ITEM 1. BUSINESS
United Trust, Inc. (the "Registrant") was incorporated in 1984, under the laws of the State of Illinois to serve as an insurance holding company. At December 31, 1996, significant majority-owned subsidiaries and affiliates of the Registrant were as depicted on the following organizational chart:
United Trust, Inc. ("UTI") is the ultimate controlling company. UTI owns 53% of United Trust Group ("UTG") and 30% of United Income, Inc. ("UII"). UII owns 47% of UTG. UTG owns 72% of First Commonwealth Corporation ("FCC"). FCC owns 100% of Universal Guaranty Life Insurance Company ("UG"). UG owns 100% of United Security Assurance Company ("USA"). USA owns 84% of Appalachian Life Insurance Company ("APPL") and APPL owns 100% of Abraham Lincoln Insurance Company ("ABE").
ITEM 1. BUSINESS
The Registrant and its subsidiaries (the "Company") operate principally in the individual life insurance business. The primary business of the Company has been the servicing of existing insurance business in force, the solicitation of new insurance business, and the acquisition of other companies in similar lines of business.
United Trust, Inc., ("UTI") was incorporated December 14, 1984, as an Illinois corporation. During the next two and a half years, UTI was engaged in an intrastate public offering of its securities, raising over $12,000,000 net of offering costs. In 1986, UTI formed a life insurance subsidiary and by 1987 began selling life insurance products.
United Income, Inc. ("UII"), an affiliated company, was incorporated on November 2, 1987, as an Ohio corporation. Between March 1988 and August 1990, UII raised a total of approximately $15,000,000 in an intrastate public offering in Ohio. During 1990, UII formed a life insurance subsidiary and began selling life insurance products.
UTI currently owns 30% of the outstanding common stock of UII and accounts for its investment in UII using the equity method.
On February 20, 1992, UTI and UII, formed a joint venture, United Trust Group, Inc., ("UTG"). On June 16, 1992, UTI contributed $2.7 million in cash, an $840,000 promissory note and 100% of the common stock of its wholly owned life insurance subsidiary. UII contributed $7.6 million in cash and 100% of its life insurance subsidiary to UTG. After the contributions of cash, subsidiaries, and the note, UII owns 47% and UTI owns 53% of UTG.
On June 16, 1992, UTG acquired 67% of the outstanding common stock of the now dissolved Commonwealth Industries Corporation, ("CIC") for a purchase price of $15,567,000. Following the acquisition UTI controlled eleven life insurance subsidiaries. The Company has taken several steps to streamline and simplify the corporate structure following the acquisitions.
On December 28, 1992, Universal Guaranty Life Insurance Company ("UG") was the surviving company of a merger with Roosevelt National Life Insurance Company ("RNLIC"), United Trust Assurance Company ("UTAC"), Cimarron Life Insurance Company ("CIM") and Home Security Life Insurance Company ("HSLIC"). On June 30, 1993, Alliance Life Insurance Company ("ALLI"), a subsidiary of UG, was merged into UG.
On March 30, 1994, Farmers and Ranchers Life Insurance Company ("F&R") was sold to an unrelated third party. F&R was a small life insurance company which did not significantly contribute to the operations of the group. F&R primarily represented a marketing opportunity. The Company determined it would not be able to allocate the time and resources necessary to properly develop the opportunity, due to continued focus and emphasis on certain other agency forces of the Company.
On July 31, 1994, Investors Trust Assurance Company ("ITAC") was merged into Abraham Lincoln Insurance Company ("ALIC").
On August 15, 1995, the shareholders of CIC, Investors Trust, Inc., ("ITI"), and Universal Guaranty Investment Company, ("UGIC"), all intermediate holding companies within the UTI group, voted to voluntarily liquidate each of the companies and distribute the assets to the shareholders (consisting solely of common stock of their respective subsidiary). As a result, the shareholders of the liquidated companies became shareholders of FCC. Following the liquidations, UTG owns 72% of the outstanding common stock of FCC.
PRODUCTS
The Company's portfolio consists of two universal life insurance products. The primary universal life insurance product is referred to as the "Century 2000". This product was introduced to the marketing force in 1993 and has become the cornerstone of current marketing. This product has a minimum face amount of $25,000 and currently credits 6% interest with a guaranteed rate of 4.5% in the first 20 years and 3% in years 21 and greater. The policy values are subject to a $4.50 monthly policy fee, an administrative load and a premium load of 6.5% in all years. The administrative load and surrender charge are based on the issue age, sex and rating class of the policy. A surrender charge is effective for the first 14 policy years. In general, the surrender charge is very high in the first couple of years and then declines to zero at the end of 14 years. Policy loans are available at 7% interest in advance. The policy's accumulated fund will be credited the guaranteed interest rate in relation to the amount of the policy loan.
The second universal life product referred to as the "UL90A", has a minimum face amount of $25,000. The administrative load is based on the issue age, sex and rating class of the policy. Policy fees vary from $1 per month in the first year to $4 per month in the second and third years and $3 per month each year thereafter. The UL90A currently credits 5.5% interest with a 4.5% guaranteed interest rate. Partial withdrawals, subject to a remaining minimum $500 cash surrender value and a $25 fee, are allowed once a year after the first duration. Policy loans are available at 7% interest in advance. The policy's accumulated fund will be credited the guaranteed interest rate in relation to the amount of the policy loan. Surrender charges are based on a percentage of target premium starting at 120% for years 1-5 then grading downward to zero in year 15. This policy contains a guaranteed interest credit bonus for the long term policyholder. From years 10 through 20, additional interest bonuses are earned with a total in the twentieth year of 1.375%. The bonus is calculated from the policy issue date and is contractually guaranteed.
The Company markets other products, none of which is significant to operations. The Company has a variety of policies in force different from those which are currently being marketed. Approximately 30% of the insurance in force is participating business. The Company's average persistency rate for its policies in force for 1996 and 1995 has been 87.9% and 87.5%, respectively. The Company does not anticipate any material fluctuations in these rates in the future that may result from competition.
The Company's actual experience for earned interest, persistency and mortality vary from the assumptions applied to pricing and for determining premiums. Accordingly, differences between the Company's actual experience and those assumptions applied may impact the profitability of the Company. The minimum interest spread between earned and credited rates is 1% on the "Century 2000" universal life insurance product. The Company monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted interest spreads. Credited rates are reviewed and established by the Board of Directors of the respective life insurance subsidiaries.
The premium rates are competitive with other insurers doing business in the states in which the Company is marketing its products.
MARKETING
The Company markets its products through separate and distinct agency forces. The Company has approximately 60 captive agents and 15 independent agents who actively write new business. No individual sales agent accounted for over 10% of the Company's premium volume in 1996. The Company's sales agents do not have the power to bind the Company.
The change in marketing strategy from traditional life insurance products to universal life insurance products had a significant impact on new business production. As a result of the change in marketing strategy the agency force went through a restructuring and retraining process. Marketing is based on a referral network of community leaders and shareholders of UII and UTI. Recruiting of agents is also based on the same referral network.
New sales are marketed by UG and USA through their agency forces using contemporary sales approaches with personal computer illustrations. Current marketing efforts are primarily focused on the Midwest region.
Recruiting of agents is based on obtaining people with little or no experience in the life insurance business. These recruits go through an extensive internal training program.
USA is licensed in Illinois, Indiana and Ohio. During 1996, Ohio accounted for 99% of USA's direct premiums collected.
ALIC is licensed in Alabama, Arizona, Illinois, Indiana, Louisiana and Missouri. During 1996, Illinois and Indiana accounted for 44% and 36%, respectively of ALIC's direct premiums collected.
APPL is licensed in Alabama, Arizona, Arkansas, Colorado, Georgia, Illinois, Indiana, Kansas, Kentucky, Louisiana, Missouri, Montana, Nebraska, Ohio, Oklahoma, Pennsylvania, Tennessee, Utah, Virginia, West Virginia and Wyoming. During 1996, West Virginia accounted for 95% of APPL's direct premiums collected.
UG is licensed in Alabama, Arizona, Arkansas, Colorado, Delaware, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, Washington, West Virginia and Wisconsin. During 1996, Illinois and Ohio accounted for 33% and 15%, respectively, of UG's direct premiums collected. No other states account for more than 7% of UG's direct premiums collected.
UNDERWRITING
The underwriting procedures of the Company's insurance subsidiaries are established by management. Insurance policies are issued by the Company based upon underwriting practices established for each market in which the Company operates. Most policies are individually underwritten. Applications for insurance are reviewed to determine additional information required to make an underwriting decision, which depends on the amount of insurance applied for and the applicant's age and medical history. Additional information may include inspection reports, medical examinations, statements from doctors who have treated the applicant in the past and, where indicated, special medical tests. After reviewing the information collected, the Company either issues the policy as applied for or with an extra premium charge because of unfavorable factors or rejects the application. Substandard risks may be referred to reinsurers for full or partial reinsurance of the substandard risk.
The Company's insurance subsidiaries require blood samples to be drawn with individual insurance applications for coverage over $45,000 (age 46 and above) or $95,000 (ages 16-45). Blood samples are tested for a wide range of chemical values and are screened for antibodies to the HIV virus. Applications also contain questions permitted by law regarding the HIV virus which must be answered by the proposed insureds.
RESERVES
The applicable insurance laws under which the Company's insurance subsidiaries operate require that each insurance company report policy reserves as liabilities to meet future obligations on the policies in force. These reserves are the amounts which, with the additional premiums to be received and interest thereon compounded annually at certain assumed rates, are calculated in accordance with applicable law to be sufficient to meet the various policy and contract obligations as they mature. These laws specify that the reserves shall not be less than reserves calculated using certain mortality tables and interest rates.
The liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance subsidiaries' experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. The Company makes these assumptions at the time the contract is
issued or, in the case of contracts acquired by purchase, at the purchase date. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. Current mortality rate assumptions are based on 1975-80 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or Linton C.
Benefit reserves for universal life insurance and interest sensitive life insurance products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims in excess of related policy account balances. Interest crediting rates for universal life and interest sensitive products range from 5.0% to 6.0% in each of the years 1996, 1995 and 1994.
REINSURANCE
As is customary in the insurance industry, the Company's insurance subsidiaries cede insurance to other insurance companies under reinsurance agreements. Reinsurance agreements are intended to limit a life insurer's maximum loss on a large or unusually hazardous risk or to obtain a greater diversification of risk. The ceding insurance company remains contingently liable with respect to ceded insurance should any reinsurer be unable to meet the obligations assumed by it, however it is the practice of insurers to reduce their financial statement liabilities to the extent that they have been reinsured with other insurance companies. The Company sets a limit on the amount of insurance retained on the life of any one person. The Company will not retain more than $125,000, including accidental death benefits, on any one life. At December 31, 1996, the Company had insurance in force of $3.953 billion of which approximately $1.109 billion was ceded to reinsurers.
The Company's reinsured business is ceded to numerous reinsurers. The Company believes the assuming companies are able to honor all contractual commitments, based on the Company's periodic reviews of their financial statements, insurance industry reports and reports filed with state insurance departments.
The Company's insurance subsidiary ("UG") entered into a coinsurance agreement with First International Life Insurance Company ("FILIC") as of September 30, 1996. Under the terms of the agreement, UG ceded to FILIC substantially all of its paid-up life insurance policies. Paid- up life insurance generally refers to non-premium paying life insurance policies. A.M. Best, an industry rating company, assigned a Best's Rating of A++ (Superior) to The Guardian Life Insurance Company of America ("Guardian"), parent of FILIC, based on the consolidated financial condition and operating performance of the company and its life/health subsidiaries. The agreement with FILIC accounts for approximately 66% of the reinsurance receivables as of December 31, 1996.
As a result of the FILIC coinsurance agreement, effective September 30, 1996, UG received a reinsurance credit in the amount of $28,318,000 in exchange for an equal amount of assets. UG also received $6,375,000 as a commission allowance.
Currently, the Company is utilizing reinsurance agreements with Business Men's Assurance Company, ("BMA") and Life Reassurance Corporation, ("LIFE RE") for new business. BMA and LIFE RE each hold an "A+" (Superior) rating from A.M. Best, an industry rating company. The reinsurance agreements were effective December 1, 1993, and cover all new business of the Company. The agreements are a yearly renewable term ("YRT") treaty where the Company cedes amounts above its retention limit of $100,000 with a minimum cession of $25,000.
In selecting a reinsurance company, the Company examines many factors including:
1) Whether the reinsurer is licensed in the states in which reinsurance coverage is being sought;
2) the solvency and stability of the company. One source utilized is the rating given the reinsurer by the A.M. Best Company, an insurance industry rating company. Another source is the statutory annual statement of the reinsurer;
3) the history and reputation of the Company;
4) competitive pricing of reinsurance coverage. The Company generally seeks quotes from several reinsurers when considering a new treaty.
The Company does not have any short-duration reinsurance contracts. The effect of the Company's long-duration reinsurance contracts on premiums earned in 1996, 1995 and 1994 was as follows:
Shown in thousands
1996 1995 1994 Premiums Premiums Premiums Earned Earned Earned Direct $ 32,387 $ 35,201 $ 38,063 Assumed 0 0 0 Ceded (4,768) (5,203) (5,659) Net premiums $ 27,619 $ 29,998 $ 32,404
INVESTMENTS
The Company retains the services of a registered investment advisor to assist the Company in managing its investment portfolio. The Company may modify its present investment strategy at any time, provided its strategy continues to be in compliance with the limitations of state insurance department regulations.
Investment income represents a significant portion of the Company's total income. Investments are subject to applicable state insurance laws and regulations which limit the concentration of investments in any one category or class and further limit the investment in any one issuer. Generally, these limitations are imposed as a percentage of statutory assets or percentage of statutory capital and surplus of each company.
The following table reflects net investment income by type of investment.
December 31, 1996 1995 1994
Fixed maturities and fixed maturities held for sale $ 13,326,312 $ 13,190,121 $ 12,185,941 Equity securities 88,661 52,445 3,999 Mortgage loans 1,047,461 1,257,189 1,423,474 Real estate 794,844 975,080 990,857 Policy loans 1,121,538 1,041,900 1,014,723 Short-term investments 515,346 505,637 444,135 Other 197,188 158,290 221,125 Total consolidated investment income 17,091,350 17,180,662 16,284,254 Investment expenses (1,222,903) (1,724,438) (1,915,808) Consolidated net investment income $ 15,868,447 $ 15,456,224 $ 14,368,446
At December 31, 1996, the Company had a total of $6,025,000 of investments, which did not produce income during 1996. These investments are comprised of $5,325,000 in real estate including its home office property and $700,000 in equity securities, which did not produce income during 1996.
The following table summarizes the Company's fixed maturities distribution at December 31, 1996 and 1995 by ratings category as issued by Standard and Poor's, a leading ratings analyst.
Fixed Maturities Rating % of Portfolio 1996 1995 Investment Grade
AAA 30% 27% AA 13% 14% A 46% 48% BBB 10% 11% Below investment grade 1% 0% 100% 100%
The following table summarizes the Company's fixed maturities and fixed maturities held for sale by major classification.
Carrying Value 1996 1995 U.S. government and $ 29,998,240 $ 29,492,006 government agencies States, municipalities and 14,561,203 7,608,494 political subdivisions Collateralized mortgage 13,246,780 15,428,596 obligations Public utilities 51,941,647 59,254,524 Corporate 72,140,081 82,516,775 $ 181,887,951 $ 194,300,395
The following table shows the composition and average maturity of the Company's investment portfolio at December 31, 1996.
Carrying Average Average INVESTMENTS Value Maturity Yield
Fixed maturities and fixed maturities held for sale $181,887,951 6 years 7.08% Equity securities 1,794,405 not applicable 4.74% Mortgage loans 11,022,792 11 years 8.41% Investment real estate 14,390,436 not applicable 5.01% Policy loans 14,438,120 not applicable 6.55% Short-term investments 430,983 159 days 4.15% Total Investments $223,964,687 7.21%
At December 31, 1996, fixed maturities and fixed maturities held for sale have a market value of $183,776,000. Fixed maturities are carried at amortized cost. Management has the ability and intent to hold these securities until maturity. Fixed maturities held for sale are carried at market.
The Company holds approximately $431,000 in short-term investments. Management monitors its investment maturities and in their opinion is sufficient to meet the Company's cash requirements. The following is a summary of other investments maturing in one to five years. Fixed maturities and mortgage loans of $13,362,000 and $1,039,000 respectively, maturing in one year and $75,691,000 and $885,000, respectively, maturing in two to five years.
The Company holds approximately $11,023,000 in mortgage loans which represents 3% of the total assets. All mortgage loans are first position loans. Before a new loan is issued, the applicant is subject to certain criteria set forth by Company management to ensure quality control. These criteria include, but are not limited to, a credit report, personal financial information such as outstanding debt, sources of income, and personal equity. Loans issued are limited to no more than 80% of the appraised value of the property and must be first position against the collateral.
The Company has $603,000 of mortgage loans, net of a $10,000 reserve allowance, which are in default or in the process of foreclosure. These loans represent approximately 5% of the total portfolio. The Company has one loan of $63,900 which is under a repayment plan. Letters are sent to each mortgagee when the loan becomes 30 days or more delinquent. Loans 90 days or more delinquent are placed on a non-performing status and classified as delinquent loans. Reserves for loan losses are established based on management's analysis of the loan balances compared to the expected realizable value should foreclosure take place. Loans are placed on a non-accrual status based on a quarterly analysis of the likelihood of repayment. All delinquent and troubled loans held by the Company are loans which were held in portfolios by acquired companies at the time of acquisition. Management believes the current internal controls surrounding, the mortgage loan selection process provide a quality portfolio with minimal risk of foreclosure and/or negative financial impact.
The Company has in place a monitoring system to provide management with information regarding potential troubled loans. Management is provided with a monthly listing of loans that are 30 days or more past due along with a brief description of what steps are being taken to resolve the delinquency. Quarterly, coinciding with external financial reporting, the Company determines how each delinquent loan should be classified. All loans 90 days or more past due are classified as delinquent. Each delinquent loan is reviewed to determine the classification and status the loan should be given. Interest accruals are analyzed based on the likelihood of repayment. In no event will interest continue to accrue when accrued interest along with the outstanding principal exceeds the net realizable value of the property. The Company does not utilize a specified number of days delinquent to cause an automatic non-accrual status.
The mortgage loan reserve is established and adjusted based on management's quarterly analysis of the portfolio and any deterioration in value of the underlying property which would reduce the net realizable value of the property below its current carrying value.
In addition, the Company also monitors that current and adequate insurance on the properties are being maintained. The Company requires proof of insurance on each loan and further requires to be shown as a lienholder on the policy so that any change in coverage status is reported to the Company. Proof of payment of real estate taxes is another monitoring technique utilized by the Company. Management believes a change in insurance status or non-payment of real estate taxes are indicators that a loan is potentially troubled. Correspondence with the mortgagee is performed to determine the reasons for either of these events occurring.
The following table shows a distribution of mortgage loans by type.
Mortgage Amount % of Loans Total FHA/VA $ 676,176 6% Commercial 1,878,158 17% Residential 8,468,458 77%
The following table shows a geographic distribution of the mortgage loan portfolio and real estate held.
Mortgage Real Loans Estate
Colorado 2% 0% Illinois 12% 60% Kansas 12% 0% Louisiana 14% 12% Mississippi 0% 16% Missouri 2% 1% North Carolina 6% 5% Oklahoma 7% 1% Virginia 4% 0% West Virginia 37% 3% Other 4% 2% Total 100% 100%
The following table summarizes delinquent mortgage loan holdings. Delinquent 31 Days or More 1996 1995 1994
Non-accrual status $ 0 $ 0 $ 0 Other 613,000 628,000 911,000 Reserve on delinquent loans (10,000) (10,000) (26,000) Total Delinquent $ 603,000 $ 618,000 $ 885,000
Interest income forgone (Delinquent loans) $ 29,000 $ 16,000 $ 4,000
In Process of Restructuring $ 0 $ 0 $ 0 Restructuring on other than market terms 0 0 0 Other potential problem loans 0 0 0 Total Problem Loans $ 0 $ 0 $ 0 Interest income foregone (Resturctured loans) $ 0 $ 0 $ 0
See Item 2, Properties, for description of real estate holdings.
COMPETITION
The insurance business is a highly competitive industry and there are a number of other companies, both stock and mutual, doing business in areas where the Company operates. Many of these competing insurers are larger, have more diversified lines of insurance coverage, have substantially greater financial resources and have a greater number of agents. Other significant competitive factors include policyholder benefits, service to policyholders, and premium rates.
The insurance industry is a mature industry. In recent years, the industry has experienced virtually no growth in life insurance sales, though the aging population has increased the demand for retirement savings products. The products offered (see Products) are similar to those offered by other major companies. The product features are regulated by the states and are subject to extensive competition among major insurance organizations. The Company believes a strong service commitment to policyholders, efficiency and flexibility of operations, timely service to the agency force and the expertise of its key executives help minimize the competitive pressures of the insurance industry.
GOVERNMENT REGULATION
The Company's insurance subsidiaries are subject to government regulation in each of the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including the power to: (i) grant and revoke licenses to transact business; (ii) regulate and supervise trade practices and market conduct; (iii) establish guaranty associations; (iv) license agents; (v) approve policy forms; (vi) approve premium rates for some lines of business; (vii) establish reserve requirements; (viii) prescribe the form and content of required financial statements and reports; (ix) determine the reasonableness and adequacy of statutory capital and surplus; and (x) regulate the type and amount of permitted investments. Insurance regulation is concerned primarily with the protection of policyholders. The Company cannot predict the form of any future proposals or regulation. The Company's insurance subsidiaries, USA, UG, APPL and ALIC are domiciled in the states of Ohio, Ohio, West Virginia and Illinois, respectively.
Most states also have insurance holding company statutes which require registration and periodic reporting by insurance companies controlled by other corporations licensed to transact business within their respective jurisdictions. The insurance subsidiaries are subject to such legislation and are registered as controlled insurers in those jurisdictions in which such registration is required. Statutes vary from state to state but typically require periodic disclosure concerning the corporation that controls the registered insurers and all subsidiaries of such corporation. In addition, prior notice to, or approval by, the state insurance commission of material intercorporate transfers of assets, reinsurance agreements, management agreements (see Note 9 to Notes to Financial Statements), and payment of dividends (see Note 2 to Notes to Financial Statements) in excess of specified amounts by the insurance subsidiary within the holding company system are required.
The National Association of Insurance Commissioners ("NAIC") is an association whose membership consists of the insurance commissioners or their designees of the various states. The NAIC has no direct regulatory authority over insurance companies, however its primary purpose is to provide a more consistent method of regulation and reporting from state to state. This is accomplished through the issuance of model regulations, which can be adopted by individual states unmodified, modified to meet the state's own needs or requirements, or dismissed entirely.
Each year the NAIC calculates financial ratio results (commonly referred to as IRIS ratios) for each company. These ratios compare various financial information pertaining to the statutory balance sheet and income statement. The results are then compared to pre- established normal ranges determined by the NAIC. Results outside the range typically require explanation to the domiciliary insurance department.
At year end 1996, UG had two ratios outside the normal range. The first ratio compared commission allowances with statutory capital and surplus. The ratio was outside the norm due to the coinsurance agreement with First International Life Insurance Company ("FILIC"). Additional information about the coinsurance agreement with FILIC can be found in the section titled Reinsurance or in Note 7 of the Notes to the Consolidated Financial Statements. Management does not believe that this ratio will be outside the normal range in future periods.
The second ratio is related to the decrease in premium income. The ratio fell outside the normal range the last two years. The decrease in premium income is directly attributable to the change in distribution systems and marketing strategy. The Company changed its focus from primarily a broker agency distribution system to a captive agent system and changed its marketing strategy from traditional whole life insurance products to universal life insurance products. Management is taking a long-term approach to its recent changes to the marketing and distribution systems and believes these changes will provide long-term benefits to the Company.
The NAIC has adopted Risk Based Capital ("RBC") rules to evaluate the adequacy of statutory capital and surplus in relation to a company's investment and insurance risks. The RBC formula reflects the level of risk of invested assets and the types of insurance products. The formula classifies company risks into four categories:
1) Asset risk - the risk of loss of principal due to default through creditor bankruptcy or decline in market value for assets reported at market.
2) Pricing inadequacy - the risk of adverse mortality, morbidity, and expense experience in relation to pricing assumptions.
3) Asset and liability mismatch - the risk of having to reinvest funds when market yields fall below levels guaranteed to contract holders, and the risk of having to sell assets when market yields are above the levels at which the assets were purchased.
4) General risk - the risk of fraud, mismanagement, and other business risks.
The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio of the insurance company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Insurance companies below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action. The levels and ratios are as follows:
Ratio of Total Adjusted Capital to Authorized Control Level RBC Regulatory Event (Less Than or Equal to)
Company action level 2.0* Regulatory action level 1.5 Authorized control level 1.0 Mandatory control level 0.7
* Or, 2.5 with negative trend.
At December 31, 1996, each of the Company's insurance subsidiaries has a Ratio that is in excess of 300% of the authorized control level; accordingly the Company's subsidiaries meet the RBC requirements.
The NAIC has recently released the Life Illustration Model Regulation. This regulation requires products which contain non-guaranteed elements, such as universal life and interest sensitive life, to comply with certain actuarially established tests. These tests are intended to target future performance and profitability of a product under various scenarios. The regulation does not prevent a company from selling a product which does not meet the various tests. The only implication is the way in which the product is marketed to the consumer. A product which does not pass the tests uses guaranteed assumptions rather than current assumptions in presenting future product performance to the consumer.
As states in which the Company does business adopt the regulation or adopt a modified version of the regulation, the Company will be required to comply with this new regulation. The Company may need to modify existing products or sales methods.
The NAIC has proposed a new Model Investment Law that may affect the statutory carrying values of certain investments; however, the final outcome of that proposal is not certain, nor is it possible to predict what impact the proposal will have or whether the proposal will be adopted in the foreseeable future.
EMPLOYEES
There are approximately 100 persons who are employed by the Company and its affiliates.
ITEM 2.

ITEM 2. PROPERTIES
The following table shows the distribution of real estate by type.
Real Estate Amount % of Total Home Office $ 2,885,908 20% Commercial $ 2,397,475 17% Residential development $ 5,260,107 36% Foreclosed real estate $ 3,846,946 27%
Real estate holdings represent approximately 4% of the total assets of the Company net of accumulated depreciation of $1,341,000 and $1,050,000 at year end 1996 and 1995 respectively. The Company owns an office complex in Springfield, Illinois, which houses the primary insurance operations. The office buildings contain 57,000 square feet of office and warehouse space. The properties are carried at approximately $2,688,000. In addition, an insurance subsidiary owns a home office building in Huntington, West Virginia. The building has 15,000 square feet and is carried at $198,000. The facilities occupied by the Company are adequate relative to the Company's present operations.
Commercial property consists primarily of former home office buildings of acquired companies no longer used in the operations of the Company. These properties are leased to various unaffiliated companies and organizations. Residential development property is primarily located in Springfield, Illinois, and entails several developments, each targeted for a different segment of the population. These targets include a development primarily for the first time home buyer, an upscale development for existing homeowners looking for a larger home, and duplex condominiums for those who desire maintenance free exteriors and surroundings. The Company's primary focus is on the development and sale of lots, with an occasional home construction to help stimulate interest.
Springfield is the State Capital of Illinois. The City's economy is service oriented with the main employers being the State of Illinois, two major area hospitals and two large insurance companies. This provides for a very stable economy not as dramatically affected by economic conditions in other parts of the United States.
Foreclosed property is carried at the unpaid loan principal balance plus accrued interest on the loan and other costs associated with the foreclosure process. The carrying value of foreclosed property does not exceed management's estimate of net realizable value. Management's estimate of net realizable value is based on significant internal real estate experience, local market experience, independent appraisals and evaluation of existing comparable property sales.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are named as defendants in a number of legal actions arising primarily from claims made under insurance policies. Those actions have been considered in establishing the Company's liabilities. Management and its legal counsel are of the opinion that the settlement of those actions will not have a material adverse effect on the Company's financial position or results of operations.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS OF A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.

ITEM 5. MARKET FOR COMPANY'S COMMON STOCK AND RELATED SECURITY HOLDERS MATTERS
On June 18, 1990, UTI became a member of NASDAQ. Quotations began on that date under the symbol UTIN. The following table shows the high and low bid quotations for each quarterly period during the past two years, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
BID PERIOD LOW HIGH
First quarter 3/8 9/16 Second quarter 3/8 11/16 Third quarter 1/2 11/16 Fourth quarter 3/8 3/4
First quarter 1/2 5/8 Second quarter 1/2 1 Third quarter 1/2 5/8 Fourth quarter 3/8 9/16
CURRENT MARKET MAKERS ARE:
M. H. Meyerson and Company Carr Securities Corporation 30 Montgomery Street 17 Battery Place Jersey City, NJ 07303 New York, NY 10004
Herzog, Heine, Geduld, Inc. Howe, Barnes Investments, Inc. 26 Broadway, 1st Floor 135 South LaSalle, Suite 1500 New York, NY 10004 Chicago, IL 60603
As of December 31, 1996, no cash dividends had been declared on the common stock of UTI.
See Note 2 in the accompanying consolidated financial statements for information regarding dividend restrictions.
Number of Common Shareholders as of March 3, 1997 is 5,689.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
FINANCIAL HIGHLIGHTS (000's omitted, except per share data) 1996 1995 1994 1993 1992
Premium income net of reinsurance $ 27,619 $ 29,998 $ 32,404 $ 31,160 $ 19,076 Total revenues $ 46,976 $ 49,869 $ 49,207 $ 48,541 $ 36,826 Net income (loss)* $ (938)$ (3,001)$ (1,624)$ (862)$ 5,661 Net income (loss) per share $ (0.05)$ (0.16)$ (0.09)$ (0.05)$ 0.30 Total assets $355,474 $356,305 $360,258 $375,755 $370,259
Total long term debt $ 19,574 $ 21,447 $ 22,053 $ 24,359 $ 27,494 Dividends paid per share NONE NONE NONE NONE NONE
* Includes equity earnings of investees.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
The Company and its consolidated subsidiaries have three principal needs for cash - the insurance companies' contractual obligations to policyholders, the payment of operating expenses and servicing of its long-term debt. Cash and cash equivalents as a percentage of total assets were 5% and 4% as of December 31, 1996, and 1995, respectively. Fixed maturities as a percentage of total invested assets were 80% and 78% as of December 31, 1996 and 1995, respectively.
Future policy benefits are primarily long-term in nature and therefore, the Company's investments are predominantly in long term fixed maturity investments such as bonds and mortgage loans which provide a sufficient return to cover these obligations. Most of the insurance company assets, other than policy loans, are invested in fixed maturities and other investments, substantially all of which are readily marketable. Although there is no present need or intent to dispose of such investments, the life companies could liquidate portions of their investments if such a need arose. The Company has the ability and intent to hold these investments to maturity; consequently, the Company's investment in long term fixed maturities are reported in the financial statements at their amortized cost.
Many of the Company's products contain surrender charges and other features which reward persistency and penalize the early withdrawal of funds. With respect to such products, surrender charges are generally sufficient to cover the Company's unamortized deferred policy acquisition costs with respect to the policy being surrendered.
Consolidated operating activities of the Company produced cash flows of $2,785,000, $453,000 and $2,145,000 in 1996, 1995 and 1994, respectively. The net cash provided by operating activities plus net policyholder contract deposits after the payment of policyholder withdrawals, equalled $9,596,000 in 1996, $9,466,000 in 1995, and $10,361,000 in 1994. Management utilizes this measurement of cash flows as an indicator of the performance of the Company's insurance operations, since reporting regulations require cash inflows and outflows from universal life insurance products to be shown as financing activities.
Cash provided by (used in) investing activities was $16,163,000, ($8,030,000) and ($28,595,000), for 1996, 1995 and 1994, respectively. The most significant aspect of cash provided by (used in) investing activities is the fixed maturity transactions. Fixed maturities account for 82%, 76% and 79% of the total cost of investments acquired in 1996, 1995 and 1994, respectively. The net cash provided by investing activities in 1996, is due to the fixed maturities sold in conjunction with the coinsurance agreement with FILIC. The Company has not directed its investable funds to so-called "junk bonds" or derivative investments.
Net cash provided by (used in) financing activities was ($14,150,000), $8,408,000 and $5,844,000 for 1996, 1995 and 1994, respectively. The change between 1996 and 1995 is due to a coinsurance agreement with First International Life Insurance Company as of September 30, 1996. At closing of the transaction, UG received a reinsurance credit of $28,318,000 for policy liabilities covered under the agreement. UG transferred assets equal to the credit received. This transfer included policy loans of $2,855,000 associated with policies under the agreement and a net cash transfer of $19,088,000 after deducting the ceding commission due UG of $6,375,000.
Policyholder contract deposits decreased 11% in 1996 compared to 1995, and increased 8% in 1995 when compared to 1994. Policyholder contract withdrawals has decreased 4% in 1996 compared to 1995, and increased 7% in 1995 compared to 1994. The changes in policyholder contract withdrawals is not attributable to any one significant event. Factors that impact policyholder contract withdrawals are fluctuation of interest rates, competition and other economic factors. The Company's current marketing strategy and product portfolio is directly structured to conserve the existing customer base and at the same time increase the customer base through new policy production.
On May 8, 1996, FCC refinanced its senior debt of $8,900,000. The refinancing was completed through First of America Bank - NA and is subject to a credit agreement. The refinanced debt bears interest to a rate equal to the "base rate" plus nine-sixteenths of one percent. The Base rate is defined as the floating daily, variable rate of interest determined and announced by First of America Bank from time to time as its "base lending rate". The base rate at issuance of the loan was 8.25%, and has remained unchanged through March 1, 1997. Interest is paid quarterly and principal payments of $1,000,000 are due in May of each year beginning in 1997, with a final payment due May 8, 2005. On November 8, 1996, the Company prepaid $500,000 of the May 8, 1997 principal payment.
On a parent only basis, UTI's cash flow is dependent on revenues from a management agreement with UII and its earnings received on invested assets and cash balances. At December 31, 1996, substantially all of the consolidated shareholders equity represents net assets of its subsidiaries. UTI does not have significant day to day operations of its own. Cash requirements of UTI primarily relate to the payment of expenses related to maintaining the Company as a corporation in good standing with the various regulatory bodies which govern corporations in the jurisdictions where the Company does business. The payment of cash dividends to shareholders is not legally restricted. However, insurance company dividend payments are regulated by the state insurance department where the company is domiciled. UG's dividend limitations are described below.
Ohio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 1996, UG had a statutory gain from operations of $8,006,000. At December 31, 1996, UG's statutory capital and surplus amounted to $10,227,000. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation.
A life insurance company's statutory capital is computed according to rules prescribed by the National Association of Insurance Commissioners ("NAIC"), as modified by the insurance company's state of domicile. Statutory accounting rules are different from generally accepted accounting principles and are intended to reflect a more conservative view by, for example, requiring immediate expensing of policy acquisition costs. The achievement of long-term growth will require growth in the statutory capital of the Company's insurance subsidiaries. The subsidiaries may secure additional statutory capital through various sources, such as internally generated statutory earnings or equity contributions by the Company from funds generated through debt or equity offerings.
The NAIC's risk-based capital requirements require insurance companies to calculate and report information under a risk-based capital formula. These requirements are intended to allow insurance regulators to identify inadequately capitalized insurance companies based upon the types and mixtures of risks inherent in the insurer's operations. The formula includes components for asset risk, liability risk, interest rate exposure, and other factors. Based upon their December 31, 1996, statutory financial reports, the Company's insurance subsidiaries are adequately capitalized under the formula.
The Company is not aware of any litigation that will have a material adverse effect on the financial position of the Company. The Company does not believe that the regulatory initiatives currently under consideration by various regulatory agencies will have a material adverse impact on the Company. The Company is not aware of any material pending or threatened regulatory action with respect to the Company or any of its subsidiaries. The Company does not believe that any insurance guaranty fund assessments will be materially different from amounts already provided for in the financial statements.
Management believes the overall sources of liquidity available will be sufficient to satisfy its financial obligations.
RESULTS OF OPERATIONS
1996 COMPARED TO 1995
(a) REVENUES
Premium income, net of reinsurance premium, decreased 8% when comparing 1996 to 1995. The decrease in premium income is primarily attributed to the change in marketing strategy and to a lesser extent the change in distribution systems. The Company changed its marketing strategy from traditional life insurance products to universal life insurance products. Universal life and interest sensitive products contribute only the risk charge to premium income, however traditional insurance products contribute all monies received to premium income. The Company changed its marketing strategy to remain competitive.
The Company changed its focus from primarily a broker agency distribution system to a captive agent system. Business written by the broker agency force, in recent years, did not meet Company expectations. With the change in focus of distribution systems, most of the broker agents were terminated. (The termination of the broker agency force caused a non-recurring write down of the value of agency force asset in 1995. See discussion of amortization of agency force for further details.)
One factor that has had a positive impact on premium income is the improvement of persistency. Persistency is a measure of insurance in force retained in relation to the previous year. The Company's average persistency rate for all policies in force for 1996 and 1995 has been approximately 87.9% and 87.5%, respectively.
Other considerations, net of reinsurance, increased 7% compared to one year ago. Other considerations consists of administrative charges on universal life and interest sensitive life insurance products. The insurance in force relating to these types of products continues to increase as marketing efforts are focused on universal life insurance products.
Net investment income increased 3% when comparing 1996 to 1995. The overall investment yields for 1996, 1995 and 1994, are 7.21%, 7.04% and 7.13%, respectively. The improvement in investment yield is primarily attributed to the fixed maturity portfolio. The Company has invested financing cash flows generated by cash received through sales of universal life insurance products.
The Company's investments are generally managed to match related insurance and policyholder liabilities. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. The minimum interest spread between earned and credited rates is 1% on the "Century 2000" universal life insurance product, the Company's primary product. The Company monitors investment yields, and when necessary adjusts credited interest rates on its insurance products to preserve targeted spreads. It is expected that the monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on insurance policies the Company has in force and will write in the future.
Realized investment losses were $988,000 and $124,000 in 1996 and 1995, respectively. Approximately $522,000 of the realized losses in 1996 is due to the charge-off of two investments. The Company realized a loss of $207,000 from a single loan and $315,000 from an investment in First Fidelity Mortgage Company ("FFMC"). The charge- off of the loan represented the entire loan balance at the time of the charge-off. Additionally, the Company sold two foreclosed real estate properties that resulted in approximately $357,000 in realized losses in 1996. The Company had other gains and losses during the period that comprised the remaining amount reported but were immaterial in nature on an individual basis.
(b) EXPENSES
Life benefits, net of reinsurance benefits and claims, increased 2% compared to 1995. The increase in life benefits is due primarily to settlement expenses discussed in the following paragraph:
In 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by Company standards. These non-standard policies had a face amount of $22,700,000 and represented 1/2 of 1% of the insurance in-force in 1994. Management's initial analysis indicated that expected death claims on the business in-force was adequate in relation to mortality assumptions inherent in the calculation of statutory reserves. Nevertheless, management determined it was in the best interest of the Company to repurchase as many of the non-standard policies as possible. Through December 31, 1996, the Company spent approximately $7,099,000 for the settlement of non-standard policies and for the legal defense of related litigation. In relation to settlement of non-standard policies the Company incurred life benefits of $3,307,000, $720,000 and $1,250,000 in 1996, 1995 and 1994, respectively. The Company incurred legal costs of $906,000, $687,000 and $229,000 in 1996, 1995 and 1994, respectively. All the policies associated with this issue have been settled as of December 31, 1996. The Company has approximately $3,742,000 of insurance in-force and $1,871,000 of reserves from the issuance of paid-up life insurance policies for settlement of matters related to the original non- standard policies. Management believes the reserves are adequate in relation to expected mortality on this block of in-force.
Commissions and amortization of deferred policy acquisition costs decreased 14% in 1996 compared to 1995. The decrease was due to the decline in first year premium production.
Amortization of cost of insurance acquired increased 28% in 1996 compared to 1995. Cost of insurance acquired is amortized in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. The Company did not have any charge-offs during the periods covered by this report. The increase in amortization during the current period is a normal fluctuation due to the expected future profits. Amortization of cost of insurance acquired is particularly sensitive to changes in persistency of certain blocks of insurance in-force.
The Company reported a non-recurring write down of value of agency force of $0 and $8,297,000 in 1996 and 1995, respectively. The write down was directly related to the Company's change in distribution systems. The Company changed its focus from primarily a broker agency distribution system to a captive agent system. Business produced by the broker agency force in recent years did not meet Company expectations. With the change in focus of distribution systems, most of the broker agents were terminated. The termination of most of the agents involved in the broker agency force caused management to re- evaluate the value of the agency force carried on the balance sheet.
Operating expenses increased 4% in 1996 compared to 1995. The primary factor that caused the increase in operating expenses is directly related to increased legal costs and reserves established for litigation. The legal costs are due to the settlement of non-standard insurance policies as was discussed in the review of life benefits. The Company incurred legal costs of $906,000, $687,000 and $229,000 in 1996, 1995 and 1994, respectively in relation to the settlement of the non-standard insurance policies.
Interest expense decreased 12% in 1996 compared to 1995. Since December 31, 1995, notes payable decreased approximately $1,873,000 which has directly attributed to the decrease in interest expense during 1996. Interest expense was also reduced as a result of the refinancing of the senior debt under which the new interest rate is more favorable. Please refer to Note 11 "Notes Payable" of the Consolidated Notes to the Financial Statements for more information on this matter.
(c) NET LOSS
The Company had a net loss of $938,000 in 1996 compared to a net loss of $3,001,000 in 1995. The net loss in 1996 is attributed to the increase in life benefits net of reinsurance and operating expenses primarily associated with settlement and other related costs of the non-standard life insurance policies.
RESULTS OF OPERATIONS
1995 COMPARED TO 1994
(a) REVENUES
Total revenue increased 1% when comparing 1995 to 1994.
Premium income, net of reinsurance premium, decreased 7% when comparing 1995 to 1994. The decrease is primarily attributed to the reduction in new business production and the change in products marketed. In 1995, the Company streamlined the product portfolio, as well as restructured the marketing force. The decrease in first year premium production was directly related to the Company's change in distribution systems. The Company has changed its focus from primarily a broker agency distribution system to a captive agent system. Business written by the broker agency force in recent years did not meet Company expectations. With the change in focus of distribution systems, most of the broker agents were terminated. (The termination of the broker agency force caused a non-recurring write down of the value of agency force asset. See discussion of amortization of agency force for further details.)
The change in marketing strategy from traditional life insurance products to universal life insurance products had a significant impact on new business production. As a result of the change in marketing strategy the agency force went through a restructuring and retraining process. Cash collected from the universal life and interest sensitive products contribute only the risk charge to premium income, however traditional insurance products contribute monies received to premium income. One factor that has had a positive impact on premium income is the improvement of persistency. Persistency is a measure of insurance in force retained in relation to the previous year. Overall, persistency improved to 87.5% in 1995 compared to 86.3% in 1994.
Other considerations, net of reinsurance, increased 13% compared to one year ago. Other considerations consists of administrative charges on universal life and interest sensitive life insurance products. The insurance in force relating to these types of products continues to increase as marketing efforts are focused on universal life insurance products.
Net investment income increased 8% when comparing 1995 to 1994. The change reflected an increase in the amount of invested assets, which was partially offset by a lower effective yield on investments acquired during 1995. The overall investment yields for 1995, 1994 and 1993, are 7.04%, 7.13% and 7.22%, respectively. The Company has been able to increase its investment portfolio through financing cash flows, generated by cash received through sales of universal life insurance products. Although the Company sold no fixed maturities during the last few years, it did experience a significant turnover in the portfolio. Many companies with bond issues outstanding took advantage of lower interest rates and retired older debt which carried higher rates. This was accomplished through early calls and accelerated pay-downs of fixed maturity investments.
The Company's investments are generally managed to match related insurance and policyholder liabilities. The Company, in conjunction with the decrease in average yield of the Company's fixed maturity portfolio has decreased the average crediting rate for the insurance and investment products. The comparison of investment return with insurance or investment product crediting rates establishes an interest spread. The minimum interest spread between earned and credited rates is 1% on the "Century 2000" universal life insurance product, the Company's primary product. The Company monitors investment yields, and when necessary takes action to adjust credited
interest rates on its insurance products to preserve targeted spreads. Over 60% of the insurance and investment product reserves are crediting 5% or less in interest and 39% of the insurance and investment product reserves are crediting 5.25% to 6% in interest. It is expected that the monitoring of the interest spreads by management will provide the necessary margin to adequately provide for associated costs on insurance policies the Company has in force and will write in the future.
Realized investment losses were $124,000 and $1,437,000 in 1995 and 1994, respectively. Fixed maturities and equity securities realized net investment losses of $224,000 and real estate realized net investment gains of $100,000 in 1995. The realized loss in 1995 cannot be attributed to any one specific transaction. In 1994, the Company realized losses of $865,000 due to a permanent impairment of property located in Louisiana. The permanent impairment was based on recent appraisals and marketing analysis of surrounding properties. The Company realized a gain of $467,000 from the sale of an insignificant subsidiary in 1994. In 1994, the Company realized a loss of $212,000 from the charge off of its investment in its equity subsidiary, United Fidelity, Inc. The Company had other gains and losses during the period that comprised the remaining amount reported but were routine or immaterial in nature to disclose on an individual basis.
(b) EXPENSES
Total expenses increased 16% when comparing 1995 to 1994.
Life benefits, net of reinsurance benefits and claims, decreased 4% compared to 1994. The decrease is related to the decrease in first year premium production. Another factor that has caused life benefits to decrease is that during 1994, the Company lowered its crediting rates on interest sensitive products in response to financial market conditions. This action will facilitate the appropriate spreads between investment returns and credited interest rates. It takes approximately one year to fully realize a change in credited rates since a change becomes effective on each policy's next anniversary. Please refer to discussion of net investment income for analysis of interest spreads.
The Company experienced an increase of 6% in mortality during 1995 compared to 1994. The increase in mortality is due primarily to settlement expenses discussed in the following paragraph:
During the third quarter of 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by Company standards. These non-standard policies had a face amount of $22,700,000 and represented 1/2 of 1% of the insurance in force in 1994. Management's initial analysis indicated that the expected death claims on the business in force to be adequately covered by the mortality assumptions inherent in the calculation of statutory reserves. Nevertheless, management determined it was in the best interest of the Company to repurchase as many of the non-standard policies as possible. As of December 31, 1995, there remained approximately $5,738,000 of the original face amount which had not been settled. Through December 31, 1995, the Company spent a total of $2,886,000 for the repurchase of the non-standard policies and for the legal defense of related litigation. In relation to settlement of non-standard policies the Company incurred life benefits of $720,000 and $1,250,000 in 1995 and 1994, respectively. The Company incurred legal costs of $687,000 and $229,000 in 1995 and 1994, respectively.
Dividends to policyholders increased approximately 16% when comparing 1995 to 1994. USA continued to market participating policies through most of 1994. Management expects dividends to policyholders will continue to increase in the future. A significant portion of the insurance in force is participating insurance. A significant portion of the participating business is relatively newer business, and the dividend scale for participating policies increases in each duration. The dividend scale is subject to approval of the Board of Directors and may be changed at their discretion. The Company has discontinued its marketing of participating policies.
Commissions and amortization of deferred policy acquisition costs increased 21% in 1995 compared to 1994. The increase is directly attributed to the amortization of a larger asset. The increase is also caused by the reduction in first year premium production. To a lesser extent the increase in amortization of deferred policy acquisition costs is directly related to the change in products that is currently marketed. The Company revised its portfolio of products as previously discussed in premium income. These new products pay lower first year commissions than the products sold in prior periods. The asset increased due to first year premium production by the agency force. The Company did benefit from improved persistency.
Amortization of cost of insurance acquired decreased 37% in 1995 compared to 1994. Cost of insurance acquired is amortized in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. The Company did not have any charge-offs during the periods covered by this report. The decrease in amortization during the current period is a normal fluctuation due to the expected future profits. Amortization of cost of insurance acquired is particularly sensitive to changes in persistency of certain blocks of insurance in force. The Company's average persistency rate for all policies in force for 1995 and 1994 has been approximately 87.5% and 86.3%, respectively.
During 1995, the Company reported a non-recurring write down of value of agency force of $8,297,000. The write down is directly related to the Company's change in distribution systems. The Company has changed its focus from primarily a broker agency distribution system to a captive agent system. Business produced by the broker agency force in recent years did not meet Company expectations. With the change in focus of distribution systems, most of the broker agents were terminated. The termination of most of the agents involved in the broker agency force caused management to re-evaluate the value of the agency force and write-off the remaining value carried on the balance sheet.
Operating expenses increased 18% in 1995 compared to 1994. The increase was caused by several factors. The primary factor for the increase in operating expenses is due to the decrease in production. The decrease in production was discussed in the analysis of premium income. As such, the Company was positioned to handle significantly more first year production than was produced. First year operating expenses that were deferred and capitalized as a deferred policy acquisition costs asset was $532,000 in 1995 compared to $1,757,000 in 1994. The difference between the policy acquisition costs deferred in 1995 compared to 1994, affected the increase in operating expenses. The increase in operating expenses was offset, to a lesser extent, from a 12% reduction in staff in 1995 compared to 1994. The reduction in staff was achieved by attrition.
Another factor that caused the increase in operating expenses is directly related to increased legal costs. During the third quarter of 1994, UG became aware that certain new insurance business was being solicited by certain agents and issued to individuals considered to be not insurable by Company standards. These policies had a face amount of $22,700,000 and represent 1/2 of 1% of the insurance in force of the Company. As of December 31, 1995, there remained approximately $5,738,000 of the original face amount which have not been settled. The Company will continue its efforts to repurchase as many of the policies as possible and regularly apprise the Ohio Department of Insurance regarding the status of this situation. The Company incurred legal costs of $687,000 and $229,000 in 1995 and 1994, respectively, for the legal defense of related litigation.
Interest expense increased slightly in 1995 compared to 1994. The increase was due to the increase in the interest rate on the Company's senior debt, which is tied to the base rate of the First Bank of Missouri. The interest rate on the senior debt increased to 10% on March 1, 1995 compared to 7% on March 1, 1994. The Company was able to minimize the effect of the higher interest rate in 1995 by early payments of principal. The Company paid $600,000 in principal payments in early 1995. The interest rate on the senior debt has decreased to 9.25% as of March 1, 1996.
(c) NET LOSS
The Company had a net loss of $3,001,000 in 1995 compared to a net loss of $1,624,000 in 1994. The decline in 1995 is attributed to the non-recurring write down of the value of agency force and the increase in operating expenses. The write down of agency force, net of deferred income taxes and minority interest, caused $2,608,000 of the $3,001,000 net loss in 1995. The net loss was minimized by the improvement of net investment income and realized investment losses when compared to the previous year.
FINANCIAL CONDITION
The financial condition of the Company was affected by a coinsurance agreement between First International Life Insurance Company ("FILIC") and the Company's insurance subsidiary Universal Guaranty Life Insurance Company ("UG") on September 30, 1996. The agreement provided UG an additional $6,375,000 of statutory capital and surplus. Under the terms of the agreement, UG ceded to FILIC substantially all of its paid-up life insurance policies. Paid-up life insurance generally refers to non-premium paying life insurance policies. Certain balance sheet line items were impacted by this agreement and effects the comparability of the current period with the prior period.
(a) ASSETS
The Company's insurance subsidiaries are regulated by insurance statutes and regulations as to the type of investments that they are permitted to make and the amount of funds that may be used for any one type of investment. In light of these statutes and regulations and the Company's business and investment strategy, the Company generally seeks to invest in United States government and government agency securities and corporate securities rated investment grade by established nationally recognized rating organizations.
The liabilities are predominantly long term in nature and therefore, the Company invests in long term fixed maturity investments which are reported in the financial statements at their amortized cost. The Company has the ability and intent to hold these investments to maturity; consequently, the Company does not expect to realize any significant loss from these investments. The Company does not own any derivative investments or "junk bonds". As of December 31, 1996, the carrying value of fixed maturity securities in default as to principal or interest was immaterial in the context of consolidated assets or shareholders' equity. The Company has identified securities it may sell and classified them as "investments held for sale". Investments held for sale are carried at market, with changes in market value charged directly to shareholders' equity.
Mortgage loans decreased 21% in 1996 as compared to 1995. The Company is not actively seeking new mortgage loans, and the decrease is due to early pay-offs from mortgagee's seeking refinancing at lower interest rates. All mortgage loans held by the Company are first position loans. The Company has $603,000 in mortgage loans, net of a $10,000 reserve allowance, which are in default or in the process of foreclosure, this represents approximately 5% of the total portfolio. The mortgage delinquency rate for the insurance industry as published by the National Association of Insurance Commissioners ("NAIC") as the "Industry Experience Factor" is 6.5%.
Investment real estate and real estate acquired in satisfaction of debt decreased 17% in 1996 compared to 1995. The decrease was due to the sale of lots from the Company's Lake Pointe development and the sale of two foreclosed properties. Real estate holdings represent approximately 4% of the total assets of the Company. Total real estate is separated into four categories: Home Office 20%, Commercial 17%, Residential Development 36% and Foreclosed Properties 27%.
Policy loans decreased 15% in 1996 compared to 1995. Policy loans decreased approximately $2,787,000 due to the coinsurance agreement with FILIC. Industry experience for policy loans indicates few policy loans are ever repaid by the policyholder other than through termination of the policy. Policy loans are systematically reviewed to ensure that no individual policy loan exceeds the underlying cash value of the policy. Policy loans will generally increase due to new loans and interest compounding on existing policy loans.
Reinsurance receivables increased significantly due to the coinsurance agreement with FILIC. The coinsurance agreement contributed approximately $28,000,000 to reinsurance receivables for future policy benefits as of December 31, 1996.
Deferred policy acquisition costs decreased 1% in 1996 compared to 1995. The costs, which vary with, and are primarily related to producing new business are referred to as deferred policy acquisition costs ("DAC"). DAC consists primarily of commissions and certain costs of policy issuance and underwriting, net of fees charged to the policy in excess of ultimate fees charged. To the extent that these costs are recoverable from future profits, the Company defers these costs and amortizes them with interest in relation to the present value of expected gross profits from the contracts, discounted using the interest rate credited by the policy. The Company had $1,276,000 in policy acquisition costs deferred, $408,000 in interest accretion and $1,796,000 in amortization in 1996. The Company did not recognize any impairments during the period.
Cost of insurance acquired decreased significantly during 1996. The decrease is primarily attributed to the coinsurance agreement with FILIC.
(b) LIABILITIES
Total liabilities increased slightly in 1996 compared to 1995. Future policy benefits increased 2% in 1996 and represented 81% of total liabilities at December 31, 1996. Management expects future policy benefits to increase in the future due to the aging of the volume of insurance in force and continued production by the Company's sales force.
Policy claims and benefits payable increased 3% in 1996 compared to 1995. There is no single event that caused this item to increase. Policy claims vary from year to year and therefore, fluctuations in this liability are to be expected and are not considered unusual by management.
Other policyholder funds decreased 7% in 1996 compared to 1995. The decrease can be attributed to a decrease in premium deposit funds. Premium deposit funds are funds deposited by the policyholder with the insurance company to accumulate interest and pay future policy premiums. The change in marketing from traditional insurance products to universal life insurance products is the primary reason for the decrease. Universal life insurance products do not have premium deposit funds. All premiums received from universal life insurance policyholders are credited to the life insurance policy and are reflected in future policy benefits.
Dividend and endowment accumulations increased 10% in 1996 compared to 1995. The increase is attributed to the significant amount of participating business the Company has in force. There are generally four options a policyholder can select to pay policy dividends. Over 47% of all dividends paid were put on deposit to accumulate with interest. Accordingly, management expects this liability to increase in the future.
Income taxes payable and deferred income taxes payable decreased significantly in 1996 compared to 1995. The primary reason for the decrease in deferred income taxes is due to the coinsurance agreement with FILIC. The change in deferred income taxes payable is attributable to temporary differences between Generally Accepted Accounting Principles ("GAAP") and tax basis. Federal income taxes are discussed in more detail in Note 3 of the Consolidated Notes to the Financial Statements.
Notes payable decreased approximately $1,873,000 in 1996 compared to 1995. On May 8, 1996, FCC refinanced its senior debt of $8,900,000. The refinancing was completed through First of America Bank - NA. The refinanced debt bears interest to a rate equal to the "base rate" plus nine-sixteenths of one percent. The Base rate is defined as the floating daily, variable rate of interest determined and announced by First of America Bank from time to time as its "base lending rate". The base rate at issuance of the loan was 8.25%, and has remained unchanged through March 1, 1997. Interest is paid quarterly. Principal payments of $1,000,000 are due in May of each year beginning in 1997, with a final payment due May 8, 2005. On November 8, 1996, the Company prepaid $500,000 of the May 8, 1997 principal payment. The Company's long term debt is discussed in more detail in Note 11 of the Notes to the Financial Statements.
(c) SHAREHOLDERS' EQUITY
Total shareholders' equity decreased 5% in 1996 compared to 1995. The decrease in shareholders' equity is primarily due to the net loss of $938,000 in 1996. The Company experienced $85,000 in unrealized depreciation of equity securities and investments held for sale in 1996.
REGULATORY ENVIRONMENT
The Company's insurance subsidiaries are subject to government regulation in each of the states in which they conduct business. Such regulation is vested in state agencies having broad administrative power dealing with all aspects of the insurance business, including the power to: (i) grant and revoke licenses to transact business; (ii) regulate and supervise trade practices and market conduct; (iii) establish guaranty associations; (iv) license agents; (v) approve policy forms; (vi) approve premium rates for some lines of business; (vii) establish reserve requirements; (viii) prescribe the form and content of required financial statements and reports; (ix) determine the reasonableness and adequacy of statutory capital and surplus; and (x) regulate the type and amount of permitted investments. Insurance regulation is concerned primarily with the protection of policyholders. The Company cannot predict the form of any future proposals or regulation. The Company's insurance subsidiaries, USA, UG, APPL and ALIC are domiciled in the states of Ohio, Ohio, West Virginia and Illinois, respectively.
Most states also have insurance holding company statutes which require registration and periodic reporting by insurance companies controlled by other corporations licensed to transact business within their respective jurisdictions. The insurance subsidiaries are subject to such legislation and are registered as controlled insurers in those jurisdictions in which such registration is required. Statutes vary from state to state but typically require periodic disclosure concerning the corporation that controls the registered insurers and all subsidiaries of such corporation. In addition, prior notice to, or approval by, the state insurance commission of material intercorporate transfers of assets, reinsurance agreements, management agreements (see Note 9 of the Notes to the Financial Statements), and payment of dividends (see Note 2 of the Notes to the Financial Statements) in excess of specified amounts by the insurance subsidiary within the holding company system are required.
The National Association of Insurance Commissioners ("NAIC") is an association whose membership consists of the insurance commissioners or their designees of the various states. The NAIC has no direct regulatory authority over insurance companies, however its primary purpose is to provide a more consistent method of regulation and reporting from state to state. This is accomplished through the issuance of model regulations, which can be adopted by individual states unmodified, modified to meet the state's own needs or requirements, or dismissed entirely.
Each year the NAIC calculates financial ratio results (commonly referred to as IRIS ratios) for each company. These ratios compare various financial information pertaining to the statutory balance sheet and income statement. The results are then compared to pre- established normal ranges determined by the NAIC. Results outside the range typically require explanation to the domiciliary insurance department.
At year end 1996, UG had two ratios outside the normal range. The first ratio compared commission allowances with statutory capital and surplus. The ratio was outside the norm due to the coinsurance agreement with First International Life Insurance Company ("FILIC"). Additional information about the coinsurance agreement with FILIC can be found in Note 7 of the Notes to the Consolidated Financial Statements. Management does not believe that this ratio will be outside the normal range in future periods.
The second ratio is related to the decrease in premium income. The ratio fell outside the normal range the last two years. The decrease in premium income is directly attributable to the change in distribution systems and marketing strategy. The Company changed its focus from primarily a broker agency distribution system to a captive agent system and changed its marketing strategy from traditional whole life insurance products to universal life insurance products. Management is taking a long-term approach to its recent changes to the marketing and distribution systems and believes these changes will provide long-term benefits to the Company.
The Company receives funds from its insurance subsidiaries in the form of management and cost sharing arrangements (See Note 9 of the Consolidated Notes to the Financial Statements) and through dividends. Annual dividends in excess of maximum amounts prescribed by state statutes ("extraordinary dividends") may not be paid without the prior approval of the insurance commissioner in which an insurance subsidiary is domiciled. (See Note 2 of the Consolidated Notes to the Financial Statements.)
The NAIC has adopted Risk-Based Capital ("RBC") requirements for life/health insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching and other business factors. The RBC formula will be used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines new minimum capital standards that will supplement the current system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio of the insurance company's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Insurance companies below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action. The levels and ratios are as follows:
Ratio of Total Adjusted Capital to Authorized Control Level RBC Regulatory Event (Less Than or Equal to)
Company action level 2* Regulatory action level 1.5 Authorized control level 1 Mandatory control level 0.7
* Or, 2.5 with negative trend.
At December 31, 1996, each of the Company's insurance subsidiaries has a Ratio that is in excess of 300% of the authorized control level; accordingly the Company's subsidiaries meet the RBC requirements.
The NAIC has recently released the Life Illustration Model Regulation. This regulation requires products which contain non-guaranteed elements, such as universal life and interest sensitive life, to comply with certain actuarially established tests. These tests are intended to target future performance and profitability of a product under various scenarios. The regulation does not prevent a company from selling a product which does not meet the various tests. The only implication is the way in which the product is marketed to the consumer. A product which does not pass the tests uses guaranteed assumptions rather than current assumptions in presenting future product performance to the consumer.
As states in which the Company does business adopt the regulation or adopt a modified version of the regulation, the Company will be required to comply with this new regulation. The Company may need to modify existing products or sales methods.
The NAIC has proposed a new Model Investment Law that may affect the statutory carrying values of certain investments; however, the final outcome of that proposal is not certain, nor is it possible to predict what impact the proposal will have on the Company or whether the proposal will be adopted in the foreseeable future.
FUTURE OUTLOOK
The Company operates in a highly competitive industry. In connection with the development and sale of its products, the Company encounters significant competition from other insurance companies, many of which have financial resources or ratings greater than those of the Company.
The insurance industry is a mature industry. In recent years, the industry has experienced virtually no growth in life insurance sales, though the aging population has increased the demand for retirement savings products. Management believes that the Company's ability to compete is dependent upon, among other things, its ability to attract and retain agents to market its insurance products and its ability to develop competitive and profitable products.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
During 1996, the Company adopted Statement of Financial Accounting Standards No. 123, accounting for stock-based compensation. The adoption of this standard did not have a material impact on the Company's financial statements.
Listed below are the financial statements included in this Part of the Annual Report on SEC Form 10-K:
UNITED TRUST, INC. AND CONSOLIDATED SUBSIDIARIES
Page No. Independent Auditor's Report for the Years ended December 31, 1996, 1995, 1994 30
Consolidated Balance Sheets 31
Consolidated Statements of Operations 32
Consolidated Statements of Shareholders' Equity 33
Consolidated Statements of Cash Flows 34
Notes to Consolidated Financial Statements 35-55
ITEM 9.

ITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
Independent Auditors' Report
Board of Directors and Shareholders United Trust, Inc.
We have audited the accompanying consolidated balance sheets of United Trust, Inc. (an Illinois corporation) and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of United Trust, Inc. and subsidiaries as of December 31, 1996 and 1995, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
We have also audited Schedule I as of December 31, 1996, and Schedules II, IV and V as of December 31, 1996 and 1995, of United Trust, Inc. and subsidiaries and Schedules II, IV and V for each of the three years in the period then ended. In our opinion, these schedules present fairly, in all material respects, the information required to be set forth therein.
KERBER, ECK & BRAECKEL LLP
Springfield, Illinois March 26, 1997
See accompanying notes.
See accompanying notes
See accompanying notes.
See accompanying notes.
UNITED TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. ORGANIZATION - At December 31, 1996, the parent, significant majority-owned subsidiaries and affiliates of United Trust, Inc. were as depicted on the following organizational chart.
United Trust, Inc. ("UTI") is the ultimate controlling company. UTI owns 53% of United Trust Group ("UTG") and 30% of United Income, Inc. ("UII"). UII owns 47% of UTG. UTG owns 72% of First Commonwealth Corporation ("FCC"). FCC owns 100% of Universal Guaranty Life Insurance Company ("UG"). UG owns 100% of United Security Assurance Company ("USA"). USA owns 84% of Appalachian Life Insurance Company ("APPL") and APPL owns 100% of Abraham Lincoln Insurance Company ("ABE").
A summary of the Company's significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows.
B. NATURE OF OPERATIONS - United Trust, Inc. is an insurance holding company that through its insurance subsidiaries sells individual life insurance products. The Company's principal market is the midwestern United States. The primary focus of the Company has been the servicing of existing insurance business in force, the solicitation of new life insurance products and the acquisition of other companies in similar lines of business.
C. PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. Investments in 20% to 50% owned affiliates in which management has the ability to exercise significant influence are included based on the equity method of accounting and the Company's share of such affiliates' operating results is reflected in Equity in loss of investees. Other investments in affiliates are carried at cost. All significant intercompany accounts and transactions have been eliminated.
D. BASIS OF PRESENTATION - The financial statements of United Trust, Inc.'s life insurance subsidiaries have been prepared in accordance with generally accepted accounting principles which differ from statutory accounting practices permitted by insurance regulatory authorities.
E. USE OF ESTIMATES - In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
F. INVESTMENTS - Investments are shown on the following bases:
Fixed maturities -- at cost, adjusted for amortization of premium or discount and other-than-temporary market value declines. The amortized cost of such investments differs from their market values; however, the Company has the ability and intent to hold these investments to maturity, at which time the full face value is expected to be realized.
Investments held for sale -- at current market value, unrealized appreciation or depreciation is charged directly to shareholders' equity.
Mortgage loans on real estate -- at unpaid balances, adjusted for amortization of premium or discount, less allowance for possible losses.
Real estate -- at cost, less allowances for depreciation and any impairment which would result in a carrying value below net realizable value. Foreclosed real estate is adjusted for any impairment at the foreclosure date. Accumulated depreciation on real estate was $1,340,746 and $1,049,652 as of December 31, 1996 and 1995, respectively.
Policy loans -- at unpaid balances including accumulated interest but not in excess of the cash surrender value.
Short-term investments -- at cost, which approximates current market value.
Realized gains and losses on sales of investments are recognized in net income on the specific identification basis.
G. RECOGNITION OF REVENUES AND RELATED EXPENSES - Premiums for traditional life insurance products, which include those products with fixed and guaranteed premiums and benefits, consist principally of whole life insurance policies, limited-payment life insurance policies, and certain annuities with life contingencies are recognized as revenues when due. Accident and health insurance premiums are recognized as revenue pro rata over the terms of the policies. Benefits and related expenses associated with the premiums earned are charged to expense proportionately over the lives of the policies through a provision for future policy benefit liabilities and through deferral and amortization of deferred policy acquisition costs. For universal life and investment products, generally there is no requirement for payment of premium other than to maintain account values at a level sufficient to pay mortality and expense charges. Consequently, premiums for universal life policies and investment products are not reported as revenue, but as deposits. Policy fee revenue for universal life policies and investment products consists of charges for the cost of insurance, policy administration, and surrenders assessed during the period. Expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances.
H. DEFERRED POLICY ACQUISITION COSTS - Commissions and other costs of acquiring life insurance products that vary with and are primarily related to the production of new business have been deferred. Traditional life insurance acquisition costs are being amortized over the premium-paying period of the related policies using assumptions consistent with those used in computing policy benefit reserves.
For universal life insurance and interest sensitive life insurance products, acquisition costs are being amortized generally in proportion to the present value of expected gross profits from surrender charges and investment, mortality, and expense margins. Under SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments," the Company makes certain assumptions regarding the mortality, persistency, expenses, and interest rates it expects to experience in future periods. These assumptions are to be best estimates and are to be periodically updated whenever actual experience and/or expectations for the future change from initial assumptions. The amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised.
The following table summarizes deferred policy acquisition costs and related data for the years shown.
1996 1995 1994 Deferred, beginning of year $ 11,437,000 $ 10,634,000 $ 7,160,000
Acquisition costs deferred: Commissions, net of reinsurance of $0 $0 and $1,837,000 845,000 1,838,000 3,182,000
Marketing, salaries and other expenses 431,000 532,000 1,757,000
Total 1,276,000 2,370,000 4,939,000
Interest accretion 408,000 338,000 181,000 Amortization charged to income (1,796,000) (1,905,000) (1,319,000) Net amortization (1,388,000) (1,567,000) (1,138,000)
Deferred acquisition costs disposed of at sale of subsidiary 0 0 (327,000) Change for the year (112,000) 803,000 3,474,000 Deferred, end of year $ 11,325,000 $ 11,437,000 $ 10,634,000
The following table reflects the components of the income statement for the line item Commissions and amortization of deferred policy acquisition costs:
1996 1995 1994
Net amortization of deferred policy acquisition costs $ 1,388,000 $ 1,567,000 $ 1,138,000 Commissions 2,837,000 3,341,000 2,922,000 Total $ 4,225,000 $ 4,908,000 $ 4,060,000
Estimated net amortization expense of deferred policy acquisition costs for the next five years is as follows:
Interest Net Accretion Amortization Amortization
1997 $ 400,000 $ 1,600,000 $ 1,200,000 1998 400,000 1,500,000 1,100,000 1999 300,000 1,300,000 1,000,000 2000 300,000 1,200,000 900,000 2001 300,000 1,000,000 700,000
I. COST OF INSURANCE ACQUIRED - When an insurance company is acquired, the Company assigns a portion of its cost to the right to receive future cash flows from insurance contracts existing at the date of the acquisition. The cost of policies purchased represents the actuarially determined present value of the projected future cash flows from the acquired policies. Cost of Insurance Acquired is amortized with interest in relation to expected future profits, including direct charge-offs for any excess of the unamortized asset over the projected future profits. The interest rates utilized in the amortization calculation are 9% on approximately 24% of the balance and 15% on the remaining balance. The interest rates vary due to differences in the blocks of business.
1996 1995 1994
Cost of insurance acquired, beginning of year $ 55,817,000 $ 60,120,000 $ 68,995,000 Additions from acquisitions 0 0 0 Interest accretion 6,313,000 7,044,000 7,593,000 Amortization (11,838,000) (11,347,000) (14,471,000) Net amortization (5,525,000) (4,303,000) (6,878,000) Balance attributable to coinsurance agreement(6,375,000) 0 0 Balance attributable to subsidiary at date of sale 0 0 (1,379,000) Balance attributable to downstream merger of subsidiary 0 0 (618,000) Write-offs due to impairment 0 0 0 Cost of insurance acquired, end of year $ 43,917,000 $ 55,817,000 $ 60,120,000 Estimated net amortization expense of cost of insurance acquired for the next five years is as follows:
Interest Net Accretion Amortization Amortization
1997 $ 5,500,000 $ 9,200,000 $3,700,000 1998 5,100,000 8,200,000 3,100,000 1999 4,800,000 7,200,000 2,400,000 2000 4,600,000 6,700,000 2,100,000 2001 4,400,000 6,700,000 2,300,000
J. COST IN EXCESS OF NET ASSETS PURCHASED - Cost in excess of net assets purchased is the excess of the amount paid to acquire a company over the fair value of its net assets. Cost in excess of net assets purchased are amortized over periods not exceeding forty years using the straight-line method. Management reviews the valuation and amortization of goodwill on an annual basis. As part of this review, the Company estimates the value of and the estimated undiscounted future cash flows expected to be generated by the related subsidiaries to determine that no impairment has occurred. Accumulated amortization of cost in excess of net assets purchased was $1,265,146 and $1,079,867 as of December 31, 1996 and 1995, respectively.
K. FUTURE POLICY BENEFITS AND EXPENSES - The liabilities for traditional life insurance and accident and health insurance policy benefits are computed using a net level method. These liabilities include assumptions as to investment yields, mortality, withdrawals, and other assumptions based on the life insurance subsidiaries' experience adjusted to reflect anticipated trends and to include provisions for possible unfavorable deviations. The Company makes these assumptions at the time the contract is issued or, in the case of contracts acquired by purchase, at the purchase date. Benefit reserves for traditional life insurance policies include certain deferred profits on limited-payment policies that are being recognized in income over the policy term. Policy benefit claims are charged to expense in the period that the claims are incurred. Current mortality rate assumptions are based on 1975-80 select and ultimate tables. Withdrawal rate assumptions are based upon Linton B or Linton C.
Benefit reserves for universal life insurance and interest sensitive life insurance products are computed under a retrospective deposit method and represent policy account balances before applicable surrender charges. Policy benefits and claims that are charged to expense include benefit claims in excess of related policy account balances. Interest crediting rates for universal life and interest sensitive products range from 5.0% to 6.0% in 1996, 1995 and 1994.
L. POLICY AND CONTRACT CLAIMS - Policy and contract claims include provisions for reported claims in process of settlement, valued in accordance with the terms of the policies and contracts, as well as provisions for claims incurred and unreported based on prior experience of the Company.
M. PARTICIPATING INSURANCE - Participating business represents 30% and 34% of the ordinary life insurance in force at December 31, 1996 and 1995, respectively. Premium income from participating business represents 52%, 55%, and 53% of total premiums for the years ended December 31, 1996, 1995 and 1994, respectively. The amount of dividends to be paid is determined annually by the respective insurance subsidiary's Board of Directors. Earnings allocable to participating policyholders are based on legal requirements which vary by state.
N. INCOME TAXES - Income taxes are reported under Statement of Financial Accounting Standards Number 109. Deferred income taxes are recorded to reflect the tax consequences on future periods of differences between the tax bases of assets and liabilities and their financial reporting amounts at the end of each such period.
O. BUSINESS SEGMENTS - The Company operates principally in the individual life insurance business.
P. EARNINGS PER SHARE - Earnings per share are based on the weighted average number of common shares outstanding during the respective period.
Q. CASH EQUIVALENTS - The Company considers certificates of deposit and other short-term instruments with an original purchased maturity of three months or less cash equivalents.
R. RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform with the 1996 presentation. Such reclassifications had no effect on previously reported net income, total assets, or shareholders' equity.
S. REINSURANCE - In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage and coinsurance contracts. The Company retains a maximum of $125,000 of coverage per individual life.
Amounts paid or deemed to have been paid for reinsurance contracts are recorded as reinsurance receivables. Reinsurance premiums, commissions, expense reimbursements, and reserves on reinsured business are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Expense reimbursements received in connection with reinsurance ceded have been accounted for as a reduction of the related policy acquisition costs or, to the extent such reimbursements exceed the related acquisition costs, as revenue.
Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company; consequently, allowances are established for amounts deemed uncollectible. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies.
2. SHAREHOLDER DIVIDEND RESTRICTION
At December 31, 1996, substantially all of consolidated shareholders' equity represents net assets of UTI's subsidiaries. The payment of cash dividends to shareholders by UTI or UTG is not legally restricted. UG's dividend limitations are described below.
Ohio domiciled insurance companies require five days prior notification to the insurance commissioner for the payment of an ordinary dividend. Ordinary dividends are defined as the greater of: a) prior year statutory earnings or b) 10% of statutory capital and surplus. For the year ended December 31, 1996, UG had a statutory gain from operations of $8,006,000. At December 31, 1996, UG's statutory capital and surplus amounted to $10,227,000. Extraordinary dividends (amounts in excess of ordinary dividend limitations) require prior approval of the insurance commissioner and are not restricted to a specific calculation.
3. FEDERAL INCOME TAXES
Until 1984, the insurance companies were taxed under the provisions of the Life Insurance Company Income Tax Act of 1959 as amended by the Tax Equity and Fiscal Responsibility Act of 1982. These laws were superseded by the Deficit Reduction Act of 1984. All of these laws are based primarily upon statutory results with certain special deductions and other items available only to life insurance companies. If any of the life companies pay shareholder dividends in excess of "shareholders' surplus" they will be required to pay taxes on income not taxed under the pre-1984 acts.
The following table summarizes the companies with this situation and the maximum amount of income which has not been taxed in each. Shareholders' Untaxed Company Surplus Balance ABE $ 5,242,000 $ 1,150,000 APPL 4,943,000 1,525,000 UG 24,038,000 4,364,000 USA 981,000 0
The payment of taxes on this income is not anticipated; and, accordingly, no deferred taxes have been established.
The life insurance company subsidiaries file a consolidated federal income tax return. The holding companies of the group file separate returns.
Life insurance company taxation is based primarily upon statutory results with certain special deductions and other items available only to life insurance companies. Income tax expense consists of the following components:
1996 1995 1994 Current tax expense (credit) $ (148,000) $ 3,000 $ 51,000 Deferred tax expense (credit) (4,556,000) (4,574,000) (2,016,000) $(4,704,000) $(4,571,000) $(1,965,000)
The Companies have net operating loss carryforwards for federal income tax purposes expiring as follows:
UTI UG FCC 2002 $ 0 $ 0 $ 527,000 2003 50,000 0 285,000 2004 826,000 0 283,000 2005 293,000 0 139,000 2006 213,000 2,109,000 33,000 2007 111,000 783,000 676,000 2008 0 940,000 4,000 2009 0 0 169,000 2010 0 0 19,000 TOTAL $ 1,493,000 $ 3,832,000 $ 2,135,000
The Company has established a deferred tax asset of $2,611,000 for its operating loss carryforwards and has established an allowance of $2,088,000.
The following table shows the reconciliation of net income to taxable income of UTI: 1996 1995 1994
Net income (loss) $ (938,000) $ (3,001,000) $ (1,624,000) Federal income tax provision (credit) (60,000) 154,000 40,000 Loss (earnings) of subsidiaries 715,000 2,613,000 341,000 Loss (earnings) of investees 95,000 636,000 1,125,000 Write off of investment in affiliate 315,000 10,000 212,000 Write off of note receivable 211,000 0 0 Depreciation 1,000 3,000 4,000 Other 26,000 22,000 20,000 Taxable income (loss) $ 365,000 $ 437,000 $ 118,000
UTI has a net operating loss carryforward of $1,493,000 at December 31, 1996. UTI has averaged $270,000 in taxable income over the past four years and must average taxable income of $136,000 per year to fully realize its net operating loss carryforwards. UTI's operating loss carryforwards do not begin to expire until 2003. Management believes future earnings of UTI will be more than sufficient to fully utilize its net operating loss carryforwards.
The provision or (credit) for income taxes shown in the statements of operations does not bear the normal relationship to pre-tax income as a result of certain permanent differences. The sources and effects of such differences are summarized in the following table:
1996 1995 1994 Tax computed at standard corporate rate $ (2,389,000) $ (3,982,000) $ (1,225,000) Changes in taxes due to: Cost in excess of net assets purchased 65,000 61,000 104,000 Special insurance deductions 0 0 (24,000) Benefit of prior losses (2,393,000) (602,000) (649,000) Other 13,000 (48,000) (171,000) Income tax expense (credit) $ (4,704,000) $ (4,571,000) $ (1,965,000)
The following table summarizes the major components which comprise the deferred tax liability as reflected in the balance sheets:
1996 1995
Investments $ (122,251) $ (48,918) Cost of insurance acquired 16,637,884 20,860,602 Other assets (187,747) 0 Deferred policy acquisition costs 3,963,875 4,002,855 Agent balances (65,609) (71,625) Furniture and equipment (37,683) (82,257) Discount of notes 922,766 1,003,038 Management/consulting fees (733,867) (841,991) Future policy benetits(5,906,087) (5,039,938) Gain on sale of subsidiary 2,312,483 2,312,483 Net operating loss carryforward (522,392) (650,358) Other liabilities (1,151,405) (818,484) Federal tax DAC (1,916,536) (2,862,999) Deferred tax liability $ 13,193,431 $ 17,762,408
4. ANALYSIS OF INVESTMENTS, INVESTMENT INCOME AND INVESTMENT GAIN
A. NET INVESTMENT INCOME - The following table reflects net investment income by type of investment: December 31, 1996 1995 1994
Fixed maturities and fixed maturities held for sale $ 13,326,312 $ 13,190,121 $ 12,185,941 Equity securities 88,661 52,445 3,999 Mortgage loans 1,047,461 1,257,189 1,423,474 Real estate 794,844 975,080 990,857 Policy loans 1,121,538 1,041,900 1,014,723 Short-term investments 515,346 505,637 444,135 Other 197,188 158,290 221,125 Total consolidated investment income 17,091,350 17,180,662 16,284,254 Investment expense (1,222,903) (1,724,438) (1,915,808) Consolidated net investment income $ 15,868,447 $ 15,456,224 $ 14,368,446
At December 31, 1996, the Company had a total of $6,025,000 of investments, comprised of $5,325,000 in real estate including its home office property and $700,000 in equity securities, which did not produce income during 1996.
The following table summarizes the Company's fixed maturity holdings and investments held for sale by major classifications: Carrying Value 1996 1995
Investments held for sale: Fixed maturities $ 1,961,166 $ 3,226,175 Equity securities 1,794,405 1,946,481 Fixed maturities: U.S. Government, government agencies and authorities 28,554,631 27,488,188 State, municipalities and political subdivision 14,421,735 6,785,476 Collateralized mortgage obligations 13,246,781 15,395,913 Public utilities 51,821,989 59,136,696 All other corporate bonds 71,881,649 82,267,947 $ 183,682,356 $196,246,876
By insurance statute, the majority of the Company's investment portfolio is required to be invested in investment grade securities to provide ample protection for policyholders. The Company does not invest in so-called "junk bonds" or derivative investments.
Below investment grade debt securities generally provide higher yields and involve greater risks than investment grade debt securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment grade issuers. In addition, the trading market for these securities is usually more limited than for investment grade debt securities. Debt securities classified as below-investment grade are those that receive a Standard & Poor's rating of BB or below.
The following table summarizes by category securities held that are below investment grade at amortized cost:
Below Investment Grade Investments 1996 1995 1994 State, Municipalities and Political Subdivisions $ 10,042 $ 0 $ 32,370 Public Utilities 117,609 116,879 168,869 Corporate 813,717 819,010 848,033 Total $ 941,368 $ 935,889 $1,049,272
B. INVESTMENT SECURITIES
The amortized cost and estimated market values of investments in securities including investments held for sale are as follows:
Cost or Gross Gross Estimated Amortized Unrealized Unrealized Market 1996 Cost Gains Losses Value Investments Held for Sale: U.S. Government and govt. agencies and authorities $1,461,068 $ 0 $ 17,458 $ 1,443,609 States, municipalities and political subdivisions 145,199 665 6,397 139,467 Collateralized mortgage obligations 0 0 0 0 Public utilities 119,970 363 675 119,658 All other corporate bonds 258,424 4,222 4,215 258,432 1,984,661 5,250 28,745 1,961,166 Equity securities 2,086,159 37,000 328,754 1,794,405 Total $4,070,820 $ 42,250 $ 357,499 $ 3,755,571
Held to Maturity Securities: U.S. Government and govt. agencies and authorities $28,554,631 $ 421,523 $ 136,410 $28,839,744 States, municipalities and political subdivisions 14,421,735 318,682 28,084 14,712,333 Collateralized mortgage obligations 13,246,780 175,163 157,799 13,264,145 Public utilities 51,821,990 884,858 381,286 52,325,561 All other corporate bond 71,881,649 1,240,230 448,437 72,673,442 Total $179,926,785 $ 3,040,456 $1,152,016 $181,815,225
Cost or Gross Gross Estimated Amortized Unrealized Unrealized Market 1995 Cost Gains Losses Value
Investments Held for Sale: U.S. Government and govt. agencies and authorities $2,001,860 $ 2,579 $ 621 $ 2,003,818 States, municipalities and political subdivisions 812,454 14,313 3,749 823,018 Collateralized mortgage obligations 32,177 506 0 32,683 Public utilities 119,379 572 2,123 117,828 All other corporate bonds 258,169 337 9,678 248,828 3,224,039 18,307 16,171 3,226,175 Equity securities 2,086,159 80,721 220,399 1,946,481 Total $5,310,198 $ 99,028 $ 236,570 $ 5,172,656
Held to Maturity Securities:
U.S. Government and govt. agenciees and authorities $27,488,188 $ 841,786 $ 76,417 $28,253,557 States, municipalities and political subdivisions 6,785,476 305,053 10,895 7,079,634 Collateralized mortgage obligations 15,395,913 295,344 67,472 15,623,785 Public utilities 59,136,696 2,279,509 134,091 61,282,114 All other corporate bonds 82,267,947 2,974,553 475,333 84,767,167 Total $191,074,220 $6,696,245 $ 764,208 $197,006,257
The amortized cost of debt securities at December 31, 1996, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Fixed Maturities Held for Sale Amortized December 31, 1996 Cost Due in one year or less $ 139,724 Due after one year through five years 1,569,804 Due after five years through ten years 115,183 Due after ten years 159,950 $1,984,661
Fixed Maturities Held to Amortized Maturity Cost December 31, 1996 Due in one year or less $13,222,084 Due after one year through five years 74,120,886 Due after five years through ten years 77,222,430 Due after ten years 15,361,385 $179,926,785
Proceeds from sales, calls and maturities of investments in debt securities during 1996 were $40,677,000. Gross gains of $101,000 and gross losses of $276,000 were realized on those sales, calls and maturities.
Proceeds from sales, calls and maturities of investments in debt securities during 1995 were $16,885,000. Gross gains of $126,000 and gross losses of $246,000 were realized on those sales, calls and maturities.
Proceeds from sales, calls and maturities of investments in debt securities during 1994 were $24,145,000. Gross gains of $84,000 and gross losses of $554,000 were realized on those sales, calls and maturities.
C. INVESTMENTS ON DEPOSIT - At December 31, 1996, investments carried at approximately $18,016,000 were on deposit with various state insurance departments.
D. INVESTMENTS IN AND ADVANCES TO AFFILIATED COMPANIES - The Company's investment in United Income, Inc., a 30% owned affiliate, is carried at an amount equal to the Company's share of the equity of United Income. The Company's equity in United Income, Inc. includes the original investment of $194,304, an increase of $4,359,749 resulting from a public offering of stock and the Company's share of earnings and losses since inception.
5. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
The financial statements include various estimated fair value information at December 31, 1996 and 1995, as required by Statement of Financial Accounting Standards 107, Disclosure about Fair Value of Financial Instruments ("SFAS 107"). Such information, which pertains to the Company's financial instruments, is based on the requirements set forth in that Statement and does not purport to represent the aggregate net fair value of the Company.
The following methods and assumptions were used to estimate the fair value of each class of financial instrument required to be valued by SFAS 107 for which it is practicable to estimate that value:
(a) Cash and Cash equivalents
The carrying amount in the financial statements approximates fair value because of the relatively short period of time between the origination of the instruments and their expected realization.
(b) Fixed maturities and investments held for sale
Quoted market prices, if available, are used to determine the fair value. If quoted market prices are not available, management estimates the fair value based on the quoted market price of a financial instrument with similar characteristics.
(c) Mortgage loans on real estate
An estimate of fair value is based on management's review of the portfolio in relation to market prices of similar loans with similar credit ratings, interest rates, and maturity dates. Management conservatively estimates fair value of the portfolio is equal to the carrying value.
(d) Investment real estate and real estate acquired in satisfaction of debt
An estimate of fair value is based on management's review of the individual real estate holdings. Management utilizes sales of surrounding properties, current market conditions and geographic considerations. Management conservatively estimates the fair value of the portfolio is equal to the carrying value.
(e) Policy loans
It is not practicable to estimate the fair value of policy loans as they have no stated maturity and their rates are set at a fixed spread to related policy liability rates. Policy loans are carried at the aggregate unpaid principal balances in the consolidated balance sheets, and earn interest at rates ranging from 4% to 8%. Individual policy liabilities in all cases equal or exceed outstanding policy loan balances.
(f) Short-term investments
For short-term instruments, the carrying amount is a reasonable estimate of fair value. All short-term instruments represent certificates of deposit with various banks and all are protected under FDIC.
(g) Notes and accounts receivable and uncollected premiums
The Company holds a $840,000 note receivable for which the determination of fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Accounts receivable and uncollected premiums are primarily insurance contract related receivables which are determined based upon the underlying insurance liabilities and added reinsurance amounts, and thus are excluded for the purpose of fair value disclosure by paragraph 8(c) of SFAS 107.
(h) Notes payable
For borrowings under the senior loan agreement, which is subject to floating rates of interest, carrying value is a reasonable estimate of fair value. For subordinated borrowings fair value was determined based on the borrowing rates currently available to the Company for loans with similar terms and average maturities.
The estimated fair values of the Company's financial instruments required to be valued by SFAS 107 are as follows as of December 31:
1996 1995 Estimated Estimated Assets Carrying Fair Carrying Fair Amount Value Amount Value Fixed maturities $179,926,785 $181,815,225 $191,074,220 $197,006,257 Fixed maturities held for sale 1,961,166 1,961,166 3,226,175 3,226,175 Equity securities 1,794,405 1,794,405 1,946,481 1,946,481 Mortgage loans on real estate 11,022,792 11,022,792 13,891,762 13,891,762 Policy loans 14,438,120 14,438,120 16,941,359 16,941,359 Short-term investments 430,983 430,983 425,000 425,000 Investment in real estate 10,543,490 10,543,490 11,978,575 11,978,575 Real estate acquired in satisfaction of debt 3,846,946 3,846,946 5,332,413 5,332,413 Notes receivable 840,066 783,310 840,066 775,399
Liabilities Notes payable 19,573,953 18,937,055 21,447,428 20,747,991
6. STATUTORY EQUITY AND GAIN FROM OPERATIONS
The Company's insurance subsidiaries are domiciled in Ohio, Illinois and West Virginia and prepare their statutory-based financial statements in accordance with accounting practices prescribed or permitted by the respective insurance department. These principles differ significantly from generally accepted accounting principles. "Prescribed" statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners ("NAIC"). "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, from company to company within a state, and may change in the future. The NAIC currently is in the process of codifying statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. Accordingly, that project, which is expected to be completed in 1997, will likely change prescribed statutory accounting practices and may result in changes to the accounting practices that insurance enterprises use to prepare their statutory financial statements. UG's total statutory shareholders' equity was $10,227,000 and $7,274,000 at December 31, 1996 and 1995, respectively. The Company's insurance subsidiaries reported combined statutory gain from operations (exclusive of intercompany dividends) was $10,692,000, $4,076,000 and $3,071,000 for 1996, 1995 and 1994, respectively.
7. REINSURANCE
The Company assumes risks from, and reinsures certain parts of its risks with other insurers under yearly renewable term and coinsurance agreements which are accounted for by passing a portion of the risk to the reinsurer. Generally, the reinsurer receives a proportionate part of the premiums less commissions and is liable for a corresponding part of all benefit payments. While the amount retained on an individual life will vary based upon age and mortality prospects of the risk, the Company generally will not carry more than $125,000 individual life insurance on a single risk.
The Company has reinsured approximately $1.109 billion, $1.088 billion and $1.217 billion in face amount of life insurance risks with other insurers for 1996, 1995 and 1994, respectively. Reinsurance receivables for future policy benefits were $38,745,000 and $13,540,000 at December 31, 1996 and 1995, respectively, for estimated recoveries under reinsurance treaties. Should any of the reinsurers be unable to meet its obligation at the time of the claim, obligation to pay such claim would remain with the Company.
The Company's insurance subsidiary (UG) entered into a coinsurance agreement with First International Life Insurance Company ("FILIC") as of September 30, 1996. Under the terms of the agreement, UG ceded to FILIC substantially all of its paid-up life insurance policies. Paid- up life insurance generally refers to non-premium paying life insurance policies. A.M. Best, an industry rating company, assigned a Best's Rating of A++ (Superior) to The Guardian Life Insurance Company of America ("Guardian"), parent of FILIC, based on the consolidated financial condition and operating performance of the company and its life/health subsidiaries. The agreement with FILIC accounts for approximately 66% of the reinsurance receivables as of December 31, 1996.
As a result of the FILIC coinsurance agreement, effective September 30, 1996, UG received a reinsurance credit in the amount of $28,318,000 in exchange for an equal amount of assets. UG also received $6,375,000 as a commission allowance.
Currently, the Company is utilizing reinsurance agreements with Business Men's Assurance Company, ("BMA") and Life Reassurance Corporation, ("LIFE RE") for new business. BMA and LIFE RE each hold an "A+" (Superior) rating from A.M. Best, an industry rating company. The reinsurance agreements were effective December 1, 1993, and cover all new business of the Company. The agreements are a yearly renewable term ("YRT") treaty where the Company cedes amounts above its retention limit of $100,000 with a minimum cession of $25,000.
The Company does not have any short-duration reinsurance contracts. The effect of the Company's long-duration reinsurance contracts on premiums earned in 1996, 1995 and 1994 was as follows:
Shown in thousands 1996 1995 1994 Premiums Premiums Premiums Earned Earned Earned Direct $ 32,387 $ 35,201 $ 38,063 Assumed 0 0 0 Ceded (4,768) (5,203) (5,659) Net premiums$ 27,619 $ 29,998 $ 32,404
8. COMMITMENTS AND CONTINGENCIES
The insurance industry has experienced a number of civil jury verdicts which have been returned against life and health insurers in the jurisdictions in which the Company does business involving the insurers' sales practices, alleged agent misconduct, failure to properly supervise agents, and other matters. Some of the lawsuits have resulted in the award of substantial judgments against the insurer, including material amounts of punitive damages. In some states, juries have substantial discretion in awarding punitive damages in these circumstances.
Under insurance guaranty fund laws in most states, insurance companies doing business in a participating state can be assessed up to prescribed limits for policyholder losses incurred by insolvent or failed insurance companies. Although the Company cannot predict the amount of any future assessments, most insurance guaranty fund laws currently provide that an assessment may be excused or deferred if it would threaten an insurer's financial strength. Those mandatory assessments may be partially recovered through a reduction in future premium taxes in some states. The Company does not believe such assessments will be materially different from amounts already provided for in the financial statements.
The Company and its subsidiaries are named as defendants in a number of legal actions arising primarily from claims made under insurance policies. Those actions have been considered in establishing the Company's liabilities. Management and its legal counsel are of the opinion that the settlement of those actions will not have a material adverse effect on the Company's financial position or results of operations.
9. RELATED PARTY TRANSACTIONS
United Trust, Inc. has a service agreement with its affiliate, UII (equity investee), to perform services and provide personnel and facilities. The services included in the agreement are claim processing, underwriting, processing and servicing of policies, accounting services, agency services, data processing and all other expenses necessary to carry on the business of a life insurance company.
UII's service agreement states that USA is to pay UII monthly fees equal to 22% of the amount of collected first year premiums, 20% in second year and 6% of the renewal premiums in years three and after. UII's subcontract agreement with UTI states that UII is to pay UTI monthly fees equal to 60% of collected service fees from USA as stated above.
USA paid $1,568,000, $2,015,000 and $1,357,000 under their agreement with UII for 1996, 1995 and 1994, respectively. UII paid $941,000, $1,209,000 and $814,000 under their agreement with UTI for 1996, 1995 and 1994, respectively.
The agreements of the insurance companies have been approved by their respective domiciliary insurance departments and it is Management's opinion that where applicable, costs have been allocated fairly and such allocations are based upon generally accepted accounting principles. The costs paid by UTI for these services include costs related to the production of new business which are deferred as policy acquisition costs and charged off to the income statement through "Amortization of deferred policy acquisition costs". Also included are costs associated with the maintenance of existing policies which are charged as current period costs and included in "general expenses".
10. CAPITAL STOCK TRANSACTIONS
A. PUBLIC OFFERING OF AFFILIATE STOCK
During 1991, an affiliated company, United Fidelity, Inc., ("UFI") began a stock offering in the State of Illinois. UFI was offering 400,000 units, each unit consisting of one share of no par value common stock and one share of Class A Preferred Stock, $15 par value per share, 9% non-cumulative convertible. The units were being offered to the public at $30 per unit. Due to large losses reported by UFI, the sale of stock units to the public was stopped on June 2, 1994. The Board of Directors of UFI voted to voluntarily terminate the offering on August 18, 1994.
The Company accounted for the investment in UFI using the equity method. At December 31, 1994, the Company charged off its remaining investment in UFI of $212,247. The Company determined any material recoverability of its investment to be unlikely due to continuing losses and limited capital of UFI. On May 26, 1995, pursuant to a plan of restructure of UFI's subsidiary, First Fidelity Mortgage Company (FFMC), UTI surrendered its common stock holdings of UFI for no value. Additionally, as a part of the FFMC restructure, UTI invested $615,000 in preferred stock of FFMC, representing 100% of the outstanding preferred stock of FFMC, and $10,000 in common stock of FFMC, representing approximately 14% of the outstanding common stock. Due to continued losses by FFMC, UTI realized losses of $315,000 and $10,000 from writedowns of their investment in FFMC at December 31, 1996 and 1995, respectively.
B. STOCK OPTION PLAN
In 1985, the Company initiated a nonqualified stock option plan for employees, agents and directors of the Company under which options to purchase up to 440,000 shares of the company's common stock are granted at $.02 per share. Through December 31, 1996 options for 424,375 shares were granted and exercised. Options for 15,625 shares remain available for grant.
During 1996, the Company adopted Statement of Financial Accounting Standards No. 123, accounting for stock-based compensation. The adoption of this standard did not have a material impact on the Company's financial statements.
Following is a summary of stock option transactions for the three years ended December 31, 1996:
1996 1995 1994 Option Shares exercised 25,000 20,000 0 Compensation expense charged to operatiions $ 13,563 $ 12,100 $ 0 Approximate percent of market value at which options were granted 3.6% 3.2% 0%
C. DEFERRED COMPENSATION PLAN
UTI and FCC established a deferred compensation plan during 1993 pursuant to which an officer or agent of FCC, UTI or affiliates of UTI, could defer a portion of their income over the next two and one-half years in return for a deferred compensation payment payable at the end of seven years in the amount equal to the total income deferred plus interest at a rate of approximately 8.5% per annum and a stock option to purchase shares of common stock of UTI. An officer or agent received an immediately exercisable option to purchase 23,000 shares of UTI common stock at $1.75 per share for each $25,000 ($10,000 per year for two and one- half years) of total income deferred. The option expires on December 31, 2000. A total of 1,050,000 options were granted in 1993 under this plan. As of December 31, 1996 no options were exercised. At December 31, 1996 and 1995, the Company held a liability of $1,268,000 and $1,167,000, respectively, relating to this plan.
11. NOTES PAYABLE
At December 31, 1996, the Company has $19,574,000 in long term debt outstanding. The debt is comprised of the following components:
1996 1995 Senior debt $ 8,400,000 $ 10,400,000 Subordinated 10 yr. notes 6,209,000 6,209,000 Subordinated 20 yr. notes 3,815,000 3,815,000 Other notes payable 1,150,000 1,000,000 Encumbrance on real estate 0 23,000 $ 19,574,000 $ 21,447,000
On May 8, 1996, FCC refinanced its senior debt of $8,900,000. The refinancing was completed through First of America Bank - NA and is subject to a credit agreement. The refinanced debt bears interest to a rate equal to the "base rate" plus nine-sixteenths of one percent. The Base rate is defined as the floating daily, variable rate of interest determined and announced by First of America Bank from time to time as its "base lending rate". The base rate at issuance of the loan was 8.25%, and has remained unchanged through March 1, 1997. Interest is paid quarterly. Principal payments of $1,000,000 are due in May of each year beginning in 1997, with a final payment due May 8, 2005. On November 8, 1996, the Company prepaid $500,000 of the May 8, 1997 principal payment.
The credit agreement contains certain covenants with which the Company must comply. The covenants contain provisions common to a loan of this type and include such items as: a minimum consolidated net worth of FCC to be no less than 400% of the outstanding balance of the debt, Statutory capital and surplus of Universal Guaranty Life Insurance Company be maintained at no less than $6,500,000; an earnings covenant requiring the sum of the pre-tax earnings plus non-cash charges of FCC (based on parent only GAAP practices) shall not be less than two hundred percent (200%) of the Company's interest expense on all of its debt service. The Company is current and in compliance with all of the terms on all of its outstanding debt and does not foresee any problem in maintaining compliance in the future.
United Income, Inc. (UII) and First Fidelity Mortgage Company through an assignment from United Trust, Inc. owned a participating interest of $700,000 and $300,000 respectively of the senior debt. At the date of the refinance, these obligations were converted from participations of senior debt to promissory notes. These notes bear interest at the rate of 1% above the variable per annum rate of interest most recently published by the Wall Street Journal as the prime rate. Interest is payable quarterly with principal due at maturity on May 8, 2006. In February 1996, FCC borrowed an additional $150,000 from UII to provide additional cash for liquidity. The note bears interest at the rate of 1% over prime as published in the Wall Street Journal, with interest payments due quarterly and principal due upon maturity of the note on June 1, 1999.
The subordinated debt was incurred June 16, 1992 as a part of an acquisition. The 10 year notes bear interest at the rate of 7 1/2% per annum, payable semi-annually beginning December 16, 1992. These notes provide for principal payments equal to 1/20th of the principal balance due with each interest installment beginning June 16, 1997, with a final payment due June 16, 2002. During 1995, the Company refinanced $300,695 of 10 year notes to 20 year notes bearing interest at the rate of 8.75%. The repayment terms of these notes are similar to the original 20 year notes. The 20 year notes bear interest at the rate of 8 1/2% per annum, payable semi-annually beginning December 16, 1992, with a lump sum principal payment due June 16, 2012. The Company's subordinated debt consists of $4,495,000 and $3,532,000 of ten year and twenty year notes, respectively, owed to current officers and directors of the Company or its affiliates.
Scheduled principal reductions on the Company's debt for the next five years is as follows:
Year Amount
1997 $ 1,037,000 1998 1,537,000 1999 1,687,000 2000 1,537,000 2001 1,537,000
12. OTHER CASH FLOW DISCLOSURE
The Company recognized an increase in its paid-in capital of $0, $0 and $277,559 for the years 1996, 1995 and 1994 respectively, from its equity investment in UFI from the offering price per share of UFI exceeding UTI's carrying amount per share.
On a cash basis, the Company paid $1,700,973, $1,934,326 and $1,937,123 in interest expense for the years 1996, 1995 and 1994, respectively. The Company paid $17,634, $25,821 and $190 in federal income tax for 1996, 1995 and 1994, respectively.
The Company's insurance subsidiary (UG) entered into a coinsurance agreement with First International Life Insurance Company (FILIC) as of September 30, 1996. At closing of the transaction, UG received a coinsurance credit of $28,318,000 for policy liabilities covered under the agreement. UG transferred assets equal to the credit received. This transfer included policy loans of $2,855,000 associated with policies under the agreement and a net cash transfer of $19,088,000 after deducting the ceding commission due UG of $6,375,000.
13. NON-RECURRING WRITE DOWN OF VALUE OF AGENCY FORCE ACQUIRED
The Company recognized a non-recurring write down of $8,297,000 on its value of agency force acquired for the year ended December 31, 1995. The write down released $2,904,000 of the deferred tax liability and $3,327,000 was attributed to minority interest in loss of consolidated subsidiaries. In addition, equity loss of investees was negatively impacted by $542,000. The effect of this write down resulted in an increase in the net loss of $2,608,000. This write down is directly related to the Company's change in distribution systems. Due to the broker agency force not meeting management's expectations and lack of production, the Company has changed its focus from a primarily broker agency distribution system to a captive agent system. With the change in focus, most of the broker agents were terminated and therefore, management re-evaluated the value of the agency force carried on the balance sheet. For purposes of the write-down, the broker agency force has no future expected cash flows and therefore warranted a write-off of the value. The write down is reported as a separate line item "non-recurring write down of value of agency force acquired" and the release of the deferred tax liability is reported in the credit for income taxes payable in the Statement of Operations. In addition, the impact to minority interest in loss of consolidated subsidiaries and equity loss of investees is in the Statement of Operations.
14. CONCENTRATION OF CREDIT RISK
The Company maintains cash balances in financial institutions which at times may exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents.
15. PENDING CHANGE IN CONTROL OF UNITED TRUST, INC.
On September 23, 1996, UTI and UII entered into a stock purchase agreement with LaSalle Group, Inc., a Delaware corporation ("LaSalle"), whereby LaSalle will acquire 12,000,000 shares of authorized but unissued shares of UTI for $1.00 per share and 10,000,000 shares of authorized but unissued shares of UII for $0.70 per share. Additionally, LaSalle intends, contemporaneously with the closing of the above transaction, to purchase in privately negotiated transactions additional shares of UTI and UII so that LaSalle will own not less than 51% of the outstanding common stock of UTI and indirectly control 51% of UII.
The agreement requires and is pending approval of the Commissioner of Insurance of the State of Ohio, Illinois and West Virginia, (the states of domicile of the insurance subsidiaries). It is anticipated the transaction will be completed during the second quarter of 1997.
PART III
With respect to Items 10 through 13, the Company will file with the Securities and Exchange Commission, within 120 days of the close of its fiscal year, a definitive proxy statement pursuant to Regulation 14-A.
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors of the Company will be set forth in the Company's proxy statement relating to the annual meeting of shareholders to be held during 1997 and is incorporated herein by reference. Information regarding executive officers of the Company is set forth under the caption "Executive Officers".
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation will be set forth in the Company's proxy statement relating to the annual meeting of shareholders to be held during 1997 and is incorporated herein by reference.
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and management will be set forth in the Company's proxy statement relating to the annual meeting of shareholders to be held during 1997 and is incorporated herein by reference.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions will be set forth in the Company's proxy statement relating to the annual meeting of shareholders to be held during 1997 and is incorporated herein by reference.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of the report:
(1) Financial Statements: See Item 8, Index to Financial Statements
(2) Financial Statement Schedules
Schedule I - Summary of Investments - other than invested in related parties.
Schedule II - Condensed financial information of registrant
Schedule IV - Reinsurance
Schedule V - Valuation and qualifying accounts
NOTE: Schedules other than those listed above are omitted for the reasons they are not required or the information is disclosed in the financial statements or footnotes.
(b) Reports on Form 8-K filed during fourth quarter.
None
(c) Exhibits:
Index to Exhibits (See Pages 58 and 59).
INDEX TO EXHIBITS
Exhibit Number
3(a) (1) Amended Articles of Incorporation for the Company dated November 20, 1987.
3(b) (1) Amended Articles of Incorporation for the Company dated December 6, 1991.
3(c) (1) Amended Articles of Incorporation for the Company dated March 30, 1993.
3(d) (1) Code of By-Laws for the Company.
10(a) (1) Compromise and Settlement Agreement dates as of February 27, 1991, among First Commonwealth Corporation, Universal Guaranty Life Insurance Company, Alliance Life Insurance Company, Roosevelt National Life Insurance Company of America, Abraham Lincoln Insurance Company, Appalachian Life Insurance Company, Liberty American Assurance Company, and Farmers and Ranchers Life Insurance Company, and Southshore Holding Corp., Public Investors, Inc., Fidelity Fire and Casualty Insurance Company, Insurance Premium Assistance Company, Agency Premium Assistance Company, Coastal Loans Acquisition Company, Bob F. Shamburger, Gary E. Jackson, Leonard H. Aucoin, Dennis J. Lafont, William Joel Herron and Jerry Palmer.
10(b) Credit Agreement dated May 8, 1996 between First of America Bank - Illinois, N.A., as lender and First Commonwealth Corporation, as borrower.
10(c) $8,900,000 Term Note of First Commonwealth Corporation to First of America Bank - Illinois, N.A. dated May 8, 1996.
10(d) Coinsurance Agreement dated September 30, 1996 between Universal Guaranty Life Insurance Company and First International Life Insurance Company, including assumption reinsurance agreement exhibit and amendments.
10(aa) (1) Subcontract Agreement dated September 1, 1990 between United Trust, Inc. and United Income, Inc.
10(bb) (1) Service Agreement dated November 8, 1989 between United Security Assurance Company and United Income, Inc.
10(cc) (1) Management and Consultant Agreement dated as of January 1, 1993 between First Commonwealth Corporation and Universal Guaranty Life Insurance Company.
10(dd) (1) Management Agreement dated December 20, 1981 among Commonwealth Industries Corporation, Executive National Life Insurance Company (now known as Investors Trust Assurance Company) and Abraham Lincoln Insurance Company.
10(ee) (1) Reinsurance Agreement dated January 1, 1991 between Universal Guaranty Life Insurance Company and Republic-Vanguard Life Insurance Company.
10(ff) (1) Reinsurance Agreement dated July 1, 1992 between United Security Assurance Company and Life Reassurance Corporation of America.
INDEX TO EXHIBITS
Exhibit Number
10(gg) (1) United Trust, Inc. Stock Option Plan.
10(hh) (1) Board Resolution adopting United Trust, Inc.'s Officer Incentive Fund.
10(ii) (1) Employment Agreement dated as of April 15, 1993 between Larry E. Ryherd and First Commonwealth Corporation and United Trust, Inc.
10(jj) (1) Employment Agreement dated as of April 15, 1993 between Thomas F. Morrow and First Commonwealth Corporation and United Trust, Inc.
10(kk) (1) Employment Agreement dated as of April 15, 1993 between James E. Melville and First Commonwealth Corporation and United Trust, Inc.
10(ll) (1) Employment Agreement dated as of June 16, 1992 between George E. Francis and First Commonwealth Corporation.
10(mm) (1) Amendment Number One to Employment Agreement dated as of April 15, 1993 between George E. Francis and First Commonwealth Corporation.
10(nn) (1) Consulting Arrangement entered into June 15, 1987 between Robert E. Cook and United Trust, Inc.
10(oo) (1) Agreement dated June 16, 1992 between John K. Cantrell and First Commonwealth Corporation.
10(pp) (1) Termination Agreement dated as of January 29, 1993 between Scott J. Engebritson and United Trust, Inc., United Fidelity, Inc., United Income, Inc., First Commonwealth Corporation and United Security Assurance Company.
10(qq) (1) Stock Purchase Agreement dated February 20, 1992 between United Trust Group, Inc. and Sellers.
10(rr) (1) Amendment No. One dated April 20, 1992 to the Stock Purchase Agreement between the Sellers and United Trust Group, Inc.
10(ss) (1) Security Agreement dated June 16, 1992 between United Trust Group, Inc. and the Sellers.
10(tt) (1) Stock Purchase Agreement dated June 16, 1992 between United Trust Group, Inc. and First Commonwealth Corporation
Footnote:
(1) Incorporated by reference from the Company's Annual Report on Form 10-K, File No. 0-5392, as of December 31, 1993.
UNITED TRUST, INC. CONDENSED FINANCIAL INFORMATION OF REGISTRANT Schedule II NOTES TO CONDENSED FINANCIAL INFORMATION
(a) The condensed financial information should be read in conjunction with the consolidated financial statements and notes of United Trust, Inc. and Consolidated Subsidiaries.
* All assumed business represents the Company's participation in the Servicemen's Group Life Insurance Program (SGLI).
* All assumed business represents the Company's participation in the Servicemen's Group Life Insurance Program (SGLI).
* All assumed business represents the Company's participation in the Servicemen's Group Life Insurance Program (SGLI).
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
UNITED TRUST, INC. (Registrant)
/s/ John S. Albin March 25, 1997 John S. Albin, Director
/s/ William F. Cellini March 25, 1997 William F. Cellini, Director
/s/ Robert E. Cook March 25, 1997 Robert E. Cook, Director
/s/ Larry R. Dowell March 25, 1997 Larry R. Dowell, Director
/s/ Donald G. Geary March 25, 1997 Donald G. Geary, Director
/s/ Raymond L. Larson March 25, 1997 Raymond L. Larson, Director
/s/ Paul D. Lovell March 25, 1997 Paul D. Lovell, Director
/s/ Dale E. McKee March 25, 1997 Dale E. McKee, Director
/s/ Thomas F. Morrow March 25, 1997 Thomas F. Morrow, Chief Operating Officer, President, and Director
/s/ Larry E. Ryherd March 25, 1997 Larry E. Ryherd, Chairman of the Board, Chief Executive Officer and Director
/s/ Robert J. Webb March 25, 1997 Robert J. Webb, Director
/s/ James E. Melville March 25, 1997 James E. Melville, Chief Financial Officer and Senior Executive Vice President