ITEM 1. BUSINESS General BNL Financial Corporation (the "Company" or "Registrant" or "BNLF") is an insurance holding company incorporated in Iowa in January 1984. The Company's administrative offices are located at 2100 West William Cannon, Suite L, Austin, Texas 78745; its telephone number is (512) 383-0220.
In March 2004, BNL Equity Corporation ("BNLE"), the immediate subsidiary of the Company was dissolved and its assets, including the stock of Brokers National Life Assurance Company ("BNLAC"), were distributed to BNLF. All outstanding shares of BNLAC are now owned directly by BNLF.
The Company has three wholly owned subsidiaries, Brokers National Life Assurance Company, BNL Brokerage Corporation and Consumers Protective Association (formerly National Dental Benefit Association, Inc.). Consumers Protective Association is an inactive association that was purchased for the purpose of marketing services, including insurance products to members.
------------------------------------- ---------------------------------- BNL Financial Corporation --- Consumer's Protective Association (Inactive Association) ------------------------------------- ---------------------------------- | | - -------------------------------------- Brokers National Life Assurance Company - -------------------------------------- | | - --------------------------------------- BNL Brokerage Corporation - ---------------------------------------
Industry Segments The operations of the Company are conducted through BNLAC, which in 2004 marketed life and accident and health insurance. In 1987 BNLAC began selling insurance in Iowa, and in 1992, BNLAC expanded its sales to other states through the acquisition of Statesman Life Insurance Company. The Company has no foreign operations.
In 2004, BNLAC received a Certificate of Authority to market insurance in New Mexico. This increased the number of states in which it is licensed to do business to 36. BNLAC is currently licensed in 36 states to offer life and accident and health insurance on an individual and group basis.
The Company conducts business in the "life, accident and health insurers" industry segment. Most of BNLAC's premium revenues are from sales of group dental insurance sold primarily on a payroll deduction basis. Financial information relating thereto is contained in the Selected Financial Data below and the Financial Statements included as Exhibits to this Report.
Sales and Marketing The Company markets its products through independent agents and brokers. BNLAC emphasizes the marketing of specialized or "niche" life and health insurance products including: a 10-year level term policy, group life, hospital indemnity policy, individual dental and group dental insurance. Most of these products are designed to be sold on a group or payroll deduction basis.
Statistics by line of business are as follows (gross before reinsurance):
Premiums collected by state are reflected in the following table:
The following chart shows group dental insurance premiums collected for each of the past five years ended December 31.
Gross Premiums Group Dental Insurance Collected ---------------- 2004 $40,681,000 2003 38,813,000 2002 39,734,000 2001 38,083,000 2000 34,464,000
The following chart shows group dental insurance claims paid and claims ratios for each of the five years ended December 31. The incurred claims loss ratio represents the ratio of incurred claims to premiums earned.
Gross Claims Group Dental Insurance Claims Paid Ratio ---------------------- ---------------- ---------------- 2004 25,044,000 62.3% 2003 24,279,000 62.7% 2002 25,772,000 64.9% 2001 24,821,000 65.5% 2000 22,504,000 63.8%
Agents' Commissions On December 31, 2004, BNLAC had 4,837 general agents and brokers that market its policies in 34 states compared to 4,590 agents and brokers on December 31, 2003
On all of its products BNLAC pays competitive commissions to agents. There is considerable competition for insurance agents and BNLAC competes with larger, well-established life insurance companies for the services of agents. BNLAC believes it is able to attract competent agents by offering competitive compensation, efficient service to agents and customers and by developing products to fill special needs within the marketplace.
BNLAC collects overwrite commissions on sales of vision insurance policies issued by Vision Service Plan, Security Life Insurance Company of America and Avesis Incorporated. The vision policies are marketed by BNLAC's agency force.
Reinsurance BNLAC reinsures with other insurance companies portions of the risks it underwrites on sales of life and accident and health insurance. Reinsurance enables BNLAC, as the "ceding company," to reduce the amount of its risk on any particular policy and to write policies in amounts larger than it could without such agreements.
The reinsurer receives a portion of the premium on the reinsured policies. BNLAC remains directly liable to policyholders to perform all policy obligations, and bears the contingent risk of the reinsurer's insolvency. Before submitting an application for a policy to the reinsurer, BNLAC determines whether the applicant is insurable, but BNLAC rejects any application which is not accepted by the reinsurer.
BNLAC reinsures its life insurance under agreements which are classified as either "automatic" or "facultative." Under an "automatic" treaty, the reinsurer agrees that it will assume liability automatically for the excess over the ceding company's retention limits on any application acceptable to the ceding company. Under a "facultative" treaty, the reinsurer retains the right to accept or reject any reinsurance submitted after reviewing each application.
BNLAC's Accidental Death Benefit riders are reinsured 100% through a Bulk ADB reinsurance agreement with Generali USA Life Reassurance Company ("Generali"), formerly Business Men's Assurance Company. Generali was rated "A" (Excellent) by AM Best Company for 2003.
BNLAC's individual life insurance products in excess of $35,000 are reinsured with Generali under an automatic treaty up to $175,000 and under a facultative treaty for amounts over $175,000.
BNLAC's Group Life insurance is reinsured under a Quota Share reinsurance agreement with Hannover Life Reassurance Company of America. The reinsurer is liable for 90% of the risk on the life of each insured up to the policy maximum of $65,000 on the group life insurance. Hannover Life Reassurance Company of America was rated "A" (Excellent) by AM Best Company for 2003.
Effective November 1, 2003, BNLAC entered into a quota share reinsurance agreement with Hannover Life Reassurance Company of America for the Accidental Death and Dismemberment plan. Hannover Life Reassurance Company of America accepts 90% of the risk. Hannover Life Reassurance Company of America was rated "A" (Excellent) by AM Best Company in 2003.
BNLAC has entered into a quota share reinsurance agreement with Hartford Life and Accident Insurance Company for its Group Life and Accidental Death and Dismemberment plans that is effective January 1, 2005 and will replace Hannover Life Reassurance Company of America. Hartford was rated "A+" (Superior) by AM Best Company for 2003.
BNLAC's Short Term Disability insurance is reinsured under a Quota Share reinsurance agreement with Fortis Benefits Insurance Company of Kansas City, Missouri. The reinsurer is liable for 75% of the risk on each policy. Fortis Benefits Insurance Company was rated "A" by AM Best Company for 2003.
The following chart shows life insurance and accidental death insurance in force net of reinsurance for each of the five past years ended December 31.
Investments BNLAC invests its available funds in a certificate of deposit, US Treasury Bills, US Government and Agency bonds, corporate bonds and other investment grade securities. The earnings from such investments represent a substantial part of BNLAC's income. For each of the five years ended December 31, BNLAC's net investment income and ratio of net return on mean invested assets were as follows:
Net Net Return on Investment Mean Invested Year Income Assets - -------------- --------------- ------------------ 2004 $879,351 4.4% 2003 854,548 4.2% 2002 1,041,679 5.6% 2001 977,578 6.2% 2000 870,482 6.5%
For information concerning realized and unrealized gains and losses on securities see Note 4 of the Notes to Consolidated Financial Statements, page.
Special Factors Relating to Accounting and Regulatory Reporting of Insurance Companies State insurance laws and regulations govern the accounting practices and the form of financial reports of insurance companies filed with state insurance regulatory agencies. Most states have adopted the uniform rules established by the National Association of Insurance Commissioners ("NAIC"). Reports prepared in accordance with statutory accounting practices reflect primarily the ability of an insurance company to meet its obligations to policyholders and do not necessarily reflect going-concern considerations. Certain statutory accounting practices differ from generally accepted accounting principles as applied to the Company's audited financial statements.
Life insurance company revenues are generated primarily from premiums and investment income. Commissions and other sales cost may exceed the amount of first year life premiums but are generally less in later policy years. Life insurance lapses and surrenders tend to occur more frequently in the earlier years after a policy is sold. Statutory accounting rules for life insurance companies require all life insurance policy acquisition costs be expensed immediately and not spread over the expected duration of the policies. Health insurance premiums are recorded the same for both Statutory and GAAP.
Statutory accounting practices also require that a relatively large portion of life premiums be held as reserves for the protection of policyholders. The amount of such reserves is based upon actuarial calculations and the annual increase in reserves is treated as an expense. Such calculations must be based upon conservative assumptions concerning mortality costs and earnings. Life premiums are earnings only to the extent that they exceed reserve requirements and commissions. BNLAC calculates reserves using the Commissioner's Reserve Valuation Method. This method provides a lower reserve in the early years of a policy to partially offset the higher first-year costs of the policy. Although such reserves are treated as liabilities and are not available for use in operations, a company is free to invest such reserves in accordance with applicable state laws. Interest earned on invested reserves is operating income to the life insurance company to the extent that it exceeds the interest required to be added to the reserves.
The Company's consolidated financial statements are required to be prepared in conformity with generally accepted accounting principles. The objective of these financial statements is to provide reliable financial information about economic resources and obligations of a business enterprise and changes in net resources resulting from its business activities, measured as a going concern. To the extent that the accounting practices prescribed or permitted by state regulatory authorities differ from generally accepted accounting principles, appropriate adjustments will be made to bring such Financial Statements into accordance with generally accepted accounting principles, including (but not limited to) the following:
a) Premiums are reported as earned over the premium paying period. Benefits and expenses are associated with earned premiums so as to result in the matching of expenses with the related premiums over the life of the contracts. This is accomplished through the provision for liabilities for future policy benefits and the deferral and amortization of acquisition costs;
b) Certain assets designated as "non-admitted assets" for statutory purposes are reinstated to the accounts;
c) The asset valuation reserve is reclassified as retained earnings rather than as a liability. The interest maintenance reserve is reclassified from a liability to investment income;
d) Premium payments received on annuities are not reported as revenue but are recorded as increases to a deposit liability account. The profits are then deferred over the life of the policy instead of being realized when the payments are received;
e) Realized gains and losses from the sale of investments are reclassified to a separate component of summary of operations. Taxes thereon are included in the tax provision; and
f) Investments in fixed maturity securities that are available for sale are carried at fair value with the unrealized appreciation (depreciation) recorded to shareholders' equity.
The ability of BNLAC to pay dividends to the Company is restricted under Arkansas insurance laws and must be approved by the insurance commissioner of the State of Arkansas, if it exceeds the lesser of 10% of surplus or net gain from operations for the year.
Insurance Regulations BNLAC is subject to regulation and supervision by the states in which it is admitted to transact business. Each state has an insurance department which has broad administrative and supervisory powers to grant and revoke licenses to transact business, regulate trade practices, establish guaranty associations, license agents, approve policy forms, regulate premium rates for some lines of business, establish reserve requirements, regulate competitive matters, prescribe the form and content of required financial statements and reports, determine the reasonableness and adequacy of statutory capital and surplus, and regulate the type and amount of investments permitted.
Most states have also enacted legislation which regulates insurance holding company activities, including acquisitions, extraordinary dividends, the terms of surplus notes, the terms of affiliate transactions and other related matters. The Company and BNLAC are registered as a holding company group pursuant to such legislation in Arkansas and BNLAC routinely reports to other jurisdictions as well.
The NAIC, through the member regulatory staffs, attempts to coordinate the state regulatory process and continually re-examines existing laws and regulations and their application to insurance companies. Recently, this re-examination has focused on insurance interpretations of existing law, the development of new laws and the implementation of non-statutory guidelines. The NAIC has formed committees and appointed advisory groups to study and formulate regulatory proposals on such diverse issues as the use of surplus debentures, accounting for reinsurance transactions and the adoption of risk-based capital ("RBC")
rules. In addition, in connection with its accreditation of states to conduct periodic company examinations, the NAIC has encouraged states to adopt model NAIC laws on specific topics, such as holding company regulations and the definition of extraordinary dividends. It is not possible to predict the future impact of changing state and federal regulation on the operations of BNLAC.
The NAIC has adopted model RBC requirements to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks associated with: (i) asset quality; (ii) mortality and morbidity; (iii) asset and liability matching; and (iv) other business factors. The RBC formula is designed to be used by the states as an early warning tool to identify possible weakly capitalized companies for the purpose of initiating regulatory action. In addition, the formula defines a new minimum capital standard which will supplement the prevailing system of low fixed minimum capital and surplus requirements on a state-by-state basis.
The RBC requirements provide for four different levels of regulatory attention depending on the ratio of a company's total adjusted capital (defined as the total of its statutory capital, surplus, asset valuation reserve and 50% of apportioned dividends) to its RBC. The "Company Action Level" is triggered if a company's total adjusted capital is less than 100% but greater than or equal to 75% of its RBC, or if total adjusted capital is less than 125% of RBC and a negative trend has occurred. The trend test calculates the greater of any decreases in the margin (i.e., the amount in dollars by which a company's total adjusted capital exceeds its RBC) between the current year and the prior year and between the current year and the average of the past three years, and assumes that the decrease could occur again in the coming year. If a similar decrease in the margin in the coming year would result in an RBC of less than 95%, then the Company Action Level would be triggered. At the Company Action Level, a company must submit a comprehensive plan to the regulatory authority which discusses proposed corrective actions to improve its capital position. The "Regulatory Action Level" is triggered if a company's total adjusted capital is less than 75% but greater than or equal to 50% of its RBC. At the Regulatory Action Level the regulatory authority will perform a special examination of the company and issue an order specifying corrective actions that must be followed. The "Authorized Control Level" is triggered if a company's total adjusted capital is less than 50% but greater than or equal to 35% of its RBC, and the regulatory authority may take any action it deems necessary, including placing the company under regulatory control. The "Mandatory Control Level" is triggered if a company's total adjusted capital is less than 35% of its RBC, and the regulatory authority is mandated to place the company under its control. Calculations using the NAIC formula at December 31, 2004 indicated that the ratios of total adjusted capital to RBC for BNLAC would have been in excess of 1,112% and, therefore, significantly above the Company Action Level.
As part of their routine regulatory process, approximately once every three years, insurance departments conduct detailed examinations ("triennial examinations") of the books, records and accounts of insurance companies domiciled in their states. Such triennial examinations are generally conducted in cooperation with the departments of other states under guidelines promulgated by the NAIC.
In July 2000, the Arkansas Insurance Department conducted its triennial statutory examination for the period ended December 31, 1999. No adjustments were made to the financial statements of the Company as a result of the examination.
BNLAC's management is not aware of any failure to comply with any significant insurance regulatory requirement to which BNLAC is subject at this time.
Competition The life and health insurance business is highly competitive, and BNLAC competes in many instances with individual companies and groups of affiliated companies that have substantially greater financial resources, larger sales forces and more widespread agency and brokerage relationships than BNLAC. Certain of these companies operate on a mutual basis which may give them an advantage over BNLAC since their profits accrue to the policyholders rather than the shareholders. In the last quarter of fiscal year 2002, BNLAC's A. M. Best's financial performance rating was raised from "B " (Fair) to "B+" (Very Good).
BNLAC focuses its marketing efforts on sales of its products to small and medium size groups of employees, association members and others. These groups range in size from three to approximately 774 persons. BNLAC also sells its products to individuals. BNLAC is a small insurance company which has no identifiable market share. BNLAC is not ranked according to its size or volume of sales.
BNLAC competes for the services of agents and brokers in several ways. First, the Company's dental insurance products are attractive to brokers and general agents because of their popularity in the employee benefit market. Second, BNLAC
strives to provide a high level of service to agents by offering products that meet their clients' needs and by providing individualized service in the administration of such products. Finally, BNLAC attempts to structure the levels of premiums, benefits and commissions on insurance products to compare favorably with competitors.
Personnel At December 31, 2004 BNLAC had four executive officers and 63 full-time administrative personnel. BNLAC's administrative staff supervises services for the agency force, policy underwriting, policy issuance and service, billing and collections, life claims, accounting and bookkeeping, preparation of reports to regulatory authorities and other matters. The Company has not experienced any work stoppages or strikes and considers its relations with its employees and agents to be excellent. The Company currently has no employees which are represented by a union. BNLAC currently uses a third party administrator to process dental claims.
ITEM 2.
ITEM 2. PROPERTIES
Neither the Company, nor any of its subsidiaries own any real estate.
During the first half of 2002 the Company leased 12,150 square feet of office space in Austin, Texas, under a seven year, triple net lease. In July 2002 the Company expanded its offices in an adjacent building and increased the space it leases by 1,596 square feet. The annual base rent for the 12,150 square feet was $137,578 a year and the cost for the additional space is $19,152 per year. The lease rate will remain in affect until the initial term of the lease expires in 2005. Effective January 1, 2003, the Company leased an additional 798 square feet in the adjacent building at a rate of $9,576 per year. The Company has an option to renew the lease for another ten years at the rate of $126,000 for the first five years and $129,000 for the second five years of the new lease term on the initial 12,150 square feet of office space. In 2005, the Company has negotiated a lease for new office space in Austin, Texas that is contingent upon the current lessee vacating the space by April 15, 2005. The cost of the lease is not materially greater than the current lease.
BNLE leases approximately 1,400 square feet of office space in Sherwood, Arkansas at a rental of $17,450 per year. BNLAC incurs 100% of the rental expense.
BNLAC leases 288 square feet of office space in Des Moines, IA at a rental of $7,230 per year. The rent includes the services of a secretary that is shared with other tenants of the building.
The Company and its subsidiaries own the majority of the furniture and equipment used in the operation of its business.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In 2001, the Board of Directors of the Company and BNL Equity Corporation approved a settlement in the class action case brought by certain shareholders. The settlement, which was approved by the Pulaski County Circuit Court and the Arkansas Insurance Commissioner, was subject to various conditions, including the approvals by any other applicable regulatory authorities and conditioned upon compliance with federal and state securities laws. As of December 31, 2002, all requisite approvals were received and redemption of the stock began in 2003.
As part of the settlement agreement, the Company issued its Bonds in the principal amount of $1.50 in exchange for each share of common stock of BNL owned by the members of the Class. The Bonds are for a term of twelve years, effective December 15, 2002, with principal payable at maturity and bear interest at the rate of 6% per annum payable annually from the previous fiscal year's earnings of BNL. The estimated annual impact to earnings per share was approximately $.013 per share. If any interest payment is not made, it will be added to the principal and paid at maturity. The Bonds are fully callable and redeemable at par at any time by BNL.
During 2003, the Company reclassified Contingent Long Term Liabilities and Contingent Treasury Stock in the amount of $3,637,288 to Bonds Payable and Treasury Stock, respectively, in accordance with the character of the litigation settlement of 2001 and the performance of all duties thereunder. The $3,637,288 of Treasury Stock was retired and returned to authorized but not issued status. The $660,447 Contingent Long Term Liabilities and Contingent Treasury Stock on the Balance Sheet in 2003 represents shares the Company had not been able to determine the status regarding their right to exchange under the settlement agreement. During 2004 the Company determined that $518,517 of the Contingent Long Term Liabilities and Contingent Treasury Stock should not be included in the settlement agreement. The remaining $141,930 were reclassified to Bonds Payable and Treasury Stock.
In 2004 and 2003, the Company made cash offers to bond holders for the purchase of bonds. Bond purchases resulted in a reduction of Bonds Payable of $1,163,456 and $611,789 in 2004 and 2003; respectively. Gains from early extinguishments of the debt were $495,462 and $424,727 in 2004 and 2003; respectively. ..
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted for a vote during the fourth quarter of 2004.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market for Stock During 2004 the Company made three separate offers to its shareholders to redeem their stock for its book value of $.53, $.60 and $.63 a share; respectively. The offers resulted in the purchase of 913,339 shares of stock for $542,012. In 2003 the Company made two separate offers to its shareholders to redeem their stock for its book value of $.47 and $.53 a share; respectively. The offers resulted in the purchase of 974,541 shares of stock for $477,023. The stock is not traded on any established trading market.
Holders As of December 31, 2004 there were 2,723 record holders of the Company's common stock.
Dividends The Company has not declared any dividends on its common stock to date and has no present plans to pay any dividends in the foreseeable future. The Company's ability to declare and pay dividends in the future will be dependent upon its earnings and the cash needs for expansion. In addition, payment of dividends by BNLAC is regulated under Arkansas insurance laws.
Equity Compensation Plan Information In 1994, the Board of Directors and Shareholders approved the 1994 Brokers and Agents' Nonqualified Stock Option Plan. This plan was established as an incentive to sales persons of BNLAC. Initially 250,000 shares were available under the plan. Options for an additional 1.75 million shares were authorized by the Board of Directors. The option period may not exceed a term of five years and the duration of the plan was ten years, expiring December 14, 2004. A four-member committee of Directors administers the plan. During 2004, 2003 and 2002, the Company granted 129,575, 131,925, and 154,855 stock options, respectively, with an exercise price of $1.00 per share for those granted in 2004, $.75 per share for those granted in 2003 and $.50 per share for those granted in 2002. There were 515,955 stock options outstanding at December 31, 2004. The number of options expiring or forfeited were 199,500 and 437,500 in 2004 and 2003, respectively. There were 38,350 options exercised in 2004 and 38,525 options exercised in 2003. Under the fair value method, total compensation recognized for grant of stock options was $4,000 in 2004. The fair value of options granted is estimated at $4,000, $0 and $1,596 in 2004, 2003 and 2002. These values were computed using a binomial method as prescribed in SFAS No. 123 and certain assumptions include a risk free interest rate of 5.0%, expected life of 3.0 years, expected volatility of 14.0% and no expected dividends due to statutory limitations. The estimated weighted average remaining life of the options is 1.5 years and the weighted average exercise price is $.76. The options do not have a dilutive effect on earnings per share at this time, but may have such an effect in the future. See Note 1.
In March 2002, the Board of Directors approved the 2002 Non-Director, Non-Executive Stock Option Plan, subject to any necessary authorizations from any regulatory authority. The plan is intended to assist the Company in attracting and retaining individuals of outstanding ability and to promote concurrence of their interests with those of the Shareholders of the Company. The Company granted 60,300 options with an exercise price of $.75 in 2004 and 55,700 options with an exercise price of $.50 in 2003. The fair value of options granted is estimated at $11,000 in 2004 and $10,940 in 2003. This value was computed using a binomial method as prescribed in SFAS No. 123 and certain assumptions include a risk free interest rate of 5.0%, expected life of 10.0 years, expected volatility of 14.0% and no expected dividends due to statutory limitations. The estimated weighted average remaining life of the options is 8.4 years. The options do not have a dilutive effect on earnings per share at this time, but may have such an effect in the future. See Note 1.
The table below reflects the Equity Compensation Plans as of December 31, 2004.
Transfer Agent and Registrar BNL Financial Corporation is the Registrar and Transfer Agent for the Company's common stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data presented below as of the end of and for each of the years in the five-year period ended December 31, 2004 are derived from the Company's consolidated financial statements. The consolidated financial statements as of December 31, 2004 and 2003, and for each of the years in the three-year period ended December 31, 2004 are included elsewhere in this Form 10-K.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In this section, we review the consolidated financial condition of the Company at December 31, 2004, 2003 and 2002 and the consolidated results of operations for the periods ended December 31, 2004, 2003 and 2002. Please read this discussion in conjunction with the accompanying consolidated financial statements and notes.
Forward-Looking Statements All statement, trend analyses and other information contained in this report and elsewhere (such as in filings by us with the Securities and Exchange Commission, press releases, presentations by us or our management or oral statements) relative to markets for our products and trends in our operations or financial results, as well as other statements including words such as "anticipate,"
"believe," "plan," "estimate," "expect," "intend," and other similar expressions, constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors which may cause actual results to be materially different from those contemplated by the forward-looking statements. Such factors include, among other things: (i) general economic conditions and other factors, including prevailing interest rate levels and stock and credit market performance which may affect (among other things) our ability to sell our products, our ability to access capital resources and the costs associated therewith, the market value of our investments and the lapse rate and profitability of policies; (ii) world conflict, including but not limited to the war in Iraq, which may affect consumers spending trends and priorities (iii) customer response to new products and marketing initiatives: (iv) mortality, morbidity and other factors which may affect the profitability of our products (v) changes in the federal income tax laws and regulations which may affect the relative income tax advantages of our products (vi) regulatory changes or actions, including those relating to regulation of financial services affecting (among other things) bank sales and underwriting of insurance products and regulation of the sale, underwriting and pricing of products (vii) the risk factors or uncertainties listed from time to time in our filings with the Securities and Exchange Commission.
Management believes the Company's current critical accounting policies are comprised of the following:
Reserves for unpaid policy claims are a sensitive accounting estimate unique to the insurance industry. Management uses an independent actuary to formulate this estimate. Differences in the estimates may result in revised claims expense which is recognized in the period in which the difference is determined. See Note 11 to our financial statements for the effect on the year 2004.
The valuation allowance against deferred taxes is a sensitive accounting estimate. The Company follows Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes," which prescribes the liability method of accounting for deferred income taxes. Under the liability method, companies establish a deferred tax liability or asset for the future tax effects of temporary differences between book and tax basis of assets and liabilities.
At December 31, 2004 and 2003, respectively, the Company had gross deferred tax assets of $807,542 and $1,004,000 with corresponding valuation allowances of $706,542 and $808,865 resulting from net operating loss carryovers and temporary differences primarily related to the life insurance subsidiary. The valuation allowance is primarily due to statutory limitations on the use of net operating losses. The resulting net deferred tax asset is $101,000 and $195,136 at December 31, 2004 and 2003, respectively. Realization of the deferred tax asset is dependent on generating sufficient taxable income prior to expiration of the loss carry forward. Although realization is not assured, management believes it is more likely than not that all of the net deferred tax asset will be realized. However, the amount of the deferred tax asset considered realizable could be reduced in the near term if estimates of future taxable income during the carry forward period are reduced.
The provision for income tax is as follows:
The reconciliation of income taxes computed at the federal statutory income tax rate to total income taxes for the years ended December 31, 2004, 2003 and 2002 is as follows:
The Company has net operating loss carry forwards for income tax purposes at December 31, 2004 as follows:
Expiring ---------------------
2005 $ 38,024 2006 545,898 2007 286,096 2008 202,779 2009 162,019 2010 185,160 2011 65,880 2012 192,537 2018 254,814 2019 130,716 2020 65,199 2023 73,260 2024 28,624 ----------------
$ 2,231,006 ================
Financial Condition
The Company's financial condition strengthened during 2004 due to the increase in net income from operations.
Liquidity and Capital Resources At December 31, 2004 the Company had liquid assets of $3,809,913 in cash, U.S. Treasury Bills, money market savings accounts, and short-term certificates of deposit. All of the non-cash liquid assets can readily be converted into cash.
The major components of operating cash flows are premiums and investment income while policy benefits are the most significant cash outflow. In 2004, BNLAC collected approximately $42.8 million of premiums and annuity deposits (gross before reinsurance) and $975,485 of investment income. Another source of cash flow in 2004 was overwrite commissions of $461,443 on vision products. At the same time the Company paid $31,766,217 in policy benefits and other insurance costs.
Approximately $664,488 of the bond portfolio is classified as Available for Sale and carried on the Balance Sheet at market value with the unrealized gain or loss recorded in the surplus section of the Balance Sheet. The bonds include; automobile bonds, government agencies and U. S. Treasury Bonds that have unrealized profits. The Company may sell these bonds before they mature.
Approximately $17.0 million of the bond portfolio is classified as Held to Maturity and is carried on the Balance Sheet at amortized cost. This classification reflects management's ability and intent to hold the bonds until maturity. No adjustments to surplus are made as bond values change.
The table below discloses the unrealized gains and losses on the "Held to Maturity" bonds.
In the third quarter of 2004, BNLAC received notification from the Arkansas Insurance Department that its bond portfolio exceeded the 20% investment limitation for certain federal agencies as they relate to its investment in Federal Home Loan Bank bonds. The Company immediately sold $900,000, par value, of its Federal Home Loan Bank bonds for a loss of $4,490 to initiate compliance with the Arkansas statute. For GAAP purposes the bonds were classified as held to maturity. Further discussions with the Arkansas Insurance Department revealed the Department's intent was not to have the Company dispose of any of its block of Federal Home Loan Bank bonds, but instead request permission to exceed the 20% investment limitation. The Company then requested and was granted permission by the Arkansas Insurance Department to exceed the 20% investment limitation. The Company has determined its held to maturity fixed securities portfolio was not tainted since the bond sales were due to an unusual and isolated occurrence that could not be reasonably foreseen. BNLAC held Federal Home Loan Bank Bonds totaling 27% of statutory assets at December 31, 2004.
The Company's investments are primarily in U.S. Government and Government Agencies ($14,803,740 amortized book value) and other investment grade bonds ($2,287,058 amortized book value). The Company does not hedge its investment income through the use of derivatives.
Other long term investments of $1,557,407 consists of, in part, a convertible debenture loan in the amount of $1,357,407 from the Company, to EPSI Benefits, Inc. (EBI), a Texas Corporation. The loan bears interest at an annual rate of 14%, payable monthly, with principal payments commencing September 15, 2008 and a maturity date of August 15, 2015. To protect its interest, BNLF may convert the debenture into 51% of the outstanding common stock of EBI, subject to regulatory approval. The note is one of several agreements entered into by the Company's subsidiaries which expand the business relationship with EBI and its subsidiary, Employer Plan Services, Inc. (EPSI), which provides substantially all of the A&H claims processing and adjudication for the Company's insurance subsidiary, BNLAC. BNLF receives a marketing fee from EBI under a related marketing agreement.
Other long-term investments also include an operating line of credit agreement in the amount of $200,000. On October 15, 2003 BNLAC and EPSI entered into a loan agreement whereby BNLAC will provide EPSI with a $200,000 line of credit maturing October 15, 2004. The line of credit was renewed and extended with interest only payments to August 1, 2005, thereafter EPSI will pay principal and interest over 60 equal monthly installments until paid in full. The line of credit is at prime, 5.25%, with interest payable monthly to BNLAC.
On November 5, 2001 the Company's Board of Directors approved a settlement of the class action lawsuit (see "Legal Proceedings") that included a $575,000 payment to Class Counsel, which was paid in December 2002.
Another term of the settlement is the issuance of Company bonds in the principal amount of $1.50 in exchange for each share of the Company's common stock owned by the members of the class. The bonds have a 12-year term and bear interest at the rate of 6% per annum, effective December 15, 2002 payable annually from the previous fiscal year's earnings. The total principal amount of class action bondholders at December 31, 2004 is $2,007,339 compared to $3,025,499 bondholders and $660,447 contingent bondholders at December 31, 2003. Bond interest expense was $115,101, and $189,985 in 2004 and 2003; respectively. BNLAC will pay dividends to BNL Financial Corporation for the payment of interest to the bondholders. The maximum amount of dividends, which can be paid by Arkansas domiciled insurance companies to shareholders without prior approval of the insurance commissioner, is subject to restrictions relating to statutory surplus. The Arkansas Insurance Commissioner has reviewed and approved the settlement. The Company does not expect the dividend restrictions to impact its ability to meet its cash needs. The Company has no plan to start a sinking fund for payment of the principal at maturity.
In 2004, BNLAC paid dividends totaling $1,150,000 to BNLF for the purchase of Company stock and bonds and for other general operating funds compared to $857,734 dividends paid in 2003. In 2005, the Company has negotiated with Universal Guaranty Life Insurance Company to purchase 2,216,776 shares of BNL Financial Corporation's common stock for $2,300,000. The transaction is pending regulatory approval. BNLAC will use short term investments to fund the dividends it will pay to the Company to purchase the stock.
The following table reflects all long-term contractual obligations of the Company as of December 31, 2004.
We believe liquid assets, along with investment income, premium income and marketing fees will be sufficient to meet our long and short-term liquidity needs. We do not have any current plans to borrow money for operations.
BNLAC reports to state regulatory authorities on a statutory accounting basis that differs from the basis used herein. Due to an Arkansas regulatory requirement associated with the redomestication in 1994, BNLAC must maintain a minimum of $2,300,000 in capital and surplus. Additionally, each state in which BNLAC is licensed has statutory minimum capital requirements required for maintaining its license to sell. Minimum capital and surplus requirements vary from $300,000 to as much as $5,000,000 in the states in which BNLAC is licensed.
Results of Operations Premium income was $43,146,365 in 2004, $40,809,336 in 2003, and $41,237,420 in 2002. The 6% increase in 2004 was due to new sales of group and individual dental insurance and increased renewal premiums from a reduction in the lapse rates on existing business. The decrease of 1% in 2003 was due to the loss of three large dental groups at the end of 2002 and the first quarter of 2003. In 2004, group dental insurance premium income made up 95.3% of total premium income.
Net investment income was $975,485 in 2004, $970,382 in 2003, and $1,148,225 in 2002, an increase of 1% in 2004, and a decrease of 12% in 2003. The slight increase in 2004 was due to an increase in investment in fixed maturities and an increase in interest rates. The decrease in 2003 was primarily due to the general decline in interest rates.
The Company receives marketing fees from EBI per the marketing agreement mentioned above. The Company received marketing fees of $165,275 in 2004, $146,107 in 2003 and $143,619 in 2002. The increase in 2004 was due to an increase in third party administrator income at EBI in 2004.
The Company had a realized gain on debt extinguishments of $495,462 in 2004 and $424,726 in 2003 due to the purchase of debentures payable at less than par value.
Realized capital gains and (losses) on investments were $124,077 in 2004, $154,628 in 2003 and ($161,430) in 2002. The realized gain in 2004 and 2003 are primarily from the sale of U.S. Treasury bonds. The realized loss in 2002 was primarily due to the write down in value of certain bonds and stock.
Increase in liability for future policy benefits was $687,619 in 2004, $34,377 in 2003 and $93,518 in 2002. The increase in 2004 was primarily due to a $611,410 increase in additional contract reserves on the individual dental policies. Beginning in 2004, new reserve rules prescribed by most state insurance departments require additional reserves be established to more properly match premiums and benefits for this product. The Company was also required to set up deferred acquisition costs on the individual dental plans that reduced general and administrative expenses by $155,410. The decrease in 2003 was due to a slight decrease in the number of whole life insurance policies in force.
Policy benefits and other insurance costs decreased from $30,789,481 in 2002, to $30,108,152 in 2003 and increased to $31,766,217 in 2004. The increase in 2004 was due to an increase in claims and commissions resulting from the increase in group and individual dental premium collected and commissions paid on a recruiting bonus program. The decrease in 2003 was the result of a $900,000 reduction in group dental claims. The claims ratio on group dental insurance, which represents the ratio of claims incurred to premium earned, was 62.3% in 2004, 62.7% in 2003 and 64.1% in 2002. The claims ratio has steadily decreased over the last three years as a result of renewal rate adjustments.
Amortization of deferred policy acquisition costs was $29,973 in 2004, $30,403 in 2003 and $26,918 in 2002. Amortizaton of deferred policy acquisition costs varies in relation to lapses or surrenders of existing policies.
Operating expenses were $7,957,447 in 2004, $7,664,081 in 2003 and $7,249,662 in 2002. The 4% increase in expenses in 2004 was primarily due to an increase in payroll expenses, employee benefits and actuarial expense which increased due to an increase in business in force, new plans of insurance available for sale and increased state filings. The increase in expenses in 2003 was due to an increase in executive bonus incentive plan expenses, which increase with profits, payroll expense and marketing expense associated with increased product and sales promotion.
Taxes other than on income were $1,344,723 in 2004, $1,326,826 in 2003 and $1,331,528 for 2002. The increase in 2004 was due to premium taxes on the increase in collected premiums. The decrease in 2003 was due to a decrease in premium taxes on fewer premiums collected.
For 2004, the consolidated net income from operations before taxes was $3,120,686 compared to $3,341,340 in 2003 and $2,876,727 in 2002. The decrease in 2004 was primarily due to the increase in additional contract reserves on the individual dental plan. The increase in 2003 was due to a decrease in claims on group dental business and an increase in realized gains.
Earnings per share was $.14, $.14, and $.12 in 2004, 2003 and 2002, respectively. The effect of the treasury shares described in Note 6 to the financial statements was immaterial in 2004 and 2003 and increased earnings per share by $.015 in 2002.
The provision for income taxes was $468,183 in 2004, $604,985 in 2003 and $376,000 in 2002. For the periods ended December 31, 2004, 2003 and 2002, the Company had $355,183, $519,949 and $174,000 of current federal tax expense and $113,000, $85,036 and $202,000 of deferred tax expense; respectively. The decrease in 2004 was due to a reduction in net income and an over accrual of approximately $36,000 in 2003. The increase in 2003 is due to the net operating losses of the life insurance subsidiary being fully utilized in 2002.
For the year ended December 31, 2004, other comprehensive income was ($87,603) compared to $56,053 in 2003 and $171,170 for the same period in 2002. The comprehensive income in 2003 and 2002 was due to a decrease in interest rates that increased the market value of the Company's bond portfolio. The decrease in comprehensive income for the period ended December 31, 2004 was due to an increase in interest rates and the reclassification adjustment for realized losses of $126,364.
Looking Forward BNLAC plans to apply for authority to market insurance products in additional states in the upcoming year. In 2004 we received approval to market insurance in New Mexico and we currently have an application pending for a certificate of authority in Wisconsin.
Market risk represents the potential loss resulting from adverse changes in the value of financial instruments, either derivative or non-derivative, caused by fluctuations in interest rates, foreign exchange rates, commodity prices, and equity security prices. We handle market risks in accordance with our established policies. The Company's conservative investment philosophies
minimize market risk and risk of default by investing in high quality debt instruments, with staggered maturity dates. We did not have financial instruments to manage and reduce the impact of changes in interest rates at December 31, 2004 and December 31, 2003. We held various financial instruments at December 31, 2004 and 2003, consisting of financial assets reported in our Consolidated Balance Sheets (refer to Note 4).
Interest Rate Risk - We are subject to interest rate risk through the investment in fixed maturity securities, such as U.S. Government and Government Agency securities and other investment grade bonds. The fair market value of long-term, fixed-interest rate debt is subject to interest rate risk. Generally, the fair value of fixed-interest rate debt will increase as interest rates fall and will decrease as interest rates rise. The estimated fair value of our fixed maturity securities at December 31, 2004 and December 31, 2003 was $17,622,189 and $16,631,478, respectively.
A one percentage point increase in prevailing interest rates would result in a decrease in the estimated fair value of fixed maturity securities held at December 31, 2004 of approximately $504,000. Initial fair values were determined using the current rates at which we could enter into comparable financial instruments with similar remaining maturities. The estimated earnings and cash flows impact for the twelve months of 2004, resulting from a one percentage point increase in interest rates, would be immaterial, holding other variables constant.
Foreign-Exchange Rate Risk - We currently have no exposure to foreign exchange rate risk because all of our financial instruments are denominated in U.S. dollars and because we do not currently engage in any operations outside of the United States.
Commodity Price Risk - We have no financial instruments subject to commodity price risk.
Equity Security Price Risk - Fair value of equity securities at December 31, 2004 totaled $628,821, or only 2.8% of total investments and cash on a consolidated basis. We do not hedge our equity price risk. As of December 31, 2004, a 20% adverse change in equity prices would result in an approximate $100,000 decrease in the fair value of our equity securities.
The preceding discussion of estimated fair value of our financial instruments and the sensitivity analyses resulting from hypothetical changes in interest rates are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements reflect our current expectations and involve uncertainties. These forward-looking market risk disclosures are selective in nature and only address the potential impact from financial instruments. They do not include other potential effects which could impact our business as a result of changes in interest rates, foreign-exchange rates, commodity prices, or equity security prices.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information on pages through attached to this Report is hereby incorporated by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
ITEM 9A.
ITEM 9A. INTERNAL CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company's reports pursuant to the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to the Company's management, including its Chief Executive Officer and its Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Within 90 days prior to the date of this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures, as that term is defined in Rule 13a-14 ( c ) under the Securities Exchange Act of 1934, as amended. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective in timely alerting the Company's Chief Executive Officer and Chief Financial Officer to material information required to be disclosed in the periodic reports filed with the SEC.
In addition, the Company's Chief Executive Officer and Chief Financial Officer have reviewed the Company's internal controls, and there have been no significant changes in the Company's internal controls or in other factors that could significantly affect those controls subsequent to the date of the last evaluation.
ITEM 9B.
ITEM 9B. FORM 8K FILINGS
The Company did not file reports on Form 8-K for the fourth quarter of the year covered by this report.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors and executive officers of the Company are as follows:
The term of office of each director expires at the annual meeting of shareholders upon the election and qualification of such director's successor. The Company's executive officers serve at the pleasure of the Board of Directors. The above officers and directors serve in the same capacity with BNLAC.
Identification of Certain Significant Employees Not applicable.
Family Relationships No family relationship exists between any director or executive officer of the Company.
Business Experience The following is a brief description of the business experience during the past five years of the directors and executive officers of the Company.
Wayne E. Ahart has served as Chairman of the Board of BNL since 1984 and BNLAC since 1986. He served as Chairman of the Board of BNLE from 1988 to 2004 and as Chairman of the Board of United Arkansas Life from 1990 to 1994. Prior to that time, Mr. Ahart served as Board Chairman of: Investors Trust, Inc. ("ITI") and its subsidiary, Investors Trust Assurance Company ("ITAC"), both of Indianapolis, Indiana (1973-1987); Liberty American Corporation ("LAC")(President since 1981) and its subsidiary Liberty American Assurance Company ("LAAC"), both of Lincoln, Nebraska (1975-1987); and (President) American Investors Corporation ("AIC") and its subsidiary, Future Security Life Insurance Company ("FSL"), both of Austin, Texas (1980-1987). Mr. Ahart has been owner and Chairman of the Board of Lone Star Pizza Garden Inc. from 1986 to the present.
C. Don Byrd has been Vice Chairman of the Board of BNL, BNLE and BNLAC since August 1, 1994. Mr. Byrd was President and a Director of BNL and BNLAC since 1984 and 1986, respectively. Mr. Byrd was Agency Director of FSL from 1983 to 1984 and Regional Director of AIC 1981 to 1983. He was an agent and Regional Director of ITI and ITAC from 1974 to 1981.
Kenneth Tobey has been President and Director of BNLAC and BNL since August 1, 1994. Mr. Tobey has served as President of BNLE since 1988 and served as President of United Arkansas Life from 1990 to 1994. He served as Assistant to the President and Training Director of BNLAC from 1986 to 1988. From 1981 to 1986, Mr. Tobey served in various capacities for AIC and FSL, including Agent, Regional Manager, Executive Sales Director and Assistant to the President.
Barry N. Shamas has served as Executive Vice President, Secretary and Treasurer of BNLE since 1988 and United Arkansas Life from 1990 to 1994. Since 1984 and 1986, respectively, he has served as Executive Vice President and Director of BNL and BNLAC, which positions he presently holds. He served in various capacities for ITI and ITAC, including Executive Vice President, Senior Vice President, Treasurer and Financial Vice President beginning in 1976 through 1987. Mr. Shamas served as Executive Vice President, Secretary/Treasurer and as Director of AIC and FSL from 1980 and 1983, respectively, until 1987. From 1978 through 1987, Mr. Shamas served as a Director and a member of the Executive Committee of LAC and LAAC.
Cecil L. Alexander retired Vice President of Public Affairs for Arkansas Power & Light Company, where he has been employed since 1980. Prior to joining the AP&L Executive Staff, Mr. Alexander served for 16 years in the Arkansas General Assembly, and during 1975-76, was Speaker of the House of Representatives. Since 1971, Mr. Alexander has been involved in the real estate business as a partner in Heber Springs Realty. He is a past president of the Cleburne County Board of Realtors and has served on the governmental affairs committee of the Arkansas Association of Realtors. Alexander is currently on the Advisory Board of Directors of V.E. Bank of Heber Springs, the Board of Directors of the Arkansas Tourism Development Foundation, and the Board of Directors of the Baptist Foundation.
Richard L. Barclay, a Certified Public Accountant, recently retired as Director of Arkansas Department of Finance and Administration and as the state's Chief Fiscal Officer. He has returned to private practice with Beall, Barclay & Co., Certified Public Accountants in Rogers, Arkansas. He is an advisory Director of Regions Bank of Rogers. He serves as past President and Board member of the Arkansas Society of Certified Public Accountants and is a member of the American Institute of Certified Public Accountants. He was a member of the Arkansas House of Representatives from 1977 until 1992.
Eugene A. Cernan has been President and Chairman of the Board of The Cernan Corporation since 1981. Captain Cernan retired from the U. S. Navy in 1976 after serving 20 years as a naval aviator, 13 of which were dedicated to direct involvement with the U. S. Space Program as a NASA Astronaut. Captain Cernan was the pilot on the Gemini 9 mission and the second American to walk in space; lunar module pilot of Apollo 10; and Spacecraft Commander of Apollo 17, which resulted in the distinction of being the last man to have left his footprints on the surface of the moon. In 1973, he served as a Senior United States Negotiator in discussions with USSR on the Apollo-Soyuz Mission. Mr. Cernan served as Executive Consultant of Aerospace and Government of Digital Equipment Corporation from 1986 to 1992, and he was a Director and Vice President-International of Coral Petroleum, Inc., Houston, Texas from 1976 to 1981. Captain Cernan is presently a Director of National Air and Space Museum and Smithsonian Educational Foundation. Captain Cernan is also a member of the Board of Trustees of the U. S. Naval Aviation Museum, NFL Alumni and Major League Baseball Players Alumni Association. In addition, Captain Cernan has served as a consultant commentator to ABC News.
Hayden Fry was Head Football Coach at the University of Iowa from 1979 to 1998, now retired. He was Head Football Coach at North Texas State University from 1973 to 1978 and at Southern Methodist University from 1962 to 1972. He was named Football Coach of the Year in the Big Ten (1981, 1990, 1991), the Missouri Valley Conference (1973), and the Southwest Conference (1962, 1966 and 1968). He is on the Board of Advisors of Wilson Sporting Goods (1962 to date); the Board of Trustees of Pop Warner Football (1962 to date); and the American Football Coaches Association (1983 to date) and was the 1993 President of the AFCA. He was President of Hawkeye Marketing Group from 1979 - 1984. He is a member of the Board of Directors of the PPI Group.
John Greig has been President of Greig and Co. since 1967. He is a Director of Boatmen's Bank of Iowa, NW., Estherville, Iowa. He has been President of the Iowa Cattlemen's Association (1975-1976) and a member of the Executive Committee of the National Cattlemen's Association (1975-1976). He was a member of the Iowa Board of Regents from 1985 to 1991. He was elected as an Iowa State Representative in 1993.
Roy Keppy has operated his grain and livestock farming operation in Davenport, Iowa since 1946. In 1982, he and his son founded Town and Country Meats in Davenport and he currently serves as its Vice President. He was a Director of Eldridge Cooperative Elevator Company for 33 years, retiring in 1982, after serving as President for 6 years. He is a past Chairman of the National Livestock and Meat Board, and was on its Board of Directors from 1970 to 1986. He was on the Board of Directors of the National Pork Producers from 1965 to 1972, serving as its President in 1970-1971.
Roy E. Ledbetter is retired as President and Chief Executive Officer of Highland Industrial Park, a division of Highland Resources, Inc. in East Camden, Arkansas. He holds a Bachelor of Science Degree in Education from Southern Arkansas University at Magnolia, a Masters Degree in Education from Henderson State University at Arkadelphia and an AMP from Harvard Business School at Boston. In 1966, Mr. Ledbetter joined Highland Resources, Inc. and coordinated organization of Southern Arkansas University Technical Branch; was promoted to Division Manager (1972), Vice President and Division Manager (1975), Senior Vice President (1980), and President in 1984. He is past President of the Camden Chamber of Commerce; was 1977 Camden Jaycee's Man of the Year; was awarded first annual Camden Area Chamber of Commerce Community Service Award in 1983; served on Education Standards Committee of the State of Arkansas; and presently serves on the Boards of East Camden and Highland Railroad, Shumaker Public Service Corporation, Merchants and Planters Bank of Camden, and First United Bancshares of El Dorado.
C. James McCormick is former Chairman of the Board of McCormick, Inc., Best Way Express, Inc., Emeritus, Inc., and President of JAMAC Corporation, all of Vincennes, Indiana. He is also the former Vice Chairman of Golf Hosts, Inc. He is the owner of CJ Leasing, LLC. Mr. McCormick is former Chairman of the Board of Directors and CEO of First Bancorp, Vincennes, Indiana; former Chairman of the Vincennes University board of trustees and a Life Director of the Indiana Chamber of Commerce; and a former member of the Young President's Organization. He is a former Chairman of the Board of the American Trucking Associations. Mr. McCormick is a Past Chairman of the National Board of Trustees of The Fellowship of Christian Athletes.
John E. Miller was a member of the State of Arkansas House of Representatives from 1959 to 2000. He has been self-employed in the insurance, abstract, real estate, heavy construction and farming business for more than 20 years. He presently serves on the Board of Directors of Calico Rock Medical Center, Easy K Foundation, National Conference of Christians and Jews, State Advocacy Services, Lions World Services for the Blind, State Board of Easter Seals, Williams Baptist College Board of Trustees and Izard County Chapter of the American Red Cross.
James A. Mullins has owned and operated Prairie Flat Farms, Corwith, Iowa since 1969. He was a Director of the Omaha Farm Credit Bank from 1985 to 1994, a Director of the Federal Farm Credit Banks Funding Corporation from 1986 to 1994, and Director of the US Meat Export Federation from 1988 to 1995. He served as Chairman of the Foreign Trade Committee, National Cattlemen's Association (1988 - - 1993). He was Chairman of the US Meat Export Federation until 1994. He was Chairman of the National Livestock & Meat Board in 1983; Chairman of the Beef Industry Council in 1979 and 1980; and Chairman of the Omaha Farm Credit Bank in 1988 and 1989.
Robert R. Rigler has been Chairman of the Board of Security State Bank, New Hampton, Iowa since 1989; he served as its President and CEO from 1968 to 1989. Mr. Rigler was Iowa Superintendent of Banking from 1989 to 1991. He was a member of the Iowa Transportation Commission from 1971 to 1986 and served as its Chairman from 1973 to 1986. He was a member of the Iowa State Senate from 1955 to 1971 and served as a Majority and Minority Floor Leader.
Chris Schenkel is a retired television sportscaster of CBS Sports and ABC Sports, New York, New York, from 1952 to 1999. He also served as Spokesperson for Owens-Illinois, Toledo, Ohio, from 1976 to 1995, for whom he spoke as voice over commercials, personal appearances, conventions and shows. Mr. Schenkel served as Chairman of the Board of Directors of Counting House Bank, North Webster, Indiana from 1974-1982. He also served as a Director of ITI and ITAC from 1978 to 1986 and on the Board of Haskell Indian University, Lawrence, Kansas. He has three Honorary Doctorate Degrees and a Lifetime Achievement Emmy.
L. Stanley Schoelerman was President and a Partner of Petersen Sheep & Cattle Co., Spencer, Iowa from 1964 to 2001. He was a Director of Home Federal Savings & Loan, Spencer, Iowa, from 1969 to 1988; and Honeybee Manufacturing, Everly, Iowa, from 1974 to 1986. He was President of Topsoil-Schoenewe, Everly, Iowa, from 1974 to 1986. Mr. Schoelerman was Commissioner of the Iowa Department of Transportation from 1974 to 1978 and was a member of the National Motor Carrier Advisory Board of the Federal Highway Administration from 1981 to 1985.
Orville Sweet served as a Visiting Industry Professor at Iowa State University from 1989 to 1990 and is President of Sweet and Associates, a consulting firm for agricultural organizations. He was Executive Vice President of the 100,000 member National Pork Producers Council, Des Moines, Iowa, from 1979 to 1989. He was President of the American Polled Hereford Association, Kansas City, Missouri in 1963-79. He is past President of the US Beef Breeds Council and the National Society of Livestock Records Association and was a Director of the Agricultural Hall of Fame and the US Meat Export Federation. He is a member of the American Society of Animal Science. He has served as a member of the USDA Advisory Council Trade Policy, the State Department Citizens Network and the Executive Committee of the Agricultural Council of America.
Audit Committee
The Company's audit committee consists of three members of the board of directors, Richard Barclay, Robert Rigler and John Greig. Mr. Barclay, a Certified Public Accountant, is the committee's financial expert and is independent of management. See description of board members for additional information.
Compensation Committee
The Company's compensation committee consists of three members of the board of directors, C. James McCormick, Roy Ledbetter and Orville Sweet. C. James McCormick is Chairman of the committee. See description of board members for additional information.
Code of Ethics
The Company has a code of ethics that applies to all employees of the Company. To receive a copy of the Company's code of ethics without charge, contact:
Ms. Pam Randolph BNL Financial Corporation 7530 Hwy. 107 Sherwood, Arkansas 72120
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION Executive Compensation The following table sets forth certain information regarding remuneration of executive officers in excess of $100,000 during the three years ended December 31.
The total number of executive officers of the Company is four and the total remuneration paid to all executive officers in 2004, as a group, is $1,021,712 including bonuses of approximately $100,000 under the Company's stock bonus plan and $291,839 under the executive incentive bonus plan. The Company has accrued bonuses payable at December 31, 2004, of approximately $100,000 under the stock bonus plan and approximately $131,000 under the executive bonus plan. The Company does not have employment agreements with any of its officers.
The Company does not have any employment or severance agreements with officers or employees.
Compensation of Directors Each director receives a fee of $500 per company, plus reasonable travel expenses for each meeting of the Board of Directors attended. The Audit and Compensation Committees receives $500 for each meeting attended.
Benefit Plans See Equity Compensation Plans for a description of the 1994 Agents' Nonqualified Stock Option Plan and the 2002 Non-Director, Non-Executive Stock Option Plan.
In 2001, the Board of Directors approved the 2001 Incentive Bonus Plan for the benefit of certain Officers of the Company. The plan provides for semi-annual payment of cash bonuses based on 10% of consolidated pre-tax operating income. The life company subsidiary bears its prorata share of the bonus expense based on its pre-tax statutory profits. Bonus expense was $312,069, $334,134 and $287,673 under this plan for 2004, 2003 and 2002, respectively.
The Company has a stock bonus plan for the benefit of certain Officers of the corporation. The plan provides for a bonus based on consolidated after-tax profits subject to specified limits. The bonus amount, net of taxes, will be used to purchase stock in the Company. Stock bonuses in the amount of $100,000, $100,000 and $100,000 were granted in 2004, 2003 and 2002, respectively.
The Company has an Employee Pension Plan that is a qualified retirement plan under the Internal Revenue Code. All employees who have attained age 21 and have completed one year of service are eligible to contribute. Employer contributions are discretionary. The Company contributed $57,698, $46,138 and $32,565 in 2004, 2003 and 2002, respectively.
Indebtedness of Management No officer, director or nominee for director of the Company or associate of such person was indebted to the Company at any time during the year ended December 31, 2004, other than for ordinary travel and expense advances and other reimbursable expenses, if any.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Security Ownership of Certain Beneficial Owners The following table reflects the persons known to the Company to be the beneficial owners of more than 5% of the Company's voting securities as of December 31, 2004:
Security Ownership of Management The following table sets forth, as of December 31, 2004, certain information concerning the beneficial ownership of the Company's Common Stock by each director of the Company and by all directors and officers as a group:
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required under this item is incorporated by reference from our Proxy Statement.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) 1. Financial Statements The information required by this section is set forth on page to of this Report and is incorporated herein by reference.
2. The following financial statement schedule required to be filed by Paragraph (d) of Item 15 of Form 10-K is submitted as a separate section of this report.
Schedule III - Condensed Financial Information of Registrant to
Schedules I and VI have been omitted as all required data is included in the Notes to Consolidated Financial Statements.
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.
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, on the 30th day of March 2005.
BNL FINANCIAL CORPORATION
/S/ Wayne E. Ahart -------------------------- By: Wayne E. Ahart, Chairman of the Board
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 Registrant and in the capacities and on the dates indicated:
ANNUAL REPORT ON FORM 10-K
ITEM 15 (a) AND 15 (d)
FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 2004
BNL FINANCIAL CORPORATION AND SUBSIDIARIES
DES MOINES, IOWA
- -------------------------------------------------------------------------------
- ------------------------------------------------------------------------------ BNL Financial Corporation and Subsidiaries Report of Independent Registered Public Accounting Firm - -----------------------------------------------------------------------------
To the Board of Directors and Shareholders BNL Financial Corporation and Subsidiaries
We have audited the consolidated financial statements of BNL Financial Corporation and Subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of BNL Financial Corporation and Subsidiaries as of December 31, 2004 and 2003, and the consolidated results of their operations and their consolidated cash flows for each of the years ended December 31, 2004, 2003 and 2002 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information required to be set forth therein.
Oklahoma City, Oklahoma SMITH, CARNEY & CO., p.c. February 7, 2005 /s/ Smith, Carney & Co
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies The consolidated financial statements include the accounts of BNL Financial Corporation and its wholly owned subsidiaries, BNL Equity Corporation, Brokers National Life Assurance Company (BNLAC), BNL Brokerage Corporation and Consumers Protective Association, Inc. All significant intercompany balances have been eliminated. In March 2004, BNL Equity Corporation (BNLE), the immediate subsidiary of the Company was dissolved and its assets, including the stock of ("BNLAC"), were distributed to BNLF. All outstanding shares of BNLAC are now owned directly by BNLF.
The preparation of financial statements in conformity with generally accepted accounting principles 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The Company's principal activity is the sale of individual and group life and accident and health insurance within the United States. The most significant income component is sales of dental insurance for which the maximum annual risk per policy is $2,000. See Note 10. The Company is licensed to sell in 36 states as of December 31, 2004. See Note 2. Substantially all of the Company's life insurance in force is nonparticipating business.
Premiums from accident and health insurance are reported as earned when due since these policies are long duration contracts.
Benefits and expenses are associated with earned premiums so as to result in recognition over the life of the policy. Such recognition is accomplished by means of the provision for future policy benefits and amortization of deferred policy acquisition costs.
Costs of acquiring new business and certain expenses of policy issuance and underwriting have been deferred; these deferred policy acquisition costs are being amortized over the premium-paying period of the policies (maximum of 30 years) in proportion to the ratio of annual premium revenue to total premium revenue anticipated.
The income tax asset includes management's estimate of the future benefit to be derived from net operating loss carry forwards and the difference in tax basis of assets and liabilities. In assessing the realization of deferred income tax assets, management considers whether it is more likely than not that the deferred income tax assets will be realized. The ultimate realization of deferred income tax assets depends upon generating future taxable income. If future income is not generated as expected, deferred income tax assets may need to be written off (no such write-offs have occurred). See Note 3.
Liability for future policy benefits for traditional and limited-payment contracts has been determined primarily by the net level premium method using the 1975 through 1980 Select and Ultimate Mortality Table, interest assumptions starting at 7% graded to 5% at the end of the sixteenth year and estimated future withdrawals based upon Linton Tables B or C.
For annuity contracts without mortality risk, net premium deposits and benefit payments are recorded as increases or decreases in a liability account rather than as revenue and expense. Expenses incurred and fees charged upon issuance are deferred and recognized in relationship to the amount of funds held. This deferred annuity profit is being amortized based on lapse and mortality assumptions (maximum of 30 years) which are revised periodically to reflect actual experience. Increases in the liability account for interest credited to contracts are charged to expense. The interest rate assumptions ranged from 4.0% to 3.0% during 2004 and 2003.
The liability for policy claims payable is composed of claims reported but not paid and claims incurred but not reported. The Company has developed a procedure for calculating incurred but not reported dental claims based on prior years' claims using dates incurred, reported to the insurance company and subsequently paid. Differences in estimates may result in revised claims expense which is recognized in the period in which the difference is determined.
Before September 30, 2002 the Company classified all of its fixed maturity investments as investments available for sale. Such securities may be sold prior to maturity due to changes that might occur in market interest rates, changes in the security's prepayment risk, the Company's liquidity needs, and similar factors, including the Company's asset/liability management strategy. Investments available for sale are carried at fair value. Unrealized gains and losses resulting from changes in the valuation of fixed maturity securities classified as available for sale are recorded as a component of comprehensive income.
Effective September 30, 2002, the Company elected to divide its portfolio and change its accounting treatment for approximately $11.6 million of debt securities in its investment portfolio in accordance with SFAS No. 115. These securities, formerly accounted for as available for sale and reflected in the financial statements at market value, will be accounted for as held to maturity. This classification change reflects management's intent and ability to hold this block of securities, and other securities purchased subsequently and so designated, to their maturity. This reclassification required the Company to report the bond's value on September 30, 2002 at fair market value at the date of reclassification. New purchases designated by management as part of the held to maturity portfolio will be presented on the financial statements at amortized book value and, therefore, unlike the available for sale portfolio, no adjustments to surplus will be made as bond values change. The election to change the method of accounting had no material effect on the financial statements of the Company in 2002 but could have a material effect in the future since surplus will not be adjusted as described above.
Realized gains or losses on sale of all investments are determined on a specific identification basis. Investments in equity securities are carried at fair value.
Cash equivalents are carried at amortized cost, which approximates fair value. Cash equivalents represent other short-term securities. For purposes of the Statement of Cash Flows, the Company considers all highly liquid short-term investments to be cash equivalents. For purpose of cash flow disclosures, there was no material interest paid in 2002. The Company made debenture interest payments of $69,307 and $71,681 in 2004 and 2003; respectively. The Company made cash payments for income taxes of $255,809, $582,833 and $173,472 in 2004, 2003 and 2002, respectively.
Furniture and equipment are recorded at cost. Maintenance and repairs are charged to expense as incurred. Provision for depreciation is made on the basis of estimated useful lives of 3 to 10 years utilizing the straight-line method. Accumulated depreciation totaled $531,219 and $487,709 at December 31, 2004 and 2003, respectively. Depreciation expense was $209,851, $195,425, and $224,660, for the years ended December 31, 2004, 2003 and 2002, respectively.
Other assets include agents' balances of $52,086 and $61,028 at December 31, 2004 and 2003, respectively, after reduction for allowance of doubtful accounts. The allowance account had a credit recorded of $2,500 and $1,000 in 2004 and 2003, respectively and an expense of $5,562 in 2002.
The Company adopted Statement #142 of the Financial Accounting Standards Board in the first quarter of 2003, as required. The adoption had no material effect on the financial statements of the Company. The new accounting rule changes the methods of accounting for intangible assets, which generally were amortized over 40 years under previous rules. The new standard requires that intangible assets be separately presented on the face of the Balance Sheet and be periodically tested for impairment of their market value and written off immediately to the extent the value is found to be impaired. As indicated on the face of the Balance Sheet, the Company has intangible assets of $154,483 and $162,237 at December 31, 2004 and 2003 respectively. These assets include the cost of 26 state licenses acquired in 1991 as part of the Statesmen Life Insurance Company acquisition and certain loan acquisition costs. Amortization expense of approximately $7,744, $5,800 and $5,800 was recorded for each of the years ended December 31, 2004, 2003 and 2002, respectively. The Company tested its intangible assets for impairment by evaluating the future benefit of the underlying investments or rights acquired in association with these assets.
The Company accounts for the 1994 Brokers and Agents Stock Option Plan and the 2002 Nondirector, Nonexecutive Stock Option Plan using the fair value method as required by SFAS No. 123. Under this method the fair value of the options granted is recorded as expense at the date of grant. See Note 9.
Net gain per share is based on net gain divided by the weighted average number of shares. The 2003 weighted average number of shares was reduced for the contingent treasury shares described in Note 6.
2. Shareholders' Equity
During 2004 and 2003, the Company made cash offers to shareholders for the purchase of stock. Stock purchases amounted to $542,012 for 913,339 shares in 2004 and $477,023 for 974,541 shares in 2003 and are included in Treasury Stock at December 31, 2004. In order to purchase additional company common stock in 2004, the Company was required to file a Schedule TO with the Securities and Exchange Commission. Included in the cost of the Treasury Stock purchased in 2004 is $77,250 which represents a portion of the cost to complete the TO filing.
2. Shareholders' Equity (continued)
At December 31, 2004 and 2003, shareholders' equity includes approximately $14,478,420 and $13,477,574, respectively, of BNLAC net assets. The ability of BNLAC to pay dividends to the Company is restricted under Arkansas insurance laws and must be approved by the insurance commissioner if it exceeds the lesser of 10% of surplus or net gain from operations for the year. In March of 2003, the Arkansas Insurance Department approved the payment of up to a maximum of $1,138,400 of dividend payments by BNLAC to the Company in order to facilitate the purchase of bonds from debenture holders. BNLAC paid $1,150,000 and $857,734 of dividends to its parent company in 2004 and 2003 respectively.
BNLAC reports to state regulatory authorities on a statutory accounting basis that differs from the basis used herein. Due to an Arkansas regulatory requirement associated with the redomestication in 1994, BNLAC must maintain a minimum of $2,300,000 in capital and surplus. Additionally, each state in which BNLAC is licensed has statutory minimum capital requirements required for maintaining its license to sell. Minimum capital and surplus requirements vary from $300,000 to as much as $5,000,000 in the states in which BNLAC is licensed.
The states periodically increase minimum capital requirements, often allowing companies with existing Certificates of Authority to continue doing business in the state under the previous existing requirements (grandfathering). States in which BNLAC is licensed to do business have increased minimum requirements to as much as $5,000,000. Management actively monitors these developments to maintain compliance with the requirements of each state.
Capital and surplus and net income of BNLAC as reported on a statutory basis are as follows:
The following is a reconciliation of consolidated net income and shareholders' equity per the financial statements included herein to BNLAC unconsolidated net income and capital and surplus on a statutory basis:
3. Income Taxes
The Company follows Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes," which prescribes the liability method of accounting for deferred income taxes. Under the liability method, companies establish a deferred tax liability or asset for the future tax effects of temporary differences between book and tax basis of assets and liabilities. Changes in future tax rates will result in immediate adjustments to deferred taxes. The Company and its Subsidiaries file consolidated income tax returns.
At December 31, 2004 and 2003, respectively, the Company had gross deferred tax assets of $807,542 and $1,004,000 with corresponding valuation allowances of $706,542 and $808,865 resulting from net operating loss carryovers, and temporary differences primarily related to the life insurance subsidiary. The valuation allowance is primarily due to statutory limitations on the use of net operating losses. The resulting net deferred tax asset is $101,000 and $195,136 at December 31, 2004 and 2003, respectively. Realization of the deferred tax asset is dependent on generating sufficient taxable income prior to expiration of the loss carry forward. Although realization is not assured, management believes it is more likely than not that all of the net deferred tax asset will be realized. However, the amount of the deferred tax asset considered realizable could be reduced in the near term if estimates of future taxable income during the carry forward period are reduced.
The provision (benefit) for income tax is as follows:
The reconciliation of income taxes computed at the federal statutory income tax rate to total income taxes for the years ended December 31, 2004, 2003 and 2002 is as follows:
3. Income Taxes (continued)
The Company has net operating loss carry forwards for income tax purposes at December 31, 2004 as follows:
Expiring ---------------------
2005 $38,024 2006 545,898 2007 286,096 2008 202,779 2009 162,019 2010 185,160 2011 65,880 2012 192,537 2018 254,814 2019 130,716 2020 65,199 2023 73,260 2024 28,624 ----------------
$2,231,006 ================
4. Investments
The amortized cost and estimated market value of investments in fixed maturity securities are as follows:
The amortized cost and estimated fair value of investments in fixed maturity securities at December 31, 2004 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties and because most mortgage-backed securities provide for periodic payments throughout their life.
Proceeds from sales and maturities of investments in fixed maturity securities and equity securities for the years ended December 31, 2004, 2003 and 2002 were $9,257,055 $7,606,037, $8,323,605 respectively. Gross gains were $146,584, $155,003 and $17,725 and gross losses were $4,863 $2,052 and $70 as of December 31, 2004, 2003 and 2002, respectively. In 2002 the Company had losses recognized due to permanent impairment of value in fixed maturity and equity securities of $179,084.
4. Investments (continued)
In the third quarter of 2004, BNLAC received notification from the Arkansas Insurance Department that its bond portfolio exceeded the 20% investment limitation for certain federal agencies as they relate to its investment in Federal Home Loan Bank bonds. The Company immediately sold $900,000, par value, of its Federal Home Loan Bank bonds for a loss of $4,490 to initiate compliance with the Arkansas statute. For GAAP purposes the bonds were classified as held to maturity. Further discussions with the Arkansas Insurance Department revealed the Department's intent was not to have the Company dispose of any of its block of Federal Home Loan Bank bonds, but instead request permission to exceed the 20% investment limitation. The Company then requested and was granted permission by the Arkansas Insurance Department to exceed the 20% investment limitation. The Company has determined its held to maturity fixed securities portfolio was not tainted since the bond sales were due to an unusual and isolated occurrence that could not be reasonably foreseen. BNLAC held Federal Home Loan Bank Bonds totaling 27% of statutory assets at December 31, 2004.
During 2004 the Company invested in preferred stock and at December 31, 2004 the cost and market value was $200,000.
Investment in equity securities at December 31, 2004 and 2003 represents common and preferred stock investments as follows:
Net investment income for the years ended December 31, 2004, 2003 and 2002 is as follows:
Net realized gains and losses are summarized below:
4. Investments (continued)
Other long-term investments of $1,557,407 and $1,527,407 in 2004 and 2003 respectively, consists of, in part, a convertible debenture loan in the amount of $1,357,407 from the Company, to EPSI Benefits, Inc. (EBI), a Texas Corporation. The loan bears interest at an annual rate of 14%, payable monthly, with principal payments commencing September 15, 2008 and a maturity date of August 15, 2015. To protect its interest, the Company may convert the debenture into 51% of the outstanding common stock of EBI, subject to regulatory approval. The note is one of several agreements entered into by the Company's subsidiaries which expand the business relationship with EBI and its subsidiary, Employer Plan Services, Inc. (EPSI), which provides substantially all of the A&H claims processing and adjudication for the Company's insurance subsidiary, BNLAC. BNLF receives a marketing fee from EBI under a related marketing agreement.
Other long-term investments also include an operating line of credit agreement in the amount of $200,000 and $170,000 in 2004 and 2003 respectively. On October 15, 2003 BNLAC and EPSI entered into a loan agreement whereby BNLAC will provide EPSI with a $200,000 line of credit maturing October 15, 2004. The line of credit was renewed and extended with interest only payments to August 1, 2005, thereafter EPSI will pay principal and interest over 60 equal monthly installments until paid in full. The line of credit is at prime, 5.25%, with interest payable monthly to BNLAC.
Regulatory authorities require certain Company investments to be deposited or pledged for the benefits of policyholders as a condition of doing business in certain states. The carrying values of these investment deposits are approximately $4,000,000 as of December 31, 2004 and 2003.
The Company's conservative investment philosophies minimize market risk and risk of default by investing in high quality debt instruments with staggered maturity dates. The Company does not hedge investment risk through the use of derivative financial instruments. The market value of the Company's investments in debt instruments varies with changes in interest rates. A significant increase in interest rates could cause decreases in the market values of investments and have a negative effect on comprehensive income and capital.
5. Fair Value of Financial Instruments
(a) The indicated assets and liabilities are carried at book value, which approximates fair value. (b) Fair value of investments is based on quoted market price or dealer quotes, when available. If quotes are not available, fair values are based on quoted prices of comparable instruments.
6. Commitments and Contingencies and Supplemental Cash Flow Information
In 2001, the Board of Directors of the Company and BNL Equity Corporation approved a settlement in the class action case brought by certain shareholders. The settlement, which was approved by the Pulaski County Circuit Court and the Arkansas Insurance Commissioner, was subject to various conditions, including the approvals by any other applicable regulatory authorities and conditioned upon compliance with federal and state securities laws. As of December 31, 2002, all requisite approvals were received and redemption of the stock began in 2003.
As part of the settlement agreement, the Company issued its Bonds in the principal amount of $1.50 in exchange for each share of common stock of BNL owned by the members of the Class. The Bonds are for a term of twelve years, effective December 15, 2002, with principal payable at maturity and bear interest at the rate of 6% per annum payable annually from the previous fiscal year's earnings of BNL and will impact earnings per share to the extent of approximately $.013 per share. If any interest payment is not made, it will be added to the principal and paid at maturity. The Bonds are fully callable and redeemable at par at any time by BNL.
During 2003, the Company reclassified Contingent Long Term Liabilities and Contingent Treasury Stock in the amount of $3,637,288 to Bonds Payable and Treasury Stock, respectively, in accordance with the character of the litigation settlement of 2001 and the performance of all duties thereunder. The $3,637,288 of Treasury Stock was retired and returned to authorized but not issued status. The $660,447 Contingent Long Term Liabilities and Contingent Treasury Stock on the Balance Sheet in 2003 represents shares the Company had not been able to determine the status regarding their right to exchange under the settlement agreement. During 2004 the Company determined that $518,517 of the Contingent Long Term Liabilities and Contingent Treasury Stock should not be included in the settlement agreement. The remaining $141,930 was reclassified to Bonds Payable and Treasury Stock.
In 2004 and 2003, the Company made cash offers to bond holders for the purchase of bonds. Bond purchases resulted in a reduction of Bonds Payable of $1,159,406 and $611,789 in 2004 and 2003; respectively. Gains from early extinguishments of the debt were $495,462 and $424,727 in 2004 and 2003; respectively.
In 2004 and 2003, the Company became a third party indemnitor by entering into a series of bond indemnity and guarantee agreements with various terms totaling approximately $545,000 in conjunction with a marketing agreement with third parties, EPSI Benefits Inc. (EBI) and Employer Plan Services Inc. (EPSI). The purpose of these agreements is to assist EPSI in becoming licensed in additional states. The Company received personal guarantees from the owners of EPSI to effectively limit potential liability under the guarantee agreements. With regard to the bond indemnity, the Company will be obligated only if EPSI, EPSI's parent and its shareholders, who are the primary obligors, were all to become insolvent. Management considers the likelihood of the Company realizing a liability under these agreements to be remote.
6. Commitments and Contingencies and Supplemental Cash Flow Information (continued)
The Company has entered into noncancelable operating leases for office space and equipment. Future minimum payments under the leases are as follows:
2005 $ 169,000 2006 24,000 2007 10,000 --------------
Total $ 203,000 ==============
Related lease cost incurred for the years ended December 31, 2004, 2003 and 2002 was $272,349, $268,892, and $226,769. respectively.
The Company's wholly owned insurance subsidiary may be subject to losses related to guaranty fund assessments. Such assessments result from liquidation of troubled insurers by state regulators. The assessment to BNLAC, if any, is not reasonably estimable, nor expected to have a material effect on the financial statements.
Periodically in the ordinary course of business the Company exceeds federally insured limits in its operating accounts. Cash deposits in excess of federally insured limits are approximately $1,750,000 at December 31, 2004.
See Note 2 for information regarding minimum capital requirements to maintain a license to sell in various states.
7. Liability for Unpaid Claims
Activity in the liability for unpaid claims is summarized as follows.
-------------- -------------- 2004 2003 -------------- -------------- Balance at January 1 $ 2,588,992 $ 2,357,549 less reinsurance recoverable 10,000 - -------------- -------------- Net Balance at January 1 2,578,992 2,357,549 -------------- -------------- Incurred related to: Current year 26,649,186 25,356,105 Prior years (252,342) (300,762) -------------- -------------- Total Incurred 26,396,844 25,055,343 -------------- --------------
Paid related to: Current year 24,412,258 22,777,113 Prior years 2,327,649 2,056,787 -------------- -------------- Total Paid 26,739,907 24,833,900 -------------- --------------
Net Balance at December 31 2,235,929 2,578,992 Plus reinsurance recoverable - 10,000 -------------- -------------- Balance at December 31 $ 2,235,929 $ 2,588,992 ============== ==============
8. Reinsurance
Liability for future policy benefits is reported before the effects of reinsurance. Reinsurance receivable (including amounts related to insurance liabilities) is reported as assets. Estimated reinsurance receivable is recognized in a manner consistent with the liabilities related to the underlying reinsurance contracts. Such amounts have been presented in accordance with Statement of Financial
8. Reinsurance (continued)
Standards No. 113, "Accounting and Reporting for Reinsurance of Short Duration and Long Duration Contracts." The Company is liable if the reinsuring companies are unable to meet their obligations under the reinsurance agreements.
BNLAC's Accidental Death Benefit riders are reinsured 100% through a Bulk ADB reinsurance agreement with Generali USA Life Reassurance Company ("Generali"), formerly Business Men's Assurance Company. Generali was rated "A" (Excellent) by AM Best Company for 2003.
BNLAC's individual life insurance products in excess of $35,000 are reinsured with Generali under an automatic treaty up to $175,000 and under a facultative treaty for amounts over $175,000.
BNLAC's Group Life insurance is reinsured under a Quota Share reinsurance agreement with Hannover Life Reassurance Company of America. The reinsurer is liable for 90% of the risk on the life of each insured up to the policy maximum of $65,000 on the group life insurance. Hannover Life Reassurance Company of America was rated "A" (Excellent) by AM Best Company for 2003.
Effective November 1, 2003, BNLAC entered into a quota share reinsurance agreement with Hannover Life Reassurance Company of America for the Accidental Death and Dismemberment plan. Hannover Life Reassurance Company of America accepts 90% of the risk. Hannover Life Reassurance Company of America was rated "A" (Excellent) by AM Best Company in 2003.
BNLAC has entered into a quota share reinsurance agreement with Hartford Life and Accident Insurance Company for its Group Life and Accidental Death and Dismemberment plans. The agreement is effective January 1, 2005 and will replace Hannover Life Reassurance Company of America. Hartford was rated A+ (Superior) by AM Best Company for 2003.
BNLAC's Short Term Disability insurance is reinsured under a Quota Share reinsurance agreement with Fortis Benefits Insurance Company of Kansas City, Missouri. The reinsurer is liable for 75% of the risk on each policy. Fortis Benefits Insurance Company was rated "A" by AM Best Company for 2003.
Following is a summary of reinsurance for December 31, 2004, 2003 and 2002:
9. Benefit Plans for Certain Brokers/Agents and Employees
In 1994, the Board of Directors and Shareholders approved the 1994 Brokers and Agents' Nonqualified Stock Option Plan. This plan was established as an incentive to sales persons of BNLAC. Initially 250,000 shares were available under the plan. Options for an additional 1.75 million shares were authorized by the Board of Directors. The option period may not exceed a term of five years and the duration of the plan is ten years. A four-member committee of Directors administers the plan. During 2004, 2003 and 2002, the Company granted 129,575, 131,925 and 154,855 stock options, respectively, with an exercise price of $1.00 per share for those granted in 2004, $.75 per share for those granted in 2003 and $50 per share for those granted in 2002. There were 515,955 stock options outstanding at December 31, 2004. The number of options expiring or forfeited were 199,500 and 437,500 in 2004 and 2003, respectively. There were 38,350 options exercised in 2004 and 38,525 options exercised in 2003. Under the fair value method, total compensation recognized for grant of stock options was $4,000 in 2004. The fair value of options granted is estimated at $4,000, 0$ and $1,596 in 2004, 2003 and 2002. These values were computed using a binomial method as prescribed in SFAS No. 123 and certain assumptions include a risk free interest rate of 5.0%, expected life of 3.0 years, expected volatility of 14.0% and no expected dividends due to statutory limitations. The estimated weighted average remaining life of the options is 1.5 years and the weighted average exercise price is $.76. The options do not have a dilutive effect on earnings per share at this time, but may have such an effect in the future. See Note 1.
In 2001, the Board of Directors approved the 2001 Incentive Bonus Plan for the benefit of certain Officers of the Company. The plan provides for semi-annual payment of cash bonuses based on 10% of consolidated pre-tax operating income. BNLAC bears its prorata share of the bonus expense based on its pre-tax statutory profits. Bonus expense was $312,069, $334,134 and $287,673 under this plan for 2004, 2003 and 2002, respectively.
In March 2002, the Board of Directors approved the 2002 Non-Director, Non-Executive Stock Option Plan, subject to any necessary authorizations from any regulatory authority. The plan is intended to assist the Company in attracting and retaining individuals of outstanding ability and to promote concurrence of their interests with those of the Shareholders of the Company. The Company granted 60,300 options with an exercise price of $.75 in 2004 and 55,700 options with an exercise price of $.50 in 2003. The fair value of options granted is estimated at $11,000 in 2004 and $10,940 in 2003. This value was computed using a binomial method as prescribed in SFAS No. 123 and certain assumptions include a risk free interest rate of 5.0%, expected life of 10.0 years, expected volatility of 14.0% and no expected dividends due to statutory limitations. The estimated weighted average remaining life of the options is 8.4 years. The options do not have a dilutive effect on earnings per share at this time, but may have such an effect in the future. See Note 1.
The Company has a stock bonus plan for the benefit of certain Officers of the corporation. The plan provides for a bonus based on consolidated after-tax profits subject to specified limits. The bonus amount, net of taxes, will be used to purchase stock in the Company. Stock bonuses in the amount of $100,000 were granted and charged to expense in each of the years 2004, 2003 and 2002, respectively.
The Company has an Employee Pension Plan that is a qualified retirement plan under the Internal Revenue Code. All employees who have attained age 21 and have completed one year of service are eligible to contribute. Employer contributions are discretionary. The Company contributed $57,698, $46,138 and $32,565 in 2004, 2003 and 2002, respectively.
10. Concentrations
The majority of the Company's premium income and gross income continues to be generated by the dental insurance products. This concentration makes the Company increasingly dependent upon the success of this block of business and any economic factors and risks unique to dental insurance. See Note 1. The Company has no distinctly reportable business segments.
11. Change in Accounting Estimate
In 2002, management evaluated the balances of certain potential liabilities that were originally recorded on a contingent basis. It was determined that the remaining amounts, approximately $195,000 of liability, were owed to sales agents who never contracted to sell for the company and the possibility is remote any claim will be made for the back commissions. Accordingly, the liability was reduced by this amount and 2002 commission expense reduced by a like amount.
11. Change in Accounting Estimate (continued)
Based on claims experience in 2004 and 2003, the estimate of claims liability at December 31, 2003 and 2002 was overstated by approximately $133,113 and $300,000; respectively (adjusted for loss adjustment expense in 2003.) The over estimate of this liability has contributed a corresponding decrease in claims expense in 2004 and 2003.
The liability for future policy benefits includes an additional contract reserve of approximately $611,410 for the individual dental policies. The Company has marketed this product since 2001 and was notified by its actuary in the first quarter of 2004, that new reserve rules prescribed by most state insurance departments now require additional reserves be established to more properly match premiums and benefits for this product. The effect of this change in reserve estimate on the net income in the period ended December 31, 2004 is approximately $378,000 ($.02 per share) after considering the tax effect and a related increase in deferred acquisition costs.
12. Subsequent Events
In 2005, the Company has negotiated a lease for new office space in Austin, Texas that is contingent upon the current lessee vacating the space by April 15, 2005. The cost of the lease per square foot is less than the current lease.
In 2005, the Company has negotiated with Universal Guaranty Life Insurance Company to purchase 2,216,776 shares of BNL Financial Corporation's common stock for $2,300,000. The transaction is pending regulatory approval.
13. Unaudited Quarterly Results of Operations
The summary unaudited quarterly results of operations were as follows:
===============================================================================
Exhibit 31.2 Certification of Chief Executive Officer Section 302
I, Wayne E. Ahart, certify that:
1. I have reviewed this Annual report on Form 10-K of BNL Financial Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 30, 2005
/s/ Wayne E. Ahart ----------------------- Wayne E. Ahart Chairman of the Board E-1
Exhibit 31.2 Certification of Chief Financial Officer Section 302
I, Barry N. Shamas, certify that:
1. I have reviewed this Annual report on Form 10-K of BNL Financial Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 30, 2005
/s/ Barry N. Shamas ----------------------- Barry N. Shamas Executive V. P. E-2
Exhibit 32.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER OF BNL FINANCIAL CORPORATION PURSUANT TO 18 U.S.C. ss. 1350
In connection with the accompanying report on Form 10K for the period ending December 31, 2004 and filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Wayne E. Ahart, Chief Executive Officer of BNL Financial Corporation, hereby certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13 (a) or 15 (d) of the Securities Exchange Act of 1934; and
2. The information contained in this Report fairly presents, in all material respects the financial condition and results of operations of the Company.
/s/ Wayne E. Ahart - -----------------------
Wayne E. Ahart Chief Executive Officer March 30, 2005
Exhibit 32.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER OF BNL FINANCIAL CORPORATION PURSUANT TO 18 U.S.C. ss. 1350
In connection with the accompanying report on Form 10Kfor the period ending December 31, 2004 and filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Barry N. Shamas, Chief Financial Officer of BNL Financial Corporation, hereby certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13 (a) or 15 (d) of the Securities Exchange Act of 1934; and
2. The information contained in this Report fairly presents, in all material respects the financial condition and results of operations of the Company.
/s/ Barry N. Shamas - -----------------------
Barry N. Shamas Chief Financial Officer March 30, 2005
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