ITEM 1.
BUSINESS.
Overview and History - US Alliance Corporation ("USAC") was formed as a Kansas corporation on April 24, 2009 to raise capital to form a new Kansas-based life insurance company. Our offices are located at 4123 SW Gage Center Drive, Suite 240, Topeka, Kansas 66604. Our telephone number is 785-228-0200 and our website address is www.usalliancecorporation.com.
USAC has five wholly-owned operating subsidiaries. US Alliance Life and Security Company ("USALSC") was formed June 9, 2011, to serve as our life insurance company. US Alliance Marketing Corporation ("USAMC") was formed April 23, 2012, to serve as a marketing resource. US Alliance Investment Corporation ("USAIC") was formed April 23, 2012 to serve as investment manager for USAC. Dakota Capital Life Insurance Company (“DCLIC”), was acquired on August 1, 2017 when USAC merged with Northern Plains Capital Corporation (“NPCC”). US Alliance Life and Security Company - Montana (USALSC-Montana), was acquired December 14, 2018. Both DCLIC and USALSC-Montana are wholly-owned subsidiaries of USALSC. Unless the context otherwise indicates, references in this registration statement to "we", "us", "our", or the "Company" refer collectively to USAC and its subsidiaries.
We initially capitalized our subsidiaries with proceeds from intrastate public offering(s) registered by qualification with the office of Kansas Securities Commissioner.
USALSC received a Certificate of Authority from the Kansas Insurance Department ("KID") effective January 2, 2012, and sold its first insurance product on May 1, 2013. USALSC currently offers the following eight product categories:
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Solid Solutions Term Life Series®, Registered Trademark No 4,740,828. This simplified issue term life insurance product is designed to provide coverage with a face value of $250,000 or less. This product features limited underwriting and is offered with 10, 20, 25, and 30 year terms.
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Sound Solutions Term Life Series®, Registered Trademark No, 4,740,827. This is a fully underwritten term life insurance product designed to provide coverage for higher face amounts. This product features multiple risk classifications and is offered with 15, 20, 25 and 30 year terms.
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Pioneer Whole Life. This is a traditional whole life insurance product designed to provide permanent coverage with a limited premium paying period. This product is sold with death benefits typically ranging from $25,000 to $100,000.
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Legacy Juvenile Series®, Registered Trademark No. 4,577,835. This product is term life insurance to age 25 available for purchase on children up to the age of 16 in an amount of $10,000 or $20,000 with a one-time premium payment.
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American Annuity Series®, Registered Trademark No. 4,582,074. This product is a flexible premium deferred annuity with initial rates guaranteed for five years by company practice.
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Thoughtful Pre-Need Series®, Registered Trademark No 4,620,073. This series of products includes a single or multiple pay premium pre-need whole life insurance policy sold by funeral directors who are licensed by the KID in conjunction with a preplanned funeral. This product is typically sold with smaller death benefits than our traditional Pioneer Whole Life.
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Group Products. This is a series of group non-medical insurance products developed for the small group marketplace. These products are sold to employers and provide benefits for their employees. Our group suite of products includes group term life insurance, group long term disability, and group short term disability.
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Critical Illness. This individual policy provides cash benefits to the insured should certain defined illnesses or injuries occur.
DCLIC received a Certificate of Authority from the North Dakota Insurance Department ("NDID") effective January 24, 2012. DCLIC currently offers the following eight product categories:
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Prarie Term Life Series®, Registered Trademark No 5,266,633. This series of products include a simplified issue term life insurance product is designed to provide coverage with a face value of $250,000 or less and a fully underwritten term life insurance product designed to provide coverage for higher face amounts.
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Accumulator Whole Life. This is a hybrid product featuring a limited pay whole life insurance policy and a flexible premium deferred annuity rider.
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Frontier Whole Life. This is a traditional whole life insurance product designed to provide permanent coverage with a limited premium paying period. This product is sold with death benefits typically ranging from $25,000 to $100,000.
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Little Missouri Juvenile Series®, Registered Trademark No. 5,271,811. This product is term life insurance to age 25 available for purchase on children up to the age of 16 in an amount of $10,000 or $20,000 with a one-time premium payment.
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Badlands Annuity Series®, Registered Trademark No. 5,266,632. This product is a flexible premium deferred annuity with initial rates guaranteed for five years by company practice.
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Peace Garden Pre-Need Series®, Registered Trademark No. 5,271,810. This series of products includes a single or multiple pay premium pre-need whole life insurance policy sold by funeral directors who are licensed by the NDID in conjunction with a preplanned funeral. This product is typically sold with smaller death benefits than our traditional Frontier Whole Life.
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Dakota Group Series®, Registered Trademark No. 5,402,079. This is a series of group non-medical insurance products developed for the small group marketplace. These products are sold to employers and provide benefits for their employees. Our group suite of products includes group term life insurance, group long term disability, and group short term disability.
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Critical Illness. This individual policy provides cash benefits to the insured should certain defined illnesses or injuries occur.
USALSC-Montana is not marketing products at this time.
Our single pay life products (which include our Juvenile and Pre-Need products) accounted for 56% of 2019 direct premium revenue. Our individual life and Critical Illness products (which include Term Life and Whole Life products) accounted for 25% of 2019 direct premium revenue. Our group products accounted for 19% of 2019 direct written premiums.
USALSC and DCLIC seek opportunities to develop and market additional products.
Our business model also seeks the acquisition by USAC and/or its subsidiaries of other insurance and insurance related companies, including third-party administrators, marketing organizations, and rights to blocks of insurance business through reinsurance or other transactions.
Material Agreements and Partners - Effective January 1, 2013, USALSC entered into a reinsurance agreement with Unified Life Insurance Company (“ULIC”) to assume 20% of a certain block of health insurance policies. This agreement renews annually unless either party provides written notice of its intent not to renew at least 120 days prior to the expiration of the then-current term. The agreement provides for monthly settlement. For the year ended December 31, 2019, USALSC assumed premiums of $3,909,810.
On September 1, 2015, USALSC entered into an agreement to provide certain insurance administrative functions, data processing systems, daily operational services, management consulting, and marketing development to Dakota Capital Life Insurance Company. This agreement has an initial term of 60 months (beginning on September 1, 2015), and requires 90-day advance written notice to terminate. In addition, the agreement requires that certain products will be exclusively administered by USALSC and administrative services with respect to such products may not be transferred without our consent. The agreement provides for monthly settlement. On August 1, 2017, DCLIC became a wholly-owned subsidiary of USALSC as described below. Subsequent to the acquisition of DCLIC, this agreement became an inter-company agreement and is eliminated as a part of the consolidation of the financial statements of the companies.
On August 1, 2017 the Company acquired NPCC pursuant to a Plan and Agreement of Merger dated May 23, 2017, under which Alliance Merger Sub, Inc. (“Acquisition”), a wholly owned subsidiary of the Company, merged with and into Northern Plains (“Merger”) with Acquisition being the surviving company. Pursuant to the agreement, the Company exchanged .5841 shares of the Company’s common stock for each share of Northern Plains common stock, or 1,644,458 shares. Subsequent to the merger, Acquisition was merged into the Company and DCLIC was contributed to USALSC.
On September 30, 2017, USALSC entered into a coinsurance agreement with American Life and Security Corporation (“ALSC”) to assume 100% of a certain block of life insurance policies. USALSC is also the servicer of this block of policies. USALSC paid a ceding commission of $1,850,000 and received $7,153,663 from ALSC. The agreement will remain in effect until all liabilities associated with this block of policies have been satisfied.
On December 14, 2018, USALSC acquired Great Western Life Insurance Company (GWLIC) pursuant to Stock Purchase agreement entered into on October 11, 2018 with Great Western Insurance Company, a wholly-owned subsidiary of American Enterprise Group, Inc. USALSC paid $500,000 to acquire all outstanding shares of GWLIC. Subsequent to the acquisition, GWLIC was renamed US Alliance Life and Security Company - Montana.
USAC uses the actuarial firm of Miller & Newberg to provide valuation, pricing and illustration actuarial services for USALSC and DCLIC.
Investments - USAC and USAIC contracted in 2013 with New England Asset Management (NEAM), a Berkshire Hathaway subsidiary, to manage the investments of USALSC and a portion of the investments of USAC. USALSC, DCLIC and USALSC-Montana have investment management agreements with USAIC, who has a sub-advisory agreement with NEAM. DCLIC was added to this agreement on August 1, 2017 and USALSC-Montana was added to this agreement on December 14, 2018. The investment parameters are determined by Kansas law, the KID, the North Dakota Insurance Department, and the Montana Insurance Department, as well as the internal investment policies of USALSC, DCLIC, USALSC-Montana and USAC.
USAC internally manages a portfolio of equities within its investment policy guidelines (as modified from time to time, "Investment Policy"), which consider type of investments and investment instruments, and establishes diversification benchmarks to help manage investment risk. USAC's investment in its subsidiaries is managed outside of its Investment Policy.
The USAC Investment Policy may be modified by USAC's Board of Directors (the "Board" or "Board of Directors") in compliance with applicable law.
The following summarizes USAC’s Investment Policy, effective September 13, 2018 as amended:
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Approved Investment Instruments. We may invest in the following approved investment classes in accordance with the restrictions and subject to the benchmark ranges set forth in our Investment Policy and described below:
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United States Government Securities - bonds or other evidences of indebtedness that are fully guaranteed or insured by the U.S. Government or any agency or instrumentality thereof.
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Securities of the District of Columbia, State, Insular or Territorial Possession Government of the United States -bonds or other evidences of indebtedness, without limitation, of the District of Columbia, State, or any political subdivision of such, or Insular or Territorial Possession of the United States.
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Canadian Government, Provincial and Municipal Obligations -bonds or other evidences of indebtedness issued by the Dominion of Canada, or by any Province thereof, or by any municipality, agency or instrumentality thereof.
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Fixed Income Obligations - bonds or other evidence of indebtedness issued, assumed or guaranteed by a corporation.
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Equity Interests - preferred stocks, common stocks, mutual funds, exchange traded funds, master limited partnerships and other securities representing equity ownership interests in a corporation, provided that we may not own more than 2% of any corporation, mutual fund, exchange traded fund, master limited partnership or other equity security.
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Real Estate - real estate for use in the operations of the Company, which we refer to as "Home Office Real Estate," or for the production of income. We may also invest in shares of beneficial interest in or obligations issued by a Real Estate Investment Trust qualified under pertinent sections of the United States Internal Revenue Code.
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Mortgage Loans - first-lien mortgage loans on commercial or residential property with loan to value of no greater than 80% at the time of purchase.
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Mortgage - Backed Securities - mortgage-backed securities issued by the Federal Home Loan Mortgage Corporation (Freddie Mac), Federal National Mortgage Association (Fannie Mae), or a private entity. Any such securities must be rated investment grade by Moody's, S&P or Fitch.
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Asset-Backed Securities - asset-backed securities designated as investment grade by Moody's, S&P or Fitch or the equivalent rating by another nationally recognized statistical rating organization.
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Certificates of Deposit, Time Deposits, Overnight Bank Deposits, Banker's Acceptances and Repurchase Agreements - certificates of deposit, time deposits, overnight bank deposits, banker's acceptances issued by federally insured banks with maturities of 270 days or less from the date of acquisition, repurchase agreements with acceptable collateral and maturities of 270 days or less from date of acquisition.
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Commercial Paper - commercial paper of US corporations that are rated at least "A-2" by S&P or "P-2" by Moody's or the equivalent rating of another nationally recognized statistical rating organization if S&P or Moody's cease publishing ratings of these securities, and have maturities of 270 days or less from the date of acquisition.
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Money Market Accounts or Funds - money market accounts or funds that meet the following criteria:
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A substantial portion of the assets of the money market account or fund must be comprised of certain qualifying investments instruments;
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Issuers of the fund or account's investments must have a combined capital and surplus in excess of $500,000,000;
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Maturities of 270 days or less from the date of acquisition;
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Have net assets of not less than $500,000,000; and
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Have the highest rating available of S&P, Moody's, or Fitch, or carry an equivalent rating by a nationally recognized statistical rating organization if the named rating agencies cease publishing ratings of investments.
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Diversification. Our portfolio is constructed to diversify risk with respect to asset class, geographical location, quality, maturity, business sector and individual issuer and issue concentrations.
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Benchmarks. We benchmark the allocation of our investments based on the criteria set forth in the table below to help assure our investments are appropriately diversified. The benchmarks may change to respond to market conditions. Based on market conditions and other considerations, investments in the approved investment instruments described are maintained in the following ranges:
The Executive Committee of our Board of Directors may modify the above benchmark ranges at any time deemed appropriate based on current conditions. Any such modifications will be subject to approval by the full Board of Directors at its next regularly scheduled meeting. USALSC's, DCLIC’s, and USALSC-Montana’s investment policy, as a regulated insurance entity, contains additional investment limitations as required by law.
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Reporting. The President, CEO, or their respective designees shall provide monthly reports to the Board of Directors reflecting the securities purchased and sold during the quarter, securities held at the end of the quarter, current benchmarks and an overall evaluation of the portfolio's investment performance.
Marketing and Distribution - USALSC and DCLIC use independent consultants and referrals to market its products and build distribution channels among funeral homes, banks, accountants, independent insurance agencies, agents, insurance brokerage firms, business owners and other distribution channels as opportunities arise. USALSC and DCLIC works with other insurance companies who have captive or non-captive agents to broaden their product offerings.
Employees - As of December 31, 2019, USAC and its subsidiaries have thirteen full-time employees and one part-time employee.
Reports to Security Holders - We provide reports to our stockholders, along with our audited year-end financial statements. In addition, all periodic reports and other information we file with the U.S. Securities and Exchange Commission (the “SEC”) are available for inspection and copying at the public reference facilities of the Securities and Exchange Commission located at 100 F Street N E, Washington, D C 20549.
Copies of such material may be obtained by mail from the Public Reference Section of the Securities and Exchange Commission, 100 F Street, N E, Washington, D.C. 20549, at prescribed rates.
Information on the operation of the Public Reference Room may be obtained by calling the SEC at l-800-SEC-0330. In addition, the Commission maintains a World Wide Website on the Internet at: http://www.sec.gov that contains reports, proxy and information statements and other information regarding registrants, including USAC, that file electronically with the SEC. You may also find this information on our website (http://www.usalliancecorporation.com).
Implications of Emerging Growth Company Status - As a company with less than $1 billion in revenue in our last fiscal year, we are defined as an “emerging growth company” under the Jumpstart Our Business Startups (“JOBS”) Act. We will retain “emerging growth company” status until the earliest of:
• The last day of the fiscal year during which our annual revenues are equal to or exceed $1.07 billion;
• The last day of the fiscal year following the fifth anniversary of our first sale of common stock pursuant to a registration statement filed under the Securities Act of 1933, as amended (the “Securities Act”);
• The date on which we have issued more than $1 billion in nonconvertible debt in a previous three-year period; or
• The date on which we qualify as a large accelerated filer under Rule 12b-2 adopted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) (i.e., an issuer with a public float of $700 million that has been filing reports with the SEC under the Exchange Act for at least 12 months).
As an emerging growth company, we may take advantage of specified reduced disclosure and other requirements that are otherwise applicable generally to SEC reporting companies. For so long as we remain an emerging growth company we will not be required to:
• Comply with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements (i.e., an auditor discussion and analysis);
• Submit certain executive compensation matters to stockholder non-binding advisory votes;
• Submit for stockholder approval golden parachute payments not previously approved;
• Disclose certain executive compensation related items, as we will be subject to the scaled disclosure requirements of a smaller reporting company with respect to executive compensation disclosure.
Pursuant to Section 107(b) of the JOBS Act, we have elected to use the extended transition period for complying with new or revised accounting standards under Section 102(b)(2) of The JOBS Act. This election allows us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies. As a result, our financial statements may not be comparable to companies that comply with public company effective dates. Section 107 of the JOBS Act provides that our decision to opt into the extended transition period for complying with new or revised accounting standards is irrevocable.
Because the worldwide market value of our common stock held by non-affiliates, or public float, is below $75 million, we are also a “smaller reporting company” as defined under the Exchange Act. Some of the foregoing reduced disclosure and other requirements are also available to us because we are a smaller reporting company and may continue to be available to us even after we are no longer an emerging growth company under the JOBS Act but remain a smaller reporting company under the Exchange Act. As a smaller reporting company we are not required to:
• Have an auditor report on our internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act; and
• Present more than two years of audited financial statements in our registration statements and annual reports on Form 10-K and present any selected financial data in such registration statements and annual reports.
ITEM 1A.
ITEM 1A.
RISK FACTORS.
Risks Associated with an Investment in USAC Stock
We face many significant risks in the operating of our business and may face significant unforeseen risks as well. Our significant material risks are set forth below:
SHARE OWNERSHIP RISK - An investment in our voting common stock is speculative. Shares of our voting common stock constitute a high-risk investment in a developing business that has incurred losses to date and expects to continue to incur losses for several years. No assurance or guaranty can be given that any of the potential benefits envisioned by our business plan will prove to be available to our stockholders, nor can any assurance or guaranty be given as to the actual amount of financial return, if any, which may result from ownership of our voting Common Stock. The entire value of the shares of USAC Common Stock may be lost.
OPERATING RISK - We face all of the risks inherent in establishing a new business, including limited capital, challenging product markets, lack of significant revenues, as well as competition from better capitalized and more seasoned companies. We have no control over general economic conditions, competitors’ products or their pricing, customer demand and costs of marketing or advertising. There can be no assurance that our life insurance operations will be successful. The likelihood of any success must be considered in light of our limited history of operations and operating losses incurred to date. These risks make it difficult to accurately predict our future revenues or results of operations. As a result, our financial results may fluctuate. The Company evaluates the financial condition of its reinsurers to minimize its exposure to losses from reinsurer insolvencies. Management believes that any liabilities arising from this contingency would not be material to the Company’s financial position.
LIQUIDITY RISK - Although USAC is considered a public company by the SEC, there is no public market for USAC Common Stock, and there is no assurance that one will develop or be sustained, or that USAC Common Stock will become publicly traded. It may be difficult to sell shares your shares USAC Common Stock. Our securities are not listed for trading on any national securities exchange nor are bid or asked quotations reported in any over-the-counter quotation service and we do not intend to seek any such listing in the foreseeable future.
PROFITABILITY - As is common among young life insurance companies, we have incurred significant losses for a number of years. As of December 31, 2019 we had a consolidated accumulated deficit of $9.9 million. These losses were attributable primarily to costs of administration, the substantial nonrecurring costs of writing new life insurance (which are deferred and amortized in accordance with our deferred acquisition policy) and include first year commissions payable to insurance agents, medical and investigation expenses as well as other expenses incidental to the issuance of new policies as well as with the reserves required to be established for each policy. 2019 was the first profitable year in our Company history.
DIVIDENDS - We have not paid a cash dividend on USAC Common Stock and we do not anticipate paying a cash dividend in the foreseeable future. We intend to retain available funds to be used in the expansion of operations. The success of any investment in USAC Common Stock will depend upon any future appreciation in its value which depends upon the success of our life insurance subsidiaries. We cannot guarantee that our common stock will appreciate in value or achieve or maintain a value equal to the price at which shares were purchased. Further, a market may never develop to sell shares of USAC Common Stock.
CAPITAL RISK - We are required by law to have adequate capital and surplus calculated in accordance with statutory accounting principles prescribed by state insurance regulatory authorities to meet regulatory requirements in the states in which we operate. The amount of capital and surplus required is based on certain “risk-based capital” standards established by statute and regulation and administered by regulators. The “risk-based capital” system establishes a framework for evaluating the adequacy of the minimum amount of capital and surplus, calculated in accordance with statutory accounting principles, necessary for an insurance company to support its overall business operations. If we fail to maintain required capital levels, our ability to conduct business would be compromised absent an infusion of capital.
DILUTION RISK - We intend to conduct additional offerings of our securities to raise additional capital to fund our growth. In February, 2010, we filed a prospectus with the Kansas Securities Commission to register shares of USAC Common Stock and warrants to purchase USAC Common Stock. In February 2015, we filed a Prospectus with the Kansas Securities Commission to register the common stock to be issued upon the exercise of the warrants, and in January 2016, filed a Supplement to the Prospectus to register an additional 1,500,000 shares of USAC Common Stock. We also commenced a private placement of USAC Common Stock in North Dakota in 2017. Any additional offerings of USAC securities that we may conduct in the future will reduce the ownership interests and be accretive to existing stockholder book value.
KEY EXECUTIVE RISK - Our ability to operate is dependent primarily upon the efforts of our Chairman and Chief Executive Officer, Jack H. Brier, and Chief Operating Officer of USALSC, Jeff Brown. The loss of the services of these officers could have a material adverse effect on our ability to execute our business plan. We do not have an employment agreement with Mr. Brier. On June 4, 2018, the Company entered into an employment agreement with Mr. Brown retroactively effective as of February 1, 2018 for a term of three years. Annually, the agreement may be extended for an additional year if agreed upon by both parties.
SEC REGISTRATION - USAC is a public company. As a public company, we incur significant legal, accounting and other expenses under the Exchange Act and the Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC. These rules impose various requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls and appropriate corporate governance practices. Our management and other personnel are required to devote a substantial amount of time to these compliance requirements. Moreover, these rules and regulations increase our legal and financial compliance costs and are time-consuming and costly.
EMERGING GROWTH COMPANY - We are an “emerging growth company,” as defined in the JOBS Act. We will remain an “emerging growth company” for up to the last day of the fifth fiscal year following the effective date of our S-4 registration statement for the sale of our common stock. However, if our annual revenues exceed $1.07 billion, our non-convertible debt issued within a three-year period exceeds $1 billion, or the market value of our ordinary shares that are held by non-affiliates exceeds $700 million on the last day of the second fiscal quarter of any given fiscal year, we would cease to be an emerging growth company as of the following fiscal year. As an emerging growth company, we are not being required to comply with the auditor attestation requirements of section 404 of the Sarbanes-Oxley Act, we have reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and we are exempt from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved.
Further, Section 102(b)(1) of the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies (that is, those that have not had a Securities Act registration statement declared effective or do not have a class of securities registered under the Exchange Act) are required to comply with the new or revised financial accounting standards. The JOBS Act provides that a company can elect to opt out of the extended transition period and comply with the requirements that apply to non-emerging growth companies but any such an election to opt out is irrevocable. We have elected not to opt out of such extended transition period which means that when a standard is issued or revised and it has different application dates for public or private companies, we, as an emerging growth company, will not adopt the new or revised standard until the time private companies are required to adopt the new or revised standard. This may make comparison of our financial statements with another public company which is neither an emerging growth company nor an emerging growth company which has opted out of using the extended transition period difficult because of the potential differences in accounting standards used.
POTENTIAL ACQUISITION RISK - In addition to our organic growth plans, we plan to pursue strategic acquisitions of insurance related companies that meet our acquisition criteria. However, suitable acquisition candidates may not be available on terms and conditions that are economically beneficial to us. In pursuing acquisitions, we compete with other companies, who may have greater financial and other resources than us. Further, if we succeed in consummating acquisitions, our business, financial condition and results of operations may be negatively affected.
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An acquired business may not achieve anticipated revenues, earnings or cash flows;
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We may assume liabilities that were not disclosed or exceed estimates;
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We may be unable to integrate acquired businesses successfully and realize anticipated economic, operational and other benefits in a timely manner;
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Acquisitions could disrupt our on-going business, distract our management and divert our financial and human resources;
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We may experience difficulties operating in markets in which we have no or only limited direct experience; and
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There is the potential for loss of customers and key employees of any acquired company.
MARKETING STRATEGY RISK - We market our products through several different distribution channels which require licensed insurance agents. These distribution channels include funeral directors, bankers, brokerages, accountants, and independent agents. The premium written will depend primarily on our products, product pricing and ability to choose and timely and adequately train and motivate agents, producers and brokers to sell our products.
Independent agents are not required to sell the Company’s products and are free to sell products from other licensed companies. We are committed to working to educate and incentivize independent agents to sell our products.
THE COMPANY’S INVESTMENTS ARE SUBJECT TO MARKET AND CREDIT RISKS - Our invested assets, are subject to customary risks of credit defaults and changes in fair value. Factors that may affect the overall default rate on and fair value of the Company’s invested assets include interest rate levels and changes, availability and cost of liquidity, financial market performance, and general economic conditions.
RATINGS RISK - We do not anticipate that USALSC, DCLIC, or USALSC-Montana will be rated by rating agencies for several years. This may have a negative impact on its ability to complete with rated insurance companies.
Insurance ratings reflect the rating agencies’ opinion of an insurance company’s history, financial strength, operating performance and ability to meet its obligations to policyholders. There can be no assurance that USALSC, DCLIC, or USALSC-Montana will be rated by a rating agency or that any rating, if and when received, will be favorable.
Risks Associated with Companies in the Life Insurance Industry, including USAC and its subsidiaries
GENERAL REGULATORY RISK -All insurance operations are subject to government regulation in each of the states in which they conduct business. Such regulatory authority is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including premium rates, policy forms, and capital adequacy, and is concerned with the protection of policyholders rather than stockholders. Among other matters, the regulations require prior approval of acquisitions of insurance companies, solvency standards, licensing of insurers and their agents, investment restrictions, deposits of securities for the benefit of policyholders, approval of policy forms and premium rates, periodic examinations, and reserves for unearned premiums, losses and other matters.
Compliance with insurance regulation is costly and time consuming, requiring the filing of detailed annual reports, and the business and accounts are subject to examination by the applicable state insurance regulator.
Increased scrutiny has been placed upon the insurance regulatory framework during the past several years, and certain state legislatures have considered or enacted laws that alter, and in many cases increase, state authority to regulate insurance companies and insurance holding company systems. The National Association of Insurance Commissioners (“NAIC”) and state insurance regulators reexamine existing laws and regulations on an ongoing basis, and focus on insurance company investments and solvency issues, risk-based capital guidelines, interpretations of existing laws, the development of new laws, the implementation of non-statutory guidelines and the circumstances under which dividends may be paid. Future NAIC initiatives, and other regulatory changes, could have a material adverse impact on the insurance industry. There is no assurance the regulatory requirements of the departments of insurance of their respective state of domicile or a similar department in any other state in which they may wish to transact business can be satisfied.
Individual state guaranty associations assess insurance companies to pay benefits to policyholders of insolvent or failed insurance companies. The amount of any future assessments to be made from known insolvencies cannot be predicted.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Reform Act”) reshaped financial regulations in the United States by creating new regulators, regulating new markets and firms, and providing new enforcement powers to regulators. Virtually all major areas of the Reform Act continue to be subject to regulatory interpretation and implementation rules requiring rulemaking that may take several years to complete. The ultimate outcome of the regulatory rulemaking proceedings cannot be predicted. The regulations promulgated could have a material impact on consolidated financial results or financial condition.
COMPETITION RISK - The operating results of life insurance companies are subject to significant fluctuations due to competition, economic conditions, interest rates, investment performance, maintenance of insurance ratings from rating agencies, the ability to choose and timely and adequately train agents, and other factors. Each company encounters significant competition from other insurance companies, as well as competition from other available products and investment alternatives.
Large life insurance companies who have greater financial resources, longer business histories, and who may have more products present significant competition to smaller insurance companies. These larger companies also generally have large distribution opportunities.
The ability to compete is dependent upon, among other things, the ability to develop competitive and profitable products, market the insurance products, and achieve efficient costs of placing policies.
ASSUMPTION RISK - In the life insurance business, assumptions as to expected mortality, lapse rates and other factors in developing the pricing and other terms of life insurance products are made. These assumptions are based on industry experience and are reviewed and revised regularly by an outside actuary to reflect actual experience on a current basis. Variation of actual experience from that assumed in developing such terms may affect a product’s profitability or sales volume and in turn adversely impact revenues.
LIABILITY RISK - Underestimating future policy benefits results in incurring additional expenses at the time a company becomes aware of the inadequacy. As a result, the ability to achieve profits would suffer as a result of such underestimates.
INTEREST RATE RISK - Spread is the difference between the amounts that the insurance company is required to pay under the contracts and the amounts the insurance company is able to earn on its investments intended to support its obligations under the contracts. Interest rate fluctuations could impair an insurance company’s ability to pay policyholder benefits with operating and investment cash flows, cash on hand and other cash sources. Annuity products expose the risk that changes in interest rates will reduce any spread. Spread is a key component of revenues.
To the extent that interest rates credited are less than those generally available in the marketplace, policyholder lapses, policy loans and surrenders, and withdrawals of life insurance policies and annuity contracts may increase as contract holders seek to purchase products with higher returns. This process may result in cash outflows requiring that an insurance subsidiary sell investments as a time when the prices of those investments are adversely affected by the increase in market interest rates, which may result in realized investment losses.
Increases in market interest rates may negatively affect profitability in periods of increasing interest rates. The ability to replace invested assets with higher yielding assets needed to fund higher crediting rates that may be necessary to keep interest sensitive products competitive.
LAPSE AND WITHDRAWAL RISK - Policy lapses in excess of those actuarially anticipated would have a negative impact on financial performance. Profitability could be reduced if lapse and surrender rates exceed the assumptions upon which the insurance policies were priced. Policy sales costs are deferred and recognized over the life of a policy. Excess policy lapses, however, cause the immediate expensing or amortizing of deferred policy sales costs. In addition, some of our policies allow holders to withdraw all or some of the policy’s value, and withdrawals beyond those anticipated could impact our business.
OPERATIONAL RISK - In the insurance industry, successful incorporation and functionality of the internal audit function, the evolution of financial and administrative internal controls to safeguard human, facility and financial assets electronically including anti-fraud initiatives and compliance with anti-money laundering requirements as well as an effective disaster recovery program and effective business continuity programs are necessary.
TAX LAW RISK - Congress has considered legislation that would eliminate the deferral of taxation on the accretion of value within certain annuities and life insurance products. This and similar legislation, including a simplified “flat tax” income tax structure with an exemption from taxation for investment income, could adversely affect the sale of life insurance products compared with other financial products. There can be no assurance as to whether such legislation will be enacted or, if enacted, whether such legislation would contain provisions with possible adverse effects on any annuity and life insurance products that we and our operating subsidiaries develop.
Under the Internal Revenue Code, income taxes payable by policyholders on investment earnings is deferred during the accumulation period of certain life insurance and annuity products. This favorable tax treatment may give certain insurance products a competitive advantage over other non-insurance products. To the extent that the Internal Revenue Code may be revised to reduce the tax-deferred status of life insurance and annuity products, or to increase the tax-deferred status of competing products, insurance companies would be adversely affected with respect to their ability to sell products. Also, depending on grandfathering provisions, the surrenders of existing annuity contracts and life insurance policies might increase. In addition, life insurance products are often used to fund estate tax obligations. We cannot predict what future tax initiatives may be proposed with respect to the estate tax or other taxes which may adversely affect us.
REINSURANCE RISK -In order to manage the risk of financial exposure to adverse underwriting results, reinsurers accept a portion of the risk of other insurance companies. However, the direct insurer remains liable with respect to ceded insurance should any reinsurer fail to meet the obligations assumed by the reinsurer.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS.
Not applicable.
ITEM 2.
ITEM 2.
PROPERTIES.
USAC and its subsidiaries share offices located at 4123 SW Gage Center Drive, Suite 240, Topeka, Kansas 66604. Effective January 1, 2015, the lease amount was $2,250 per month for three years with a one-year option under the same rate, terms, and conditions. Effective January 1, 2019 the company extended its lease for up to three additional years at a lease amount of $3,152 per month. Total rent expense was $34,671 and $27,000 for the years ended December 31, 2019 and 2018, respectively.
DCLIC also maintains an office at 107 W. Main Avenue, Suite 325, Bismarck, North Dakota, 58501. The lease for the Bismarck office expired on September 30, 2018 and was renewed for an additional two year term. The lease rate for this location is $920 per month for the first year of the renewal. The Company paid $11,114 and $12,166 in rent for this location in 2019 and 2018, respectively.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
Neither the Company nor any of its principals are presently engaged in any material pending litigation which might have an adverse impact on its net assets.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
(a)
Market Information
There is no established trading market for our voting common stock. Our securities are not listed for trading or quoted on any national securities exchange nor are bid or asked quotations reported in any over-the-counter quotation system.
As of December 31, 2019, we had issued and outstanding 7,734,004 shares of our voting common stock. No other equity securities of the company have been issued.
(b)
Holders of Record
As of February 3, 2020 there are approximately 3,500 holders of record of our voting common stock.
(c)
Dividends
We have not paid dividends on USAC Common Stock and do not anticipate paying dividends in the foreseeable future. We intend to retain any future earnings for reinvestment into our business.
(d)
Securities Authorized for Issuance Under Equity Compensation Plans
We have not established any equity compensation plans or granted any equity awards under such plans. As a result, there are no securities authorized for issuance under such plans.
(e)
Recent Sales of Unregistered Securities
During the year ended December 31, 2019, the Company issued 23,025 shares of common stock, for aggregate consideration of $161,175, pursuant to an offering to residents of the state of Kansas that was registered with the Kansas Securities Commissioner.
The offering of shares in the above -described transaction was self-underwritten and sold through agents of the Company licensed to sell securities in Kansas. Proceeds from the sale of common stock were used to finance the growth of the Company’s life insurance subsidiary and to provide working capital for the Company. The offer and sale of common stock was exempt from registration under Section 3(a)11 of the Securities Act of 1933 for securities offered and sold on a wholly intrastate basis. The shares of common stock were sold only to bona fide residents of the state of Kansas.
During the year ended December 31, 2019, the Company issued 60,428 shares of common stock, for aggregate consideration of $422,996, pursuant to a private placement offering to accredited investor residents of the state of North Dakota (the “North Dakota Offering”). Proceeds from the sale of shares in the North Dakota were used to finance the growth of DCLIC and to provide working capital for the Company. The North Dakota Offering and sales of shares thereunder were not registered with the SEC in reliance on an exemption for registration under Rule 506(b) of Regulation D under this Securities Act of 1933 (“Reg D”). Shares were sold only to “accredited investors”, as that term is defined in Rule 501 of Reg D, and were not sold by any means of general advertisement or solicitation.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA.
As a “smaller reporting company”, the Company is not required to provide disclosure pursuant to this item.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion should be read in conjunction with our condensed consolidated financial statements and notes thereto included in this Form 10-K. In connection with, and because we desire to take advantage of, the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we caution readers regarding certain forward looking statements in the following discussion and elsewhere in this report and in any other statement made by, or on our behalf, whether or not in future filings with the Securities and Exchange Commission. Forward looking statements are statements not based on historical information and which relate to future operations, strategies, financial results or other developments. Forward looking statements are necessarily based upon estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and many of which, with respect to future business decisions, are subject to change. These uncertainties and contingencies can affect actual results and could cause actual results to differ materially from those expressed in any forward looking statements made by, or on our behalf. We disclaim any obligation to update forward looking statements.
Overview
USAC was formed as a Kansas corporation on April 24, 2009 for the purpose of raising capital to form a new Kansas-based life insurance company. We presently conduct our business through our five wholly-owned subsidiaries: USALSC, a life insurance corporation; DCLIC, a life insurance corporation; USALSC-Montana, a life insurance corporation; USAMC, an insurance marketing corporation; and USAIC, an investment management corporation.
On January 2, 2012, USALSC was issued a Certificate of Authority to conduct life insurance business in the State of Kansas. We began third party administrative services in 2015.
On August 1, 2017, the Company merged with Northern Plains Capital Corporation with the Company being the ultimate surviving entity. As a result of this merger, the Company acquired Dakota Capital Life Insurance Company which became a wholly owned subsidiary of USALSC.
On December 14, 2018, the Company acquired Great Western Life Insurance Company. Great Western Life Insurance Company was renamed US Alliance Life and Security Company - Montana and is a subsidiary of USALSC.
The Company assumes business under two reinsurance treaties. On January 1, 2013, the Company entered into an agreement to assume 20% of a certain block of health insurance policies from Unified Life Insurance Company. On September 30, 2018, the Company entered into a coinsurance agreement to assume 100% of a certain block of life insurance policies from American Life and Security Company.
Critical Accounting Policies and Estimates
Our accounting and reporting policies are in accordance with GAAP. Preparation of the consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The following is an explanation of our accounting policies and the estimates considered most significant by management. These accounting policies inherently require significant judgment and assumptions and actual operating results could differ significantly from management’s estimates determined using these policies. We believe the following accounting policies, judgments and estimates are the most critical to the understanding of our results of operations and financial position. A detailed discussion of significant accounting policies is provided in this report in the Notes to Consolidated Financial Statements included with this annual report.
Valuation of Investments
The Company's principal investments are in fixed maturity and equity securities. Fixed maturity and equity securities, classified as available for sale, are carried at their fair value in the consolidated balance sheets, with unrealized gains or losses recorded in comprehensive income (loss). Our fixed income investment manager utilizes external independent third-party pricing services to determine the fair values of investment securities available for sale.
We have a policy and process in place to identify securities that could potentially have an impairment that is other-than-temporary. The assessment of whether impairments have occurred is based on a case-by-case evaluation of underlying reasons for the decline in fair value. We consider severity of impairment, duration of impairment, forecasted recovery period, industry outlook, financial condition of the issuer, issuer credit ratings and whether we intend to sell a security, or it is more likely than not that we would be required to sell a security, prior to the recovery of the amortized cost. New England Asset Management, our investment manager, provides support to the Company in making these determinations.
The recognition of other-than-temporary impairment losses on debt securities is dependent on the facts and circumstances related to the specific security. If we intend to sell a security or it is more likely than not that we would be required to sell a security prior to recovery of the amortized cost, the difference between amortized cost and fair value is recognized in the income statement as an other-than-temporary impairment. Our membership in the Federal Home Loan Bank provides additional liquidity which further reduces the likelihood that we would be required to sell a security prior to recovery. As it relates to debt securities, if we do not expect to recover the amortized basis, do not plan to sell the security and if it is not more likely than not that we would be required to sell a security before the recovery of its amortized cost, the other-than-temporary impairment would be recognized. We would recognize the credit loss portion through earnings in the income statement and the noncredit loss portion in accumulated other comprehensive loss.
Deferred Acquisition Costs
Incremental direct costs, net of amounts ceded to reinsurers, that result directly from and are essential to a product sale and would not have been incurred by us had the sale not occurred, are capitalized, to the extent recoverable, and amortized over the life of the premiums produced. Recoverability of deferred acquisition costs is evaluated periodically by comparing the current estimate of the present value of expected pretax future profits to the unamortized asset balance. If this current estimate is less than the existing balance, the difference is charged to expense.
Value of Business Acquired
Value of business acquired (VOBA) represents the estimated value assigned to purchased companies or insurance in- force of the assumed policy obligations at the date of acquisition of a block of policies. At least annually, a review is performed of the models and the assumptions used to develop expected future profits, based upon management’s current view of future events. VOBA is reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts. Management’s view primarily reflects our experience but can also reflect emerging trends within the industry. Short-term deviations in experience affect the amortization of VOBA in the period, but do not necessarily indicate that a change to the long-term assumptions of future experience is warranted. If it is determined that it is appropriate to change the assumptions related to future experience, then an unlocking adjustment is recognized for the block of business being evaluated. Certain assumptions, such as interest spreads and surrender rates, may be interrelated. As such, unlocking adjustments often reflect revisions to multiple assumptions. The VOBA balance is immediately impacted by any assumption changes, with the change reflected through the statements of comprehensive income as an unlocking adjustment in the amount of VOBA amortized. These adjustments can be positive or negative with adjustments reducing amortization limited to amounts previously deferred plus interest accrued through the date of the adjustment.
In addition, we may consider refinements in estimates due to improved capabilities resulting from administrative or actuarial system upgrades. We consider such enhancements to determine whether and to what extent they are associated with prior periods or simply improvements in the projection of future expected gross profits due to improved functionality. To the extent they represent such improvements, these items are applied to the appropriate financial statement line items in a manner similar to unlocking adjustments.
VOBA is also reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts. If it is determined from emerging experience that the premium margins or gross profits are less than the unamortized value of business acquired, then the asset will be adjusted downward with the adjustment recorded as an expense in the current period.
Goodwill
Goodwill represents the excess of the amounts paid to acquire subsidiaries and other businesses over the fair value of their net assets at the date of acquisition. Goodwill is tested for impairment at least annually in the fourth quarter or more frequently if events or circumstances change that would indicate that a triggering event has occurred.
We assess the recoverability of indefinite-lived intangible assets at least annually or whenever events or circumstances suggest that the carrying value of an identifiable indefinite-lived intangible asset may exceed the sum of the future discounted cash flows expected to result from its use and eventual disposition. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset.
Reinsurance
In the normal course of business, we seek to limit aggregate and single exposure to losses on risk by purchasing reinsurance. The amounts reported in the consolidated balance sheets as reinsurance recoverable include amounts billed to reinsurers on losses paid as well as estimates of amounts expected to be recovered from reinsurers on insurance liabilities that have not yet been paid. Reinsurance recoverable on unpaid losses are estimated based upon assumptions consistent with those used in establishing the liabilities related to the underlying reinsured contracts. Insurance liabilities are reported gross of reinsurance recoverable. Management believes the recoverables are appropriately established. We diversify our credit risks related to reinsurance ceded. Reinsurance premiums are generally reflected in income in a manner consistent with the recognition of premiums on the reinsured contracts. Reinsurance does not extinguish our primary liability under the policies written. We regularly evaluate the financial condition of our reinsurers including their activities with respect to claim settlement practices and commutations, and establish allowances for uncollectible reinsurance recoverable as appropriate.
Future Policy Benefits
We establish liabilities for amounts payable under insurance policies, including traditional life insurance and annuities. Generally, amounts are payable over an extended period of time. Liabilities for future policy benefits of traditional life insurance have been computed by using a net level premium method based upon estimates at the time of issue for investment yields, mortality and withdrawals. These estimates include provisions for experience less favorable than initially expected. Mortality assumptions are based on industry experience expressed as a percentage of standard mortality tables. Such liabilities are reviewed quarterly by an independent consulting actuary.
Income Taxes
Deferred tax assets are recorded based on the differences between the financial statement and tax basis of assets and liabilities at the enacted tax rates. The principal assets and liabilities giving rise to such differences are investments, insurance reserves, and deferred acquisition costs. A deferred tax asset valuation allowance is established when there is uncertainty that such assets would be realized. We have no uncertain tax positions we believe are more-likely-than-not that the benefit will not to be realized.
Recognition of Revenues
Revenues on traditional life insurance products consist of direct and assumed premiums reported as earned when due.
Amounts received as payment for annuities are recognized as deposits to policyholder account balances and included in future insurance policy benefits. Revenues from these contracts are comprised of investment earnings of the deposits, which are recognized over the period of the contracts, and included in revenue. Deposits are shown as a financing activity in the Consolidated Statements of Cash Flows.
Mergers and Acquisitions
On May 23, 2017 the Company entered into a definitive merger agreement with Northern Plains Capital Corporation. The merger transaction closed on July 31, 2017. NPCC shareholders received .5841 shares of US Alliance Corporation stock for each share of NPCC stock owned. USAC issued 1,644,458 shares of common stock to holders of NPCC shares.
On October 11, 2018 the Company entered into a stock purchase agreement with Great Western Insurance Company to acquire Great Western Life Insurance Company. The transaction closed on December 14, 2018. USALSC paid $500,000 to acquire all of the outstanding shares of GWLIC.
New Accounting Standards
A detailed discussion of new accounting standards is provided in the Notes to Consolidated Financial Statements beginning on p. of this annual report.
Discussion of Consolidated Results of Operations
Revenues. Insurance revenues are primarily generated from premium revenues and investment income. Insurance revenues for the years ended December 31, 2019 and 2018 are summarized in the table below.
Our 2019 revenues grew to $11,966,286, an increase of $506,999 from 2018 revenues of $11,459,287. The Company was required to implement a new accounting standard in 2019 which results in unrealized gains and losses on equity securities being included in total income.
The following graph summarizes our five-year trend of GAAP revenues:
*2017 revenue includes one-time revenue of $3.9 million from the ALSC reinsurance transaction.
Premium revenue: Premium revenue for the year ended December 31, 2019 was $9,076,205 compared to $8,807,779 in 2018, an increase of $268,426. The increase is a result of growth of our direct recurring premiums.
Direct, assumed and ceded premiums for the years ended December 31, 2019 and 2018 are summarized in the following table.
The Company continues to search for new product and distribution opportunities to increase premium production on both a direct and assumed basis.
Investment income, net of expenses: The components of net investment income for the years ended December 31, 2019 and 2018 are as follows:
Net investment income for the years ended December 31, 2019 was $1,790,601, compared to $1,477,403 in 2018, an increase of $313,198 or 21%. This increase in investment income is primarily a result of increased invested assets as a result of our premium income and an improvement in our book yield.
Net investment gains (losses): Net investment gains for the year ended December 31, 2019 were $1,042,334, compared to losses of $4,499 in 2018, an increase of $1,046,833. The increase in net investment gains is attributable to unrealized gains in our equity portfolio. Net investments gains for 2019 were comprised of $1,256,769 of unrealized gains in our equity portfolio and realized losses of $214,435. Realized gains and losses related to the sale of securities for the years ended December 31, 2019 and 2018 are summarized as follows:
Gain on bargain purchase: The Company acquired USALSC-Montana (Formerly Great Western Life Insurance Company) on December 14, 2018. The total identifiable net assets of the purchase were $1,640,996 and the Company paid $500,000 for the acquisition. This resulted in a gain on bargain purchase of $1,140,996 in 2018.
Other income: Other income for the year ended December 31, 2019 was $57,146 compared to $37,608 in 2018, an increase of $19,538. The increase is driven by an increase in commission income.
Expenses. Expenses for the year ended December 31, 2019 and 2018 are summarized in the table below.
The following chart and graph summarizes our five-year expense trend:
Increases in policyholder reserves represents funds that we maintain and invest for the future benefit of our policyholders. Other policy-related expenses represent the other expenses associated with fulfilling our obligations to our policyholders and producers. Operating expenses represent the costs to operate the company. It is important to note that our 2017 operating expense ratio is impacted by the one-time reserve increase which resulted from our transaction with ALSC. Absent this transaction, our 2017 ratio would have been 25%.
Death claims: Death benefits were $1,287,893 in the year ended December 31, 2019 compared to $959,005 in 2018, an increase of $328,888. This increase is attributable to the growth of our in-force block of life insurance policies. The majority of death claims paid from inception have been on pre-need policies. We expect these claims to grow as we continue to increase the size of our in-force pre-need business.
Policyholder benefits: Policyholder benefits were $4,212,534 in the year ended December 31, 2019 compared to $3,957,090 in 2018, an increase of $255,444. The primary driver of this increase is the growth of our assumed policyholder benefits.
Increase in policyholder reserves: Policyholder reserves increased $2,599,575 in the year ended December 31, 2019, compared to $2,766,169 in 2018, a decrease of $165,594. The decrease is driven reserves released in support of claim payments.
Commissions, net of deferrals: The Company pays commissions to the ceding company on a block of assumed policies as well as commissions to agents on directly written business. Commissions, net of deferrals, were $783,724 in the year ended December 31, 2019, compared to $637,425 in 2018, an increase of $146,299. This increase is due to an increase and changing mix of premiums.
Amortization of deferred acquisition costs: The amortization of deferred acquisition costs was $433,218 in the year ended December 31, 2019, compared to $454,906 in 2018, a decrease of $21,688. The amortization decrease is attributable to the reduction of our deferred acquisition cost asset related to our reinsurance transaction with ALSC.
Salaries and benefits: Salaries and benefits were $1,081,955 for the year ended December 31, 2019, compared to $1,152,728 in 2018, a decrease of $70,773. Staffing costs decreased due to reduced staffing and bonus payments.
Other expenses: Other operating expenses were $1,379,034 in the year ended December 31, 2019, compared to $1,967,796 in 2018, a decrease of $588,762. Operating costs were driven lower due to decreased information technology costs and decreased selling and marketing expenses. Additionally, updated interpretations of accounting guidance on leased software resulted in the full amortization of our software fixed assets in 2018 and there was not a similar expense in 2019.
Federal income tax benefit: In the year ended December 31, 2019, the Company recognized a deferred income tax benefit of $431,158. The benefit is the result in a reduction in the deferred tax asset valuation allowance. There was no such benefit in the year ended December 31, 2018.
Net Income: Our net income was $599,208 in the year ended December 31, 2019 compared to net loss of $456,136 in the same period of 2018, an increase of $1,055,344. Our net income per share increased to $0.08 from a net loss per share of $0.06 in 2018, basic and diluted. This increase is primarily attributable to income from unrealized gains on our equity securities and the recognition of a deferred tax asset.
The following graph illustrates our five-year trend of net income per share:
Discussion of Consolidated Balance Sheet
Assets. Assets have increased to $54,939,249 as of December 31, 2019, an increase of $10,410,260 or 23% from December 31, 2018 assets of $44,528,989. This is primarily the result of the growth of our business and by an increase in the market value of our fixed maturity and equity investments.
Available for sale fixed maturity securities: As of December 31, 2019, we had available for sale fixed maturity assets of $33,152,892, an increase of $6,169,088 from the December 31, 2018 balance of $26,983,804. The increase is driven by the purchase of additional assets and by an increase in the market value of these securities. If we hold our fixed maturity securities to maturity, as we intend to do, any changes in market value is temporary.
Available for sale equity securities: As of December 31, 2019, we had available for sale equity assets of $10,141,503, a decrease of $744,471 from the December 31, 2018 balance of $10,885,974. This reduction is driven by a transition from exchanged traded funds to individual managed redeemable preferred stocks.
Cash and cash equivalents: As of December 31, 2019, we had cash and cash equivalent assets of $6,678,805, an increase of $4,601,159 from the December 31, 2018 balance of $2,077,646. This increase was strategic as beneficial long-term investment opportunities were limited in the last half of 2019.
Investment income due and accrued: As of December 31, 2019, our investment income due and accrued was $321,362 compared to $286,980 as of December 31, 2018, an increase of $34,382. This increase is attributable to the growth of our invested assets.
Policy loans: As of December 31, 2019, our policy loans were $118,930, an increase of $62,391 from the December 31, 2018 balance of $56,539. The increase is a result of normal policy loan activity.
Reinsurance related assets: As of December 31, 2019, our reinsurance related assets were $188,382 compared to $161,846 as of December 31, 2018, an increase of $26,536. This increase is the result of an increase in amounts due from reinsurers.
Deferred acquisition costs, net: As of December 31, 2019, our deferred acquisition costs were $2,652,674 compared to $2,757,404 as of December 31, 2018, a reduction of $104,730. The reduction is the result of amortization of the cost of reinsurance deferred on our coinsurance agreement with ALSC.
Value of business acquired, net: As of December 31, 2019 our value of business acquired asset was $559,994, compared to $580,297 as of December 31, 2018. This asset was established in the third quarter of 2017 as a result of our acquisition of DCLIC and is amortized on a straight-line basis.
Property, equipment and software, net: As of December 31, 2019 our property, equipment and software assets were $43,841, a decrease of $10,237 from the December 31, 2018 balance of $54,078. This decrease is the result of normal amortization of these assets.
Goodwill: As of December 31, 2019 and 2018, our goodwill was $277,542. Goodwill was established as a result of our merger with Northern Plains and we had no previous goodwill balances. We have determined that there has been no impairment to our goodwill balance.
Deferred tax asset, net of valuation allowance: The Company had a net deferred tax asset of $431,158 as of December 31, 2019 which was the result of a reduction in the deferred tax asset valuation allowance. The Company did not have a net deferred tax asset as of December 31, 2018 due to a 100% valuation allowance.
Other assets: As of December 31, 2019, our other assets were $372,166, a decrease of $34,803 from the December 31, 2018 balance of $406,969. This decrease was driven by a reduction in our pre-paid assets.
Liabilities. Our total liabilities were $38,063,052 as of December 31, 2019, an increase of $6,166,729 or 19% from our December 31, 2018 liabilities of $31,896,323.
Policy liabilities: Our total policy liabilities as of December 31, 2019 were $36,924,885 compared to $31,556,529 as of December 31, 2018, an increase of $5,368,356 or 17%. This increase is the result new policy sales and the growth of our in-force policies.
Accounts payable and accrued expenses: As of December 31, 2019, our accounts payable and accrued expenses were $122,981 compared to $311,082 as of December 31, 2018, a decrease of $188,101. The decrease is driven by the release of expenses accrued as a result of our acquisition of USALSC-Montana.
Federal Home Loan Bank advance: In October of 2019, the Company took an advance of $1,000,000 from the Federal Home Loan Bank of Topeka (“FHLB”) which was outstanding as of December 31, 2019. The Company did not have any FHLB advances in 2018.
Shareholders’ Equity. Our shareholders’ equity was $16,876,197 as of December 31, 2019, an increase of $4,243,531 from our December 31, 2018 shareholders’ equity of $12,632,666. The growth in shareholders’ equity was driven by an increase of $4,513,924 in other comprehensive income, from a loss of $2,184,429 as of December 31,2018 to a gain of $2,329,495 as of December 31, 2019. Other comprehensive income consists of the unrealized gains and losses on our fixed maturity portfolio. The increase in other comprehensive income is the result of lower interest rates which increases the market value of our fixed maturity securities.
Investments
Our overall investment philosophy is reflected in the allocation of our investments. We emphasize investment grade debt securities with smaller holdings in equity securities and other investments. The following table shows the carrying value of our investments by investment category and cash and cash equivalents, and the percentage of each to total invested assets as of December 31, 2019 and December 31, 2018.
The total value of our investments and cash and cash equivalents increased to $49,973,200 as of December 31, 2019 from $39,947,424 at December 31, 2018, an increase of $10,025,776. Increases in investments are primarily attributable to premiums and annuity deposits received by USALSC and DCLIC.
The following table shows the distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value as of December 31, 2019 and 2018.
Reflecting the high quality of securities maintained by us, 94.6% of all fixed maturity securities were investment grade as of December 31, 2019. As of December 31, 2018, 97.7% of all fixed maturity securities were investment grade.
The amortized cost and fair value of debt securities as of December 31, 2019 and 2018, by contractual maturity, are shown below. Equity securities do not have stated maturity dates and therefore are not included in the following maturity summary. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Market Risk of Financial Instruments
We hold a diversified portfolio of investments that primarily includes cash, bonds and equity securities. Each of these investments is subject to market risks that can affect their return and their fair value. A majority of the investments are fixed maturity securities including debt issues of corporations, US Treasury securities, or securities issued by government agencies. The primary market risks affecting the investment portfolio are interest rate risk, credit risk, and equity risk.
Interest Rate Risk
Interest rate risk arises from the price sensitivity of investments to changes in interest rates. Interest represents the greatest portion of an investment's return for most fixed maturity securities in stable interest rate environments. The changes in the fair value of such investments are inversely related to changes in market interest rates. As interest rates fall, the interest and dividend streams of existing fixed-rate investments become more valuable and fair values rise. As interest rates rise, the opposite effect occurs.
We attempt to mitigate our exposure to adverse interest rate movements through laddering the maturities of the fixed maturity investments and through maintaining cash and other short term investments to assure sufficient liquidity to meet our obligations and to address reinvestment risk considerations. Due to the composition of our book of insurance business, management believes it is unlikely that we would encounter large surrender activity due to an interest rate increase that would force the disposal of fixed maturities at a loss.
Credit Risk
We are exposed to credit risk through counterparties and within the investment portfolio. Credit risk relates to the uncertainty associated with an obligor's ability to make timely payments of principal and interest in accordance with the contractual terms of an instrument or contract. We manage our credit risk through established investment policies and guidelines which address the quality of creditors and counterparties, concentration limits, diversification practices and acceptable risk levels. These policies and guidelines are regularly reviewed and approved by senior management and USAC's Board of Directors.
Liquidity and Capital Resources
Our operations have generated operating losses since we were incorporated in 2009. In 2019, USAC has been profitable.
Premium income, deposits to policyholder account balances, investment income, and capital raising are the primary sources of funds while withdrawals of policyholder account balances, investment purchases, policy benefits in the form of claims, and operating expenses are the primary uses of funds. To ensure we will be able to pay future commitments, the funds received as premium payments and deposits are invested in primarily fixed income securities. Funds are invested with the intent that the income from investments, plus proceeds from maturities, will in the future meet our ongoing cash flow needs. The approach of matching asset and liability durations and yields requires an appropriate mix of investments. Our investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs. Cash flow projections and cash flow tests under various market interest scenarios are also performed annually to assist in evaluating liquidity needs and adequacy. As a member of the Federal Home Loan Bank, USALSC has immediate access to additional cash liquidity.
Net cash provided by operating activities was $2,270,041 for the year ended December 31, 2019. The primary sources of cash from operating activities were premiums and deposits received from policyholders. The primary uses of cash for operating activities were for payments of commissions to agents and settlement of policy liabilities. Net cash used in investing activities was $1,074,643. The primary source of cash was from sales of available for sale securities and our FHLB advance. Offsetting this source of cash was our purchases of investments in available-for-sale securities. Cash provided by financing activities was $3,405,761. The primary sources of cash were receipts on deposit-type contracts and issuance of USAC Common Stock.
The following chart and graph illustrate our five-year trend of cash flow from insurance activities:
Cash flow from insurance activities combines cash flow from operations with the net cash received from deposit type contracts to show the impact of our insurance operations on our cash flows. Cash flow from deposit type contracts is primarily made up of funds received into our annuity products.
At December 31, 2019, we had cash and cash equivalents totaling $6,678,805. We believe that our existing cash and cash equivalents will be sufficient to fund the anticipated operating expenses and capital expenditures for the foreseeable future. We have based this estimate upon assumptions that may prove to be wrong and we could use our capital resources sooner than we currently expect. The growth of USALSC and DCLIC, our insurance subsidiaries, is uncertain and will require additional capital if they continue to grow.
Impact of Inflation
Insurance premiums are established before the amount of losses, or the extent to which inflation may affect such losses and expenses, are known. We attempt, in establishing premiums, to anticipate the potential impact of inflation. If, for competitive reasons, premiums cannot be increased to anticipate inflation, this cost would be absorbed by us. Inflation also affects the rate of investment return on the investment portfolio with a corresponding effect on investment income.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a “smaller reporting company”, the Company is not required to provide disclosure pursuant to this item.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements are included as part of this reporting beginning on page.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There are not and have not been any disagreements between USAC and its auditor, Kerber, Eck and Braeckel LLP on any matter of accounting principles, practices or financial statement disclosure.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
We have established disclosure controls and procedures to ensure, among other things, material information relating to our Company, including our consolidated subsidiaries, is made known to our officers who certify our financial reports and to the other members of our senior management and the Board of Directors.
As required by Exchange Act Rule 13a-15(b), management of the Company, including the Chief Executive Officer and the Vice President and Principal Financial Officer conducted an evaluation as of the end of the period covered by this report, of the effectiveness of the Company’s disclosure controls and procedures as defined in Exchange Act Rules 13a-15(e). Based upon an evaluation at the end of the period, the Chief Executive Officer and the Vice President concluded that the disclosure controls and procedures are effective in timely alerting them to material information relating to us and our consolidated subsidiaries required to be disclosed in our periodic reports under the exchange act.
There were no changes to the Company’s internal control over financial reporting as defined in Exchange Act Rule 13a-15(f) during the year ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item is set forth under the captions “Proposal One-Election of Directors,” “Corporate Governance,” “Executive Officers” and “Beneficial Ownership Reporting Compliance” in our definitive proxy statement to be filed in connection with our 2020 annual stockholders’ meeting (“2020 Proxy Statement”) and is incorporated herein by reference.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information required by this item is set forth under the captions “Director and Management Compensation” in our 2020 Proxy Statement and is incorporated herein by reference.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is set forth under the captions “Security Ownership” in our 2020 Proxy Statement and is incorporated herein by reference.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by this item is set forth under the captions “Certain Relationships and Related Parties” in our 2020 Proxy Statement and is incorporated herein by reference.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is set forth under the caption “Principal Accountant Fees and Services” in our 2020 Proxy Statement and is incorporated herein by reference
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(1)
Consolidated financial statements:
The list of financial statements filed with this Annual Report on Form 10-K is provided on page.
Financial Statement Schedules
We have omitted schedules required by applicable SEC accounting regulations because they are either not required under the related instructions, are inapplicable, or we present the required information in the financial statements or notes thereto.
Exhibit Index
* Filed herewith.
† XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
US ALLIANCE CORPORATION
(Registrant)
Date:
By:
/s/ Jack H. Brier
Jack H. Brier
President and Chairman
(principal executive officer)
POWER OF ATTORNEY
Know all people by these presents, that each person whose signature appears below constitutes and appoints Jack H. Brier his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any amendments to this annual report on Form 10-K, and to file the same, with all exhibits thereto, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully and to all intents and purposes as he or she might or could do in person, hereby confirming all that said attorneys-in-fact and agents or either of them, or his or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities indicated on January 29, 2016.
US Alliance Corporation
Consolidated Financial Statements
December 31, 2019 and 2018
(With Independent Auditor’s Report Thereon)
Contents
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements
Consolidated Balance Sheets
Consolidated Statements of Comprehensive Income (Loss)
Consolidated Statements of Changes in Shareholders’ Equity
Consolidated Statements of Cash Flows
Supplemental Cash Flow Information
Notes to Consolidated Financial Statements
-
Report of Independent Registered Public Accounting Firm
To the Board of Directors and
Shareholders of US Alliance Corporation
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of US Alliance Corporation and Subsidiaries (the Company) as of December 31, 2019 and 2018, and the related consolidated statements of comprehensive income (loss), changes in shareholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2019, and the related notes (collectively referred to as the financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Kerber, Eck & Braeckel, LLP
We have served as the US Alliance Corporation’s auditor since 2016.
Springfield, Illinois
February 20, 2020
US Alliance Corporation
Consolidated Balance Sheets
See Notes to Consolidated Financial Statements.
US Alliance Corporation
Consolidated Statements of Comprehensive Income (Loss)
See Notes to Consolidated Financial Statements.
See Notes to Consolidated Financial Statements.
US Alliance Corporation
Consolidated Statements of Cash Flows
See Notes to Consolidated Financial Statements.
US Alliance Corporation
Supplemental Cash Flow Information
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 1. Description of Business and Significant Accounting Policies
Description of business: US Alliance Corporation ("USAC") was formed as a Kansas corporation on April 24, 2009 to raise capital to form a new Kansas-based life insurance company. The Company's offices are located at 4123 SW Gage Center Drive, Suite 240, Topeka, Kansas 66604. The Company's telephone number is 785-228-0200 and website address is www.usalliancecorporation.com.
USAC has five wholly-owned operating subsidiaries. US Alliance Life and Security Company ("USALSC") was formed June 9, 2011, to serve as the Company's life insurance company. US Alliance Marketing Corporation ("USAMC") was formed April 23, 2012, to serve as a marketing resource. US Alliance Investment Corporation ("USAIC") was formed April 23, 2012 to serve as investment manager for USAC. Dakota Capital Life Insurance Company (“DCLIC”), was acquired on August 1, 2017 when USAC merged with Northern Plains Capital Corporation (“NPCC”). US Alliance Life and Security Company - Montana (USALSC-Montana), was acquired December 14, 2018. Both DCLIC and USALSC-Montana are wholly-owned subsidiaries of USALSC.
The Company terminated its initial public offering on February 24, 2013. During the balance of 2013, the Company achieved approval of an array of life insurance and annuity products, began development of various distribution channels and commenced insurance operations and product sales. The Company sold its first insurance product on May 1, 2013. The Company continued to expand its product offerings and distribution channels throughout 2014 and 2015. On February 24, 2015, the Company commenced a warrant exercise offering set to expire on February 24, 2016. On February 24, 2016, the Company extended the offering until February 24, 2017 and made additional shares available for purchase. All outstanding warrants expired on April 1, 2016. The Company further extended this offering to February 24, 2020. During the 4th quarter of 2017, the Company began a private placement offering to accredited investors in the state of North Dakota.
USALSC received a Certificate of Authority from the Kansas Insurance Department ("KID") effective January 2, 2012, and sold its first insurance product on May 1, 2013. DCLIC received a Certificate of Authority from the North Dakota Insurance Department ("NDID") effective January 24, 2012.
The Company's single pay life products (which include our Juvenile and Pre-Need products) accounted for 56% of 2019 direct premium revenue. The Company's individual life and Critical Illness products (which include Term Life and Whole Life products) accounted for 25% of 2019 direct premium revenue. The Company's group products accounted for 19% of 2019 direct written premiums.
USALSC and DCLIC seek opportunities to develop and market additional products.
The Company's business model also anticipates the acquisition by USAC and/or USALSC of other insurance and insurance related companies, including third-party administrators, marketing organizations, and rights to other blocks of insurance business through reinsurance or other transactions.
Basis of presentation: The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted (“GAAP”) in the United States of America.
Principles of consolidation: The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated from the consolidated financial statements.
Area of Operation: US Alliance Life and Security Company is authorized to operate in the states of Kansas, North Dakota, Missouri, Nebraska and Oklahoma. DCLIC is authorized to operate in the states of North Dakota and South Dakota. USALSC-Montana is authorized to operate in the state of Montana.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 1. Description of Business and Significant Accounting Policies (Continued)
Cash and cash equivalents: For purposes of the statement of cash flows, the Company considers demand deposits and highly liquid investments with original maturities of three months or less when purchased to be cash and cash equivalents. The Company maintains its operating cash balances in one financial institution located in Topeka, Kansas. The FDIC insures aggregate balances, including interest-bearing and noninterest-bearing accounts, of $250,000 per depositor per insured institution. The Company’s financial institution is a member of a network that participates in the Insured Cash Sweep (ICS) program. By participating in ICS, the Company’s deposits in excess of the insured limit are apportioned and placed in demand deposit accounts at other financial institutions in amounts under the insured limit. As a result, the Company can access insurance coverage from multiple financial institutions while working directly with one. The Company had no amounts uninsured as of December 31, 2019. The Company also has funds deposited in an overnight deposit account at the Federal Home Loan Bank of Topeka which are included as part of its cash and cash equivalents. 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.
Property, equipment and software: Property, equipment and software are stated at cost less accumulated depreciation. Expenditures for additions and improvements that significantly add to the productive capacity or extend the useful life of an asset are capitalized. Expenditures for maintenance and repairs are charged to income currently. Upon disposition, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in income.
Depreciation is computed by the straight-line method over the estimated useful lives of the assets. Computer equipment is depreciated over no longer than a 5-year period. Furniture and equipment are depreciated over no longer than a 10-year period. Major categories of depreciable assets and the respective book values as of December 31, 2019 and 2018 are represented below.
Pre-paid expenses: The Company recognizes pre-paid expenses (reported in other assets) as the expenses are incurred. Pre-paid expenses consist of systems consulting hours and insurance. Systems consulting hours are charged as they are incurred on projects. Insurance expenses are charged straight line over the life of the contract.
Investments: Investments in available-for-sale securities are carried in the consolidated financial statements at fair value. Net unrealized holding gains (losses) on fixed maturity securities are included in accumulated other comprehensive income. Bond premiums and discounts are amortized using the scientific-yield method over the term of the bonds. Net unrealized holding gains (losses) on equity securities are included as a component of net investment gains (losses).
Realized gains and losses on securities sold during the year are determined using the specific identification method and included in investment income as a component of net investment gains (losses). Investment income is recognized as earned.
Management has a policy and process in place to identify securities that could potentially have an impairment that is other-than-temporary. The assessment of whether impairments have occurred is based on a case-by-case evaluation of underlying reasons for the decline in fair value. Management considers severity of impairment, duration of impairment, forecasted recovery period, industry outlook, financial condition of the issuer, issuer credit ratings and whether the Company intends to sell a security or it is more likely than not that the Company would be required to sell a security prior to the recovery of the amortized cost.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 1. Description of Business and Significant Accounting Policies (Continued)
The recognition of other-than-temporary impairment losses on debt securities is dependent on the facts and circumstances related to the specific security. If the Company intends to sell a security or it is more likely than not that the Company would be required to sell a security prior to recovery of the amortized cost, the difference between amortized cost and fair value is recognized in the income statement as an other-than-temporary impairment. As it relates to debt securities, if the Company does not expect to recover the amortized basis, do not plan to sell the security and if it is not more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, the other-than-temporary impairment would be recognized. The Company would recognize the credit loss portion through earnings in the income statement and the noncredit loss portion in accumulated other comprehensive loss. As of December 31, 2019 and 2018, the Company had no investment securities that were evaluated to be other than temporarily impaired.
Value of business acquired: Value of business acquired (VOBA) represents the estimated value assigned to purchased companies or insurance in- force of the assumed policy obligations at the date of acquisition of a block of policies. At least annually, a review is performed of the models and the assumptions used to develop expected future profits, based upon management’s current view of future events. VOBA is reviewed on an ongoing basis to determine that the unamortized portion does not exceed the expected recoverable amounts. Management’s view primarily reflects our experience but can also reflect emerging trends within the industry. Short-term deviations in experience affect the amortization of VOBA in the period, but do not necessarily indicate that a change to the long-term assumptions of future experience is warranted. If it is determined that it is appropriate to change the assumptions related to future experience, then an unlocking adjustment is recognized for the block of business being evaluated. Certain assumptions, such as interest spreads and surrender rates, may be interrelated. As such, unlocking adjustments often reflect revisions to multiple assumptions. The VOBA balance is immediately impacted by any assumption changes, with the change reflected through the statements of comprehensive income as an unlocking adjustment in the amount of VOBA amortized. These adjustments can be positive or negative with adjustments reducing amortization limited to amounts previously deferred plus interest accrued through the date of the adjustment. VOBA is amortized on a straight-line method over 30 years.
In addition, managment may consider refinements in estimates due to improved capabilities resulting from administrative or actuarial system upgrades. The Company considers such enhancements to determine whether and to what extent they are associated with prior periods or simply improvements in the projection of future expected gross profits due to improved functionality. To the extent they represent such improvements, these items are applied to the appropriate financial statement line items in a manner similar to unlocking adjustments.
Goodwill: Goodwill represents the excess of the amounts paid to acquire subsidiaries and other businesses over the fair value of their net assets at the date of acquisition. Goodwill is tested for impairment at least annually in the fourth quarter or more frequently if events or circumstances change that would indicate that a triggering event has occurred. Management assess the recoverability of indefinite-lived intangible assets at least annually or whenever events or circumstances suggest that the carrying value of an identifiable indefinite-lived intangible asset may exceed the sum of the future discounted cash flows expected to result from its use and eventual disposition. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset.
Reinsurance: In the normal course of business, the Company seeks to limit aggregate and single exposure to losses on risks by purchasing reinsurance. The amounts reported in the consolidated balance sheets as reinsurance recoverable include amounts billed to reinsurers on losses paid as well as estimates of amounts expected to be recovered from reinsurers on insurance liabilities that have not yet been paid. Reinsurance recoverable on unpaid losses are estimated based upon assumptions consistent with those used in establishing the liabilities related to the underlying reinsured contracts. Insurance liabilities are reported gross of reinsurance recoverable. Management believes the recoverables are appropriately established. Reinsurance premiums are generally reflected in income in a manner consistent with the recognition of premiums on the reinsured contracts. Reinsurance does not extinguish the Company’s primary liability under the policies written. Therefore, the Company regularly evaluates the financial condition of its reinsurers including their activities with respect to claim settlement practices and commutations, and establishes allowances for uncollectible reinsurance recoverable as appropriate. There were no allowances as of December 31, 2019 and 2018.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 1. Description of Business and Significant Accounting Policies (Continued)
Benefit reserves: The Company establishes liabilities for amounts payable under insurance policies, including traditional life insurance and annuities. Generally, amounts are payable over an extended period of time. Liabilities for future policy benefits of traditional life insurance have been computed by a net level premium method based upon estimates at the time of issue for investment yields, mortality and withdrawals. These estimates include provisions for experience less favorable than initially expected. Mortality assumptions are based on industry experience expressed as a percentage of standard mortality tables.
Policy claims: Policy claims are based on reported claims plus estimated incurred but not reported claims developed from trends of historical data applied to current exposure. The Company’s current estimate of incurred but not reported claims as of December 31, 2019 and 2018 is $127,711 and $139,753 and is included as a part of policyholder benefit reserves.
Deposit-type contracts: Deposit-type contracts consist of amounts on deposit associated with deferred annuity contracts and premium deposit funds. The deferred annuity contracts credit interest based upon a fixed interest rate set by the Company. The Company has the ability to change this rate annually subject to minimums established by law or administrative regulation.
Liabilities for deferred annuity deposit-type contracts are included without reduction for potential surrender charges. This liability is equal to the accumulated account deposits, plus interest credited, and less policyholder withdrawals. The following table provides information about deferred annuity deposit-type contracts for the years ended December 31, 2019 and 2018.
The premium deposit funds credit interest based upon a fixed interest rate set by the Company. The Company has the ability to change this rate subject to minimums established by law or administrative regulation.
Liabilities for premium deposit fund deposit-type contracts are included without reduction for potential surrender charges. This liability is equal to the accumulated account deposits, plus interest credited, and less withdrawals. The table on the following page provides information about premium deposit fund deposit-type contracts for the years ended December 31, 2019 and 2018.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 1. Description of Business and Significant Accounting Policies (Continued)
Revenue recognition and related expenses: Revenues on traditional life insurance products consist of direct premiums reported as earned when due. Premium income includes reinsurance assumed and is reduced by premiums ceded.
Amounts received as payment for annuity contracts without life contingencies are recognized as deposits to policyholder account balances and included in future insurance policy benefits. Revenues from these contracts are comprised of fees earned for contract-holder services, which are recognized over the period of the contracts, and included in revenue. Deposits are shown as a financing activity in the Consolidated Statements of Cash Flows.
Liabilities for future policy benefits are provided and acquisition costs are amortized by associating benefits and expenses with earned premiums to recognize related profits over the life of the contracts.
Deferred acquisition costs: The Company capitalizes and amortizes over the life of the premiums produced incremental direct costs that result directly from and are essential to the contract acquisition transaction and would not have been incurred by the Company had the contract acquisition not occurred. An entity may defer incremental direct costs of contract acquisition that are incurred in transactions with independent third parties or employees as well as the portion of employee compensation and other costs directly related to underwriting, policy issuance and processing, medical inspection, and contract selling for successfully negotiated contracts. Additionally, an entity may capitalize as a deferred acquisition cost only those advertising costs meeting the capitalization criteria for direct-response advertising. Acquisition costs are amortized over the premium paying period using the net level premium method. Traditional life insurance products are treated as long duration contracts, which generally remain in force for the lifetime of the insured.
The following table provides information about deferred acquisition costs for the years ended December 31, 2019 and 2018, respectively.
Comprehensive loss: Comprehensive loss is comprised of net loss and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses from marketable fixed maturity securities classified as available for sale, net of applicable taxes.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 1. Description of Business and Significant Accounting Policies (Continued)
Common stock and earnings (loss) per share: The par value for common stock is $0.10 per share with 20,000,000 shares authorized. As of December 31, 2019 and 2018 the company had 7,734,004 and 7,650,551 common shares issued and outstanding, respectively.
Earnings (loss) per share attributable to the Company’s common stockholders were computed based on the net income (loss) and the weighted average number of shares outstanding during each year. The weighted average number of shares outstanding during the years ended December 31, 2019 and 2018 were 7,688,560 and 7,393,795 shares, respectively. Potential common shares are excluded from the computation when their effect is anti-dilutive. Basic and diluted net loss per common share is the same for the years ended December 31, 2019 and 2018.
Income taxes: The Company is subject to U.S. federal and state taxes. The provision for income taxes is based on income as reported in the consolidated financial statements. The income tax provision is calculated using the asset and liability method. Deferred income taxes are recorded based on the differences between the financial statement and tax basis of assets and liabilities at the enacted rates expected to apply to taxable income in the years in which the differences are expected to reverse. A valuation allowance is established for the amount of any deferred tax asset that exceeds the amount of the estimated future taxable income needed to utilize the future tax benefits.
All of the Company’s tax returns are subject to U.S. federal, state and local income tax examinations by tax authorities. The Company had no known uncertain tax benefits included in its provision for income taxes as of December 31, 2019 and 2018. The Company’s policy is to recognize interest and penalties (if applicable) as an element of the provision for income taxes in the consolidated statements of income.
The tax years which remain subject to examination by taxing authorities are the years ended December 31, 2016 through 2019.
Risk and uncertainties: Certain risks and uncertainties are inherent in the Company’s day-to-day operations and in the process of preparing its consolidated financial statements. The more significant of those risks and uncertainties, as well as the Company’s method for mitigating the risks, are presented below and throughout the notes to the consolidated financial statements.
- Use of Estimates: The preparation of consolidated financial statements in conformity with US GAAP, generally accepted accounting principles in the United States, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
- Regulatory Factors: The insurance laws of Kansas, North Dakota, and Montana give insurance regulators broad regulatory authority, including powers 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.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 1. Description of Business and Significant Accounting Policies (Continued)
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Reform Act") reshapes financial regulations in the United States by creating new regulators, regulating new markets and firms, and providing new enforcement powers to regulators. Virtually all major areas of the Reform Act continue to be subject to regulatory interpretation and implementation rules requiring rulemaking that may take several years to complete. The ultimate outcome of the regulatory rulemaking proceedings cannot be predicted with certainty. The regulations promulgated could have a material impact on consolidated financial results or financial condition.
- Reinsurance:
In order to manage the risk of financial exposure to adverse underwriting results, the Company reinsures a portion of its individual and group life risks with other insurance companies. The Company retains $35,000 on its Whole Life products and $25,000 on its term life products. The Company also reinsures 100% of the risk on its individual accidental death benefit rider. The Company retains 25% of the risk for each covered life on its group life product to a maximum of $100,000 on any individual person. The Company retains 25% of the risk for each covered life on its group accidental death and dismemberment product to a maximum of $25,000 on any individual person. The Company also has catastrophic reinsurance coverage to protect against three or more group life deaths resulting from a single event. The Company also reinsures 90% of the risk on its group disability products. The Company reinsurers 66% of the risk on its critical illness product. Optimum Re Insurance Company (a subsidiary of Optimum Group), General Reinsurance Corporation (a subsidiary of Berkshire Hathaway), Reliance Standard Life Insurance Company (a subsidiary of Tokio Marine Holdings), Hartford Life and Accident Company, and Unified Life Insurance Company provide reinsurance for USALSC and DCLIC. The Company evaluates the financial condition of its reinsurers to minimize its exposure to losses from reinsurer insolvencies. Management believes that any liabilities arising from this contingency would not be material to the Company’s financial position.
- Interest Rate Risk:
Interest rate fluctuations could impair an insurance company's ability to pay policyholder benefits with operating and investment cash flows, cash on hand and other cash sources. Annuity products expose the risk that changes in interest rates will reduce any spread, or the difference between the amounts that the insurance company is required to pay under the contracts and the amounts the insurance subsidiary is able to earn on its investments intended to support its obligations under the contracts. Spread is a key component of revenues.
To the extent that interest rates credited are less than those generally available in the marketplace, policyholder lapses, policy loans and surrenders, and withdrawals of life insurance policies and annuity contracts may increase as contract holders seek to purchase products with perceived higher returns. This process may result in cash outflows requiring that an insurance subsidiary sell investments at a time when the prices of those investments are adversely affected by the increase in market interest rates, which may result in realized investment losses.
Increases in market interest rates may also negatively affect profitability in periods of increasing interest rates. The ability to replace invested assets with higher yielding assets needed to fund the higher crediting rates that may be necessary to keep interest sensitive products competitive.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 1. Description of Business and Significant Accounting Policies (Continued)
If interest rates were to increase by 1%, the market value of our fixed income securities would decrease by 9.4% as of December 31, 2019. The Company therefore may have to accept a lower spread and thus lower profitability or face a decline in sales and greater loss of existing contracts.
Conversely, in a period of prolonged low interest rates it is difficult to invest assets and earn the rate of return necessary to support insurance products. Some central banks currently have negative interest rates which contributes to the current low interest rate environment.
Policy lapses in excess of those actuarially anticipated would have a negative impact on our financial performance.
Profitability could be reduced if lapse and surrender rates exceed the assumptions upon which the insurance policies were priced. Policy sales costs are deferred and recognized over the life of a policy. Excess policy lapses, however, cause the immediate expensing or amortizing of deferred policy sales costs.
- Investment Risk:
Our invested assets are subject to customary risks of defaults and changes in market values. Factors that may affect the overall default rate on, and market value of, the invested assets include interest rate levels, financial market performance, and general economic conditions.
- Assumptions Risk: In the life insurance business, assumptions as to expected mortality, lapse rates and other factors in developing the pricing and other terms of life insurance products are made. These assumptions are based on industry experience and are reviewed and revised regularly by an outside actuary to reflect actual experience on a current basis. However, variation of actual experience from that assumed in developing such terms may affect a product's profitability or sales volume and in turn adversely impact our revenues.
Reclassifications: Certain reclassifications of a minor nature have been made to prior-year balances to conform to current-year presentation with no net impact to net loss/income or equity.
New accounting standards:
Revenue from Contracts with Customers
In May 2014, the Financial Accounting Standards Board (“FASB”) issued updated guidance to clarify the principles for recognizing revenue. While insurance contracts and revenues from financial institutions are not within the scope of this updated guidance, the Company's fee income related to providing services will be subject to this updated guidance. The Company did not earn any fee income in 2019 or 2018. The updated guidance requires an entity to recognize revenue as performance obligations are met, in order to reflect the transfer of promised goods or services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services.
The following steps are applied in the updated guidance: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract and (5) recognize revenue when, or as, the entity satisfies a performance obligation.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 1. Description of Business and Significant Accounting Policies (Continued)
In July 2015, the FASB deferred the effective date of the updated guidance on revenue recognition by one year to the quarter ending March 31, 2018. As an emerging growth company, the Company has chosen to defer implementation of this accounting standard until the year ending December 31, 2019. The adoption of this guidance did not have any effect on the Company’s result of operations, financial position or liquidity.
Recognition and Measurement of Financial Assets and Financial Liabilities
In January 2016, the FASB issued updated guidance regarding financial instruments. This guidance intends to enhance reporting for financial instruments and addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The significant amendments in this update generally require equity investments to be measured at fair value with changes in fair value recognized in net income, require the use of an exit price notion when measuring the fair value of financial instruments for disclosure purposes and clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities. This guidance also intends to enhance the presentation of certain fair value changes for financial liabilities measured at fair value. It also amends certain disclosure requirements associated with the fair value of financial instruments.
This guidance was effective for the Company for the year ended December 31, 2019 and required a cumulative effect adjustment to opening retained earnings to be recorded for equity investments with readily determinable fair values. As of the adoption date, the Company held publicly traded equity investments with a fair value of $ 10,987,539 million in a net unrealized gain position of $ 1,098,760 million. The Company has recorded a cumulative-effect adjustment of $ 1,098,760 to decrease Accumulated Other Comprehensive Income (AOCI) with a corresponding increase to accumulated deficit for unrealized gains as of the beginning of fiscal year 2019. As a result of the implementation of ASU 2016-01, unrealized gains and losses in equity investments with readily determinable fair values are recorded on the Consolidated Statements of Comprehensive Income (Loss) within net investment gains (losses). The Company recorded a gain in net investment gains (losses) of $1.1 million for year ended December 31, 2019 as a result of adopting this standard. The implementation of this guidance is expected to increase volatility in our net income as the volatility previously recorded in Comprehensive Income (OCI) related to changes in the fair market value of available-for-sale equity investments will now be reflected in net income effective with the adoption date.
Leases
In February 2016, the FASB issued updated guidance to require lessees to recognize a right-to-use asset and a lease liability for leases with terms of more than 12 months. The updated guidance retains the two classifications of a lease as either an operating or finance lease (previously referred to as a capital lease). Both lease classifications require the lessee to record the right-to-use asset and the lease liability based upon the present value of cash flows. Finance leases will reflect the financial arrangement by recognizing interest expense on the lease liability separately from the amortization expense of the right-to-use asset. Operating leases will recognize lease expense (with no separate recognition of interest expense) on a straight-line basis over the term of the lease. The accounting by lessors is not significantly changed by the updated guidance. The updated guidance requires expanded qualitative and quantitative disclosures, including additional information about the amounts recorded in the financial statements.
The updated guidance is effective for reporting periods beginning after December 15, 2018, and will require that the earliest comparative period presented include the measurement and recognition of existing leases with an adjustment to equity as if the updated guidance had always been applied. Early adoption is permitted. As an emerging growth company, the Company has elected to defer implementation of this standard to fiscal years beginning after December 15, 2020. The adoption of this guidance is not expected to have a material effect on the Company’s results of operations, financial position or liquidity.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 1. Description of Business and Significant Accounting Policies (Continued)
Measurement of Credit Losses on Financial Instruments
In June 2016, the FASB issued updated guidance for the accounting for credit losses for financial instruments. The updated guidance applies a new credit loss model (current expected credit losses or CECL) for determining credit-related impairments for financial instruments measured at amortized cost (e.g. reinsurance recoverables) and requires an entity to estimate the credit losses expected over the life of an exposure or pool of exposures. The estimate of expected credit losses should consider historical information, current information, as well as reasonable and supportable forecasts, including estimates of prepayments. The expected credit losses, and subsequent adjustments to such losses, will be recorded through an allowance account that is deducted from the amortized cost basis of the financial asset, with the net carrying value of the financial asset presented on the consolidated balance sheet at the amount expected to be collected.
The updated guidance also amends the current other-than-temporary impairment model for available-for-sale debt securities by requiring the recognition of impairments relating to credit losses through an allowance account and limits the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. In addition, the length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists.
The updated guidance is effective for reporting periods beginning after December 15, 2019. Early adoption is permitted for reporting periods beginning after December 15, 2018. As an emerging growth company, the Company has elected to defer implementation of this standard to fiscal years beginning after December 15, 2022. The Company will not be able to determine the impact that the updated guidance will have on its results of operations, financial position or liquidity until the updated guidance is adopted.
Classification of Certain Cash Receipts and Cash Payment
In August 2016, the FASB issued new guidance that clarifies the classification of certain cash receipts and cash payments in the statement of cash flows under eight different scenarios including, but not limited to: (i) debt prepayment or debt extinguishment costs; (ii) proceeds from the settlement of corporate-owned life insurance policies including bank-owned life insurance policies; (iii) distributions received from equity method investees; and (iv) separately identifiable cash flows and application of the predominance principle. This guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. As an emerging growth company, the Company elected to defer implementation of this standard to fiscal years beginning after December 15, 2018. The implementation of this standard did not have a material impact on the Company’s statement of cash flows.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 1. Description of Business and Significant Accounting Policies (Continued)
Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income
On December 22, 2017, the U.S. federal government enacted a tax bill, H.R.1, An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018 (Tax Cuts and Jobs Act). In February 2018, FASB issued guidance to address certain issues related to the Tax Cuts and Jobs Act. This new guidance allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. Consequently, the amendments eliminate the stranded tax effects resulting from the Tax Cuts and Jobs Act and will improve the usefulness of information reported to financial statement users. This guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The adoption of this guidance did not have a material effect on the Company’s results of operations, financial position or liquidity.
Targeted Improvements to the Accounting for Long-Duration Contracts
In August 2018, the FASB issued ASU 2018-12 “Targeted Improvements to the Accounting for Long-Duration Contracts.” ASU 2018-12 requires periodic reassessment of actuarial and discount rate assumptions used in the valuation of policyholder liabilities and deferred acquisition costs arising from the issuance of long-duration insurance and reinsurance contracts, with the effects of the changes in cash flow assumptions reflected in earnings and the effects of changes in discount rate assumptions reflected in other comprehensive income. Under current accounting guidance, the actuarial and discount rate assumptions are set at the contract inception date and not subsequently changed, except in limited circumstances. ASU 2018-12 also requires new disclosures and is effective for fiscal years beginning after December 15, 2023, with early adoption permitted. The Company is evaluating the effect this standard will have on our Consolidated Financial Statements.
All other new accounting standards and updates of existing standards issued through the date of this filing were considered by management and did not relate to accounting policies and procedures pertinent or material to the Company at this time.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 2. Acquisitions
On December 14, 2018 the Company acquired USALSC-Montana (formerly Great Western Life Insurance Company, “GWLIC”) pursuant to a Stock Purchase Agreement (“SPA”) with Great Western Insurance Company, a wholly-owned subsidiary of American Enterprise Group, Inc. Pursuant to the SPA, the Company paid $500,000 to acquire all of the outstanding shares of GWLIC.
The acquisition was accounted for under the acquisition method of accounting, which requires the consideration transferred and all assets and liabilities assumed to be recorded at fair value. The following table summarizes the fair value of GWLIC’s assets acquired and liabilities assumed and the gain from purchase:
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 3. Investments
The amortized cost and fair value of available for sale investments as of December 31 is as follows:
The amortized cost and fair value of debt securities as of December 31, 2019 and 2018, by contractual maturity, are shown on the following page. Equity securities do not have stated maturity dates and therefore are not included in the following maturity summary. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 3. Investments (Continued)
Proceeds from the sale of securities, maturities, and asset paydowns in 2019 and 2018 were $8,605,475 and $460,638, respectively. Realized gains and losses related to the sale of securities are summarized as follows:
Gross unrealized losses by duration are summarized as follows:
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 3. Investments (Continued)
Unrealized losses occur from market price declines that may be due to a number of factors, including economic downturns, changes in interest rates, competitive forces within an industry, issuer specific events, operational difficulties, lawsuits, and market pricing anomalies caused by factors such as temporary lack of liquidity.
The total number of securities in the investment portfolio in an unrealized loss position as of December 31, 2019 was 19, which represented an unrealized loss of $113,329 of the aggregate carrying value of those securities. The 19 securities breakdown as follows: 6 bonds, 6 mortgage and asset backed securities, 4 common stocks, 2 preferred stock index funds, and 1 senior loan fund. The Company determined that no securities were considered to be other-than-temporarily impaired as of December 31, 2019 and 2018.
The Company was required to implement a new accounting standard in the first quarter of 2019 which requires that the unrealized gains and losses on equity securities be reported as income on the Consolidated Statements of Comprehensive Income (Loss). For 2019, net investment gains (losses) is compromised of $1,256,769 of unrealized gains on our equity portfolio and net realized losses of $214,435. For 2018, net investment losses consist entirely of our realized losses of $4,499.
Note 4. Fair Value Measurements
The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. The Company uses a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
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Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement rate.
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Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
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Level 3 inputs are unobservable for the asset or liability and reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.
Investments, available for sale: Fair values of available for sale fixed maturity securities are provided by a third-party pricing service. The pricing service uses a variety of sources to determine fair value of securities. The Company’s fixed maturity securities are highly liquid, which allows for a high percentage of the portfolio to be priced through pricing sources. Fair values for equity securities are also provided by a third-party pricing service and are derived from active trading on national market exchanges. The Company's investment in FHLB stock is carried at redemption value which approximates fair value.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 4. Fair Value Measurements (Continued)
The table below presents the amounts of assets measured at fair value on a recurring basis as of December 31, 2019 and 2018:
The Company discloses the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above. The methodologies for other financial assets and financial liabilities are discussed below:
Cash and cash equivalents: The carrying amounts approximate fair value because of the short maturity of these instruments.
Investment income due and accrued: The carrying amounts approximate fair value because of the short maturity of these instruments.
Policy loans: Policy loans are stated at unpaid principal balances. As these loans are fully collateralized by the cash surrender value of the underlying insurance policies, the carrying value of the policy loans approximates their fair value.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 4. Fair Value Measurements (Continued)
Federal Home Loan Bank advance: FHLB advances are stated at the outstanding principal balance and the carrying value approximates their fair value.
Policyholder deposits in deposit-type contracts: The fair value for policyholder deposits deposit-type insurance contracts (accumulation annuities) is calculated using a discounted cash flow approach. Cash flows are projected using actuarial assumptions and discounted to the valuation date using risk-free rates adjusted for credit risk and the nonperformance risk of the liabilities.
The estimated fair values of the Company’s financial assets and liabilities at December 31 are as follows:
Note 5. Federal Income Taxes
USAC files federal income taxes returns based on type of return. USAC files a consolidated corporate federal income tax return with USAMC and USAIC. USASLC, DCLIC, and USALSC-MT file a consolidated life insurance federal income tax return. Certain items included in income reported for financial statement purposes are not included in taxable income for the current period, resulting in deferred income taxes.
A reconciliation of federal income tax expense computed by applying the federal income tax rate of 21% to income before federal income tax expense for the years ended December 31, 2019 and 2018, respectively, is summarized as follows:
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 5. Federal Income Taxes (Continued)
For the year ended December 31, 2019, the Company recognized a deferred tax benefit related to the reduction of its deferred tax asset valuation allowance. The net change in the allowance resulted in a net tax benefit of $431,158. Deferred taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax liabilities and assets as of December 31, 2019 and 2018 are summarized as follows:
As of December 31, 2019, the Company has net operating loss carryforwards of $12,577,367 of which $10,485,338 will expire between 2026 through 2037 and of which $2,092,029 is indefinite. The Company had net operating loss carryforwards of $12,617,489 as of December 31, 2018.
The 2016 through 2019 U.S. federal tax years are subject to income tax examination by tax authorities. Penalties and interest assessed by taxing authorities are included in the provision for income taxes, if applicable. There were no interest or penalties paid during 2019 and 2018.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 6. Reinsurance
A summary of significant reinsurance amounts affecting the accompanying consolidated financial statements as of December 31, 2019 and 2018 and for the years ended December 31, 2019 and 2018 is listed in the following table.
The company currently reinsures business in excess of its retention with General Re Life Corporation, Reliance Standard Life Insurance Company, Unified Life Insurance Company, Hartford Life and Accident Company, and Optimum Re Insurance Company. The Company also currently assumes business under agreements with Unified Life Insurance Company and American Life and Security Corporation.
Note 7. Lease Commitments
Total rent expense was $45,785 and $39,166 for the years ended December 31, 2019 and 2018, respectively. The Company amended its lease on its Topeka headquarters effective January 1, 2019 which extended its termination date for two years with three additional optional years. The future rent payments required under the lease are $37,824 in 2020. The Company also maintains an office in Bismarck, ND with a lease that expires on September 30, 2020. The future rent payments required under this lease are $8,446 in 2020.
Note 8. Related Party Transaction
Brier Development Company, Inc. is owned solely by Jack Brier, President and CEO of the Company. Brier Development Company, Inc. owns 20,000 shares of stock in USAC which are in escrow until 5 years after the termination of the public offering. The Company makes reimbursements to Brier Development Company, Inc. on behalf of Jack H. Brier for single coverage for long-term care and an allowance for vehicle expenses. Reimbursements for these items were $19,421 and $19,421 for years ended December 31, 2019 and 2018, respectively.
Note 9. Federal Home Loan Bank Advances
One of the Company’s subsidiaries, USALSC, is a member of the Federal Home Loan Bank of Topeka (FHLB), which provides access to collateralized borrowings. Any borrowings from FHLB requires the purchase of FHLB common stock in an amount equal to 4.5% of the borrowing. On October 31, 2019, USALSC received an advance of $ 1,000,000 based on USALSC purchasing $ 45,000 of FHLB common stock. The Company had outstanding advances from the Federal Home Loan Bank of Topeka of $1,000,000 at December 31, 2019. Advances from the FHLB are secured by the Federal Home Loan Bank of Topeka stock and pledged assets consisting of mortgage backed securities and overnight deposit funds with a fair value of $1,132,099. This regular fixed convertible advance has a 10 year term with an FHLB option to convert to an adjustable rate on the 5th anniversary. The interest rate at issue was 1.66%.
As of December 31, 2019, USALSC had pledged $932,099 of mortgage backed securities and $200,000 of overnight deposits to FHLB in support of its outstanding advance.
Note 10. Restricted Funds
As required by Kansas law, US Alliance Life and Security Company maintains a trust account at Capitol Federal Savings Bank which is jointly owned by the Kansas Insurance Department. The life insurance company is required by the State of Kansas to hold $400,000 of asset book value in this account. The Company placed additional assets into this trust account in 2015 to meet the minimum deposit requirement for the State of Missouri. These assets were held in bonds and other invested assets with a statement value of $625,000 and $625,000 as of December 31, 2019 and 2018, respectively. Additionally, the Company has a special deposit with the State of Missouri with asset book value of $300,000. Dakota Capital Life Insurance Company has $200,000 of funds on deposit jointly owned with the North Dakota Insurance Department at the Bank of North Dakota. US Alliance Life and Security Company - Montana has $325,000 of funds on deposit jointly owned by the Montana Department of Insurance at Wells Fargo.
US Alliance Corporation
Notes to Consolidated Financial Statements
Note 11. Statutory Net Income and Surplus
US Alliance Life and Security Company is required to prepare statutory financial statements in accordance with statutory accounting practices prescribed or permitted by the Kansas Insurance Department. Dakota Capital Life Insurance Company is required to prepare statutory financial statements in accordance with statutory accounting practices prescribed or permitted by the North Dakota Insurance Department. US Alliance Life and Security Company - Montana is required to prepare statutory financial statements in accordance with statutory accounting practices prescribed or permitted by the Montana Insurance Department. Statutory practices primarily differ from GAAP by charging policy acquisition costs to expense as incurred, establishing future policy benefit liabilities using different actuarial assumptions as well as valuing investments and certain assets and accounting for deferred taxes on a different basis.
The following table summarizes the statutory net income (loss) and statutory capital and surplus of US Alliance Life and Security Company, Dakota Capital Life Insurance Company, and US Alliance Life and Security Company - Montana as of December 31, 2019 and 2018 and for the years ended December 31, 2019 and 2018.
The payment of dividends to US Alliance Corporation by US Alliance Life and Security Company is subject to limitations imposed by applicable insurance laws. For example, “extraordinary” dividends may not be paid without permission of the Kansas Insurance Department. An “extraordinary” dividend is defined, in general, as any dividend or distribution of cash or other property whose fair market value, compared with that of other dividends or distributions made within the preceding 12 months, exceeds the greater of (i) 10% of the policyholders’ surplus (total statutory capital stock and surplus) as of December 31 of the preceding year or (ii) the statutory net gain from operations excluding realized gains on investments) of the insurer for the 12 month period ending December 31 of the preceding year.
The payment of dividends to US Alliance Life and Security Company by Dakota Capital Life Insurance Company and US Alliance Life and Security Company - Montana is subject to similar limitations.
Note 12. Subsequent Events
All of the effects of subsequent events that provide additional evidence about conditions that existed at the balance sheet date, including the estimates inherent in the process of preparing the consolidated financial statements, are recognized in the consolidated financial statements. The Company does not recognize subsequent events that provide evidence about conditions that did not exist at the balance sheet date but arose after, but before the consolidated financial statements are issued. In some cases, unrecognized subsequent events are disclosed to keep the consolidated financial statements from being misleading.
The Company has evaluated subsequent events through February 20, 2020, the date on which the consolidated financial statements were issued.