XNAS:KCLI Kansas City Life Insurance Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012 or

 

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                        to                         

Commission File Number 2-40764

KANSAS CITY LIFE INSURANCE COMPANY

(Exact name of registrant as specified in its charter)

 

Missouri   44-0308260
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)

 

3520 Broadway, Kansas City, Missouri   64111-2565
(Address of principal executive offices)   (Zip Code)

816-753-7000

Registrant’s telephone number, including area code

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x                                          No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x                                          No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨

 

Accelerated filer x

 

Non-accelerated filer ¨

 

Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨                                          No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common Stock, $1.25 par   11,309,477 shares
Class   Outstanding March 31, 2012


Table of Contents

KANSAS CITY LIFE INSURANCE COMPANY

TABLE OF CONTENTS

 

Part I. Financial Information

     3   

Item 1. Financial Statements

     3   

Consolidated Balance Sheets

     3   

Consolidated Statements of Comprehensive Income

     4   

Consolidated Statement of Stockholders’ Equity

     5   

Consolidated Statements of Cash Flows

     6   

Notes to Consolidated Financial Statements (Unaudited)

     8   

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     35   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     62   

Item 4. Controls and Procedures

     62   

Part II: Other Information

     63   

Item 1. Legal Proceedings

     63   

Item 1A. Risk Factors

     63   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     64   

Item 3. Defaults Upon Senior Securities

     64   

Item 4. Mine Safety Disclosures

     64   

Item 5. Other Information

     65   

Item 6. Exhibits

     67   

Signatures

     68   

 

2


Table of Contents

Part I. Financial Information

Item 1. Financial Statements

Amounts in thousands, except share data, or as otherwise noted

Kansas City Life Insurance Company

Consolidated Balance Sheets

 

     March 31
2012
    December 31
2011
 
     (Unaudited)        

ASSETS

    

Investments:

    

Fixed maturity securities available for sale, at fair value

   $ 2,770,777      $ 2,682,142   

Equity securities available for sale, at fair value

     37,245        36,689   

Mortgage loans

     573,702        601,923   

Real estate

     98,595        127,962   

Policy loans

     79,574        80,375   

Short-term investments

     54,293        49,316   

Other investments

     3,113        3,364   
  

 

 

   

 

 

 

Total investments

     3,617,299        3,581,771   

Cash

     5,172        10,436   

Accrued investment income

     38,981        34,705   

Deferred acquisition costs

     179,987        181,564   

Reinsurance receivables

     191,214        189,885   

Property and equipment

     22,419        22,671   

Other assets

     60,576        60,601   

Separate account assets

     341,250        316,609   
  

 

 

   

 

 

 

Total assets

   $ 4,456,898      $ 4,398,242   
  

 

 

   

 

 

 

LIABILITIES

    

Future policy benefits

   $ 880,071      $ 879,015   

Policyholder account balances

     2,105,428        2,089,452   

Policy and contract claims

     33,836        36,511   

Other policyholder funds

     151,005        152,125   

Other liabilities

     217,661        213,825   

Separate account liabilities

     341,250        316,609   
  

 

 

   

 

 

 

Total liabilities

     3,729,251        3,687,537   
  

 

 

   

 

 

 

STOCKHOLDERS’ EQUITY

    

Common stock, par value $1.25 per share

    

Authorized 36,000,000 shares, issued 18,496,680 shares

     23,121        23,121   

Additional paid in capital

     41,106        41,101   

Retained earnings

     797,305        780,918   

Accumulated other comprehensive income

     30,636        30,086   

Treasury stock, at cost (2012 - 7,187,203 shares; 2011 - 7,187,315 shares)

     (164,521     (164,521
  

 

 

   

 

 

 

Total stockholders’ equity

     727,647        710,705   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 4,456,898      $ 4,398,242   
  

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited)

 

3


Table of Contents

Kansas City Life Insurance Company

Consolidated Statements of Comprehensive Income

 

     Quarter Ended March 31  
             2012                     2011          
     (Unaudited)  

REVENUES

    

Insurance revenues:

    

Premiums, net

   $ 32,704      $ 33,625   

Contract charges

     25,133        26,234   
  

 

 

   

 

 

 

Total insurance revenues

     57,837        59,859   

Investment revenues:

    

Net investment income

     44,209        45,391   

Net realized investment gains, excluding impairment losses

     15,837        1,012   

Net impairment losses recognized in earnings:

    

Total other-than-temporary impairment losses

     (268     (269

Portion of impairment losses recognized in other comprehensive income

     108        58   
  

 

 

   

 

 

 

Net impairment losses recognized in earnings

     (160     (211
  

 

 

   

 

 

 

Total investment revenues

     59,886        46,192   

Other revenues

     2,185        2,408   
  

 

 

   

 

 

 

Total revenues

     119,908        108,459   
  

 

 

   

 

 

 

BENEFITS AND EXPENSES

    

Policyholder benefits

     38,470        45,274   

Interest credited to policyholder account balances

     20,558        20,481   

Amortization of deferred acquisition costs

     7,901        9,584   

Operating expenses

     23,962        25,865   
  

 

 

   

 

 

 

Total benefits and expenses

     90,891        101,204   
  

 

 

   

 

 

 

Income before income tax expense

     29,017        7,255   

Income tax expense

     9,576        2,464   
  

 

 

   

 

 

 

NET INCOME

   $ 19,441      $ 4,791   
  

 

 

   

 

 

 

Comprehensive income, net of taxes:

    

Change in net unrealized gains on securities available for sale

   $ 2,092      $ (625

Change in future policy benefits

     (1,467     720   

Change in policyholder account balances

     (75     7   
  

 

 

   

 

 

 

Other comprehensive income

     550        102   
  

 

 

   

 

 

 

COMPREHENSIVE INCOME

   $ 19,991      $ 4,893   
  

 

 

   

 

 

 

Basic and diluted earnings per share:

    

Net income

   $ 1.72      $ 0.42   
  

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited)

 

4


Table of Contents

Kansas City Life Insurance Company

Consolidated Statement of Stockholders’ Equity

 

     Quarter Ended
March 31, 2012
 
     (Unaudited)  

COMMON STOCK, beginning and end of period

   $ 23,121   
  

 

 

 

ADDITIONAL PAID IN CAPITAL

  

Beginning of period

     41,101   

Excess of proceeds over cost of treasury stock sold

     5   
  

 

 

 

End of period

     41,106   
  

 

 

 

RETAINED EARNINGS

  

Beginning of period

     780,918   

Net income

     19,441   

Stockholder dividends of $0.27 per share

     (3,054
  

 

 

 

End of period

     797,305   
  

 

 

 

ACCUMULATED OTHER COMPREHENSIVE

  

INCOME, net of taxes

  

Beginning of period

     30,086   

Other comprehensive income

     550   
  

 

 

 

End of period

     30,636   
  

 

 

 

TREASURY STOCK, at cost

  

Beginning of period

     (164,521

Cost of 103 shares acquired

     (3

Cost of 215 shares sold

     3   
  

 

 

 

End of period

     (164,521
  

 

 

 

TOTAL STOCKHOLDERS’ EQUITY

   $ 727,647   
  

 

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited)

 

5


Table of Contents

Kansas City Life Insurance Company

Consolidated Statements of Cash Flows

 

     Quarter Ended March 31  
     2012     2011  
     (Unaudited)  

OPERATING ACTIVITIES

    

Net income

   $ 19,441      $ 4,791   

Adjustments to reconcile net income to net cash provided (used) by operating activities:

    

Amortization of investment premium and discount

     995        939   

Depreciation

     828        645   

Acquisition costs capitalized

     (9,652     (8,743

Amortization of deferred acquisition costs

     7,901        9,584   

Realized investment gains

     (15,677     (801

Changes in assets and liabilities:

    

Reinsurance receivables

     (1,329     (2,220

Future policy benefits

     (1,200     (2,962

Policyholder account balances

     (1,714     (6,381

Income taxes payable and deferred

     5,976        1,577   

Other, net

     (9,304     3,992   
  

 

 

   

 

 

 

Net cash provided (used)

     (3,735     421   
  

 

 

   

 

 

 

INVESTING ACTIVITIES

    

Purchases of investments:

    

Fixed maturity securities

     (128,592     (78,118

Equity securities

     (705     (1,030

Mortgage loans

     (11,292     (15,472

Real estate

     (2,656     (2,900

Policy loans

     (3,460     (3,450

Sales of investments:

    

Fixed maturity securities

     6,250        10,143   

Equity securities

     150        201   

Real estate

     47,328        -   

Net purchases of short-term investments

     (4,977     (7,517

Maturities, calls, and principal paydowns of investments:

    

Fixed maturity securities

     40,036        64,114   

Mortgage loans

     38,954        19,864   

Policy loans

     4,261        4,822   

Net disposition (acquisition) of property and equipment

     (72     40   
  

 

 

   

 

 

 

Net cash used

     (14,775     (9,303
  

 

 

   

 

 

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited)

 

6


Table of Contents

Kansas City Life Insurance Company

Consolidated Statements of Cash Flows (Continued)

 

     Quarter Ended March 31  
     2012     2011  
     (Unaudited)  

FINANCING ACTIVITIES

    

Deposits on policyholder account balances

   $ 61,463      $ 57,464   

Withdrawals from policyholder account balances

     (43,661     (47,888

Net transfers from separate accounts

     1,358        871   

Change in other deposits

     (2,865     921   

Cash dividends to stockholders

     (3,054     (3,096

Net disposition of treasury stock

     5        7   
  

 

 

   

 

 

 

Net cash provided

     13,246        8,279   
  

 

 

   

 

 

 

Decrease in cash

     (5,264     (603

Cash at beginning of year

     10,436        5,445   
  

 

 

   

 

 

 

Cash at end of period

   $ 5,172      $ 4,842   
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

    

Cash paid during the period for:

    

Interest

   $ -      $ -   

Income taxes

     3,000        2,000   

See accompanying Notes to Consolidated Financial Statements (Unaudited)

 

7


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)

1. Nature of Operations and Significant Accounting Policies

Basis of Presentation

The unaudited interim consolidated financial statements and the accompanying notes to these unaudited interim consolidated financial statements of Kansas City Life Insurance Company include the accounts of the consolidated entity (the Company), which primarily consists of three life insurance companies. Kansas City Life Insurance Company (Kansas City Life) is the parent company. Sunset Life Insurance Company of America (Sunset Life) and Old American Insurance Company (Old American) are wholly-owned subsidiaries.

The unaudited interim consolidated financial statements have been prepared on the basis of U.S. generally accepted accounting principles (GAAP) for interim financial reporting and with the instructions to Form 10-Q and Regulations S-K, S-X, and other applicable regulations. Accordingly, they do not include all of the disclosures required by GAAP for complete financial statements. As such, these unaudited interim consolidated financial statements should be read in conjunction with the Company’s 2011 Form 10-K as filed with the Securities and Exchange Commission. Management believes that the disclosures are adequate to make the information presented not misleading, and all normal and recurring adjustments necessary to present fairly the financial position at March 31, 2012 and the results of operations for all periods presented have been made. The results of operations for any interim period are not necessarily indicative of the Company’s operating results for a full year. Significant intercompany transactions have been eliminated in consolidation and certain immaterial reclassifications have been made to prior period results to conform with the current period’s presentation.

The preparation of the unaudited interim consolidated financial statements requires management of the Company to make estimates and assumptions relating to the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the unaudited interim consolidated financial statements, and the reported amounts of revenue and expenses during the period. These estimates are inherently subject to change and actual results could differ from these estimates.

Immaterial Correction of Errors

During the first quarter of 2012, the Company identified an error related to the amortization period for unrecognized actuarial gains and losses for its pension plan of $2.0 million before applicable income taxes and an after-tax impact of $1.3 million to net income and stockholders’ equity, which had been previously recorded during 2011. Management has evaluated this error both quantitatively and qualitatively, concluding that the error is not material to the consolidated financial statements. Please refer to Note 11 – Pensions and Other Postretirement Benefits for additional information.

During 2011, the Company identified errors related to the classification of amounts reported in the Consolidated Statement of Cash Flows. The Company has revised the Consolidated Statement of Cash Flows for the period ended March 31, 2011. The changes resulted in an increase of $1.9 million to cash flows from operating activities and a decrease of the same amount to cash flows from financing activities. This change did not impact net income, the balance sheet, or stockholders’ equity for the period. Management has evaluated this error both quantitatively and qualitatively, concluding that this correction is not material to the consolidated financial statements.

Significant Accounting Policies

No significant updates or changes to these policies occurred during the quarter ended March 31, 2012.

For a full discussion of these significant accounting policies, please refer to the Company’s 2011 Form 10-K.

 

8


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

2. New Accounting Pronouncements

For a full discussion of new accounting pronouncements and other regulatory activity and their impact on the Company, please refer to the Company’s 2011 Form 10-K.

Accounting Pronouncements Adopted During 2012

In October 2010, the FASB issued guidance that modifies the types of costs incurred by insurance entities that can be capitalized when issuing or renewing insurance contracts. The guidance defines allowable deferred acquisition costs as incremental or directly related to the successful acquisition of new or renewal contracts. In addition, certain costs related directly to acquisition activities performed by the insurer, such as underwriting and policy issuance, are also deferrable. This guidance also defines the considerations for the deferral of direct-response advertising costs. This guidance became effective for interim and annual periods beginning after December 15, 2011, with either prospective or retrospective application permitted. The Company adopted this new guidance prospectively on January 1, 2012. Please refer to Note 7 – Change in Accounting Principle for additional information.

In April 2011, the FASB issued new guidance concerning repurchase agreements. This guidance amends previously provided guidance as to when an entity may or may not recognize a sale upon the transfer of financial assets subject to repurchase agreements. That determination was previously based upon whether the entity has maintained effective control over the transferred financial assets. One of the relevant considerations for assessing effective control is the transferor’s ability to repurchase or redeem financial assets before maturity. This update removes the assessment of effective control. The update became effective for interim or annual periods beginning on or after December 15, 2011. The Company adopted this new guidance on January 1, 2012 with no material impact to the consolidated financial statements.

In May 2011, the FASB issued new guidance concerning fair value measurements and disclosure. The new guidance is the result of joint efforts by the FASB and the International Accounting Standards Board (IASB) to develop a single, converged fair value framework on how to measure fair value and the necessary disclosures concerning fair value measurements. The guidance became effective for interim and annual periods beginning after December 15, 2011. The Company adopted this new guidance on January 1, 2012 with no material impact to the consolidated financial statements.

In June 2011, the FASB issued new guidance regarding the manner in which entities present comprehensive income in the financial statements. This guidance removes the previous presentation options and provides that entities must report comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements. This guidance also includes the requirement for reclassification adjustments for items that are reclassified from other comprehensive income to net income to be presented on the face of the financial statements. This guidance does not change the items that must be reported in other comprehensive income nor does it require any disclosures in addition to those previously required. In December 2011, the FASB deferred the effective date for amendments to the presentation of reclassification adjustments. The guidance became effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company adopted this new guidance on January 1, 2012 with no material impact to the consolidated financial statements.

All other new accounting standards and updates of existing standards issued through the date of this filing were considered by management and did not relate to accounting policies and procedures pertinent to the Company at this time.

 

9


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

3. Investments

Fixed Maturity and Equity Securities Available for Sale

Securities by Asset Class

The following table provides amortized cost and fair value of securities by asset class at March 31, 2012.

 

     Amortized
Cost
     Gross
Unrealized
     Fair
Value
 
      Gains      Losses     
           

U.S. Treasury securities and obligations of U.S. Government

   $ 118,343       $ 11,886       $ 58       $ 130,171   

Federal agencies 1

     22,206         3,075         1         25,280   

Federal agency issued residential mortgage-backed securities 1

     103,397         9,756         -         113,153   
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     243,946         24,717         59         268,604   

Corporate obligations:

           

Industrial

     476,199         41,500         2,312         515,387   

Energy

     165,977         19,033         144         184,866   

Communications and technology

     195,564         17,497         209         212,852   

Financial

     313,231         18,598         2,483         329,346   

Consumer

     478,165         42,792         862         520,095   

Public utilities

     260,966         36,009         579         296,396   
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     1,890,102         175,429         6,589         2,058,942   

Corporate private-labeled residential mortgage-backed securities

     163,020         2,425         9,238         156,207   

Municipal securities

     148,669         21,608         20         170,257   

Other

     109,840         3,846         8,768         104,918   

Redeemable preferred stocks

     11,735         337         223         11,849   
  

 

 

    

 

 

    

 

 

    

 

 

 

Fixed maturity securities

     2,567,312         228,362         24,897         2,770,777   

Equity securities

     35,504         1,890         149         37,245   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,602,816       $ 230,252       $ 25,046       $ 2,808,022   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

1

Federal agency securities are not backed by the full faith and credit of the U.S. Government.

 

10


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

The following table provides amortized cost and fair value of securities by asset class at December 31, 2011.

 

     Amortized
Cost
     Gross
Unrealized
     Fair
Value
 
      Gains      Losses     

U.S. Treasury securities and obligations of U.S. Government

   $ 120,593       $ 13,856       $ 12       $ 134,437   

Federal agencies 1

     22,401         3,480         -         25,881   

Federal agency issued residential mortgage-backed securities 1

     109,738         9,901         2         119,637   
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     252,732         27,237         14         279,955   

Corporate obligations:

           

Industrial

     444,030         43,710         860         486,880   

Energy

     152,580         19,131         -         171,711   

Communications and technology

     184,983         16,566         156         201,393   

Financial

     308,813         15,155         5,890         318,078   

Consumer

     452,962         43,788         263         496,487   

Public utilities

     259,609         38,094         1,366         296,337   
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     1,802,977         176,444         8,535         1,970,886   

Corporate private-labeled residential mortgage-backed securities

     167,666         1,856         12,620         156,902   

Municipal securities

     150,267         18,316         61         168,522   

Other

     100,315         3,576         9,235         94,656   

Redeemable preferred stocks

     11,735         226         740         11,221   
  

 

 

    

 

 

    

 

 

    

 

 

 

Fixed maturity securities

     2,485,692         227,655         31,205         2,682,142   

Equity securities

     34,951         1,873         135         36,689   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,520,643       $ 229,528       $ 31,340       $ 2,718,831   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

1

Federal agency securities are not backed by the full faith and credit of the U.S. Government.

Contractual Maturities

The following table provides the distribution of maturities for fixed maturity securities available for sale at March 31, 2012 and December 31, 2011. Expected maturities may differ from these contractual maturities since borrowers may have the right to call or prepay obligations.

 

     March 31, 2012      December 31, 2011  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 

Due in one year or less

   $ 99,799       $ 101,794       $ 79,651       $ 81,212   

Due after one year through five years

     582,944         626,986         599,904         639,706   

Due after five years through ten years

     1,039,768         1,140,637         946,752         1,045,645   

Due after ten years

     484,594         528,887         486,126         532,927   

Securities with variable principal payments

     348,472         360,624         361,524         371,431   

Redeemable preferred stocks

     11,735         11,849         11,735         11,221   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,567,312       $ 2,770,777       $ 2,485,692       $ 2,682,142   
  

 

 

    

 

 

    

 

 

    

 

 

 

Unrealized Losses on Investments

The Company reviews all security investments, with particular attention given to those having unrealized losses. Further, the Company specifically assesses all investments with greater than 10% declines in fair value below amortized cost and, in general, monitors all security investments as to ongoing risk. These risks are fundamentally evaluated through both a qualitative and quantitative analysis of the issuer. The Company also prepares a formal review document no less often than quarterly of all investments where fair value is less than 80% of amortized cost for six months or more and selected investments that have changed significantly from a previous period and that have a decline in fair value greater than 10% of amortized cost.

 

11


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

The Company has a policy and process in place to identify securities that could potentially have an impairment that is other-than-temporary (OTTI). This process involves monitoring market events and other items that could impact issuers. The Company considers relevant facts and circumstances in evaluating whether the impairment of a security is other-than-temporary. Relevant facts and circumstances considered are described in the Valuation of Investments section of Note 1 – Nature of Operations and Significant Accounting Policies of the Company’s 2011 Form 10-K.

To the extent the Company determines that a fixed maturity security is deemed to be other-than-temporarily impaired, the portion of the impairment that is deemed to be due to credit is charged to the Consolidated Statements of Comprehensive Income and the cost basis of the underlying investment is reduced. The portion of such impairment that is determined to be non-credit-related is deducted from net realized loss in the Consolidated Statements of Comprehensive Income and is reflected in other comprehensive income and accumulated other comprehensive income.

There are a number of significant risks and uncertainties inherent in the process of monitoring impairments, determining if an impairment is other-than-temporary and determining the portion of an other-than-temporary impairment that is due to credit. These risks and uncertainties are described in the Valuation of Investments section of Note 1 of the Company’s 2011 Form 10-K.

Once a security is determined to have met certain of the criteria for consideration as being other-than-temporarily impaired, further information is gathered and evaluated pertaining to the particular security. If the security is an unsecured obligation, the additional research is a top-down approach with particular emphasis on the likelihood of the issuer to meet the contractual terms of the obligation. If the security is secured by an asset or guaranteed by another party, the value of the underlying secured asset or the financial ability of the third-party guarantor is evaluated as a secondary source of repayment. Such research is based upon a top-down approach, narrowing to the specific estimates of value and cash flow of the underlying secured asset or guarantor. If the security is a collateralized obligation, such as a mortgage-backed or other asset-backed instrument, research is also conducted to obtain and analyze the performance of the collateral relative to expectations at the time of acquisition and with regard to projections for the future. Such analyses are based upon historical results, trends, comparisons to collateral performance of similar securities, and analyses performed by third parties. This information is used to develop projected cash flows that are compared to the amortized cost of the security.

If a determination is made that an unsecured security, secured security, or security with a guaranty of payment by a third-party is other-than-temporarily impaired, an estimate is developed of the portion of such impairment that is due to credit. The estimate of the portion of impairment due to credit is based upon a comparison of ratings and maturity horizon for the security and relative historical default probabilities from one or more nationally recognized rating organizations. When appropriate for any given security, sector or period in the business cycle, the historical default probability is adjusted to reflect periods or situations of distress by adding to the default probability increments of standard deviations from mean historical results. The credit impairment analysis is supplemented by estimates of potential recovery values for the specific security, including the potential impact of the value of any secured assets, in the event of default. This information is used to determine the Company’s best estimate, derived from probability-weighted cash flows.

The evaluation of loan-backed and similar asset-backed securities, particularly including residential mortgage-backed securities, with significant indications of potential other-than-temporary impairment requires considerable use of estimates and judgment. Specifically, the Company performs discounted cash flow projections on these securities to evaluate whether the value of the investment is expected to be fully realized. Projections of expected future cash flows are based upon considerations of the performance of the actual underlying assets, including historical delinquencies, defaults, severity of losses incurred, and prepayments, along with the Company’s estimates of future results for these factors. The Company’s estimates of future results are based upon actual historical performance of the underlying assets relative to historical, current and expected general economic conditions, specific conditions related to the underlying assets, industry data, and other factors that are believed to be relevant. If the present value of the projected expected future cash flows is determined to be below the Company’s carrying value, the Company recognizes an other-than-temporary impairment on the portion of the carrying value that exceeds the projected expected future cash flows. To the extent that the loan-backed or other asset-backed securities were high quality investments at the time of acquisition, and they remain high quality investments and do not otherwise demonstrate characteristics of impairment, the Company performs other initial evaluations to determine whether other-than-temporary cash flow evaluations need to be performed.

 

12


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

The discounted future cash flow calculation typically becomes the primary determinant of whether any portion and to what extent an unrealized loss is due to credit on loan-backed and similar asset-backed securities with significant indications of potential other-than-temporary impairment. Such indications typically include below investment grade ratings and significant unrealized losses for an extended period of time, among other factors. The Company identified 17 non-U.S. Agency mortgage-backed securities that had such indications at March 31, 2012 and December 31, 2011. Discounted future cash flow analysis was performed for each of these securities to determine if any portion of the impairment was due to credit and deemed to be other-than-temporary. The discount rate used in calculating the present value of future cash flows was the investment yield at the time of purchase for each security. The initial default rates were assumed to remain constant over a 24-month time frame and grade down thereafter, reflecting the general perspective of a more stabilized residential housing environment in the future.

For loan-backed and similar asset-backed securities, the determination of any amount of impairment that is due to credit is based upon the present value of projected future cash flows being less than the amortized cost of the security. This amount is recognized as a realized loss in the Company’s Consolidated Statements of Comprehensive Income and the carrying value of the security is written down by the same amount. The portion of an impairment that is determined not to be due to credit is recorded as a component of accumulated other comprehensive income in the Consolidated Balance Sheets.

As part of the required accounting for unrealized gains and losses, the Company also adjusts the deferred acquisition costs (DAC) and value of business acquired (VOBA) assets to recognize the adjustment to those assets as if the unrealized gains and losses from securities classified as available for sale actually had been realized.

The following table provides information regarding fixed maturity and equity security investments available for sale with unrealized losses by length of time at March 31, 2012.

 

    Less Than 12 Months     12 Months or Longer     Total  
    Fair
Value
    Unrealized
Losses
    Fair
Value
    Unrealized
Losses
    Fair
Value
    Unrealized
Losses
 

U.S. Treasury securities and obligations of U.S. Government

  $ 3,798      $ 47      $ 907      $ 11      $ 4,705      $ 58   

Federal agency issued residential mortgage-backed securities 1

    -        -        294        1        294        1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    3,798        47        1,201        12        4,999        59   

Corporate obligations:

           

Industrial

    33,204        2,312        -        -        33,204        2,312   

Energy

    10,594        144        -        -        10,594        144   

Communications and technology

    13,048        209        -        -        13,048        209   

Financial

    18,230        183        17,873        2,300        36,103        2,483   

Consumer

    49,311        665        4,537        197        53,848        862   

Public utilities

    7,169        327        11,924        252        19,093        579   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    131,556        3,840        34,334        2,749        165,890        6,589   

Corporate private-labeled residential mortgage-backed securities

    12,866        1,779        59,115        7,459        71,981        9,238   

Municipal securities

    -        -        882        20        882        20   

Other

    3,125        1,054        45,671        7,714        48,796        8,768   

Redeemable preferred stocks

    622        3        3,461        220        4,083        223   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fixed maturity securities

    151,967        6,723        144,664        18,174        296,631        24,897   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Equity securities

    67        106        1,041        43        1,108        149   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 152,034      $ 6,829      $ 145,705      $ 18,217      $ 297,739      $ 25,046   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

1

Federal agency securities are not backed by the full faith and credit of the U.S. Government.

 

13


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

The following table provides information regarding fixed maturity and equity security investments available for sale with unrealized losses by length of time at December 31, 2011.

 

    Less Than 12 Months     12 Months or Longer     Total  
    Fair
Value
    Unrealized
Losses
    Fair
Value
    Unrealized
Losses
    Fair
Value
    Unrealized
Losses
 

U.S. Treasury securities and obligations of U.S. Government

  $ -      $ -      $ 959      $ 12      $ 959      $ 12   

Federal agency issued residential mortgage-backed securities 1

    649        -        294        2        943        2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    649        -        1,253        14        1,902        14   

Corporate obligations:

           

Industrial

    25,455        860        -        -        25,455        860   

Communications and technology

    7,239        156        -        -        7,239        156   

Financial

    51,273        2,107        16,402        3,783        67,675        5,890   

Consumer

    11,765        119        3,689        144        15,454        263   

Public utilities

    4,710        344        11,152        1,022        15,862        1,366   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    100,442        3,586        31,243        4,949        131,685        8,535   

Corporate private-labeled residential mortgage-backed securities

    41,734        2,668        61,864        9,952        103,598        12,620   

Municipal securities

    -        -        3,909        61        3,909        61   

Other

    9,257        921        47,146        8,314        56,403        9,235   

Redeemable preferred stocks

    2,939        115        3,056        625        5,995        740   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fixed maturity securities

    155,021        7,290        148,471        23,915        303,492        31,205   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Equity securities

    69        104        1,054        31        1,123        135   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 155,090      $ 7,394      $ 149,525      $ 23,946      $ 304,615      $ 31,340   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

1

Federal agency securities are not backed by the full faith and credit of the U.S. Government.

In addition, the Company also considers as part of its monitoring and evaluation process the length of time the fair value of a security is below amortized cost. At March 31, 2012, the Company had 82 issues in its investment portfolio of fixed maturity and equity securities with unrealized losses. Included in this total, 46 security issues were below cost for less than one year; 7 security issues were below cost for one year or more and less than three years; and 29 security issues were below cost for three years or more. At December 31, 2011 the Company had 85 issues in its investment portfolio of fixed maturity and equity securities with unrealized losses. Included in this total, 46 security issues were below cost for less than one year; 10 security issues were below cost for one year or more and less than three years; and 29 security issues were below cost for three years or more.

 

14


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

The following table provides the distribution of maturities for fixed maturity securities available for sale with unrealized losses at March 31, 2012 and December 31, 2011. Expected maturities may differ from these contractual maturities since borrowers may have the right to call or prepay obligations.

 

     March 31, 2012      December 31, 2011  
     Fair
Value
     Gross
Unrealized
Losses
     Fair
Value
     Gross
Unrealized
Losses
 

Fixed maturity security securities available for sale:

           

Due in one year or less

   $ 935       $ 20       $ 2,953       $ 48   

Due after one year through five years

     18,682         392         42,416         2,120   

Due after five years through ten years

     117,755         3,983         64,772         2,616   

Due after ten years

     82,899         11,038         82,816         13,060   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     220,271         15,433         192,957         17,844   

Securities with variable principal payments

     72,277         9,241         104,540         12,621   

Redeemable preferred stocks

     4,083         223         5,995         740   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 296,631       $ 24,897       $ 303,492       $ 31,205   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table provides a reconciliation of credit losses recognized in earnings on fixed maturity securities held by the Company for which a portion of the other-than-temporary loss was recognized in other comprehensive income for the quarter ended March 31, 2012.

 

Credit losses on securities held at beginning of year in accumulated other comprehensive income

   $  13,559   

Additions for credit losses not previously recognized in other-than-temporary impairment

     28   

Additions for increases in the credit loss for which an other-than-temporary impairment was previously recognized when there was no intent to sell the security before recovery of its amortized cost basis

     132   

Reductions for securities sold during the period (realized)

     -   

Reductions for securities previously recognized in other comprehensive income because of intent to sell the security before recovery of its amortized cost basis

     -   

Reductions for increases in cash flows expected to be collected that are recognized over the remaining life of the security

     (4
  

 

 

 

Credit losses on securities held at the end of year in accumulated other comprehensive income

   $ 13,715   
  

 

 

 

 

15


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

Realized Gains (Losses)

The following table provides detail concerning realized investment gains and losses for the first quarters ended March 31, 2012 and 2011.

 

     Quarter Ended
March 31
 
     2012     2011  

Gross gains resulting from:

    

Sales of investment securities

   $ 313      $ 311   

Investment securities called and other

     208        863   

Sales of real estate

     15,170        -   
  

 

 

   

 

 

 

Total gross gains

     15,691        1,174   
  

 

 

   

 

 

 

Gross losses resulting from:

    

Investment securities called and other

     (53     (54

Mortgage loans

     (165     (3
  

 

 

   

 

 

 

Total gross losses

     (218     (57

Change in allowance for potential future losses on mortgage loans

     364        -   

Amortization of DAC and VOBA

     -        (105
  

 

 

   

 

 

 

Net realized investment gains, exluding impairment losses

     15,837        1,012   
  

 

 

   

 

 

 

Net impairment losses recognized in earnings:

    

Total other-than-temporary impairment losses

     (268     (269

Portion of loss recognized in other comprehensive income

     108        58   
  

 

 

   

 

 

 

Net impairment losses recognized in earnings

     (160     (211
  

 

 

   

 

 

 

Net realized investment gains

   $ 15,677      $ 801   
  

 

 

   

 

 

 

Proceeds From Sales of Investment Securities

The table below provides information regarding sales of fixed maturity and equity securities, excluding maturities and calls, for the quarters ended March 31.

 

     2012      2011  

Proceeds

   $ 6,400       $ 10,143   

Gross realized gains

     313         311   

Gross realized losses

     -         -   

Mortgage Loans

The Company invests on an ongoing basis in commercial mortgage loans that are secured by real estate. The Company had 16% of its invested assets in commercial mortgage loans at March 31, 2012, compared to 17% at December 31, 2011. In addition to the subject collateral underlying the mortgage, the Company typically requires some amount of recourse from borrowers as another potential source of repayment. The recourse requirement is determined as part of the underwriting requirements of each loan. The average loan to value ratio for the overall portfolio was 45% and 46% at March 31, 2012 and December 31, 2011, respectively, and is based upon the appraisal of value at the time the loan was originated or acquired.

 

16


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

The following table summarizes the amount of mortgage loans held by the Company at March 31, 2012 and December 31, 2011, segregated by year of origination. Purchased loans are shown in the year acquired by the Company, although the individual loans may have been initially originated in prior years.

 

     March 31
2012
    %
of Total
     December 31
2011
    %
of Total
 

Prior to 2002

   $ 24,382        4%       $ 28,437        5%   

2003

     39,632        7%         42,112        7%   

2004

     29,460        5%         29,966        5%   

2005

     53,229        9%         54,802        9%   

2006

     41,420        7%         42,676        7%   

2007

     34,964        6%         35,323        6%   

2008

     38,940        7%         44,285        7%   

2009

     48,872        8%         50,574        8%   

2010

     108,278        19%         133,684        22%   

2011

     141,592        25%         142,913        24%   

2012

     15,418        3%         -        -   
  

 

 

   

 

 

    

 

 

   

 

 

 
     576,187        100%         604,772        100%   

Allowance for potential future losses

     (2,485        (2,849  
  

 

 

      

 

 

   

Total

   $ 573,702         $ 601,923     
  

 

 

      

 

 

   

The following table identifies mortgage loans by geographic location at March 31, 2012 and December 31, 2011.

 

     March 31
2012
    %
of Total
     December 31
2011
    %
of Total
 

Pacific

   $ 135,033        23%       $ 138,529        23%   

West north central

     106,635        19%         130,481        22%   

West south central

     100,445        17%         98,036        16%   

Mountain

     81,144        14%         82,029        14%   

South atlantic

     61,567        11%         63,125        10%   

Middle atlantic

     41,851        7%         42,112        7%   

East north central

     30,682        5%         30,482        5%   

East south central

     18,830        4%         19,978        3%   
  

 

 

   

 

 

    

 

 

   

 

 

 
     576,187        100%         604,772        100%   

Allowance for potential future losses

     (2,485        (2,849  
  

 

 

      

 

 

   

Total

   $ 573,702         $ 601,923     
  

 

 

      

 

 

   

The following table identifies mortgage loans by property type at March 31, 2012 and December 31, 2011. The Other category consists of apartments and retail properties.

 

     March 31
2012
    %
Total
     December 31
2011
    %
Total
 

Industrial

   $ 242,222        42%       $ 251,839        42%   

Office

     236,417        41%         243,885        40%   

Medical

     42,572        7%         43,089        7%   

Other

     54,976        10%         65,959        11%   
  

 

 

   

 

 

    

 

 

   

 

 

 
     576,187        100%         604,772        100%   

Allowance for potential future losses

     (2,485        (2,849  
  

 

 

      

 

 

   

Total

   $ 573,702         $ 601,923     
  

 

 

      

 

 

   

 

17


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

The following table identifies the concentration of mortgage loans by state greater than 5% at March 31, 2012 and December 31, 2011.

 

     March 31
2012
    %
of Total
     December 31
2011
    %
of Total
 

California

   $ 115,233        20%       $ 117,261        19%   

Texas

     87,289        15%         84,724        14%   

Minnesota

     63,932        11%         64,952        11%   

Florida

     35,093        6%         31,310        5%   

All others

     274,640        48%         306,525        51%   
  

 

 

   

 

 

    

 

 

   

 

 

 
     576,187        100%         604,772        100%   

Allowance for potential future losses

     (2,485        (2,849  
  

 

 

      

 

 

   

Total

   $ 573,702         $ 601,923     
  

 

 

      

 

 

   

The table below identifies the carrying amount of mortgage loans by maturity at March 31, 2012 and December 31, 2011.

 

     March 31
2012
    %
of Total
     December 31
2011
    %
of Total
 

Due in one year or less

   $ 6,188        1%       $ 2,356        -   

Due after one year through five years

     191,385        33%         153,822        25%   

Due after five years through ten years

     239,835        42%         255,615        42%   

Due after ten years

     138,779        24%         192,979        33%   
  

 

 

   

 

 

    

 

 

   

 

 

 
     576,187        100%         604,772        100%   

Allowance for potential future losses

     (2,485        (2,849  
  

 

 

      

 

 

   

Total

   $ 573,702         $ 601,923     
  

 

 

      

 

 

   

The Company may refinance commercial mortgage loans prior to contractual maturity as a means of originating new loans that meet the Company’s underwriting and pricing parameters. The Company refinanced loans with outstanding balances of $4.7 million and $7.8 million during the first quarters of 2012 and 2011, respectively.

In the normal course of business, the Company commits to fund commercial mortgage loans generally up to 120 days in advance. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, the Company retains the commitment fee. For additional information, please see Note 16-Commitments.

At March 31, 2012, the Company had a construction-to-permanent loan in the amount of $2.8 million, of which $2.5 million had been disbursed. At completion and fulfillment of occupancy requirements, the construction loan will convert to long-term, fixed rate permanent loans.

4. Fair Value Measurements

Under U.S. GAAP, fair value represents the price that would be received to sell an asset (exit price) or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is the Company’s policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value and for estimating fair value for financial instruments not recorded at fair value but for which fair value is disclosed.

Assets

Securities Available for Sale

Fixed maturity and equity securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon unadjusted quoted prices, if available, except as described in the subsequent paragraphs.

 

18


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

Short-Term Financial Assets

Short-term financial assets include cash and other short-term assets. Other short-term assets are invested in institutional money market funds. These assets are categorized as Level 2 in the fair value hierarchy as the valuation is based upon the net asset value (NAV) of the fund.

Loans

The Company does not record loans at fair value. As such, valuation techniques discussed herein for loans are primarily for estimating fair value for purpose of disclosure.

Fair values of mortgage loans on real estate properties are calculated by discounting contractual cash flows, using discount rates based on current industry pricing or the Company’s estimate of an appropriate risk-adjusted discount rate for loans of similar size, type, remaining maturity, likelihood of prepayment, and repricing characteristics. Mortgage loans are categorized as Level 3 in the fair value hierarchy.

The Company also has loans made to policyholders. These loans cannot exceed the cash surrender value of the policy. Carrying value of policy loans approximates fair value. Policy loans are categorized as Level 3 in the fair value hierarchy.

Separate Accounts

The separate account assets and liabilities, which are equal, are recorded at fair value based upon NAV. They are categorized as Level 2 in the fair value hierarchy, as the Company receives independent prices from external pricing sources to determine the fair value.

Liabilities

Investment-Type Liabilities Included in Policyholder Account Balances and Other Policyholder Funds

Fair values for liabilities under investment-type insurance contracts are based upon account value. The fair values of investment-type insurance contracts included with policyholder account balances for fixed deferred annuities are estimated to be their cash surrender values. The fair values of supplementary contracts without life contingencies are estimated to be the present value of payments using a market yield. The fair values of deposits with no stated maturity are estimated to be the amount payable on demand at the measurement date. These liabilities are categorized as Level 3 in the fair value hierarchy.

Guaranteed Minimum Withdrawal Benefits (GMWB)

The Company offers a GMWB rider that can be added to new or existing variable annuity contracts. The rider provides an enhanced withdrawal benefit that guarantees a stream of income payments to an owner or annuitant, regardless of the contract account value. Fair value for GMWB rider contracts is a Level 3 valuation, as it is based on models which utilize significant unobservable inputs. These models require actuarial and financial market assumptions, which reflect the assumptions market participants would use in pricing the contract, including adjustments for volatility, risk, and issuer non-performance.

Notes Payable

Fair values for short-term notes payable approximate carrying value. The carrying amount is a reasonable estimate of the fair value because of the relatively short time between the origination of the loan and its expected repayment.

Determination of Fair Value

The determination of the fair value of the Company’s fixed maturity and equity securities is the responsibility of the Company’s investment accounting group, which reports to the Principal Accounting Officer. This group manages and creates the policies and processes used to determine the fair value for these assets. This group employs third-party pricing services and obtains selected support from the Company’s portfolio managers in order to achieve results for this multi-tiered process. All prices are reviewed by the investment accounting group. The financial reporting group, the Principal Accounting Officer, and the Chief Financial Officer also review the fair value methodologies and the fair values that are obtained each quarter. The results of those reviews are made known to the Company’s internal Disclosure Committee and to the Company’s Audit Committee. In addition, any significant policy or process changes made during the quarter are also discussed with the Company’s Audit Committee.

The Company utilizes external independent third-party pricing services to determine the majority of its fair values on investment securities available for sale. At March 31, 2012, 96% of the carrying value of these investments was from external pricing services, 1% was from brokers, and 3% was derived from internal matrices and calculations. In the event that the primary pricing service does not provide a price, the Company utilizes the price provided by a second pricing service. The Company reviews prices received from service providers for unusual fluctuations but generally accepts the price identified from the primary pricing service. In the event that a price is not available from either third-party pricing service,

 

19


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

the Company pursues external pricing from brokers. Generally, the Company pursues and utilizes only one broker quote per security. In doing so, the Company solicits only brokers which have previously demonstrated knowledge and experience of the subject security. If a broker price is not available, the Company determines a fair value through various valuation techniques that may include discounted cash flows, spread-based models or similar techniques, depending upon the specific security to be priced. These techniques are primarily applied to private placement securities. The Company utilizes available market information, wherever possible, to identify inputs into the fair value determination, primarily including prices and spreads on comparable securities. In total, the Company internally determined the prices for 18 securities at March 31, 2012. These securities totaled 3% of the fair value of the Company’s investment portfolio.

Each quarter, the Company performs an analysis on the prices received from third-party security pricing services and independent brokers to assess that the prices represent a reasonable estimate of the fair value. The Company corroborates and validates the primary pricing sources through a variety of procedures that include but are not limited to comparison to additional independent third-party pricing services or brokers, where possible; a review of third-party pricing service methodologies; back testing; and comparison of prices to actual trades for specific securities where observable data exists. In addition, the Company analyzes the primary third-party pricing service’s methodologies and related inputs and also evaluates the various types of securities in its investment portfolio to determine an appropriate fair value hierarchy.

Fair value measurements for assets and liabilities where there exists limited or no observable market data are calculated using the Company’s own estimates and are categorized as Level 3. These estimates are based on current interest rates, credit spreads, liquidity premium or discount, the economic and competitive environment, unique characteristics of the asset or liability, and other pertinent factors. Therefore, these estimates cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be inherent weaknesses in any valuation technique. Further, changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values.

The Company’s own estimates of fair value of fixed maturity and equity securities are derived in a number of ways, including but not limited to: 1) pricing provided by brokers, where the price indicates reliability as to value; 2) fair values of comparable securities, incorporating a spread adjustment for maturity differences, collateralization, credit quality, liquidity, and other items, if applicable; 3) discounted cash flow models and margin spreads; 4) bond yield curves; 5) observable market prices and exchange transaction information not provided by external pricing services; and 6) statement values provided to the Company by fund managers.

The determination of the value of the Company’s liabilities that are reported at fair value in the financial statements is the responsibility of the Company’s valuation actuary group, which reports to the Company’s Senior Vice President and Actuary. This group manages and creates the policies and processes used to determine the fair value for these liabilities. This methodology uses internal assumptions and directed third-party inputs to derive a value including a risk-neutral option pricing model that incorporates a third-party-developed index that is consistent with the attributes of the product and provides for an approximate match of the volatility measure with the expected life of the underlying contracts. The fair value methodologies and the fair values are reviewed by the Senior Vice President and Actuary, the Principal Accounting Officer, and the Chief Financial Officer. The results of those reviews are made known to the Company’s internal Disclosure Committee and to the Company’s Audit Committee. In addition, any significant policy or process changes made during the quarter are also discussed with the Company’s Audit Committee.

Fair Values Hierarchy

The Company categorizes its financial assets and liabilities measured at fair value in three levels, based on the inputs and assumptions used to determine the fair value. These levels are as follows:

Level 1 – Valuations are based upon quoted prices for identical instruments traded in active markets.

Level 2 – Valuations are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Valuations are obtained from third-party pricing services or inputs that are observable or derived principally from or corroborated by observable market data.

Level 3 – Valuations are generated from techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of discounted cash flow models, spread-based models, and similar techniques, using the best information available in the circumstances.

 

20


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

Categories Reported at Fair Value

The following tables present categories reported at fair value on a recurring basis.

 

     March 31, 2012  
Assets:    Level 1      Level 2      Level 3     Total  

U.S. Treasury securities and obligations of U.S. Government

   $ 12,781       $ 114,005       $ 3,385      $ 130,171   

Federal agencies 1

     -         25,280         -        25,280   

Federal agency issued residential mortgage-backed securities 1

     -         113,153         -        113,153   
  

 

 

    

 

 

    

 

 

   

 

 

 

Subtotal

     12,781         252,438         3,385        268,604   

Corporate obligations:

          

Industrial

     -         512,936         2,451        515,387   

Energy

     -         182,475         2,391        184,866   

Communications and technology

     -         212,852         -        212,852   

Financial

     -         317,554         11,792        329,346   

Consumer

     -         498,831         21,264        520,095   

Public utilities

     -         296,396         -        296,396   
  

 

 

    

 

 

    

 

 

   

 

 

 

Subtotal

     -         2,021,044         37,898        2,058,942   

Corporate private-labeled residential mortgage-backed securities

     -         156,207         -        156,207   

Municipal securities

     -         165,888         4,369        170,257   

Other

     -         104,918         -        104,918   

Redeemable preferred stocks

     11,849         -         -        11,849   
  

 

 

    

 

 

    

 

 

   

 

 

 

Fixed maturity securities

     24,630         2,700,495         45,652        2,770,777   
  

 

 

    

 

 

    

 

 

   

 

 

 

Equity securities

     2,297         33,855         1,093        37,245   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 26,927       $ 2,734,350       $ 46,745      $ 2,808,022   
  

 

 

    

 

 

    

 

 

   

 

 

 

Percent of total

     1%         97%         2%        100%   
  

 

 

    

 

 

    

 

 

   

 

 

 

Liabilities:

          

Other policyholder funds

          

GMWB

   $ -       $ -       $ (950   $ (950
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ -       $ -       $ (950   $ (950
  

 

 

    

 

 

    

 

 

   

 

 

 

 

1

Federal agency securities are not backed by the full faith and credit of the U.S. Government.

 

21


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

     December 31, 2011  
     Level 1      Level 2      Level 3     Total  

Assets:

          

U.S. Treasury securities and obligations of U.S. Government

   $ 12,876       $ 118,130       $ 3,431      $ 134,437   

Federal agencies 1

     -         25,881         -        25,881   

Federal agency issued residential mortgage-backed securities 1

     -         119,637         -        119,637   
  

 

 

    

 

 

    

 

 

   

 

 

 

Subtotal

     12,876         263,648         3,431        279,955   

Corporate obligations:

          

Industrial

     -         486,380         500        486,880   

Energy

     -         169,342         2,369        171,711   

Communications and technology

     -         201,393         -        201,393   

Financial

     -         307,464         10,614        318,078   

Consumer

     -         474,553         21,934        496,487   

Public utilities

     -         296,337         -        296,337   
  

 

 

    

 

 

    

 

 

   

 

 

 

Subtotal

     -         1,935,469         35,417        1,970,886   

Corporate private-labeled residential mortgage-backed securities

     -         156,902         -        156,902   

Municipal securities

     -         163,611         4,911        168,522   

Other

     -         94,656         -        94,656   

Redeemable preferred stocks

     11,221         -         -        11,221   
  

 

 

    

 

 

    

 

 

   

 

 

 

Fixed maturity securities

     24,097         2,614,286         43,759        2,682,142   
  

 

 

    

 

 

    

 

 

   

 

 

 

Equity securities

     2,216         33,350         1,123        36,689   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 26,313       $ 2,647,636       $ 44,882      $ 2,718,831   
  

 

 

    

 

 

    

 

 

   

 

 

 

Percent of total

     1%         97%         2%        100%   
  

 

 

    

 

 

    

 

 

   

 

 

 

Liabilities:

          

Other policyholder funds

          

GMWB

   $ -       $ -       $ (187   $ (187
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ -       $ -       $ (187   $ (187
  

 

 

    

 

 

    

 

 

   

 

 

 

 

1

Federal agency securities are not backed by the full faith and credit of the U.S. Government.

 

22


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

The following tables present the fair value of fixed maturity and equity securities available for sale by pricing source and fair value hierarchy level.

 

     March 31, 2012  
     Level 1      Level 2      Level 3      Total  

Fixed maturity securities available for sale:

           

Priced from external pricing services

   $ 24,630       $ 2,662,120       $ -       $ 2,686,750   

Priced from independent broker quotations

     -         38,375         -         38,375   

Priced from internal matrices and calculations

     -         -         45,652         45,652   
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     24,630         2,700,495         45,652         2,770,777   
  

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities available for sale:

           

Priced from external pricing services

     2,297         7,245         -         9,542   

Priced from independent broker quotations

     -         -         -         -   

Priced from internal matrices and calculations

     -         26,610         1,093         27,703   
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     2,297         33,855         1,093         37,245   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 26,927       $ 2,734,350       $ 46,745       $ 2,808,022   
  

 

 

    

 

 

    

 

 

    

 

 

 

Percent of total

     1%         97%         2%         100%   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2011  
     Level 1      Level 2      Level 3      Total  

Fixed maturity securities available for sale:

           

Priced from external pricing services

   $ 24,097       $ 2,582,617       $ -       $ 2,606,714   

Priced from independent broker quotations

     -         31,669         -         31,669   

Priced from internal matrices and calculations

     -         -         43,759         43,759   
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     24,097         2,614,286         43,759         2,682,142   
  

 

 

    

 

 

    

 

 

    

 

 

 

Equity securities available for sale:

           

Priced from external pricing services

     2,216         7,444         -         9,660   

Priced from independent broker quotations

     -         -         -         -   

Priced from internal matrices and calculations

     -         25,906         1,123         27,029   
  

 

 

    

 

 

    

 

 

    

 

 

 

Subtotal

     2,216         33,350         1,123         36,689   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 26,313       $ 2,647,636       $ 44,882       $ 2,718,831   
  

 

 

    

 

 

    

 

 

    

 

 

 

Percent of total

     1%         97%         2%         100%   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

23


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the first quarter ended March 31, 2012 and year ended December 31, 2011 are summarized below:

 

     Quarter Ended March 31, 2012  
     Assets     Liabilities  
     Fixed maturity
securities available
for sale
    Equity securities
available for
sale
    Total     GMWB  

Beginning balance

   $ 43,759      $ 1,123      $ 44,882      $ (187

Included in earnings

     4        -        4        (688

Included in other comprehensive income

     (299     (30     (329     -   

Purchases, issuances, sales and other dispositions:

        

Purchases

     -        -        -        -   

Issuances

     -        -        -        55   

Sales

     -        -        -        -   

Other dispositions

     (1,626     -        (1,626     (130

Transfers into Level 3

     3,814        -        3,814        -   

Transfers out of Level 3

     -        -        -        -   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 45,652      $ 1,093      $ 46,745      $ (950
  

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized losses

   $ (299   $ (30   $ (329  
  

 

 

   

 

 

   

 

 

   
     Year Ended December 31, 2011  
     Assets     Liabilities  
     Fixed maturity
securities available
for sale
    Equity securities
available for
sale
    Total     GMWB  

Beginning balance

   $ 55,801      $ 1,180      $ 56,981      $ (2,799

Included in earnings

     11        92        103        2,500   

Included in other comprehensive income

     1,385        51        1,436        -   

Purchases, issuances, sales and other dispositions:

        

Purchases

     -        -        -        -   

Issuances

     -        -        -        163   

Sales

     -        -        -        -   

Other dispositions

     (2,977     (200     (3,177     (51

Transfers into Level 3

     8,640        -        8,640        -   

Transfers out of Level 3

     (19,101     -        (19,101     -   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 43,759      $ 1,123      $ 44,882      $ (187
  

 

 

   

 

 

   

 

 

   

 

 

 

Net unrealized gains

   $ 1,401      $ 105      $ 1,506     
  

 

 

   

 

 

   

 

 

   

The Company did not exclude any realized or unrealized gains or losses on items transferred into Level 3. Depending upon the availability of Level 1 or Level 2 pricing, specific securities may transfer into or out of Level 3. The Company did not have any transfers between Level 1 or Level 2 during the quarter ended March 31, 2012.

 

24


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

The following table presents quantitative information about Level 3 fair value measurements as of March 31, 2012.

 

     Fair
Value
     Valuation
Technique
   Unobservable
Inputs
   Range      Weighted
Average
 

Fixed maturity securities

   $ 45,652       Market comparable    Spread adjustment      46-376         180   

The Company’s primary category of Level 3 fair values is fixed maturity securities, totaling $45.7 million as of March 31, 2012. These assets are valued using comparable security valuations through the unobservable input of estimated discount spreads. Specifically, the Company reviews the values and discount spreads on similar securities for which such information is observable in the market. Estimates of increased discount spreads are then determined based upon the characteristics of the securities being evaluated. The Company estimates that an increased spread of 10 basis points on each of the Level 3 securities would reduce the reported fair value by $0.2 million, as of March 31, 2012.

Other assets and liabilities categorized as Level 3 for purposes of fair value determination are not material to the Company’s financial statements, and the sensitivities of such valuations to unobservable inputs are also believed to not be material.

The table below is a summary of fair value estimates at March 31, 2012 and December 31, 2011 for financial instruments. The Company has not included assets and liabilities that are not financial instruments in this disclosure. The total of the fair value calculations presented do not represent, and should not be construed to represent, the underlying value of the Company.

 

     March 31, 2012     December 31, 2011  
     Carrying
Value
    Fair
Value
    Carrying
Value
    Fair
Value
 

Assets:

        

Investments:

        

Fixed maturity securities available for sale

   $ 2,770,777      $ 2,770,777      $ 2,682,142      $ 2,682,142   

Equity securities available for sale

     37,245        37,245        36,689        36,689   

Mortgage loans

     573,702        615,458        601,923        642,905   

Policy loans

     79,574        79,574        80,375        80,375   

Cash and short-term investments

     59,465        59,465        59,752        59,752   

Separate account assets

     341,250        341,250        316,609        316,609   

Liabilities:

        

Individual and group annuities

     1,101,097        1,079,562        1,082,324        1,062,407   

Supplementary contracts without life contingencies

     55,488        54,216        56,193        54,824   

Separate account liabilities

     341,250        341,250        316,609        316,609   

Other policyholder funds - GMWB

     (950     (950     (187     (187

5. Financing Receivables

The Company has financing receivables that have both a specific maturity date, either on demand or on a fixed or determinable date, and are recognized as an asset in the Company’s balance sheet.

The table below identifies the Company’s financing receivables by classification at March 31, 2012 and December 31, 2011.

 

     March 31
2012
     December 31
2011
 

Receivables:

     

Agent receivables, net (allowance $2,232; $2,226—2011)

   $ 1,524       $ 1,708   

Investment-related financing receivables:

     

Mortgage loans, net (allowance $2,485; $2,849—2011)

     573,702         601,923   
  

 

 

    

 

 

 

Total financing receivables

   $ 575,226       $ 603,631   
  

 

 

    

 

 

 

 

25


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

Agent Receivables

The Company has agent receivables which are classified as financing receivables and which are reduced by an allowance for doubtful accounts. These trade receivables from agents are long-term in nature and are specifically assessed as to the collectability of each receivable. The Company’s gross agent receivables totaled $3.7 million at March 31, 2012 and the Company maintained an allowance for doubtful accounts totaling $2.2 million. Gross agent receivables totaled $3.9 million with an allowance for doubtful accounts of $2.2 million at December 31, 2011. The Company identified additions to the allowance for doubtful accounts of $0.1 million in the first quarter of 2012, the result of expected defaults on selected agent receivables. Also, the allowance was reduced $0.1 million during the first quarter of 2012, largely due to write-offs of defaulted agent receivables and collections of agent receivables. The Company has two types of agent receivables included in this category as follows:

 

   

Agent specific loans. At March 31, 2012, these loans totaled $1.0 million with an allowance for doubtful accounts of $0.2 million. At December 31, 2011, agent specific loans totaled $0.8 million with an allowance for doubtful accounts of $0.2 million.

   

Various agent commission advances and other commission receivables. Gross agent receivables in this category totaled $2.7 million, with an allowance for doubtful accounts of $2.0 million at March 31, 2012. Gross agent receivables totaled $3.1 million and the allowance for doubtful accounts was $2.0 million at December 31, 2011.

Mortgage Loans

The Company considers its mortgage loan portfolio to be long-term financing receivables. Mortgage loans are stated at cost, net of allowance for potential future losses. Mortgage loan interest income is recognized on an accrual basis with any premium or discount amortized over the life of the loan. Prepayment and late fees are recorded on the date of collection. Loans in foreclosure, loans considered impaired or loans past due 90 days or more are placed on a non-accrual status.

If a mortgage loan is determined to be on non-accrual status, the Company does not accrue interest income. The loan is independently monitored and evaluated as to potential impairment or foreclosure. This evaluation includes assessing the probability of receiving future cash flows, along with consideration of many of the factors described below. If delinquent payments are made and the loan is brought current, then the Company returns the loan to active status and accrues income accordingly.

Generally, the Company considers its mortgage loans to be a portfolio segment. The Company considers its primary class to be property type. The Company primarily uses loan-to-value as its credit risk quality indicator but also monitors additional secondary risk factors, such as geographic distribution both on a regional and specific state basis. The mortgage loan portfolio segment is presented by property-type in a table in Note 3—Investments. In addition, geographic distributions for both regional and significant state concentrations are also presented in Note 3. These measures are also supplemented with various other analytics to provide additional information concerning mortgage loans and management’s assessment of financing receivables.

 

26


Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

The following table presents an aging schedule for delinquent payments for both principal and interest at March 31, 2012 and December 31, 2011, by property type.

 

            Amount of Payments Past Due  
     Book Value      30-59 Days      60-89 Days      > 90 Days      Total  

March 31, 2012

              

Industrial

   $ -       $ -       $ -       $ -       $ -   

Medical

     -         -         -         -         -   

Office

     184         9         -         -         9   

Other

     -         -         -         -         -   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 184       $ 9       $ -       $ -       $ 9   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

              

Industrial

   $ -       $ -       $ -       $ -       $ -   

Office

     816         13         -         -         13   

Medical

     7,019         75         -         -         75   

Other

     -         -         -         -         -   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 7,835       $ 88       $ -       $ -       $ 88   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At March 31, 2012, there was one mortgage loan that was 30 days past due. Subsequently, payment was received and this loan was brought current in April 2012.

The allowance for potential future losses on mortgage loans is maintained at a level believed by management to be adequate to absorb estimated credit losses. Management’s periodic evaluation and assessment of the adequacy of the reserve is based on known and inherent risks in the portfolio, historical and industry data, current economic conditions, and other relevant factors. The Company assesses the amount it maintains in the mortgage loan allowance through an assessment of what the Company believes are relevant factors at both the macro-environmental level and specific loan basis. A loan is considered impaired if it is probable that contractual amounts due will not be collected. The Company’s allowance for credit losses was $2.5 million at March 31, 2012 and $2.8 million at December 31, 2011. For information regarding management’s periodic evaluation and assessment of mortgage loans and the allowance for potential future losses, please refer to Note 5 – Financing Receivables in the Company’s 2011 Form 10-K.

The following table details the activity of the allowance for potential future losses on mortgage loans at March 31, 2012 and December 31, 2011.

 

     March 31,
2012
    December 31,
2011
 

Beginning of year

   $ 2,849      $ 3,410   

Additions

     -        -   

Deductions

     (364     (561
  

 

 

   

 

 

 

End of period

   $ 2,485      $ 2,849   
  

 

 

   

 

 

 

The Company has had three mortgage loan defaults in the current and prior year. One loan was foreclosed in the first quarter of 2012 and an impairment of $0.2 million was recorded. One of the loan defaults in 2011 resulted in an impairment of $0.4 million, while the second loan default in 2011 did not result in an impairment based upon the fair value of the property being greater than the loan value. The Company had no troubled loans that were restructured or modified during 2012 or 2011.

6. Variable Interest Entities

The Company invests in certain affordable housing and real estate joint ventures which are considered to be variable interest entities (VIEs) and are included in Real Estate in the Consolidated Balance Sheets. The assets held in affordable housing real estate joint venture VIEs are primarily residential real estate properties that are restricted to provide affordable housing under federal or state programs for varying periods of time. The restrictions primarily apply to the rents that may be paid by tenants residing in the properties during the term of an agreement to remain in the affordable housing program. Investments in real estate joint ventures are equity interests in partnerships or limited liability corporations that may or may not participate in profits or residual value. In certain cases, the Company may issue fixed-rate senior mortgage loan investments secured by properties controlled by VIEs. These investments are classified as mortgage loans in the Consolidated Balance Sheets, and

 

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Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

the income received from such investments is recorded as investment income in the Consolidated Statements of Comprehensive Income. For additional information, please refer to Note 6 - Variable Interest Entities in the Company’s 2011 Form 10-K.

The following table presents the carrying amount and maximum exposure to loss relating to VIEs for which the Company holds a variable interest, but is not the primary beneficiary, and which had not been consolidated at March 31, 2012 and December 31, 2011. The table includes investments in eight real estate joint ventures and 28 affordable housing real estate joint ventures at March 31, 2012 and investments in eleven real estate joint ventures and 28 affordable housing real estate joint ventures at December 31, 2011.

 

     March 31
2012
     December 31
2011
 
     Carrying
Amount
     Maximum
Exposure
to Loss
     Carrying
Amount
     Maximum
Exposure
to Loss
 

Real estate joint ventures

   $ 24,170       $ 24,170       $ 35,551       $ 35,551   

Affordable housing real estate joint ventures

     22,127         61,007         20,749         61,124   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 46,297       $ 85,177       $ 56,300       $ 96,675   
  

 

 

    

 

 

    

 

 

    

 

 

 

The maximum exposure to loss relating to the real estate joint ventures and affordable housing real estate joint ventures, as shown in the table above, is equal to the carrying amounts plus any unfunded equity commitments, exposure to potential recapture of tax credits, guarantees of debt or other obligations of the VIE with recourse to the Company. Unfunded equity and loan commitments typically require financial or operating performance by other parties and have not yet become due or payable but which may become due in the future.

At March 31, 2012 and December 31, 2011, the Company had $4.3 million and $6.4 million, respectively, in fixed-rate senior mortgage loan commitments outstanding to the benefit of entities that are also real estate joint venture VIEs. The loan commitments are included in the discussion of commitments in the Notes to Consolidated Financial Statements (Unaudited) for both periods. The Company also has contingent commitments to fund additional equity contributions for operating support to certain real estate joint venture VIEs, which could result in additional exposure to loss. However, the Company is not able to quantify the amount of these contingent commitments.

In addition, the maximum exposure to loss on affordable housing joint ventures at March 31, 2012 and December 31, 2011 includes $12.5 million and $13.2 million, respectively, of losses which could be realized if the tax credits received by the VIEs were recaptured. Recapture events would cause the Company to reverse some or all of the benefit previously recognized by the Company or third parties to whom the tax credit interests were transferred. A recapture event can occur at any time during a 15-year required compliance period. The principal causes of recapture include financial default and non-compliance with affordable housing program requirements by the properties controlled by the VIE. The potential exposure due to recapture may be mitigated by guarantees from the managing member or managing partner in the VIE, insurance contracts, or changes in the residual value accruing to the Company’s interests in the VIEs.

7. Change in Accounting Principle

The Company adopted Accounting Standards Update (ASU) No. 2010-26 “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” effective January 1, 2012. This guidance modifies the types of costs incurred by insurance entities that can be capitalized when issuing or renewing insurance contracts. The guidance defines allowable deferred acquisition costs as incremental or directly related to the successful acquisition of new or renewal contracts. In addition, certain costs related directly to acquisition activities performed by the insurer, such as underwriting and policy issuance, are also deferrable. This guidance also defines the considerations for the deferral of direct-response advertising costs.

Effective January 1, 2012, the Company prospectively adopted this guidance. Pursuant to this guidance, the Company evaluated the types of acquisition costs it capitalizes. The Company capitalizes agent compensation and benefits and other expenses that are directly related to the successful acquisition of contracts. The Company also capitalizes expenses directly related to activities performed by the Company, such as underwriting, policy issuance, and processing fees incurred in connection with successful contract acquisitions.

 

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Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

Deferred acquisition costs are capitalized as incurred. These costs for life insurance products are generally deferred and amortized over the premium paying period. Policy acquisition costs that relate to interest sensitive and variable insurance products are deferred and amortized in relation to the estimated gross profits to be realized over the lives of the contracts. For interest sensitive and variable insurance products, estimated gross profits are composed of net interest income, net realized investment gains and losses, fees, surrender charges, expenses, and mortality gains and losses. At the issuance of policies, projections of estimated gross profits are made which are then replaced by actual gross profits over the lives of the policies. The Company considers the following assumptions to be of significance when projecting future estimated gross profits: mortality, interest rates and spreads, surrender and withdrawal rates and expense margins.

The amount of acquisition costs capitalized during the first quarter of 2012, the period of adoption, was $9.7 million. The amount of acquisition costs that would have been capitalized during the first quarter of 2012 if the Company’s previous policy had been applied during that period would have been $8.7 million. Thus, the adoption of this guidance resulted in a $1.0 million increase in the amount of acquisition costs capitalized. In addition, the implementation of this guidance also impacted the amortization of DAC and benefit and contract reserve change on selected products. The net result of the adoption of ASU No. 2010-26 was a $0.7 million increase in pretax earnings in the first quarter of 2012.

8. Separate Accounts

The Company has a guaranteed minimum withdrawal benefit (GMWB) rider that can be added to new or existing variable annuity contracts. The rider provides an enhanced withdrawal benefit that guarantees a stream of income payments to an owner or annuitant, regardless of the contract account value. The value of variable annuity separate accounts with the GMWB rider was $94.2 million at March 31, 2012 (December 31, 2011—$86.6 million) and the guarantee liability was ($1.0) million at March 31, 2012 (December 31, 2011—($0.2) million). The value of the GMWB rider is recorded at fair value. The change in this value is included in policyholder benefits in the Consolidated Statements of Comprehensive Income. The value of variable annuity separate accounts with the GMWB rider is recorded in separate account liabilities and the value of the rider is included in other policyholder funds in the Consolidated Balance Sheets. The determination of fair value of the GMWB liability requires models that use actuarial and financial market assumptions, which reflect the assumptions market participants would use in pricing the contract, including adjustments for risk and issuer non-performance.

Guarantees are offered under variable universal life and variable annuity contracts: a guaranteed minimum death benefit (GMDB) rider is available on certain variable universal life contracts, and GMDB are provided on all variable annuities. The GMDB rider for variable universal life and variable annuity contracts guarantees the death benefit for specified periods of time, regardless of investment performance, provided cumulative premium requirements are met. The total reserve held for the variable annuity GMDB at March 31, 2012 was $0.1 million (December 31, 2011—$0.2 million).

9. Notes Payable

The Company had no notes payable at March 31, 2012 or December 31, 2011.

As a member of the Federal Home Loan Bank of Des Moines (FHLB) with a capital investment of $4.8 million, the Company has the ability to borrow on a collateralized basis from the FHLB. The Company received dividends on the capital investment of less than $0.1 million in both the first quarter of 2012 and 2011.

The Company has unsecured revolving lines of credit of $60.0 million with two major commercial banks with no balances outstanding and which are at variable interest rates based upon short-term indices. These lines of credit will expire in June of 2012. The Company anticipates renewing these lines as they come due.

10. Income Taxes

The first quarter income tax expense was $9.6 million or 33% of income before tax for 2012, versus $2.5 million or 34% of income before tax for the prior year period.

The effective income tax rate in 2012 was less than the prevailing corporate federal income tax rate of 35% primarily due to permanent differences, including the dividends-received deduction, and tax benefits related to affordable housing investments.

 

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Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

The effective income tax rate in 2011 was less than the prevailing corporate federal income tax rate of 35% primarily due to permanent differences, including the dividends-received deduction, which resulted in a tax benefit of approximately 2% of income before tax. Partially offsetting the benefit from the permanent differences was a tax expense of approximately 1% of income before tax related to affordable housing investments.

The Company did not have any uncertain tax positions at March 31, 2012.

At March 31, 2012, the Company had a $5.6 million current tax liability and a $69.1 million deferred tax liability compared to a $0.3 million current tax recoverable and a $68.8 million deferred tax liability at December 31, 2011.

11. Pensions and Other Postretirement Benefits

The following table provides the components of net periodic benefit cost for the first quarters ended March 31, 2012 and 2011:

 

     Pension Benefits     Other Benefits  
     Quarter Ended     Quarter Ended  
     March 31     March 31  
     2012     2011     2012     2011  

Service cost

   $ -      $ -      $ 199      $ 161   

Interest cost

     1,475        1,871        452        387   

Expected return on plan assets

     (2,225     (2,342     (8     (9

Amortization of:

        

Unrecognized actuarial gain (loss)

     (1,425     896        70        4   

Unrecognized prior service cost

     -        -        (63     (68
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit cost

   $ (2,175   $ 425      $ 650      $ 475   
  

 

 

   

 

 

   

 

 

   

 

 

 

During the first quarter of 2012, the Company identified an error related to the amortization period for unrecognized actuarial gains and losses for its pension plan. The Company determined that upon curtailment of the plan on January 1, 2011, the status of the plan participants should have changed from active to inactive. The amortization period was corrected from the average remaining service period of plan participants, approximately 10 years, to the average remaining life expectancy of plan participants, approximately 26 years. The Company has recognized approximately a $2.0 million pre-tax benefit related to the reversal of amortization recorded during 2011.

12. Share-Based Payment

The Company has a long-term incentive plan for senior management that provides a cash award to participants for the increase in the share price of the Company’s common stock through units (phantom shares) assigned by the Board of Directors. The cash award is calculated over a three-year interval on a calendar year basis. At the conclusion of each three-year interval, participants will receive a cash award based on the increase in the share price during a defined measurement period, times the number of units. The increase in the share price will be determined based on the change in the share price from the beginning to the end of the three-year interval. Dividends are accrued and paid at the end of each three-year interval to the extent that they exceed negative stock price appreciation. Plan payments are contingent on the continued employment of the participant unless termination is due to a qualifying event such as death, disability or retirement. The Company does not make payments in shares, warrants or options.

No payments were made under this plan during quarters ended March 31, 2012 and 2011.

At each reporting period, an estimate of the share-based compensation expense is accrued, utilizing the share price at the period end. Accruals of share-based compensation as operating expense were $0.3 million and $0.1 million, net of tax, in the first quarters of 2012 and 2011, respectively.

 

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Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

13. Comprehensive Income

Comprehensive income is comprised of net income and other comprehensive income. Other comprehensive income includes the unrealized investment gains or losses on securities available for sale (net of adjustments for realized investment gains or losses) net of adjustments to DAC, VOBA, future policy benefits, and policyholder account balances. In addition, other comprehensive income includes the change in the liability for benefit plan obligations. Other comprehensive income reflects these items net of tax.

The table below provides information about comprehensive income for the first quarters ended March 31, 2012 and 2011.

 

     Quarter Ended March 31, 2012  
     Before-Tax     Tax (Expense)     Net-of-Tax  
     Amount     or Benefit     Amount  

Net unrealized gains (losses) arising during the year

      

Fixed maturity securities

   $ 7,324      $ 2,563      $ 4,761   

Equity securities

     2        1        1   

Less reclassification adjustments:

      

Net realized investment gains (losses), excluding impairment losses

     468        164        304   

Other-than-temporary impairment losses recognized in earnings

     (268     (94     (174

Other-than-temporary impairment losses recognized in other comprehensive income

     108        38        70   
  

 

 

   

 

 

   

 

 

 

Net unrealized gains (losses) excluding impairment losses

     7,018        2,456        4,562   

Effect on DAC and VOBA

     (3,800     (1,330     (2,470

Future policy benefits

     (2,256     (789     (1,467

Policyholder account balances

     (116     (41     (75
  

 

 

   

 

 

   

 

 

 

Other comprehensive income

   $ 846      $ 296      $ 550   
  

 

 

   

 

 

   

 

 

 

Net income

         19,441   
      

 

 

 

Comprehensive income

       $ 19,991   
      

 

 

 

 

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Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

     Quarter Ended March 31, 2011  
     Before-Tax     Tax (Expense)     Net-of-Tax  
     Amount     or Benefit     Amount  

Net unrealized gains (losses) arising during the year

      

Fixed maturity securities

   $ (146   $ (51   $ (95

Equity securities

     28        10        18   

Less reclassification adjustments:

      

Net realized investment gains (losses), excluding impairment losses

     1,120        392        728   

Other-than-temporary impairment losses recognized in earnings

     (269     (94     (175

Other-than-temporary impairment losses recognized in other comprehensive income

     58        20        38   
  

 

 

   

 

 

   

 

 

 

Net unrealized gains (losses) excluding impairment losses

     (1,027     (359     (668

Effect on DAC and VOBA

     67        24        43   

Future policy benefits

     1,107        387        720   

Policyholder account balances

     10        3        7   
  

 

 

   

 

 

   

 

 

 

Other comprehensive income

   $ 157      $ 55      $ 102   
  

 

 

   

 

 

   

 

 

 

Net income

         4,791   
      

 

 

 

Comprehensive income

       $ 4,893   
      

 

 

 

The following table provides accumulated balances related to each component of accumulated other comprehensive income at March 31, 2012.

 

     Net
Unrealized
Gain (Loss) on
Non-Impaired
Securities
     Net
Unrealized
Gain (Loss) on
Impaired
Securities
    Benefit
Plan
Obligations
    DAC/
VOBA
Impact
    Future
Policy
Benefits
    Policyholder
Account
Balances
    Tax Effect     Total  

Beginning of year

   $ 213,800       $ (15,612   $ (78,451   $ (56,971   $ (15,903   $ (578   $ (16,199   $ 30,086   

Other comprehensive income

     2,138         4,880        -        (3,800     (2,256     (116     (296     550   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

End of period

   $ 215,938       $ (10,732   $ (78,451   $ (60,771   $ (18,159   $ (694   $ (16,495   $ 30,636   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

14. Earnings Per Share

Due to the Company’s capital structure and the absence of other potentially dilutive securities, there is no difference between basic and diluted earnings per common share for any of the periods reported. The average number of shares outstanding for the quarters ended March 31, 2012 and 2011 was 11,309,395 and 11,467,208, respectively. The number of shares outstanding at March 31, 2012 and 2011 was 11,309,477 and 11,467,319, respectively.

 

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Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

15. Segment Information

The following schedule provides the financial performance of each of the three reportable operating segments of the Company.

 

            Individual
Insurance
     Group
Insurance
    Old
American
    Intercompany
Eliminations
1
    Consolidated  

Insurance revenues:

              

First quarter:

     2012       $ 28,569       $ 12,067      $ 17,300      $ (99   $ 57,837   
     2011         30,732         12,554        16,708        (135     59,859   

Net investment income:

              

First quarter:

     2012       $ 41,121       $ 128      $ 2,960      $ -      $ 44,209   
     2011         42,113         145        3,133        -        45,391   

Net income (loss):

              

First quarter:

     2012       $ 19,487       $ (335   $ 289      $ -      $ 19,441   
     2011         6,105         (400     (914     -        4,791   

 

1

Elimination entries to remove intercompany transactions for life and accident and health insurance that the Company purchases for its employees and agents were as follows: insurance revenues from the Group Insurance segment and operating expenses from the Individual Insurance segment to arrive at Consolidated Statements of Comprehensive Income.

16. Commitments

In the normal course of business, the Company has open purchase and sale commitments. At March 31, 2012, the Company had purchase commitments to fund mortgage loans and other investments of $13.5 million. Included in this total, the Company had commitments to originate mortgage loans of $8.9 million at March 31, 2012 with fixed interest rates ranging from 4.125% to 5.50%. At March 31, 2012, the Company also had commitments to fund one construction-to-permanent loan of $0.3 million that is subject to the borrower’s performance.

17. Contingent Liabilities

The Company is occasionally involved in litigation, both as a defendant and as a plaintiff. The life insurance industry, including the Company and its subsidiaries, has been subject to an increase in litigation in recent years. Such litigation has been pursued on behalf of purported classes of insurance purchasers, often questioning the conduct of insurers in the marketing of their products. In addition, state regulatory bodies, the SEC, FINRA, and other regulatory bodies regularly make inquiries and conduct examinations or investigations concerning the Company’s compliance with laws in relation to, but not limited to, insurance, securities and activities of broker-dealers and investment advisors.

The Company’s retail broker-dealer subsidiary is in an industry that involves substantial risks of liability. The Company’s broker-dealer subsidiary, SFS, has been named as a defendant in several new cases in recent periods. In recent years, regulatory proceedings, litigation, and FINRA arbitration actions related to registered representative activity and securities products (including, mutual funds, variable annuities, and alternative investments, such as real estate investment products and oil and gas investments) have continued to increase. Given the significant decline in the major market indices beginning in 2008, and the generally poor performance of investments that have historically been considered safe and conservative, there is the potential for an increase in the number of proceedings to which a broker-dealer may be named as a party.

In addition to the above, the Company and its subsidiaries are defendants in, or subject to, other claims or legal actions related to insurance and investment products. Some of these claims and legal actions are in jurisdictions where juries are given substantial latitude in assessing damages, including punitive damages.

Although no assurances can be given and no determinations can be made at this time, management believes that the ultimate liability, if any, with respect to these legal actions and other claims would not have a material effect on the Company’s business, results of operations or financial position.

 

 

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Table of Contents

Kansas City Life Insurance Company

Notes to Consolidated Financial Statements (Unaudited)–Continued

 

In accordance with applicable accounting guidelines, the Company has established an accrued liability for litigation and regulatory matters when those matters present loss contingencies that are both probable and estimable. As a litigation or regulatory matter develops, it is evaluated on an ongoing basis, in conjunction with outside counsel, as to whether the matter presents a loss contingency that meets conditions indicating the need for accrual and/or disclosure. If and when a loss contingency related to litigation or regulatory matters is deemed to be both probable and estimable, the Company establishes an accrued liability. This accrued liability is then monitored for further developments that may affect the amount of the accrued liability.

18. Guarantees and Indemnifications

The Company is subject to various indemnification obligations issued in conjunction with certain transactions, primarily assumption reinsurance agreements, stock purchase agreements, mortgage servicing agreements, tax credit assignment agreements, construction and lease guarantees and borrowing agreements whose terms range in duration and often are not explicitly defined. Generally, a maximum obligation is not explicitly stated. Therefore, the overall maximum amount of the obligation under the indemnifications cannot be reasonably estimated. The Company is unable to estimate with certainty the ultimate legal and financial liability with respect to these indemnifications. The Company believes that the likelihood is remote that material payments would be required under such indemnifications and therefore such indemnifications would not result in a material adverse effect on the financial position or results of operations.

19. Subsequent Events

On April 23, 2012, the Board of Directors declared a quarterly dividend of $0.27 per share that will be paid May 9, 2012 to stockholders of record as of May 3, 2012.

 

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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Amounts are stated in thousands, except share data, or as otherwise noted.

Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to provide in narrative form the perspective of the management of Kansas City Life Insurance Company (the Company) on its financial condition, results of operations, liquidity, and certain other factors that may affect its future results. The following is a discussion and analysis of the results of operations for the quarters ended March 31, 2012 and 2011 and the financial condition of the Company at March 31, 2012. This discussion should be read in conjunction with the consolidated financial statements and accompanying notes included in this document, as well as the Company’s 2011 Form 10-K.

Overview

Kansas City Life Insurance Company is a financial services company that is predominantly focused on the underwriting, sales, and administration of life insurance and annuity products. The consolidated entity (the Company) primarily consists of three life insurance companies. Kansas City Life Insurance Company (Kansas City Life) is the parent company. Sunset Life Insurance Company of America (Sunset Life) and Old American Insurance Company (Old American) are wholly-owned subsidiaries. For additional information, please refer to the Overview included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s 2011 Form 10-K.

Cautionary Statement on Forward-Looking Information

This report reviews the Company’s financial condition and results of operations, and historical information is presented and discussed. Where appropriate, factors that may affect future financial performance are also identified and discussed. Certain statements made in this report include “forward-looking statements” that fall within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include any statement that may predict, forecast, indicate or imply future results, performance or achievements rather than historical facts and may contain words like “believe,” “expect,” “estimate,” “project,” “forecast,” “anticipate,” “plan,” “will,” “shall,” and other words, phrases, or expressions with similar meaning.

Actual results may differ materially from those included in the forward-looking statements as a result of risks and uncertainties. Those risks and uncertainties include, but are not limited to, the risk factors listed in Item 1A. Risk Factors and Cautionary Factors that may Affect Future Results as filed in the Company’s 2011 Form 10-K. For additional information, please refer to the Overview included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s 2011 Form 10-K.

 

35


Table of Contents

Consolidated Results of Operations

Summary of Results

The Company earned net income of $19.4 million in the first quarter of 2012 compared to $4.8 million in the first quarter of 2011. Net income per share was $1.72 in the first quarter of 2012 versus $0.42 in same period in the prior year. The following table presents variances between the results for the first quarters ended March 31, 2012 and 2011. Additional information on these items is presented below.

 

Insurance and other revenues

   $ (2,245

Net investment income

     (1,182

Net realized investment gains

     14,876   

Policyholder benefits and interest credited to policyholder account balances

     6,727   

Amortization of deferred acquisition costs

     1,683   

Operating expenses

     1,903   

Income tax expense

     (7,112
  

 

 

 

Total variance

   $ 14,650   
  

 

 

 

Sales

The Company measures sales in terms of new premiums and deposits. Sales of traditional life insurance, immediate annuities, and accident and health products are reported as premium income for financial statement purposes. Deposits received from the sale of interest sensitive products, including universal life insurance, fixed deferred annuities, variable universal life, variable annuities, and supplementary contracts without life contingencies are reflected as deposits in the Consolidated Statements of Cash Flows.

The Company’s marketing plan for individual products focuses on three main aspects: providing financial security with respect to life insurance, the accumulation of long-term value, and future retirement income needs. The primary emphasis is on the growth of individual life insurance business, including new premiums for individual life products and new deposits for universal life and variable universal life products.

Sales are primarily made through the Company’s existing sales force. The Company emphasizes growth of the sales force with the addition of new general agents and agents. The Company believes that increased sales will result through both the number and productivity of general agents and agents. In addition, the Company places an emphasis on training and direct support to the field force to assist new agents in their start-up phase. This assistance includes support to existing agents to stay abreast of the ever-changing regulatory environment and to introduce agents to new products and enhanced features of existing products. On occasion, the Company may also selectively utilize third-party marketing arrangements to enhance its sales objectives. This allows the Company flexibility to identify niches or pursue unique avenues in the existing market environment and to react quickly to take advantage of opportunities when they occur.

The Company also markets a series of group products. These products include group life, dental, disability, and vision products. The primary growth strategies for these products include increased productivity of the existing group representatives; planned expansion of the group distribution system; and to selectively utilize third-party marketing arrangements. Further, growth is to be supported by the addition of new products to the portfolio, particularly voluntary-type products.

 

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Table of Contents

The following table presents gross premiums by new and renewal business, less reinsurance ceded, as included in insurance revenues for the first quarters ended March 31, 2012 and 2011. New premiums are also detailed by product.

 

     Quarter Ended March 31  
     2012     % Change     2011     % Change  

New premiums:

        

Individual life insurance

   $ 4,356        (1   $ 4,411        12   

Immediate annuities

     1,708        (37     2,709        (50

Group life insurance

     481        (3     494        (21

Group accident and health insurance

     2,544        (30     3,624        9   
  

 

 

     

 

 

   

Total new premiums

     9,089        (19     11,238        (15

Renewal premiums

     37,250        5        35,446        2   
  

 

 

     

 

 

   

Total premiums

     46,339        (1     46,684        (3

Reinsurance ceded

     (13,635     4        (13,059     1   
  

 

 

     

 

 

   

Premiums, net

   $ 32,704        (3   $ 33,625        (4
  

 

 

     

 

 

   

Consolidated total premiums decreased $0.3 million or 1% in the first quarter of 2012 versus the same period in the prior year, as total new premiums decreased $2.1 million or 19% and total renewal premiums increased $1.8 million or 5%. The decrease in total new premiums primarily reflected reductions of $1.1 million or 30% and $1.0 million or 37% in new group accident and health insurance and immediate annuities, respectively. New group accident and health insurance premiums decreased due to declines in short-term disability and dental sales. Immediate annuity receipts can have sizeable fluctuations, as receipts from policyholders largely result from one-time premiums rather than recurring premiums. The decrease in new immediate annuity sales can also be attributed to lower interest rates and increased competition from alternative products. The increase in renewal premiums was largely due to a $1.3 million or 14% increase in group accident and health premiums and a $0.8 million increase in individual life insurance premiums. The increase in group accident and health renewal premiums was largely due to increases in short-term disability product line renewals.

The following table reconciles deposits with the Consolidated Statements of Cash Flows and provides detail by new and renewal deposits for the first quarters ended March 31, 2012 and 2011. New deposits are also detailed by product.

 

     Quarter Ended March 31  
     2012      % Change     2011      % Change  

New deposits:

          

Universal life insurance

   $ 3,303         17      $ 2,812         (18

Variable universal life insurance

     157         (30     225         (7

Fixed deferred annuities

     19,150         29        14,892         35   

Variable annuities

     3,961         3        3,837         (35
  

 

 

      

 

 

    

Total new deposits

     26,571         22        21,766         6   

Renewal deposits

     34,892         (2     35,698         8   
  

 

 

      

 

 

    

Total deposits

   $ 61,463         7      $ 57,464         7   
  

 

 

      

 

 

    

Total new deposits increased $4.8 million or 22% in the first quarter of 2012 compared with the first quarter of 2011. This change was primarily due to a $4.3 million or 29% increase in new fixed deferred annuity deposits and a $0.5 million or 17% increase in new universal life deposits. Total renewal deposits decreased $0.8 million or 2% in the first quarter of 2012 versus last year. Renewal variable annuity deposits decreased $1.1 million or 37%. Partially offsetting this was a $0.5 million or 6% increase in renewal fixed deferred annuity deposits.

Insurance Revenues

Insurance revenues consist of premiums, net of reinsurance, and contract charges. In the first quarter of 2012, total insurance revenues decreased $2.0 million or 3%, reflecting a $0.9 million or 3% decrease in net premiums and a $1.1 million or 4% decrease in contract charges. Total individual life premiums increased $0.8 million or 3% and total accident and health premiums were essentially flat compared with last year. Offsetting these, total immediate annuity premiums decreased $1.3 million or 42%.

 

37


Table of Contents

Contract charges consist of cost of insurance, expense loads, amortization of unearned revenues, and surrender charges on policyholder account balances. Certain contract charges are not recognized in income immediately but are deferred and are amortized into income in proportion to the expected future gross profits of the business, in a manner similar to DAC. Profit expectations are based upon assumptions of future interest spreads, mortality margins, expense margins, and policy and premium persistency experience. At least annually, a review is performed of the assumptions related to profit expectations. If it is determined the assumptions should be revised, the impact is recorded as a change in the revenue reported in the current period as an unlocking adjustment.

Contract charges are impacted by the sales of new products and the persistency of both existing and closed blocks of business. The closed blocks of business reflect policies and companies that the Company has purchased but to which the Company is not actively pursuing marketing efforts to generate new sales and has the intent of servicing to achieve long-term profit streams. Total contract charges on closed blocks equaled 35% of total consolidated contract charges in both the first quarters of 2012 and 2011. Total contract charges on closed blocks declined 3% in the first quarter of 2012 compared to the first quarter of 2011, while total contract charges on open, or ongoing, blocks of business decreased 5%.

Total contract charges on all blocks of business decreased $1.1 million or 4% in the first quarter of 2012 compared to the first quarter of 2011. The largest factor in the 2012 decline was a $0.8 million decrease in deferred revenue, largely resulting from a system upgrade during 2011 that led to enhanced reinsurance modeling capabilities. In addition, cost of insurance charges decreased $0.2 million, largely due to the runoff of closed blocks.

The Company uses reinsurance as a means to mitigate its risks and to reduce the earnings volatility from claims. Reinsurance ceded premiums increased $0.6 million or 4% in the first quarter as compared to the same period in 2011. The Group segment experienced a $0.7 million or 30% increase in reinsurance ceded, reflecting increased disability and group life sales that were reinsured. Reinsurance ceded for the Old American segment declined $0.1 million or 18% in the first quarter of 2012, reflecting the continued runoff of a large closed block of reinsured business. Reinsurance ceded for the Individual Insurance segment remained essentially flat in the first quarter of 2012 compared to one year earlier.

Investment Revenues

Gross investment income is largely composed of interest, dividends and other earnings on fixed maturity securities, equity securities, short-term investments, mortgage loans, real estate, and policy loans. Gross investment income decreased $1.5 million or 3% in the first quarter of 2012, compared with the same period in 2011. While average invested assets increased during 2012, this was more than offset by lower yields earned on certain investments.

Fixed maturity securities provided a majority of the Company’s investment income during the quarter ended March 31, 2012. Income on these investments declined $1.5 million or 4% in the first quarter of 2012 compared to the prior year, reflecting declines in average invested assets and yields earned.

Investment income from mortgage loans increased $0.7 million or 8% in the first quarter of 2012 compared to the same period in 2011. This improvement was largely the result of higher mortgage loan portfolio holdings in the first quarter of 2012 compared to the first quarter of 2011, as the Company significantly increased the mortgage loan balance through purchases made during 2011.

In addition, the market value declined on an alternative investment fund, which resulted in a decrease of investment income of $0.3 million in the first quarter of 2012 compared to the first quarter of 2011.

Net investment income is stated net of investment expenses. Investment expenses decreased $0.3 million or 9% in the first quarter of 2012 compared to the same period in 2011. This change is largely attributable to decreased real estate expenses, resulting from the sale of several properties.

The Company realizes investment gains and losses from several sources, including write-downs of investments and sales of investment securities and real estate. Many securities purchased by the Company contain call provisions, which allow the issuer to redeem the securities at a particular price. Depending upon the terms of the call provision and price at which the security was purchased, a gain or loss may be realized.