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 7010 Hwy. 71 West, Suite 100, Austin, Texas 78735; 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
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Consumer's Protective Association
(Inactive Association)
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Brokers National Life Assurance Company
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BNL Brokerage Corporation
Industry Segments
The operations of the Company are conducted through BNLAC, which in 2006 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 2006, BNLAC was granted a certificate of authority in California and Wisconsin and in the first quarter of 2007 the Company received a certificate of authority in Virginia and North Carolina. This makes 40 states the Company is able 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. BNLAC also markets group and individual vision insurance products that are underwritten by other insurance companies, on which BNLAC does not have any exposure to underwriting (claims) losses. 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: individual and group term life insurance, hospital indemnity insurance, group and individual dental insurance, short term disability insurance, accidental death and dismemberment insurance and cancer insurance. Most of these products are designed to be sold on a group or payroll deduction basis.
BNLAC also markets group and individual vision insurance products that are underwritten (issued) by other insurance companies. BNLAC "co-brands" these products with its name and logo and markets them through its sales force. BNLAC collects overwrite commissions and/or administrative fees on these products and does not have any exposure to underwriting (claims) losses.
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 and individual dental insurance premiums collected for each of the past five years ended December 31.
The following chart shows group dental insurance claims paid and incurred 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.
Agents' Commissions
On December 31, 2006, BNLAC had 4,728 general agents and brokers that market its policies in 38 states compared to 4,927 agents and brokers on December 31,
On all of its products BNLAC believes it 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.
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.
In 2005, BNLAC’s accidental death benefit riders were 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 2005. Effective July 1, 2005, administration was taken over by Optimum Re on the Bulk ADB insurance. Optimum Re was rated “A-“(Excellent) by AM Best Company for 2005. In 2006, Optimum Re agreed to reinsure this block under the same terms as Generali.
In 2005, BNLAC’s individual life insurance products in excess of $35,000 were reinsured with Generali under an automatic treaty up to $175,000 and under a facultative treaty for amounts over $175,000. Effective July 1, 2005, administration was taken over by Optimum Re on the individual life insurance products. Optimum Re was rated “A-“ (Excellent) by AM Best Company for 2005. In the Company reached an agreement with Optimum Re to reinsure this block under the same terms as Generali.
BNLAC entered into a quota share reinsurance agreement with Hartford Life and Accident Insurance Company for its group life and accidental death and dismemberment plans effective January 1, 2005 whereby Hartford accepts 90% of the risk up to a maximum of $100,000 per life. This reinsurance replaced Hannover Life Reassurance Company of America. Hartford was rated “A+” (Excellent) by AM Best Company for 2005.
BNLAC’s Short Term Disability insurance is reinsured under a quota share reinsurance agreement with Assurant Health, Milwaukee, Wisconsin, (formerly Fortis Benefits Insurance Company of Kansas City, Missouri). The reinsurer is liable for 75% of the risk on each policy. Assurant Health was rated “A” (Excellent) by AM Best Company for 2005.
Group and individual dental is not reinsured due to the economics of the dental business and the small annual maximum liability per policy.
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 and corporate bonds and common stocks. The earnings from such investments represent a substantial part of BNLAC's income. For each of the five years ended December 31, BNLAC's statutory net investment income and ratio of net return on mean invested assets were as follows:
For information concerning realized and unrealized gains and losses on securities see Note 4 of the Notes to Consolidated Financial Statements on page and the table on page 17.
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. 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 are 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, 2006 indicated that the ratios of total adjusted capital to RBC for BNLAC would have been in excess of 912% and, therefore, significantly above the Company Action Level.
As part of their routine regulatory process, approximately once every five years, insurance departments conduct detailed examinations of the books, records and accounts of insurance companies domiciled in their states. Such examinations are generally conducted in cooperation with the departments of other states under guidelines promulgated by the NAIC.
In September 2005, the Arkansas Insurance Department conducted its statutory examination for the period ended December 31, 2004. 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.
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 1,150 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, 2006 BNLAC had four executive officers and 61 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 labor union. BNLAC uses a third party administrator to process dental claims.
ITEM 1A.
ITEM 1A. Risk Factors
The Company is not aware of any risk factors which may relate to speculative or risky circumstances to the Company’s outstanding common stock.
To the extent which any matters presented in Item 1, Business, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, or Item 7A, Quantitive and Qualitative Disclosures About Market Risk may be applicable, they are incorporated herein by reference.
ITEM 1B.
ITEM 1B. Unresolved Staff Comments
None.
ITEM 2.
ITEM 2. Properties
Neither the Company, nor any of its subsidiaries own any real estate.
During the first quarter of 2005 the Company entered into a lease for 20,337 square feet of office space in Austin, Texas, under an eight year, triple net lease. The base rent is $0 in the first year (June 1, 2005 to May 31, 2006), $157,612 in the second year and payments escalate to $264,384 in the final year of the lease. Leasehold improvements totaled approximately $872,000 ($203,000 funded by landlord) on the new lease space that was occupied in December 2005. Leasehold improvements are being amortized over the lease term. The $117,000 initial rent holiday and $203,000 of landlord funded leasehold improvements will be amortized over the lease term and reduce lease expense. Deferred rent credits are included in other liabilities and were approximately $380,000 and $320,000 for 2006 and 2005, respectively.
During the first half of 1998 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. Effective January 1, 2004, the Company leased an additional 798 square feet in the adjacent building at a rate of $9,576 per year. The lease rate remained in affect until the term of the lease expired. The Company terminated lease payments at the end of February 2006.
BNLF leases approximately 1,400 square feet of office space in Sherwood, Arkansas at a rental of $18,120 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 $7,476 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 balance of Bonds Payable was $1,639,984 and $1,747,178 at December 31, 2006 and 2005, respectively. 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.
In and 2005, the Company made cash offers to bond holders for the purchase of bonds. Bond purchases resulted in a reduction of Bonds Payable of $107,194, and $259,757 in 2006 and 2005; respectively. Gains from early extinguishments of the debt were $35,732, $102,067 and $495,462 in 2006, 2005 and 2004; 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 2006.
PART II
ITEM 5.
ITEM 5. Market for Registrant’s Common Equity and Related Stockholder Matters
Market for Stock
On April 15, 2005, the Company purchased 2,216,776 shares of its Common Stock, approximately 11% of the Company's outstanding Common Stock, from Universal Guaranty Life Insurance Company, at a purchase price of $2,300,000 (approximately $1.04 per share) which purchase and purchase price were negotiated. From time to time during 2005, some shareholders requested that the Company purchase their shares and the Company did purchase a total of 148,667 shares from such shareholders at prices ranging from $.63 to $1.04 per share.
During the second quarter of 2005, the Company retired 3,767,590 treasury shares
Beginning on June 8, 2006, the Company made an issuer tender offer (with a Form TO filing with the Securities and Exchange Commission) at a purchase price of $1.00 per share ("2006 Issuer Tender Offer"). The 2006 Issuer Tender Offer terminated on September 8, 2006, and as a result the Company purchased 1,192,729 shares of its Common Stock for a total amount of $1,192,729. The Company purchased an additional 55,562 shares at the request of shareholders at $1.00 per share in 2006.
The stock is not traded on any established trading market.
Purchases of Common Stock During Last Quarter
The following table sets forth the shares of the Company’s outstanding Common Stock which the Company purchased during each of the three months within the fourth quarter of fiscal year ending December 31, 2006:
Period
(a)
Total number of shares purchased
Note
(b)
Average price paid per share
(c)
Total number of shares purchased as part of publicly announced plans or programs
(d)
Maximum number of shares that may yet be purchased under the plans or programs
Month #1 (October 1-31)
4,668
$1.00
NA
NA
Month #2 (November 1-30)
-
-
NA
NA
Month #3 (December 1-31)
52,762
$1.00
NA
NA
Total
56,762
$1.00
NA
NA
Note 1 to the above table: During the fourth quarter of 2006, the Company did not have any publicly announced plan or program to repurchase its outstanding Common Stock. From time to time, some shareholders of the Company request the Company to purchase their stock and the Company does, from time to time, make such repurchases but only does so in its sole and absolute discretion and the Company is under no obligation to make any such repurchases in the future.
Holders
As of December 31, 2006 there were 2,206 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 2003 and 2004, the Company granted 129,575 and 131,925 stock options, respectively, with an exercise price of $.75 per share for those granted in 2003 and $1.00 per share for those granted in 2004. There were 245,575 stock options outstanding at December 31, 2006. The number of options expiring or forfeited were 148,205 and 103,725 in 2006 and 2005, respectively. There were 1,000 options exercised in 2006 and 17,450 options exercised in 2005. The fair value of options granted was estimated at $4,000 and 2004. These values were computed using a binomial method as prescribed in SFAS No. 123(R) 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 .61 years and the weighted average exercise price is $.88. 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. No options were granted in 2006. 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(R) 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 6.4 years and weighted average exercise price is $.63. 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 sets forth the Equity Compensation Plans as of December 31, 2006.
Plan Category
A
Number of Securities to be issued upon exercise of outstanding options
B
Weighted Average exercise price of outstanding options
C
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)
Approved by security holders
Brokers and Agents Plan
245,575
$.88
-
Not approved by security holders
Employee Plan
108,000
$.63
134,000
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, 2006 are derived from the Company's consolidated financial statements. The consolidated financial statements as of December 31, 2006 and 2005, and for each of the years in the three-year period ended December 31, 2006 are included elsewhere in this Form 10-K.
*This information should be read in conjunction with the disclosure concerning the Management's Discussion and Analysis of Financial Condition and the audited Financial Statements and Notes thereto set forth 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, 2006, 2005 and 2004 and the consolidated results of operations for the periods ended December 31, 2006, 2005 and 2004. 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:
Liabilities 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 and actual results may result in revised claims expense which is recognized in the period in which the difference is determined. See Note 1, 7 and 11 to our financial statements for the effect on the year 2006.
Claim Liability Methodology
The Company, through its wholly owned subsidiary, BNLAC, has a single line of business which is life and accident and health insurance. The Company’s SIC code is 6311 which is a standard industrial classification used by the United States Securities and Exchange Commission (“SEC”). Using such SIC code, an interested person can research the internet website of the SEC, www.sec.gov, to find and review business and financial information of other companies which are in the same line of business.
The following is a summary description of the Company’s methodology for estimating its claim liabilities for its insurance policies. The Company and management believe that this discussion constitutes forward looking statements and, therefore, this discussion is given full safe-harbor.
It should be understood that there is no assurance that anything which the Company and its management have done in the past regarding its claim liability methodology will be done in the future. The Company and its management are afforded full and complete authority and judgment in determining and implementing its claim liability methodology which includes any and all changes which may be made from time to time.
The Company’s significant insurance product types are presently dental (group and individual), life (group and individual), and annuities.
In the life and accident and health insurance industry, the liabilities for claims and the related expensing of those liabilities are evaluated and recorded using estimates of claim liabilities. The Company estimates its claim liabilities using the general methodology described herein.
The liability for claims generally consists of the following: (1) due and unpaid claims, (2) claims in the course of settlement, and (3) claims incurred but unreported. The Company records the actual liability for all claims that are due but unpaid, Item (1). But, with regard to the last Items (2) and (3), the Company must make estimates. The estimates are based on actuarial principles. The Company’s independent consulting actuary works with Company financial personnel and management in determining the estimates and the independent consulting actuary annually gives the Company a certification as to the amounts of the liabilities.
The Company calculates and maintains claim liabilities for the estimated future payments on claims incurred before the statement date. These calculations are based on actuarial principles in accordance with industry standards and applicable GAAP requirements. Development of such liabilities is done with Company financial personnel and management working with the Company’s independent consulting actuary. These liabilities involve many considerations including but not limited to economic and social conditions, inflation, and healthcare costs. The claim liabilities developed include significant estimates and assumptions based on management’s review of historical experience in consultation with its independent actuary. The extent to which future payments match the claims liabilities is dependent on how well actual future experience matches the assumptions management makes regarding the future experience. The Company’s liabilities are estimates that require significant judgment and, therefore, are inherently uncertain.
It is common in the life and accident and health insurance industry for a consulting actuary to give either (A) a liability certification where the liabilities are expressed as a range of numbers for each relevant liability (the “Range Estimate”), or (B) a
liability certification where the liabilities are expressed as a single number for each relevant liability (the “Single Point Estimate”).
Where the Range Estimate method is used, the management of an insurance company makes its own choice to record an amount within the range. The Company does not use the Range Estimate for any of its insurance products. Instead, for all of its insurance products, the Company uses the Single Point Estimate.
For the Company’s group and individual dental insurance, the Company’s financial personnel develop and make a Single Point Estimate for the claim liabilities which work results in the Company’s Single Point Estimate for the end of each fiscal quarter and year end. The Company’s independent consulting actuary develops and makes its separate Single Point Estimate for such liabilities. The Company’s financial personnel and independent consulting actuary compare their Single Point Estimates, reconcile any differences and agree on a Single Point Estimate for such liabilities. Annually, the Company’s independent consulting actuary gives a Single Point Estimate liability certification to the Company with the agreed amount and the Company uses such certified amount without change.
For the Company’s group and individual life and annuity insurance, the Company’s financial personnel make the Single Point Estimate for each such claim liability. Annually, the Company’s consulting actuary independently reviews the Single Point Estimates. If the independent consulting actuary agrees with the Single Point Estimates, he gives a certification to the Company.
The Company’s financial personnel have significant experience and knowledge in developing claim estimates for the Company’s insurance products. However, the Company’s financial personnel are not formally trained, certified or recognized as actuaries. The Company continually engages independent consulting actuaries. The Company makes extensive use of its independent consulting actuaries which includes the actuaries’ assistance in the development and creation of policy assumptions, the development and modification of reserve and claim liability methodologies and assumptions, estimations and calculations of reserves and claim liabilities, and the annual certification of the amount of the Company’s liabilities for its products.
While claim liabilities are estimated as an inherent part of the insurance industry, management of the Company believes that it follows standard industry practices in estimating claim liabilities.
The following discussions of claim liability methodology are separated by the Company’s product types as indicated by the section headings.
Dental Insurance - Group and Individual
For the Company’s group and individual dental insurance policies, the Company and its independent consulting actuary use a completion factor approach (sometimes referred to as the development method) which provides best estimates of the factors to determine claim liabilities.
In implementing the completion factor approach, a review of payment history develops the completion factors. These completion factors relate what percentage of an ultimate claim is paid based upon its duration from date of service. Such completion factors are monitored over time and have been relatively stable. The completion factors are used to estimate the liabilities for the months in which the claims are incurred where they are deemed to be credible.
However, with respect to claims incurred in the most recent months, the completion factors may not be fully credible (the payment history is not complete). So, as is common in the industry, a review is made of developing claims per insured by month and loss ratios by month for the most recent months. The Company’s financial personnel and management and the Company’s independent consulting actuary make a Single Point Estimate based upon their determination of the loss ratios and claims per insured for the most recent months.
Of all the assumptions made by the Company’s financial personnel and management and the Company’s independent consulting actuary, the loss ratio and the claims per insured per month for the most recent months are the most sensitive ones for liability estimation. If the loss ratios and claims per insured per month increase, claim liabilities will likely increase by some amount. If the loss ratios and claims per insured per month decrease, claim liabilities will likely decrease by some amount.
Management reviews trends in loss ratios and claims per insured per month in determining its estimate for the most recent months. Generally, while fluctuations do occur, the Company’s loss ratio and claims per insured per month are stable. In estimating claim liabilities (the policy claims payable on the Company’s balance sheet), the Company consistently uses the
assumptions of loss ratio and claims per insured per month which are based on actual, historical data. See, the discussion in the section herein entitled “Trends in Completion Factors, Loss Ratio, and Claims Per Insured Per Month”.
As to the consistency of the Company’s estimation of its claim liabilities (the policy claims payable on the Company’s balance sheet), you may reference Notes 7 and 11 to the Company’s Financial Statements. Notes 7 and 11 present data indicating the actual claims paid in a subsequent fiscal year for a prior fiscal year; actual claims incurred in a subsequent year for a prior fiscal year; and the claim liabilities for the prior fiscal year. Notes 7 and 11 are limited to the most recent fiscal year being reported, December 31, 2006, and the previous fiscal years of 2005 and 2004.
Life Insurance - Group and Individual - and Annuities
The Company reinsures a substantial portion of its life insurance and the associated risks and liabilities. See Item 1, Business, Reinsurance; and Note 8, Reinsurance, to the Company’s financial statements.
The Company determines its life insurance claim liabilities by recording three items: (1) actual claims due and unpaid; (2) the claims received during the day period following year end (this is done by taking an inventory of claims received during the thirty day period); and (3) estimating a liability amount for claims which have been incurred but not yet reported by the end of the thirty day period.
The Company’s annuity policies are simple deferred annuities. The Company does not explicitly establish a claim liability for its annuities since the liability is already held in the annuity deposit liability.
Trends in Completion Factors, Loss Ratio and Claims Per Insured Per Month
Claim liabilities for the Group Dental line are the most significant part of the Company’s claim liability. As stated above, the Company uses the completion factor method for calculating the liability. Two main assumptions are made in this approach. First, for months the claims are incurred where the completion factor is credible, the Company uses that completion factor to calculate the liability associated with that month the claim occurred. Second, for the most recent months before the Company’s financial statement date where it is determined that the completion factors are not fully credible, the Company reviews loss ratios and claims per insured per month to determine the liability for those months.
The discussion in this paragraph relates to the months where the completion factors are deemed to be fully credible which are typically the months prior to November and December. The completion factors have been relatively stable in the recent past. In the future, there could be changes in the trend of completion factors. The Company and its independent consulting actuary review the trends in the completion factors and when necessary make judgments as to the Single Point Estimate value for these items. Such estimates are based on observable trends and would also reflect any known major changes. Professional judgments are made based on the experience of the actuary and Company’s financial personnel and management. To observe the possible sensitivity of assuming 100% reliance on completion factors for claims incurred during the months for which completion factors are believed to be fully credible, if the associated claim liabilities for those months had increased by 5%, the year end December 31, 2006, claim liabilities would have been increased by approximately $22,000.
The discussion in this paragraph relates to the months where the completion factors are deemed to be not fully credible which are typically the months of November and December. The choice of the loss ratio assumption or claims per insured per month assumption for the most recent month of the claim was incurred may also have an impact on the liability estimate. These assumptions are monitored for trends. The Company and its consulting actuary monitor the loss ratio and claims per insured month and override the completion factor approach for the most recent months before the Company’s financial statement date where the completion factors are not fully credible, i.e. November and December. To observe the possible sensitivity of assuming 100% reliance on loss ratio or claims per insured per month factors for claims incurred during the months for which completion are believed to be not fully credible (typically November and December of a fiscal year), if the loss ratio or claims per insured per month had increased by 3% for those months (a multiple of 1.03), the associated claim liabilities for those months and the year end December 31, 2006, claim liability would have been increased by approximately $135,000.
The Company believes that its recorded claim liabilities are reasonable and adequate to satisfy its ultimate claims liability. The Company’s recorded claim liabilities are, in accordance with industry practice, estimates of such liabilities.
The reader must recognize that the completion factors, loss ratios and claims per insured per month may, and probably will, be affected by events and conditions which are or will be unknown to the Company’s financial personnel or management or the
Company’s consulting actuary. The reader must also recognize that any trending of the completion factors, loss ratios or claims per insured per month may not be indicative of changes in the Company’s financial condition.
While a presentation such as described above provides some mathematical and hypothetical numerical calculations, such calculations may or may not have any relevance to the Company’s future financial condition, earnings or cash flow.
Deferred Tax Asset
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, 2006 and 2005, respectively, the Company had gross deferred tax assets of $1,397,439 and $1,410,226 with corresponding valuation allowances of $1,072,825 and $1,094,773, and gross deferred tax liabilities of $303,614 and $278,453, 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 $21,000 and $37,000 at December 31, 2006 and 2005, 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, 2006, 2005 and 2004 is as follows:
The Company has net operating loss carry forwards for income tax purposes at December 31, 2005 as follows:
Financial Condition
The statutory capital and surplus of insurance subsidiary decreased in 2005 primarily due to $2,950,000 of dividends paid to the Company.
Liquidity and Capital Resources
At December 31, 2006 the Company had liquid assets of $1,673,058 in cash, receivable on fixed securities, 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 2006, BNLAC collected approximately $44.8 million of premiums and annuity deposits (gross before reinsurance) and realized $1,005,775 of net investment income. Another source of cash flow in 2006 was overwrite commissions of $1,603,767 on vision products. During the year the Company incurred $34,374,507 in policy benefits and other insurance costs.
The net cash flow for 2006 was $726,786 versus operating income of $3,082,645. The difference is primarily due to the purchase of $1,297,948 of the Company’s treasury stock, a decrease in annuity deposits of approximately $350,367, the purchase of fixed assets and leasehold improvements of $269,487 and purchase of bonds payable and equity securities totaling $294,744 .
Approximately $596,800 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 $19.1 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.
The Company’s investments are primarily in U.S. Government and Government Agencies ($15,819,988 amortized book value), other investment grade bonds ($2,886,306 amortized book value) and less than investment grade ($422,343 amortized book value).
The table below discloses the unrealized gains and losses on the bonds that are less than investment grade.
The Company does not hedge its investment income through the use of derivatives.
Other long term investments of $1,507,809 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 $150,402 and $186,034 in 2006 and 2005 respectively. On October 15, 2003 BNLAC and EPSI entered into a loan agreement whereby BNLAC provided 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, at which time EPSI began paying principal and interest payments amortized over five years. The line of credit is at 8.00% with interest and principal 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"). One term of the settlement was 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 bonds payable at December 31, 2006 is $1,639,984 compared to $1,747,178 at December 31, 2005. Bond interest expense was $86,700, and $116,920 in 2006 and 2005; 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 2006, BNLAC paid dividends totaling $1,450,000 to BNLF for the purchase of Company stock and bonds and for other general operating funds compared to $2,950,000 dividends paid in 2005. In 2005, the Company 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 following table reflects all long-term contractual obligations of the Company as of December 31, 2006.
* The notes to this long-term contractual obligations table are part of the table and are important.
** Interest payments are made only if the Company is profitable.
Notes to Long-Term Contractual Obligations Table:
Special Note Relating to Notes A, B, C and D and the information and presentation for liabilities for future policy benefits, policy claims payable, annuity deposits and supplementary contracts.
The data, information and presentation in this Long-term Contractual Obligations Table relating to the Company’s Liabilities for Future Policy Benefits, Policy Claims Payable, Annuity Deposits and Supplementary Contracts are all, separately and collectively, forward looking statements and are given full safe harbor protection.
NOTE A, Liabilities for Future Policy Benefits.
In calculating the payments above, BNLAC used models of the business created for statutory asset adequacy analysis. The modeled life block was assumed to surrender for its reserve at the end of 20 years. Health blocks tested were projected using approximate means beyond 20 years. Payments on blocks not initially modeled were projected on an approximate basis. The total estimated future payments to be made relating to the Liability for Future Policy Benefits is stated as $10,679,039 which does not match the balance sheet liability total of $2,472,849 and the difference is $8,206,190. This is primarily due to the fact that the estimated future payments presented in the long term contractual obligations table for Future Policy Benefits includes consideration for future premiums, investment income and maintenance expenses and such assumptions, and perhaps other assumptions, may differ from the assumptions initially used to establish the balance sheet liability. The estimated future payments presented in the long term contractual obligations table are based on current assumptions while the balance sheet liability is based on assumptions locked in at the date the policy was approved for issue. Assumptions for estimating future payments are made regarding such items as interest earnings, mortality, morbidity, and persistency. It is likely that the actual experience will deviate from these assumptions - sometimes materially. A number of factors can have an effect such as economic conditions, changes in policyholder actions regarding premium payments and withdrawals, mortality and morbidity improvement or deterioration, and inflation. Random fluctuation in experience could also have an effect. The determination of the amount of the future payments is based upon estimates and the timing and amount of future payments is not always reasonably fixed and determinable. Because of the above considerations, the amounts and timing of future payments will likely vary from that presented in the above table.
Future payments related to short duration contracts such as group dental are not included in the above table in the line item Liabilities for Future Policy Benefits.
NOTE B, Policy Claims Payable.
The total estimated future payments to be made relating to Policy Claims Payable do match the balance sheet liability total. The estimated future payments are estimates of future occurrences based on many significant assumptions and are forward looking statements which are to be given the full protection of safe harbor. In developing the Policy Claims Payable, assumptions are made regarding such items as loss ratios, claims per insured or certificate holder per month, completion factors, morbidity trends, speed at which incurred claims are submitted, and speed at which they are processed. It is likely that the actual experience will deviate from these assumptions - sometimes materially. Random fluctuation is likely. The determination of the liability amounts is based upon estimates and the timing of payments is not always reasonably fixed and determinable. Because of the above considerations, the amounts and timing of payments will likely vary from that presented in the above table.
NOTE C, Annuity Deposits.
In calculating the payments above, BNLAC used models of the business created for statutory asset adequacy analysis. The modeled annuity block was assumed to surrender for its reserve at the end of 20 years. The total estimated future payments to be made relating to the Annuity Deposits liability is stated as $5,792,954 which does not match the balance sheet liability total of $2,536,225 and the difference is $3,256,729. The balance sheet Annuity Deposit liability represents such items as deposits, premiums, investment income, expenses, and withdrawals which have already occurred while the total estimated future payments presented in this long term contractual obligations table are estimated using assumptions for future occurrences of such factors and other factors. The estimated future payments are based on many significant assumptions regarding future occurrences such as future premium payments, interest earnings, mortality, and persistency. It is likely that the actual experience will deviate from these assumptions - sometimes materially. A number of factors can have an effect such as economic conditions, changes in policyholder actions regarding annuity deposits and withdrawals, mortality improvement or deterioration, and inflation. Random fluctuation in experience could also have an effect. The determination of the Annuity Deposit estimated future payments is based upon estimates and the timing and amount of estimated future payments is not always reasonably fixed and determinable. Because of the above considerations, the amounts and timing of estimated future payments will likely vary from that presented in the above table.
NOTE D, Supplementary Contracts.
The total estimated future payments to be made relating to the Supplementary Contracts without life contingencies liability is stated as $33,000 which does not match the balance sheet liability total of $17,241 and the difference is $15,759. This is primarily due to the fact that the estimated future payments in this long term contractual obligations table for Supplementary Contracts includes consideration of future investment income, withdrawals (if permitted) and maintenance expenses and such assumptions, and perhaps other assumptions, may differ from the assumptions initially used to establish the balance sheet liability. The estimated future payments presented in the long term contractual obligations table are based on current assumptions while the balance sheet liability is based on assumptions locked in at the date the policy was approved for issue. The estimated future payments are based on many significant assumptions regarding future occurrences such as interest earnings, mortality, and persistency. It is likely that the actual experience will deviate from these assumptions - sometimes materially. A number of factors can have an effect such as economic conditions, changes in policyholder actions regarding withdrawals (if allowed), and mortality improvement or deterioration. Random fluctuation in experience could also have an effect. The Supplementary Contracts estimated future payments are based upon estimates and the timing and amount of future payments is not always reasonably fixed and determinable. Because of the above considerations, the amounts and timing of estimated future payments will likely vary from that presented in the above table.
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 $44,646,393 in 2006, $44,303,827 in 2005 and $42,451,319 in 2004. The increase in 2006 was due to new sales of group dental insurance which was offset by approximately a $1.1 million reduction in group dental premium due to the termination of an agreement between the Company and Southeast Managers, Inc. (“SEMI”). This agreement allowed SEMI to market a dental product of BNLAC’s in Tennessee and the Company received 5.0% of premium revenue with no exposure to underwriting losses. As part of the termination agreement, the block of business was transferred to another company associated with SEMI. The increase of 4% in 2005 was due to new sales of group dental insurance and increased group and individual dental renewal premiums
Net investment income was $1,191,583 in 2006, $1,003,613 in 2005 and $975,485 in 2004, an increase of 18% in 2006, and an increase of 3% in 2005. The increase in 2006 was primarily due to delinquent interest received on bonds previously in default and an increase in fixed maturities investment yield. The increase in 2005 was due to an increase in investment in fixed maturities and an increase in interest rates. Continued profitability and stable or increased interest rates in subsequent years, will permit the Company to invest its profits in fixed maturities and continue the trend of increased investment income.
The Company receives marketing fees from EBI per the marketing agreement mentioned above. The Company received marketing fees of $143,315 in 2006, $115,233 in and $165,275 in 2004. The decrease in marketing fees in 2005 compared to 2006 and 2004 is due to reduced operating income at EBI.
BNLAC markets group and individual vision insurance products that are underwritten by other insurance companies, on which BNLAC does not have any exposure to underwriting (claims) losses. The Company had vision insurance income of $1,603,767, $1,051,720 and $695,046 in 2006, 2005 and 2004, respectively. The vision income increased by 49% and 51% in 2006 and 2005, respectively, primarily due to the addition of group voluntary vision plans.
The Company had a realized gain on debt extinguishments of $35,732 in 2006, $102,067 in 2005 and $495,462 in 2004 due to the purchase of debentures payable at less than par value. The Company purchased fewer debentures in 2006 and 2005 than it did in 2004, which resulted in less realized gain in debt extinguishments.
Realized capital gains and (losses) on investments were $25,547 in 2006, $37,816 in and $124,078 in 2004. The realized gain in 2006 and 2005 was primarily from the sale of equity securities. The realized gain in 2004 is primarily from the sale of U.S. Treasury bonds.
Increases in liability for future policy benefits were ($123,066), $308,563 and $687,619 in 2006, 2005 and 2004, respectively. The decrease in future policy benefits in 2006 was primarily due to the decrease in future policy benefits liability as a result of the terminated agreement between the Company and SEMI mentioned above. As part of the termination agreement, the block of business was transferred to another company associated with SEMI and the liability for future policy benefits was reduced by $95,000. The decrease in expense was also due to a reduction in life liabilities from an increase in surrenders on a seasoned block of life policies. The $308,563 in 2005 is comprised primarily of an increase in unearned premium liabilities on group and individual dental business.
In 2004, a future policy benefit reserve amount of $611,410 was booked for individual dental policies then in force. This amount included additional reserves for the individual dental policies issued in 2001, 2002 and 2003, which remained in force (not terminated) in 2004 and also included reserves for individual dental policies issued in 2004. The Company began issuing individual dental policies in 2001 as a new product. The Company’s calculations indicate that in 2004 the Company recorded individual dental policy cumulative gross benefit reserves for policies issued prior to 2004 in the amount of $280,292 and the combined after-tax charge for those policies was $181,699 ($.01 per share of Common Stock) which was accounted for as a change in estimate. For the year ended December 31, 2004, the after-tax effect of recording the liabilities, including the cumulative change in estimate, was calculated to have been a decrease in net income of approximately $378,000 ($.02 per share of Common Stock).
Policy benefits and other insurance costs increased from $31,766,217 in 2004, to $33,317,136 in 2005 and increased to $34,374,507 in 2006. The increase in 2005 was primarily due to an increase in claims ($1.3 million) resulting from an increase in group and individual dental business. The increase in 2006 was due to an increase in claims of approximately $740,000 and a $344,000 increase in commissions resulting from the increase in group dental premium collected. The claims ratio on group dental insurance, which represents the ratio of claims incurred to premium earned, was 64.1% in 2006, 63.1% in 2005 and 62.3% in 2004. The claims ratio has increased over the last three years primarily due to increased utilization by policyholders. Management closely monitors claims ratios on group and individual dental business
Amortization of deferred policy acquisition costs was $26,219 in 2006, $22,467 in 2005 and $29,973 in 2004. Amortization of deferred policy acquisition costs are primarily costs associated with a seasoned block of business written between 1988 and 1990. The decrease in amortization expense trend should continue in subsequent years until the acquisition costs are completely amortized. Amortization expense per year may vary in relation to lapses or surrenders of the existing block of business.
Operating expenses were $8,759,605 in 2006, $8,558,205 in 2005 and $7,957,447 in 2004. The increase for 2006 is primarily due to an increase in payroll expense associated with the issuance of policies, customer service and information systems. The increase in expenses in 2005 was due primarily to an increase in payroll expense, claims administration expense and office lease expense due to the increase in the number of group and individual policies in force. The increase in 2005 operating expenses was also due to an increase in professional fees, including actuarial, independent public accounting fees and legal fees incurred to assist management in replying to the Securities and Exchange Commission comments on the Company’s 2004 10K.
Taxes other than on income were $1,526,427 in 2006, $1,577,775 in 2005 and $1,344,723 for 2004. The decrease for 2006 is due to an over accrual in 2005 for state taxes. The increase in 2005 was due to an increase in premium taxes on additional premiums collected and from prior year accrual adjustments.
In 2006, the consolidated net income from operations before taxes was $3,082,645 compared to $2,830,130 in 2005 and $3,120,686 in 2004. The increase in 2006 was primarily due to the increase in vision insurance income and investment income. The decrease in 2005 was primarily due to the decrease in realized gains from debt extinguishments.
Earnings per share was $.16, $.13, and $.14 in 2006, 2005 and 2004, respectively. The effect of the treasury shares acquired in 2006 and 2005 (see Market for Stock) increased earnings per share by $.01 and $.02, respectively.
The provision for income taxes was $518,402 in 2006, $527,041 in 2005 and $468,183 in 2004. For the periods ended December 31, 2006, 2005 and 2004, the Company had $514,377, $448,040 and $355,183 of current tax expense and $4,025,
$79,001 and $113,000 of deferred tax expense; respectively. Fluctuations in tax expense are primarily due to changes in taxable income, limitations on net operating losses utilized and adjustments in estimates for income taxes in prior years.
For the year ended December 31, 2006, other comprehensive income was $57,735 compared to ($79,542) in 2005 and ($87,603) or the same period in 2004. The increase in comprehensive income for the period ended December 31, 2006 was primarily due to an increase in the market value of equity securities in 2006. The comprehensive losses in 2005 and 2004 were due to an increase in interest rates that decreased the market value of the Company’s bond portfolio.
Future Marketing Plans
BNLAC plans to apply for authority to market insurance products in additional states in the upcoming year. In 2006 we received a certificate of authority in California and Wisconsin and in the first part of 2007 we received a certificate of authority in Virginia and North Carolina.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk.
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, 2006 and December 31, 2005. We held various financial instruments at December 31, 2006 and 2005, consisting of financial assets reported in our Consolidated Balance Sheets (refer to Note 4). See page 17 for information on less than investment grade bonds held by the Company.
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, 2006 and December 31, 2005 was $19,395,602 and $18,935,460, 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, 2006 of approximately $671,000. 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 2006, 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, 2006 totaled $509,381, or only 2.2% of total investments and cash on a consolidated basis. We do not hedge our equity price risk. As of December 31, 2006 a 20% adverse change in equity prices would result in an approximate $95,000 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 in response to this Item 8 is set forth on pages through attached to this Report which pages are 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 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. Other Information
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, Executive Officers and Corporate Governance 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 was named Chief Financial Officer and Chief Operating Officer of BNL and BNLAC in 2005. 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. Mr. Shamas has been a Director of the Arkansas Life and Health Insurance Guaranty Association since July 2006.
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 was an advisory Director of Regions Bank of Rogers from 1998 to December 2005. He joined United Bank, January 2006. 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 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 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 and Berthel Fisher Co.
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 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 to 1986. He was a member of the Iowa State Senate from 1955 to 1971 and served as a Majority and Minority Floor Leader.
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
Hwy.
Sherwood, Arkansas 72120
Additional information required by this item is incorporated by reference from the Company’s 2007 Proxy Statement for its annual meeting of shareholders scheduled for May 22, 2007 and the sections therein entitled “Beneficial Ownership of Common Stock,” “Corporate Governance,” “Audit Committee Charter and Report,” "Compensation Committee Charter," "Purposes and Processes and Report,” “Compensation of Executive Officers,” and “Compensation of Directors.”
ITEM 11.
ITEM 11. Executive Compensation
The information required by this item is incorporated by reference from the Company’s 2007 Proxy Statement for its annual meeting of shareholders scheduled for May 22, 2007 and the sections therein entitled “Beneficial Ownership of Common Stock,” “Corporate Governance,” “Audit Committee Charter and Report,” "Compensation Committee Charter," "Purposes and Processes and Report,” “Compensation of Executive Officers,” and “Compensation of Directors.”
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 5% or more of the Company's voting securities as of December 31,
Title of Class
Name and Address of Beneficial Owner
Amount and Nature of Beneficial Ownership(1)
Percent of Class as of
December 31, 2006
Common Stock
Wayne E. Ahart
4,712,216(2)
29.99%
Cobblestone
Austin, TX 78735
Common Stock
Barry N. Shamas
2,801,816(3)
17.83%
Hidden Hills Dr
Dripping Springs, TX 78620
Common Stock
C. Don Byrd
1,744,843 (4)
11.11%
S. 50th Unit 144
W. Des Moines, IA 50265
Common Stock
Kenneth Tobey
1,043,886
6.64%
Tennyson
N. Little Rock, AR 72116
(1) To the Company's knowledge, all shares are beneficially owned by, and the sole voting and investment power is held by the persons named, except as otherwise indicated.
(2) This includes 133,290 shares owned directly by Wayne Ahart and Wayne Ahart’s indirect ownership of 1,200,000 shares which are owned by National Iowa Corporation and 649,363 shares which are owned by Arkansas National Corporation. Wayne Ahart controls both National Iowa Corporation and Arkansas National Corporation and votes the shares of the Company’s common stock owned by both corporations. LeRene Ahart, as a shareholder in National Iowa Corporation and Arkansas National Corporation, has an indirect pecuniary interest in 1,200,000 shares of the Company’s common stock owned by National Iowa Corporation and 649,363 shares of the Company’s common stock owned by Arkansas National Corporation. Wayne Ahart has voting control of all 2,400,000 shares of the Company’s common stock owned by National Iowa Corporation and all 2,178,926 shares of the Company’s common stock owned by Arkansas National Corporation plus the 133,290 shares which are owned directly by Wayne Ahart. Consequently, Wayne Ahart has voting control of 4,712,216 (29.99%) shares of the Company’s common stock.
(3) Includes 1,400,000 shares held in the name of Life Industries of Iowa, Inc., and 1,335,171 shares held in the name of Arkansas Industries Corporation, both of which are controlled by Mr. Shamas.
(4) All of Mr. Byrd's shares are subject to a right of first refusal of the Company to acquire said shares on the same terms and conditions as any proposed sale or other transfer by Mr. Byrd.
Security Ownership of Management
The following table sets forth, as of December 31, 2006, 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:
(1) To the Company's knowledge all shares are beneficially owned by the persons named, except as otherwise indicated, and they hold the sole voting and investment power.
(2) This includes 133,290 shares owned directly by Wayne Ahart and Wayne Ahart’s indirect ownership of 1,200,000 shares which are owned by National Iowa Corporation and 649,363 shares which are owned by Arkansas National Corporation. Wayne Ahart controls both National Iowa Corporation and Arkansas National Corporation and votes the shares of the Company’s common stock owned by both corporations. LeRene Ahart, as a shareholder in National Iowa Corporation and Arkansas National Corporation, has an indirect pecuniary interest in 1,200,000 shares of the Company’s common stock owned by National Iowa Corporation and 649,363 shares of the Company’s common stock owned by Arkansas National Corporation. Wayne Ahart has voting control of all 2,400,000 shares of the Company’s common stock owned by National Iowa Corporation and all 2,178,926 shares of the Company’s common stock owned by Arkansas National Corporation plus the 133,290 shares which are owned directly by Wayne Ahart. Consequently, Wayne Ahart has voting control of 4,712,216 (29.99%) shares of the Company’s common stock.
(3) All of Mr. Byrd's shares are subject to a right of first refusal of the Company to acquire said shares on the same terms and conditions as any proposed sale or other transfer by Mr. Byrd.
(4) Includes 10,000 shares held in the name of C. James McCormick and 90,000 shares divided equally among and held in the names of Mr. McCormick’s four children.
(5) Includes 1,400,000 shares held in the name of Life Industries of Iowa, Inc., and 1,335,171 shares held in the name of Arkansas Industries Corporation, both of which are controlled by Mr. Shamas.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions and Directors Independence
None
ITEM 14.
ITEM 14. Principal Accountant Fees and Services
The information required under this item is incorporated by reference from the Company’s Proxy 2007 Statement for its annual meeting of shareholders scheduled for May 22, 2007.
PART IV
ITEM 15.
ITEM 15. Exhibits, Financial Statement Schedules
(a) 1. Financial Statements
The information required by this section is set forth on pages to
of this Report which are 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 II - Condensed Financial Information of Registrant to
Schedules I and IV 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.
3. Exhibits
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
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:
SIGNATURE
TITLE
DATE
/S/ Wayne E. Ahart
03/30/2006
Wayne E. Ahart
Chairman of the Board, Director (Principal Executive Officer)
/S/ C. Donald Byrd
03/27/2007
C. Donald Byrd
Vice Chairman of the Board and Director
/S/ Kenneth Tobey
03/27/2007
Kenneth Tobey
President and Director
/S/ Barry N. Shamas
03/30/2007
Barry N. Shamas
Executive Vice President, Treasurer, Chief Operating Officer, Chief Financial Officer and Director (Principal Financial and Accounting Officer)
Hayden Fry
Director
/S/ John Greig
03/27/2007
John Greig
Director
/S/ C. James McCormick
03/27/2007
C. James McCormick
Director
/S/ James A. Mullins
03/27/2007
James A. Mullins
Director
/S/ Robert R. Rigler
03/23/2007
Robert R. Rigler
Director
/S/ Stanley Schoelerman
03/27/2007
Stanley Schoelerman
Director
/S/ Orville Sweet
03/27/2007
Orville Sweet
Director
/S/ Cecil Alexander
03/27/2007
Cecil Alexander
Director
/S/ Richard Barclay
03/27/2007
Richard Barclay
Director
/S/ Eugene A. Cernan
03/27/2007
Eugene A. Cernan
Director
/S/ Roy Ledbetter
03/27/2007
Roy Ledbetter
Director
/S/ John E. Miller
03/27/2007
John E. Miller
Director
ANNUAL REPORT ON FORM 10-K
ITEM (a) AND 15 (d)
FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 2006
BNL FINANCIAL CORPORATION AND SUBSIDIARIES
DES MOINES, IOWA
Page Number of 2006
Form 10-K
Item 15(a) Financial Statements
Report of Independent Accountants on Financial Statements
Consolidated Balance Sheet, December 31, 2006 and 2005
Consolidated Statement of Operations and Comprehensive Income for the years ended December 31, 2006, 2005 and 2004
Consolidated Statement of Changes in Shareholders' Equity for the years ended December 31, 2006, 2005 and 2004
Consolidated Statement of Cash Flows for the years ended December 31, 2006, 2005 and
Notes to Consolidated Financial Statements
Item 15(d) - Schedule II, Condensed Financial Information of Registrant
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, 2006 and 2005, and the consolidated results of their operations and their consolidated cash flows for each of the years ended December 31, 2006, 2005 and 2004 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.
March 27, 2007 /s/ Smith, Carney & Co., p.c.
BNL Financial Corporation and Subsidiaries
Consolidated Balance Sheets
December 31, 2006 and 2005
The accompanying notes are an integral part of the consolidated financial statements.
BNL Financial Corporation and Subsidiaries
Consolidated Statements of Operations and Comprehensive Income
For the years ended December 31, 2006, 2005 and 2004
The accompanying notes are an integral part of the consolidated financial statements.
BNL Financial Corporation and Subsidiaries
Consolidated Statements of Changes in Shareholders’ Equity
For the years ended December 31, 2006, 2005 and 2004
The accompanying notes are an integral part of the consolidated financial statements.
BNL Financial Corporation and Subsidiaries
Consolidated Statements of Cash Flows
For the years ended December 31, 2006, 2005 and 2004
The accompanying notes are an integral part of the consolidated financial statements.
1. Summary of Significant Accounting Policies
The consolidated financial statements include the accounts of BNL Financial Corporation (“BNLF”) 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 38 states as of December 31, 2006. See Note 2. Substantially all of the Company's life insurance in force is nonparticipating business.
Premiums from group accident and health insurance are reported as earned when due since these policies are short duration contracts.
Individual dental and individual life insurance 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 2006 and 2005.
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.
The Company has devided its fixed maturity investments into two classes “available for sale” and “held to maturity” in accordance with managements intent in regard to these investments. Investments available for sale 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.
1. Summary of Significant Accounting Policies (continued)
The “held to maturity” classification reflects management's intent and ability to hold this block of securities to their maturity. Investments designated by management as part of the held to maturity portfolio are presented on the financial statements at amortized book value and, therefore, unlike the available for sale portfolio, no adjustments to surplus are made as bond values change.
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. The Company made debenture interest payments of $86,700 $83,855 and $69,307 in 2006, 2005 and 2004; respectively. The Company made cash payments for income taxes of $500,000, $533,540 and $255,809 in 2006, 2005 and 2004, respectively.
Leasehold improvements and 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. Leasehold improvements are amortized over the lease term. Accumulated depreciation and amortization totaled $781,706 and $634,951 at December 31, 2006 and 2005, respectively. Depreciation and amortization expense was $311,488, $234,631, and $209,851, for the years ended December 31, 2006, 2005 and 2004, respectively.
Other assets include agents’ balances of $57,054 and $55,350 at December 31, 2006 and 2005, respectively, after reduction for allowance of doubtful accounts. The allowance account had a credit recorded of $4,313, $8,627 and $2,500 in 2006, 2005 and 2004, respectively.
The Company adopted Statement #142 of the Financial Accounting Standards Board in the first quarter of 2004, 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 $142,853 and $146,539 at December 31, 2006 and 2005 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 $5,815, $5,815 and $7,714 was recorded for each of the years ended December 31, 2006, 2005 and 2004, 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 Nondirector, Nonexecutive Stock Option Plan using the fair value method as required by SFAS No. 123(R). Under this method the fair value of the options granted is recorded as expense at the date of grant for fully vested instruments. See Note 9.
Net gain per share is based on net gain divided by the weighted average number of shares.
Certain reclassifications have been made to the prior year financial statements in order for them to be in conformity with the current year presentation. BNLAC markets group and individual vision insurance products that are underwritten by other insurance companies and as a result, BNLAC does not have any exposure to underwriting losses. The Company’s vision insurance income increased to more than a million dollars in 2005 and is reported as a separate line item on the income statement.
2. Shareholders' Equity
During 2006, 2005 and 2004, the Company made cash offers to shareholders for the purchase of stock. These offers resulted in stock purchases amounting to $1,297,948 for 1,297,948 shares in 2006, $132,056 for 148,667 shares in 2005 and $542,012 for 913,339 shares in 2004. In order to purchase company common stock, the Company was required to file a Schedule TO in 2004 and 2006 with the Securities and
2. Shareholders' Equity (continued)
Exchange Commission. Included in the cost of the Treasury Stock purchased in 2006 and 2004 is $43,657 and $77,250, respectively; which represents a portion of the cost to complete the TO filings.
On March 21, 2005, the Company entered into a Stock Purchase Agreement with Universal Guaranty Life Insurance Company (“UGL”). Wayne E. Ahart, Chairman of the Company’s Board of Directors and the Company’s Chief Executive Officer, was also a party to the Stock Purchase Agreement.
UGL owned 2,216,776 shares of the Company’s issued and outstanding common stock, which represented approximately 11.6% of the Company’s total issued and outstanding common stock as of December 31, 2004. Pursuant to the Stock Purchase Agreement, the Company purchased all of the Shares for the purchase price of $2,300,000 and placed them in treasury stock.
Mr. Ahart was a party to an agreement dated August 16, 1986, with Commonwealth Industries, Inc. (“CIC”) whereby if Mr. Ahart or CIC agreed to sell their shares of the Company to a bona fide third party purchaser, the shares of both Mr. Ahart and CIC would be sold together to such purchaser. UGL is the successor in interest to CIC. Upon the closing of the Company’s purchase of the Shares owned by UGL, this agreement was terminated and the Company did not purchase any of Mr. Ahart’s shares.
During the second quarter of 2005, the Company retired 3,767,590 treasury shares.
At December 31, 2006 and 2005, shareholders' equity includes approximately $14,789,381 and $13,683,225, 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 2006, BNLAC paid $1,450,000 of ordinary dividends to the Company, primarily for the purchase of the company common stock. In April of 2005 BNLAC received approval to pay a dividend of $2,600,000 to the Company to purchase $2,300,000 of company common stock and $300,000 for operating expenses. BNLAC paid dividends of $2,950,000 and $1,150,000 the Company in 2005 and 2004, 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:
2. Shareholders' Equity (continued)
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, 2006 and 2005, respectively, the Company had gross deferred tax assets of $1,397,439 and $1,410,226 with corresponding valuation allowances of $1,072,825 and $1,094,773, and gross deferred tax liabilities of $303,614 and $278,453, 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 $21,000 and $37,000 at December 31, 2006 and 2005, 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:
Current tax provisions
$ 514,377
$ 448,040
$ 335,183
Deferred tax provision
4,025
79,001
113,000
Total income tax provision
$518,402
$527,041
$468,183
The reconciliation of income taxes computed at the federal statutory income tax rate to total income taxes for the years ended December 31, 2006, 2005 and 2004 is as follows:
3. Income Taxes (continued)
The Company has net operating loss carry forwards for income tax purposes at December 31, 2006 as follows:
Expiring
$286,000
203,000
162,000
186,000
66,000
193,000
112,000
131,000
65,000
$1,404,000
4. Investments
The amortized cost and estimated market value of investments in fixed maturity securities are as follows:
4. Investments (continued)
The amortized cost and estimated fair value of investments in fixed maturity securities at December 31, 2006 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, 2006, 2005 and 2004 were $3,605,879, $4,263,935, $9,257,055 respectively. Gross gains were $23,059, $41,060 and $146,584 and gross losses were $5,692, $107 and $4,863 as of December 31, 2006, 2005 and 2004, respectively.
Arkansas Insurance statutes impose limitations on the amounts of investments held in one entity or government sponsored agency including a 20% of statutory assets limitation for certain federal agencies. In 2004 the Company requested, and was
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4. Investments (continued)
granted permission by the Arkansas Insurance Department to exceed the 20% investment limitation with regard to its Federal Home Loan Bank Bonds which are classified as held to maturity. Federal Home Loan Bank Bonds totaled 19% of statutory assets at December 31, 2006 compared to 23% at the end of 2005.
Investment in equity securities at December 31, 2006 and 2005 represents common and preferred stock investments as follows:
Net investment income for the years ended December 31, 2006, 2005 and 2004 is as follows:
Net realized gains and losses are summarized below:
Other long-term investments of $1,507,809 and $1,543,441 in 2006 and 2005 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
4. Investments (continued)
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 $150,402 and $186,034 in 2006 and 2005 respectively. On October 15, 2003 BNLAC and EPSI entered into a loan agreement whereby BNLAC provided 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, at which time EPSI began paying principal and interest payments amortized over five years. The line of credit is at 8.00% with interest and principal 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, 2006 and 2005.
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
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 balance of Bonds Payable was $1,639,784 and $1,747,178 at December 31, 2006 and 2005 respectively. 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. 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.
In 2006, 2005 and 2004, the Company made cash offers to bond holders for the purchase of bonds. Bond purchases resulted in a reduction of Bonds Payable of $107,194, $259,757 and $1,159,406 in 2006, 2005 and 2004; respectively. Gains from early extinguishments of the debt were $ 35,732, $102,067 and $495,462 in 2006, and 2004; respectively.
In and 2004, 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.
The Company has entered into noncancelable operating leases for office space and equipment. Future minimum payments under the leases are as follows:
During the first quarter of 2005 the Company entered into a lease for 20,337 square feet of office space in Austin, Texas, under an eight year, triple net lease. The base rent is $0 in the first year (June 1, 2005 to May 31, 2006), $157,612 in the second year and payments escalate to $264,384 in the final year of the lease. Leasehold improvements totaled approximately $872,000 ($203,000 funded by landlord) on the new lease space that was occupied in December 2005. Leasehold improvements are being amortized over the lease term. The $117,000 initial rent holiday and $203,000 of landlord funded leasehold improvements will be amortized over the lease term and reduce lease expense. Deferred rent credits are included in other liabilities and were approximately $380,000 and $320,000 for 2006 and 2005, respectively.
6. Commitments and Contingencies (continued)
Related lease cost incurred for the years ended December 31, 2006, 2005 and 2004 was $393,100, $296,169, and $272,349. 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 $800,000 at December 31, 2006.
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 accident and health unpaid claims net of reinsurance is summarized as follows.
The activity summary in the liability for unpaid accident and health claims net of reinsurance shows that claims liabilities were overstated by $34,030, $ 28,226 and $252,342 for the years ended December 31, 2005, 2004 and 2003, respectively. Such liability adjustments, which affected current operations during 2006, and 2004 respectively, resulted in part from developed claims for prior years being different than were anticipated when the liabilities for unpaid accident and health claims were originally estimated. These trends have been considered in establishing the current year liability for unpaid accident and health claims. Included in the unpaid accident and health claims are an estimate of claim adjustment expenses of $116,854, $121,349 and $106,353 in 2005, 2004 and 2003, respectively. Netting out claim adjustment expenses would make accident and health liabilities understated in 2005 and 2004 by $82,824 and $93,123, respectively and overstated by $145,989 in 2003.
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 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.
8. Reinsurance (continued)
In and 2005, BNLAC’s accidental death benefit riders were reinsured 100% through a bulk ADP reinsurer agreement with Generali USA Life Reassurance Company (“Generali”), formerly Business Men’s Assurance Company. Generali was rated “A” (Excellent) by AM Best Company for 2005. Effective July 1, 2005, administration was taken over by Optimum Re on the Bulk ADB insurance. Optimum Re was rated “A-“(Excellent) by AM Best Company for 2005. In 2006 the Company reached an agreement with Optimum Re to reinsure this block under the same terms as Generali.
In and 2006, BNLAC’s individual life insurance products in excess of $35,000 were reinsured with Generali under an automatic treaty up to $175,000 and under a facultative treaty for amounts over $175,000. Effective July 1, 2005, administration was taken over by Optimum Re on the individual life insurance products. In the Company reached an agreement with Optimum Re to reinsure this block under the same terms as Generali.
From November 1, 2004 to December 31, 2004, BNLAC’s group life insurance was reinsured under a quota share reinsurance agreement with Hannover Life Reassurance Company of America. The reinsurer was 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 2005.
BNLAC entered into a quota share reinsurance agreement with Hartford Life and Accident Insurance Company for its Group Life and Accidental Death and Dismemberment plans effective January 1, 2005 whereby Hartford accepts 90% of the risk up to a maximum of $100,000 per life. This reinsurance replaced Hannover Life Reassurance Company of America. Hartford was rated “A+” (Superior) by AM Best Company for 2005.
BNLAC’s Short Term Disability insurance is reinsured under a Quota Share reinsurance agreement with Assurant Health, Milwaukee, WI (formerly Fortis Benefits Insurance Company). The reinsurer is liable for 75% of the risk on each policy. Assurant Health was rated “A” (Excellent) by AM Best Company for 2005.
Group and individual dental is not reinsured due to the economics of the dental insurance business and the small annual maximum liability per policy.
Following is a summary of reinsurance for December 31, 2006, 2005 and 2004:
8. Reinsurance (continued)
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 was ten years, expiring December 14, 2004. A four-member committee of Directors administers the plan. During 2003 and 2004, the Company granted 129,575 and 131,925 stock options, respectively, with an exercise price of $.75 per share for those granted in 2003 and $1.00 per share for those granted in 2004.
There were 245,575 stock options outstanding at December 31, 2006. The number of options expiring or forfeited were 148,205 and 103,725 in 2006 and 2005, respectively. There were 1,000 options exercised in 2006 and 17,450 options exercised in 2005. The fair value of options granted was estimated at $4,000 for 2004. These values were computed using a binomial method as prescribed in SFAS No. 123(R) 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 .61 years and the weighted average exercise price is $.88. 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. No options were granted in 2006. 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(R) 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 6.4 years and weighted average exercise price is $.63. 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 $74,866, $100,000 and $100,000 were granted and charged to expense in each of the years 2006, 2005 and 2004, respectively. The maximum of 400,000 shares per officer was reached in 2006.
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 $61,853, $65,219 and $57,698 in 2006, 2005 and 2004, 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
Based on claims experience in 2006 and 2005, the estimate of claims liability at December 31, 2005 and 2004 was understated by approximately $83,000 and $93,000; respectively as described in Note 7. The change in estimate of this liability has contributed a corresponding increase in claims expense in 2006 and 2005.
In 2004, a future policy benefit reserve amount of $611,410 was booked for individual dental policies then in force. This amount included additional reserves for the individual dental policies issued in 2001, 2002 and 2003, which remained in force (not terminated) in 2004 and also included reserves for individual dental policies issued in 2004. The Company began issuing individual dental policies in 2001 as a new product. The Company’s calculations indicate that in 2004 the Company recorded individual dental policy cumulative gross benefit reserves for policies issued prior to 2004 in the amount of $280,292 and the combined after-tax charge for those policies was $181,699 ($.01 per share of Common Stock) which was accounted for as a change in estimate. For the year ended December 31, 2004, the after-tax effect of recording the reserves, including the cumulative change in estimate, was calculated to have been a decrease in net income of approximately $378,000 ($.02 per share of Common Stock).
12. Subsequent Events
There have been no events subsequent to December 31, 2006 that will have a material impact on the financial condition of the Company.
13. Unaudited Quarterly Results of Operations
The summary unaudited quarterly results of operations were as follows:
13. Unaudited Quarterly Results of Operations (continued)
Item 15(d) - Schedule II, Condensed Financial Information of Registrant
BNL Financial Corporation (Parent Company)
Balance Sheets
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Item 15(d) - Schedule II, Condensed Financial Information of Registrant
BNL Financial Corporation (Parent Company)
Statement of Operations
Item 15(d) - Schedule II, Condensed Financial Information of Registrant
BNL Financial Corporation (Parent Company)
Statements of Cash Flows