compensation plan elements described above for all executive officers to determine Mr. Ryherd's 1997 compensation. In setting both the cash-based and equity-based elements of Mr. Ryherd's compensation, the Board of Directors made an overall assessment of Mr. Ryherd's leadership in achieving the Company's long-term strategic and business goals. Mr. Ryherd's base salary reflects a consideration of both competitive forces and the Company's performance. The Board of Directors does not assign specific weights to these categories. The Company surveys total cash compensation for chief executive officers at the same group of companies described under "Base Salary" above. Based upon its survey, the Company then determines a median around which it builds a competitive range of compensation for the CEO. As a result of this review, the Board of Directors concluded that Mr. Ryherd's base salary was in the low end of the competitive market, and his total direct compensation (including stock incentives) was competitive for CEOs running companies comparable in size and complexity to the Company. The Board of Directors considered the Company's financial results as compared to other companies within the industry, financial performance for fiscal 1997 as compared to fiscal 1996, the Company's progress as it relates to the Company's growth through acquisitions and simplification of the organization, the fact that since the Company does not have a Chief Marketing Officer, Mr. Ryherd assumes additional responsibilities of the Chief Marketing Officer, and Mr. Ryherd's salary history, performance ranking and total compensation history. Through fiscal 1997, Mr. Ryherd's annual salary was $400,000, the amount the Board of Directors set in January 1996. In July 1997, the Board of Directors reviewed Mr. Ryherd's salary. Following a review of the above factors, the Board of Directors decided to recognize Mr. Ryherd's performance by placing a greater emphasis on long-term incentive awards, and therefore retained Mr. Ryherd's base salary at $400,000. CONCLUSION. The Board of Directors believes the mix of structured employment agreements with certain key executives, conservative market based salaries, competitive cash incentives for short-term performance and the potential for equity-based rewards for long term performance represents an appropriate balance. This balanced Executive Compensation Plan provides a competitive and motivational compensation package to the executive officer team necessary to continue to produce the results the Company strives to achieve. The Board of Directors also believes the Executive Compensation Plan addresses both the interests of the shareholders and the executive team. BOARD OF DIRECTORS Vincent T. Aveni Charlie E. Nash Marvin W. Berschet Larry E. Ryherd James E. Melville Robert W. Teater PERFORMANCE GRAPH The following graph compares the cumulative total shareholder return on the Company's Common Stock during the five fiscal years ended December 31, 1997, with the cumulative total return on the NASDAQ Composite Index Performance and the NASDAQ Insurance Stock Index (1): 100 UII NASDAQ NASDAQ Ins 1992 100 100 100 1993 100 114.68 106.83 1994 92 111.93 100.49 1995 92 158.72 142.93 1996 40 194.95 162.93 1997 32 239.45 238.54 (1)The Company selected the NASDAQ Composite Index Performance as an appropriate comparison because the Company's Common Stock is not listed on any exchange but the Company's Common Stock is traded in the over- the-counter market. Furthermore, the Company selected the NASDAQ Insurance Stock Index as the second comparison because there is no similar single "peer company" in the NASDAQ system with which to compare stock performance and the closest additional line-of-business index which could be found was the NASDAQ Insurance Stock Index. Trading activity in the Company's Common Stock is limited, which may be in part a result of the Company's low profile from not being listed on any exchange, and its reported operating losses. The Company has experienced a tremendous growth rate over the period shown in the Return Chart with assets growing from approximately $233 million in 1991 to approximately $333 million in 1997. The growth rate has been the result of acquisitions of other companies and new insurance writings. The Company has incurred costs of conversions and administrative consolidations associated with the acquisitions which has contributed to the operating losses. The Return Chart is not intended to forecast or be indicative of possible future performance of the Company's stock. The foregoing graph shall not be deemed to be incorporated by reference into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates such information by reference. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The following persons served as directors of the Company during 1997 and were officers or employees of the Company or its affiliates during 1997: James E. Melville and Larry E. Ryherd. Accordingly, these individuals have participated in decisions related to compensation of executive officers of the Company and its affiliates. During 1997, the following executive officers of the Company were also members of the Board of Directors of FCC, two of whose executive officers served on the Board of Directors of the Company: Messrs. Melville and Ryherd. During 1997, Larry E. Ryherd and James E. Melville, executive officers of the Company, were also members of the Board of Directors of UTI, two of whose executive officers served on the Board of Directors of the Company: Messrs. Melville, and Ryherd. 101 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF UII PRINCIPLE HOLDERS OF SECURITIES The following tabulation sets forth the name and address of the entity known to be the beneficial owners of more than 5% of the Company's Common Stock and shows: (i) the total number of shares of Common Stock beneficially owned by such person as of March 31, 1998 and the nature of such ownership; and (ii) the percent of the issued and outstanding shares of Common Stock so owned as of the same date. Title Number of Shares Percent Of Name and Address and Nature of of Class of Beneficial Owner Beneficial Ownership Class Common United Trust, Inc. 565,766 40.6%. Stock no 5250 South Sixth Street par value Springfield, IL 62703 SECURITY OWNERSHIP OF MANAGEMENT OF UII The following tabulation shows with respect to each of the directors and nominees of the Company, with respect to the Company's chief executive officer and each of the Company's executive officers whose salary plus bonus exceeded $100,000 for fiscal 1997, and with respect to all executive officers and directors of the Company as a group: (i) the total number of shares of all classes of stock of the Company or any of its parents or affiliates, beneficially owned as of March 31, 1998 and the nature of such ownership; and (ii) the percent of the issued and outstanding shares of stock so owned as of the same date. Title Directors, Named Executive Number of Shares Percent of Officers, & All Directors & and Nature of of Class Executive Officers as a Group Ownership Class UTI's Vincent T. Aveni 0 * Common Marvin W. Berschet 0 * Stock, no George E. Francis 4,600 (1) * Par value James E. Melville 52,500 (2) 3.2% Charlie E. Nash 0 * Larry E. Ryherd 562,431 (3) 33.8% Robert W. Teater 0 * All directors and executive officers as a group 619,531 37.2% (seven in number) FCC's Vincent T. Aveni 0 * Common Marvin W. Berschet 0 * Stock, George E. Francis 0 * $1.00 James E. Melville 544 (4) * Par Value Charlie E. Nash 0 * Larry E. Ryherd 0 * Robert W. Teater 0 * All directors and executive officers as a group 544 * (seven in number) 102 Company's Vincent T. Aveni 7,716 (5) * Common Marvin W. Berschet 7,161 (6) * Stock, no George E. Francis 0 * Par value James E. Melville 0 * Charlie E. Nash 7,052 (7) * Larry E. Ryherd 47,250 (9) * Robert W. Teater 7,380 (8) * All directors and executive officers as a group 76,559 5.5% (seven in number) (1)Includes 4,600 shares which may be acquired upon the exercise of outstanding stock options. (2) James E. Melville owns 2,500 shares individually and 14,000 shares jointly with his spouse. Includes: (i) 3,000 shares of UTI's Common Stock which are held beneficially in trust for his daughter, namely Bonnie J. Melville; (ii) 3,000 shares of UTI's Common Stock, 750 shares of which are in the name of Matthew C. Hartman, his nephew; 750 shares of which are in the name of Zachary T. Hartman, his nephew; 750 shares of which are in the name of Elizabeth A. Hartman, his niece; and 750 shares of which are in the name of Margaret M. Hartman, his niece; and (iii) 30,000 shares which may be acquired by James E. Melville upon exercise of outstanding stock options. (3) Larry E. Ryherd owns 230,621 shares of UTI's Common Stock in his own name. Includes: (i) 150,050 shares of UTI's Common Stock in the name of Dorothy LouVae Ryherd, his wife; (ii) 150,000 shares of UTI's Common Stock which are held beneficially in trust for the three children of Larry E. Ryherd and Dorothy LouVae Ryherd, namely Shari Lynette Serr, Derek Scott Ryherd and Jarad John Ryherd; (iii) 14,800 shares of UTI's Common Stock, 6,700 shares of which are in the name of Shari Lynette Serr, 1,200 shares of which are held in the name of Derek Scott Ryherd, 6,900 shares of which are in the name of Jarad John Ryherd; (iv) 500 shares of UTI's Common Stock held in the name of Larry E. Ryherd as custodian for Charity Lynn Newby, his niece; (v) 500 shares held in the name of Larry E. Ryherd as custodian for Lesley Carol Newby, his niece; (vi) 2,000 shares held by Dorothy LouVae Ryherd, his wife as custodian for granddaughter, 160 shares held by Larry E. Ryherd as custodian for granddaughter; and (vii) 13,800 shares which may be acquired by Larry E. Ryherd upon exercise of outstanding stock options. (4) James E. Melville owns 168 shares individually and 376 shares jointly with his spouse. (5) Includes 272 shares owned directly by Mr. Aveni's brother and 210 shares owned directly by Mr. Aveni's son. (6) Includes 42 shares owned directly by each of Mr. Berschet's two sons and 77 shares owned directly by Mr. Berschet's daughter, a total of 161 shares. (7) Includes 47,250 shares beneficially in trust for the three children of Larry E. Ryherd and Dorothy LouVae Ryherd, namely Shari Lynette Serr, Derek Scott Ryherd and Jarad John Ryherd. (8) Includes 210 shares owned directly by Mr. Teater's spouse. (9) In addition, Mr. Ryherd is a director and officer of UTI, who owns 565,766 shares (29.9%) of the Company. Mr. Ryherd disclaims any beneficial interest in the shares of the Company owned by UTI as the UTI board of directors controls the voting and investment decisions regarding such shares. * Less than 1%. Except as indicated above, the foregoing persons hold sole voting and investment power. Directors and officers of the Company file periodic reports regarding ownership of Company securities with the Securities and Exchange Commission pursuant to Section 16(a) of the Securities Exchange Act of 1934 as amended, and the rules promulgated thereunder. 103 DIRECTORS AND EXECUTIVE OFFICERS OF UTI THE BOARD OF DIRECTORS In accordance with the laws of Illinois and the Certificate of Incorporation and Bylaws of the Company, as amended, the Company is managed by its executive officers under the direction of the Board of Directors. The Board elects executive officers, evaluates their performance, works with management in establishing business objectives and considers other fundamental corporate matters, such as the issuance of stock or other securities, the purchase or sale of a business and other significant corporate business transactions. In the fiscal year ended December 31, 1997, the Board met five times. All directors attended at least 75% of all meetings of the board except for Messers. Albin and Cellini. The Board of Directors has an Audit Committee consisting of Messrs. Albin, Geary, McKee and Larson. The Audit Committee reviews and acts or reports to the Board with respect to various auditing and accounting matters, the scope of the audit procedures and the results thereof, the internal accounting and control systems of the Company, the nature of services performed for the Company and the fees to be paid to the independent auditors, the performance of the Company's independent and internal auditors and the accounting practices of the Company. The Audit Committee also recommends to the full Board of Directors the auditors to be appointed by the Board. The Audit Committee met once in 1997. The Board of Directors has a Nominating Committee consisting of Messrs. Cook, Lovell, and Morrow. The Nominating Committee reviews, evaluates and recommends directors, officers and nominees for the Board of Directors. There is no formal mechanism by which shareholders of the Company can recommend nominees for the Board of Directors, although any recommendations by shareholders of the Company will be considered. Shareholders desiring to make nominations to the Board of Directors should submit their nominations in writing to the Chairman of the Board no later than February 1st of the year in which the nomination is to be made. The Committee did not meet in 1997. The compensation of the Company's executive officers is determined by the full Board of Directors (see report on Executive Compensation). Under the Company's Certificate of Incorporation, the Board of Directors may be comprised of between five and twenty-one directors. The Board currently has a fixed number of directors at ten. Shareholders elect Directors to serve for a period of one year at the Company's Annual Shareholders' meeting. The following information with respect to business experience of the Board of Directors has been furnished by the respective directors or obtained from the records of the Company. DIRECTORS NAME, AGE POSITION WITH THE COMPANY, BUSINESS EXPERIENCE AND OTHER DIRECTORSHIPS John S. Albin 70 Director of the Company since 1984; farmer in Douglas and Edgar counties, Illinois, since 1951; Chairman of the Board of Longview State Bank since 1978; President of the Longview Capitol Corporation, a bank holding company, since 1978; Chairman of First National Bank of Ogden, Illinois, since 1987; Chairman of the State Bank of Chrisman since 1988; Director and Secretary of Illini Community Development Corporation since 1990; Chairman of Parkland College Board of Trustees since 1990; board member of the Fisher National Bank, Fisher, Illinois, since 1993. William F. Cellini 63 Director of FCC and certain affiliate companies since 1984; Chairman of the Board of New Frontier Development Group, Chicago, Illinois for more than the past five years; Executive Director of Illinois Asphalt Pavement Association. 104 Robert E. Cook 72 Director of the Company since 1984; President of United Fidelity, Inc. since 1990; Chairman of the Board of Directors of First Fidelity Mortgage Company since 1991; President of Cook-Witter, Inc., a governmental consulting and lobbying firm with offices in Springfield, Illinois, from 1985 until 1990. Larry R. Dowell 63 Director of the Company since 1984; cattleman and farmer in Stronghurst, Henderson County, Illinois since 1956; member of the Illinois Beef Association; past Board and Executive Committee member of Illinois Beef Council; Chairman of Henderson County Board of Supervisors since 1992. Donald G. Geary 74 Director of FCC and certain affiliate companies since 1984; industrial warehousing developer and founder of Regal 8 Inns for more than the past five years. Raymond L. Larson 63 Director of the Company since 1984; cattleman and farmer since 1953; Director of the Bank of Sugar Grove, Illinois since 1977; Board member of National Livestock and Meat Board since 1983 and currently Treasurer, Board member and past President of Illinois Beef Council; member of National Cattlemen's Association and Illinois Cattlemen's Association. Dale E. McKee 79 Director of the Company since 1984; pork producer and farmer in Rio, Illinois, since 1947; President of McKee and Flack, Inc., an Iowa corporation engaged in farming since 1975; director of St. Mary's Hospital of Galesburg since 1984. James E. Melville 52 President and Chief Operating Officer since July 1997; Chief Financial Officer of the Company since 1993, Senior Executive Vice President of the Company since September 1992; President of certain Affiliate Companies from May 1989 until September 1991; Chief Operating Officer of FCC from 1989 until September 1991; Chief Operating Officer of certain Affiliate Companies from 1984 until September 1991; Senior Executive Vice President of certain affiliate companies from 1984 until 1989; Consultant to UTI and UTG from March 1992 through September 1992; President and Chief Operating Officer of certain affiliate life insurance companies and Senior Executive Vice President of non-insurance affiliate companies since 1992. Thomas F. Morrow 53 Director of the Company since 1984; Director of certain affiliate companies since 1992 and Treasurer since 1993. Mr. Morrow has served as Vice Chairman and Director of certain affiliate life insurance companies since 1992 as well as having held similar positions with other affiliate life insurance companies from 1987 to 1992. Larry E. Ryherd 58 Chairman of the Board of Directors and a Director since 1984, CEO since 1991; Chairman of the Board of UII since 1987, CEO since 1992 and President since 1993; Chairman, CEO and Director of UTG since 1992; President, CEO and Director of certain affiliate companies since 1992. Mr. Ryherd has served as Chairman of the Board, .CEO, President and COO of certain affiliate life insurance companies since 1992 and 1993. He has also been a Director of the National Alliance of Life Companies since 1992 and is the 1994 Membership Committee Chairman; he is a member of the American Council of Life Companies and Advisory Board Member of its Forum 500 since 1992. Paul D. Lovell, a Director of the Company resigned effective September 23, 1997. Mr. Lovell is retired. EXECUTIVE OFFICERS OF THE COMPANY More detailed information on the following officers of the Company appears under "Election of Directors": Larry E. Ryherd Chairman of the Board and Chief Executive Officer James E. Melville President and Chief Operating Officer 105 Other officers of the company are set forth below: NAME, AGE POSITION WITH THE COMPANY, BUSINESS EXPERIENCE AND OTHER DIRECTORSHIPS George E. Francis 53 Executive Vice President since July 1997; Secretary of the Company since February 1993; Director of certain Affiliate Companies since October 1992; Senior Vice President and Chief Administrative Officer of certain Affiliate Companies since 1989; Secretary of certain Affiliate Companies since March 1993; Treasurer and Chief Financial Officer of certain Affiliate Companies from 1984 until September 1992. Theodore C. Miller 35 Senior Vice President and Chief Financial Officer since July 1997; Vice President and Treasurer since October 1992; Vice President and Controller of certain Affiliate Companies from 1984 to 1992. ITEM 11. EXECUTIVE COMPENSATION EXECUTIVE COMPENSATION TABLE The following table sets forth certain information regarding compensation paid to or earned by the Company's Chief Executive Officer and each of the Executive Officers of the Company whose salary plus bonus exceeded $100,000 during each of the Company's last three fiscal years: Compensation for services provided by the named executive officers to the Company and its affiliates is paid by FCC as set forth in their employment agreements. (See Employment Contracts). SUMMARY COMPENSATION TABLE Annual Compensation (1) Other Annual Name and Compensation (2) Principal Position Salary($) $ Larry E. Ryherd 1997 400,000 18,863 Chairman of the Board 1996 400,000 17,681 Chief Executive Officer 1995 400,000 13,324 James E. Melville 1997 237,000 29,538 President, Chief 1996 237,000 27,537 Operating Officer 1995 237,000 38,206(3) George E. Francis 1997 122,000 8,187 Executive Vice 1996 119,000 7,348 President, Secretary 1995 119,000 4,441 (1) Compensation deferred at the election of named officers is included in this section. (2) Other annual compensation consists of interest earned on deferred compensation amounts pursuant to their employment agreements and the Company's matching contribution to the First Commonwealth Corporation Employee Savings Trust 401(k) Plan. (3) Includes $16,000 for the value of personal perquisites owing Mr. Melville. AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES The following table summarizes for fiscal year ending, December 31, 1997, the number of shares subject to unexercised options and the value of 106 unexercised options of the Common Stock of UTI held by the named executive officers. The values shown were determined by multiplying the applicable number of unexercised share options by the difference between the per share market price on December 31, 1997 and the applicable per share exercise price. There were no options granted to the named executive officers for the past three fiscal years. Number of Shares Number of Securities Underlying Acquired on Value Unexercised Options/SARs Exercise (#) Realized ($) at FY-End(#) Name Exercisable Unexercisable Larry E. Ryherd - - 13,800 - James E. Melville - - 30,000 - George E. Francis - - 4,600 - Value of Unexercised In the Money Options/Sars at FY-End ($) Exercisable Unexercisable Larry E. Ryherd - - James E. Melville - - George E. Francis - - COMPENSATION OF DIRECTORS The Company's standard arrangement for the compensation of directors provide that each director shall receive an annual retainer of $2,400, plus $300 for each meeting attended and reimbursement for reasonable travel expenses. The Company's director compensation policy also provides that directors who are employees of the Company do not receive any compensation for their services as directors except for reimbursement for reasonable travel expenses for attending each meeting. EMPLOYMENT CONTRACTS On July 31, 1997, Larry E. Ryherd entered into an employment agreement with FCC. Formerly, Mr. Ryherd had served as Chairman of the Board and Chief Executive Officer of the Company and its affiliates. Pursuant to the agreement, Mr. Ryherd agreed to serve as Chairman of the Board and Chief Executive Officer of the Company and in addition, to serve in other positions of the affiliated companies if appointed or elected. The agreement provides for an annual salary of $400,000 as determined by the Board of Directors. The term of the agreement is for a period of five years. Mr. Ryherd has deferred portions of his income under a plan entitling him to a deferred compensation payment on January 2, 2000 in the amount of $240,000 which includes interest at the rate of approximately 8.5% per year. Additionally, Mr. Ryherd was granted an option to purchase up to 13,800 of the Common Stock of the Company at $17.50 per share. The option is immediately exercisable and transferable. The option will expire December 31, 2000. FCC entered into an employment agreement dated July 31, 1997 with James E. Melville pursuant to which Mr. Melville is employed as President and Chief Operating Officer and in addition, to serve in other positions of the affiliated companies if appointed or elected at an annual salary of $238,200. The term of the agreement expires July 31, 2002. Mr. Melville has deferred portions of his income under a plan entitling him to a deferred compensation payment on January 2, 2000 of $400,000 which includes interest at the rate of approximately 8.5% annually. Additionally, Mr. Melville was granted an option to purchase up to 30,000 shares of the Common Stock of the Company at $17.50 per share. The option is immediately exercisable and transferable. The option will expire December 31, 2000. FCC entered into an employment agreement with George E. Francis on July 31, 1997. Under the terms of the agreement, Mr. Francis is employed as Executive Vice President of the Company at an annual salary of $126,200. Mr. Francis also agreed to serve in other positions if appointed or elected to such positions without additional compensation. The term of the agreement expires July 31, 2000. Mr. Francis has deferred portions of his income under a plan entitling him to a deferred compensation payment on January 2, 2000 of $80,000 which includes interest at the rate of approximately 8.5% per year. Additionally, Mr. Francis was granted an option to purchase up to 4,600 shares of the Common Stock of the Company at $17.50 per share. The option is immediately exercisable and transferable. This option will expire on December 31, 2000. On July 31, 1997, the Company entered into a severance agreement with Thomas F. Morrow, Director of the Company since 1984. Mr. Morrow had certain expectations and understandings as to the length of time he would be employed by the Company and desired to retire effective July 31, 1997. 107 Mr. Morrow has agreed to continue as director of the Company and his duties as an executive officer ceased. The Company paid Mr. Morrow six months' severance in a lump sum of $150,000. In lieu of renewal commissions that Mr. Morrow was entitled to under prior agreements, Mr. Morrow will be paid a monthly sum of $4,000 for a period of 24 months commencing July 31, 1997. Thereafter, Morrow will be paid a monthly sum of $3,000 for the next 24 month period ending July 31, 2001. Prior to his retirement, Mr. Morrow deferred portions of his income under a plan entitling him to a deferred compensation payment on January 2, 2000 in the amount of $300,000 which includes interest at the rate of approximately 8.5% annually. Additionally, Mr. Morrow was granted an option to purchase up to 17,200 of UTI Common Stock at $17.50 per share. The option is immediately exercisable and transferable. The option will expire December 31, 2000. Mr. Morrow also redeemed the Common Stock of the Company and UII held by himself and his family. See "Related Party Transactions". REPORT ON EXECUTIVE COMPENSATION INTRODUCTION The compensation of the Company's executive officers is determined by the full Board of Directors. The Board of Directors strongly believes that the Company's executive officers directly impact the short-term and long-term performance of the Company. With this belief and the corresponding objective of making decisions that are in the best interest of the Company's shareholders, the Board of Directors places significant emphasis on the design and administration of the Company's executive compensation plans. EXECUTIVE COMPENSATION PLAN ELEMENTS BASE SALARY. The Board of Directors establishes base salaries each year at a level intended to be within the competitive market range of comparable companies. In addition to the competitive market range, many factors are considered in determining base salaries, including the responsibilities assumed by the executive, the scope of the executive's position, experience, length of service, individual performance and internal equity considerations. During the last three fiscal years, there were no material changes in the base salaries of the named executive officers. STOCK OPTIONS. One of the Company's priorities is for the executive officers to be significant shareholders so that the interest of the executives are closely aligned with the interests of the Company's other shareholders. The Board of Directors believes that this strategy motivates executives to remain focused on the overall long-term performance of the Company. Stock options are granted at the discretion of the Board of Directors and are intended to be granted at levels within the competitive market range of comparable companies. During 1993, each of the named executive officers were granted options under their employment agreements for the Company's Common Stock as described in the Employment Contracts section. There were no options granted to the named executive officers during the last three fiscal years. DEFERRED COMPENSATION. A very significant component of overall Executive Compensation Plans is found in the flexibility afforded to participating officers in the receipt of their compensation. The availability, on a voluntary basis, of the deferred compensation arrangements as described in the Employment Contracts section may prove to be critical to certain officers, depending upon their particular financial circumstance. CHIEF EXECUTIVE OFFICER Larry E. Ryherd has been Chairman of the Board and Chief Executive Officer since 1984. The Board of Directors used the same compensation plan elements described above for all executive officers to determine Mr. Ryherd's 1997 compensation. In setting both the cash-based and equity-based elements of Mr. Ryherd's compensation, the Board of Directors made an overall assessment of Mr. Ryherd's leadership in achieving the Company's long-term strategic and business goals. Mr. Ryherd's base salary reflects a consideration of both competitive forces and the Company's performance. The Board of Directors does not assign specific weights to these categories. 108 The Company surveys total cash compensation for chief executive officers at the same group of companies described under "Base Salary" above. Based upon its survey, the Company then determines a median around which it builds a competitive range of compensation for the CEO. As a result of this review, the Board of Directors concluded that Mr. Ryherd's base salary was in the low end of the competitive market, and his total direct compensation (including stock incentives) was competitive for CEOs running companies comparable in size and complexity to the Company. The Board of Directors considered the Company's financial results as compared to other companies within the industry, financial performance for fiscal 1997 as compared to fiscal 1996, the Company's progress as it relates to the Company's growth through acquisitions and simplification of the organization, the fact that since the Company does not have a Chief Marketing Officer, Mr. Ryherd assumes additional responsibilities of the Chief Marketing Officer, and Mr. Ryherd's salary history, performance ranking and total compensation history. Through fiscal 1997, Mr. Ryherd's annual salary was $400,000, the amount the Board of Directors set in January 1996. In July 1997, the Board of Directors reviewed Mr. Ryherd's salary. Following a review of the above factors, the Board of Directors decided to recognize Mr. Ryherd's performance by placing a greater emphasis on long-term incentive awards, and therefore retained Mr. Ryherd's base salary at $400,000. CONCLUSION. The Board of Directors believes the mix of structured employment agreements with certain key executives, conservative market based salaries, competitive cash incentives for short-term performance and the potential for equity-based rewards for long term performance represents an appropriate balance. This balanced Executive Compensation Plan provides a competitive and motivational compensation package to the executive officer team necessary to continue to produce the results the Company strives to achieve. The Board of Directors also believes the Executive Compensation Plan addresses both the interests of the shareholders and the executive team. BOARD OF DIRECTORS John S. Albin Raymond L. Larson William F. Cellini Dale E. McKee Robert E. Cook James E. Melville Larry R. Dowell Thomas F. Morrow Donald G. Geary Larry E. Ryherd James E. Melville PERFORMANCE GRAPH The following graph compares the cumulative total shareholder return on the Company's Common Stock during the five fiscal years ended December 31, 1997, with the cumulative total return on the NASDAQ Composite Index Performance and the NASDAQ Insurance Stock Index (1): 109 UTI NASDAQ NASDAQ Ins 1992 100 100 100 1993 62.5 114.68 106.83 1994 25 111.93 100.49 1995 19 158.72 142.93 1996 31.5 194.95 162.93 1997 40 239.45 238.54 (1)The Company selected the NASDAQ Composite Index Performance as an appropriate comparison because the Company's Common Stock is not listed on any exchange but the Company's Common Stock is traded on the NASDAQ Small Cap exchange under the sign "UTIN". Furthermore, the Company selected the NASDAQ Insurance Stock Index as the second comparison because there is no similar single "peer company" in the NASDAQ system with which to compare stock performance and the closest additional line- of-business index which could be found was the NASDAQ Insurance Stock Index. Trading activity in the Company's Common Stock is limited, which may be due in part as a result of the Company's low profile, and its reported operating losses. The Company has experienced a tremendous growth rate over the period shown in the Return Chart with assets growing from approximately $233 million in 1991 to approximately $333 million in 1997. The growth rate has been the result of acquisitions of other companies and new insurance writings. The Company has incurred costs of conversions and administrative consolidations associated with the acquisitions which has contributed to the operating losses. The Return Chart is not intended to forecast or be indicative of possible future performance of the Company's stock. The foregoing graph shall not be deemed to be incorporated by reference into any filing of the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates such information by reference. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The following persons served as directors of the Company during 1997 and were officers or employees of the Company or its subsidiaries during 1997: James E. Melville and Larry E. Ryherd. Accordingly, these individuals have participated in decisions related to compensation of executive officers of the Company and its subsidiaries. During 1997, the following executive officers of the Company were also members of the Board of Directors of UII, two of whose executive officers served on the Board of Directors of the Company: Messrs. Melville and Ryherd. During 1997, Larry E. Ryherd and James E. Melville, executive officers of the Company, were also members of the Board of Directors of FCC, two of whose executive officers served on the Board of Directors of the Company: Messrs. Melville and Ryherd. 110 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF UTI PRINCIPAL HOLDERS OF SECURITIES The following tabulation sets forth the name and address of the entity known to be the beneficial owners of more than 5% of the Company's Common Stock and shows: (i) the total number of shares of Common Stock beneficially owned by such person as of March 31, 1998 and the nature of such ownership; and (ii) the percent of the issued and outstanding shares of Common Stock so owned as of the same date. Title Number of Shares Percent Of Name and Address and Nature of of Class of Beneficial Owner Beneficial Ownership Class Common Larry E. Ryherd 562,431(1) 33.8% Stock no 12 Red Bud Lane par value Springfield, IL 62707 (1) Larry E. Ryherd owns 230,621 shares of the Company's Common Stock in his own name. Includes: (i) 150,050 shares of the Company's common Stock in the name of Dorothy LouVae Ryherd, his wife; (ii) 150,000 shares of the Company's Common Stock which are held beneficially in trust for the three children of Larry E. Ryherd and Dorothy LouVae Ryherd, namely Shari Lynette Serr, Derek Scott Ryherd and Jarad John Ryherd; (iii) 14,800 shares of the Company's Common Stock, 6,700 shares of which are in the name of Shari Lynette Serr, 1,200 shares of which are held in the name of Derek Scott Ryherd and 6,900 shares of which are in the name of Jarad John Ryherd; (iv) 500 shares of the Company's Common Stock held in the name of Larry E. Ryherd as custodian for Charity Lynn Newby, his niece; (v) 500 shares held in the name of Larry E. Ryherd as custodian for Lesley Carol Newby, his niece; (vi) 2,000 shares held by Dorothy LouVae Ryherd, his wife, as custodian for granddaughter; 160 shares held by Larry E. Ryherd as custodian for granddaughter; and (vii) 13,800 shares which may be acquired by Larry E. Ryherd upon the exercise of outstanding stock options. SECURITY OWNERSHIP OF MANAGEMENT OF UTI The following tabulation shows with respect to each of the directors and nominees of the Company, with respect to the Company's chief executive officer and each of the Company's executive officers whose salary plus bonus exceeded $100,000 for fiscal 1997, and with respect to all executive officers and directors of the Company as a group: (i) the total number of shares of all classes of stock of the Company or any of its parents or subsidiaries, beneficially owned as of March 31, 1998 and the nature of such ownership; and (ii) the percent of the issued and outstanding shares of stock so owned as of the same date. Title Directors, Named Executive Number of Shares Percent of Officers, & All Directors & and Nature of of Class Executive Officers as a Group Ownership Class FCC's John S. Albin 0 * Common William F. Cellini 0 * Stock, Robert E. Cook 0 * $1.00 Larry R. Dowell 0 * par value George E. Francis 0 * Donald G. Geary 225 * Raymond L. Larson 0 * Dale E. McKee 0 * James E. Melville 544 (1) * Thomas F. Morrow 0 * Larry E. Ryherd 0 * All directors and executive officers as a group 769 * (eleven in number) 111 UII's John S. Albin 0 * Common William F. Cellini 0 * Stock, no Robert E. Cook 4,025 * par value Larry R. Dowell 0 * George E. Francis 0 * Donald G. Geary 0 * Raymond L. Larson 0 * Dale E. McKee 0 * James E. Melville 0 * Thomas F. Morrow 0 * Larry E. Ryherd 47,250 (2)(9) 3.4% All directors and executive officers as a group 51,275 3.7% (eleven in number) Company's John S. Albin 10,503 (3) * Common William F. Cellini 1,000 * Stock, no Robert E. Cook 10,199 * par value Larry R. Dowell 10,142 * George E. Francis 4,600 (4) * Donald G. Geary 1,200 * Raymond L. Larson 4,400 (5) * Dale E. McKee * James E. Melville 52,500 (6) 3.2% Thomas F. Morrow 40,555 (7) 2.4% Larry E. Ryherd 562,431 (8) 33.8% All directors and executive officers as a group 708,652 42.6% (eleven in number) (1) James E. Melville owns 168 shares individually and 376 shares owned jointly with his spouse. (2) Includes 47,250 shares beneficially in trust for the three children of Larry E. Ryherd and Dorothy LouVae Ryherd, namely Shari Lynette Serr, Derek Scott Ryherd and Jarad John Ryherd. (3) Includes 392 shares owned directly by Mr. Albin's spouse. (4) Includes 4,600 shares which may be acquired upon exercise of outstanding stock options. (5) Includes 375 shares owned directly by Mr. Larson's spouse. (6) James E. Melville owns 2,500 shares individually and 14,000 shares jointly with his spouse. Includes: (i) 3,000 shares of UTI's Common Stock which are held beneficially in trust for his daughter, namely Bonnie J. Melville; (ii) 3,000 shares of UTI's Common Stock, 750 shares of which are in the name of Matthew C. Hartman, his nephew; 750 shares of which are in the name of Zachary T. Hartman, his nephew; 750 shares of which are in the name of Elizabeth A. Hartman, his niece; and 750 shares of which are in the name of Margaret M. Hartman, his niece; and (iii) 30,000 shares which may be acquired by James E. Melville upon exercise of outstanding stock options. (7) Includes 17,200 shares which may be acquired upon exercise of outstanding stock options. (8) Includes 1,500 shares as custodian for grandchildren. (9) In addition, Mr. Ryherd is a director and officer of UII. The Company owns 565,766 shares of UII. Mr. Ryherd disclaims any beneficial interest of the 565,766 shares of UII owned by the Company as the Company's Board of directors controls the voting and investment decisions regarding such shares. * Less than 1%. Except as indicated above, the foregoing persons hold sole voting and investment power. 112 Directors and officers of the Company file periodic reports regarding ownership of Company securities with the Securities and Exchange Commission pursuant to Section 16(a) of the Securities Exchange Act of 1934 as amended, and the rules promulgated thereunder. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Company has a service agreement with its affiliate, UII (equity investee), to perform services and provide personnel and facilities. The services included in the agreement are claim processing, underwriting, processing and servicing of policies, accounting services, agency services, data processing and all other expenses necessary to carry on the business of a life insurance company. UII has a service agreement with USA which states that USA is to pay UII monthly fees equal to 22% of the amount of collected first year premiums, 20% in second year and 6% of the renewal premiums in years three and after. UII's subcontract agreement with the Company states that UII is to pay the Company monthly fees equal to 60% of collected service fees from USA as stated above. On January 1, 1993, the Company entered into an agreement with UG pursuant to which the Company provides management services necessary for UG to carry on its business. In addition to the UG agreement, the Company and its affiliates have either directly or indirectly entered into management and/or cost-sharing arrangements for the Company's management services. The Company received net management fees of $9,893,321, $9,927,000 and $10,464,000 under these arrangements in 1997, 1996 and 1995, respectively. UG paid $8,660,481, $9,626,559 and $10,164,000 to the Company in 1997, 1996 and 1995, respectively. USA paid $989,295, $1,567,891 and $2,015,325 under their agreement with UII for 1997, 1996 and 1995, respectively. UII paid $593,577, $940,734 and $1,209,195 under their agreement with the Company for 1997, 1996 and 1995, respectively. Their respective domiciliary insurance departments have approved the agreements of the insurance companies and it is Management's opinion that where applicable, costs have been allocated fairly and such allocations are based upon generally accepted accounting principles. The costs paid by the Company for these services include costs related to the production of new business, which are deferred as policy acquisition costs and charged off to the income statement through "Amortization of deferred policy acquisition costs". Also included are costs associated with the maintenance of existing policies that are charged as current period costs and included in "general expenses". On July 31, 1997, the Company issued convertible notes for cash received totaling $2,560,000 to seven individuals, all officers or employees of the Company. The notes bear interest at a rate of 1% over prime, with interest payments due quarterly and principal due upon maturity of July 31, 2004. The conversion price of the notes are graded from $12.50 per share for the first three years, increasing to $15.00 per share for the next two years and increasing to $20.00 per share for the last two years. Conditional upon the seven individuals placing the funds with the Company were the acquisition of a portion of the holdings of the Company owned by Larry E. Ryherd and his family and the acquisition of common stock of the Company and UII held by Thomas F. Morrow and his family and the simultaneous retirement of Mr. Morrow. Neither Mr. Morrow nor Mr. Ryherd was a party to the convertible notes. Approximately $1,048,000 of the cash received from the issuance of the convertible notes was used to acquire stock holdings of the Company and UII of Mr. Morrow and to acquire a portion of the Company's stock held by Larry E. Ryherd and his family. The remaining cash received will be used by the Company to provide additional operating liquidity and for future acquisitions of life insurance companies. On July 31, 1997, the Company acquired a total of 126,921 of its own shares of common stock and 47,250 shares of UII common stock from Thomas F. Morrow and his family. Mr. Morrow simultaneously retired as an executive officer of the Company. Mr. Morrow will remain as a member of the Board of Directors of the Company. In exchange for his stock, Mr. Morrow and his family received approximately $348,000 in cash, promissory notes valued at $140,000 due in eighteen months, and promissory notes valued at $1,030,000 due January 31, 2005. These notes bear interest at a rate of 1% over prime, with interest due quarterly and principal due upon maturity. The notes do not contain any conversion privileges. Additionally, on July 31, 1997, The Company acquired a total of 97,499 shares of its common stock from Larry E. Ryherd and his family. Mr. Ryherd and his family received approximately $700,000 in cash and a promissory note valued at $251,000 due January 31, 2005. The acquisition of approximately 16% of Mr. Ryherd's stock holdings of the Company was completed as a prerequisite to the convertible notes placed by other management personnel to reduce the total holdings of Mr. Ryherd and his family to make the stock more attractive to the investment community. Following the transaction, Mr. Ryherd and his family own approximately 31% of the outstanding common stock of the Company. 113 POTENTIAL CONFLICT OF INTEREST The Chairman of the Board, Mr. Larry Ryherd and the President, Mr. James Melville of UTI serve as directors and executive officers of both UTI and UII. The board of directors of UTI, consists of ten in number, of which eight are independent directors. Mr. Ryherd beneficially owns 562,431 (33.8%) shares of the issued and outstanding UTI Common Stock. The directors and officers of UTI together beneficially own 42.6% of the issued and outstanding UTI Common Stock. Additionally, UTI owns 40.6% of the outstanding UII Common Stock. The board of directors of UII consists of six in number, of which four are independent directors who together beneficially own 5.5% of the issued and outstanding UII Common Stock. The board of directors of both UTI and UII and the management of UTI representing the shares of UII owned by UTI intend to vote in favor of the proposals. Because of the existence of minority interest in certain holding companies within the UTI holding company system potential conflicts of interest may arise with respect to intracompany transactions. Such transactions may include mergers and allocation of expenses among the companies in the UTI holding company system. UTI has taken a number of steps to reduce potential conflicts of interest by increasing the commonality of ownership interest in the subsidiaries (See `THE UTI HOLDING COMPANY SYSTEM"). One of the reasons for this Merger is to increase the commonality of ownership among UTI and UII. (See "Information REGARDING THE PROPOSED MERGER" - Reasons for the Merger). YEAR 2000 ISSUE The "Year 2000 Issue" is the inability of computers and computing technology to recognize correctly the Year 2000 date change. The problem results from a long-standing practice by programmers to save memory space by denoting Years using just two digits instead of four digits. Thus, systems that are not Year 2000 compliant may be unable to read dates correctly after the Year 1999 and can return incorrect or unpredictable results. This could have a significant effect on the Company's business/financial systems as well as products and services, if not corrected. The Company established a project to address year 2000 processing concerns in September of 1996. In 1997 the Company completed the review of the Company's internally and externally developed software, and made corrections to all year 2000 non-compliant processing. The Company also secured verification of current and future year 2000 compliance from all major external software vendors. In December of 1997, a separate computer operating environment was established with the system dates advanced to December of 1999. A parallel model office was established with all dates in the data advanced to December of 1999. Parallel model office processing is being performed using dates from December of 1999 to January of 2001, to insure all year 2000 processing errors have been corrected. Testing should be completed by the end of the first quarter of 1998. After testing is completed, periodic regression testing will be performed to monitor continuing compliance. By addressing year 2000 compliance in a timely manner, compliance will be achieved using existing staff and without significant impact on the Company operationally or financially. 114 RECENT DEVELOPMENT Equity Investment in UTI On April 30, 1998, UTI and First Southern Funding, a Kentucky corporation ("FSF"), signed a Definitive Agreement ("the FSF Agreement") whereby FSF will make an equity investment in UTI. Under the terms of the FSF Agreement, FSF will buy 473,523 authorized but unissued shares of UTI common stock for $15.00 a share and will also buy 389,715 shares of UTI common stock that UTI purchased during the last year in private transactions at the average price UTI paid for such stock, plus interest, or approximately $10.00 per share. FSF will also purchase 66,667 shares of UTI common stock and $2,560,000 of face amount convertible bonds which are due and payable on any change in control of UTI, in private transactions, primarily from officers of UTI. In addition, FSF will be granted a three year option to purchase up to 1,450,000 shares of UTI common stock for $15.00 per share. Management of UTI intends to use the equity that is being contributed to expand their operations through the acquisition of other life companies. The transaction is subject to the receipt of regulatory and other approvals; and the satisfaction of certain conditions. The transaction is not expected to be completed before July 31, 1998, and there can be no assurance that the transaction will be completed. FSF is an affiliate of First Southern Bancorp, Inc., a bank holding company that owns five banks that operate out of 14 locations in central Kentucky. Effect on Merger of UTI and UII If the FSF Agreement is consummated, the transaction will have no effect on the Merger, and in fact, will enhance the need to simplify the organizational structure which is one of the reasons for the merger. (See "INFORMATION REGARDING THE PROPOSED MERGER - Reasons for the merger UTI"). UTI has sufficient authorized and unissued shares to cover both the FSF Agreement and the Merger and as such, the transactions are not conditioned upon the UTI shareholders approving the proposed increase in authorized common stock of UTI; however, the option granted to FSF in the FSF Agreement to purchase up to 1,450,000 shares of UTI common stock will require and increase in its authorized common stock (See "PROPOSED INCREASE IN THE AUTHORIZED COMMON STOCK OF UTI"). Effects on Shareholders of UTI and UII If the FSF Agreement is consummated, there will be no effect on the UII shareholders. The effect on UTI shareholders will be positive to the extent that UTI will have an increase in its stockholders' equity from the FSF investment which will provide additional working capital to expand its operations through acquisitions. The issuance of the shares to FSF will have a dilutive ownership effect on UTI shareholders in that the shareholders will own a smaller percentage of UTI; yet UTI shareholders' equity will be increased. If the Merger is also consummated, the UII shareholders will be effected in the same manner as the UTI shareholders. Additionally, if the merger is consummated and should FSF exercise its options, FSF would then own approximately 51% of the outstanding common stock of UTI. DESCRIPTION OF UTI AND UII CAPITAL STOCK UTI UTI's Articles of Incorporation, as amended authorizes the issuance of 3,500,000 shares of Common Stock, no par value, and 150,000 shares of Preferred Stock, par value $100 per share. As of January 5, 1998, there were 1,655,200 shares of Common Stock outstanding and no shares of Preferred Stock outstanding. While shares of Preferred Stock may be issued from time to time in the future, UTI has no current plans to issue any such shares. The rights of holders of Common Stock may be materially limited or qualified upon issuance of Preferred Stock, as described below under "Preferred Stock". 115 DESCRIPTION OF COMMON STOCK Voting Rights. All shares of Common Stock have equal voting rights, with one vote per share, on all matters submitted to the shareholders for their consideration. The shares of Common Stock do not have cumulative voting rights. Dividends. Subject to the prior rights of the holders of the Preferred Stock, holders of Common Stock are entitled to receive dividends when and if declared by the Board of Directors, out of funds of the Company legally available therefrom. Other. Holders of shares of Common Stock do not have any preemptive rights or other rights to subscribe for additional shares, or any conversion rights. Upon any liquidation, dissolution or winding up of the affairs of the Company, holders of the Common Stock are entitled to share ratably in the assets available for distribution to such shareholder after the payment of all liabilities and after the liquidation preference of any Preferred Stock outstanding at the time. There are no sinking fund provisions applicable to the Common Stock. The outstanding shares of the Company are fully paid and non-assessable. All shares of Common Stock issuable upon the merger will likewise be fully paid and non-assessable. Transfer Agent and Registrar. UTI serves as its own registrar and transfer agent for the Common Stock. DESCRIPTION OF PREFERRED STOCK Under UTI's Articles of Incorporation, in addition to Common Stock, the Board of Directors authorized to issue, from time to time, without any further action on the part of its shareholders, up to 150,000 shares of Preferred Stock in one or more series with such preferences, limitations and relative rights are are determined by the Board of Directors at the time of issuance. There are no shares of Preferred Stock currently outstanding. The rights of holders of Common Stock may be materially limited or adversely affected upon issuance of shares of Preferred Stock. For example, the issuance of Preferred Stock could be used in certain circumstances to render more difficult or discourage a merger, tender offer or proxy contest or a removal of incumbent management. Preferred Stock may be issued with voting and conversion rights that could adversely affect the voting power and other rights of the holders of Common Stock. While shares of Preferred Stock may be issued from time to time in the future, UTI has no current plans to issue any such shares. LIQUIDATION Upon liquidation, after payment of the liquidation preferences of any outstanding Preferred Stock, the remaining net assets of UTI will be distributed pro rata to the holders of the Common Stock, in cash or in kind. UII UII Articles of Incorporation, as amended authorizes the issuance of 2,310,001 shares of Common Stock, no par value, and 150,000 shares of Preferred Stock, par value $100 per share. As of January 5, 1998, there were 1,391,919 shares of Common Stock outstanding and no shares of Preferred Stock outstanding. The rights of holders of Common Stock may be materially limited or qualified upon issuance of Preferred Stock, as described below under "Preferred Stock". Voting Rights. All shares of Common Stock have equal voting rights, with one vote per share, on all matters submitted to the shareholders for their consideration. The shares of Common Stock do not have cumulative voting rights. Dividends. Subject to the prior rights of the holders of the Preferred Stock, holders of Common Stock are entitled to receive dividends when and if declared by the Board of Directors, out of funds of the Company legally available therefrom. 116 Other. Holders of shares of Common Stock do not have any preemptive rights or other rights to subscribe for additional shares, or any conversion rights. Upon any liquidation, dissolution or winding up of the affairs of the Company, holders of the Common Stock are entitled to share ratably in the assets available for distribution to such shareholder after the payment of all liabilities and after the liquidation preference of any Preferred Stock outstanding at the time. There are no sinking fund provisions applicable to the Common Stock. The outstanding shares of the Company are fully paid and non-assessable Transfer Agent and Registrar. UII serves as its own registrar and transfer agent for the Common Stock. DESCRIPTION OF PREFERRED STOCK Under UII's Articles of Incorporation, in addition to Common Stock, the Board of Directors of the Company is authorized to issue, from time to time, without any further action on the part of its shareholders, up to 150,000 shares of Preferred Stock in one ore more series with such preferences, limitations and relative rights as are determined by the Board of Directors at the time of issuance. There are no shares of Preferred Stock currently outstanding. The rights of holders of Common Stock may be materially limited or adversely affected upon issuance of shares of Preferred Stock. For example, the issuance of Preferred Stock could be used in certain circumstances to render more difficult or discourage a merger, tender offer or proxy contest or a removal of incumbent management. Preferred Stock may be issued with voting and conversion rights that could adversely affect the voting power and other rights of the holders of Common Stock. While shares of Preferred Stock may be issued from time to time in the future, UII has no current plans to issue any such shares. LIQUIDATION Upon liquidation, after payment of the liquidation preferences of any outstanding Preferred Stock, the remaining net assets of UII will be distributed pro rata to the holders of the Common Stock, in cash or in kind. 117 PROPOSED INCREASE IN THE AUTHORIZED COMMON STOCK OF UTI The Board of Directors of UTI has declared advisable and in the best interests of UTI and its stockholders, and has recommended to the stockholders, an amendment of Article Fourth of UTI's Articles of Incorporation (the "Amendment") increasing UTI's authorized Common Stock from 3,500,000 shares to 7,000,000 shares. Appendix D, to this Proxy Statement contains the text of the Amendment. The following discussion of the Amendment is qualified in its entirety by reference to the text of the Amendment set forth in Appendix C. At present, UTI's authorized capital stock consists of 3,500,000 shares of Common Stock, no par value and 150,000 shares of Preferred Stock, par value $100 per share. As of the record date there were no shares of the Preferred Stock issued and outstanding. On that date there were 1,912,239 shares of Common Stock issued and outstanding with 257,039 shares being held in UTI's treasury. The proposed Amendment increases the number of authorized shares of Common Stock from 3,500,000 shares to 7,000,000 shares. The Amendment has no effect on the present authorization with respect to the Preferred Stock. The purpose of the Amendment is to provide UTI with the flexibility to engage in future transactions that UTI's Board of Directors may deem necessary or desirable. For example, the increase in authorized shares of Common Stock would allow UTI to declare and effectuate a stock dividend without further shareholder action or to acquire another company by exchanging shares of Common Stock of UTI for shares of the other company. The Amendment would also enable UTI to grant options to purchase shares of the authorized but unissued Common Stock to certain employees. Other than the Proposed Merger, UTI has committed approximately 360,000 shares of authorized but unissued Common Stock under current agreements. The additional shares of authorized Common Stock resulting from the Amendment would be identical in all respects to the existing Common Stock. All outstanding Common Stock would continue to have one vote per share. The authorized but currently unissued Preferred Stock would continue to be issuable by the Board, from time to time, with the voting powers, designations, preferences and relative, participating, optional or other special rights, and the qualifications, limitations, or restrictions, as described at DESCRIPTION OF UTI AND UII CAPITAL STOCK - UTI -Preferred Stock. The Board is empowered to issue authorized shares of Common stock in excess of those outstanding without further action by the stockholders, unless such action is required by applicable law or regulatory agencies or by the rules, if UTI shall choose to comply with such rules, of any stock exchange on which UTI's securities may then be listed. Current stockholders have no pre-emptive rights to subscribe to or to purchase any securities of UTI of any kind or class. Additional shares might be issued at such times and under such circumstances as to have a dilutive effect on earnings per share and on the equity ownership of the present holders of Common Stock. Such shares could also be used to make more difficult a change in control of UTI. Under certain circumstances, the Board of Directors of UTI could create impediments or frustrate persons seeking to effect a takeover or otherwise gain control of UTI, by causing such shares to be issued to a holder or holders who might side with the Board in opposing a takeover bid that the Board determines is not in the best interests of UTI and its stockholders. In addition, the existence of such shares might have the effect of discouraging an attempt by another person or entity to acquire control of UTI through the acquisition of a substantial amount of Common Stock, since the issuance of such shares could dilute the stock ownership of such person or entity. The Board of Directors of UTI recommends to the stockholders of UTI that they vote in favor of the Amendment. The affirmative vote of two thirds of the outstanding shares of UTI Common Stock is required to approve the proposal. Unless otherwise instructed, proxies will be voted in favor of the proposal to adopt the Amendment. If approved, the Amendment will become effective upon filing and recording as required by the Illinois Business Corporation Act. 118 RELATIONSHIP WITH INDEPENDENT PUBLIC ACCOUNTANTS Kerber, Eck and Braeckel LLP served as UTI's and UII's independent certified public accounting firm for the fiscal year ended December 31, 1997 and for fiscal year ended December 31, 1996. In serving its primary function as outside auditor, Kerber, Eck and Braeckel LLP performed the following audit services: examination of annual consolidated financial statements; assistance and consultation on reports filed with the Securities and Exchange Commission and; assistance and consultation on separate financial reports filed with the State insurance regulatory authorities pursuant to certain statutory requirements. UTI and UII do not expect that a representative of Kerber, Eck and Braeckel LLP will be present at the Special Meeting of Shareholders. Kerber, Eck and Braeckel LLP has been selected for fiscal year 1998. OTHER MATTERS TO COME BEFORE THE MEETING The management does not intend to bring any other business before the meetings of the UTI and UII shareholders and has no reason to believe that any will be presented in the meetings. If, however, any other business should properly be presented to the meetings, the proxies named in the enclosed form of proxy will vote the proxies in accordance with their best judgement. SHAREHOLDER PROPOSALS FOR 1998 ANNUAL MEETING Proposals intended to be presented by Shareholders at the 1998 Annual Meeting of Shareholders of UTI and UII must be received by UTI or UII, as the case may be, not later than December 31, 1998, in order to be considered for inclusion in the proxy statement and form of proxy relating to that meeting. Any such proposal should be communicated in writing to the particular company's Secretary at the address indicated above. If the Merger is consummated, no such UII meeting will be held. 119 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Springfield, State of Illinois, on UNITED TRUST, INC. By /s/ Larry E. Ryherd Larry E. Ryherd Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933, this Amendment No. 1 to the Registration Statement has been signed by the following persons in the capacities and on the dates indicated. /s/ John S. Albin John S. Albin, Director /s/ William F. Cellini William F. Cellini, Director /s/ Robert E. Cook Robert E. Cook, Director /s/ Larry R. Dowell Larry R. Dowell, Director /s/ Donald G. Geary Donald G. Geary, Director /s/ Raymond L. Larson Raymond L. Larson, Director / /s/ Dale E. McKee Dale E. McKee, Director /s/ Thomas F. Morrow Thomas F. Morrow, Director /s/ Larry E. Ryherd Larry E. Ryherd, Chairman of the Board, Chief Executive Officer and Director /s/ James E. Melville James E. Melville, Chief Operating Officer, President, and Director /s/ Theodore C. Miller Theodore C. Miller, Senior Vice President, Chief Financial Officer (Principal Financial and Accounting Officer) 120 UTI INDEX TO EXHIBITS Exhibit Number 3(a) (1) Amended Articles of Incorporation for the Company dated November 20, 1987. 3(b) (1) Amended Articles of Incorporation for the Company dated December 6, 1991. 3(c) (1) Amended Articles of Incorporation for the Company dated March 30, 1993. 3(d) (1) Code of By-Laws for the Company. 10(a) (2) Credit Agreement dated May 8, 1996 between First of America Bank - Illinois, N.A., as lender and First Commonwealth Corporation, as borrower. 10(b) (2) $8,900,000 Term Note of First Commonwealth Corporation to First of America Bank - Illinois, N.A. dated May 8, 1996. 10(c) (2) Coinsurance Agreement dated September 30, 1996 between Universal Guaranty Life Insurance Company and First International Life Insurance Company, including assumption reinsurance agreement exhibit and amendments. 10(d) (1) Subcontract Agreement dated September 1, 1990 between United Trust, Inc. and United Income, Inc. 10(e) (1) Service Agreement dated November 8, 1989 between United Security Assurance Company and United Income, Inc. 10(f) (1) Management and Consultant Agreement dated as of January 1, 1993 between First Commonwealth Corporation and Universal Guaranty Life Insurance Company. 10(g) (1) Management Agreement dated December 20, 1981 between Commonwealth Industries Corporation, and Abraham Lincoln Insurance Company. 10(h) (1) Reinsurance Agreement dated January 1, 1991 between Universal Guaranty Life Insurance Company and Republic Vanguard Life Insurance Company. 10(i) (1) Reinsurance Agreement dated July 1, 1992 between United Security Assurance Company and Life Reassurance Corporation of America. 121 UTI INDEX TO EXHIBITS Exhibit Number 10(j) (1) United Trust, Inc. Stock Option Plan. 10(k) (1) Board Resolution adopting United Trust, Inc.'s Officer Incentive Fund. 10(l) (3) Employment Agreement dated as of July 31, 1997 between Larry E. Ryherd and First Commonwealth Corporation 10(m) (3) Employment Agreement dated as of July 31, 1997 between James E. Melville and First Commonwealth Corporation 10(n) (3) Employment Agreement dated as of July 31, 1997 between George E. Francis and First Commonwealth Corporation. Agreements containing the same terms and conditions excepting title and current salary were also entered into by Joseph H. Metzger, Brad M. Wilson, Theodore C. Miller, Michael K. Borden and Patricia G. Fowler. 10(o) (1) Consulting Arrangement entered into June 15, 1987 between Robert E. Cook and United Trust, Inc. 10(p) (1) Agreement dated June 16, 1992 between John K. Cantrell and First Commonwealth Corporation. 10(q) (1) Termination Agreement dated as of January 29, 1993 between Scott J. Engebritson and United Trust, Inc., United Fidelity, Inc., United Income, Inc., First Commonwealth Corporation and United Security Assurance Company. 10(r) (1) Stock Purchase Agreement dated February 20, 1992 between United Trust Group, Inc. and Sellers. 10(s) (1) Amendment No. One dated April 20, 1992 to the Stock Purchase Agreement between the Sellers and United Trust Group, Inc. 10(t) (1) Security Agreement dated June 16, 1992 between United Trust Group, Inc. and the Sellers. 10(u) (1) Stock Purchase Agreement dated June 16, 1992 between United Trust Group, Inc. and First Commonwealth Corporation Footnote: (1) Incorporated by reference from the Company's Annual Report on Form 10-K, File No. 0-5392, as of December 31, 1993. (2) Incorporated by reference from the Company's Annual Report on Form 10-K, File No. 0-5392, as of December 31, 1996. (3) Incorporated by reference from the Company's Annual Report on Form 10-K, File No. 0-5392, as of December 31, 1997 122 UII INDEX TO EXHIBITS Exhibit Number 3(i) (1) Articles of Incorporation for the Company dated November 2, 1987. 3(i) (1) Amended Articles of Incorporation for the Company dated January 27, 1988. 3(ii) (1) Code of Regulations for the Company. 10(a) (1) Service Agreement between United Income, Inc. and United Security Assurance Company dated November 8, 1989. 10(b) (2) Subcontract Service Agreement between United Income, Inc. and United Trust, Inc. dated September 1, 1990. 10(c) (2) Non-Qualified Stock Option Plan 10(d) (2) Stock Option Plan 10(e) (3) Credit Agreement dated May 8, 1996 between First of America Bank - Illinois, N.A., as lender and First Commonwealth Corporation, as borrower. 10(f) (3) $8,900,000 Term Note of First Commonwealth Corporation to First of America Bank - Illinois, N.A. dated May 8, 1996. 10(g) (3) Coinsurance Agreement dated September 30, 1996 between Universal Guaranty Life Insurance Company and First International Life Insurance Company, including assumption reinsurance agreement exhibit and amendments. 10(h) (4) Employment Agreement dated as of July 31, 1997 between Larry E. Ryherd and First Commonwealth Corporation 10(i) (4) Employment Agreement dated as of July 31, 1997 between James E. Melville and First Commonwealth Corporation 10(j) (4) Employment Agreement dated as of July 31, 1997 between George E. Francis and First Commonwealth Corporation. Agreements containing the same terms and conditions excepting title and current salary were also entered into by Joseph H. Metzger, Brad M. Wilson, Theodore C. Miller, Michael K. Borden and Patricia G. Fowler. 99(a) (1) Order of Ohio Division of Securities registering United Income, Inc.'s securities dated March 9, 1988. 99(b) (1) Order of Ohio Division of Securities registering United Income, Inc.'s Securities dated April 5, 1989. 99(c) (1) Order of Ohio Division of Securities registering United Income, Inc.'s Securities dated April 23, 1990. 99(d) Audited financial statements of United Trust Group, Inc. 123 FOOTNOTE (1) Incorporated by reference from the Company's Registration Statement on Form 10, File No. 0-18540, filed on April 30, 1990. (2) Incorporated by reference from the Company's Annual Report on Form 10-K, File No. 0-18540, as of December 31, 1991. (3) Incorporated by reference from the Company's Annual Report on Form 10-K, File No. 0-18540, as of December 31, 1996. (4) Incorporated by reference from the Company's Annual Report on Form 10-K, File No. 0-1854, as of December 31, 1997. 124 INDEX TO FINANCIAL STATEMENTS United Trust, Inc. Annual Consolidated Financial Statements Consolidated Balance Sheets as of December 31, 1997 and 1996 127 Consolidated Statements of Operations Three Years Ended December 31, 1997 128 Consolidated Statements of Shareholders' Equity Three Years Ended December 31, 1997 129 Consolidated Statements of Cash Flows Three Years Ended December 31, 1997 130 Notes to Financial Statements 131 Interim Financial Statements Consolidated Balance Sheets as of March 31, 1998 and December 31, 1997 165 Consolidated Statements of Operations Three Months Ended March 31, 1998 and 1997 166 Consolidated Statements of Cash Flows Three Months Ended March 31, 1998 and 1997 167 Notes to Consolidated Financial Statements 168 United Income, Inc. Consolidated Balance Sheets as of December 31, 1997 and 1996 176 Consolidated Statements of Operations Three Years Ended December 31, 1997 177 Consolidated Statements of Shareholders' Equity Three Years Ended December 31, 1997 178 Consolidated Statements of Cash Flows Three Years Ended December 31, 1997 179 Notes to Financial Statements 180 Exhibit Containing Audited Consolidated Financial Statements and Notes of United Trust Group, Inc. 190 Interim Financial Statements Consolidated Balance Sheets as of March 31, 1998 and December 31, 1997 225 Consolidated Statements of Operations Three Months Ended March 31, 1998 and 1997 226 Consolidated Statements of Cash Flows Three Months Ended March 31, 1998 and 1997 227 Notes to Consolidated Financial Statements 228 125 INDEPENDENT AUDITORS' REPORT BOARD OF DIRECTORS AND SHAREHOLDERS UNITED TRUST, INC. We have audited the accompanying consolidated balance sheets of United Trust, Inc. (an Illinois corporation) and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of United Trust, Inc. and subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. We have also audited Schedule I as of December 31, 1997, and Schedules II, IV and V as of December 31, 1997 and 1996, of United Trust, Inc. and subsidiaries and Schedules II, IV and V for each of the three years in the period then ended. In our opinion, these schedules present fairly, in all material respects, the information required to be set forth therein. KERBER, ECK & BRAECKEL LLP Springfield, Illinois March 26, 1998 126 UNITED TRUST, INC.CONSOLIDATED BALANCE SHEETSAs of December 31, 1997 and 1996 ASSETS 1997 1996 Investments: Fixed maturities at amortized cost $ 180,970,333 $ 179,926,785 (market $184,782,568 and $181,815,225) Investments held for sale: Fixed maturities, at market 1,668,630 1,961,166 (cost $1,672,298 and $1,984,661) Equity securities, at market 3,001,744 1,794,405 (cost $3,184,357 and $2,086,159) Mortgage loans on real estate at amortized cost 9,469,444 11,022,792 Investment real estate, at cost, 9,760,732 9,779,984 net of accumulated depreciation Real estate acquired in satisfaction of debt 1,724,544 1,724,544 Policy loans 14,207,189 14,438,120 Short-term investments 1,798,878 430,983 222,601,494 221,078,779 Cash and cash equivalents 16,105,933 17,326,235 Investment in affiliates 5,636,674 4,826,584 Accrued investment income 3,686,562 3,461,799 Reinsurance receivables: Future policy benefits 37,814,106 38,745,013 Policy claims and other benefits 3,529,078 3,856,124 Other accounts and notes receivable 845,066 894,321 Cost of insurance acquired 41,522,888 43,917,280 Deferred policy acquisition costs 10,600,720 11,325,356 Cost in excess of net assets purchased, net of accumulated amortization 2,777,089 5,496,808 Property and equipment, net of 3,412,956 3,255,171 of accumulated depreciation Other assets 767,258 1,290,192 Total assets $ 349,299,824 $ 355,473,662 LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities and accruals: Future policy benefits $ 248,805,695 $ 248,879,317 Policy claims and benefits payable 2,080,907 3,193,806 Other policyholder funds 2,445,469 2,784,967 Dividend and endowment accumulations 14,905,816 13,913,676 Income taxes payable: Current 15,730 70,663 Deferred 14,174,260 13,193,431 Notes payable 21,460,223 19,573,953 Indebtedness to affiliates, net 18,475 31,837 Other liabilities 3,790,051 5,975,483 Total liabilities 307,696,626 307,617,133 Minority interests in consolidated subsidiaries 26,246,580 29,842,672 Shareholders' equity: Common stock - no par value, stated value share. Authorized 3,500,000 shares - 1,634,779 and 1,870,093 shares issued after deducting treasury shares of 277,460 and 42,384 32,696 37,402 Additional paid-in capital 16,488,375 18,638,591 Unrealized depreciation of investments held for sale (29,127) (86,058) Accumulated deficit (1,135,326) (576,078) Total shareholders' equity 15,356,618 18,013,857 Total liabilities and shareholders' equity $ 349,299,824 $ 355,473,662
127 UNITED TRUST, INC.CONSOLIDATED STATEMENTS OF OPERATIONS Three Years Ended December 31, 1997 1997 1996 1995 Revenues: Premiums and policy fees $ 33,373,950 $ 35,891,609 $ 38,481,638 Reinsurance premiums and policy fees (4,734,705) (4,947,151) (5,383,102) Net investment income 14,857,297 15,868,447 15,456,224 Realized investment gains (279,096) (987,930) (124,235) and (losses), net Other income 774,884 1,151,395 1,438,559 43,992,330 46,976,370 49,869,084 Benefits and other expenses: Benefits, claims and settlement expenses: Life 23,644,252 26,568,062 26,680,217 Reinsurance benefits and claims (2,078,982) (2,283,827) (2,850,228) Annuity 1,560,828 1,892,489 1,797,475 Dividends to policyholders 3,929,073 4,149,308 4,228,300 Commissions and amortization of deferred policy acquisition costs 3,616,365 4,224,885 4,907,653 Amortization of cost of insurance acquired 2,394,392 5,524,815 4,303,237 Amortization of agency force 0 0 396,852 Non-recurring write down of value 0 0 8,296,974 of agency force Operating expenses 9,222,913 11,994,464 11,517,648 Interest expense 1,816,491 1,731,309 1,966,776 44,105,332 53,801,505 61,244,904 Loss before income taxes, minority interest and equity in loss of investees (113,002) (6,825,135) (11,375,820 Income tax credit (expense) (986,229) 4,703,741 4,571,028 Minority interest in loss of consolidated subsidiaries 563,699 1,278,883 4,439,496 Equity in loss of investees (23,716) (95,392) (635,949) Net loss $ (559,248)$ (937,903)$ (3,001,245) Net loss per common share $ (0)$ (1)$ (2) Average common shares outstanding 1,772,870 1,869,511 1,866,851
128 UNITED TRUST, INC.CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Three Years Ended December 31, 1997 1997 1996 1995 Common stock Balance, beginning of year $ 37,402 $ 37,352 $ 37,312 Issued during year 0 50 40 Stock retired from purchase of fractional shares of reverse stock split (7) 0 0 Purchase treasury stock (4,699) 0 0 Balance, end of year $ 32,696 $ 37,402 $ 37,352 Additional paid-in capital Balance, beginning of year $18,638,591 $18,624,578 $18,612,118 Issued during year 0 14,013 12,460 Stock retired from purchase of fractional shares of reverse stock split (2,374) 0 0 Purchase treasury stock (2,147,842) 0 0 Balance, end of year $16,488,375 $18,638,591 $18,624,578 Unrealized appreciation (depreciation) of investments held for sale Balance, beginning of year $ (86,058) $ (1,499) $ (143,405) Change during year 56,931 (84,559) 141,906 Balance, end of year $ (29,127) $ (86,058) $ (1,499) Retained earnings (accumulated deficit) Balance, beginning of year $ (576,078) $ 361,825 $ 3,363,070 Net loss (559,248) (937,903) (3,001,245) Balance, end of year $(1,135,326) $ (576,078) $ 361,825 Total shareholders' equity, end $15,356,618 $18,013,857 $19,022,256
129 UNITED TRUST, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Three Years Ended December 31, 1997 1997 1996 1995 Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net loss $ (559,248) $ (937,903) $(3,001,245) Adjustments to reconcile net loss to net cash provided by (used in) operating activities net of changes in assets and liabilities resulting from the sales and purchases of subsidiaries: Amortization/accretion of fixed maturities 670,185 899,445 803,696 Realized investment (gains) losses 279,096 987,930 124,235 Policy acquisition costs deferred (586,000) (1,276,000) (2,370,000) Amortization of deferred policy acquisition costs 1,310,636 1,387,372 1,567,748 Amortization of cost of insurance acquired 2,394,392 5,524,815 4,303,237 Amortization of value of agency force 0 0 396,852 Non-recurring write down of value of agency force 0 0 8,296,974 Amortization of costs in excess of 155,000 185,279 423,192 net assets purchased Depreciation 469,854 390,357 720,605 Minority interest (563,699) (1,278,883) (4,439,496) Equity in loss of investees 23,716 95,392 635,949 Change in accrued investment income (224,763) 210,043 (171,257) Change in reinsurance receivables 1,257,953 83,871 (482,275) Change in policy liabilities and accruals (547,081) 3,326,651 3,581,928 Charges for mortality and administration of universal life and annuity products (10,588,874) (10,239,476) (9,757,354) Interest credited to account balances 7,212,406 7,075,921 6,644,282 Change in income taxes payable 925,896 (4,714,258) (4,595,571) Change in indebtedness (to) from affiliates, net (13,362) 119,706 (20,004) Change in other assets and liabilities, net (1,593,358) 1,299,773 (2,175,839) Net cash provided by (used in) operating activities 22,749 3,140,035 485,657 Cash flows from investing activities: Proceeds from investments sold and matured: Fixed maturities held for sale 290,660 1,219,036 619,612 Fixed maturities sold 0 18,736,612 0 Fixed maturities matured 21,488,265 20,721,482 16,265,140 Equity securities 76,302 8,990 104,260 Mortgage loans 1,794,518 3,364,427 2,252,423 Real estate 1,136,995 3,219,851 1,768,254 Policy loans 4,785,222 3,937,471 4,110,744 Short term 410,000 825,000 25,000 Total proceeds from investments sold and matured 29,981,962 52,032,869 25,145,433 Cost of investments acquired: Fixed maturities (23,220,172) (29,365,111) (25,112,358) Equity securities (1,248,738) 0 (1,000,000) Mortgage loans (245,234) (503,113) (322,129) Real estate (1,444,980) (813,331) (1,902,609) Policy loans (4,554,291) (4,329,124) (4,713,471) Short term (1,726,035) (830,983) (100,000) Total cost of investments acquired (32,439,450) (35,841,662) (33,150,567) Purchase of property and equipment (531,528) (383,411) (57,625) Net cash provided by (used in) investing activities (2,989,016) 15,807,796 (8,062,759) Cash flows from financing activities: Policyholder contract deposits 17,905,246 22,245,369 25,021,983 Policyholder contract withdrawals(14,515,576) (15,433,644) (16,008,462) Net cash transferred from coinsurance ceded 0 (19,088,371) 0 Proceeds from notes payable 2,560,000 9,050,000 300,000 Payments of principal on notes payable (1,874,597) (10,923,475) (905,861) Payment for fractional shares from (2,381) 0 0 reverse stock split Payment for fractional shares from (534,251) 0 0 stock split of subsidiary Purchase of stock of affiliates (865,877) 0 0 Purchase of treasury stock (926,599) 0 0 Proceeds from issuance of common 0 500 400 Net cash provided by (used in ) financing activities 1,745,965 (14,149,621) 8,408,060 Net increase (decrease) in cash and cash equivalents (1,220,302) 4,798,210 830,958 Cash and cash equivalents at beginning of year 17,326,235 12,528,025 11,697,067 Cash and cash equivalents at end of year $ 16,105,933 $ 17,326,235 $ 12,528,025
130 UNITED TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. ORGANIZATION - At December 31, 1997, the parent, significant majority-owned subsidiaries and affiliates of United Trust, Inc., were as depicted on the following organizational chart. ORGANIZATIONAL CHART AS OF DECEMBER 31, 1997 United Trust, Inc. ("UTI") is the ultimate controlling company. UTI owns 53% of United Trust Group ("UTG") and 41% of United Income, Inc. ("UII"). UII owns 47% of UTG. UTG owns 79% of First Commonwealth Corporation ("FCC") and 100% of Roosevelt Equity Corporation ("REC"). FCC owns 100% of Universal Guaranty Life Insurance Company ("UG"). UG owns 100% of United Security Assurance Company ("USA"). USA owns 84% of Appalachian Life Insurance Company ("APPL") and APPL owns 100% of Abraham Lincoln Insurance Company ("ABE"). 131 The Company's significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements are summarized as follows. B. NATURE OF OPERATIONS - United Trust, Inc. is an insurance holding company, which sells individual life insurance products through its subsidiaries. The Company's principal market is the Midwestern United States. The primary focus of the Company has been the servicing of existing insurance business in force, the solicitation of new life insurance products and the acquisition of other companies in similar lines of business. C. PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. Investments in 20% to 50% owned affiliates in which management has the ability to exercise significant influence are included based on the equity method of accounting and the Company's share of such affiliates' operating results is reflected in Equity in loss of investees. Other investments in affiliates are carried at cost. All significant intercompany accounts and transactions have been eliminated. D. BASIS OF PRESENTATION - The financial statements of United Trust, Inc.'s life insurance subsidiaries have been prepared in accordance with generally accepted accounting principles which differ from statutory accounting practices permitted by insurance regulatory authorities. E. USE OF ESTIMATES - In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F. INVESTMENTS - Investments are shown on the following bases: Fixed maturities -- at cost, adjusted for amortization of premium or discount and other-than-temporary market value declines. The amortized cost of such investments differs from their market values; however, the Company has the ability and intent to hold these investments to maturity, at which time the full face value is expected to be realized. Investments held for sale -- at current market value, unrealized appreciation or depreciation is charged directly to shareholders' equity. Mortgage loans on real estate -- at unpaid balances, adjusted for amortization of premium or discount, less allowance for possible losses. Real estate - Investment real estate at cost, less allowances for depreciation and, as appropriate, provisions for possible losses. Foreclosed real estate is adjusted for any impairment at the foreclosure date. Accumulated depreciation on investment real estate was $539,366 and $442,373 as of December 31, 1997 and 1996, respectively. Policy loans -- at unpaid balances including accumulated interest but not in excess of the cash surrender value. Short-term investments -- at cost, which approximates current market value. Realized gains and losses on sales of investments are recognized in net income on the specific identification basis. G. RECOGNITION OF REVENUES AND RELATED EXPENSES - Premiums for traditional life insurance products, which include those products with fixed and guaranteed premiums and benefits, consist principally of whole life insurance policies, limited-payment life insurance policies, and certain annuities with life contingencies are recognized as revenues when due. Accident and health insurance premiums are recognized as revenue pro rata over the terms of the policies. Benefits and related expenses associated with the premiums earned are charged to expense proportionately over the lives of the policies through a provision for future policy benefit 132 liabilities and through deferral and amortization of deferred policy acquisition costs. For universal life and investment products, generally there is no requirement for payment of premium other than to maintain account values at a level sufficient to pay mortality and expense charges. Consequently, premiums for universal life policies and investment products are not reported as revenue, but as deposits. Policy fee revenue for universal life policies and investment products consists of charges for the cost of insurance and policy administration fees assessed during the period. Expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances. H. DEFERRED POLICY ACQUISITION COSTS - Commissions and other costs of acquiring life insurance products that vary with and are primarily related to the production of new business have been deferred. Traditional life insurance acquisition costs are being amortized over the premium-paying period of the related policies using assumptions consistent with those used in computing policy benefit reserves. For universal life insurance and interest sensitive life insurance products, acquisition costs are being amortized generally in proportion to the present value of expected gross profits from surrender charges and investment, mortality, and expense margins. Under SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments," the Company makes certain assumptions regarding the mortality, persistency, expenses, and interest rates it expects to experience in future periods. These assumptions are to be best estimates and are to be periodically updated whenever actual experience and/or expectations for the future change from initial assumptions. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised. The following table summarizes deferred policy acquisition costs and related data for the years shown. 1997 1996 1995 Deferred, beginning of year $ 11,325,356 $ 11,436,728 $ 10,634,476 Acquisition costs deferred: Commissions 312,000 845,000 1,838,000 Other expenses 274,000 431,000 532,000 Total 586,000 1,276,000 2,370,000 Interest accretion 425,000 408,000 338,000 Amortization charged to (1,735,636) (1,795,372) (1,905,748) income Net amortization (1,310,636) (1,387,372) (1,567,748) Change for the year (724,636) (111,372) 802,252 Deferred, end of year $ 10,600,720 $ 11,325,356 $ 11,436,728
The following table reflects the components of the income statement for the line item Commissions and amortization of deferred policy acquisition costs: 1997 1996 1995 Net amortization of deferred policy acquisition costs $ 1,310,636 $ 1,387,372 $ 1,567,748 Commissions 2,305,729 2,837,513 3,339,905 Total $ 3,616,365 $ 4,224,885 $ 4,907,653
133 Estimated net amortization expense of deferred policy acquisition costs for the next five years is as follows: Interest Net Accretion Amortization Amortization 1998 $ 403,000 $ 1,530,000 $ 1,127,000 1999 365,000 1,359,000 994,000 2000 330,000 1,211,000 881,000 2001 299,000 1,082,000 783,000 2002 270,000 969,000 699,000 I.COST OF INSURANCE ACQUIRED - When an insurance company is acquired, the Company assigns a portion of its cost to the right to receive future cash flows from insurance contracts existing at the date of the acquisition. The cost of policies purchased represents the actuarially determined present value of the projected future cash flows from the acquired policies. Cost of Insurance Acquired is amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. The interest rates utilized in the amortization calculation are 9% on approximately 24% of the balance and 15% on the remaining balance. The interest rates vary due to differences in the blocks of business. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised. 1997 1996 1995 Cost of insurance acquired, beginning of year $ 43,917,280 $ 55,816,934 $ 60,120,171 Interest accretion 5,962,644 6,312,931 7,044,239 Amortization (8,357,036 (11,837,746) (11,347,476) Net amortization (2,394,392 (5,524,815) (4,303,237) Balance attributable to coinsurance agreement 0 (6,374,839) 0 Cost of insurance acquired, end of year $ 41,522,888 $ 43,917,280 $ 55,816,934 Estimated net amortization expense of cost of insurance acquired for the next five years is as follows: Interest Net Accretion Amortization Amortization 1998 $ 6,113,000 $ 8,261,000 $ 2,148,000 1999 5,787,000 7,271,000 1,484,000 2000 5,559,000 6,811,000 1,252,000 2001 5,367,000 6,828,000 1,461,000 2002 4,737,000 6,203,000 1,466,000 J.COST IN EXCESS OF NET ASSETS PURCHASED - Cost in excess of net assets purchased is the excess of the amount paid to acquire a company over the fair value of its net assets. Costs in excess of net assets purchased are amortized on the straight-line basis over a 40-year period. Management continually reviews the value of goodwill based on estimates of future earnings. As part of this review, management determines whether goodwill is fully recoverable from projected undiscounted net cash flows from earnings of the subsidiaries over the remaining amortization period. If management were to determine that changes in such projected cash flows no longer supported the recoverability of goodwill over the remaining amortization period, the carrying value of goodwill would be reduced with a corresponding charge to expense or by shortening the amortization period (no such changes have occurred). Accumulated amortization of cost in excess of net assets purchased was $1,420,146 and $1,265,146 as of December 31, 1997 and 1996, respectively. A reverse stock split of FCC in May of 1997 created negative goodwill of $2,564,719. The credit to goodwill resulted from the retirement of fractional shares. Please refer to Note 11 to the Consolidated Financial Statements for additional information concerning the reverse stock split. 134 K. PROPERTY AND EQUIPMENT - Company- occupied property, data processing equipment and furniture and office equipment are stated at cost less accumulated depreciation of $1,990,314 and $1,617,453 at December 31, 1997 and 1996, respectively. Depreciation is computed on a straight-line basis for financial reporting purposes using estimated useful lives of three to 30 years. Depreciation expense was $372,861 and $418,449 for the years ended December 31, 1997 and 1996, respectively. L.FUTURE POLICY BENEFITS AND EXPENSES - The liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance subsidiaries' experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. The Company makes these assumptions at the time the contract is issued or, in the case of contracts acquired by purchase, at the purchase date. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. Current mortality rate assumptions are based on 1975-80 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or Linton C, which are industry standard actuarial tables for forecasting assumed policy lapse rates. Benefit reserves for universal life insurance and interest sensitive life insurance products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims in excess of related policy account balances. Interest crediting rates for universal life and interest sensitive products range from 5.0% to 6.0% in 1997, 1996 and 1995. M.POLICY AND CONTRACT CLAIMS - Policy and contract claims include provisions for reported claims in process of settlement, valued in accordance with the terms of the policies and contracts, as well as provisions for claims incurred and unreported based on prior experience of the Company. N.PARTICIPATING INSURANCE - Participating business represents 29% and 30% of the ordinary life insurance in force at December 31, 1997 and 1996, respectively. Premium income from participating business represents 50%, 52%, and 55% of total premiums for the years ended December 31, 1997, 1996 and 1995, respectively. The amount of dividends to be paid is determined annually by the respective insurance subsidiary's Board of Directors. Earnings allocable to participating policyholders are based on legal requirements that vary by state. O.INCOME TAXES - Income taxes are reported under Statement of Financial Accounting Standards Number 109. Deferred income taxes are recorded to reflect the tax consequences on future periods of differences between the tax bases of assets and liabilities and their financial reporting amounts at the end of each such period. P.BUSINESS SEGMENTS - The Company operates principally in the individual life insurance business. Q.EARNINGS PER SHARE - Earnings per share are based on the weighted average number of common shares outstanding during each year, retroactively adjusted to give effect to all stock splits. In accordance with Statement of Financial Accounting Standards No. 128, the computation of diluted earnings per share is not shown since the Company has a loss from continuing operations in each period presented, and any assumed conversion, exercise, or contingent issuance of securities would have an antidilutive effect on earnings per share. R.CASH EQUIVALENTS - The Company considers certificates of deposit and other short-term instruments with an original purchased maturity of three months or less cash equivalents. 135 S.RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform with the 1997 presentation. Such reclassifications had no effect on previously reported net loss, total assets, or shareholders' equity. T.REINSURANCE - In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage and coinsurance contracts. The Company retains a maximum of $125,000 of coverage per individual life. Amounts paid or deemed to have been paid for reinsurance contracts are recorded as reinsurance receivables. Reinsurance receivables is recognized in a manner consistent with the liabilities relating to the underlying reinsured contracts. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. 2. SHAREHOLDER DIVIDEND RESTRICTION At December 31, 1997, substantially all of consolidated shareholders' equity represents net assets of UTI's subsidiaries. The payment of cash dividends to shareholders is not legally restricted. However, insurance company dividend payments are regulated by the state insurance department where the company is domiciled. UTI is the ultimate parent of UG through ownership of several intermediary holding companies. UG can not pay a dividend directly to UTI due to the ownership structure. UG's dividend limitations are described below without effect of the ownership structure. Ohio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 1997, UG had a statutory gain from operations of $1,779,246. At December 31, 1997, UG's statutory capital and surplus amounted to $10,997,365. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. 3. INCOME TAXES Until 1984, the insurance companies were taxed under the provisions of the Life Insurance Company Income Tax Act of 1959 as amended by the Tax Equity and Fiscal Responsibility Act of 1982. These laws were superseded by the Deficit Reduction Act of 1984. All of these laws are based primarily upon statutory results with certain special deductions and other items available only to life insurance companies. Under the provision of the pre-1984 life insurance company income tax regulations, a portion of "gain from operations" of a life insurance company was not subject to current taxation but was accumulated, for tax purposes, in a special tax memorandum account designated as "policyholders' surplus account". Federal income taxes will become payable on this account at the then current tax rate when and if distributions to shareholders, other than stock dividends and other limited exceptions, are made in excess of the accumulated previously taxed income maintained in the "shareholders surplus account". The following table summarizes the companies with this situation and the maximum amount of income that has not been taxed in each. Shareholders' Untaxed Company Surplus Balance ABE $ 5,237,958 $ 1,149,693 APPL 5,417,825 1,525,367 UG 27,760,313 4,363,821 USA 0 0 136 The payment of taxes on this income is not anticipated; and, accordingly, no deferred taxes have been established. The life insurance company subsidiaries file a consolidated federal income tax return. The holding companies of the group file separate returns. Life insurance company taxation is based primarily upon statutory results with certain special deductions and other items available only to life insurance companies. Income tax expense consists of the following components: 1997 1996 1995 Current tax $ 5,400 $ (148,148) $ 2,641 expense Deferred tax (4,573,669) expense (credit) 980,829 (4,555,593) (credit) $ 986,229 $(4,703,741) $ (4,571,028) The Companies have net operating loss carryforwards for federal income tax purposes expiring as follows: UTI UG FCC 2004 $ 597,103 $ 0 $ 163,334 2005 292,656 0 138,765 2006 212,852 2,400,574 33,345 2007 110,758 782,452 676,067 2008 0 939,977 4,595 2009 0 0 168,800 2010 0 0 19,112 2012 0 2,970,692 0 TOTAL $ 1,213,369 $ 7,093,695 $ 1,204,018 The Company has established a deferred tax asset of $3,328,879 for its operating loss carryforwards and has established an allowance of $2,904,200. The following table shows the reconciliation of net income to taxable income of UTI: 1997 1996 1995 Net income (loss) $ (559,248) $ (937,903) $(3,001,245) Federal income tax 153,764 provision (credit) 414,230 (59,780) Loss of 356,422 714,916 2,613,546 subsidiaries Loss of investees 23,716 95,392 635,949 Write off of 10,000 investment in 0 315,000 affiliate Write off of note 0 211,419 0 receivable Depreciation 0 1,046 3,095 Other 44,059 25,528 22,091 Taxable income $ 279,179 $ 365,618 $ 437,200
UTI has a net operating loss carryforward of $1,213,369 at December 31, 1997. UTI has averaged $300,000 in taxable income over the past four years and must average taxable income of $122,000 per year to fully realize its net operating loss carryforwards. UTI's operating loss carryforwards do not begin to expire until the year 2004. Management believes future earnings of UTI will be sufficient to fully utilize its net operating loss carryforwards. 137 The expense or (credit) for income differed from the amounts computed by applying the applicable United State statutory rate of 35% to the loss before income taxes as a result of the following differences: 1997 1996 1995 Tax computed $ (39,551) $ (2,388,797) $ (3,981,537) at statutory rate Changes in taxes due to: Cost in excess of net assets purchased 54,250 64,848 60,594 purchased Current year loss for which no benefit realized 1,039,742 0 0 Benefit of prior losses (324,705) (2,393,395) (601,563) Other 256,493 13,603 (48,522) Income tax $ 986,229 $ (4,703,741) $ (4,571,028) expense (credit) The following table summarizes the major components that comprise the deferred tax liability as reflected in the balance sheets: 1997 1996 Investments $ (228,027) $ (122,251) Cost of insurance acquired 15,753,308 16,637,884 Other assets (72,468) (187,747) Deferred policy acquisition costs 3,710,252 3,963,875 Agent balances (23,954) (65,609) Property and equipment (19,818) (37,683) Discount of notes 1,097,352 922,766 Management/consulting fees (573,182) (733,867) Future policy benefits (4,421,038) (5,906,087) Gain on sale of subsidiary 2,312,483 2,312,483 Net operating loss carryforward (424,679) (522,392) Other (756,482) (1,151,405) liabilities Federal tax DAC (2,179,487) (1,916,536) Deferred tax liability $ 14,174,260 $ 13,193,431
138 4. ANALYSIS OF INVESTMENTS, INVESTMENT INCOME AND INVESTMENT GAIN A.NET INVESTMENT INCOME - The following table reflects net investment income by type of investment: December 31, 1997 1996 1995 Fixed maturities and fixed maturities held for sale $ 12,677,348 $ 13,326,312 $ 13,190,121 Equity securities 87,211 88,661 52,445 Mortgage loans 802,123 1,047,461 1,257,189 Real estate 745,502 794,844 975,080 Policy loans 976,064 1,121,538 1,041,900 Short-term investments 70,624 21,423 21,295 Other 696,486 691,111 642,632 Total consolidated investment income 16,055,358 17,091,350 17,180,662 Investment expenses (1,198,061) (1,222,903) (1,724,438) Consolidated net investment $ 14,857,297 $ 15,868,447 $ 15,456,224 income
At December 31, 1997, the Company had a total of $5,797,000 of investments, comprised of $3,848,000 in real estate and $1,949,000 in equity securities, which did not produce income during 1997. The following table summarizes the Company's fixed maturity holdings and investments held for sale by major classifications: Carrying Value 1997 1996 Investments held for sale: Fixed maturities $ 1,668,630 $ 1,961,166 Equity securities 3,001,744 1,794,405 Fixed maturities: U.S. Government, government agencies and authorities 28,259,322 28,554,631 State, municipalities and political subdivisions 22,778,816 14,421,735 Collateralized mortgage obligations 11,093,926 13,246,781 Public utilities 47,984,322 51,821,989 All other corporate bonds 70,853,947 71,891,649 $ 185,640,707 $ 183,692,356
By insurance statute, the majority of the Company's investment portfolio is required to be invested in investment grade securities to provide ample protection for policyholders. The Company does not invest in so- called "junk bonds" or derivative investments. Below investment grade debt securities generally provide higher yields and involve greater risks than investment grade debt securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment grade issuers. In addition, the trading market for these securities is usually more limited than for investment grade debt securities. Debt securities classified as below- investment grade are those that receive a Standard & Poor's rating of BB or below. 139 The following table summarizes by category securities held that are below investment grade at amortized cost: Below Investment Grade 1997 1996 1995 Investments State, Municipalities and political $ 0 $ 10,042 $ 0 Subdivisions Public 80,497 117,609 116,879 Utilities Corporate 656,784 813,717 819,010 Total $ 737,281 $ 941,368 $ 935,889 B. INVESTMENT SECURITIES The amortized cost and estimated market values of investments in securities including investments held for sale are as follows: Cost or Gross Gross Estimated Amortized Unrealized Unrealized Market 1997 Cost Gains Losses Value Investments Held for Sale: U.S. Government and govt. agencies and authorities $ 1,448,202 $ 0 $ (5,645) $ 1,442,557 States, municipalities and political subdivisions 35,000 485 0 35,485 subdivisions Collateralized mortgage obligations 0 0 0 0 Public utilities 80,169 328 0 80,496 All other corporate bonds 108,927 1,164 0 110,092 1,672,298 1,977 (5,645) 1,668,630 Equity securities 3,184,357 176,508 (359,121) 3,001,744 Total $ 4,856,655 $ 178,485 $ (364,766) $ 4,670,374 Held to Maturity Securities: U.S. Government and govt. agencies and authorities $ 28,259,322 $ 415,419 $ (51,771) $ 28,622,970 States, municipalities and political subdivisions 22,778,816 672,676 (1,891) 23,449,601 subdivisions Collateralized mortgage obligations 11,093,926 210,435 (96,714) 11,207,647 Public utilities 47,984,322 1,241,969 (84,754) 49,141,537 All other corporate bonds 70,853,947 1,599,983 (93,117) 72,360,813 Total $ 180,970,333 $ 4,140,482 $ (328,247) $184,782,568
140 Cost or Gross Gross Estimated Amortized Unrealized Unrealized Market 1996 Cost Gains Losses Value Investments Held for Sale: U.S. Government and govt. agencies and authorities $ 1,461,068 $ 0 $ (17,458) $ 1,443,609 States, municipalities and political subdivisions 145,199 665 (6,397) 139,467 Collateralized mortgage obligations 0 0 0 0 Public utilities 119,970 363 (675) 119,658 All other corporate bonds 258,424 4,222 (4,215) 258,432 1,984,661 5,250 (28,745) 1,961,166 Equity securities 2,086,159 37,000 (328,754) 1,794,405 securities Total $ 4,070,820 $ 42,250 $ (357,499) $ 3,755,571 Held to Maturity Securities: U.S. Government and govt. agencies and authorities $ 28,554,631 $ 421,523 $ (136,410) $ 28,839,744 States, municipalities 14,421,735 318,682 (28,084) 14,712,333 and political subdivisions Collateralized mortgage obligations 13,246,780 175,163 (157,799) 13,264,145 Public utilities 51,821,990 884,858 (381,286 52,325,561 All other corporate bonds 71,881,649 1,240,230 (448,437) 72,673,442 Total $ 179,926,785 $ 3,040,456 $ (1,152,016) $181,815,225
The amortized cost of debt securities at December 31, 1997, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Fixed Maturities Estimated Held for Sale Amortized Market December 31, 1997 Cost Value Due in one year or less $ 83,927 $ 84,952 Due after one year through five years 1,533,202 1,528,211 Due after five years through ten years 55,169 55,467 Due after ten years 0 0 Collateralized mortgage obligations 0 0 Total $ 1,672,298 $ 1,668,630
141 Fixed Maturities Held to Amortized Estimated Maturity Cost Market December 31, 1997 Value Due in one year or less $ 15,023,173 $ 15,003,728 Due after one year through five years 118,849,668 120,857,201 Due after five years through ten years 30,266,228 31,726,265 Due after ten years 5,737,338 5,987,726 Collateralized mortgage obligations 11,093,926 11,207,648 Total $ 180,970,333 $ 184,782,568
An analysis of sales, maturities and principal repayments of the Company's fixed maturities portfolio for the years ended December 31, 1997, 1996 and 1995 is as follows: Cost or Gross Gross Proceeds Amortized Realized Realized from Year ended December Cost Gains Losses Sale 31, 1997 Scheduled principal repayments, calls and tenders: Held for sale $ 299,390 $ 931 $ (9,661) $ 290,660 Held to maturity 21,467,552 21,435 (722) 21,488,265 Sales: Held for sale 0 0 0 0 Held to maturity 0 0 0 0 Total $ 21,766,942 $ 22,366 $ (10,383) $ 21,778,925
Cost or Gross Gross Proceeds Amortized Realized Realized from Year ended December Cost Gains Losses Sale 31, 1996 Scheduled principal repayments, calls and tenders: Held for sale $ 699,361 $ 6,035 $ (813) $ 704,583 Held to maturity 20,900,159 13,469 (192,146) 20,721,482 Sales: Held for sale 517,111 0 (2,658) 514,453 Held to maturity 18,735,848 81,283 (80,519) 18,736,612 Total $ 40,852,479 $ 100,787 $ (276,136) $ 40,677,130
142 Cost or Gross Gross Proceeds Amortized Realized Realized from Year ended December Cost Gains Losses Sale 31, 1995 Scheduled principal repayments, calls and tenders: Held for sale $ 621,461 $ 0 $ (1,849) $ 619,612 Held to maturity 16,383,921 125,740 (244,521) 16,265,140 Sales: Held for sale 0 0 0 0 Held to maturity 0 0 0 0 Total $ 17,005,382 $ 125,740 $ (246,370) $ 16,884,752
C.INVESTMENTS ON DEPOSIT - At December 31, 1997, investments carried at approximately $17,801,000 were on deposit with various state insurance departments. D.INVESTMENTS IN AND ADVANCES TO AFFILIATED COMPANIES - The Company's investment in United Income, Inc., a 40% owned affiliate, is carried at an amount equal to the Company's share of the equity of United Income. The Company's equity in United Income, Inc. includes the original investment of $194,304, an increase of $4,359,749 resulting from a public offering of stock and the Company's share of earnings and losses since inception. 5. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS The financial statements include various estimated fair value information at December 31, 1997 and 1996, as required by Statement of Financial Accounting Standards 107, Disclosure about Fair Value of Financial Instruments ("SFAS 107"). Such information, which pertains to the Company's financial instruments, is based on the requirements set forth in that Statement and does not purport to represent the aggregate net fair value of the Company. The following methods and assumptions were used to estimate the fair value of each class of financial instrument required to be valued by SFAS 107 for which it is practicable to estimate that value: (a) Cash and Cash equivalents The carrying amount in the financial statements approximates fair value because of the relatively short period of time between the origination of the instruments and their expected realization. (b) Fixed maturities and investments held for sale Quoted market prices, if available, are used to determine the fair value. If quoted market prices are not available, management estimates the fair value based on the quoted market price of a financial instrument with similar characteristics. (c) Mortgage loans on real estate The fair values of mortgage loans are estimated using discounted cash flow analyses and interest rates being offered for similar loans to borrowers with similar credit ratings. (d) Investment real estate and real estate acquired in satisfaction of debt An estimate of fair value is based on management's review of the individual real estate holdings. Management utilizes sales of surrounding properties, current market conditions and geographic considerations. Management conservatively estimates the fair value of the portfolio is equal to the carrying value. 143 (e) Policy loans It is not practicable to estimate the fair value of policy loans as they have no stated maturity and their rates are set at a fixed spread to related policy liability rates. Policy loans are carried at the aggregate unpaid principal balances in the consolidated balance sheets, and earn interest at rates ranging from 4% to 8%. Individual policy liabilities in all cases equal or exceed outstanding policy loan balances. (f) Short-term investments For short-term instruments, the carrying amount is a reasonable estimate of fair value. Short-term instruments represent United States Government Treasury Bills and certificates of deposit with various banks that are protected under FDIC. (g) Notes and accounts receivable and uncollected premiums The Company holds a $840,066 note receivable for which the determination of fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Accounts receivable and uncollected premiums are primarily insurance contract related receivables which are determined based upon the underlying insurance liabilities and added reinsurance amounts, and thus are excluded for the purpose of fair value disclosure by paragraph 8(c) of SFAS 107. (h) Notes payable For borrowings under the senior loan agreement, which is subject to floating rates of interest, carrying value is a reasonable estimate of fair value. For subordinated borrowings fair value was determined based on the borrowing rates currently available to the Company for loans with similar terms and average maturities. The estimated fair values of the Company's financial instruments required to be valued by SFAS 107 are as follows as of December 31: 1997 1996 Estimated Estimated Carrying Fair Carrying Fair Assets Amount Value Amount Value Fixed maturities $ 180,970,333 $ 184,782,568 $ 179,926,785 $ 181,815,225 Fixed maturities held for sale 1,668,630 1,668,630 1,961,166 1,961,166 Equity securities 3,001,744 3,001,744 1,794,405 1,794,405 Mortgage loans on real estate 9,469,444 9,837,530 11,022,792 11,022,792 Policy loans 14,207,189 14,207,189 14,438,120 14,438,120 Short-term investments 1,798,878 1,798,878 430,983 430,983 Investment in real estate 9,760,732 9,760,732 9,779,984 9,779,984 Real estate acquired in satisfaction of debt 1,724,544 1,724,544 1,724,544 1,724,544 Notes receivable 840,066 784,831 840,066 783,310 Liabilities Notes payable 21,460,223 20,925,184 19,573,953 18,937,055
144 6. STATUTORY EQUITY AND GAIN FROM OPERATIONS The Company's insurance subsidiaries are domiciled in Ohio, Illinois and West Virginia and prepare their statutory-based financial statements in accordance with accounting practices prescribed or permitted by the respective insurance department. These principles differ significantly from generally accepted accounting principles. "Prescribed" statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners ("NAIC"). "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, from company to company within a state, and may change in the future. The NAIC currently is in the process of codifying statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. Accordingly, that project, which has not yet been completed, will likely change prescribed statutory accounting practices and may result in changes to the accounting practices that insurance enterprises use to prepare their statutory financial statements. UG's total statutory shareholders' equity was $10,997,365 and $10,226,566 at December 31, 1997 and 1996, respectively. The Company's insurance subsidiaries reported combined statutory gain from operations (exclusive of intercompany dividends) was $3,978,000, $10,692,000 and $4,076,000 for 1997, 1996 and 1995, respectively. 7. REINSURANCE Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The Company assumes risks from, and reinsures certain parts of its risks with other insurers under yearly renewable term and coinsurance agreements that are accounted for by passing a portion of the risk to the reinsurer. Generally, the reinsurer receives a proportionate part of the premiums less commissions and is liable for a corresponding part of all benefit payments. While the amount retained on an individual life will vary based upon age and mortality prospects of the risk, the Company generally will not carry more than $125,000 individual life insurance on a single risk. The Company has reinsured approximately $1.022 billion, $1.109 billion and $1.088 billion in face amount of life insurance risks with other insurers for 1997, 1996 and 1995, respectively. Reinsurance receivables for future policy benefits were $37,814,106 and $38,745,093 at December 31, 1997 and 1996, respectively, for estimated recoveries under reinsurance treaties. Should any reinsurer be unable to meet its obligation at the time of a claim, obligation to pay such claim would remain with the Company. Currently, the Company is utilizing reinsurance agreements with Business Men's Assurance Company, ("BMA") and Life Reassurance Corporation, ("LIFE RE") for new business. BMA and LIFE RE each hold an "A+" (Superior) rating from A.M. Best, an industry rating company. The reinsurance agreements were effective December 1, 1993, and cover all new business of the Company. The agreements are a yearly renewable term ("YRT") treaty where the Company cedes amounts above its retention limit of $100,000 with a minimum cession of $25,000. One of the Company's insurance subsidiaries (UG) entered into a coinsurance agreement with First International Life Insurance Company ("FILIC") as of September 30, 1996. Under the terms of the agreement, UG ceded to FILIC substantially all of its paid-up life insurance policies. Paid-up life insurance generally refers to non-premium paying life insurance policies. A.M. Best assigned FILIC a Financial Performance Rating (FPR) of 7 (Strong) on a scale of 1 to 9. A.M. Best assigned a Best's Rating of A++ (Superior) to The Guardian Life Insurance Company of America ("Guardian"), parent of FILIC, based on the consolidated financial condition and operating performance of the company and its life/health subsidiaries. During 1997, FILIC changed its name to Park Avenue Life Insurance Company ("PALIC"). The agreement with PALIC accounts for approximately 65% of the reinsurance receivables as of December 31, 1997. The Company does not have any short-duration reinsurance contracts. The effect of the Company's long-duration reinsurance contracts on premiums earned in 1997, 1996 and 1995 was as follows: 145 Shown in thousands 1997 1996 1995 Premiums Premiums Premiums Earned Earned Earned Direct $ 33,374 $ 35,891 $ 38,482 Assumed 0 0 0 Ceded (4,735) (4,947) (5,383) Net premiums $ 28,639 $ 30,944 $ 33,099 8. COMMITMENTS AND CONTINGENCIES The insurance industry has experienced a number of civil jury verdicts which have been returned against life and health insurers in the jurisdictions in which the Company does business involving the insurers' sales practices, alleged agent misconduct, failure to properly supervise agents, and other matters. Some of the lawsuits have resulted in the award of substantial judgments against the insurer, including material amounts of punitive damages. In some states, juries have substantial discretion in awarding punitive damages in these circumstances. Under the insurance guaranty fund laws in most states, insurance companies doing business in a participating state can be assessed up to prescribed limits for policyholder losses incurred by insolvent or failed insurance companies. Although the Company cannot predict the amount of any future assessments, most insurance guaranty fund laws currently provide that an assessment may be excused or deferred if it would threaten an insurer's financial strength. Mandatory assessments may be partially recovered through a reduction in future premium tax in some states. The Company does not believe such assessments will be materially different from amounts already provided for in the financial statements. The Company and its subsidiaries are named as defendants in a number of legal actions arising primarily from claims made under insurance policies. Those actions have been considered in establishing the Company's liabilities. Management and its legal counsel are of the opinion that the settlement of those actions will not have a material adverse effect on the Company's financial position or results of operations. 9. RELATED PARTY TRANSACTIONS United Trust, Inc. has a service agreement with its affiliate, UII (equity investee), to perform services and provide personnel and facilities. The services included in the agreement are claim processing, underwriting, processing and servicing of policies, accounting services, agency services, data processing and all other expenses necessary to carry on the business of a life insurance company. UII has a service agreement with USA which states that USA is to pay UII monthly fees equal to 22% of the amount of collected first year premiums, 20% in second year and 6% of the renewal premiums in years three and after. UII's subcontract agreement with UTI states that UII is to pay UTI monthly fees equal to 60% of collected service fees from USA as stated above. USA paid $989,295, $1,567,891 and $2,015,325 under their agreement with UII for 1997, 1996 and 1995, respectively. UII paid $593,577, $940,734 and $1,209,195 under their agreement with UTI for 1997, 1996 and 1995, respectively. Respective domiciliary insurance departments have approved the agreements of the insurance companies and it is Management's opinion that where applicable, costs have been allocated fairly and such allocations are based upon generally accepted accounting principles. The costs paid by UTI for services include costs related to the production of new business, which are deferred as policy acquisition costs and charged off to the income statement through "Amortization of deferred policy acquisition costs". Also included are costs associated with the maintenance of existing policies that are charged as current period costs and included in "general expenses". 146 On July 31, 1997, United Trust Inc. issued convertible notes for cash received totaling $2,560,000 to seven individuals, all officers or employees of United Trust Inc. The notes bear interest at a rate of 1% over prime, with interest payments due quarterly and principal due upon maturity of July 31, 2004. The conversion price of the notes are graded from $12.50 per share for the first three years, increasing to $15.00 per share for the next two years and increasing to $20.00 per share for the last two years. Conditional upon the seven individuals placing the funds with the Company were the acquisition by UTI of a portion of the holdings of UTI owned by Larry E. Ryherd and his family and the acquisition of common stock of UTI and UII held by Thomas F. Morrow and his family and the simultaneous retirement of Mr. Morrow. Neither Mr. Morrow nor Mr. Ryherd was a party to the convertible notes. Approximately $1,048,000 of the cash received from the issuance of the convertible notes was used to acquire stock holdings of United Trust Inc. and United Income, Inc. of Mr. Morrow and to acquire a portion of the United Trust Inc. holdings of Larry E. Ryherd and his family. The remaining cash received will be used by the Company to provide additional operating liquidity and for future acquisitions of life insurance companies. On July 31, 1997, the Company acquired a total of 126,921 shares of United Trust Inc. common stock and 47,250 shares of United Income, Inc. common stock from Thomas F. Morrow and his family. Mr. Morrow simultaneously retired as an executive officer of the Company. Mr. Morrow will remain as a member of the Board of Directors. In exchange for his stock, Mr. Morrow and his family received approximately $348,000 in cash, promissory notes valued at $140,000 due in eighteen months, and promissory notes valued at $1,030,000 due January 31, 2005. These notes bear interest at a rate of 1% over prime, with interest due quarterly and principal due upon maturity. The notes do not contain any conversion privileges. Additionally, on July 31, 1997, the Company acquired a total of 97,499 shares of United Trust Inc. common stock from Larry E. Ryherd and his family. Mr. Ryherd and his family received approximately $700,000 in cash and a promissory note valued at $251,000 due January 31, 2005. The acquisition of approximately 16% of Mr. Ryherd's stock holdings in United Trust Inc. was completed as a prerequisite to the convertible notes placed by other management personnel to reduce the total holdings of Mr. Ryherd and his family in the Company to make the stock more attractive to the investment community. Following the transaction, Mr. Ryherd and his family own approximately 31% of the outstanding common stock of United Trust Inc. On September 23, 1997, the Company acquired 10,056 shares of UTI common stock from Paul Lovell, a director, for $35,000 and a promissory note valued at $61,000 due September 23, 2004. The note bears interest at a rate of 1% over prime, with interest due quarterly and principal reductions of $10,000 annually until maturity. Simultaneous with the stock purchase, Mr. Lovell resigned his position on the UTI board. On July 31,1997, the Company entered into employment agreements with eight individuals, all officers or employees of the Company. The agreements have a term of three years, excepting the agreements with Mr. Ryherd and Mr. Melville, which have five-year terms. The agreements secure the services of these key individuals, providing the Company a stable management environment and positioning for future growth. 10. CAPITAL STOCK TRANSACTIONS A. STOCK OPTION PLAN In 1985, the Company initiated a nonqualified stock option plan for employees, agents and directors of the Company under which options to purchase up to 44,000 shares of UTI's common stock are granted at a fixed price of $.20 per share. Through December 31, 1997 options for 42,438 shares were granted and exercised. Options for 1,562 shares remain available for grant. 147 A summary of the status of the Company's stock option plan for the three years ended December 31, 1997, and changes during the years ending on those dates is presented below.: 1997 1996 1995 Exercise Exercise Exercise Shares Price Shares Price Shares Price Outstanding at beginning of year 1,562 $ 0.20 4,062 $ 0.20 6,062 $ 0.20 Granted 0 0.00 0 0.00 0 0.00 Exercised 0 0.00 (2,500) 0.20 (2,000) 0.20 Forfeited 0 0.00 0 0.00 0 0.00 Outstanding at end of year 1,562 $ 0.20 1,562 $ 0.20 4,062 $ 0.20 Options exercisable at year end 1,562 $ 0.20 1,562 $ 0.20 4,062 $ 0.20 Fair value of options granted during the year $ 0.00 $ 5.43 $ 6.05
The following information applies to options outstanding at December 31, 1997: Number outstanding 1,562 Exercise price $ 0.20 Remaining contractual life Indefinite B. DEFERRED COMPENSATION PLAN UTI and FCC established a deferred compensation plan during 1993 pursuant to which an officer or agent of FCC, UTI or affiliates of UTI, could defer a portion of their income over the next two and one-half years in return for a deferred compensation payment payable at the end of seven years in the amount equal to the total income deferred plus interest at a rate of approximately 8.5% per annum and a stock option to purchase shares of common stock of UTI. At the beginning of the deferral period an officer or agent received an immediately exercisable option to purchase 2,300 shares of UTI common stock at $17.50 per share for each $25,000 ($10,000 per year for two and one-half years) of total income deferred. The option expires on December 31, 2000. A total of 105,000 options were granted in 1993 under this plan. As of December 31, 1997 no options were exercised. At December 31, 1997 and 1996, the Company held a liability of $1,376,384 and $1,267,598, respectively, relating to this plan. At December 31, 1997, UTI common stock had a bid price of $8.00 and an ask price of $9.00 per share. The following information applies to deferred compensation plan stock options outstanding at December 31, 1997: Number outstanding 105,000 Exercise price $17.50 Remaining contractual life 3 years C. CONVERTIBLE NOTES On July 31, 1997, United Trust Inc. issued convertible notes for cash in the amount of $2,560,000 to seven individuals, all officers or employees of United Trust Inc. The notes bear interest at a rate of 1% over prime, with interest payments due quarterly and principal due upon maturity of July 31, 2004. The conversion price of the notes are graded from $12.50 per share for the first three years, increasing to $15.00 per share for the next two years and increasing to $20.00 per share for the last two years. As of December 31, 1997, the notes were convertible into 204,800 shares of UTI common stock with no conversion privileges having been exercised. At December 31, 1997, UTI common stock had a bid price of $8.00 and an ask price of $9.00 per share. 148 D. REVERSE STOCK SPLIT On May 13, 1997, UTI effected a 1 for 10 reverse stock split. Fractional shares received a cash payment on the basis of $1.00 for each old share. The reverse split was completed to enable UTI to meet new NASDAQ requirements regarding market value of stock to remain listed on the NASDAQ market and to increase the market value per share to a level where more brokers will look at UTI and its stock. Prior period numbers have been restated to give effect of the reverse split. 11. REVERSE STOCK SPLIT OF FCC On May 13, 1997, FCC effected a 1 for 400 reverse stock split. Fractional shares received a cash payment on the basis of $.25 for each old share. FCC maintained a significant number of shareholder accounts with less than $100 of market value of stock. The reverse stock split enabled these smaller shareholders to receive cash for their shares without incurring broker costs and will save the Company administrative costs associated with maintaining these small accounts. 12. NOTES PAYABLE At December 31, 1997 and 1996, the Company has $21,460,223 and $19,573,953 in long-term debt outstanding, respectively. The debt is comprised of the following components: 1997 1996 Senior debt $ 6,900,000 $ 8,400,000 Subordinated 10 yr. notes 5,746,774 6,209,293 Subordinated 20 yr. notes 3,902,582 3,814,660 Convertible notes 2,560,000 0 Other notes payable 2,350,867 1,150,000 $ 21,460,223 $ 19,573,953 A. Senior debt The senior debt is through First of America Bank - Illinois NA and is subject to a credit agreement. The debt bears interest at a rate equal to the "base rate" plus nine-sixteenths of one percent. The Base rate is defined as the floating daily, variable rate of interest determined and announced by First of America Bank from time to time as its "base lending rate." The base rate at December 31, 1997 was 8.5%. Interest is paid quarterly. Principal payments of $1,000,000 are due in May of each year beginning in 1997, with a final payment due May 8, 2005. On November 8, 1997, the Company prepaid the May 1998 principal payment. The credit agreement contains certain covenants with which the Company must comply. These covenants contain provisions common to a loan of this type and include such items as; a minimum consolidated net worth of FCC to be no less than 400% of the outstanding balance of the debt; Statutory capital and surplus of Universal Guaranty Life Insurance Company be maintained at no less than $6,500,000; an earnings covenant requiring the sum of the pre- tax earnings of Universal Guaranty Life Insurance Company and its subsidiaries (based on Statutory Accounting Practices) and the after-tax earnings plus non-cash charges of FCC (based on parent only GAAP practices) shall not be less than two hundred percent (200%) of the Company's interest expense on all of its debt service. The Company is in compliance with all of the covenants of the agreement. B. Subordinated debt The subordinated debt was incurred June 16, 1992 as a part of the acquisition of the now dissolved Commonwealth Industries Corporation, (CIC). The 10-year notes bear interest at the rate of 7 1/2% per annum, payable semi-annually beginning December 16, 1992. These notes, except for one $840,000 note, provide for principal payments equal to 1/20th of the principal balance due with each interest installment beginning December 16, 1997, with a final payment due June 16, 2002. The aforementioned $840,000 note provides for a lump sum principal payment due June 16, 2002. In June 1997, the Company refinanced a $204,267 subordinated 10-year note as a subordinated 20-year note bearing interest at the rate of 8.75% per annum. The repayment terms of the refinanced note are the same as the original subordinated 20 year notes. The original 20-year notes bear interest at the rate of 8 1/2% per annum on $3,397,620 and 8.75% per annum on $504,962 (of which the $204,267 note refinanced in the current year is included), payable semi-annually with a lump sum principal payment due June 16, 2012. 149 C. Convertible notes On July 31, 1997, United Trust Inc. issued convertible notes for cash in the amount of $2,560,000 to seven individuals, all officers or employees of United Trust Inc. The notes bear interest at a rate of 1% over prime, with interest payments due quarterly and principal due upon maturity of July 31, 2004. The conversion price of the notes are graded from $12.50 per share for the first three years, increasing to $15.00 per share for the next two years and increasing to $20.00 per share for the last two years. D. Other notes payable United Income, Inc. holds two promissory notes receivable totaling $850,000 due from FCC. Each note bears interest at the rate of 1% over prime as published in the Wall Street Journal, with interest payments due quarterly. Principal of $150,000 is due upon the maturity date of June 1, 1999, with the remaining principal payment of $700,000 becoming due upon the maturity date of May 8, 2006. As partial proceeds in the acquisition of common stock from certain officers and directors in the third quarter of 1997, the Company issued unsecured promissory notes. These notes bear interest at 1% over prime with interest payments due quarterly. Principal comes due at varying times with $150,000 maturing on January 31, 1999, $1,654,507 maturing on July 31, 2005 and one note of $70,392 requiring annual principal reductions of $10,000 until maturity on September 23, 2004. The interest rates were deemed favorable to UTI and as a result, the Company has discounted the notes to reflect a 15% effective rate of interest for financial statement purposes. The notes have a total face maturity value of $1,874,899 and a discounted value at December 31, 1997 of $1,500,867. Scheduled principal reductions on the Company's debt for the next five years is as follows: Year Amount 1998 $ 526,504 1999 1,826,504 2000 1,526,504 2001 1,526,504 2002 4,690,758 13. OTHER CASH FLOW DISCLOSURES On a cash basis, the Company paid $1,800,110, $1,700,973 and $1,934,326 in interest expense for the years 1997, 1996 and 1995, respectively. The Company paid $57,277, $17,634 and $25,821 in federal income tax for 1997, 1996 and 1995, respectively. As partial proceeds for the acquisition of common stock of UTI and UII during 1997, UTI issued promissory notes of $140,000 due in eighteen months, $61,000 due in seven years and $1,281,000 due in seven and one-half years. One of the Company's insurance subsidiaries ("UG") entered into a coinsurance agreement with Park Avenue Life Insurance Company ("PALIC") at September 30, 1996. At closing of the transaction, UG received a coinsurance credit of $28,318,000 for policy liabilities covered under the agreement. UG transferred assets equal to the credit received. This transfer included policy loans of $2,855,000 associated with policies under the agreement and a net cash transfer of $19,088,000 after deducting the ceding commission due UG of $6,375,000. To provide the cash required to be transferred under the agreement, the Company sold $18,737,000 of fixed maturity investments. 150 14. NON-RECURRING WRITE DOWN OF VALUE OF AGENCY FORCE ACQUIRED During the year-ended December 31, 1995, the Company recognized a non- recurring write down of $8,297,000 on its value of agency force acquired. The write down released $2,904,000 of the deferred tax liability and $3,327,000 was attributed to minority interest in loss of consolidated subsidiaries. In addition, equity loss of investees was negatively impacted by $542,000. The effect of this write down resulted in an increase in the net loss of $2,608,000. This write down is directly related to the Company's change in distribution systems. Due to the broker agency force not meeting management's expectations and lack of production, the Company has changed its focus from a primarily broker agency distribution system to a captive agent system. With the change in focus, most of the broker agents were terminated and therefore, management re- evaluated the value of the agency force carried on the balance sheet. For purposes of the write-down, the broker agency force has no future expected cash flows and therefore warranted a write-off of the value. The write down is reported as a separate line item "non-recurring write down of value of agency force acquired" and the release of the deferred tax liability is reported in the credit for income taxes payable in the Statement of Operations. In addition, the impact to minority interest in loss of consolidated subsidiaries and equity loss of investees is in the Statement of Operations. 15. CONCENTRATION OF CREDIT RISK The Company maintains cash balances in financial institutions that at times may exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents. 16. NEW ACCOUNTING STANDARDS The Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards (SFAS) No. 128 entitled Earnings per share, which is effective for financial statements for fiscal years beginning after December 15, 1997. SFAS No. 128 specifies the computation, presentation, and disclosure requirements for earnings per share (EPS) for entities with publicly held common stock or potential common stock. The Statement's objective is to simplify the computation of earnings per share, and to make the U.S. standard for computing EPS more compatible with the EPS standards of other countries. Under SFAS No. 128, primary EPS computed in accordance with previous opinions is replaced with a simpler calculation called basic EPS. Basic EPS is calculated by dividing income available to common stockholders (i.e., net income or loss adjusted for preferred stock dividends) by the weighted-average number of common shares outstanding. Thus, in the most significant change in current practice, options, warrants, and convertible securities are excluded from the basic EPS calculation. Further, contingently issuable shares are included in basic EPS only if all the necessary conditions for the issuance of such shares have been satisfied by the end of the period. Fully diluted EPS has not changed significantly but has been renamed diluted EPS. Income available to common stockholders continues to be adjusted for assumed conversion of all potentially dilutive securities using the treasury stock method to calculate the dilutive effect of options and warrants. However, unlike the calculation of fully diluted EPS under previous opinions, a new treasury stock method is applied using the average market price or the ending market price. Further, prior opinion requirement to use the modified treasury stock method when the number of options or warrants outstanding is greater than 20% of the outstanding shares also has been eliminated. SFAS 128 also includes certain shares that are contingently issuable; however, the test for inclusion under the new rules is much more restrictive. SFAS No. 128 requires companies reporting discontinued operations, extraordinary items, or the cumulative effect of accounting changes are to use income from operations as the control number or benchmark to determine whether potential common shares are dilutive or antidilutive. Only dilutive securities are to be included in the calculation of diluted EPS. 151 This statement was adopted for the 1997 Financial Statements. For all periods presented the Company reported a loss from continuing operations so any potential issuance of common shares would have an antidilutive effect on EPS. Consequently, the adoption of SFAS No. 128 did not have an impact on the Company's financial statement. The FASB has issued SFAS No. 130 entitled Reporting Comprehensive Income and SFAS No. 132 Employers' Disclosures about Pensions and Other Postretirement Benefits. Both of the above statements are effective for financial statements with fiscal years beginning after December 15, 1997. SFAS No. 130 defines how to report and display comprehensive income and its components in a full set of financial statements. The purpose of reporting comprehensive income is to report a measure of all changes in equity of an enterprise that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners. SFAS No. 132 addresses disclosure requirements for post-retirement benefits. The statement does not change post-retirement measurement or recognition issues. The Company will adopt both SFAS No. 130 and SFAS No. 132 for the 1998 financial statements. Management does not expect either adoption to have a material impact on the Company's financial statements. 17. PENDING CHANGE IN CONTROL OF UNITED TRUST, INC. On February 19, 1998, UTI signed a letter of intent with Jesse T. Correll, whereby Mr. Correll will personally or in combination with other individuals make an equity investment in UTI over a period of three years. Under the terms of the letter of intent Mr. Correll will buy 2,000,000 authorized but unissued shares of UTI common stock for $15.00 per share and will also buy 389,715 shares of UTI common stock, representing stock of UTI and UII, that UTI purchased during the last eight months in private transactions at the average price UTI paid for such stock, plus interest, or approximately $10.00 per share. Mr. Correll also will purchase 66,667 shares of UTI common stock and $2,560,000 of face amount of convertible bonds (which are due and payable on any change in control of UTI) in private transactions, primarily from officers of UTI. UTI intends to use the equity that is being contributed to expand their operations through the acquisition of other life insurance companies. The transaction is subject to negotiation of a definitive purchase agreement; completion of due diligence by Mr. Correll; the receipt of regulatory and other approvals; and the satisfaction of certain conditions. The transaction is not expected to be completed before June 30, 1998, and there can be no assurance that the transaction will be completed. 152 18. PROPOSED MERGER On March 25, 1997, the Board of Directors of UTI and UII voted to recommend to the shareholders a merger of the two companies. Under the Plan of Merger, UTI would be the surviving entity with UTI issuing one share of its stock for each share held by UII shareholders. UTI owns 53% of United Trust Group, Inc., an insurance holding company, and UII owns 47% of United Trust Group, Inc. Neither UTI nor UII have any other significant holdings or business dealings. The Board of Directors of each company thus concluded a merger of the two companies would be in the best interests of the shareholders. The merger will result in certain cost savings, primarily related to costs associated with maintaining a corporation in good standing in the states in which it transacts business. A vote of the shareholders of UTI and UII regarding the proposed merger is anticipated to occur sometime during the third quarter of 1998. 153 19.. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) 03/31/98 Premium income and other considerations, net $ 7,231,481 Net investment income 3,727,002 Total revenues 11,226,760 Policy benefits including dividends 6,827,040 Commissions and amortization of DAC 1,043,677 Operating expenses 2,237,840 Operating income (loss) 19,707 Net income (loss) 114,441 Basic earnings per share .07 Diluted earnings per share .08
1997 1st 2nd 3rd 4th Premium income and other considerations, net $ 7,926,386 $ 7,808,782 $ 6,639,394 $ 6,264,683 Net investment income 3,844,899 3,825,457 3,686,861 3,500,080 Total revenues 11,965,571 11,871,953 10,354,133 9,800,673 Policy benefits including dividends 7,718,015 6,861,699 6,467,739 6,007,718 Commissions and amortization of DAC 1,110,410 553,913 1,083,006 869,036 Operating expenses 2,589,176 2,777,409 2,378,618 1,477,710 Operating income (loss) (393,242) 683,223 (679,495) 276,512 Net income (loss) 47,026 101,812 (524,441) (183,645) Basic earnings per share .03 .05 (.28) (.12) Diluted earnings per share .03 .06 (.28) (.12) 1996 1st 2nd 3rd 4th Premium income and other considerations, net $ 8,481,511 $ 8,514,175 $ 7,348,199 $ 6,600,573 Net investment income 3,973,349 3,890,127 4,038,831 3,966,140 Total revenues 12,870,140 12,455,875 11,636,614 10,013,741 Policy benefits including dividends 6,528,760 7,083,803 8,378,710 8,334,759 Commissions and amortization of DAC 1,161,850 924,174 703,196 1,435,665 Operating expenses 3,447,329 2,851,752 3,422,654 2,272,729 Operating income (loss) (71,615) (137,198) (2,346,452) (4,269,870) Net income (loss) 304,737 9,038 (892,761) (358,917) Basic earnings per share .16 0.0 (.48) (.18) Diluted earnings per share .18 0.0 (.48) (.18)
154 1995 1st 2nd 3rd 4th Premium income and other considerations, net $ 9,445,222 $ 8,765,804 $ 7,868,803 $ 7,018,707 Net investment income 3,850,161 3,843,518 3,747,069 4,015,476 Total revenues 13,694,471 12,933,370 11,829,921 11,411,322 Policy benefits including dividends 8,097,830 9,113,933 5,978,795 6,665,206 Commissions and amortization of DAC 1,556,526 1,960,458 1,350,662 40,007 Operating expenses 3,204,217 2,492,689 2,232,938 3,587,804 Operating income (loss) (495,966) (1,939,361) 120,393 (9,060,886) Net income (loss) 179,044 (689,602) 198,464 (2,689,151) Basic earnings per share .10 (.37) .11 (1.45) Diluted earnings per share .11 (.37) .12 (1.45)
155 UNITED TRUST, INC.SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES As of December 31, 1997 Schedule I Column A Column B Column C Column D Amount at Which Shown in Balance Cost Value Sheet Fixed maturities: Bonds: United States Government and government agencies and authorities $ 28,259,322 $ 28,622,970 $ 28,259,322 State, municipalities, and political subdivisions 22,778,816 23,449,601 22,778,816 Collateralized mortgage obligations 11,093,926 11,207,647 11,093,926 Public utilities 47,984,322 49,141,537 47,984,322 All other corporate bonds 70,853,947 72,360,813 70,853,947 Total fixed maturities 180,970,333 $184,782,568 180,970,333 Investments held for sale: Fixed maturities: United States Goverment and government agencies and authorities 1,448,202 $ 1,442,557 1,442,557 State, municipalities, and political subdivisions 35,000 35,485 35,485 Public utilities 80,169 80,496 80,496 All other corporate bonds 108,927 110,092 110,092 1,672,298 $ 1,668,630 1,668,630 Equity securities: Banks, trusts and insurance companies 2,473,969 $ 2,167,368 2,167,368 All other corporate securities 710,388 834,376 834,376 3,184,357 $ 3,001,744 3,001,744 Mortgage loans on real estate 9,469,444 9,469,444 Investment real estate 9,760,732 9,760,732 Real estate acquired in satisfaction of debt 1,724,544 1,724,544 Policy loans 14,207,189 14,207,189 Short term investments 1,798,878 1,798,878 Total investments $222,787,775 $222,601,494
156 UNITED TRUST, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT Schedule II NOTES TO CONDENSED FINANCIAL INFORMATION (a) The condensed financial information should be read in conjunction with the consolidated financial statements and notes of United Trust, Inc. and Consolidated Subsidiaries. 157 UNITED TRUST, INC.CONDENSED FINANCIAL INFORMATION OFREGISTRANT PARENT ONLY BALANCE SHEETS As of December 31, 1997 and 1996 Schedule II 1997 1996 ASSETS Investment in affiliates $ 19,974,098 $ 19,475,431 Cash and cash equivalents 342,294 422,446 Notes receivable from affiliate 1,682,245 265,900 Receivable from affiliates, net 31,502 30,247 Accrued interest income 21,334 2,051 Other assets 225,986 262,927 Total assets $ 22,277,459 $ 20,459,002 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Notes payable $ 4,060,866 $ 0 Notes payable to affiliate 840,000 840,000 Deferred income taxes 2,016,575 1,602,345 Other liabilities 3,400 2,800 Total liabilities 6,920,841 2,445,145 Shareholders' equity: Common stock 32,696 37,402 Additional paid-in capital 16,488,375 18,638,591 Unrealized depreciation of investments held for sale of affiliate (29,127) (86,058) Accumulated deficit (1,135,326) (576,078) Total shareholders' equity 15,356,618 18,013,857 Total liabilities and shareholders' equity $ 22,277,459 $ 20,459,002
158 UNITED TRUST, INC.CONDENSED FINANCIAL INFORMATION OF REGISTRANT PARENT ONLY STATEMENTS OF OPERATIONS Three Years Ended December 31, 1997 Schedule II 1997 1996 1995 Revenues: Management fees from affiliates $ 593,577 $ 940,734 $ 1,209,196 Other income from affiliates 73,515 115,235 113,869 Interest income from affiliates 53,492 21,264 13,583 Interest income 37,620 29,340 21,678 Realized investment losses 0 (207,051) 0 Loss from write down of investee 0 (315,000) (10,000) 758,204 584,522 1,348,326 Expenses: Management fee to affiliate 200,000 575,000 800,000 Interest expense 194,543 0 0 Interest expense to affiliates 63,000 63,000 63,000 Operating expenses 65,541 133,897 83,312 523,084 771,897 946,312 Operating income (loss) 235,120 (187,375) 402,014 Income tax credit (expense) (414,230) 59,780 (153,764) Equity in loss of investees (23,716) (95,392) (635,949) Equity in loss of subsidiaries (356,422) (714,916) (2,613,546) Net loss $ (559,248)$ (937,903)$ (3,001,245)
159 UNITED TRUST, INC.CONDENSED FINANCIAL INFORMATION OF REGISTRANTPARENT ONLY STATEMENTS OF CASH FLOWS Three Years Ended December 31, 1997 Schedule II 1997 1996 1995 Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net loss $ (559,248)$ (937,903)$(3,001,245) Adjustments to reconcile net loss to net cash provided by operating activities: Equity in loss of subsidiaries 356,422 714,916 2,613,546 Equity in loss of investees 23,716 95,392 635,949 Compensation expense through 0 13,563 12,100 stock option plan Change in accrued interest income (19,283) 14,222 2,260 Depreciation 12,439 18,366 26,412 Realized investment losses 0 207,051 0 Loss from writedown of investee 0 315,000 10,000 Change in deferred income taxes 414,230 (60,524) 153,764 Change in indebtedness (to) (1,255) (104,766) (23,027) from affiliates, net Change in other assets and liabilities 44,029 (728) (274,167) Net cash provided by operating activities 271,050 274,589 155,592 Cash flows from investing activities: Purchase of stock of affiliates (865,877) 0 (325,000) Change in notes receivable from affiliate (1,116,345) (250,000) 300,000 Capital contribution to affiliate 0 (106,000) (53,000) Net cash used in investing activities (1,982,222) (356,000) (78,000) Cash flows from financing activities: Purchase of treasury stock (926,599) 0 0 Proceeds from issuance of notes payable 2,560,000 0 0 Payment for fractional shares from (2,381) 0 0 reverse stock split Proceeds from issuance of common stock 0 500 400 Net cash provided by financing activities 1,631,020 500 400 Net increase (decrease) in cash and cash equivalents (80,152) (80,911) 77,992 Cash and cash equivalents at beginning of year 422,446 503,357 425,365 Cash and cash equivalents at end of year $ 342,294 $ 422,446 $ 503,357
160 UNITED TRUST, INC.REINSURANCE As of December 31, 1997 and the year ended December 31, 1997 Schedule IV Column A Column B Column C Column D Column E Column F Percentage Ceded to Assumed of amount other from other assumed to Gross amount companies companies* Net amount net Life insurance in force $3,691,867,000 $1,022,458,000 $1,079,885,000 $3,749,294,000 28.80% Premiums and policy fees: Life insurance $ 33,133,414 $ 4,681,928 $ 0 $ 28,451,486 0.00% Accident and health insurance 240,536 52,777 0 187,759 0.00% $ 33,373,950 $ 4,734,705 $ 0 $ 28,639,245 0.00% * All assumed business represents the Company's participation in the Servicemen's Group Life Insurance Program (SGLI).
161 UNITED TRUST, INC.REINSURANCE As of December 31, 1996 and the yearended December 31, 1996 Schedule IV Column A Column B Column C Column D Column E Column F Percentage Ceded to Assumed of amount other from other assumed to Gross amount companies companies* Net amount net Life insurance in force $3,952,958,000 $1,108,534,000 $1,271,766,000 $4,116,190,000 30.90% Premiums and policy fees: Life insurance $ 35,633,232 $ 4,896,896 $ 0 $ 30,736,336 0.00% Accident and health insurance 258,377 50,255 0 208,122 0.00% $ 35,891,609 $ 4,947,151 $ 0 $ 30,944,458 0.00% * All assumed business represents the Company's participation in the Servicemen's Group Life Insurance Program (SGLI).
162 UNITED TRUST, INC.REINSURANCE As of December 31, 1995 and the year ended December 31, 1995 Schedule IV Column A Column B Column C Column D Column E Column F Percentage Ceded to Assumed of amount other from other assumed to Gross amount companies companies* Net amount net Life insurance in force $4,207,695,000 $1,087,774,000 $1,039,517,000 $4,159,438,000 25.00% Premiums and policy fees: Life insurance $ 38,233,190 $ 5,330,351 $ 0 $ 32,902,839 0.00% Accident and health insurance 248,448 52,751 0 195,697 0.00% $ 38,481,638 $ 5,383,102 $ 0 $ 33,098,536 0.00% * All assumed business represents the Company's participation in the Servicemen's Group Life Insurance Program (SGLI).
163 UNITED TRUST, INC.VALUATION AND QUALIFYING ACCOUNTS For the years ended December 31, 1997, 1996 and 1995 Schedule V Balance at Additions Beginning Charges Balances at Description Of Period and Expenses Deductions End of Period December 31, 1997 Allowance for doubtful accounts - mortgage loans $ 10,000 $ 0 $ 0 $ 10,000 December 31, 1996 Allowance for doubtful accounts - mortgage loans $ 10,000 $ 0 $ 0 $ 10,000 December 31, 1995 Allowance for doubtful accounts - mortgage loans $ 26,000 $ 0 $ 16,000 $ 10,000
164 PART 1. FINANCIAL INFORMATION Item 1. Financial Statements UNITED TRUST, INC. AND SUBSIDIARIES Consolidated Balance Sheets March 31, December 31, ASSETS 1998 1997 Investments: Fixed maturities at amortized cost (market $179,693,379 and $184,782,568) $ 175,588,738$ 180,970,333 Investments held for sale: Fixed maturities, at market (cost $1,669,020 and $1,672,298) 1,668,515 1,668,630 Equity securities, at market (cost $3,184,357 and $3,184,357) 2,619,571 3,001,744 Mortgage loans on real estate at amortized cost 9,314,870 9,469,444 Investment real estate, at cost, net of accumulated depreciation 9,137,807 9,760,732 Real estate acquired in satisfaction of debt 1,724,544 1,724,544 Policy loans 14,242,429 14,207,189 Short-term investments 627,845 1,798,878 Other invested assets 66,212 0 214,990,531 222,601,494 Cash and cash equivalents 24,978,271 16,105,933 Investment in affiliates 5,622,841 5,636,674 Accrued investment income 4,037,979 3,686,562 Reinsurance receivables: Future policy benefits 37,601,740 37,814,106 Policy claims and other benefits 3,576,509 3,529,078 Other accounts and notes receivable 903,254 845,066 Cost of insurance acquired 40,912,005 41,522,888 Deferred policy acquisition costs 10,283,427 10,600,720 Costs in excess of net assets purchased, net of accumulated amortization 2,718,102 2,777,089 Property and equipment, net of accumulated depreciation 3,390,147 3,412,956 Other assets 1,007,870 767,258 Total assets $ 350,022,676$ 349,299,824 LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities and accruals: Future policy benefits $ 249,368,889$ 248,805,695 Policy claims and benefits payable 1,939,075 2,080,907 Other policyholder funds 2,519,118 2,445,469 Dividend and endowment accumulations 15,089,100 14,905,816 Income taxes payable: Current 10,662 15,730 Deferred 14,078,843 14,174,260 Notes payable 21,511,706 21,460,223 Indebtedness to affiliates, net 85,476 18,475 Other liabilities 4,209,287 3,790,051 Total liabilities 308,812,156 307,696,626 Minority interests in consolidated subsidiaries 26,021,111 26,246,580 Shareholders' equity: Common stock - no par value, stated value $.02 per share. Authorized 3,500,000 shares - 1,62 and 1,634,779 shares issued after deducting treasury shares of 285,039 and 277,460 32,544 32,696 Additional paid-in capital 16,420,442 16,488,375 Unrealized depreciation of investments held for sale (242,692) (29,127) Accumulated deficit (1,020,885) (1,135,326) Total shareholders' equity 15,189,409 15,356,618 Total liabilities and shareholders' equity $ 350,022,676$ 349,299,824
165 UNITED TRUST, INC. AND SUBSIDIARIES Consolidated Statements of Operations Three Months Ended March 31, March 31, 1998 1997 Revenues: Premiums and policy fees $ 8,468,346 $ 9,072,396 Reinsurance premiums and policy fees (1,236,865) (1,146,010) Net investment income 3,727,002 3,844,899 Realized investment gains and (losses), net 92,248 (6,136) Other income 176,029 200,422 11,226,760 11,965,571 Benefits and other expenses: Benefits, claims and settlement expenses: Life 6,023,110 6,671,186 Reinsurance benefits and claims (589,874) (433,176) Annuity 377,860 352,503 Dividends to policyholders 1,015,944 1,127,502 Commissions and amortization of deferred policy acquisition costs 1,043,677 1,110,410 Amortization of cost of insurance acquired 610,883 526,264 Operating expenses 2,237,840 2,589,176 Interest expense 487,613 414,948 11,207,053 12,358,813 Income (loss) before income taxes, minority interest and equity in earnings of investees 19,707 (393,242) Income tax credit 85,031 403,562 Minority interest in loss (income) of consolidated subsidiaries (33,048) 20,092 Equity in earnings of investees 42,751 16,614 Net income $ 114,441 $ 47,026 Basic earnings per share from continuing operations and net income $ 0.07 $ 0.03 Diluted earnings per share from continuing operations and net income $ 0.08 $ 0.03
166 UNITED TRUST, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Three Months Ended March 31, March 31, 1998 1997 Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net income $ 114,441 $ 47,026 Adjustments to reconcile net income to net cash provided by (used in) operating activities net of changes in assets and liabilities resulting from the sales and purchases of subsidiaries: Amortization/accretion of fixed maturities 146,403 173,627 Realized investment (gains) losses, net (92,248) 6,136 Policy acquisition costs deferred (89,000) (234,000) Amortization of deferred policy acquisition costs 406,293 474,659 Amortization of cost of insurance acquired 610,883 526,264 Amortization of costs in excess of net assets purchased 22,500 38,750 Depreciation 118,631 101,245 Minority interest 33,048 (20,092) Equity in earnings of investees (42,751) (16,614) Change in accrued investment income (351,417) (644,956) Change in reinsurance receivables 164,935 374,086 Change in policy liabilities and accruals 31,192 (4,983) Charges for mortality and administration of universal life and annuity products (2,715,992) (2,632,738) Interest credited to account balances 1,781,211 1,840,372 Change in income taxes payable (100,485) (473,741) Change in indebtedness (to) from affiliates, net 67,001 (51,890) Change in other assets and liabilities, net 204,736 (7,954) Net cash provided by (used in) operating activities 309,381 (504,803) Cash flows from investing activities: Proceeds from investments sold and matured: Fixed maturities held for sale 0 0 Fixed maturities sold 0 0 Fixed maturities matured 15,433,649 953,856 Equity securities 0 0 Mortgage loans 154,574 539,138 Real estate 745,741 159,705 Policy loans 909,847 954,692 Short-term 1,180,000 0 Total proceeds from investments sold and matured 18,423,811 2,607,391 Cost of investments acquired: Fixed maturities held for sale 0 0 Fixed maturities (10,210,000) (3,947,561) Equity securities 0 0 Mortgage loans 0 0 Real estate (138,171) (252,742) Policy loans (945,087) (1,178,553) Other invested assets (66,212) 0 Short-term 0 0 Total cost of investments acquired (11,359,470) (5,378,856) Purchase of property and equipment (56,741) (28,123) Net cash provided by (used in) investing activities 7,007,600 (2,799,588) Cash flows from financing activities: Policyholder contract deposits 4,505,638 5,190,761 Policyholder contract withdrawals (2,923,754) (3,411,032) Purchase of treasury stock (26,527) 0 Net cash provided by financing activities 1,555,357 1,779,729 Net increase (decrease) in cash and cash equivalents 8,872,338 (1,524,662) Cash and cash equivalents at beginning of period 16,105,933 17,326,235 Cash and cash equivalents at end of period $ 24,978,271 $ 15,801,573
167 UNITED TRUST, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements 1. BASIS OF PRESENTATION The accompanying consolidated financial statements have been prepared by United Trust Inc. ("UTI") and its consolidated subsidiaries ("Company") pursuant to the rules and regulations of the Securities and Exchange Commission. Although the Company believes the disclosures are adequate to make the information presented not be misleading, it is suggested that these consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto presented in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 1997. The information furnished reflects, in the opinion of the Company, all adjustments (which include only normal and recurring accruals) necessary for a fair presentation of the results of operations for the periods presented. Operating results for interim periods are not necessarily indicative of operating results to be expected for the year or of the Company's future financial condition. At March 31, 1998, the parent, significant subsidiaries and affiliates of United Trust Inc. were as depicted on the following organizational chart. ORGANIZATIONAL CHART AS OF MARCH 31, 1998 United Trust, Inc. ("UTI") is the ultimate controlling company. UTI owns 53% of United Trust Group ("UTG") and 41% of United Income, Inc. ("UII"). UII owns 47% of UTG. UTG owns 79% of First Commonwealth Corporation ("FCC") and 100% of Roosevelt Equity Corporation ("REC"). FCC owns 100% of Universal Guaranty Life Insurance Company ("UG"). UG owns 100% of United Security Assurance Company ("USA"). USA owns 84% of Appalachian Life Insurance Company ("APPL") and APPL owns 100% of Abraham Lincoln Insurance Company ("ABE"). 168 2. INVESTMENTS As of March 31, 1998, fixed maturities and fixed maturities held for sale represented 82% of total invested assets. As prescribed by the various state insurance department statutes and regulations, the insurance companies' investment portfolio is required to be invested in investment grade securities to provide ample protection for policyholders. The Company does not invest in so-called "junk bonds" or derivative investments. The liabilities of the insurance companies are predominantly long term in nature and therefore, the companies invest primarily in long term fixed maturity investments. The Company has analyzed its fixed maturity portfolio and reclassified those securities expected to be sold prior to maturity as investments held for sale. The investments held for sale are carried at market. Management has the intent and ability to hold its fixed maturity portfolio to maturity and as such carries these securities at amortized cost. As of March 31, 1998, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in the context of consolidated assets or shareholders' equity. 3. NOTES PAYABLE At March 31, 1998 and December 31, 1997, the Company has $21,511,706 and $21,460,223 in long-term debt outstanding, respectively. The debt is comprised of the following components: 1998 1997 Senior debt $ 6,900,000 $ 6,900,000 Subordinated 10 yr. notes 5,746,774 5,746,774 Subordinated 20 yr. notes 3,902,582 3,902,582 Convertible notes 2,560,000 2,560,000 Other notes payable 2,392,686 2,350,867 $ 21,511,706 $ 21,460,223 A. Senior debt The senior debt is through First of America Bank - Illinois NA and is subject to a credit agreement. The debt bears interest at a rate equal to the "base rate" plus nine-sixteenths of one percent. The Base rate is defined as the floating daily, variable rate of interest determined and announced by First of America Bank from time to time as its "base lending rate." The base rate at March 31, 1998 was 8.5%. Interest is paid quarterly. Principal payments of $1,000,000 are due in May of each year, with a final payment due May 8, 2005. On November 8, 1997, the Company prepaid the May 1998 principal payment. The credit agreement contains certain covenants with which the Company must comply. These covenants contain provisions common to a loan of this type and include such items as; a minimum consolidated net worth of FCC to be no less than 400% of the outstanding balance of the debt; Statutory capital and surplus of Universal Guaranty Life Insurance Company be maintained at no less than $6,500,000; an earnings covenant requiring the sum of the pre- tax earnings of Universal Guaranty Life Insurance Company and its subsidiaries (based on Statutory Accounting Practices) and the after-tax earnings plus non-cash charges of FCC (based on parent only GAAP practices) shall not be less than two hundred percent (200%) of the Company's interest expense on all of its debt service. The Company is in compliance with all of the covenants of the agreement. B. Subordinated debt The subordinated debt was incurred June 16, 1992 as a part of the acquisition of the now dissolved Commonwealth Industries Corporation, (CIC). The 10-year notes bear interest at the rate of 7 1/2% per annum, payable semi-annually beginning December 16, 1992. These notes, except for one $840,000 note, provide for principal payments equal to 1/20th of the principal balance due with each interest installment beginning December 16, 1997, with a final payment due June 16, 2002. The aforementioned $840,000 note provides for a lump sum principal payment due June 16, 2002. In June 1997, the Company refinanced a $204,267 subordinated 10-year note as a subordinated 20-year note bearing interest at the rate of 8.75% per annum. The repayment terms of the refinanced note are the same as the original subordinated 20 year notes. The original 20-year notes bear interest at the rate of 8 1/2% per annum on $3,397,620 and 8.75% per annum on $504,962 (of which the $204,267 note refinanced in the current year is included), payable semi-annually with a lump sum principal payment due June 16, 2012. 1693 C. Convertible notes On July 31, 1997, United Trust Inc. issued convertible notes for cash in the amount of $2,560,000 to seven individuals, all officers or employees of United Trust Inc. The notes bear interest at a rate of 1% over prime, with interest payments due quarterly and principal due upon maturity of July 31, 2004. The conversion price of the notes are graded from $12.50 per share for the first three years, increasing to $15.00 per share for the next two years and increasing to $20.00 per share for the last two years. D. Other notes payable United Income, Inc. holds two promissory notes receivable totaling $850,000 due from FCC. Each note bears interest at the rate of 1% over prime as published in the Wall Street Journal, with interest payments due quarterly. Principal of $150,000 is due upon the maturity date of June 1, 1999, with the remaining principal payment of $700,000 becoming due upon the maturity date of May 8, 2006. As partial proceeds in the acquisition of common stock from certain officers and directors in the third quarter of 1997, the Company issued unsecured promissory notes. These notes bear interest at 1% over prime with interest payments due quarterly. Principal comes due at varying times with $150,000 maturing on January 31, 1999, $1,654,507 maturing on July 31, 2005 and one note of $70,392 requiring annual principal reductions of $10,000 until maturity on September 23, 2004. The interest rates were deemed favorable to UTI and as a result, the Company has discounted the notes to reflect a 15% effective rate of interest for financial statement purposes. The notes have a total face maturity value of $1,874,899 and a discounted value at March 31, 1998 of $1,510,530. On January 16, 1998, the Company acquired 7,579 shares of UTI common stock from the estate of Robert Webb, a former director, for $26,527 and a promissory note valued at $41,819 due January 16, 2005. The note bears interest at a rate of 1% over prime, with interest due quarterly and principal due on maturity. Scheduled principal reductions on the Company's debt for the next five years is as follows: Year Amount 1998 $ 526,504 1999 1,826,504 2000 1,526,504 2001 1,526,504 2002 4,690,758 4. CAPITAL STOCK TRANSACTIONS A. STOCK OPTION PLAN In 1985, the Company initiated a nonqualified stock option plan for employees, agents and directors of the Company under which options to purchase up to 44,000 shares of UTI's common stock are granted at a fixed price of $.20 per share. Through March 31, 1998 options for 42,438 shares were granted and exercised. Options for 1,562 shares remain available for grant. 170 A summary of the status of the Company's stock option plan through March 31, 1998 and March 31, 1997 is presented below. 1998 1997 Exercise Exercise Shares Price Shares Price Outstanding at beginning of year 1,562 $ 0.20 1,562 $ 0.20 Granted 0 0.00 0 0.00 Exercised 0 0.00 0 0.20 Forfeited 0 0.00 0 0.00 Outstanding at end of period 1,562 $ 0.20 1,562 $ 0.20 Options exercisable at end of period 1,562 $ 0.20 1,562 $ 0.20 Fair value of options granted during the period $ 0.00 $ 0.00
The following information applies to options outstanding at March 31, 1998: Number outstanding 1,562 Exercise price $ 0.20 Remaining contractual life Indefinite B. DEFERRED COMPENSATION PLAN UTI and FCC established a deferred compensation plan during 1993 pursuant to which an officer or agent of FCC, UTI or affiliates of UTI, could defer a portion of their income over the next two and one-half years in return for a deferred compensation payment payable at the end of seven years in the amount equal to the total income deferred plus interest at a rate of approximately 8.5% per annum and a stock option to purchase shares of common stock of UTI. At the beginning of the deferral period an officer or agent received an immediately exercisable option to purchase 2,300 shares of UTI common stock at $17.50 per share for each $25,000 ($10,000 per year for two and one-half years) of total income deferred. The option expires on December 31, 2000. A total of 105,000 options were granted in 1993 under this plan. As of March 31, 1998 no options were exercised. At March 31, 1998 and December 31, 1997, the Company held a liability of $1,405,544 and $1,376,384, respectively, relating to this plan. At March 31, 1998, UTI common stock had a bid price of $9.375 and an ask price of $9.875 per share. The following information applies to deferred compensation plan stock options outstanding at March 31, 1998: Number outstanding 105,000 Exercise price $17.50 Remaining contractual life 3 years C. CONVERTIBLE NOTES On July 31, 1997, United Trust Inc. issued convertible notes for cash in the amount of $2,560,000 to seven individuals, all officers or employees of United Trust Inc. The notes bear interest at a rate of 1% over prime, with interest payments due quarterly and principal due upon maturity of July 31, 2004. The conversion price of the notes are graded from $12.50 per share for the first three years, increasing to $15.00 per share for the next two years and increasing to $20.00 per share for the last two years. As of March 31, 1998, the notes were convertible into 204,800 shares of UTI common stock with no conversion privileges having been exercised. At March 31, 1998, UTI common stock had a bid price of $9.375 and an ask price of $9.875 per share. 171 D. PURCHASE OF TREASURY STOCK On January 16, 1998, the Company acquired 7,579 shares of UTI common stock from the estate of Robert Webb, a former director, for $26,527 and a promissory note valued at $41,819 due January 16, 2005. The note bears interest at a rate of 1% over prime, with interest due quarterly and principal due on maturity. 5. EARNINGS PER SHARE The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computations as presented on the income statement. For the period ended March 31, 1998 Income Shares Per-Share (Numerator) (Denominator) Amount Basic EPS Income available to common shareholders $ 114,441 1,628,547 $ 0.07 Effect of Dilutive Securities Convertible notes 38,979 204,800 Options 1,562 Diluted EPS Income available to common shareholders + assumed conversions $ 153,420 1,834,909 $ 0.08 For the period ended March 31, 1997 Income Shares Per-Share (Numerator) (Denominator) Amount Basic EPS Income available to common shareholders $ 47,026 1,870,094 $ 0.03 Effect of Dilutive Securities Options 1,562 Diluted EPS Income available to common shareholders + assumed conversions $ 47,026 1,871,656 $ 0.03
UTI has stock options outstanding during the first quarter of 1998 and 1997 for 105,000 shares of common stock at $17.50 per share that were not included in the computation of diluted EPS because the exercise price was greater than the average market price of the common shares. 172 6. COMMITMENTS AND CONTINGENCIES The insurance industry has experienced a number of civil jury verdicts which have been returned against life and health insurers in the jurisdictions in which the Company does business involving the insurers' sales practices, alleged agent misconduct, failure to properly supervise agents, and other matters. Some of the lawsuits have resulted in the award of substantial judgments against the insurer, including material amounts of punitive damages. In some states, juries have substantial discretion in awarding punitive damages in these circumstances. Under the insurance guaranty fund laws in most states, insurance companies doing business in a participating state can be assessed up to prescribed limits for policyholder losses incurred by insolvent or failed insurance companies. Although the Company cannot predict the amount of any future assessments, most insurance guaranty fund laws currently provide that an assessment may be excused or deferred if it would threaten an insurer's financial strength. Mandatory assessments may be partially recovered through a reduction in future premium tax in some states. The Company does not believe such assessments will be materially different from amounts already provided for in the financial statements. The Company and its subsidiaries are named as defendants in a number of legal actions arising primarily from claims made under insurance policies. Those actions have been considered in establishing the Company's liabilities. Management and its legal counsel are of the opinion that the settlement of those actions will not have a material adverse effect on the Company's financial position or results of operations. 7. OTHER CASH FLOW DISCLOSURE On a cash basis, the Company paid $285,784 and $216,650 in interest expense during the first quarter of 1998 and 1997, respectively. The Company paid no federal income tax in the first quarter of 1998 and $60,044 of federal income tax in the first quarter of 1997. As partial proceeds for the acquisition of treasury common stock of UTI during 1998, UTI issued promissory notes of $41,819 due January 16, 2005. 8. PROPOSED MERGER OF UNITED TRUST, INC. AND UNITED INCOME, INC. On March 25, 1997, the Board of Directors of UTI and UII voted to recommend to the shareholders a merger of the two companies. Under the Plan of Merger, UTI would be the surviving entity with UTI issuing one share of its stock for each share held by UII shareholders. UTI owns 53% of United Trust Group, Inc., an insurance holding company, and UII owns 47% of United Trust Group, Inc. Neither UTI nor UII have any other significant holdings or business dealings. The Board of Directors of each company thus concluded a merger of the two companies would be in the best interests of the shareholders. The merger will result in certain cost savings, primarily related to costs associated with maintaining a corporation in good standing in the states in which it transacts business. A vote of the shareholders of UTI and UII regarding the proposed merger is anticipated to occur sometime during the third quarter of 1998. 9. PENDING CHANGE IN CONTROL OF UNITED TRUST, INC. On April 30, 1998, UTI and First Southern Funding, a Kentucky corporation ("FSF"), signed a Definitive Agreement ("the FSF Agreement") whereby FSF will make an equity investment in UTI. Under the terms of the FSF Agreement, FSF will buy 473,523 authorized but unissued shares of UTI common stock for $15.00 a share and will also buy 389,715 shares of UTI common stock that UTI purchased during the last year in private transactions at the average price UTI paid for such stock, plus interest, or approximately $10.00 per share. FSF will also purchase 66,667 shares of UTI common stock and $2,560,000 of face amount convertible bonds which are due and payable on any change in control of UTI, in private transactions, primarily from officers of UTI. In addition, FSF will be granted a three year option to purchase up to 1,450,000 shares of UTI common stock for $15.00 per share. 173 Management of UTI intends to use the equity that is being contributed to expand their operations through the acquisition of other life insurance companies. The transaction is subject to the receipt of regulatory and other approvals; and the satisfaction of certain conditions. The transaction is not expected to be completed before July 31, 1998, and there can be no assurance that the transaction will be completed. FSF is an affiliate of First Southern Bancorp, Inc., a bank holding company that owns five banks that operate out of 14 locations in central Kentucky. 174 INDEPENDENT AUDITORS' REPORT BOARD OF DIRECTORS AND SHAREHOLDERS UNITED INCOME,, INC. We have audited the accompanying consolidated balance sheets of United Income, Inc. (an Ohio corporation) and subsidiaries as of December 31, 1997and 1996, and the related statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of United Income, Inc. as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. KERBER, ECK & BRAECKEL LLP Springfield, Illinois March 26, 1998 175 UNITED INCOME, INC.BALANCE SHEETS As of December 31, 1997 and 1996 ASSETS 1997 1996 Cash and cash equivalents $ 710,897 $ 439,676 Mortgage loans 121,520 122,853 Notes receivable from affiliate 864,100 864,100 Accrued interest income 12,068 11,784 Property and equipment (net of accumulated depreciation of $93,648 and $92,140) 1,070 2,578 Investment in affiliates 11,060,682 11,324,947 Receivable from affiliate 23,192 31,837 Other assets (net of accumulated amortization of $138,810 and $101,794) 46,258 83,274 Total assets $ 12,839,787 $ 12,881,049 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities and accruals: Convertible debentures $ 902,300 $ 902,300 Other liabilities 1,534 1,273 Total liabilities 903,834 903,573 Shareholders' equity: Common stock - no par value, stated value $.033 per share. 'Authorized 2,310,001 shares - 1,391,919 and 1,392,130 shares issued after deducting treasury shares of 177,590 and 1 45,934 45,940 Additional paid-in capital 15,242,365 15,244,471 Unrealized depreciation of investments held for sale of affiliate (19,603) (59,508) Accumulated deficit (3,332,743) (3,253,427) Total shareholders' equity 11,935,953 11,977,476 Total liabilities and shareholders' equity $ 12,839,787 $ 12,881,049
176 UNITED INCOME, INC.STATEMENTS OF OPERATIONS Three Years Ended December 31, 1997 1997 1996 1995 Revenues: Interest income $ 27,127 $ 13,099 $ 16,516 Interest income from affiliates 82,579 79,433 71,646 Service agreement income from affiliates 989,295 1,567,891 2,015,325 Other income from affiliates 87,073 127,922 129,627 Realized investment gains 0 2,599 905 Other income 48 3 130 1,186,122 1,790,947 2,234,149 Expenses: Management fee to affiliate 743,577 1,240,735 1,809,195 Operating expenses 80,173 89,529 78,505 Interest expense 85,155 84,027 88,538 908,905 1,414,291 1,976,238 Gain before income taxes and equity in loss of investees 277,217 376,656 257,911 Provision for income taxes 0 0 0 Equity in loss of investees (356,533) (695,739) (2,405,813) Net loss $ (79,316)$ (319,083)$ (2,147,902) Net loss per common share $ (0.06)$ (0.23)$ (1.54) Average common shares outstanding 1,391,996 1,392,084 1,392,060
177 UNITED INCOME, INC.STATEMENTS OF SHAREHOLDERS' EQUITY Three Years Ended December 31, 1997 1997 1996 1995 Common stock Balance, beginning of year $ 45,940 $ 45,938 $ 45,938 Exercise of stock options 0 2 0 Stock retired from purchase of fractional shares of reverse stock split (6) 0 0 Balance, end of year $ 45,934 $ 45,940 $ 45,938 Additional paid-in capital Balance, beginning of year $15,244,471 $15,243,773 $15,243,773 Exercise of stock options 0 698 0 Stock retired from purchase of fractional shares of reverse stock split (2,106) 0 0 Balance, end of year $15,242,365 $15,244,471 $15,243,773 Unrealized appreciation (depreciation) of investments held for sale Balance, beginning of year $ (59,508)$ (236)$ (99,907) Change during year 39,905 (59,272) 99,671 Balance, end of year $ (19,603)$ (59,508)$ (236) Accumulated deficit Balance, beginning of year $(3,253,427)$(2,934,344)$ (786,442) Net loss (79,316) (319,083) (2,147,902) Balance, end of year $(3,332,743)$(3,253,427)$(2,934,344) Total shareholders' equity, end of year $11,935,953 $11,977,476 $12,355,131
178 UNITED INCOME, INC.STATEMENTS OF CASH FLOWS Three Years Ended December 31, 1997 1997 1996 1995 Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net loss $ (79,316)$ (319,083) $(2,147,902) Adjustments to reconcile net loss to net cash provided by (used in) operating activities Depreciation and amortization 38,524 45,331 52,169 Gain on payoff of mortgage loan 0 (2,599) 0 Accretion of discount on mortgage loans (266) (481) (1,591) Compensation expense through stock option plan 0 667 0 Equity in loss of investees 356,533 695,739 2,405,813 Changes in assets and liabilities: Change in accrued interest income (284) (4,744) (1,713) Change in receivable from affiliates 8,645 (119,706) 25,598 Change in other liabilities 261 (39,449) (5,469) Net cash provided by operating activities 324,097 255,675 326,905 Cash flows from investing activities: Change in notes receivable from affiliate 0 (150,000) 0 Purchase of investments in affiliates (52,363) 0 (26,091) Capital contribution to investee 0 (94,000) (47,000) Sale of investments in affiliates 0 0 1,810 Payments of principal on mortgage loans 1,599 62,434 4,480 Purchase of mortgage loan 0 0 (126,000) Proceeds from sale of property and equipment 0 1,164 0 Net cash used in investing activities (50,764) (180,402) (192,801) Cash flows from financing activities: Proceeds from sale of common stock 0 33 0 Payment for fractional shares from reverse stock split (2,112) 0 0 Net cash provided by (used in) financing activities (2,112) 33 0 Net increase in cash and cash equivalents 271,221 75,306 134,104 Cash and cash equivalents at beginning of year 439,676 364,370 230,266 Cash and cash equivalents at end of year $ 710,897 $ 439,676 $ 364,370
179 UNITED INCOME, INC. NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A.ORGANIZATION - At December 31, 1997, the affiliates of United Income, Inc. were as depicted on the following organizational chart. ORGANIZATIONAL CHART AS OF DECEMBER 31, 1997 United Trust, Inc. ("UTI") is the ultimate controlling company. UTI owns 53% of United Trust Group ("UTG") and 41% of United Income, Inc. ("UII"). UII owns 47% of UTG. UTG owns 79% of First Commonwealth Corporation ("FCC") and 100% of Roosevelt Equity Corporation ("REC"). FCC owns 100% of Universal Guaranty Life Insurance Company ("UG"). UG owns 100% of United Security Assurance Company ("USA"). USA owns 84% of Appalachian Life Insurance Company ("APPL") and APPL owns 100% of Abraham Lincoln Insurance Company ("ABE"). 180 The summary of the Company's significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows. B.NATURE OF OPERATIONS - United Income, Inc. ("UII"), referred to as the ("Company"), was incorporated November 2, 1987, and commenced its activities January 20, 1988. UII is an insurance holding company that through its insurance affiliates sells individual life insurance products. UII is an affiliate of UTI, an Illinois insurance holding company. UTI owns 40.6% of UII. C.MORTGAGE LOANS - at unpaid balances, adjusted for amortization premium or discount, less allowance for possible losses. Realized gains and losses on sales of mortgage loans are recognized in net income on a specific identification basis. D.PROPERTY AND EQUIPMENT - Property and equipment is recorded at cost. Depreciation is provided using a straight-line method. Accumulated depreciation was $93,648 in 1997 and $92,140 in 1996. Depreciation expense for the years ended December 1997, 1996, and 1995 was $1,508, $8,315, and $11,265 respectively. E.CASH AND CASH EQUIVALENTS - The Company considers certificates of deposit and other short-term investment instruments with an original purchased maturity of three months or less as cash equivalents. F.EARNINGS PER SHARE - Earnings per share are based on the weighted average number of common shares outstanding during each year, retroactively adjusted to give effect to all stock splits. In accordance with Statement of Financial Accounting Standards No. 128, the computation of diluted earnings per share is not shown since the Company has a loss from continuing operations in each period presented, and any assumed conversion, exercise, or contingent issuance of securities would have an antidilutive effect on earnings per share. G.USE OF ESTIMATES - In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. H.RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform with the current year presentation. Such reclassifications had no effect on previously reported net income (loss), total assets, or shareholders' equity. 2. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each class of financial instrument required to be valued by SFAS 107 for which it is practicable to estimate that value: (a) Mortgage loans Mortgage loans are carried at the unpaid principal balances net of unamortized purchase discounts. Yields on these loans exceed current mortgage loan rates in the market. Therefore, management believes the market value of these loans is at least equal to carrying value. (b) Notes receivable from affiliate For notes receivable from affiliate, which is subject to a floating rate of interest, carrying value is a reasonable estimate of fair value. 181 (c) Convertible debentures For the convertible debentures, which are subject to a floating rate of interest, carrying value is a reasonable estimate of fair value. 3. RELATED PARTY TRANSACTIONS Effective November 8, 1989, United Security Assurance Company ("USA") entered a service agreement with its then direct parent, UII, for certain administrative services. Pursuant to the terms of the agreement, USA pays UII monthly fees equal to 22% of the amount of collected first year premiums, 20% in second year and 6% of the renewal premiums in years three and after. The Company recognized service agreement income of $989,295, $1,567,891 and $2,015,325 in 1997, 1996 and 1995, respectively. Effective September 1, 1990, UII entered a service agreement with United Trust, Inc. (UTI) for certain administrative services. Through its personnel, UTI performs such services as may be mutually agreed upon between the parties. In compensation for its services, UII pays UTI a contractually established fee. The Company incurred expenses of $593,577, $940,735 and $1,209,195 during 1997, 1996 and 1995, respectively, pursuant to the terms of the service agreement with UTI. In addition, the Company incurred $150,000, $300,000 and $600,000 during 1997, 1996 and 1995, respectively, as reimbursement for services performed on its behalf by FCC. At December 31, 1997, the Company owns $864,100 in notes receivable from affiliates. The notes carry interest at a rate of 1% above prime. Interest is received quarterly. Principal is due upon maturity, with $150,000 maturing in 1999, $700,000 maturing in 2006 and $14,100 maturing in 2012. 4. STOCK OPTION PLANS The Company has a stock option plan under which certain directors, officers and employees may be issued options to purchase up to 31,500 shares of common stock at $13.07 per share. Options become exercisable at 25% annually beginning one year after date of grant and expire generally in five years. In November 1992, 10,437 option shares were granted. At December 31, 1997, options for 451 shares were exercisable and options for 20,576 shares were available for grant. Options for 10,437 shares expired during 1997. No options were exercised during 1997. A summary of the status of the Company's stock option plan for the three years ended December 31, 1997, and changes during the years ending on those dates is presented below. 1997 1996 1995 Exercise Exercise Exercise Shares Price Shares Price Shares Price Outstanding at beginning of year 10,888 $ 13.07 10,888 $ 13.07 10,437 $ 13.07 Granted 0 0.00 0 0.00 451 13.07 Exercised 0 0.00 0 0.00 0 0.00 Forfeited 10,437 13.07 0 0.00 0 0.00 Outstanding at end of year 451 $ 13.07 10,888 $ 13.07 10,888 $ 13.07 Options exercisable at year end 451 $ 13.07 10,888 $ 13.07 10,888 $ 13.07
182 The following information applies to options outstanding at December 31, 1997: Number outstanding 451 Exercise price $ 13.07 Remaining contractual life 3 years On January 15, 1991, the Company adopted an additional Non-Qualified Stock Option Plan under which certain employees and sales personnel may be granted options. The plan provides for the granting of up to 42,000 options at an exercise price of $.47 per share. The options generally expire five years from the date of grant. Options for 10,220 shares of common stock were granted in 1991, options for 1,330 shares were granted in 1993 and options for 301 shares were granted in 1995. A total of 11,620 option shares have been exercised as of December 31, 1997. At December 31, 1997, 231 options have been granted and are exercisable. Options for 0 and 70 shares were exercised during 1997 and 1996, respectively. A summary of the status of the Company's stock option plan for the three years ended December 31, 1997, and changes during the years ending on those dates is presented below. 1997 1996 1995 Exercise Exercise Exercise Shares Price Shares Price Shares Price Outstanding at beginning of year 231 $ 0.47 301 $ 0.47 0 $ 0.47 Granted 0 0.00 0 0.00 301 0.47 Exercise d 0 0.00 (70) 0.47 0 0.00 Forfeited 0 0.00 0 0.00 0 0.00 Outstanding at end of year 231 $ 0.47 231 $ 0.47 301 $ 0.47 Options exercisable at year end 231 $ 0.47 231 $ 0.47 301 $ 0.47 Fair value of options granted during the year $ 0.00 $ 0.00 $ 8.40
The following information applies to options outstanding at December 31, 1997: Number outstanding 231 Exercise price $ 0.47 Remaining contractual life 3 years 5. INCOME TAXES The Company has net operating loss carryforwards for federal income tax purposes expiring as follows: UII 2006 $ 41,314 2007 531,747 TOTAL $ 573,061 The Company has established a deferred tax asset of $200,571 for its operating loss carryforwards and has established an allowance of $200,571 against this asset. The Company has no other deferred tax components which would be reflected in the balance sheets. 183 The provision for income taxes shown in the statements of operations does not bear the normal relationship to pre-tax income as a result of certain permanent differences. The sources and effects of such differences are summarized in the following table: 1997 1996 1995 Income tax at statutory rate of 35% of income before income taxes $ 97,026 $ 131,830 $ 90,269 Utilization of net operating loss carryforward (97,026) (133,866) (92,049) Depreciation 0 2,036 1,780 Provision for income taxes $ 0 $ 0 $ 0
6. SUMMARIZED FINANCIAL INFORMATION OF UNITED TRUST GROUP, INC. The following provides summarized financial information for the Company's 50% or less owned affiliate: December 31, December 31, 1997 1996 ASSETS Total investments $ 222,601,494 $ 221,078,779 Cash and cash equivalents 15,763,639 16,903,789 Cost of insurance acquired 45,009,452 47,536,812 Other assets 64,576,450 69,480,242 TOTAL ASSETS $ 347,951,035 $ 354,999,622 LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities $ 268,237,887 $ 268,771,766 Notes payable 19,081,602 19,839,853 Deferred taxes 12,157,685 11,591,086 Other liabilities 4,053,293 6,335,866 TOTAL LIABILITIES 303,530,467 306,538,571 Minority interests in consolidated subsidiaries 10,130,024 13,332,034 Shareholders' equity Common stock no par value Authorized 10,000 shares - 100 45,926,705 45,926,705 issued Unrealized depreciation of investment (41,708) (126,612) in stocks Accumulated deficit (11,594,453) (10,671,076) TOTAL SHAREHOLDERS' EQUITY 34,290,544 35,129,017 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 347,951,035 $ 354,999,622
184 1997 1996 1995 Premiums and policy fees, net of reinsurance $ 28,639,245 $ 30,944,458 $ 33,098,536 Net investment income 14,882,677 15,902,107 15,497,547 Other (171,304) (370,454) 1,237 43,350,618 46,476,111 48,597,320 Benefits, claims and settlement expenses 27,055,171 30,326,032 29,855,764 Other expenses 16,776,537 22,953,093 30,725,908 43,831,708 53,279,125 60,581,672 Loss before income tax and minority interest (481,090) (6,803,014) (11,984,352) Income tax credit (provision) (571,999) 4,643,961 4,724,792 Minority interest in loss of consolidated subsidiaries 129,712 498,356 1,938,684 Net loss $ (923,377) $ (1,660,697) $ (5,320,876)
7. SHAREHOLDER DIVIDEND RESTRICTION At December 31, 1997, substantially all of consolidated shareholders' equity represents investment in affiliates. The payment of cash dividends to shareholders is not legally restricted. However, insurance company dividend payments are regulated by the state insurance department where the company is domiciled. UTI is the ultimate parent of UG through ownership of several intermediary holding companies. UG can not pay a dividend directly to UII due to the ownership structure. UG's dividend limitations are described below without effect of the ownership structure. Ohio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 1997, UG had a statutory gain from operations of $1,779,246. At December 31, 1997, UG's statutory capital and surplus amounted to $10,997,365. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. 8. CONVERTIBLE DEBENTURES In early 1994, UII received $902,300 from the sale of Debentures. The Debentures were issued pursuant to an indenture between the Company and First of America Bank - Southeast Michigan, N.A., as trustee. The Debentures are general unsecured obligations of UII, subordinate in right of payment to any existing or future senior debt of UII. The Debentures are exchangeable and transferable, and are convertible at any time prior to March 31, 1999 into UII's Common Stock at a conversion price of $25.00 per share, subject to adjustment in certain events. The Debentures bear interest from March 31, 1994, payable quarterly, at a variable rate equal to one percentage point above the prime rate published in the Wall Street Journal from time to time. On or after March 31, 1999, the Debentures will be redeemable at UII's option, in whole or in part, at redemption prices declining from 103% of their principal amount. No sinking fund will be established to redeem Debentures. The Debentures will mature on March 31, 2004. The Debentures are not listed on any national securities exchange or the NASDAQ National Market System. 185 9. NEW ACCOUNTING STANDARDS The Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards (SFAS) No. 128 entitled Earnings per share, which is effective for financial statements for fiscal years beginning after December 15, 1997. SFAS No. 128 specifies the computation, presentation, and disclosure requirements for earnings per share (EPS) for entities with publicly held common stock or potential common stock. The Statement's objective is to simplify the computation of earnings per share, and to make the U.S. standard for computing EPS more compatible with the EPS standards of other countries. Under SFAS No. 128, primary EPS computed in accordance with previous opinions is replaced with a simpler calculation called basic EPS. Basic EPS is calculated by dividing income available to common stockholders (i.e., net income or loss adjusted for preferred stock dividends) by the weighted-average number of common shares outstanding. Thus, in the most significant change in current practice, options, warrants, and convertible securities are excluded from the basic EPS calculation. Further, contingently issuable shares are included in basic EPS only if all the necessary conditions for the issuance of such shares have been satisfied by the end of the period. Fully diluted EPS has not changed significantly but has been renamed diluted EPS. Income available to common stockholders continues to be adjusted for assumed conversion of all potentially dilutive securities using the treasury stock method to calculate the dilutive effect of options and warrants. However, unlike the calculation of fully diluted EPS under previous opinions, a new treasury stock method is applied using the average market price or the ending market price. Further, prior opinion requirement to use the modified treasury stock method when the number of options or warrants outstanding is greater than 20% of the outstanding shares also has been eliminated. SFAS 128 also includes certain shares that are contingently issuable; however, the test for inclusion under the new rules is much more restrictive. SFAS No. 128 requires companies reporting discontinued operations, extraordinary items, or the cumulative effect of accounting changes are to use income from operations as the control number or benchmark to determine whether potential common shares are dilutive or antidilutive. Only dilutive securities are to be included in the calculation of diluted EPS. This statement was adopted for the 1997 Financial Statements. For all periods presented the Company reported a loss from continuing operations so any potential issuance of common shares would have an antidilutive effect on EPS. Consequently, the adoption of SFAS No. 128 did not have an impact on the Company's financial statement. The FASB has issued SFAS No. 130 entitled Reporting Comprehensive Income and SFAS No. 132 Employers' Disclosures about Pensions and Other Postretirement Benefits. Both of the above statements are effective for financial statements with fiscal years beginning after December 15, 1997. SFAS No. 130 defines how to report and display comprehensive income and its components in a full set of financial statements. The purpose of reporting comprehensive income is to report a measure of all changes in equity of an enterprise that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners. SFAS No. 132 addresses disclosure requirements for post-retirement benefits. The statement does not change post-retirement measurement or recognition issues. The Company will adopt both SFAS No. 130 and SFAS No. 132 for the 1998 financial statements. Management does not expect either adoption to have a material impact on the Company's financial statements. 186 10. PENDING CHANGE IN CONTROL OF UNITED TRUST, INC. On February 19, 1998, UTI signed a letter of intent with Jesse T. Correll, whereby Mr. Correll will personally or in combination with other individuals make an equity investment in UTI over a three year period of time. Under the terms of the letter of intent, Mr. Correll will buy 2,000,000 authorized but unissued shares of UTI common stock for $15.00 per share and will also buy 389,715 shares of UTI common stock, representing stock of UTI and UII, that UTI purchased during the last eight months in private transactions at the average price UTI paid for such stock, plus interest, or approximately $10.00 per share. Mr. Correll also will purchase 66,667 shares of UTI common stock and $2,560,000 of face amount of convertible bonds (which are due and payable on any change in control of UTI) in private transactions, primarily from officers of UTI. UTI intends to use the equity that is being contributed to expand their operations through the acquisition of other life insurance companies. The transaction is subject to negotiation of a definitive purchase agreement; completion of due diligence by Mr. Correll; the receipt of regulatory and other approvals; and the satisfaction of certain conditions. The transaction is not expected to be completed before June 30, 1998, and there can be no assurance that the transaction will be completed. 11. REVERSE STOCK SPLIT On May 13, 1997, UII effected a 1 for 14.2857 reverse stock split. Fractional shares received a cash payment on the basis of $0.70 for each old share. Prior period numbers have been restated to give effect of the reverse split. 12. PROPOSED MERGER On March 25, 1997, the Board of Directors of UTI and UII voted to recommend to the shareholders a merger of the two companies. Under the Plan of Merger, UTI would be the surviving entity with UTI issuing one share of its stock for each share held by UII shareholders. UTI owns 53% of United Trust Group, Inc., an insurance holding company, and UII owns 47% of United Trust Group, Inc. Neither UTI nor UII have any other significant holdings or business dealings. The Board of Directors of each company thus concluded a merger of the two companies would be in the best interests of the shareholders. The merger will result in certain cost savings, primarily related to costs associated with maintaining a corporation in good standing in the states in which it transacts business. A vote of the shareholders of UTI and UII regarding the proposed merger is anticipated to occur sometime during the third quarter of 1998. 187 13. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) 03/31/98 Interest income $ 11,551 Interest income/affil. 20,488 Service agreement income 237,358 Total revenues 287,351 Management fee 142,415 Operating expenses 50,140 Interest expense 21,430 Operating income 73,366 Net income (loss) 105,177 Basic earnings per share .08 Diluted earnings per share .09
1997 1st 2nd 3rd 4th Interest income $ 2,659 $ 2,680 $ 10,806 $ 10,982 Interest income/affil. 19,956 20,171 21,521 20,931 Service agreement income 294,095 287,596 213,518 194,086 Total revenues 342,657 333,661 266,816 242,988 Management fee 226,457 247,558 153,111 116,451 Operating expenses 50,318 9,682 9,912 10,261 Interest expense 20,866 21,430 21,429 21,430 Operating income 45,016 54,991 82,364 94,846 Net income (loss) 55,572 84,941 (136,852) (82,977) Basic earnings per share .04 .06 (.10) (.06) Diluted earnings per share .05 .07 (.10) (.06) 1996 1st 2nd 3rd 4th Net investment income $ 3,673 $ 3,793 $ 2,893 $ 2,740 Interest income/affil. 18,078 20,717 20,249 20,389 Service agreement income 536,604 459,454 406,952 164,881 Total revenues 583,627 535,094 456,715 215,511 Management fee 421,963 425,672 294,170 98,930 Operating expenses 51,804 14,514 12,045 11,166 Interest expense 21,430 20,865 20,866 20,866 Operating income 88,430 74,043 129,634 84,549 Net income (loss) 235,469 50,795 (583,728) (21,619) Basic earnings per share .01 .00 (.03) .00 Diluted earnings per share .01 .00 (.03) .00
188 1995 1st 2nd 3rd 4th Net investment income $ 1,431 $ 7,283 $ 4,064 $ 3,738 Investment income/affil. 22,111 13,830 17,778 17,927 Service agreement income 505,118 529,411 494,867 485,929 Total revenues 570,284 587,002 540,031 536,832 Management fee 437,041 483,677 452,935 435,542 Operating expenses 46,264 23,951 12,243 (3,953) Interest expense 21,485 22,676 22,384 21,993 Operating income (loss) 65,494 56,698 52,469 83,250 Net income (loss) 137,752 (530,781) 132,804 (1,887,677) Basic earnings per share .01 (.03) .01 (.11) Diluted earnings per share .01 (.03) .01 (.11)
189 EXHIBIT 99(D) AUDITED FINANCIAL STATEMENTS OF UNITED TRUST GROUP, INC. 190 Independent Auditors' Report Board of Directors and Shareholders United Trust Group, Inc. We have audited the accompanying consolidated balance sheets of United Trust Group, Inc. (an Illinois corporation) and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of United Trust Group, Inc. and subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. We have also audited Schedule I as of December 31, 1997, and Schedules II, IV and V as of December 31, 1997 and 1996, of United Trust Group, Inc. and subsidiaries and Schedules II, IV and V for each of the three years in the period then ended. In our opinion, these schedules present fairly, in all material respects, the information required to be set forth therein. KERBER, ECK & BRAECKEL LLP Springfield, Illinois March 26, 1998 191 UNITED TRUST GROUP, INC. CONSOLIDATED BALANCE SHEETS As of December 31, 1997 and 1996 ASSETS 1997 1996 Investments: Fixed maturities at amortized cost $ 180,970,333$ 179,926,785 (market $184,782,568 and $181,815,225) Investments held for sale: Fixed maturities, at market 1,668,630 1,961,166 (cost $1,672,298 and $1,984,661) Equity securities, at market 3,001,744 1,794,405 (cost $3,184,357 and $2,086,159) Mortgage loans on real estate at amortized cost 9,469,444 11,022,792 Investment real estate, at cost, 9,760,732 9,779,984 net of accumulated depreciation Real estate acquired in satisfaction of debt 1,724,544 1,724,544 Policy loans 14,207,189 14,438,120 Short-term investments 1,798,878 430,983 222,601,494 221,078,779 Cash and cash equivalents 15,763,639 16,903,789 Investment in affiliates 350,000 350,000 Accrued investment income 3,665,228 3,459,748 Reinsurance receivables: Future policy benefits 37,814,106 38,745,013 Policy claims and other benefits 3,529,078 3,856,124 Other accounts and notes receivable 1,680,066 1,734,321 Cost of insurance acquired 45,009,452 47,536,812 Deferred policy acquisition costs 10,600,720 11,325,356 Cost in excess of net assets purchased, net of accumulated amortization 2,777,089 5,496,808 Property and equipment, 3,392,905 3,255,171 net of accumulated depreciation Other assets 767,258 1,257,701 Total assets $ 347,951,035$ 354,999,622 LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities and accruals: Future policy benefits $ 248,805,695$ 248,879,317 Policy claims and benefits payable 2,080,907 3,193,806 Other policyholder funds 2,445,469 2,784,967 Dividend and endowment accumulations 14,905,816 13,913,676 Income taxes payable: Current 15,730 70,663 Deferred 12,157,685 11,591,086 Notes payable 19,081,602 19,839,853 Indebtedness to affiliates, net 49,977 62,084 Other liabilities 3,987,586 6,203,119 Total liabilities 303,530,467 306,538,571 Minority interests in consolidated subsidiaries 10,130,024 13,332,034 Shareholders' equity: Common stock - no par value Authorized 10,000 shares - 100 shares issued 45,926,705 45,926,705 Unrealized depreciation of investments held for sale (41,708) (126,612) Accumulated deficit (11,594,453) (10,671,076 Total shareholders' equity 34,290,544 35,129,017 Total liabilities and shareholders' equity $ 347,951,035$ 354,999,622
192 UNITED TRUST GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Three Years Ended December 31, 1997 1997 1996 1995 Revenues: Premiums and policy fees $ 33,373,950 $ 35,891,609 $ 38,481,638 Reinsurance premiums and policy fees (4,734,705) (4,947,151) (5,383,102) Net investment income 14,882,677 15,902,107 15,497,547 Realized investment gains and (losses), net (279,096) (465,879) (114,235) Other income 107,792 95,425 115,472 43,350,618 46,476,111 48,597,320 Benefits and other expenses: Benefits, claims and settlement expenses: Life 23,644,252 26,568,062 26,680,217 Reinsurance benefits and claims(2,078,982) (2,283,827) (2,850,228) Annuity 1,560,828 1,892,489 1,797,475 Dividends to policyholders 3,929,073 4,149,308 4,228,300 Commissions and amortization of deferred policy acquisition costs 3,616,365 4,224,885 4,907,653 Amortization of cost of insurance acquired 2,527,360 5,690,069 4,509,755 Amortization of agency force 0 0 396,852 Non-recurring write down of 0 0 8,296,974 value of agency force Operating expenses 8,957,372 11,285,566 10,634,314 Interest expense 1,675,440 1,752,573 1,980,360 43,831,708 53,279,125 60,581,672 Loss before income taxes, minority interest and equity in loss of investees (481,090) (6,803,014) (11,984,352 Credit (provision) for income taxes (571,999) 4,643,961 4,724,792 Minority interest in loss of consolidated subsidiaries 129,712 498,356 1,938,684 Net loss $ (923,377)$ (1,660,697)$ (5,320,876) Net loss per common share $ (9,233.77)$ (16,606.97)$ (53,208.76) Average common shares outstanding 100 100 100
193 UNITED TRUST GROUP, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Three Years Ended December 31, 1997 1997 1996 1995 Common stock Balance, beginning of year $ 45,926,705 $ 45,726,705 $ 45,626,705 Capital contribution 0 200,000 100,000 Balance, end of year $ 45,926,705 $ 45,926,705 $ 45,726,705 Unrealized appreciation (depreciation) of investments held for sale Balance, beginning of year $ (126,612) $ (501) $ (212,567) Change during year 84,904 (126,111) 212,066 Balance, end of year $ (41,708) $ (126,612) $ (501) Accumulated deficit Balance, beginning of year $(10,671,076 $ (9,010,379) $ (3,689,503) Net loss (923,377) (1,660,697) (5,320,876) Balance, end of year $(11,594,453) $(10,671,076) $ (9,010,379) Total shareholders' equity, end of year $ 34,290,544 $ 35,129,017 $ 36,715,825
194 UNITED TRUST GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Three Years Ended December 31, 1997 1997 1996 1995 Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net loss $ (923,377)$ (1,660,697)$ (5,320,876) Adjustments to reconcile net loss to net cash provided by (used in) operating activities net of changes in assets and liabilities resulting from the sales and purchases of subsidiaries: Amortization/accretion of fixed maturities 670,185 899,445 803,696 Realized investment (gains) losses 279,096 465,879 114,235 Policy acquisition costs deferred (586,000) (1,276,000) (2,370,000) Amortization of deferred policy acquisition costs 1,310,636 1,387,372 1,567,748 Amortization of cost of insurance acquired 2,527,360 5,690,069 4,509,755 Amortization of value of agency force 0 0 396,852 Non-recurring write down of value of agency force 0 0 8,296,974 Amortization of costs in excess of net assets purchased 155,000 185,279 423,192 Depreciation 457,415 371,991 694,194 Minority interest 129,712 498,356 (1,938,684) Change in accrued investment income (205,480) 195,821 (173,517) Change in reinsurance receivables 1,257,953 83,871 (482,275) Change in policy liabilities and accruals (547,081) 3,326,651 3,581,928 Charges for mortality and administration of universal life and annuity products (10,588,874) (10,239,476) (9,757,354) Interest credited to account balances 7,212,406 7,075,921 6,644,282 Change in income taxes payable 511,666 (4,653,734) (4,749,335) Change in indebtedness (to) from affiliates, net (12,107) 224,472 (3,023) Change in other assets and liabilities, net (1,893,811) 396,226 (1,529,727) Net cash provided by (used in) operating activities (245,301) 2,971,446 708,065 Cash flows from investing activities: Proceeds from investments sold and matured: Fixed maturities held for sale 290,660 1,219,036 619,612 Fixed maturities sold 0 18,736,612 0 Fixed maturities matured 21,488,265 20,721,482 16,265,140 Equity securities 76,302 8,990 104,260 Mortgage loans 1,794,518 3,364,427 2,252,423 Real estate 1,136,995 3,219,851 1,768,254 Policy loans 4,785,222 3,937,471 4,110,744 Short term 410,000 825,000 25,000 Total proceeds from investments sold and matured 29,981,962 52,032,869 25,145,433 Cost of investments acquired: Fixed maturities (23,220,172) (29,365,111) (25,112,358 Equity securities (1,248,738) 0 (1,000,000) Mortgage loans (245,234) (503,113) (322,129) Real estate (1,444,980) (813,331) (1,902,609) Policy loans (4,554,291) (4,329,124) (4,713,471) Short term (1,726,035) (830,983) (100,000) Total cost of investments acquired (32,439,450) (35,841,662) (33,150,567 Purchase of property and equipment (531,528) (383,411) (57,625) Net cash provided by (used in) investing activities (2,989,016) 15,807,796 (8,062,759) Cash flows from financing activities: Policyholder contract deposits 17,902,246 22,245,369 25,021,983 Policyholder contract withdrawals (14,515,576) (15,433,644) (16,008,462 Net cash transferred from coinsurance ceded 0 (19,088,371) 0 Proceeds from notes payable 1,000,000 9,300,000 300,000 Payments on principal of notes payable (1,758,252) (10,923,475) (1,205,861) Payment for fractional shares from reverse stock split of subsidiary (534,251) 0 0 Net cash provided by financing activities 2,094,167 (13,900,121) 8,107,660 Net increase (decrease) in cash and cash equivalents (1,140,150) 4,879,121 752,966 Cash and cash equivalents at beginning of year 16,903,789 12,024,668 11,271,702 Cash and cash equivalents at end of year $ 15,763,639 $ 16,903,789 $ 12,024,668
195 UNITED TRUST, GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. ORGANIZATION - At December 31, 1997, the parent, significant majority-owned subsidiaries and affiliates of United Trust Group, Inc., were as depicted on the following organizational chart. ORGANIZATIONAL CHART AS OF DECEMBER 31, 1997 United Trust, Inc. ("UTI") is the ultimate controlling company. UTI owns 53% of United Trust Group ("UTG") and 41% of United Income, Inc. ("UII"). UII owns 47% of UTG. UTG owns 79% of First Commonwealth Corporation ("FCC") and 100% of Roosevelt Equity Corporation ("REC"). FCC owns 100% of Universal Guaranty Life Insurance Company ("UG"). UG owns 100% of United Security Assurance Company ("USA"). USA owns 84% of Appalachian Life Insurance Company ("APPL") and APPL owns 100% of Abraham Lincoln Insurance Company ("ABE"). 196 The Company's significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements are summarized as follows. B. NATURE OF OPERATIONS - United Trust Group, Inc. is an insurance holding company, which sells individual life insurance products through its subsidiaries. The Company's principal market is the Midwestern United States. The primary focus of the Company has been the servicing of existing insurance business in force, the solicitation of new life insurance products and the acquisition of other companies in similar lines of business. C. PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. D. BASIS OF PRESENTATION - The financial statements of United Trust Group, Inc.'s life insurance subsidiaries have been prepared in accordance with generally accepted accounting principles which differ from statutory accounting practices permitted by insurance regulatory authorities. E. USE OF ESTIMATES - In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F. INVESTMENTS - Investments are shown on the following bases: Fixed maturities -- at cost, adjusted for amortization of premium or discount and other-than-temporary market value declines. The amortized cost of such investments differs from their market values; however, the Company has the ability and intent to hold these investments to maturity, at which time the full face value is expected to be realized. Investments held for sale -- at current market value, unrealized appreciation or depreciation is charged directly to shareholders' equity. Mortgage loans on real estate -- at unpaid balances, adjusted for amortization of premium or discount, less allowance for possible losses. Real estate - Investment real estate at cost, less allowances for depreciation and, as appropriate, provisions for possible losses. Foreclosed real estate is adjusted for any impairment at the foreclosure date. Accumulated depreciation on investment real estate was $539,366 and $442,373 as of December 31, 1997 and 1996, respectively. Policy loans -- at unpaid balances including accumulated interest but not in excess of the cash surrender value. Short-term investments -- at cost, which approximates current market value. Realized gains and losses on sales of investments are recognized in net income on the specific identification basis. G. RECOGNITION OF REVENUES AND RELATED EXPENSES - Premiums for traditional life insurance products, which include those products with fixed and guaranteed premiums and benefits, consist principally of whole life insurance policies, limited-payment life insurance policies, and certain annuities with life contingencies are recognized as revenues when due. Accident and health insurance premiums are recognized as revenue pro rata over the terms of the policies. Benefits and related expenses associated with the premiums earned are charged to expense proportionately over the lives of the policies through a provision for future policy benefit liabilities and through deferral and amortization of deferred policy acquisition costs. For universal life and investment products, generally there is no requirement for payment of premium other than to maintain account values at a level sufficient to pay mortality and expense charges. Consequently, premiums for universal life policies and investment products are not reported as revenue, but as deposits. Policy fee revenue for universal life policies and investment products consists of charges for the cost of insurance and policy administration fees assessed during the period. Expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances. 197 H. DEFERRED POLICY ACQUISITION COSTS - Commissions and other costs of acquiring life insurance products that vary with and are primarily related to the production of new business have been deferred. Traditional life insurance acquisition costs are being amortized over the premium-paying period of the related policies using assumptions consistent with those used in computing policy benefit reserves. For universal life insurance and interest sensitive life insurance products, acquisition costs are being amortized generally in proportion to the present value of expected gross profits from surrender charges and investment, mortality, and expense margins. Under SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments," the Company makes certain assumptions regarding the mortality, persistency, expenses, and interest rates it expects to experience in future periods. These assumptions are to be best estimates and are to be periodically updated whenever actual experience and/or expectations for the future change from initial assumptions. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised. The following table summarizes deferred policy acquisition costs and related data for the years shown. 1997 1996 1995 Deferred, beginning of year $ 11,325,356 $ 11,436,728 $ 10,634,476 Acquisition costs deferred: Commissions 312,000 845,000 1,838,000 Other expenses 274,000 431,000 532,000 Total 586,000 1,276,000 2,370,000 Interest accretion 425,000 408,000 338,000 Amortization charged to income (1,735,636) (1,795,372) (1,905,748) Net amortization (1,310,636) (1,387,372) (1,567,748) Change for the year (724,636) (111,372) 802,252 Deferred, end of year $ 10,600,720 $ 11,325,356 $ 11,436,728
198 The following table reflects the components of the income statement for the line item Commissions and amortization of deferred policy acquisition costs: 1997 1996 1995 Net amortization of deferred policy acquisition costs $ 1,310,636 $ 1,387,372 $ 1,567,748 Commissions 2,305,729 2,837,513 3,339,905 Total $ 3,616,365 $ 4,224,885 $ 4,907,653
Estimated net amortization expense of deferred policy acquisition costs for the next five years is as follows: Interest Net Accretion Amortization Amortization 1998 $ 403,000 $ 1,530,000 $ 1,127,000 1999 365,000 1,359,000 994,000 2000 330,000 1,211,000 881,000 2001 299,000 1,082,000 783,000 2002 270,000 969,000 699,000
I.COST OF INSURANCE ACQUIRED - When an insurance company is acquired, the Company assigns a portion of its cost to the right to receive future cash flows from insurance contracts existing at the date of the acquisition. The cost of policies purchased represents the actuarially determined present value of the projected future cash flows from the acquired policies. Cost of Insurance Acquired is amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits.. The interest rates utilized in the amortization calculation are 9% on approximately 24% of the balance and 15% on the remaining balance. The interest rates vary due to differences in the blocks of business. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised. 1997 1996 1995 Cost of insurance acquired, beginning of year $ 47,536,812 $ 59,601,720 $ 64,111,475 Interest accretion 6,288,402 6,649,203 7,044,239 Amortization (8,815,762) (12,339,272) (11,553,994) Net amortization (2,527,360) (5,690,069) (4,509,755) Balance attributable to coinsurance agreement 0 (6,374,839) 0 Cost of insurance acquired,end of year $ 45,009,452 $ 47,536,812 $ 59,601,720
199 Estimated net amortization expense of cost of insurance acquired for the next five years is as follows: Interest Net Accretion Amortization Amortization 1998 $ 6,427,000 $ 8,696,000 $ 2,269,000 1999 6,090,000 7,688,000 1,598,000 2000 5,851,000 7,229,000 1,378,000 2001 5,649,000 7,229,000 1,580,000 2002 5,008,000 6,569,000 1,561,000
J.COST IN EXCESS OF NET ASSETS PURCHASED - Cost in excess of net assets purchased is the excess of the amount paid to acquire a company over the fair value of its net assets. Costs in excess of net assets purchased are amortized on the straight-line basis over a 40-year period. Management continually reviews the value of goodwill based on estimates of future earnings. As part of this review, management determines whether goodwill is fully recoverable from projected undiscounted net cash flows from earnings of the subsidiaries over the remaining amortization period. If management were to determine that changes in such projected cash flows no longer supported the recoverability of goodwill over the remaining amortization period, the carrying value of goodwill would be reduced with a corresponding charge to expense or by shortening the amortization period (no such changes have occurred). Accumulated amortization of cost in excess of net assets purchased was $1,420,146 and $1,265,146 as of December 31, 1997 and 1996, respectively. A reverse stock split of FCC in May of 1997 created negative goodwill of $2,564,719. The credit to goodwill resulted from the retirement of fractional shares. Please refer to Note 11 to the Consolidated Financial Statements for additional information concerning the reverse stock split. K. PROPERTY AND EQUIPMENT - Company- occupied property, data processing equipment and furniture and office equipment are stated at cost less accumulated depreciation of $1,375,105 and $1,014,683 at December 31, 1997 and 1996, respectively. Depreciation is computed on a straight-line basis for financial reporting purposes using estimated useful lives of three to thirty years. Depreciation expense was $360,422 and $277,567 for the years ended December 31, 1997 and 1996, respectively. L.FUTURE POLICY BENEFITS AND EXPENSES - The liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance subsidiaries' experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. The Company makes these assumptions at the time the contract is issued or, in the case of contracts acquired by purchase, at the purchase date. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. Current mortality rate assumptions are based on 1975-80 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or Linton C, which are industry standard actuarial tables for forecasting assumed policy lapse rates. Benefit reserves for universal life insurance and interest sensitive life insurance products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims in excess of related policy account balances. Interest crediting rates for universal life and interest sensitive products range from 5.0% to 6.0% in 1997, 1996 and 1995. M.POLICY AND CONTRACT CLAIMS - Policy and contract claims include provisions for reported claims in process of settlement, valued in accordance with the terms of the policies and contracts, as well as provisions for claims incurred and unreported based on prior experience of the Company. 200 N.PARTICIPATING INSURANCE - Participating business represents 29% and 30% of the ordinary life insurance in force at December 31, 1997 and 1996, respectively. Premium income from participating business represents 50%, 52%, and 55% of total premiums for the years ended December 31, 1997, 1996 and 1995, respectively. The amount of dividends to be paid is determined annually by the respective insurance subsidiary's Board of Directors. Earnings allocable to participating policyholders are based on legal requirements that vary by state. O.INCOME TAXES - Income taxes are reported under Statement of Financial Accounting Standards Number 109. Deferred income taxes are recorded to reflect the tax consequences on future periods of differences between the tax bases of assets and liabilities and their financial reporting amounts at the end of each such period. P.BUSINESS SEGMENTS - The Company operates principally in the individual life insurance business. Q.EARNINGS PER SHARE - Earnings per share are based on the weighted average number of common shares outstanding during each year. R.CASH EQUIVALENTS - The Company considers certificates of deposit and other short-term instruments with an original purchased maturity of three months or less cash equivalents. S.RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform with the 1997 presentation. Such reclassifications had no effect on previously reported net loss, total assets, or shareholders' equity. T.REINSURANCE - In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage and coinsurance contracts. The Company retains a maximum of $125,000 of coverage per individual life. Amounts paid or deemed to have been paid for reinsurance contracts are recorded as reinsurance receivables. Reinsurance receivables is recognized in a manner consistent with the liabilities relating to the underlying reinsured contracts. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. 2. SHAREHOLDER DIVIDEND RESTRICTION At December 31, 1997, substantially all of consolidated shareholders' equity represents net assets of UTG's subsidiaries. The payment of cash dividends to shareholders is not legally restricted. However, insurance company dividend payments are regulated by the state insurance department where the company is domiciled. UTI is the ultimate parent of UG through ownership of several intermediary holding companies. UG can not pay a dividend directly to UII due to the ownership structure. UG's dividend limitations are described below without effect of the ownership structure. Ohio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 1997, UG had a statutory gain from operations of $1,779,246. At December 31, 1997, UG's statutory capital and surplus amounted to $10,997,365. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation. 201 3. INCOME TAXES Until 1984, the insurance companies were taxed under the provisions of the Life Insurance Company Income Tax Act of 1959 as amended by the Tax Equity and Fiscal Responsibility Act of 1982. These laws were superseded by the Deficit Reduction Act of 1984. All of these laws are based primarily upon statutory results with certain special deductions and other items available only to life insurance companies. Under the provision of the pre-1984 life insurance company income tax regulations, a portion of "gain from operations" of a life insurance company was not subject to current taxation but was accumulated, for tax purposes, in a special tax memorandum account designated as "policyholders' surplus account". Federal income taxes will become payable on this account at the then current tax rate when and if distributions to shareholders, other than stock dividends and other limited exceptions, are made in excess of the accumulated previously taxed income maintained in the "shareholders surplus account". The following table summarizes the companies with this situation and the maximum amount of income that has not been taxed in each. Shareholders' Untaxed Company Surplus Balance ABE $ 5,237,958 $ 1,149,693 APPL 5,417,825 1,525,367 UG 27,760,313 4,363,821 USA 0 0 The payment of taxes on this income is not anticipated; and, accordingly, no deferred taxes have been established. The life insurance company subsidiaries file a consolidated federal income tax return. The holding companies of the group file separate returns. Life insurance company taxation is based primarily upon statutory results with certain special deductions and other items available only to life insurance companies. Income tax expense consists of the following components: 1997 1996 1995 Current tax $ 5,400 $ (148,148) $ 1,897 expense Deferred tax expense 566,599 (4,495,813) (4,726,689) (credit) $ 571,999 $ (4,643,961) $ (4,724,792) The Companies have net operating loss carryforwards for federal income tax purposes expiring as follows: UG FCC 2004 $ 0 $ 163,334 2005 0 138,765 2006 2,400,574 33,345 2007 782,452 676,067 2008 939,977 4,595 2009 0 168,800 2010 0 19,112 2012 2,970,692 0 TOTAL $ 7,093,695 $ 1,204,018 202 The Company has established a deferred tax asset of $2,904,200 for its operating loss carryforwards and has established an allowance of $2,904,200. The expense or (credit) for income taxes differed from the amounts computed by applying the applicable United States statutory rate of 35% to the loss before taxes as a result of the following differences: 1997 1996 1995 Tax computed at statutory rate $ (168,382) $ (2,381,055) $ (4,194,523) Changes in taxes due to: Cost in excess of net assets purchased 54,250 64,848 60,594 Current year loss for which no benefit realized 1,039,742 0 0 Benefit of prior losses (324,705) (2,393,395) (598,563) Other (28,906) 65,641 7,700 Income tax expense (credit) $ 571,999 $ (4,643,961) $ (4,724,792)
The following table summarizes the major components that comprise the deferred tax liability as reflected in the balance sheets: 1997 1996 Investments $ (228,027) $ (122,251) Cost of insurance acquired 15,753,308 16,637,883 Deferred policy acquisition costs 3,710,252 3,963,875 Agent balances (23,954) (65,609) Property and equipment (19,818) (37,683) Discount of notes 896,113 922,766 Management/consulting fees (573,182) (733,867) Future policy benefits (4,421,038) (5,906,087) Other liabilities (756,482) (1,151,405) Federal tax DAC (2,179,487) (1,916,536) Deferred tax liability $12,157,685 $ 11,591,086
203 4. ANALYSIS OF INVESTMENTS, INVESTMENT INCOME AND INVESTMENT GAIN A.NET INVESTMENT INCOME - The following table reflects net investment income by type of investment: December 31, 1997 1996 1995 Fixed maturities and fixed maturities held for sale $ 12,677,348 $ 13,326,312 $ 13,253,122 Equity securities 87,211 88,661 52,445 Mortgage loans 802,123 1,047,461 1,257,189 Real estate 745,502 794,844 975,080 Policy loans 976,064 1,121,538 1,041,900 Short-term investments 70,624 21,423 21,295 Other 721,866 724,771 620,954 Total consolidated investment income 16,080,738 17,125,010 17,221,985 Investment expenses (1,198,061) (1,222,903) (1,724,438) Consolidated net investment income $ 14,882,677 $ 15,902,107 $ 15,497,547
At December 31, 1997, the Company had a total of $5,797,000 of investments, comprised of $3,848,000 in real estate and $1,949,000 in equity securities, which did not produce income during 1997. The following table summarizes the Company's fixed maturity holdings and investments held for sale by major classifications: Carrying Value 1997 1996 Investments held for sale: Fixed maturities $ 1,668,630 $ 1,961,166 Equity securities 3,001,744 1,794,405 Fixed maturities: U.S. Government, government agencies and authorities 28,259,322 28,554,631 State, municipalities and political subdivisions 22,778,816 14,421,735 Collateralized mortgage obligations 11,093,926 13,246,781 Public utilities 47,984,322 51,821,989 All other corporate bonds 70,853,947 71,891,649 $ 185,640,707 $ 183,692,356
By insurance statute, the majority of the Company's investment portfolio is required to be invested in investment grade securities to provide ample protection for policyholders. The Company does not invest in so-called "junk bonds" or derivative investments. Below investment grade debt securities generally provide higher yields and involve greater risks than investment grade debt securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment grade issuers. In addition, the trading market for these securities is usually more limited than for investment grade debt securities. Debt securities classified as below- investment grade are those that receive a Standard & Poor's rating of BB or below. 204 The following table summarizes by category securities held that are below investment grade at amortized cost: Below Investment Grade Investments 1997 1996 1995 State, Municipalities and political Subdivisions $ 0 $ 10,042 $ 0 Public Utilities 80,497 117,609 116,879 Corporate 656,784 813,717 819,010 Total $ 737,281 $ 941,368 $ 935,889
B. INVESTMENT SECURITIES The amortized cost and estimated market values of investments in securities including investments held for sale are as follows: Cost or Gross Gross Estimated Amortized Unrealized Unrealized Market 1997 Cost Gains Losses Value Investments Held for Sale: U.S. Government and govt. agencies and authorities $ 1,448,202 $ 0 $ (5,645) $ 1,442,557 States, municipalities and political subdivisions 35,000 485 0 35,485 Collateralized mortgage obligations 0 0 0 0 Public utilities 80,169 328 0 80,497 All other corporate bonds 108,927 1,164 0 110,091 1,672,298 1,977 (5,645) 1,668,630 Equity securities 3,184,357 176,508 (359,121) 3,001,744 Total $ 4,856,655 $ 178,485 $ (364,766) $ 4,670,374 Held to Maturity Securities: U.S. Government and govt. agencies and authorities $ 28,259,322 $ 415,419 $ (51,771) $ 28,622,970 States, municipalities and political subdivisions 22,778,816 672,676 (1,891) 23,449,601 Collateralized mortgage obligations 11,093,926 210,435 (96,714) 11,207,647 Public utilities 47,984,322 1,241,969 (84,754) 49,141,537 All other corporate bonds 70,853,947 1,599,983 (93,117) 72,360,813 Total $ 180,970,333 $ 4,140,482 $ (328,247) $184,782,568
205 Cost or Gross Gross Estimated Amortized Unrealized Unrealized Market 1996 Cost Gains Losses Value Investments Held for Sale: U.S. Government and govt. agencies and authorities $ 1,461,068 $ 0 $ (17,458) $ 1,443,609 States, municipalities and political subdivisions 145,199 665 (6,397) 139,467 Collateralized mortgage obligations 0 0 0 0 Public utilities 119,970 363 (675) 119,658 All other corporate bonds 258,424 4,222 (4,215) 258,432 1,984,661 5,250 (28,745) 1,961,166 Equity securities 2,086,159 37,000 (328,754) 1,794,405 Total $ 4,070,820 $ 42,250 $ (357,499) $ 3,755,571 Held to Maturity Securities: U.S. Government and govt. agencies and authorities $ 28,554,631 $ 421,523 $ (136,410) $ 28,839,744 States, municipalities and political subdivisions 14,421,735 318,682 (28,084) 14,712,333 Collateralized mortgage obligations 13,246,780 175,163 (157,799) 13,264,145 Public utilities 51,821,990 884,858 (381,286) 52,325,561 All other corporate bonds 71,881,649 1,240,230 (448,437) 72,673,442 Total $ 179,926,785 $ 3,040,456 $ (1,152,016) $ 181,815,225
The amortized cost of debt securities at December 31, 1997, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Fixed Maturities Held Estimated for Sale Amortized Market December 31, 1997 Cost Value Due in one year or less $ 83,927 $ 84,952 Due after one year 1,533,202 1,528,211 through five years Due after five years through ten years 55,169 55,467 Due after ten years 0 0 Collateralized mortgage obligations 0 0 Total $ 1,672,298 $ 1,668,630
206 Fixed Maturities Held to Amortized Estimated Maturity Cost Market December 31, 1997 Value Due in one year or less $ 15,023,173 $ 15,003,728 Due after one year through five years 118,849,668 120,857,201 Due after five years through ten years 30,266,228 31,726,265 Due after ten years 5,737,338 5,987,726 Collateralized mortgage obligations 11,093,926 11,207,648 Total $ 180,970,333 $ 184,782,568
An analysis of sales, maturities and principal repayments of the Company's fixed maturities portfolio for the years ended December 31, 1997, 1996 and 1995 is as follows: Cost or Gross Gross Proceeds Amortized Realized Realized from Year ended December Cost Gains Losses Sale 31, 1997 Scheduled principal repayments, calls and tenders: Held for sale $ 299,390 $ 931 $ (9,661) $ 290,660 Held to maturity 21,467,552 21,435 (722) 21,488,265 Sales: Held for sale 0 0 0 0 Held to maturity 0 0 0 0 Total $ 21,766,942 $ 22,366 $ (10,383) $ 21,778,925
Cost or Gross Gross Proceeds Amortized Realized Realized from Year ended December Cost Gains Losses Sale 31, 1996 Scheduled principal repayments, calls and tenders: Held for sale $ 699,361 $ 6,035 $ (813) $ 704,583 Held to maturity 20,900,159 13,469 (192,146) 20,721,482 Sales: Held for sale 517,111 0 (2,658) 514,453 Held to maturity 18,735,848 81,283 (80,519) 18,736,612 Total $ 40,852,479 $ 100,787 $ (276,136) $ 40,677,130
207 Cost or Gross Gross Proceeds Amortized Realize Realized from Year ended December Cost Gains Losses Sale 31, 1995 Scheduled principal repayments, calls and tenders: Held for sale $ 621,461 $ 0 $ (1,849) $ 619,612 Held to maturity 16,383,921 125,740 (244,521) 16,265,140 Sales: Held for sale 0 0 0 0 Held to maturity 0 0 0 0 Total $ 17,005,382 $ 125,740 $ (246,370) $ 16,884,752
C.INVESTMENTS ON DEPOSIT - At December 31, 1997, investments carried at approximately $17,801,000 were on deposit with various state insurance departments. 5. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS The financial statements include various estimated fair value information at December 31, 1997 and 1996, as required by Statement of Financial Accounting Standards 107, Disclosure about Fair Value of Financial Instruments ("SFAS 107"). Such information, which pertains to the Company's financial instruments, is based on the requirements set forth in that Statement and does not purport to represent the aggregate net fair value of the Company. The following methods and assumptions were used to estimate the fair value of each class of financial instrument required to be valued by SFAS 107 for which it is practicable to estimate that value: (a) Cash and Cash equivalents The carrying amount in the financial statements approximates fair value because of the relatively short period of time between the origination of the instruments and their expected realization. (b) Fixed maturities and investments held for sale Quoted market prices, if available, are used to determine the fair value. If quoted market prices are not available, management estimates the fair value based on the quoted market price of a financial instrument with similar characteristics. (c) Mortgage loans on real estate The fair values of mortgage loans are estimated using discounted cash flow analyses and interest rates being offered for similar loans to borrowers with similar credit ratings. (d) Investment real estate and real estate acquired in satisfaction of debt An estimate of fair value is based on management's review of the individual real estate holdings. Management utilizes sales of surrounding properties, current market conditions and geographic considerations. Management conservatively estimates the fair value of the portfolio is equal to the carrying value. 208 (e) Policy loans It is not practicable to estimate the fair value of policy loans as they have no stated maturity and their rates are set at a fixed spread to related policy liability rates. Policy loans are carried at the aggregate unpaid principal balances in the consolidated balance sheets, and earn interest at rates ranging from 4% to 8%. Individual policy liabilities in all cases equal or exceed outstanding policy loan balances. (f) Short-term investments For short-term instruments, the carrying amount is a reasonable estimate of fair value. Short-term instruments represent United States Government Treasury Bills and certificates of deposit with various banks that are protected under FDIC. (g) Notes and accounts receivable and uncollected premiums The Company holds a $840,066 note receivable for which the determination of fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Accounts receivable and uncollected premiums are primarily insurance contract related receivables which are determined based upon the underlying insurance liabilities and added reinsurance amounts, and thus are excluded for the purpose of fair value disclosure by paragraph 8(c) of SFAS 107. (h) Notes payable For borrowings under the senior loan agreement, which is subject to floating rates of interest, carrying value is a reasonable estimate of fair value. For subordinated borrowings fair value was determined based on the borrowing rates currently available to the Company for loans with similar terms and average maturities. The estimated fair values of the Company's financial instruments required to be valued by SFAS 107 are as follows as of December 31: 1997 1996 Estimated Estimated Carrying Fair Carrying Fair Assets Amount Value Amount Value Fixed maturities $ 180,970,333 $ 184,782,568 $ 179,926,785 $ 181,815,225 Fixed maturities held for sale 1,668,630 1,668,630 1,961,166 1,961,166 Equity securities 3,001,744 3,001,744 1,794,405 1,794,405 Mortgage loans on real estate 9,469,444 9,837,530 11,022,792 11,022,792 Policy loans 14,207,189 14,207,189 14,438,120 14,438,120 Short-term investments 1,798,878 1,798,878 430,983 430,983 Investment in real estate 9,760,732 9,760,732 9,779,984 9,779,984 Real estate acquired in satisfaction of debt 1,724,544 1,724,544 1,724,544 1,724,544 Notes receivable 1,680,066 1,569,603 1,680,066 1,566,562 Liabilities Notes payable 19,081,602 18,539,301 19,839,853 18,671,155
209 6. STATUTORY EQUITY AND GAIN FROM OPERATIONS The Company's insurance subsidiaries are domiciled in Ohio, Illinois and West Virginia and prepare their statutory-based financial statements in accordance with accounting practices prescribed or permitted by the respective insurance department. These principles differ significantly from generally accepted accounting principles. "Prescribed" statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners ("NAIC"). "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, from company to company within a state, and may change in the future. The NAIC currently is in the process of codifying statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. Accordingly, that project, which has not yet been completed, will likely change prescribed statutory accounting practices and may result in changes to the accounting practices that insurance enterprises use to prepare their statutory financial statements. UG's total statutory shareholders' equity was $10,997,365 and $10,226,566 at December 31, 1997 and 1996, respectively. The Company's insurance subsidiaries reported combined statutory gain from operations (exclusive of intercompany dividends) was $3,978,000, $10,692,000 and $4,076,000 for 1997, 1996 and 1995, respectively. 7. REINSURANCE Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The Company assumes risks from, and reinsures certain parts of its risks with other insurers under yearly renewable term and coinsurance agreements that are accounted for by passing a portion of the risk to the reinsurer. Generally, the reinsurer receives a proportionate part of the premiums less commissions and is liable for a corresponding part of all benefit payments. While the amount retained on an individual life will vary based upon age and mortality prospects of the risk, the Company generally will not carry more than $125,000 individual life insurance on a single risk. The Company has reinsured approximately $1.022 billion, $1.109 billion and $1.088 billion in face amount of life insurance risks with other insurers for 1997, 1996 and 1995, respectively. Reinsurance receivables for future policy benefits were $37,814,106 and $38,745,093 at December 31, 1997 and 1996, respectively, for estimated recoveries under reinsurance treaties. Should any reinsurer be unable to meet its obligation at the time of a claim, obligation to pay such claim would remain with the Company. Currently, the Company is utilizing reinsurance agreements with Business Men's Assurance Company, ("BMA") and Life Reassurance Corporation, ("LIFE RE") for new business. BMA and LIFE RE each hold an "A+" (Superior) rating from A.M. Best, an industry rating company. The reinsurance agreements were effective December 1, 1993, and cover all new business of the Company. The agreements are a yearly renewable term ("YRT") treaty where the Company cedes amounts above its retention limit of $100,000 with a minimum cession of $25,000. One of the Company's insurance subsidiaries (UG) entered into a coinsurance agreement with First International Life Insurance Company ("FILIC") as of September 30, 1996. Under the terms of the agreement, UG ceded to FILIC substantially all of its paid-up life insurance policies. Paid-up life insurance generally refers to non-premium paying life insurance policies. A.M. Best assigned FILIC a Financial Performance Rating (FPR) of 7 (Strong) on a scale of 1 to 9. A.M. Best assigned a Best's Rating of A++ (Superior) to The Guardian Life Insurance Company of America ("Guardian"), parent of FILIC, based on the consolidated financial condition and operating performance of the company and its life/health subsidiaries. During 1997, FILIC changed its name to Park Avenue Life Insurance Company ("PALIC"). The agreement with PALIC accounts for approximately 65% of the reinsurance receivables as of December 31, 1997. 210 The Company does not have any short-duration reinsurance contracts. The effect of the Company's long-duration reinsurance contracts on premiums earned in 1997, 1996 and 1995 was as follows: Shown in thousands 1997 1996 1995 Premiums Premiums Premiums Earned Earned Earned Direct $ 33,374 $ 35,891 $ 38,482 Assumed 0 0 0 Ceded (4,735) (4,947) (5,383) Net premiums $ 28,639 $ 30,944 $ 33,099 8. COMMITMENTS AND CONTINGENCIES The insurance industry has experienced a number of civil jury verdicts which have been returned against life and health insurers in the jurisdictions in which the Company does business involving the insurers' sales practices, alleged agent misconduct, failure to properly supervise agents, and other matters. Some of the lawsuits have resulted in the award of substantial judgments against the insurer, including material amounts of punitive damages. In some states, juries have substantial discretion in awarding punitive damages in these circumstances. Under the insurance guaranty fund laws in most states, insurance companies doing business in a participating state can be assessed up to prescribed limits for policyholder losses incurred by insolvent or failed insurance companies. Although the Company cannot predict the amount of any future assessments, most insurance guaranty fund laws currently provide that an assessment may be excused or deferred if it would threaten an insurer's financial strength. Mandatory assessments may be partially recovered through a reduction in future premium tax in some states. The Company does not believe such assessments will be materially different from amounts already provided for in the financial statements. The Company and its subsidiaries are named as defendants in a number of legal actions arising primarily from claims made under insurance policies. Those actions have been considered in establishing the Company's liabilities. Management and its legal counsel are of the opinion that the settlement of those actions will not have a material adverse effect on the Company's financial position or results of operations. 9. RELATED PARTY TRANSACTIONS UII has a service agreement with USA which states that USA is to pay UII monthly fees equal to 22% of the amount of collected first year premiums, 20% in second year and 6% of the renewal premiums in years three and after. UII's subcontract agreement with UTI states that UII is to pay UTI monthly fees equal to 60% of collected service fees from USA as stated above. USA paid $989,295, $1,567,891 and $2,015,325 under their agreement with UII for 1997, 1996 and 1995, respectively. UII paid $593,577, $940,734 and $1,209,195 under their agreement with UTI for 1997, 1996 and 1995, respectively. Respective domiciliary insurance departments have approved the agreements of the insurance companies and it is Management's opinion that where applicable, costs have been allocated fairly and such allocations are based upon generally accepted accounting principles. The costs paid by UTG for services include costs related to the production of new business, which are deferred as policy acquisition costs and charged off to the income statement through "Amortization of deferred policy acquisition costs". Also included are costs associated with the maintenance of existing policies that are charged as current period costs and included in "general expenses". On July 31,1997, the Company entered into employment agreements with eight individuals, all officers or employees of the Company. The agreements have a term of three years, excepting the agreements with Mr. Ryherd and Mr. Melville, which have five-year terms. The agreements secure the services of these key individuals, providing the Company a stable management environment and positioning for future growth. 211 10. DEFERRED COMPENSATION PLAN UTI and FCC established a deferred compensation plan during 1993 pursuant to which an officer or agent of FCC, UTI or affiliates of UTI, could defer a portion of their income over the next two and one-half years in return for a deferred compensation payment payable at the end of seven years in the amount equal to the total income deferred plus interest at a rate of approximately 8.5% per annum and a stock option to purchase shares of common stock of UTI. At the beginning of the deferral period an officer or agent received an immediately exercisable option to purchase 2,300 shares of UTI common stock at $17.50 per share for each $25,000 ($10,000 per year for two and one-half years) of total income deferred. The option expires on December 31, 2000. A total of 105,000 options were granted in 1993 under this plan. As of December 31, 1997 no options were exercised. At December 31, 1997 and 1996, the Company held a liability of $1,376,384 and $1,267,598, respectively, relating to this plan. At December 31, 1997, UTI common stock had a bid price of $8.00 and an ask price of $9.00 per share. The following information applies to deferred compensation plan stock options outstanding at December 31, 1997: Number outstanding 105,000 Exercise price $17.50 Remaining contractual life 3 years 12. REVERSE STOCK SPLIT OF FCC On May 13, 1997, FCC effected a 1 for 400 reverse stock split. Fractional shares received a cash payment on the basis of $.25 for each old share. FCC maintained a significant number of shareholder accounts with less than $100 of market value of stock. The reverse stock split enabled these smaller shareholders to receive cash for their shares without incurring broker costs and will save the Company administrative costs associated with maintaining these small accounts. 12. NOTES PAYABLE At December 31, 1997 and 1996, the Company has $19,081,602 and $19,839,853 in long-term debt outstanding, respectively. The debt is comprised of the following components: 1997 1996 Senior debt $ 6,900,000 $ 8,400,000 Subordinated 10 yr. notes 5,746,774 6,209,293 Subordinated 20 yr. notes 4,034,828 3,830,560 Other notes payable 2,400,000 1,400,000 $ 19,081,602 $ 19,839,853 A. Senior debt The senior debt is through First of America Bank - Illinois NA and is subject to a credit agreement. The debt bears interest at a rate equal to the "base rate" plus nine-sixteenths of one percent. The Base rate is defined as the floating daily, variable rate of interest determined and announced by First of America Bank from time to time as its "base lending rate." The base rate at December 31, 1997 was 8.5%. Interest is paid quarterly. Principal payments of $1,000,000 are due in May of each year beginning in 1997, with a final payment due May 8, 2005. On November 8, 1997, the Company prepaid the May 1998 principal payment. 212 The credit agreement contains certain covenants with which the Company must comply. These covenants contain provisions common to a loan of this type and include such items as; a minimum consolidated net worth of FCC to be no less than 400% of the outstanding balance of the debt; Statutory capital and surplus of Universal Guaranty Life Insurance Company be maintained at no less than $6,500,000; an earnings covenant requiring the sum of the pre- tax earnings of Universal Guaranty Life Insurance Company and its subsidiaries (based on Statutory Accounting Practices) and the after-tax earnings plus non-cash charges of FCC (based on parent only GAAP practices) shall not be less than two hundred percent (200%) of the Company's interest expense on all of its debt service. The Company is in compliance with all of the covenants of the agreement. B. Subordinated debt The subordinated debt was incurred June 16, 1992 as a part of the acquisition of the now dissolved Commonwealth Industries Corporation, (CIC). The 10-year notes bear interest at the rate of 7 1/2% per annum, payable semi-annually beginning December 16, 1992. These notes, except for one $840,000 note, provide for principal payments equal to 1/20th of the principal balance due with each interest installment beginning December 16, 1997, with a final payment due June 16, 2002. The aforementioned $840,000 note provides for a lump sum principal payment due June 16, 2002. In June 1997, the Company refinanced a $204,267 subordinated 10-year note as a subordinated 20-year note bearing interest at the rate of 8.75% per annum. The repayment terms of the refinanced note are the same as the original subordinated 20 year notes. The original 20-year notes bear interest at the rate of 8 1/2% per annum on $3,397,620 and 8.75% per annum on $504,962 (of which the $204,267 note refinanced in the current year is included), payable semi-annually with a lump sum principal payment due June 16, 2012. C. Other notes payable United Income, Inc. holds two promissory notes receivable totaling $850,000 due from FCC. Each note bears interest at the rate of 1% over prime as published in the Wall Street Journal, with interest payments due quarterly. Principal of $150,000 is due upon the maturity date of June 1, 1999, with the remaining principal payment of $700,000 becoming due upon the maturity date of May 8, 2006. United Trust, Inc. holds three promissory notes receivable totaling $1,550,000 due from FCC. Each note bears interest at the rate of 1% over prime as published in the Wall Street Journal, with interest payments due quarterly. Principal of $250,000 is due upon the maturity date of June 1, 1999, with the remaining principal payment of $1,300,000 becoming due upon maturity in 2006. Scheduled principal reductions on the Company's debt for the next five years is as follows: Year Amount 1998 $ 516,504 1999 1,916,504 2000 1,516,504 2001 1,516,504 2002 2,356,504 13. OTHER CASH FLOW DISCLOSURES On a cash basis, the Company paid $1,658,703, $1,700,973 and $1,934,326 in interest expense for the years 1997, 1996 and 1995, respectively. The Company paid $57,277, $17,634 and $25,821 in federal income tax for 1997, 1996 and 1995, respectively. One of the Company's insurance subsidiaries ("UG") entered into a coinsurance agreement with Park Avenue Life Insurance Company ("PALIC") at September 30, 1996. At closing of the transaction, UG received a coinsurance credit of $28,318,000 for policy liabilities covered under the agreement. UG transferred assets equal to the credit received. This transfer included policy loans of $2,855,000 associated with policies under the agreement and a net cash transfer of $19,088,000 after deducting the ceding commission due UG of $6,375,000. To provide the cash required to be transferred under the agreement, the Company sold $18,737,000 of fixed maturity investments. 213 14. NON-RECURRING WRITE DOWN OF VALUE OF AGENCY FORCE ACQUIRED During the year-ended December 31, 1995, the Company recognized a non- recurring write down of $8,297,000 on its value of agency force acquired The write down released $2,904,000 of the deferred tax liability and $3,327,000 was attributed to minority interest in loss of consolidated subsidiaries. In addition, equity loss of investees was negatively impacted by $542,000. The effect of this write down resulted in an increase in the net loss of $2,608,000. This write down is directly related to the Company's change in distribution systems. Due to the broker agency force not meeting management's expectations and lack of production, the Company has changed its focus from a primarily broker agency distribution system to a captive agent system. With the change in focus, most of the broker agents were terminated and therefore, management re- evaluated the value of the agency force carried on the balance sheet. For purposes of the write-down, the broker agency force has no future expected cash flows and therefore warranted a write-off of the value. The write down is reported as a separate line item "non-recurring write down of value of agency force acquired" and the release of the deferred tax liability is reported in the credit for income taxes payable in the Statement of Operations. In addition, the impact to minority interest in loss of consolidated subsidiaries and equity loss of investees is in the Statement of Operations. 15. CONCENTRATION OF CREDIT RISK The Company maintains cash balances in financial institutions that at times may exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents. 16. NEW ACCOUNTING STANDARDS The Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards (SFAS) No. 128 entitled Earnings per share, which is effective for financial statements for fiscal years beginning after December 15, 1997. SFAS No. 128 specifies the computation, presentation, and disclosure requirements for earnings per share (EPS) for entities with publicly held common stock or potential common stock. The Statement's objective is to simplify the computation of earnings per share, and to make the U.S. standard for computing EPS more compatible with the EPS standards of other countries. Under SFAS No. 128, primary EPS computed in accordance with previous opinions is replaced with a simpler calculation called basic EPS. Basic EPS is calculated by dividing income available to common stockholders (i.e., net income or loss adjusted for preferred stock dividends) by the weighted-average number of common shares outstanding. Thus, in the most significant change in current practice, options, warrants, and convertible securities are excluded from the basic EPS calculation. Further, contingently issuable shares are included in basic EPS only if all the necessary conditions for the issuance of such shares have been satisfied by the end of the period. Fully diluted EPS has not changed significantly but has been renamed diluted EPS. Income available to common stockholders continues to be adjusted for assumed conversion of all potentially dilutive securities using the treasury stock method to calculate the dilutive effect of options and warrants. However, unlike the calculation of fully diluted EPS under previous opinions, a new treasury stock method is applied using the average market price or the ending market price. Further, prior opinion requirement to use the modified treasury stock method when the number of options or warrants outstanding is greater than 20% of the outstanding shares also has been eliminated. SFAS 128 also includes certain shares that are contingently issuable; however, the test for inclusion under the new rules is much more restrictive. SFAS No. 128 requires companies reporting discontinued operations, extraordinary items, or the cumulative effect of accounting changes are to use income from operations as the control number or benchmark to determine whether potential common shares are dilutive or antidilutive. Only dilutive securities are to be included in the calculation of diluted EPS. This statement was adopted for the 1997 Financial Statements. For all periods presented the Company reported a loss from continuing operations so any potential issuance of common shares would have an antidilutive effect on EPS. Consequently, the adoption of SFAS No. 128 did not have an impact on the Company's financial statement. 214 The FASB has issued SFAS No. 130 entitled Reporting Comprehensive Income and SFAS No. 132 Employers' Disclosures about Pensions and Other Postretirement Benefits. Both of the above statements are effective for financial statements with fiscal years beginning after December 15, 1997. SFAS No. 130 defines how to report and display comprehensive income and its components in a full set of financial statements. The purpose of reporting comprehensive income is to report a measure of all changes in equity of an enterprise that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners. SFAS No. 132 addresses disclosure requirements for post-retirement benefits. The statement does not change post-retirement measurement or recognition issues. The Company will adopt both SFAS No. 130 and SFAS No. 132 for the 1998 financial statements. Management does not expect either adoption to have a material impact on the Company's financial statements. 17. PENDING CHANGE IN CONTROL OF UNITED TRUST, INC. On February 19, 1998, UTI signed a letter of intent with Jesse T. Correll, whereby Mr. Correll will personally or in combination with other individuals make an equity investment in UTI over a period of three years. Under the terms of the letter of intent Mr. Correll will buy 2,000,000 authorized but unissued shares of UTI common stock for $15.00 per share and will also buy 389,715 shares of UTI common stock, representing stock of UTI and UII, that UTI purchased during the last eight months in private transactions at the average price UTI paid for such stock, plus interest, or approximately $10.00 per share. Mr. Correll also will purchase 66,667 shares of UTI common stock and $2,560,000 of face amount of convertible bonds (which are due and payable on any change in control of UTI) in private transactions, primarily from officers of UTI. Upon completion of the transaction, Mr. Correll would be the largest shareholder of UTI. UTI intends to use the equity that is being contributed to expand their operations through the acquisition of other life insurance companies. The transaction is subject to negotiation of a definitive purchase agreement; completion of due diligence by Mr. Correll; the receipt of regulatory and other approvals; and the satisfaction of certain conditions. The transaction is not expected to be completed before June 30, 1998, and there can be no assurance that the transaction will be completed. 18. PROPOSED MERGER On March 25, 1997, the Board of Directors of UTI and UII voted to recommend to the shareholders a merger of the two companies. Under the Plan of Merger, UTI would be the surviving entity with UTI issuing one share of its stock for each share held by UII shareholders. UTI owns 53% of United Trust Group, Inc., an insurance holding company, and UII owns 47% of United Trust Group, Inc. Neither UTI nor UII have any other significant holdings or business dealings. The Board of Directors of each company thus concluded a merger of the two companies would be in the best interests of the shareholders. The merger will result in certain cost savings, primarily related to costs associated with maintaining a corporation in good standing in the states in which it transacts business. A vote of the shareholders of UTI and UII regarding the proposed merger is anticipated to occur sometime during the third quarter of 1998. 215 19. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) 1st 2nd 3rd 4th Premiums and policy fees, net $ 7,926,386 $ 7,808,782 $ 6,639,394 $ 6,264,683 Net investment income 3,859,875 3,839,519 3,691,584 3,491,699 Total revenues 11,781,878 11,687,887 10,216,109 9,664,744 Policy benefits including dividends 7,718,01 6,861,699 6,467,739 6,007,718 Commissions and amortization of DAC and COI 1,670,854 1,174,116 1,727,317 1,571,438 Operating and interest expenses 2,884,663 3,084,239 2,778,435 1,885,475 Operating income (loss) (491,654) 567,833 (757,382) 200,113 Net income (loss) (23,565) 27,351 (512,444) (414,719) Net income (loss) per share (235.65) 273.51 (5,124.44) (4,147.19) 1996 1st 2nd 3rd 4th Premiums and policy fees, net $ 7,637,503 8,514,175 $ 7,348,199 $ 7,444,581 Net investment income 3,974,407 3,930,487 4,002,258 3,994,955 Total revenues 12,513,692 12,187,077 11,331,283 10,444,059 Policy benefits including dividends 6,528,760 7,083,803 8,378,710 8,334,759 Commissions and amortization of DAC and COI 2,567,921 2,298,549 1,734,048 3,314,436 Operating and interest expenses 3,616,660 3,072,535 3,685,600 910,771 Operating income (loss) (198,649) (267,810) (2,467,075) (3,869,480) Net income (loss) 268,675 (93,640) (1,563,817) (271,915) Net income (loss) per share 2,686.75 (936.40) (15,638.17) (2,719.15) 1995 1st 2nd 3rd 4th Premiums and policy fees, net $ 8,703,332 $ 9,507,694 $ 7,868,803 $ 7,018,707 Net investment income 3,857,562 3,849,212 3,757,605 3,918,933 Total revenues 13,385,477 12,566,391 11,514,869 11,130,583 Policy benefits including dividends 8,097,830 9,113,933 5,978,795 6,665,206 Commissions and amortization of DAC and COI 2,451,030 2,860,032 3,044,057 1,459,141 Operating and interest expenses 3,449,062 2,742,174 2,498,472 3,924,966 Operating income (loss) (612,445) (2,149,748) (6,455) (9,215,704) Net income (loss) 95,608 (1,305,599) 126,751 (4,237,636) Net income (loss) per share 956.08 (13,055.99) 1,267.51 (42,376.60)
216 UNITED TRUST GROUP, INC. SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES As of December 31, 1997 Schedule I Column A Column B Column C Column D Amount at Which Shown in Balance Cost Value Sheet Fixed maturities: Bonds: United States Goverment and government agencies and authorities $ 28,259,322$ 28,622,970$ 28,259,322 State, municipalities, and political subdivisions 22,778,816 23,449,601 22,778,816 Collateralized mortgage obligations 11,093,926 11,207,647 11,093,926 Public utilities 47,984,322 49,141,537 47,984,322 All other corporate bonds 70,853,947 72,360,813 70,853,947 Total fixed maturities 180,970,333$ 184,782,568 180,970,333 Investments held for sale: Fixed maturities: United States Goverment and government agencies and authorities 1,448,202$ 1,442,557 1,442,557 State, municipalities, and political subdivisions 35,000 35,485 35,485 Public utilities 80,169 80,496 80,496 All other corporate bonds 108,927 110,092 110,092 1,672,298$ 1,668,630 1,668,630 Equity securities: Banks, trusts and insurance companies 2,473,969$ 2,167,368 2,167,368 All other corporate securities 710,388 834,376 834,376 3,184,357$ 3,001,744 3,001,744 Mortgage loans on real estate 9,469,444 9,469,444 Investment real estate 9,760,732 9,760,732 Real estate acquired in satisfaction of debt 1,724,544 1,724,544 Policy loans 14,207,189 14,207,189 Short-term investments 1,798,878 1,798,878 Total investments $ 222,787,775 $ 222,601,494
217 UNITED TRUST GROUP, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT PARENT ONLY BALANCE SHEETS As of December 31, 1997 and 1996 Schedule II 1997 1996 ASSETS Investment in affiliates $ 34,683,168 $ 35,548,414 Cash and cash equivalents 25,980 39,529 Notes receivable from affiliate 9,781,602 10,039,853 Accrued interest income 34,455 35,202 Total assets $ 44,525,205 $ 45,662,998 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Notes payable $ 9,635,257 $ 10,009,853 Notes payable to affiliate 146,345 30,000 Income taxes payable 5,175 6,663 Accrued interest payable 34,455 35,202 Other liabilities 413,429 452,263 Total liabilities 10,234,661 10,533,981 Shareholders' equity: Common stock 45,926,705 45,926,705 Unrealized depreciation of investments held for sale of affiliates (41,708) (126,612) Accumulated deficit (11,594,453) (10,671,076) Total shareholders' equity 34,290,544 35,129,017 Total liabilities and shareholders' equity $ 44,525,205 $ 45,662,998
218 UNITED TRUST GROUP, INC.CONDENSED FINANCIAL INFORMATION OF REGISTRANT PARENT ONLY STATEMENTS OF OPERATIONS Three Years Ended December 31, 1997 Schedule II 1997 1996 1995 Revenues: Interest income from affiliates $ 782,892 $ 792,046 $ 790,334 Other income 37,641 34,600 31,774 820,533 826,646 822,108 Expenses: Interest expense 776,230 789,496 787,784 Interest expense to affiliates 6,662 2,550 2,550 Operating expenses 5,585 4,624 3,341 788,477 796,670 793,675 Operating income 32,056 29,976 28,433 Provision for income taxes (5,362) (4,664) (3,221) Equity in loss of subsidiaries (950,071) (1,686,009) (5,346,088) Net loss $ (923,377)$ (1,660,697)$ (5,320,876)
219 UNITED TRUST GROUP, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT PARENT ONLY STATEMENTS OF CASH FLOWS Three Years Ended December 31, 1997 Schedule II 1997 1996 1995 Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net loss $ (923,377)$ (1,660,697)$ (5,320,876) Adjustments to reconcile net loss to net cash provided by operating activities: Equity in loss of subsidiaries 950,071 1,686,009 5,346,088 Change in accrued interest income 747 0 (167) Change in accrued interest payable (747) 0 167 Change in income taxes payable (1,488) 3,442 3,221 Change in other liabilities (38,834) (139,256) (96,843) Net cash used in operating activities (13,628) (110,502) (68,410) Cash flows from investing activities: Proceeds for fractional shares from reverse stock split of subsidiary 79 0 0 Purchase of stock of affiliates 0 (95,000) (200) Net cash provided by (used in) investing activities 79 (95,000) (200) Cash flows from financing activities: Receipt of principal on notes receivable from affiliate 258,252 0 0 Payments of principal on notes payable (258,252) 0 0 Capital contribution from affiliates 0 200,000 100,000 Net cash provided by financing activities 0 200,000 100,000 Net increase (decrease) in cash and cash equivalents (13,549) (5,502) 31,390 Cash and cash equivalents at beginning of year 39,529 45,031 13,641 Cash and cash equivalents at end of year $ 25,980 $ 39,529 $ 45,031
220 UNITED TRUST GROUP, INC.REINSURANCE As of December 31, 1997 and the year ended December 31, 1997 Schedule IV Column A Column B Column C Column D Column E Column F Percentage Ceded to Assumed of amount other from other assumed to Gross amount companies companies* Net amount net Life insurance in force $3,691,867,000 $1,022,458,000 $1,079,885,000 $3,749,294,000 28.80% Premiums and policy fees: Life insurance $ 33,133,414 $ 4,681,928 $ 0 28,451,486 0.00% Accident and health insurance 240,536 52,777 0 187,759 0.00% $ 33,373,950 $ 4,734,705 $ 0 $ 28,639,245 0.00% * All assumed business represents the Company's participation in the Servicemen's Group Life Insurance Program (SGLI).
221 UNITED TRUST GROUP, INC.REINSURANCE As of December 31, 1996 and the year ended December 31, 1996 Schedule IV Column A Column B Column C Column D Column E Column F Percentage Ceded to Assumed of amount other from other assumed to Gross amount companies companies* Net amount net Life insurance in force $3,952,958,000 $1,108,534,000 $1,271,766,000 $4,116,190,000 30.90% Premiums and policy fees: Life insurance $ 35,633,232 $ 4,896,896 $ 0 $ 30,736,336 0.00% Accident and health insurance 258,377 50,255 0 208,122 0.00% $ 35,891,609 $ 4,947,151 $ 0 $ 30,944,458 0.00% * All assumed business represents the Company's participation in the Servicemen's Group Life Insurance Program (SGLI).
222 UNITED TRUST GROUP, INC.REINSURANCE As of December 31, 1995 and the year ended December 31, 1995 Schedule IV Column A Column B Column C Column D Column E Column F Percentage Ceded to Assumed of amount other from other assumed to Gross amount companies companies* Net amount net Life insurance in force $4,207,695,000 $1,087,774,000 $1,039,517,000 $4,159,438,000 25.00% Premiums and policy fees: Life insurance $ 38,233,190 $ 5,330,351 $ 0 $ 32,902,839 0.00% Accident and health insurance 248,448 52,751 0 195,697 0.00% $ 38,481,638 $ 5,383,102 $ 0 $ 33,098,536 0.00% * All assumed business represents the Company's participation in the Servicemen's Group Life Insurance Program (SGLI).
223 UNITED TRUST GROUP, INC.VALUATION AND QUALIFYING ACCOUNTS For the years ended December 31, 1997, 1996 and 1995 Schedule V Balance at Additions Beginning Charges Balances at Description Of Period and Expenses Deductions End of Period December 31, 1997 Allowance for doubtful accounts - mortgage loans $ 10,000 $ 0 $ 0 $ 10,000 December 31, 1996 Allowance for doubtful accounts - mortgage loans $ 10,000 $ 0 $ 0 $ 10,000 December 31, 1995 Allowance for doubtful accounts - mortgage loans $ 26,000 $ 0 $ 16,000 $ 10,000
224 PART 1. FINANCIAL INFORMATION Item 1. Financial Statements UNITED INCOME, INC. Balance Sheet March 31, December 31, 1998 1997 ASSETS Cash and cash equivalents $ 734,827 $ 710,897 Mortgage loan 121,165 121,520 Notes receivable from affiliate 864,100 864,100 Accrued interest income 11,996 12,068 Property and equipment (net of accumulated depreciation $93,910 and $93,648) 808 1,070 Investment in affiliates 10,959,408 11,060,682 Receivable from affiliate, net 85,476 23,192 Other assets (net of accumulated amortization $148,064 and $138,810) 37,004 46,258 Total assets $ 12,814,784 $ 12,839,787 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities and accruals: Convertible debentures $ 902,300 $ 902,300 Other liabilities 10,564 1,534 Total liabilities 912,864 903,834 Shareholders' equity: Common stock - no par value, stated value $.033 per share. Authorized 2,310,001 shares - 1,391,919 and 1,391,919 shares issued after deducting treasury shares of 177,590 and 177,590 45,934 45,934 Additional paid-in capital 15,242,365 15,242,365 Unrealized appreciation (depreciation) of investments held for sale of affiliate (158,813) (19,603) Accumulated deficit (3,227,566) (3,332,743) Total shareholders' equity 11,901,920 11,935,953 Total liabilities and shareholders' equity $ 12,814,784 $ 12,839,787
225 UNITED INCOME, INC. Statement of Operations Three Months Ended March 31, March 31, 1998 1997 Revenues: Interest income $ 11,551 $ 2,659 Interest income from affiliates 20,488 19,956 Service agreement income from affiliates 237,358 294,095 Other income from affiliates 17,954 25,947 287,351 342,657 Expenses: Management fee to affiliate 142,415 226,457 Operating expenses 50,140 50,318 Interest expense 21,430 20,866 213,985 297,641 Income before provision for income taxes and equity income of investees 73,366 45,016 Provision for income taxes 0 0 Equity in income of investees 31,811 10,556 Net income $ 105,177 $ 55,572 Basic earnings per share from continuing operations and net income $ 0.08 $ 0.04 Diluted earnings per share from continuing operations and net income $ 0.09 $ 0.05
226 UNITED INCOME, INC. Statement of Cash Flows March 31, March 31, 1998 1997 Increase (decrease) in cash and cash equivalents Cash flows from operating activities: Net income $ 105,177 $ 55,572 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 9,516 9,639 Accretion of discount on mortgage loan (65) (67) Equity in loss of investees (31,811) (10,556) Changes in assets and liabilities: Change in accrued interest income 72 62 Change in indebtedness of affiliates (62,284) 45,035 Change in other liabilities 9,030 8,573 Net cash provided by operating activities 29,635 108,258 Cash flows from investing activities: Purchase of investments in affiliates (6,125) (10,409) Payments received on mortgage loans 420 388 Net cash used in investing activities (5,705) (10,021) Net increase in cash and cash equivalents 23,930 98,237 Cash and cash equivalents at beginning of period 710,897 439,676 Cash and cash equivalents at end of period $ 734,827 $ 537,913
227 UNITED INCOME, INC. Notes to Financial Statements 1. BASIS OF PRESENTATION The accompanying financial statements have been prepared by United Income, Inc. (the "Company") pursuant to the rules and regulations of the Securities and Exchange Commission. Although the Company believes the disclosures are adequate to make the information presented not be misleading, it is suggested that these financial statements be read in conjunction with the financial statements and the notes thereto presented in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 1997. The information furnished reflects, in the opinion of the Company, all adjustments (which include only normal and recurring accruals) necessary for a fair presentation of the results of operations for the periods presented. Operating results for interim periods are not necessarily indicative of operating results to be expected for the year or of the Company's future financial condition. At March 31, 1998, the affiliates of United Income, Inc., were as depicted on the following organizational chart. ORGANIZATIONAL CHART AS OF MARCH 31, 1998 United Trust, Inc. ("UTI") is the ultimate controlling company. UTI owns 53% of United Trust Group ("UTG") and 41% of United Income, Inc. ("UII"). UII owns 47% of UTG. UTG owns 79% of First Commonwealth Corporation ("FCC") and 100% of Roosevelt Equity Corporation ("REC"). FCC owns 100% of Universal Guaranty Life Insurance Company ("UG"). UG owns 100% of United Security Assurance Company ("USA"). USA owns 84% of Appalachian Life Insurance Company ("APPL") and APPL owns 100% of Abraham Lincoln Insurance Company ("ABE"). 228 2. STOCK OPTION PLANS The Company has a stock option plan under which certain directors, officers and employees may be issued options to purchase up to 31,500 shares of common stock at $13.07 per share. Options become exercisable at 25% annually beginning one year after date of grant and expire generally in five years. In November 1992, 10,437 option shares were granted. At March 31, 1998, options for 451 shares were exercisable and options for 20,576 shares were available for grant. No options were exercised during 1998. A summary of the status of the Company's stock option plan for the periods ended March 31, 1998 and December 31, 1997, and changes during the periods ending on those dates is presented below. March 31, 1998 December 31, 1997 Exercise Exercise Shares Price Shares Price Outstanding at beginning of period 451 $ 13.07 10,888 $ 13.07 Granted 0 0.00 0 0.00 Exercised 0 0.00 0 0.00 Forfeited 0 13.07 10,437 13.07 Outstanding at end of period 451 $ 13.07 451 $ 13.07 Options exercisable at period end 451 $ 13.07 10,888 $ 13.07 The following information applies to options outstanding at March 31, 1998: Number outstanding 451 Exercise price $ 13.07 Remaining contractual life 3 years On January 15, 1991, the Company adopted an additional Non-Qualified Stock Option Plan under which certain employees and sales personnel may be granted options. The plan provides for the granting of up to 42,000 options at an exercise price of $.47 per share. The options generally expire five years from the date of grant. Options for 10,220 shares of common stock were granted in 1991, options for 1,330 shares were granted in 1993 and options for 301 shares were granted in 1995. A total of 11,620 option shares have been exercised as of March 31, 1998. At March 31, 1998, 231 options have been granted and are exercisable. No options were exercised during 1998 and 1997, respectively. A summary of the status of the Company's stock option plan for the periods ended March 31, 1998 and December 31, 1997, and changes during the periods ending on those dates is presented below. March 31, 1998 December 31, 1997 Exercise Exercise Shares Price Shares Price Outstanding at beginning of period 231 $ 0.47 231 $ 0.47 Granted 0 0.00 0 0.00 Exercised 0 0.00 0 0.00 Forfeited 0 0.00 0 0.00 Outstanding at end of period 231 $ 0.47 231 $ 0.47 Options exercisable at period end 231 $ 0.47 231 $ 0.47 Fair value of options granted during the year $ 0.00 $ 0.00 229 The following information applies to options outstanding at March 31, 1998: Number outstanding 231 Exercise price $ 0.47 Remaining contractual life 3 years 3. COMMITMENTS AND CONTINGENCIES The insurance industry has experienced a number of civil jury verdicts which have been returned against life and health insurers in the jurisdictions in which the Company does business involving the insurers' sales practices, alleged agent misconduct, failure to properly supervise agents, and other matters. Some of the lawsuits have resulted in the award of substantial judgements against the insurer, including material amounts of punitive damages. In some states, juries have substantial discretion in awarding punitive damages in these circumstances. Under insurance guaranty fund laws in most states, insurance companies doing business in a participating state can be assessed up to prescribed limits for policyholder losses incurred by insolvent or failed insurance companies. Although the Company cannot predict the amount of any future assessments, most insurance guaranty fund laws currently provide that an assessment may be excused or deferred if it would threaten an insurer's financial strength. Those mandatory assessments may be partially recovered through a reduction in future premium taxes in some states. The Company does not believe such assessments will be materially different from amounts already provided for in the financial statements. The Company and its affiliates are named as defendants in a number of legal actions arising primarily from claims made under insurance policies. Those actions have been considered in establishing the Company's liabilities. Management and its legal counsel are of the opinion that the settlement of those actions will not have a material adverse effect on the Company's financial position or results of operations. 4. EARNINGS PER SHARE The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computations as presented on the income statement. For the period ended March 31, 1998 Income Shares Per-Share (Numerator) (Denominator) Amount BASIC EPS Income available to common shareholders $ 105,177 1,391,919 $ 0.08 EFFECT OF DILUTIVE SECURITIES Convertible debentures 21,430 36,092 Options 231 DILUTED EPS Income available to common shareholders + assumed conversions $ 126,607 1,428,242 $ 0.09 230 For the period ended March 31, 1997 Income Shares Per-Share (Numerator) (Denominator) Amount BASIC EPS Income available to common shareholders $ 55,572 1,392,130 $ 0.04 EFFECT OF DILUTIVE SECURITIES Convertible debentures 20,866 36,092 Options 231 DILUTED EPS Income available to common shareholders + assumed conversions $ 76,438 1,428,453 $ 0.05 UII has stock options outstanding during the first quarter of 1998 and 1997 for 451 shares of common stock at $13.07 per share that were not included in the computation of diluted EPS because the exercise price was greater than the average market price of the common shares. Due to the limited trading of the stock of UII, market price is assumed to be equal to book value for purposes of this calculation. 5. PROPOSED MERGER OF UNITED TRUST INC. AND UNITED INCOME INC. On March 25, 1997, the Board of Directors of UTI and UII voted to recommend to the shareholders a merger of the two companies. Under the Plan of Merger, UTI would be the surviving entity with UTI issuing one share of its stock for each share held by UII shareholders. UTI owns 53% of United Trust Group, Inc., an insurance holding company, and UII owns 47% of United Trust Group, Inc. Neither UTI nor UII have any other significant holdings or business dealings. The Board of Directors of each company thus concluded a merger of the two companies would be in the best interests of the shareholders. The merger will result in certain cost savings, primarily related to costs associated with maintaining a corporation in good standing in the states in which it transacts business. A vote of the shareholders of UTI and UII regarding the proposed merger is anticipated to occur sometime during the third quarter of 1998. 6. PENDING CHANGE IN CONTROL OF UNITED TRUST, INC. On April 30, 1998, UTI and First Southern Funding, a Kentucky corporation ("FSF"), signed a Definitive Agreement ("the FSF Agreement") whereby FSF will make an equity investment in UTI. Under the terms of the FSF Agreement, FSF will buy 473,523 authorized but unissued shares of UTI common stock for $15.00 a share and will also buy 389,715 shares of UTI common stock that UTI purchased during the last year in private transactions at the average price UTI paid for such stock, plus interest, or approximately $10.00 per share. FSF will also purchase 66,667 shares of UTI common stock and $2,560,000 of face amount convertible bonds which are due and payable on any change in control of UTI, in private transactions, primarily from officers of UTI. In addition, FSF will be granted a three year option to purchase up to 1,450,000 shares of UTI common stock for $15.00 per share. Management of UTI intends to use the equity that is being contributed to expand their operations through the acquisition of other life insurance companies. The transaction is subject to the receipt of regulatory and other approvals; and the satisfaction of certain conditions. The transaction is not expected to be completed before July 31, 1998, and there can be no assurance that the transaction will be completed. 231 FSF is an affiliate of First Southern Bancorp, Inc., a bank holding company that owns five banks that operate out of 14 locations in central Kentucky. 7. SUMMARIZED FINANCIAL INFORMATION OF UNITED TRUST GROUP, INC. The following provides summarized financial information for the Company's 50% or less owned affiliate: March 31, December 31, 1998 1997 ASSETS Total investments $ 214,990,531 $ 222,601,494 Cash and cash equivalents 24,681,509 15,763,639 Cost of insurance acquired 44,366,265 45,009,452 Other assets 64,436,093 64,576,450 TOTAL ASSETS $ 348,474,398 $ 347,951,035 LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities $ 268,916,182 $ 268,237,887 Notes payable 19,081,602 19,081,602 Deferred taxes 12,043,806 12,157,685 Other liabilities 4,378,095 4,053,293 TOTAL LIABILITIES 304,419,685 303,530,467 Minority interests in 10,029,049 10,130,024 consolidated subsidiaries Shareholders' equity Common stock no par value 45,926,705 45,926,705 Authorized 10,000 shares - 100 issued Unrealized depreciation of (337,899) (41,708) investment in stocks Accumulated deficit (11,563,142) (11,594,453) TOTAL SHAREHOLDERS' EQUITY 34,025,664 34,290,544 TOTAL LIABILITIES AND $ 348,474,398 $ 347,951,035 SHAREHOLDERS' EQUITY
232 March 31, 1998 March 31, 1997 Premiums and policy fees, net $ 7,231,481 $ 7,926,386 of reinsurance Net investment income 3,738,105 3,859,875 Other 111,132 (4,383) 11,080,718 11,781,878 Benefits, claims and 6,827,040 7,718,015 settlement expenses Other expenses 4,307,528 4,555,517 11,134,568 12,273,532 Loss before income tax and minority interest (53,850) (491,654) Income tax credit 103,493 459,073 Minority interest in (income) loss of (18,332) 9,016 consolidated subsidiaries Net income (loss) $ 31,311 $ (23,565)
233 APPENDIX A AGREEMENT AND PLAN OF REORGANIZATION AGREEMENT AND PLAN OF REORGANIZATION (this "Agreement") dated March 31, 1998, by and between United Income, Inc., an Ohio corporation ("UII"), and United Trust, Inc., an Illinois corporation ("UTI"). WITNESSETH: UTI and UII have reached an agreement to combine their companies through a merger (the "Merger") of UII into UTI. UTI and UII jointly own 100% of the outstanding capital stock of United Trust Group, Inc., an Illinois corporation ("UTG"). Simultaneously at closing, UTG shall be liquidated and UTI's name will be changed to United Trust Group, Inc. UTI and UII now wish to enter into a definitive agreement setting forth the terms and conditions of the Merger. Accordingly, in consideration of the foregoing and of the covenants, agreements, representations and warranties hereinafter contained, UTI and UII hereby agree as follows: 1.REPRESENTATIONS AND WARRANTIES OF UTI. UTI hereby represents and warrants to UII as follows: 1.1 Organization and Standing. UTI is a corporation duly organized, validly existing and in good standing under the laws of the State of Illinois and has full corporate power to carry on its business as it is now being conducted and to own or hold under lease the properties and assets it now owns or holds under lease. Copies of the certificate of incorporation and bylaws of UTI have been delivered to UII, and such copies are complete and correct and in full force and effect on the date hereof. 1.2 Capitalization. UTI's entire authorized capital stock consists of 3,500,000 shares of Common Stock, no par value and 150,000 shares of Preferred Stock, par value $100 per share. As of May 4, 1998, there were 1,655,200 shares of Common Stock outstanding and no shares of Preferred Stock outstanding. 1.3 Financial Statements. UTI has delivered to UII copies of UTI's audited consolidated financial statements for the fiscal years ended December 31, 1996, 1997 and unaudited financial statements for the three month periods ended March 31, 1997 and March 31, 1998. These financial statements have been prepared in accordance with generally accepted accounting principles consistently followed throughout the periods covered by such statements (except as may be stated in the notes to such statements), and present fairly the consolidated financial position and consolidated results of operations of UTI and its subsidiaries at the dates of and for the periods covered thereby. UTI also has delivered to UII copies of UTI's Form 10-K's, Form 10-Q's, Form 8-K's and proxy statements filed with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934 (the "Exchange Act") in respect of or during the three years ended December 31, 1996 and thereafter through the date hereof. All such reports were filed in a timely manner and complied in all material respects with the applicable requirements of the Exchange Act and the rules and regulations promulgated thereunder. 1.4 Absence of Certain Changes, Events or Conditions. Since March 31, 1998, there has not been any change in UTI's consolidated financial position, results of operations, assets, liabilities, net worth or business, other than as described in a schedule heretofore delivered to UII referring to this Section 1.4 and changes in the ordinary course of business which have not been materially adverse. 1.5 Litigation, etc. Except as described in a schedule heretofore delivered to UII referring to this Section 1.5, there is no pending litigation or other claim or matter against or relating to UTI, its properties or business, or the transactions contemplated by this Agreement, which, under Statement No. 5 of the Financial Accounting Standards Board, would require disclosure in footnotes to, or accrual in, the consolidated financial statements of UTI. 234 1.6 Information for Proxy Statement. The information and data provided and to be provided by UTI for use in the Registration Statement and the Proxy Statement referred to in Section 5, when such Registration Statement becomes effective and at the time of mailing of the Prospectus and Proxy Statement included therein to UTI and UII stockholders pursuant to Section 5, will not contain any untrue statement of a material fact and will not omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading. 1.7 No Conflict With Other Documents. Neither the execution and delivery of this Agreement nor the carrying out of the transactions contemplated hereby will result in any material violation, termination or modification of, or conflict with, any terms of any material contract or other instrument to which UTI is a party, or of any material judgment, decree or order applicable to UTI. 1.8 Authority. The execution, delivery and performance of this Agreement by UTI have been authorized by its Board of Directors, and this Agreement is a valid, legally binding and enforceable obligation of UTI subject to the discretion of a court of equity and subject to bankruptcy insolvency and similar laws affecting the rights of creditors generally. 1.9 Validity of Common Stock to Be Issued. Subject to the approval by the stockholders of UTI, the shares of UTI Common Stock to be issued by UTI in connection with the Merger have been duly authorized by UTI's board of directors for issue and will, when issued and delivered as provided in this Agreement, be duly and validly issued, fully paid and non-assessable. 2. REPRESENTATIONS AND WARRANTIES OF UII. UII hereby represents and warrants to UTI as follows: 2.1 Organization and Standing. UII is a corporation duly organized, validly existing and in good standing under the laws of the State of Ohio, and has full corporate power to carry on its business as it is now being conducted and to own or hold under lease the properties and assets it now owns or holds under lease. UII has delivered to UTI a true and complete schedule referring to Section 2.1 and listing all of its (i) corporate officers ("Officers"), (ii) members of the board of directors ("Directors") and (iii) subsidiaries of which 20% or more of the common stock is directly or indirectly owned by UII. 2.2 Capitalization. UII's entire authorized capital stock consists of 2,310,001 shares of Common Stock, no par value and 150,000 shares of Preferred Stock, par value $100 per share. As of May 4, 1998, there were 1,391,919 shares of Common Stock outstanding and no shares of Preferred Stock outstanding. 2.3 Financial Statements. UII has delivered to UTI copies of the following: UII's audited consolidated financial statements for the fiscal years ended December 31, 1995, 1996 and 1997 and unaudited financial statements for the nine month periods ended March 31, 1997 and March 31, 1998. These financial statements have been prepared in accordance with generally accepted accounting principles consistently followed throughout the periods covered by such statements (except as may be stated in the explanatory notes to such statements), and, at the dates of and for the periods covered thereby, present fairly the consolidated financial position and results of operations of UII and its subsidiaries. UII also has delivered to UTI copies of UII's Form 10-K's, Form 10-Q's, Form 8-K's and proxy statements filed with the Securities and Exchange Commission pursuant to the Exchange Act in respect of or during the three years ended December 31, 1996 and thereafter through the date hereof. All such reports were filed in a timely manner and complied in all material respects with the applicable requirements of the Exchange Act and the rules and regulations promulgated thereunder. 2.4 No Undisclosed Liabilities. Except as and to the extent reflected or reserved against in the consolidated balance sheets included within UII's financial statements referred to in Section 2.3, at the date of such statements UII had no material liabilities or obligations (whether accrued, absolute or contingent), of the character which, under generally accepted accounting principles, should be shown, disclosed or indicated in a balance sheet or explanatory notes or information supplementary thereto, including, without limitation, any liabilities resulting from failure to comply with any law or any federal, state or local tax liabilities due or to become due whether (a) incurred in respect of or measured by income for any period prior to the close of business on such dates, or (b) arising out of transactions entered into, or any state of facts existing, prior thereto. 235 2.5 Absence of Certain Changes, Events or Conditions. Since December 31, 1997, there has not been any change in UII's financial position, results of operations, assets, liabilities, net worth or business, other than as described in a schedule heretofore delivered to UTI referring to this Section 2.5 and changes in the ordinary course of business which have not been materially adverse. 2.6 Litigation, etc. Except as described on a schedule heretofore delivered to UTI and referring to this Section 2.6, there is no litigation, proceeding or governmental investigation pending or threatened, and, so far as is known to UII, there is no such litigation, proceeding or governmental investigation which is probable of assertion in the reasonable opinion of UII's officers, against or relating to UII, its properties or business, or the transactions contemplated by this Agreement. UII is not subject to any order of any court, regulatory commission, board or administrative body entered in any proceeding to which they are a party or of which they have knowledge. 2.7 Compliance. UII has all licensed, permits, approvals and other authorizations, and have made all filings and registrations, necessary in order to enable them to conduct their businesses in all material respects. UII has heretofore delivered a schedule to UTI referring to this Section 2.7 which fairly and accurately summarizes or lists all licenses, permits, approvals, authorizations and regulatory matters relating to UII. UII has complied with all applicable laws, regulations and ordinances to the extent material to their businesses. The schedule referred to in this Section 2.7 fairly and accurately describes all instances, known to the Officers or Directors of UII, in which UII is not currently in compliance with any applicable law, regulation or ordinance. 2.8 Information for Proxy Statement. The information and data provided and to be provided by UII for use in the Registration Statement and the Proxy Statement referred to in Section 5, when such Registration Statement becomes effective and at the time of mailing of the Prospectus and Proxy Statement included therein to UTI and UII stockholders, will not contain any untrue statement of a material fact and will not omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading. 2.9 No Conflict With Other Documents. Except as described in a schedule heretofore delivered to UTI and referring to this Section 2.9, neither the execution and delivery of this Agreement nor the carrying out of the transactions contemplated hereby will result in any violation, termination or modification of, or be in conflict with, any term of any contract or other instrument to which UII is a party, or of any judgment, decree or order applicable to UII, or result in the creation of any lien, charge or encumbrance upon any of the properties or assets of UII. 2.10 Authority. The execution, delivery and performance of this Agreement by UII have been authorized by its Board of Directors, and this Agreement is a valid, legally binding and enforceable obligation of UII subject to the discretion of a court of equity and subject to bankruptcy, insolvency and similar laws affecting the rights of creditors generally. 2.11 Contracts. Except as shown on a schedule delivered to UTI and referring to this Section 2.11, UII is not a party to or subject to: (a) any employment contract with any officer, consultant, director or employee; (b) any plan or contract or arrangement providing for bonuses, pensions, options, deferred compensation, retirement payments, profit sharing, or the like; (c) any contract or agreement with any labor union; (d) any lease of real or personal property with a remaining term in excess of one year (except for normal office equipment); (e) any instrument creating a lien or evidencing or related to indebtedness for borrowed money; (f) any contract containing covenants not to enter into or consummate the transactions contemplated hereby or which will be terminated or modified by the carrying out of such transactions; or (g) any other contract or agreement with a value exceeding $25,000 not of the type covered by any of the other specific items of this Section 2.11. Each of the instruments described in such schedule is valid and in full force and effect, and a true and complete copy thereof has heretofore been delivered to UTI. UII is not in default, or alleged to be in default, under any agreement, instrument or obligation to which it is a party or by which it is bound, in any material respect, nor, in the reasonable opinion of UII's Officers, is any such agreement, instrument or obligation unduly burdensome. Except as shown on such schedule, the consummation of the Merger and the transactions contemplated by this Agreement will not cause a default under any such agreement or provide any right of termination to any party thereto other than UII. No party with whom UII has an agreement which is of any material importance to UII is in default thereunder in any material respect. Except as set forth in the schedule referred to in this Section 2.11, since September 30, 1997 UII has not taken any action which would have violated Section 4.1 had this Agreement been dated September 30, 1997. 236 2.12 Tax Matters. The provisions made for taxes on the December 31, 1997 and March 31, 1998 consolidated balance sheets referred to in Section 2.3 are sufficient for the payment of all unpaid taxes of the entities included therein, whether or not disputed. The United States federal income tax returns of UII have been audited by the Internal Revenue Service (or are no longer subject to audit) for all years to and including December 31, 1993. Except as described on a schedule heretofore delivered to UTI and referring to this Section 2.12, with respect to UII, there are no proposed additional taxes, interest or penalties with respect to any year examined or not yet examined, and except as set forth in said schedule none of such entities has entered into any agreements extending the statute of limitations with respect to any federal or state taxes. UII has provided to UTI true and complete copies of the federal and state income tax returns of UII for the three years ended December 31, 1996, together with true and complete copies of all reports of any taxing authority relating to examinations thereof which have been delivered to UII. 2.13 Title to Properties; Absence of Liens and Encumbrances, etc. UII has good and marketable title to all their properties and assets, real and personal (including those reflected in the consolidated balance sheets contained in the financial statements referred to in Section 2.3, except as sold or otherwise disposed of in the ordinary course of business from the date thereof), in each case free and clear of all liens and encumbrances, except those shown in such financial statements, the lien of current taxes not yet in default or payable and such imperfections of title, easements and encumbrances, if any, as are not substantial in character, amount or extent, and do not materially detract from the value, or interfere with the present or currently planned business use, of the properties subject thereto or affected thereby, or impair business operations. 3. COVENANTS OF UTI. UTI covenants to UII that, except as otherwise consented to in writing by UII after the date of this Agreement: 3.1 Authorized Stock Increase and Reservation. UTI will solicit and will use its best efforts to cause its stockholders to increase the authorized Common Stock of UTI from 3,500,000 shares to 7,000,000 shares. If such increase is obtained, UTI will keep available a sufficient number of shares of UTI Common Stock for issuance and delivery to the stockholders of UII between the date hereof and the closing of the transactions contemplated by this Agreement. 3.2 Consents. UTI will take all necessary corporate or other action, and use its best efforts to obtain all consents and approvals, required for consummation of the transactions contemplated by this Agreement. 3.3 Meeting of Stockholders. UTI will duly call and convene a meeting of its stockholders to act upon the Merger, the increase in authorized Common Stock of UTI and the other transactions contemplated by this Agreement as soon as practicable, and the Board of Directors of UTI will recommend a favorable vote thereon. UTI will solicit the proxies of its stockholders to vote on the transactions contemplated by this Agreement. 3.4 Conditions to be Satisfied. UTI will use its best efforts to cause all of the conditions described in Sections 7 and 8 of this Agreement to be satisfied and to cause the officers and directors to UTI to cooperate to that end. 4. COVENANTS OF UII. UII covenants to UTI that, except as otherwise consented to in writing by UTI after the date of this Agreement: 4.1 Conduct of Business. After the date of this Agreement, with respect to UII (a) its business will be conducted only in the ordinary course; (b) it will not enter into or amend any employment contract with any officer, consultant, or employee; (c) there shall be no change in any of its 237 pension, retirement or similar benefits nor any increase in salaries of any of its executive officers except for ordinary increases in accordance with UII's established practice; (d) it shall not incur any liability for borrowed money, encumber any of its assets or enter into any agreement relating to the incurrence of additional debt (other than in connection with purchases or leases of equipment which would not have been required to be listed on the schedule provided under Section 2.11 or short term bank credit, entered into in the ordinary course of operations); (e) it will use its best efforts to preserve its business organization intact, to keep available the service of its officers and employees and to preserve the good will of its independent agents; (f) no change shall be made in its charter documents or bylaws; (g) no change shall be made in the number of shares or terms of its authorized, issued or outstanding capital stock and, it shall not enter into any options, calls, contracts or commitments of any character relating to any issued or unissued capital stock; and (h) no dividend or other distribution or payment shall be declared or paid in respect of the UII Common Stock or the UII Preferred Stock. 4.2 Information. UII will give to UTI and UTI's officers, accountants, counsel and other representatives reasonable access, during normal business hours throughout the period prior to the closing of the transactions contemplated by this Agreement, to the properties, books, contracts, commitments and records of UII. UII will furnish to UTI during such period all such information concerning UII and its business and properties as UTI may reasonably request. 4.3 Meeting of Stockholders. UII will duly call and convene a meeting of its stockholders to act upon the transactions contemplated by this Agreement as soon as practicable, and the Board of Directors of UII will recommend a favorable vote thereon. UII will solicit the proxies of its stockholders to vote on the transactions contemplated by this Agreement. 4.4 Consents. UII will take all necessary corporate or other action and use its best efforts to obtain all consents and approvals required for consummation of the transactions contemplated by this Agreement. 4.5 Conditions To Be Satisfied. UII will use its best efforts to cause all of the conditions described in Articles 7 and 8 of this Agreement to be satisfied and to cause the Officers and Directors of UII to cooperate to that end. 5. S-4 REGISTRATION STATEMENT AND PROXY STATEMENT. As promptly as practical, each of UTI and UII will file proxy materials under the Exchange Act, and UTI will file a registration statement on Form S-4 under the Securities Act of 1933, with the Securities and Exchange Commission, to permit the solicitation of proxies under the Exchange Act and the offering and delivery of shares of UTI Common Stock to the stockholders of UII in connection with the Merger. Each of UTI and UII will exert its best efforts to cause such registration statement to become effective as soon as practicable, and UTI and UII agree to cooperate in such efforts. The registration statement and the proxy statement in the form in which they exist when the proxy statement is actually first mailed to the stockholders of UTI and UII are herein referred to as the "Registration Statement" and the "Proxy Statement". Upon the effectiveness of the Registration Statement, each of UTI and UII will cause the Proxy Statement to be delivered to its stockholders entitled to vote on the Merger at least 20 days prior to the date of the meeting of its stockholders that is called to act upon the Merger in accordance with applicable law. 6. MERGER OF UII AND UTI. Subject to the terms and conditions of this Agreement, UTI and UII agree to effect the following transactions at the Closing (as defined in Section 6.10): 6.1 Conditions. UTI and UII will each deliver to the other reasonably appropriate evidence of the satisfaction of the conditions, contained in Sections 7 and 8, to their respective obligations hereunder. 6.2 Increase in Authorized UTI Common Stock. The certificate of incorporation of UTI shall have been amended to increase the number of authorized shares of UTI Common Stock from 3,500,000 to 7,000,000. 6.3 Merger. At the time of Closing UII will be merged with and into UTI (the "Merger") pursuant to the provisions and with the effect provided in the Illinois Business Corporation Act and the Ohio General Corporation Law, and in the Agreement of Merger, including without limitation the liquidation of UTG and the assumption by UTI of all liabilities and obligations of UII. The Agreement of Merger shall be filed with the Secretary of State of each Illinois and Ohio on the date of Closing. UTI will be the surviving corporation in the Merger and its corporate name will be changed to United Trust Group, Inc. ("UTG"). 238 6.4 Conversion of Shares. The manner and basis of converting the UII Common Stock into shares of UTG Common Stock are as follows. Each (one) share of UII Common Stock issued and outstanding immediately prior to the Merger (excluding shares held by UII as treasury stock, if any, which shares shall be cancelled and extinguished), and all rights in respect thereof, shall by virtue of the Merger, without any action by the holder thereof, be converted into one share of UTG Common Stock (subject to adjustment for any stock split, reverse stock split and stock dividend with respect to UTI Common Stock from the date hereof to the Closing). From and after the Closing, each certificate converted pursuant to this Section 6.3 which theretofore represented shares of UII Common Stock shall evidence ownership of shares of UTG Common Stock on the basis herein above set forth, and the conversion shall be complete and effective at the effective time of the Merger. 6.5 Issuance of Certificates. As soon as practicable after the Closing of the Merger, UTG will mail a letter of instruction and new stock certificate of UTG Common Stock ("New Shares") to each UTI and UII shareholder replacing their UTI Common Stock certificate and UII Common Stock certificate ("Old Shares"). The Old Shares will be considered null and void. Shareholders should not forward their certificates representing the Old Shares before receiving their instructions. 6.6 Surrender of Certificates. As soon as practicable after the Closing of the Merger, UTI will mail to each UII shareholder a form letter of transmittal and instructions for surrendering certificates representing their share of UII Common Stock and for receiving shares of UTG Common Stock pursuant to the Merger. 6.7 Procedure. UTI shall have the right to make rules, not inconsistent with the terms of this Agreement, governing any of the foregoing procedures contemplated by this Section 6. 6.8 UII Transfer Books Closed and Stock Delisted. On the date of the Closing, the stock transfer books of UII shall be deemed closed, and no transfer of shares of UII shall be made thereafter. UII shall notify the National Association of Securities Dealers, and the transfer agent and registrar for the shares of UII capital stock, at least 10 calendar days before the anticipated date of the Closing, that no transfer of shares will be made after that date 6.9 Effective Date. The closing of the transactions (the "Effective Date") contemplated by this Agreement shall take place at the executive offices of UII beginning at 2:00 p.m. on the first business day following the day upon which the UTI and UII stockholders meetings to approve the Merger were held, or at such other time and place as may be agreed upon by UTI and UII; provided, that if all of the conditions specified in this Agreement have not been satisfied or waived as of such date, the Closing shall be postponed until two business days following the satisfaction or waiver of all of the conditions of this Agreement. In accordance with Section 13, this Agreement may be terminated at the election of either party if Closing does not occur on or before December 31, 1998. 7. CONDITIONS TO UTI'S OBLIGATIONS. Unless waived by UTI in writing at its sole discretion, all obligations of UTI under this Agreement are subject to the fulfillment, prior to or at the Closing, of each of the following conditions: 7.1 Representations, Warranties and Covenants. The representations and warranties of UII contained in Section 2 of this Agreement shall be true at and as of the date of the Closing and, except as otherwise clearly contemplated hereby, shall be deemed made again at and as of such date and be true as so made again; UII shall have performed all obligations and complied with all covenants required by this Agreement to be performed or complied with by it prior to the Closing. UTI shall have received from UII a certificate or certificates in such reasonable detail as UTI may reasonably request, signed by the President or a Vice-President of UII and dated the date of Closing, to the effect stated in this Section 7.1 and with respect to the fulfillment of the conditions set forth in Sections 7.2 through 7.7. 239 7.2 Approval of Stockholders. The transactions shall have been duly approved by (i) a favorable vote of the holders of at least two-thirds of the issued and outstanding shares of each of the UTI Common Stock entitled to vote thereon, and (ii) a favorable vote of the holders of a majority of the issued and outstanding UII Common Stock entitled to vote thereon. 7.3 Approvals of Governmental Authorities. All governmental approvals necessary to consummate the transactions contemplated by this Agreement shall have been received. 7.4 Accuracy of Prospectus and Proxy Statement. On and as of the dates of the meetings of stockholders of UTI and UII at which action is to be taken on the transactions contemplated hereby, the Proxy Statement and the Registration Statement shall contain no statement which, at the time and in light of the circumstances under which it is made, is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements made therein not misleading. 7.5 No Adverse Proceedings or Events. No suit, action or other proceedings against UTI or UII or their officers and directors shall be pending before any court or governmental agency in which it will be, or it is, sought to restrain or prohibit or to obtain damages or other relief in connection with this Agreement or the transactions contemplated hereby. 7.6 Consents and Actions; Contracts. All requisite consents of any third parties and other actions which UII has covenanted to use its best efforts to obtain and take under Section 4.4 hereof shall have been obtained and completed. 7.7 Increase in Authorized UTI Common Stock. The certificate of incorporation of UTI shall have been amended to increase the number of authorized shares of UTI Common Stock from 3,500,000 to 7,000,000 and its corporate name changed to United Trust Group, Inc. 8. CONDITIONS TO UII'S OBLIGATIONS. Unless waived by UII in writing at its sole discretion, all obligations of UII under this Agreement are subject to the fulfillment, prior to or at the Closing, of each of the following conditions: 8.1 Representations, Warranties and Covenants. The representations and warranties of UTI contained in Section 1 shall be true at and as of the date of the Closing and, except as otherwise clearly contemplated hereby, shall be deemed made again at and as of such date and be true as so made again; UTI shall have performed all obligations and complied with all covenants required by this Agreement to be performed or complied with by it on or prior to the Closing; and UII shall have received from UTI a certificate or certificates in such reasonable detail as UII may reasonably request, signed by the President or a Vice President of UTI and dated the date of Closing, to the effect stated in this Section 8.1 and with respect to the fulfillment of the conditions set forth in Sections 8.2 through 8.7. 8.2 Approval of Stockholders. The transactions contemplated by this Agreement shall have been duly approved by (i) a favorable vote of the holders of at least two-thirds of the issued and outstanding shares of UTI Common Stock entitled to vote thereon, and (ii) a favorable vote of the holders of a majority of the issued and outstanding shares of UII Common Stock entitled to vote thereon. 8.3 Approvals of Governmental Authorities. All governmental approvals necessary to consummate the transactions contemplated by this Agreement shall have been received. 8.4 Accuracy of Prospectus and Proxy Statement. On and as of the dates of the meetings of stockholders of UTI and UII at which action is to be taken on the transactions contemplated hereby, the Proxy Statement and the Registration Statement shall contain no statement which, at the time and in light of the circumstances under which it is made, is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements made therein not misleading. 8.5 No Adverse Proceedings or Events. No suit, action or other proceeding against UTI or UII or their officers and directors, or the consummation of the transactions contemplated by this Agreement, shall have been instituted and resulted in the entry of a court order (which has not been subsequently dismissed, terminated or vacated) enjoining, either temporarily or permanently, the consummation of the transactions contemplated by this Agreement. 240 8.6 Consents and Actions. All requisite consents of any third parties or other actions which UTI has covenanted to use its best efforts to obtain and take under Section 3.2 shall have been obtained and completed. 8.7 Increase in Authorized UTI Common Stock. The certificate of incorporation of UTI shall have been amended to increase the number of authorized shares of UTI Common Stock from 3,500,000 to 7,000,000. 9. BROKERS AND ADVISORS. Each of UTI and UII represents and warrants to the other that the transactions contemplated by this Agreement have been negotiated directly between them and their respective counsel, without the intervention of any person which might give rise to a valid claim against any of them for a brokerage commission, finder's fee, counseling or advisory fee, or like payment, and each agrees to indemnify the other against any such liability. 10. UPDATING OF CERTAIN CONDITIONS. The requirement for the continuing accuracy of the representations and warranties set forth in Section 7.1 and 8.1 shall be subject to the following provisions. Each of UTI and UII will promptly furnish to the other any information which, either before or after the time of the mailing of the Proxy Statement and Prospectus included in the Registration Statement, shall be necessary in order to make the representations and warranties in Section 1.6 and 2.8 true as of the time of the meetings of the UTI and UII stockholders, the Closing and any earlier date subsequent to the mailing of the Proxy Statement. In the event that any such information would or might, in the absence of any other action, cause the non-fulfillment of the conditions of this Agreement due to a possible material adverse change or otherwise, a determination shall be made by the Board of Directors of UTI in the case of information pertaining to UII and by the Board of Directors of UII in the case of information pertaining to UTI whether or not to continue the transaction; and, if the transaction is continued, UTI and UII shall each take such action as may be necessary to amend or supplement the Proxy Statement and Registration Statement. If action is taken to continue the transaction and so to amend or supplement the Proxy Statement or Registration Statement, the supplemental or amended information included therein shall be deemed to modify the requirements for the continuing accuracy of any previous information, and shall be deemed part of the Proxy Statement and Registration Statement. 11. EXPENSES. Each party to this Agreement shall pay all of its expenses relating hereto, including fees and disbursements of its counsel, accountants and financial advisors, whether or not the transactions hereunder are consummated. Expenses of printing this Agreement, the Proxy Statement and Registration Statement and any other documents used in the transactions contemplated hereunder shall be divided equally between UTI and UII. The fee for registration under the Securities Act of 1933 of the shares of UTI Common Stock to be issued upon conversion of shares of UII capital stock shall be paid by UTI. 12. NOTICES. All notices, requests, demands and other communications under or in connection with this Agreement shall be in writing, and, shall be addressed to each company's principal executive offices as shown on the cover page of the most recent SEC report delivered by such company pursuant to Section 1.3 or 2.3 of this Agreement, as the case may be. All such notices, requests, demands or communication shall be mailed postage prepaid, first class mail, or delivered personally, and shall be sufficient and effective when delivered to or received at the address so specified. Any party may change the address at which it is to receive notice by like written notice to the other. 13. AMENDMENTS AND TERMINATION. UTI and UII by mutual consent of their respective Boards of Directors or authorized committees or officers may amend this Agreement in such manner as may be agreed upon only by a written instrument executed by UTI and UII, whether before or after the meetings of the stockholders of UTI and UII, at which action upon the transactions contemplated hereby is to be taken; provided, however, that after the requisite approval of the stockholders has been obtained, neither UTI nor UII shall consent to any amendment or modification which would change the provisions with respect to the transactions contemplated by this Agreement in any manner which would materially and adversely affect the rights of UTI's or UII's stockholders. UTI and UII, by mutual consent of their Boards of Directors, may terminate this Agreement at any time prior to the Closing and, unless otherwise specifically provided in such consent, any such termination shall be without liability on the part of UTI or UII except as provided in Section 11. 241 UTI or UII may at its election terminate this Agreement and the Merger in the event that any condition for it to close has not been met or waived by it in its sole discretion, or if for any reason the Merger shall not have become effective on or before December 31, 1998. Any Such termination shall be without liability to UTI or UII except as provided in Section 11 and except to the extent that such termination was caused by the knowing or intentional material breach of covenants, representations, or warranties contained in this Agreement. 14. ENTIRE AGREEMENT. This Agreement (including the exhibits hereto and the lists, schedules and documents delivered pursuant hereto, which are a part hereof) is intended by the parties to and does constitute the entire agreement of the parties with respect to the transactions contemplated by this Agreement. This Agreement supersedes any and all prior understandings, written or oral, between the parties, and this Agreement may not be amended, modified, waived, discharged or terminated orally, but only by an instrument in writing signed by an authorized executive officer of the party against which enforcement of the amendment, modification, waiver, discharge or termination is sought. 15. GENERAL. The paragraph headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. This Agreement may be executed simultaneously in counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. This Agreement shall inure to the benefit of and be binding upon the parties hereto and their respective successors and assigns, but nothing herein, express or implied, is intended to or shall confer any rights, remedies or benefits upon any person other than the parties hereto. This Agreement may not be assigned by any party hereto. It is understood, recognized, and agreed that the validity of this Agreement and the enforceability of any provision hereof, whether before or after the Closing, are subject to bankruptcy and insolvency laws affecting the rights of creditors generally. 16. SURVIVAL. The respective representations, certifications and warranties of the parties hereto, including those made in or resulting from any certificates, instruments or other documents delivered pursuant to this Agreement, shall expire with and be terminated and extinguished by the Closing hereunder, and thereafter no party hereto shall be under any liability whatsoever with respect to any such representation, certification or warranty, it being intended that the sole remedy of any party for a breach of any such representation, certification or warranty shall be to elect not to proceed with the Closing hereunder if such breach has resulted in a condition to such party's obligations hereunder not being satisfied. The foregoing shall not be applicable to any knowing or intentional breach of this Agreement or to any knowing or intentional misrepresentation, certification or warranty, as to each of which, all legal remedies of the party adversely affected may be enforced and shall survive the Closing hereunder. 242 IN WITNESS WHEREOF, each of the parties hereto has caused this agreement to be duly executed by its undersigned officer thereunto duly authorized on the date first above written. ATTEST: UNITED TRUST, INC. /s/ George E. Francis George E. Francis By: /s/ Larry E. Ryherd Secretary Larry E. Ryherd, Chief Executive Officer [CORPORATE SEAL] ATTEST: UNITED INCOME, INC. /s/ George E. Francis George E. Francis By:/s/ James E. Melville Secretary James E. Melville President [CORPORATE SEAL] 243 Exhibit A To Agreement and Plan Of Reorganization AGREEMENT AND ARTICLES OF MERGER Merging UNITED INCOME, INC. a corporation of the State of Ohio With and Into UNITED TRUST INC. a corporation of the State of Illinois Agreement and Articles of Merger, dated June 25, 1998, by and between United Trust, Inc., an Illinois corporation ("UTI"), and United Income, Inc., an Ohio corporation ("UII"), said corporations being together hereinafter sometimes referred to as the "constituent Corporations". Whereas, UTI is a corporation duly organized and existing under the laws of the State of Illinois and has authorized capital stock of 3,500,000 shares of Common Stock, no par value, of which 1,912,239 shares are issued and outstanding with 257,039 shares being held in the treasury and 150,000 shares of Preferred Stock, par value $100 per share of which no shares are outstanding. Whereas, UII is a corporation duly organized and existing under the laws of the State of Ohio and has authorized capital stock of 2,310,001 shares of Common Stock, no par value, of which 1,569,509 shares are issued and outstanding with 177,590 shares being held in the treasury and 150,000 shares of Preferred Stock, par value $100 per share of which no shares are outstanding. Whereas, the Board of Directors of each of the Constituent Corporations has adopted resolutions declaring advisable and to the best interests of the Constituent Corporations and their respective stockholders that UII be merged with and into UTI, and that simultaneously UTI will change its name to United Trust Group, Inc. (the "Surviving Corporation"), under and pursuant to the Illinois Business Corporation Act and the Ohio General Corporation Law, and on the terms and conditions herein contained (the "Merger"). ARTICLE I 1.1 UTI and UII agree to effect the Merger of UII with and into UTI. UTI and UII jointly own 100% of the outstanding capital stock of United Trust Group, Inc., an Illinois corporation ("UTG"). At the time of Merger UTI and UII agree to dissolve UTG. UTI will change its name to UTG and shall be the Surviving Corporation and shall continue to be governed by the laws of the State of Illinois. The name of the Surviving Corporation shall be "United Trust Group, Inc". The terms and conditions of the Merger and the manner of carrying the same into effect are as set forth in this Agreement and Articles of Merger (hereinafter referred to as this "Agreement"). 1.2 The Certificate of Incorporation of UTI, as in effect immediately prior to the Effective Date, until further amended, shall be and constitute the Certificate of Incorporation of the Surviving Corporation, and an amendment to said Certificate of Incorporation shall be effected as a result of the Merger to reflect its name change to United Trust Group, Inc. 1.3 The Bylaws of UTI, as in effect immediately prior to the Effective Date, until further amended, shall be and constitute the Bylaws of the Surviving Corporation. 244 1.4 The Board of Directors of UTI shall not be changed as a result of the Merger. 1.5 The officers of UTI shall not be changed as a result of the Merger. ARTICLE II 2.1 The existence of UII shall cease on the Effective Date of the Merger, and the existence of UTI shall continue unaffected and unimpaired by the Merger. On the Effective Date of the Merger, in addition to the general powers of corporations, UTI shall enjoy the rights, franchises and privileges possessed by each of the Constituent Corporations, subject to the restrictions, liabilities, duties and provisions of a corporation organized under the Illinois Business Corporation Act; and all the rights, privileges, franchises and interest of each of the Constituent Corporation, and all the property, real, personal and mixed, and all the debts due on whatever account to either of them, as well as all stock subscriptions, securities and other things in action belonging to either of them, shall be taken and deemed to be transferred to and vested in the Surviving Corporation, without further act or deed; and all claims, demands, property and every interest shall be the property of the Surviving Corporation as they were of the Constituent Corporations, and the title to all real estate, taken by deed or otherwise vested in any of the Constituent Corporation, shall not be deemed to revert or deemed to be in any way impaired by reason of the Merger, but shall be vested in the Surviving Corporation; provided, however, that rights of creditors and all liens upon any property of any of the Constituent Corporations shall not in any manner be impaired, nor shall any liability or obligation due or to become due, or any claim or demand for any cause existing against any such corporation be released or impaired by such Merger; but the Surviving Corporation shall be deemed to have assumed and shall be liable for liabilities and obligations of either of the Constituent Corporations, in the same manner as if the Surviving Corporations, in the same manner as if the Surviving Corporation had itself incurred such liabilities or obligations. 2.2 The Surviving Corporation may be served with process in the State of Ohio in any proceeding therein for enforcement of any obligation of UII as well as for enforcement of any obligation UII or the Surviving Corporation arising from the Merger, and the Surviving Corporation does hereby irrevocably appoint the Secretary of State of Ohio as its agent to accept service of process in any such suit or other proceeding. The address to which a copy of such process shall be mailed to said agent is c/o United Trust Group, Inc., 5250 South Sixth Street Road, Springfield, Illinois 62703, until UTG shall have hereafter designated in writing to the said agent a different address for such purpose. Service of such process may be made by personally delivering to and leaving with said agent duplicate copies of such process, one of which copies the agent shall forthwith send by registered mail to UTG at the above address. 2.3 The Surviving Corporation will promptly pay to dissenting stockholders of UII the amount, if any, to which they are entitled under the relevant provisions of the Ohio General Corporation Law. 2.4 Subject to the terms and conditions herein provided, this Agreement shall be certified, executed and acknowledged to comply with applicable filing and recording requirements of the Illinois Business Corporation Act and the Ohio General Corporation Law on the closing date referred to in Section 6.8 of that certain Agreement and Plan of Reorganization, dated , between the Constituent Corporations (the "Acquisition Agreement"), (the date of such certification, execution and acknowledgment being herein referred to as the "Closing Date"). On the Closing Date or as soon thereafter as practicable, a certified Agreement and Articles of Merger incorporating this Agreement shall be filed pursuant to Illinois Business Corporation Act and the Ohio General Corporation Law with the Secretary of State of Illinois and Ohio, respectively, and a certified copy thereof shall be recorded in the Office of the Recorder of the appropriate county or counties in Illinois and Ohio, respectively. This Agreement shall become effective in the State of Illinois at the close of business on the day on which such filing is completed, and shall become effective in the State of Ohio upon the issuance by the Secretary of State of Ohio of a Certificate of Merger (the latter of which dates is herein referred to as the "Effective Date"). 245 ARTICLE III 3.1 The manner of converting or exchanging the shares of UII into shares of UTI shall be as hereinafter set forth in this Article III. 3.2 Each share of UTI Common Stock issued and outstanding immediately prior to the Effective Date shall continue to be an issued and outstanding share of UTI, fully paid and non-assessable. 3.3 Each share of UII Common Stock issued and outstanding immediately prior to the Effective Date (excluding shares of UII Common Stock held by UII as treasury stock, which shares shall be cancelled and extinguished at the Effective Date) and all rights in respect thereof shall, upon the Effective Date, by virtue of the Merger and without any action on the part of the holder thereof, be exchanged for and converted into one share of UTI Common Stock. 3.4 Each share of UTI Common Stock issued pursuant to this Article III shall be fully paid and non-assessable. From and after the Effective Date, each certificate which theretofore represented shares of UII Common Stock shall evidence ownership of shares of the UTI Common Stock on the basis hereinabove set forth, and the exchange and conversion shall be complete and effective on the Effective Date without regard to the date or dates on which outstanding UII Common Stock shall be cancelled. 3.5 On the Effective Date, UTI will deliver to the Exchange Agent certificates representing the number of shares of UTI Common Stock that will be required for delivery to the stockholders of UII pursuant to the Merger, and will take such further action as may be necessary in order that certificates for shares of the UTI Common Stock may be delivered to the stockholders of UII. Dividends or other distributions payable after the Effective Date to holder of record in respect of such shares of the UTI Common Stock issued in exchange for UII Common Stock shall not be paid to holders thereof until certificates evidencing the UII Common Stock are surrendered for exchange as aforesaid. ARTICLE IV 4.1 The obligations of UTI and UII to effect the Merger shall be subject to all of the terms and conditions of the Acquisition Agreement. 4.2 This Agreement may be terminated or amended prior to the Effective Date in the manner and upon the conditions set forth in the Acquisition Agreement. 4.3 This Agreement may be executed in any number of counterparts, each of which shall be deemed and original but all of which together shall constitute but one instrument. IN WITNESS WHEREOF, each of the Constituent Corporations has caused this Agreement to be duly executed by its duly authorized officer, attested to by its Secretary and its corporate seal, all as of the date first above written. UNITED TRUST, INC. ATTEST: George E. Francis Larry E. Ryherd Secretary Chief Executive Officer [CORPORATE SEAL] 246 UNITED INCOME, INC. ATTEST: George E. Francis James E. Melville Secretary President [CORPORATE SEAL] 247 THE UNDERSIGNED, Chief Executive Officer of United Trust Inc. who executed on behalf of said corporation the foregoing Agreement and Articles of Merger, of which this Certificate is made a part, hereby acknowledges, in the name of and on behalf of said corporation, the foregoing Agreement and Articles of Merger to be the corporate act of said corporation and further certifies that, to the best of his knowledge, information and belief, the matters and facts set forth therein with respect to the approval thereof are true in all material respects, under the penalties of perjury. Larry E. Ryherd Chief Executive Officer THE UNDERSIGNED, President of United Income, Inc. who executed on behalf of said corporation the foregoing Agreement and articles of Merger, of which this Certificate is made a part, hereby acknowledges, in the name of and on behalf of said corporation, the foregoing Agreement and articles of Merger to be the corporate act of said corporation and further certifies that, to the best of his knowledge, information and belief, the matters and facts set forth therein with respect to the approval thereof are true in all material respects, under the penalties of perjury. James E. Melville President 248 UNITED INCOME, INC. Secretary's Certificate I, George E. Francis, Secretary of United Income, Inc., an Ohio corporation ("UII"), do hereby certify, in accordance with the provisions of the Ohio General Corporation Law, that the foregoing Agreement and Articles of Merger, having been duly authorized and adopted by the Board of Directors of UII and signed under its corporate seal by officers of UII thereunto duly authorized, was duly approved and adopted by the Stockholders of UII on the 25th day of June, 1998 at a Special Meeting of the shareholders of UII, that at the time of said meeting UII had outstanding 1,391,919 shares of its common stock, and no other shares of capital stock; that at said meeting shares of UII common stock were voted in favor of, and shares of UII common stock were voted against, the plan of merger. Witness my hand and the seal of UII this 25th day of June, 1998. George E. Francis, Secretary [CORPORATE SEAL] 249 UNITED TRUST, INC. Secretary's Certificate I, George E. Francis, Secretary of United Trust, Inc., an Illinois corporation ("UTI"), do hereby certify, in accordance with the provisions of the Illinois Business Corporation Act, that the foregoing Agreement and Articles of Merger, having been duly authorized and adopted by the Board of Directors of UTI and signed under its corporate seal by officers of UTI thereunto duly authorized, was duly approved and adopted by the Stockholders of UTI on the 25th day of June, 1998 at a Special Meeting of the shareholders of UTI, that at the time of said meeting UTI had outstanding 1,655,200 shares of its Common Stock, and no other shares of capital stock; that at said meeting shares of UTI Common Stock were voted in favor of, and shares of UTI Common Stock were voted against, the plan of the Agreement of Merger. Witness my hand and the seal of UTI this 25th day of June, 1998. George E. Francis, Secretary [CORPORATE SEAL] 250 CERTIFICATE OF EXECUTION The foregoing Agreement of Merger, having been duly entered into and signed by United Trust Inc., an Illinois corporation ("UTI") and United Income, Inc., an Ohio corporation ("UII"), and having been duly adopted by the stockholders of UTI and the stockholders of UII, all in accordance with the provisions of the Illinois Business Corporation Act and the Ohio General Corporation Law; the Chief Executive Officer of UTI and the Senior Executive Vice President of UII do now hereby re-execute said Agreement of Merger under the respective corporate seals of UTI and UII, attested by the respective secretaries of UTI and UII, by authority of and as the act, deed and agreement of UTI and UII, respectively, on this 25th day of June 1998. UNITED TRUST, INC. ATTEST: George E. Francis Larry E. Ryherd Secretary Chief Executive Officer [CORPORATE SEAL] UNITED INCOME, INC. ATTEST: George E. Francis James E. Melville Secretary President [CORPORATE SEAL] 251 APPENDIX B Sections 1701.84 and 1701.85 Ohio General Corporation Law RIGHTS OF DISSENTING STOCKHOLDERS OF UNITED INCOME, INC. 1701.84 Persons entitled to relief as dissenting shareholders. The following are entitled to relief as dissenting shareholders under section 1701.85 of the Revised Code; (A) Shareholders of a domestic corporation that is being merged or consolidated into a surviving or new entity, domestic or foreign, pursuant to section 1701.78, 1701.781 [1701.78.1], 1701.79, 1701.791 [1701.79.1], or 1701.801 [1701.80.1] of the Revised Code; (B) In the case of a merger into a domestic corporation, shareholders of the surviving corporation who under section 1071.78 or 1701.781 [1701.78.1] of the Revised Code are entitled to vote on the adoption of an agreement of merger, but only as to the shares so entitling them to vote; (C) Shareholders, other than the parent corporation, of a domestic subsidiary corporation that is being merged into the domestic or foreign parent corporation pursuant to section 1701.80 of the Revised Code; (D) In the case of a combination or a majority share acquisition, shareholders of the acquiring corporation who under section 1701.83 of the Revised Code are entitled to vote on such transaction, but only as to the shares so entitling them to vote; (E) Shareholders of a domestic subsidiary corporation into which one or more domestic or foreign corporations are being merged pursuant to section 1701.801 [1701.80.1] of the Revised Code. (F) Dissenting shareholder's demand for fair cash value of shares. 1701.85 Dissenting shareholder's demand for fair cash value of shares. (A)(1) A shareholder of a domestic corporation is entitled to relief as a dissenting shareholder in respect to the proposals described in sections 1701.74, 1701.76, and 1701.84 of the Revised Code, only in compliance with this section. (2) If the proposal must be submitted to the shareholders of the corporation involved, the dissenting shareholder shall be a record holder of the shares of the corporation as to which he seeks relief as of the date fixed for the determination of shareholders entitled to notice of a meeting of the shareholders at which the proposal is to be submitted, and such shares shall not have been voted in favor of the proposal. Not later than ten days after the date on which the vote on the proposal was taken at the meeting of the shareholders, the dissenting shareholder shall deliver to the corporation a written demand for payment to him of the fair cash value of the shares as to which he seeks relief, which demand shall state his address, the number and class of such shares, and the amount claimed by him as the fair cash value of the shares. (3) The dissenting shareholder entitled to relief under division (C) of section 1701.84 of the Revised Code in the case of a merger pursuant to section 1701.80 of the Revised Code and a dissenting shareholder entitled to relief under division (E) of section 1701.84 of the Revised Code in the case of a merger pursuant to section 1701.801 [1701.80.1] of the Revised Code shall be a record holder of the shares of the corporation as to which he seeks relief as of the date on which the agreement of merger was adopted by the directors of that corporation. Within twenty days after he has been sent the notice provided in section 1701.80 or 1701.801 [1701.80.1] of the Revised Code, the dissenting shareholder shall deliver to the corporation a written demand for payment with the same information as that provided for in division (A)(2) of this section. 252 (4) In the case of a merger or consolidation, a demand served on the constituent corporation involved constitutes service on the surviving or the new entity, whether the demand is served before, on, or after the effective date of the merger or consolidation. (5) If the corporation sends to the dissenting shareholder, at the address specified in his demand, a request for the certificates representing the shares as to which he seeks relief, the dissenting shareholder, within fifteen days from the date of the sending of such request, shall deliver to the corporation the certificates requested so that the corporation may forthwith endorse on them a legend to the effect that demand for the fair cash value of such shares has been made. The corporation promptly shall return such endorsed certificates to the dissenting shareholder. A dissenting shareholder's failure to deliver such certificates terminates his rights as a dissenting shareholder, at the option of the corporation, exercised by written notice sent to the dissenting shareholder within twenty days after the lapse of the fifteen- day period, unless a court for good cause shown otherwise directs. If shares represented by a certificate on which such a legend has been endorsed are transferred, each new certificate issued for them shall bear a similar legend, together with the name of the original dissenting holder of such shares. Upon receiving a demand for payment from a dissenting shareholder who is the record holder of uncertificated securities, the corporation shall make an appropriate notation of the demand for payment in its shareholder records. If uncertificated shares for which payment has been demanded are to be transferred, any new certificate issued for the shares shall bear the legend required for certificated securities as provided in this paragraph. A transferee of the shares so endorsed, or of uncertificated securities where such notation has been made, acquires only such rights in the corporation as the original dissenting holder of such shares had immediately after the service of a demand for payment of the fair cash value of the shares. A request under this paragraph by the corporation is not an admission by the corporation that the shareholder is entitled to relief under this section. (B) Unless the corporation and the dissenting shareholder have come to an agreement on the fair cash value per share of the shares as to which the dissenting shareholder seeks relief, the dissenting shareholder or the corporation, which in case of a merger or consolidation may be the surviving or new entity, within three months after the service of the demand by the dissenting shareholder, may file a complaint in the court of common pleas of the county in which the principal office of the corporation that issued the shares is located or was located when the proposal was adopted by the shareholders of the corporation, or, if the proposal was not required to be submitted to the shareholders, was approved by the directors. Other dissenting shareholders, within that three-month period, may join as plaintiffs or may be joined as defendants in any such proceeding, and any two or more such proceedings may be consolidated. The complaint shall contain a brief statement of the facts, including the vote and the facts entitling the dissenting shareholder to the relief demanded. No answer to such a complaint is required. Upon the filing of such a complaint, the court, on motion of the petitioner, shall enter an order fixing a date for a hearing on the complaint and requiring that a copy of the complaint and a notice of the filing and of the date for hearing be given to the respondent or defendant in the manner in which summons is required to be served or substituted service is required to be made in other cases. On the day fixed for the hearing on the complaint or any adjournment of it, the court shall determine from the complaint and from such evidence as is submitted by either party whether the dissenting shareholder is entitled to be paid the fair cash value of any shares and, if so, the number and class of such shares. If the court finds that the dissenting shareholder is so entitled, the court may appoint one or more persons as appraisers to receive evidence and to recommend a decision on the amount of the fair cash value. The appraisers have such power and authority as is specified in the order of their appointment. The court thereupon shall make a finding as to the fair cash value of a share and shall render judgment against the corporation for the payment of it, with interest at such rate and from such date as the court considers equitable. The costs of the proceeding, including reasonable compensation to the appraisers to be fixed by the court, shall be assessed or apportioned as the court considers equitable. The proceeding is a special proceeding and final orders in it may be vacated, modified, or reversed on appeal pursuant to the Rules of Appellate Procedure and, to the extent not in conflict with those rules, Chapter 2505, of the Revised Code. If, during the pendency of 253 any proceeding instituted under this section, a suit or proceeding is or has been instituted to enjoin or otherwise to prevent the carrying out of the action as to which the shareholder has dissented, the proceeding instituted under this section shall be stayed until the final determination of the other suit or proceeding. Unless any provision in division (D) of this section is applicable, the fair cash value of the shares that is agreed upon by the parties or fixed under this section shall be paid within thirty days after the date of final determination of such value under this division, the effective date of the amendment to the articles, or the consummation of the other action involved, whichever occurs last. Upon the occurrence of the last such event, payment shall be made immediately to a holder of uncertificated securities entitled to such payment. In the case of holders of shares represented by certificates, payment shall be made only upon and simultaneously with the surrender to the corporation of the certificates representing the shares for which the payment is made. (C) If the proposal was required to be submitted to the shareholder of the corporation, fair cash value as to those shareholders shall be determined as of the day prior to the day on which the vote by the shareholders was taken and, in the case of a merger pursuant to section 1701.80 or 1701.801 [1701.80.1] of the Revised Code, fair cash value as to shareholders of a constituent subsidiary corporation shall be determined as of the day before the adoption of the agreement of merger by the directors of the particular subsidiary corporation. The fair cash value of a share for the purposes of this section is the amount that a willing seller who is under no compulsion to sell would be willing to accept and that a willing buyer who is under no compulsion to purchase would be willing to pay, but in no event shall the fair cash value of a share exceed the amount specified in the demand of the particular shareholder. In computing such fair cash value, any appreciation or depreciation in market value resulting from the proposal submitted to the directors or to the shareholders shall be excluded. (D)(1) The right and obligation of a dissenting shareholder to receive such fair cash value and to sell such shares as to which he seeks relief, and the right and obligation of the corporation to purchase such shares and to pay the fair cash value of them terminates if any of the following applies: (a) The dissenting shareholder has not complied with this section, unless the corporation by its directors waives such failure; (b) The corporation abandons the action involved or is finally enjoined or prevented from carrying it out, or the shareholders rescind their adoption of the action involved; (c) The dissenting shareholder withdraws his demand, with the consent of the corporation by its directors; (d) The corporation and the dissenting shareholder have not come to an agreement as to the fair cash value per share, and neither the shareholder nor the corporation has filed or joined in a complaint under division (B) of this section within the period provided in that division. (2) For purposes of division (D)(1) of this section, if the merger or consolidation has become effective and the surviving or new entity is not a corporation, action required to be taken by the directors of the corporation shall be taken by the general partners of a surviving or new partnership or the comparable representatives of any other surviving or new entity. (E) From the time of the dissenting shareholder's giving of the demand until either the termination of the rights and obligations arising from it or the purchase of the shares by the corporation, all other rights accruing from such shares, including voting and dividend or distribution rights, are suspended. If during the suspension, any dividend or distribution is paid in money upon shares of such class or any dividend, distribution, or interest is paid in money upon any securities issued in extinguishment of or in substitution for such shares, an amount equal to the dividend, distribution, or interest which, except for the suspension, would have been payable upon such shares or securities, shall be paid to the holder of record as a credit upon the fair cash value of the shares. If the right to receive fair cash value is terminated other than by the purchase of the shares by the corporation, all rights of the holder shall be restored and 254 all distributions which, except for the suspension, would have been made shall be made to the holder of record of the shares at the time of termination. 255 APPENDIX C Section 5/11.65 and 5/11.70 Illinois Business Corporation Act RIGHTS OF DISSENTING STOCKHOLDERS OF UNITED TRUST, INC. 5/11.65 RIGHT TO DISSENT. - (a) A shareholder of a corporation is entitled to dissent from, and obtain payment for his or her shares in the event of any of the following corporate actions: (1) consummation of a plan of merger of consolidation or a plan of share exchange to which the corporation is a party if (i) shareholder authorization is required for the merger or consolidation or the share exchange by Section 11.20 or the articles of incorporation or (ii) the corporation is a subsidiary that is merged with its parent or another subsidiary under Section 11.30; (2) consummation of a sale, lease or exchange of all, or substantially all, of the property and assets of the corporation other than in the usual and regular course of business; (3) an amendment of the articles of incorporation that materially and adversely affects rights in respect of a dissenter's shares because it: (i) alters or abolishes a preferential right of such shares; (ii) alters or abolishes a right in respect of redemption, including a provision respecting a sinking fund for the redemption or repurchase, of such shares; (iii) in the case of a corporation incorporated prior to January 1, 1982, limits or eliminates cumulative voting rights with respect to such shares; or (4) any other corporate action taken pursuant to a shareholder vote if the articles of incorporation, by-laws, or a resolution of the board of directors provide that shareholders are entitled to dissent and obtain payment for their shares in accordance with the procedures set forth in Section 11.70 or as may be otherwise provided in the articles, by-laws or resolution. (b) A shareholder entitled to dissent and obtain payment for his or her shares under this Section may not challenge the corporate action creating his or her entitlement unless the action is fraudulent with respect to the shareholder or the corporation or constitutes a breach of a fiduciary duty owed to the shareholder. (c) A record owner of shares may assert dissenters' rights as to fewer than all the shares recorded in such person's name only if such person dissents with respect to all shares beneficially owned by any one person and notifies the corporation in writing of the name and address of each person on whose behalf the record owner asserts dissenters' rights. The rights of a partial dissenter are determined as if the shares as to which dissent is made and the other shares recorded in the names of different shareholders. A beneficial owner of shares who is not the record owner may assert dissenters' rights as to shares held on such person's behalf only if the beneficial owner submits to the corporation the record owner's written consent to the dissent before or at the same time the beneficial owner asserts dissenters' rights. 5/11.70 PROCEDURE TO DISSENT. - (a) If the corporate action giving rise to the right to dissent is to be approved at a meeting of shareholders, the notice of meeting shall inform the shareholders of their right to dissent and the procedure to dissent. If, prior to the meeting, the corporation furnishes to the shareholders material information with respect to the transaction that will objectively enable a shareholder to vote on the transaction and to determine whether or not to exercise dissenters' rights, a shareholder may assert dissenters' rights only if the shareholder delivers to the corporation before the vote is taken a written demand for payment for his or her shares if the proposed action is consummated, and the shareholder does not vote in favor of the proposed action. 256 (b) If the corporate action giving rise to the right to dissent is not to be approved at a meeting of shareholders, the notice to shareholders describing the action taken under Section 11.30 or Section 7.10 shall inform the shareholders of their right to dissent and the procedure to dissent. If, prior to or concurrently with the notice, the corporation furnishes to the shareholders material information with respect to the transaction that will objectively enable a shareholder to determine whether or not to exercise dissenters' rights, a shareholder may assert dissenter's rights only if he or she delivers to the corporation within 30 days from the date of mailing the notice a written demand for payment for his or her shares. (c) Within 10 days after the date on which the corporate action giving rise to the right to dissent is effective or 30 days after the shareholder delivers to the corporation the written demand for payment, whichever is later, the corporation shall send each shareholder who has delivered a written demand for payment a statement setting forth the opinion of the corporation as to the estimated fair value of the shares, the corporation's latest balance sheet as of the end of a fiscal year ending not earlier than 16 months before the delivery of the statement, together with the statement of income for that year and the latest available interim financial statements, and either a commitment to pay for the shares of the dissenting shareholder at the estimated fair value thereof upon transmittal to the corporation of the certificate or certificates, or other evidence of ownership, with respect to the shares, or instructions to the dissenting shareholder to sell his or her shares within 10 days after delivery of the corporation's statement to the shareholder. The corporation may instruct the shareholder to sell only if there is a public market for the shares at which the shares may be readily sold. If the shareholder does not sell within that 10 day period after being so instructed by the corporation, for purposes of this Section the shareholder shall be deemed to have sold his or her shares at the average closing price of the shares, if listed on a national exchange, or the average of the bid and asked price with respect to the shares quoted by a principal market maker, if not listed on a national exchange, during that 10 day period. (d) A shareholder who makes written demand for payment under this Section retains all other rights of a shareholder until those rights are cancelled or modified by the consummation of the proposed corporate action. Upon consummation of that action, the corporation shall pay to each dissenter who transmits to the corporation the certificate of other evidence of ownership of the shares the amount the corporation estimates to be the fair value of the shares, plus accrued interest, accompanied by a written explanation of how the interest was calculated. (e) If the shareholder does not agree with the opinion of the corporation as to the estimated fair value of the shares or the amount of interest due, the shareholder, within 30 days from the delivery of the corporation's statement value, shall notify the corporation in writing of the shareholder's estimated fair value and amount of interest due and demand payment for the difference between the shareholder's estimate of fair value and interest due and the amount of the payment by the corporation or the proceeds of sale by the shareholder, whichever is applicable because of the procedure for which the corporation opted pursuant to subsection (c). (f) If, within 60 days from delivery to the corporation of the shareholder notification of estimate of fair value of the shares and interest due, the corporation and the dissenting shareholder have not agreed in writing upon the fair value of the shares and interest due, the corporation shall either pay the difference in value demanded by the shareholder, with interest or file a petition in the county in which either the registered office or the principal office of the corporation is located, requesting the court to determine the fair value of the shares and interest due. The corporation shall make all dissenters, whether or not residents of this State, whose demands remain unsettled parties to the proceeding as an action against their shares and all parties shall be served with a copy of the petition. Nonresidents may be served by registered or certified mail or by publication as provided by law. Failure of the corporation to commence an action pursuant to this Section shall not limit or affect the right of the dissenting shareholders to otherwise commence an action as permitted by law. 257 (g) The jurisdiction of the court in which the proceeding is commenced under subsection (f) by a corporation is plenary and exclusive. The court may appoint one or more persons as appraisers to receive evidence and recommend decision on the question of fair value. The appraisers have the power described in the order appointing them, or in any amendment to it. (h) Each dissenter made a party to the proceeding is entitled to judgment for the amount, if any, by which the court finds that fair value of his or her shares, plus interest, exceeds the amount paid by the corporation or the proceeds of sale by the shareholder, whichever amount is applicable. (i) The court, in a proceeding commenced under subsection (f), shall determine all costs of the proceeding, including the reasonable compensation and expenses of the appraisers, if any, appointed by the court under subsection (g), but shall exclude the fees and expenses of counsel and experts for the respective parties. If the fair value of the shares as determined by the court materially exceeds the amount which the corporation estimated to be the fair value of the shares or if no estimate was made in accordance with subsection (c), then all or any part of the costs may be assessed against the corporation. If the amount which any dissenter estimated to be the fair value of the shares materially exceeds the fair value of the shares as determined by the court, then all or any part of the costs may be assessed against that dissenter. The court may also assess the fees and expenses of counsel and experts for the respective parties, in amounts the court finds equitable, as follows: (1) Against the corporation and in favor of any or all dissenters if the court finds that the corporation did not substantially comply with the requirements or subsections (a), (b), (c), (d), or (f). (2) Against either the corporation or a dissenter and in favor of any other party if the court finds that the party against whom the fees and expenses are assessed acted arbitrarily, vexatiously, or not in good faith with respect to the rights provided by this Section. If the court finds that the services of counsel for any dissenter were of substantial benefit to other dissenters similarly situated and that the fees for those services should not be assessed against the corporation, the court may award to that counsel reasonable fees to be paid out of the amounts awarded to the dissenters who are benefited. Except as otherwise provided in this Section, the practice, procedure, judgment and costs shall be governed by the Code of Civil Procedure. (j) As used in this Section: (1) "Fair value", with respect to a dissenter's shares, means the value of the shares immediately before the consummation of the corporate action to which the dissenter objects excluding any appreciation or depreciation in anticipation of the corporate action, unless exclusion would be inequitable. (2) "Interest" means interest from the effective date of the corporate action until the date of payment, at the average rate currently paid by the corporation on its principal bank loans or, if none, at a rate that is fair and equitable under all the circumstances. 258 APPENDIX D PROPOSED AMENDMENT TO PARAGRAPH 1 OF ARTICLE FOURTH OF ARTICLES OF INCORPORATION OF UNITED TRUST, INC. ARTICLE FOURTH Paragraph 1: The aggregate number of shares which the corporation is authorized to issue is 7,150,000 divided into two classes. The designation of each class, the number of shares of each class, and the par value, if any, of the shares of each class, or a statement that the shares of any class are without par value, are as follows: Par value per share or Series Number of statement that shares are Class (if any) shares without par value Common None 7,000,000 Without par value Preferred To be fixed 150,000 $100 By the Board Of Directors 259 PART II INFORMATION NOT REQUIRED IN PROSPECTUS Item 20. Indemnification of Directors and Officers The Illinois Business Corporation Act empowers the Registrant to indemnify each officer and director of the Registrant against liabilities and expenses incurred by reason of the fact that he or she is or was an officer or director of the Registrant, or is or was serving as such at the request of the Registrant with respect to another corporation, partnership, joint venture, trust, or other enterprise. The Act also empowers the Registrant to purchase and maintain insurance on behalf of any such officer or director of the Registrant against liability asserted against or incurred by him or her in any such capacity, whether or not the Registrant would have power to indemnify such officer or direction against such liability. Article 1.1 of the Registrant's Bylaws provides, in effect, for the indemnification by the Registrant of each director, officer, employee, or agent of the Registrant to the full extent permitted by the Illinois Business Corporation Act. Item 21. Exhibits and Financial Statements Schedules A list of exhibits and financial statement schedules included as part of this Registration Statement is set forth in the list that immediately precedes such exhibits and schedules and is hereby incorporated herein by reference. Item 22. Undertakings The undersigned Registrant hereby undertakes: 1. To file, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement (i) to include any prospectus required by Section 10(a)(3) of the Securities Act, (ii) to reflect in the prospectus any facts or events arising after the effective date of the Registration Statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the Registration Statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement; and (iii) to include any material information with respect to the plan of distribution not previously disclosed in the Registration Statement or any material change to such information in the Registration Statement. 2. That, for the purpose of determining any liability under the Securities Act, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. 3. To remove from registration by means of post-effective amendment any of the securities being registered which remain unsold in the termination of the offering. 4. To respond to requests for information that is incorporated by reference into the prospectus pursuant to Item 4, 10(b), 11 or 13 of this form, within one business day of receipt of such request, and to send the incorporated documents by first class mail or other equally prompt means. This includes information contained in documents filed subsequent to the effective date of the Registration Statement through the date of responding to the request. 260 5. To supply by means of a post-effective amendment all information concerning a transaction, and the company being acquired involved therein, that was not the subject of and included in the Registration Statement when it became effective. 6. Prior to any public reoffering of the securities registered hereunder through use of a prospectus which is a part of this registration statement, by any person or party who is deemed to be an underwriter within the meaning of Rule 145(c), the issuer undertakes that such reoffering prospectus will contain the information called for by the applicable registration form with respect to reofferings by persons who may be deemed underwriters, in addition to the information called for by the other items of the applicable form. 7. That every prospectus (i) that is filed pursuant to paragraph 6 immediately preceding, or (ii) that purports to meet the requirements of Section 10(a)(3) of the Act and is used in connection with an offering of securities subject to Rule 415, will be filed as a part of an amendment to the registration statement and will not be used until such amendment is effective, and that, for purposes of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. 8. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the AFG pursuant to the provisions described under Item 20 above, or otherwise (other than insurance), AFG has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by AFG of expenses incurred or paid by a director, officer or controlling person of AFG in the successful defense of any action, suit or proceeding) is asserted by such director, officer of controlling person in connection with the Securities being registered, AFG will, unless in the opinion of its counsel the matter has been settled by question whether such indemnification by it, other than indemnification pursuant to court order and not including any coverage under, or agreement to pay premiums for, any policy of insurance, is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. 261 -----END PRIVACY-ENHANCED MESSAGE-----