MIDWEST HOLDING INC. – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following Management's Discussion and Analysis ("MD&A") is intended to help
the reader understand the financial condition of the Company as of
2022
three months ended
of
as a supplement to, and should be read in conjunction with, our Consolidated
Financial Statements and the accompanying notes to the Consolidated Financial
Statements ("Notes") presented in "Part 1 - Item 1. Financial Statements" of
this Report and our Form 10-K for the year ended
Form 10-K"), including the sections entitled "Part I - Item 1A. Risk Factors,"
and "Part II - Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Cautionary Note Regarding Forward-Looking Statements and Risk Factors
Except for certain historical information contained herein, this report contains
certain statements that may be considered "forward-looking statements" within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), and Section 27A of the Securities Act of 1933, as amended
(the "Securities Act"), and such statements are subject to the safe harbor
created by those sections. All statements, other than statements of historical
fact, are statements that could be deemed forward-looking statements, including
without limitation: any projections of revenues, earnings, cash flows, capital
expenditures, or other financial items; any statement of plans, strategies, and
objectives of management for future operations; any statements concerning new
products or services, or developments; any statements regarding future economic
conditions or performance; and any statements of belief and any statement of
assumptions underlying any of the foregoing. Words such as "believe," "may,"
"could," "expects," "hopes," "estimates," "projects," "should," "intends,"
"will," "anticipates," and "likely," and variations of these words, or similar
expressions, terms, or phrases, are intended to identify such forward-looking
statements. Forward-looking statements are inherently subject to risks,
assumptions, and uncertainties, many of which cannot be predicted or quantified,
which could cause future events and actual results to differ materially from
those set forth in, contemplated by, or underlying the forward-looking
statements. Factors that could cause or contribute to such differences include,
but are not limited to, those discussed in "Item 1A. Risk Factors" of our 2021
Form 10-K and below in Part III - Other Information - Item 1A Risk Factors.
Factors that may cause our actual results to differ materially from those
contemplated or projected, forecast, estimated or budgeted in such
forward-looking statements include among others, the following possibilities:
? our business plan, particularly including our reinsurance strategy, may not
prove to be successful;
? the success of our recent changes in executive leadership;
? our reliance on third-party insurance marketing organizations to market and
sell our insurance products through a network of independent agents;
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? adverse changes in the ratings obtained from independent rating agencies;
? failure to maintain adequate reinsurance;
? our inability to expand our insurance operations outside the 22 states and
? our insurance products may not achieve significant market acceptance;
? we may continue to experience operating losses in the foreseeable future;
? the possible loss or retirement of one or more of our key executive personnel;
intense competition, including the intensification of price competition, the
? entry of new competitors, and the introduction of new products by new and
existing competitors;
adverse state and federal legislation or regulation, including limitations on
? premium levels, increases in minimum capital and reserve requirements, benefit
mandates and tax treatment of insurance products;
fluctuations in interest rates causing a reduction of investment income or
? increase in interest expense and in the market value of interest-rate sensitive
investments;
? failure to obtain new customers, retain existing customers, or reductions in
policies in force by existing customers;
higher service, administrative, or general expense due to the need for
? additional marketing, administrative or management information systems
expenditures related to implementation of our business plan;
? changes in our liquidity due to changes in asset and liability matching;
? possible claims relating to sales practices for insurance products;
? accuracy of management's assumptions and estimates;
? variability of statutory capital required to be held by insurance or
reinsurance entities; and
? lawsuits in the ordinary course of business.
See "Risk Factors" beginning on page Part II, Item 1A for further discussion of
the material risks associated with our business.
All such forward-looking statements speak only as of the date of this report.
You are cautioned not to place undue reliance on such forward-looking
statements. We expressly disclaim any obligation or undertaking to release
publicly any updates or revisions to any forward-looking statements contained
herein to reflect any change in our expectations with regard thereto or any
change in the events, conditions, or circumstances on which any such statements
are based.
incorporated in
financial services company. We redomesticated from the
and operate through our wholly owned subsidiaries,
Corp.
captive reinsurance company,
Overview of Company and Business Model
We are a financial services company focused on helping people plan and secure
their future by providing technology-enabled and services-oriented solutions to
support individuals' retirement through our annuity products. We currently
distribute our
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annuities through independent distributors who are primarily independent
marketing organizations ("IMOs"). Our operations are comprised of four distinct,
inter-connected businesses. We seek to reinsure our annuity policies using a
reinsurance platform that is attractive to traditional reinsurance entities and
other institutional investors seeking above average risk-adjusted returns
uncorrelated to the equity markets. To date we have developed relationships with
reinsurers who capitalize and manage their own reinsurance capital vehicles
utilizing our infrastructure and expertise. Our long-term goal is to build a
platform that provides competitive annuity and life insurance products via
efficient technology resulting in a seamless customer experience.
We believe that our operating capabilities and technology platform provides
annuity distributors and reinsurers with flexible and cost-effective solutions.
We seek to create value through our ability to provide the distributors and
reinsurers with annuity product innovation, speed to market for new products,
competitive rates and commissions, and streamlined customer and agent
experiences. Our capital model allows us to support increasing annuity sales
volumes with capital capacity provided by reinsurers.
We provide an end-to-end solution to manage annuity products that includes a
broad set of product development, distribution support, policy administration,
and asset/liability management services. Our technology platform enables us to
efficiently develop, sell and administer a wide range of products. Our asset
management services are also provided to third-party insurers and reinsurers.
We currently offer annuity products, consisting of multi-year guaranteed annuity
("MYGA") and fixed indexed annuity ("FIA") policies, through IMOs that in turn
distribute our products and services to independent insurance agents in 22
states and the
development expertise, administrative capabilities and technology platform.
We seek to reinsure substantially all of our annuity policies with third-party
reinsurers and our captive reinsurance subsidiary, Seneca Re. Our third-party
reinsurers include traditional reinsurers and capital markets reinsurers, which
are third-party investors, who are seeking exposure to reinsurance revenue and
typically do not have their own reinsurance platforms or insurance related
operations. We also have the flexibility to selectively retain assets and
liabilities associated with our policies for a period of time when we expect
that doing so will provide an attractive return on our capital.
We operate our core business through four subsidiaries under one reportable
segment. American Life is a
also commercially domiciled in
underwrite, and market life insurance and annuity products in 22 states and the
rating of B++ ("Good") from
agency for insurance companies, that was affirmed in
2022
bbb+ from bbb in
annuities are written by American Life.
Our other insurance subsidiary, Seneca Re, is a
captive reinsurance company established in early 2020 to reinsure various types
of risks on behalf of American Life and third-party capital providers through
special purpose reinsurance entities known as "protected cells." Through Seneca
Re, we assist capital market investors in establishing and licensing new
protected cells. We also own 1505 Capital, which is an
adviser that provides financial, investment advisory, and management services.
At
assets under management.
We seek to deliver long-term value by growing our annuity volumes and generating
profitable fee-based revenue. We generate fees and other revenue based on the
gross deposits received on the annuity policies we issue, reinsure, and
administer.
By reinsuring a significant portion of the annuity policies we issue, the level
of capital needed for American Life is significantly less than retaining all of
the business on its books. We believe this "capital light" approach has the
potential to produce enhanced returns for our business compared to a traditional
insurance company capital structure. This strategy helps alleviate our insurance
regulatory capital requirements because policies that are reinsured require
substantially less capital and surplus than policies retained by us.
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As of
year, relating to our annuity products were ceded to reinsurance vehicles
capitalized by third party reinsurers or held in protected cells within Seneca
Re for future reinsurance transactions.
We receive ceding commissions and expense reimbursement from reinsurers at the
time we cede our primary insurance liabilities to them, providing meaningful
cash flow. During the three months ended
our balance sheet is an item "deferred gains on reinsurance" equaling
million and
respectively which will be earned as revenue over the relevant reinsured annuity
contract periods. Amortization of the deferred gain on reinsurance was
and
and was recognized as revenue under GAAP.
For the three months ended
and a negative
investments, ceding commissions earned, policy administration, and asset
management fees.
Through our ancillary services businesses we administer the policies we issue
and offer asset management services to our reinsurance partners for a fee.
Through Seneca Re, we also assist capital market investors in establishing and
licensing new special purpose reinsurance entities. We believe our broad service
offering provides a growing and valuable fee stream and expect that our policy
administration and asset management fee income will increase as we grow our
number of administered policies and the associated assets that we manage. In the
future, we expect to have opportunities to increase our policy administration
and asset management revenue by providing these services on a stand-alone basis
to new customers.
We seek to create value for our distribution and reinsurance partners by
facilitating product innovation, rapid speed to market for new products,
competitively priced products, streamlined customer and agent experience, and
efficient technology-enabled operations. We generate fee income from reinsurers
in the form of ceding commissions, policy administration fees, and asset
management fees. We typically receive upfront ceding commissions and expense
reimbursements at the time the policies are reinsured and policy administration
fees over the policy lifetimes. We also earn asset management fees on the assets
we hold that support the obligations of a majority of our reinsurers. In
investing on behalf of our insurance and reinsurance company subsidiaries, we
seek to maximize yield by constructing portfolios that include a diversified
portfolio of bonds, mortgages, private credit and structured securities
(including collateralized loan obligations), while minimizing the difference in
duration between our investment assets and liabilities.
Our Products
Through American Life we presently issue several MYGA and FIA products. American
Life presently offers fix annuity products, two MYGAs, two FIAs, and two bonus
plans associated with the FIA product. It is not presently offering any
traditional life insurance products. Fixed annuities are a type of insurance
contract in which the policyholder makes one or more premium deposits, earning
interest at a crediting rate determined in relation to a specific market index,
on a tax deferred basis. MYGAs are insurance contracts under which the
policyholder makes deposits and earns a crediting rate guaranteed for a
specified number of years before it may be changed. American Life's MYGA
products are three and five-year single premium deferred individual annuity
contracts, providing consumers with an attractive, low risk, predictable and
tax-deferred investment option. American Life's FIA products are long-term (7
and 10-year) annuity products with interest rates that are tied, in part, to
published stock market indices chosen by customers. The FIA products are
modified single premium annuity contracts designed for individuals seeking to
benefit from potential market gains with fully protected principal. American
Life began selling its MYGA and FIA products in 2019.
In 2021, we introduced two new indexes into the selections on FIA products. The
S&P 500 ESG index for fixed annuities is comprised of a subset S&P 500 companies
built to meet the increasing needs of investors seeking socially responsible
investments aligned with a mainstream index which is published by one of the
foremost index authorities in the world,
Our second new index, the Goldman Sachs Xenith Index is a multi-asset strategy
that uses the anticipated macro regime, as identified by a leading economic
indicator, to make asset allocations. By using a leading economic indicator, the
Goldman Sachs Xenith Index differs from indices that rely on a backward-looking
methodology alone. Instead of relying purely on the
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S&P 500 Index for exposure to
overlay that can reduce equity exposure based on intra-day trading "signals". As
a result, the strategy incorporates real-time market movements, in addition to
other factors, in its rules-based methodology.
We expect to expand American Life's product line in the future. Depending on
market demand, we expect to consider having American Life write a wide variety
of insurance products, including fixed deferred, fixed indexed and other
annuities. Any new insurance products we create must be filed with and approved
by appropriate state insurance regulatory authorities before being offered to
the public. American Life's MYGA and FIA products were developed using an
independent consulting actuary, and we expect that any new products will utilize
similar services. Our long-term plan is to broaden our products to life and
Medicare supplements under attractive market conditions.
The table below sets forth American Life's MYGA and FIA deposits received during
the three months ended
Three months ended March 31,
2022 2021
(In thousands) Deposits Received(1) Deposits Received(1)
Annuity Premium
MYGA $ 25,464 $ 9,369
FIA 72,647 114,285
Total issued $ 98,111 $ 123,654
1) Under generally accepted accounting principles in
America
therefore, the deposits received are accounted for under GAAP as deposit-type
liabilities on our balance sheet and are not recognized as revenue in our
consolidated statement of comprehensive loss. Under Statutory Accounting
Principles, the MYGA and FIA premiums are treated as premiums written and as
revenue when earned.
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Industry Trends and Market Conditions
Market
We participate in a large U.S. market that we expect to grow in part due to a
number of demographic trends. As measured by annual premiums written, annuities
are the largest product line in the life, annuity, and accident and health
sector. Annuities play an important role in retirement planning by providing
individuals with stable, tax-efficient sources of income. In 2020 annuity
premiums, accounted for
the
according to
fixed and variable and can be written on an individual or group basis. Our
current products are MYGAs and FIA's written on an individual basis.
An increasing portion of the
expected to increase the retirement income needs of retirees. The number of
people of retirement age has increased significantly since 2010, driven by the
aging of the "Baby Boomer" generation. The
forecast to grow from 56 million in 2020 to an estimated 81 million in the next
20 years, according to the
Projections. This study also forecasted that
old is expected to grow by 44% from 2020 to 2040, while the total
population is expected to grow by only 12%. Annuities in the
distributed through a number of channels, most of which are independent from the
insurance companies that issue annuities. Independent distribution channels
serve as the primary and a growing source of annuity distribution. In 2020,
approximately 77% of
distributors, including independent agents, broker-dealers, and banks,
representing an increase from approximately 70% in 2016 according to
Individual Annuities, 2020 Year in Review,
Association
distribution channel, behind independent broker-dealers, accounting for
approximately 19% of
independent agents with access to annuity products along with operational
support services and functionality to support the distribution services of the
agents. The infrastructure and support services provided by IMOs to independent
agents are critical to the success of independent agents and their ability to
serve their customers and generate additional sales.
We believe that capital markets investors have been actively seeking investing
in and acquiring insurance and reinsurance companies in recent years. Fixed
annuities provide upfront premiums and stable, long-term payment obligations and
are thus attractive sources of liability-funded assets for a variety of
traditional and alternative asset managers and investors. However, there are
significant regulatory and operational hurdles for capital providers looking to
enter the insurance market. These hurdles are exacerbated by the limited legacy
administrative capabilities, product development processes and technology
systems, of traditional insurers and reinsurers. We provide asset managers and
investors the ability to seamlessly access funding from annuities through a
variety of reinsurance entities that we can form quickly and operate efficiently
with lower upfront and ongoing regulatory and operating costs.
State expansion efforts have taken more time than anticipated, as states would
like to see a more meaningful historical financial footprint. We are working
diligently to file in more states, responding and providing increased
information to regulators and discussing how the model ensures policyholders are
protected, given the capital held and supported by the use of reinsurance.
We currently distribute annuity products through eight third-party IMOs. We
believe our product development, prompt policy processing, operating flexibility
and speed to market make us a desirable partner for insurance distributors. We
will seek to grow by increasing volumes with our current IMOs and by
establishing new IMO relationships.
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Competition
We operate in highly competitive markets with a variety of participants,
including insurance companies, financial institutions, asset managers, and
reinsurance companies. These companies compete in various forms in the annuity
market, for investment assets and for services. We seek to build strong
relationships along with offering technology-enabled and services-oriented
solutions for our partners. The market for annuities is dynamic we believe. The
combination of the treasury market experiencing the largest rate increase since
1928 1 and the volatility in the market resulting from the war in
opened up investment opportunities that allow us, and our reinsurance partners,
to support more competitive rates for annuities. Based on our experience with
COVID, we expect this investment environment to be conducive to our business
model. We have been reviewing pricing along with reinsurer appetite to ensure we
continue to grow the business while managing risk. We have taken pricing action
on both our FIA and MYGA products and continue to monitor our competitiveness in
the market. We have also increased our focus on marketing, reestablishing, and
expanding our relationships on the distribution side through various channels
and are reallocating or adding resources relating to this initiative. We are
starting to see some encouraging trends in 2022.
Given the potential premium growth, we have capacity to cover the capital needs
of writing new business through existing reinsurers. Additionally, we have a
number of potential reinsurance transactions in the pipeline that are
anticipated to close in the year.
Interest Rate Environment
The
quarter of 2022, compared to the historically low levels in the same period in
2021 and the expectation is for rate increases to continue to raise during the
remainder of 2022 and reach 2.9% in early 2023. We seek to address our interest
rate risk through managing the duration of the liabilities and purchasing and
holding high quality, long-term assets that mirror that duration.
If interest rates were to rise, we believe the yield on floating rate
investments and the yield on new investment purchases would rise. We also
believe our products would be more attractive to consumers and impact sales
positively.
Discontinuation of Libor
Interbank Offered Rate ("LIBOR"), previously indicated that it intends to stop
persuading or compelling panel banks to submit quotes used to determine LIBOR
after 2021. On
consultation regarding its intention to cease the publication of one week and
two-month
the publication of the remaining
three, six and 12 month
intends to share the results of the consultation with the
summary of the responses.
and, subject to certain limited exceptions, advised banks to cease writing new
We are in the process of analyzing and identifying our population of securities,
financial instruments and contracts that utilize LIBOR (collectively "LIBOR
Instruments") to determine if we have any material exposure to the transition
from LIBOR. To the extent we hold LIBOR Instruments, the terms of these
instruments may have fallback provisions that provide for an alternative
reference rate when LIBOR ceases to exist. For securities without adequate
fallback provisions already in place, legislation governing securities under
York
recommended alternative reference rate. In addition, federal legislation has
been introduced to provide the same protection for securities not governed by
Notwithstanding, in preparation for the phase out of LIBOR, we may need to
renegotiate our LIBOR Instruments that utilize LIBOR. However, these efforts may
not be successful in mitigating the legal and financial risk from changing the
reference
1 Sources: Natixis, NYU Stern
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rate in our LIBOR Instruments. Furthermore, the discontinuation of LIBOR may
adversely impact our ability to manage and hedge exposures to fluctuations in
interest rates using derivative instruments.
As a result, the transition of our LIBOR Instruments to alternative reference
rates may result in adverse changes to the net investment income, fair market
value and return on those investments. We intend to continue to evaluate and
monitor the risks associated with the LIBOR transition which include identifying
and monitoring our exposure to LIBOR, monitoring the market adoption of
alternative reference rates and ensuring operational processes are updated to
accommodate alternative rates. Due to uncertainty surrounding alternative rates,
we are unable to predict the overall impact of this change at this time.
COVID-19
We continue to closely monitor developments related to the COVID-19 pandemic to
assess any potential adverse impact on our business. Due to the evolving and
highly uncertain nature of this pandemic, it currently is not possible to
provide a longer-term estimate of potential insurance or reinsurance exposure or
the indirect effects the pandemic may have on our results of operations,
financial condition or liquidity. Management implemented our business continuity
plan in early
employees working remotely. Operations continued as normal despite a sharp
increase in sales during the period. We continue to monitor the
Disease Control and Prevention
employee safety. Our management continues to monitor our investments and cash
flows to evaluate the impact as this pandemic evolves.
Critical Accounting Policies and Estimates
Part II - Item 7 - Management's Discussion and Analysis of Financial Condition
and Results of Operations included in our 2021 Form 10-K ("2021 Form 10-K MD&A")
contains a detailed discussion of our critical accounting policies and
estimates. This report should be read in conjunction with the "Critical
Accounting Policies and Estimates" discussed in our 2021 Form 10-K MD&A.
Derivatives
The Company entered into derivative instruments to hedge FIA products that
guarantee the return of principal to the policyholders and credit interest based
on a percentage of the gain in a specified market index. To hedge against
adverse changes in equity indices, the Company entered into contracts to buy
equity indexed options. The change in fair value of the derivatives for hedging
the FIA index credits and the related embedded derivative liability fluctuate
from period to period based on the change in the market interest rates. The
indexed reserves are measured at fair value for the current period and future
periods. We hedge with options that align with the terms of our FIA products
which is between three and seven years. We have analyzed our hedging strategy on
our FIA products and, while the correlation of the hedges to the FIA products is
not matched dollar for dollar, we believe the hedges are effective as of
31, 2022
American Life also has agreements with several third-party reinsurers that have
FW and
are maintained by American Life as collateral; however, ownership of the assets
and the total return on the asset portfolios belong to the third-party
reinsurers. Under GAAP, this arrangement is considered an embedded derivative as
discussed in "Note 5 - Derivative Instruments" to our Consolidated Financial
Statements. Assets carried as investments on American Life's financial
statements for the third-party reinsurers contained unrealized losses as of
approximately
provide that unrealized gains and unrealized losses on the portfolios accrue to
the third-party reinsurers. We account for these unrealized losses as gains by
recording equivalent realized losses or gains on our Consolidated Statement of
Comprehensive Loss. Accordingly, the unrealized losses on the assets held by
American Life on behalf of the third-party reinsurers were offset by recording
an embedded derivative gain of
months ended
fluctuate, the unrealized gains or losses of the third-party reinsurers may also
fluctuate; therefore, the associated embedded derivative gain (loss) recognized
by us would be increased or decreased accordingly.
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Comprehensive Net Income (Loss)
In this section, unless otherwise noted the discussion below first compares the
three months ended
We incurred a comprehensive loss of
in 2021. Our revenues increased to
by an overall increase in investment income and fee revenue; offset by realized
losses due to the increase in the
decreased to a negative
reason for the negative expenses was also due to the
rate increases resulting in losses in the embedded derivative creating negative
interest credited on our FIA product and a gain from passing the losses of the
mark-to-market on the reinsurance option allowances. These decreases in expense
were offset by increases in consulting related to new software implementation.
Other reasons for the increase in Consolidated Statements of Comprehensive Loss:
Taxes. Our GAAP effective tax rates are unusually high in 2021 compared to
2020. The increase is primarily due to our change in valuation allowances. We
1) expect the effective rates will come down throughout the remainder of 2022.
Note 8 to our financial statements provides further information related to
this increase in tax rate.
Change in Unrealized Investment Losses (Gains). This change was a loss of
2)
interest rates in 2022 decreased the value of our fixed-income investments to
a much greater extent than occurred in 2021.
Our FIA products have three components influencing our Consolidated Statements
of Comprehensive Loss:
The derivatives we purchase to hedge interest rate risk we would otherwise face
from our FIA. We carry these derivatives at fair value on our Consolidated
Balance Sheets, recording the change in fair value in our Consolidated
Statements of Comprehensive Loss as either a realized gain or realized loss. In
2022, the decrease in the market value of the derivative option assets was
million
of
The embedded derivative in our FIAs. We carry this derivative at fair value,
with the change in fair value recorded in the interest credited line of our
Consolidated Statements of Comprehensive Loss. Across all of products,
interest credited was a negative
1)
related to our FIAs was included in this overall interest credited. Reflecting
our risk management, the change in the value of the embedded derivative
equaled the change in the value of option contracts we use to hedge this
exposure.
The option budget reinsurers pay us to purchase derivative assets. We mark
these assets to market each period. Separately, we record a payable to the
reinsurers that is owed to a reinsurer when a policy is surrendered, an
annuitant dies, or a policy lapses. We compare what the reinsurer paid for the
2) original option budget to the market value at the end of the period. The
change in the market value is added to or subtracted from the payable to the
reinsurer to cover the reinsurer's obligations to the policyholder. This
change in market value that resulted in negative $6.4 million was included in
our other operating expense in 2022 compared to a negative $4.1 million
expense in the prior year.
Consolidated Results of Operations - Three Months Ended
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Note 2 – Financial Condition, Going Concern and Management Plans
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