The following discussion of the financial condition and results of operations of
UTG, Inc. and its subsidiaries (collectively, the "Company") should be read in
conjunction with, and is qualified in its entirety by reference to, the
Consolidated Financial Statements of the Company and the related Notes thereto
appearing in the Company's annual report on Form 10-K for the year ended
December 31, 2011, as filed with the Securities and Exchange Commission, and our
unaudited Condensed Consolidated Financial Statements and related Notes thereto
appearing elsewhere in this quarterly report.
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:
Prevailing interest rate levels, which may affect the ability of the
Company to sell its products, the market value of the Company's
1. 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.
Changes in the regulation of financial services, including bank sales
3. and underwriting of insurance products, which may affect the competitive
environment for the Company's products.
Other factors affecting the performance of the Company, including, but
not limited to, market conduct claims, insurance industry insolvencies,
4. insurance regulatory initiatives and developments, stock market
performance, an unfavorable outcome in pending litigation, and
UTG, Inc., a Delaware corporation, is a life insurance holding company. The
Company's dominant business is individual life insurance, which includes the
servicing of existing insurance policies in force, the acquisition of other
companies in the life insurance business and the administration and processing
of life insurance business for other entities. The Company's focus for the
future includes growing the administrative portion of the business.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect reported amounts and related disclosures.
Actual results could differ significantly from those estimates. The Company has
identified certain estimates that involve a higher degree of judgment and are
subject to a significant degree of variability. The Company's critical
accounting policies and the related estimates considered most significant by
management are disclosed in the Company's Annual Report on Form 10-K for the
year ended December 31, 2011. Management has identified the accounting policies
related to cost of insurance acquired, assumptions and judgments utilized in
determining if declines in fair values of investments are other-than-temporary,
and valuation methods for investments that are not actively traded as those, due
to the judgments, estimates and assumptions inherent in those policies, are
critical to an understanding of the Company's Condensed Consolidated Financial
Statements and this Management's Discussion and Analysis.
During the six months ended June 30, 2012, there were no additions to or changes
in the critical accounting policies disclosed in the 2011 Form 10-K, except for
recently adopted accounting standards discussed in Note 2 of the Notes to the
Condensed Consolidated Financial Statements.
Results of Operations
The Company's premium and policy fee revenues, net of reinsurance, were
approximately $2.6 million for the second quarter of 2012 (a decrease of less
than one percent compared to the second quarter of 2011) and approximately $5.2
million for the six months ended June 30, 2012 (a decrease of 6% compared to the
corresponding period ended in 2011). Unless the Company acquires a block of
in-force business management expects premium revenue to continue to decline on
the existing block of business at a rate consistent with prior experience.
The Company's primary source of new business production, which has been
immaterial, comes from internal conservation efforts. Several of the customer
service representatives of the Company are also licensed insurance agents,
allowing them to offer other products within the Company's portfolio to existing
customers. Additionally, efforts continue to be made in policy retention
through more personal contact with the customer including telephone calls to
discuss alternatives and reasons for a customer's request to surrender their
Net investment income decreased approximately 56% when comparing 2012 and 2011
second quarter results and 21% when comparing the six months ended June 30, 2012
to the same period in 2011. The decrease in investment income for the six
months ended June 30, 2012 and the second quarter ended 2012, in comparison to
the same periods in 2011, is attributable to activity in the trading securities
portfolio and the mortgage loan portfolio.
During the second quarter of 2012, the Company experienced a slight loss of
income in the trading securities portfolio while during the second quarter of
2011, the Company recorded approximately $3 million in income from the trading
securities investment portfolio. For the six months ended June 30, 2012 and
2011, the Company recognized investment income of approximately $2 million and
$4.7 million, respectively, from the trading securities portfolio. The decrease
in trading securities income in 2012, in comparison to 2011, is a result of a
reallocation of the Company's investment portfolio beginning during the third
quarter of 2011. Management made the decision to scale back the Company's
trading securities investing activities and allocate additional funds to the
fixed maturities investment portfolio, based upon adverse experience in the
trading securities portfolio in the third quarter of 2011.
During 2012, the Company has seen a positive turn in earnings from the trading
securities. Volatility as well as possible losses should be expected in the
trading securities portfolio. Management's target return on the trading
securities portfolio is 6% to 8%.
The Company received less income from mortgage loans, including discounted
mortgage loans, during the second quarter of 2012 and the first six months of
2012 compared to the same periods in 2011. During the second quarter of 2012 and
2011, the Company received mortgage loan interest of approximately $1.2 million
and $1.8 million, respectively. During the six months ended June 30, 2012 and
2011, the Company recorded mortgage loan interest of $2.8 million and $5.2
million, respectively, which mainly attributable to discounted mortgage loan
activity. This decrease is due to fewer discounted mortgage loan settlements.
Should any of the factors change, such as the ability to acquire additional
loans at such a large discount due to increased competition or insufficient
supply, the ability of borrowers to settle loans mainly through refinancing,
another decline in the overall economy, and other such factors, the performance
of this type of investment could abruptly end, directly affecting future net
income. While management believes the current portfolio would remain profitable
in another downturn, with no source of new acquisitions of discounted loans, the
future profit stream from this activity would be limited. Alternatively, should
the Company need to look at fixed maturities for additional investment if
discounted loans were no longer a viable option, the rate of return would be
significantly lower given the low interest rate environment also resulting in
substantially lower income.
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 Company
monitors investment yields, and when necessary adjusts credited interest rates
on its insurance products to preserve targeted interest spreads, ranging from 1%
to 2%. Interest crediting rates on adjustable rate policies have been reduced
to their guaranteed minimum rates, and as such, cannot lower them any further.
Policy interest crediting rate changes and expense load changes become
effective on an individual policy basis on the next policy anniversary.
Therefore, it takes a full year from the time the change was determined for the
full impact of such change to be realized. If interest rates decline in the
future, the Company won't be able to lower rates and both net investment income
and net income will be impacted negatively.
The Company had net realized investment gains of approximately $3.8 million and
$100,000 for the second quarter of 2012 and 2011, respectively and approximately
$11 million and $1.7 million for the six months ended June 30, 2012 and 2011,
respectively. The increase in net realized gains in 2012, in comparison to
2011, is mainly attributable to the sale of bonds and certain real estate
During 2012, the Company reported realized gains of approximately $9 million
from the sale of bonds, primarily U.S. Treasury holdings. Additionally,
realized gains of approximately $1.7 million were recognized from the sale of
During the fourth quarter of 2011 and first six months of 2012, the Company took
advantage of the unusually high price spreads on U.S. government treasury
securities relative to other types of bonds in the marketplace, by selling a
majority of its U.S. treasury holdings. The Company has redeployed a majority
of its excess cash balances into BBB and BB rated corporate debt issues.
Included in fixed maturity purchases, the Company purchased approximately
$66,509,000 and $22,325,000 of BBB and BB rated corporate debt issues,
respectively. These corporate debt issues have an average interest yield of
5.03%. Interest spreads on these investments are higher than historic trends
and Management believes this is an opportunity to enhance yield and provide more
recurring investment income. Lower rated bonds are viewed by the marketplace to
inherently hold more default risk. The trade-off on this risk is a higher
interest yield. Each investment is analyzed prior to acquisition to determine
if Management is comfortable with the increased risk relative to the yield.
Management believes there are opportunities currently available in this area
where certain corporate bond issues have been more harshly impacted by the
marketplace than may really be justified. It is this type of bond Management is
primarily searching for to invest in.
Management continues to view the Company's investment portfolio with utmost
priority. Significant time has been spent internally researching the Company's
risk and communicating with outside investment advisors about the current
investment environment and ways to ensure preservation of capital and mitigate
any losses. Management has put extensive efforts into evaluating the investment
holdings. Additionally, members of the Company's board of directors and
investment committee have been solicited for advice and provided with
information. Management has reviewed the Company's entire portfolio on a
security level basis to be sure all understand our holdings, potential risks and
underlying credit supporting the investments. Management intends to continue
its close monitoring of its bond holdings and other investments for additional
deterioration or market condition changes. Future events may result in
Management's determination certain current investment holdings may need to be
sold which could result in gains or losses in future periods. Such future
events could also result in other than temporary declines in value that could
result in future period impairment losses.
There are a number of significant risks and uncertainties inherent in the
process of monitoring impairments and determining if impairment is
other-than-temporary. These risks and uncertainties related to management's
assessment of other than temporary declines in value include but are not limited
to: the risk that Company's assessment of an issuer's ability to meet all of its
contractual obligations will change based on changes in the credit
characteristics of that issuer; the risk that the economic outlook will be worse
than expected or have more of an impact on the issuer than anticipated; the risk
that fraudulent information could be provided to the Company's investment
professionals who determine the fair value estimates.
Other income primarily represented revenues received relating to the performance
of administrative work as a TPA for unaffiliated life insurance companies, which
has remained consistent over the periods presented. The Company receives
monthly fees based on policy in force counts and certain other activity
indicators such as number of policies issued. Management remains committed to
the pursuit of additional TPA clients and believes this area continues to show
potential for growth.
Life benefits, claims and settlement expenses, net of reinsurance benefits and
claims, increased approximately 13% in the sixth month period ended June, 30
2012 compared to the same period in 2011 and by approximately 12% for the second
quarter 2012, compared to the same quarter in 2011 due to higher claims. Policy
claims vary from period to period and therefore, fluctuations in mortality are
to be expected and are not considered unusual by management.
Commissions and amortization of deferred policy acquisition costs decreased
approximately 34% in the six month period ended June 30, 2012 compared to the
same period in 2011 and by approximately 40% for the second quarter 2012,
compared to the same quarter in 2011. The majority of this number is driven by
a financial reinsurance agreement. The earnings on the block of business
covered by this agreement are utilized to re-pay the original borrowed amount.
The commission allowance reported each period from this agreement represents
the net earnings on the identified policies covered by the agreement in each
reporting period. As financial reinsurance, all financial results relating to
this block of business are utilized to repay the outstanding borrowed amount
from the reinsurer. Securities are specifically identified and segregated in a
trust account relative to this arrangement. Should a gain or loss occur on one
of these identified securities in the trust account, the results are included in
the calculation of the current period financial results of the treaty with the
reinsurer. While the agreement may result in variances in this line item,
this arrangement has no material impact on net income. A liability for the
original ceding commission was established at the origination of the agreement
and is amortized through this line item as earnings on the block of business are
realized. Another significant factor is attributable to the Company paying
fewer commissions since the Company writes very little new business and renewal
premiums on existing business continue to decline. Most of the Company's agent
agreements contained vesting provisions, which provide for continued
compensation payments to agents upon their termination subject to certain
minimums and often limited to a specific period of time. Another factor is
attributable to normal amortization of the deferred policy acquisition costs
asset. The Company reviews the recoverability of the asset based on current
trends and known events compared to the assumptions used in the establishment of
the original asset. No impairments were recorded in any of the periods
Net amortization of cost of insurance acquired decreased approximately 7% in the
six month period ended June 30, 2012 compared to the same period in 2011 and by
approximately 7% for the second quarter 2012 compared to the same quarter in
2011. 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 Company utilizes a 12%
discount rate on the remaining unamortized business. The interest rates may
vary due to risk analysis performed at the time of acquisition on the business
acquired. The amortization is adjusted retrospectively when estimates of current
or future gross profits to be realized from a group of products are revised.
Amortization of cost of insurance acquired is particularly sensitive to changes
in interest rate spreads and persistency of certain blocks of insurance
in-force. This expense is expected to decrease, unless the Company acquires a
new block of business.
Operating expenses increased approximately 28% in the six month period ended
June 30, 2012 in comparison to the same period in 2011 and by approximately 17%
for the second quarter 2012 in comparison to the same quarter in 2011. The
increase in 2012 expenses, in comparison to 2011, is primarily attributable to
an increase in legal expenses, charitable contributions and new aircraft use
The Company's legal expenses increased approximately $250,000 when comparing the
six month period ended June 30, 2012 to the same period in 2011 and by
approximately $42,000 when comparing the second quarter of 2012 to the second
quarter of 2011. The increase in legal expenses is primarily attributable to
the merger of American Capitol and the ACAP dissenters' lawsuit.
The Company's charitable contributions increased by approximately 47% when
comparing the six month period ended June 30, 2012 to the same period in 2011.
Charitable contributions decreased by approximately 57% when comparing the
second quarter 2012 to the same quarter in 2011. Charitable contributions are
expected to vary from quarter to quarter and year to year depending on the
earnings of the Company.
Additionally, in August 2011, the Company entered into a new agreement relating
to the use of an aircraft. This agreement resulted in increased expenses of
approximately $25,000 per month, beginning in January 2012.
Management continues to place significant emphasis on expense monitoring and
cost containment. Maintaining administrative efficiencies directly impacts net
Interest expense increased approximately 10% in the first six months of 2012
compared to the same period in 2011. The increase in interest expense during
2012 is mainly attributable to interest from the long-term debt and increased
use of lines of credit. Interest expense increased less than 1% when comparing
the second quarter of 2012 to the same quarter in 2011.
(c) Net Income/Loss
The Company reported net income attributable to common shareholders' of
approximately $6.7 million during the six month period ended June 30, 2012, an
increase of approximately 44% in comparison to the same period in 2011. Second
quarter 2012 net income was $1.4 million, an increase of approximately 15% in
comparison to the second quarter of 2011. The increase in net income is mainly
attributable to realized gains on bonds sold, which was partially offset by an
increase in operating expenses.
Future earnings will be significantly negatively impacted should earnings from
these one-time items not be realizable in a future period. While management
believes there remain additional investments with such one-time earnings, when
or if realized remains uncertain.
Total shareholders' equity increased by less than 1% as of June 30, 2012
compared to December 31, 2011. Retained earnings increased by approximately 53%
as of June 30, 2012. The increase in retained earnings is attributable to the
current year earnings of the Company. The increase in retained earnings was
offset by a decrease of approximately 55% in accumulated other comprehensive
income. The decrease in accumulated other comprehensive income is due to the
change in the unrealized values on investments.
Investments represent approximately 76% and 61% of total assets at June 30, 2012
and December 31, 2011, 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, the majority of the
Company's investment portfolio is invested in a diverse set of securities.
As of June 30, 2012, the carrying value of fixed maturity securities in default
as to principal or interest was immaterial in the context of consolidated
assets, shareholders' equity or results from operations. To provide additional
flexibility and liquidity, the Company has identified all fixed maturity
securities as "investments held for sale". Investments held for sale are
carried at market, with changes in market value charged directly to
In April 2012, the Company received the necessary approvals and completed the
merger of its two 100% owned insurance subsidiaries, with American Capitol
Insurance Company being merged into Universal Guaranty Life Insurance Company.
This transaction was done to provide the Company with additional administrative
efficiencies and cost savings related to maintaining separate legal entities.
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
debt service. Cash and cash equivalents as a percentage of total assets were
approximately 4% and 19% as of June 30, 2012, and December 31, 2011,
respectively. Fixed maturities as a percentage of total assets were
approximately 38% and 29% as of June 30, 2012 and December 31, 2011,
The Company currently has access to funds for operating liquidity. UTG has a
$5,000,000 revolving credit note with First Tennessee Bank National Association.
The revolving credit note was increased at renewal, during 2011, to provide for
additional operating liquidity and flexibility for current operations. On April
6, 2011, UTG Avalon was extended a credit note from First National Bank of
Tennessee for $5,000,000. UG is a member of the FHLB which allows UG access to
credit. UG's current line of credit with the FHLB is $15,000,000. At June 30,
2012, the Company had $6,075,000 of outstanding borrowings attributable to the
lines of credit.
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
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.
Net cash provided by (used in) operating activities was $(4,273,933) and
$2,545,816 for the six months ending June 30, 2012 and 2011, respectively.
Net cash used in investing activities was $(62,102,530) and $(2,718,514) for the
six month period ending June 30, 2012 and 2011, respectively. During the first
six months of 2012, more emphasis was placed on the sale of U.S. treasury
holdings and re-deploying the cash through the purchase of BBB and BB rated
Net cash provided by (used in) financing activities was $(899,400) and
$3,158,137 for the six month period ending June 30, 2012 and 2011, respectively.
At June 30, 2012, the Company had $9,591,220 of debt outstanding. At December
31, 2011, the Company had $9,531,645 of debt outstanding. The debt is primarily
attributable to the acquisition of ACAP at the end of 2006 and the borrowings on
the line of credit to purchase investments.
UTG is a holding company that has no day-to-day operations of its own. Funds
required to meet its expenses, generally costs associated with maintaining the
company in good standing with states in which it does business and the servicing
of its debt, are primarily provided by its subsidiaries. On a parent only
basis, UTG's cash flow is dependent on management fees received from its
insurance subsidiaries, stockholder dividends from its subsidiaries and earnings
received on cash balances. At June 30, 2012, substantially all of the
consolidated shareholders equity represents net assets of its subsidiaries. The
Company's insurance subsidiaries have maintained adequate statutory capital and
surplus. The payment of cash dividends to shareholders by UTG is not legally
restricted. However, the state insurance department regulates insurance company
dividend payments where the company is domiciled. No dividends were paid to
shareholders in 2011 or the first six months of 2012.
UG is an Ohio domiciled insurance company, which requires notification within
five business days to the insurance commissioner following the declaration of
any ordinary dividend and at least ten calendar days prior to payment of such
dividend. Ordinary dividends are defined as the greater of: a) prior year
statutory net income or b) 10% of statutory capital and surplus. For the year
ended December 31, 2011, UG had statutory net income of $582,217. At
December 31, 2011 UG's statutory capital and surplus amounted to $33,167,222.
Extraordinary dividends (amounts in excess of ordinary dividend limitations)
require prior approval of the insurance commissioner and are not restricted to a
specific calculation. During the first six months of 2012, UG paid UTG ordinary
dividends of $384,722. In July 2012, UG paid a dividend of $1,602,000 to UTG.
UTG used this dividend to pay off a portion of its long-term debt and line of
Management believes the overall sources of liquidity available will be
sufficient to satisfy the Company's financial obligations.