U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________________ to ______________________.
Commission File Number 000-25253
SUMMIT LIFE CORPORATION
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(Name of small business issuer in its charter)
OKLAHOMA 73-1448244
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
3021 Epperly Dr., P.O. Box 15808, Oklahoma City, Oklahoma 73155
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (405) 677-0781
Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12 (g) of the Act:
Common Stock, $.01 par value per share
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(Title of class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes X No
--- ---
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B is not contained in this form, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. X
Issuer's revenues for its most recent fiscal year were $609,614.
The aggregate market value of the registrant's common stock, $.01 par
value, held by non-affiliates of the registrant as of March 27, 2002 was
$1,062,695 based on the closing price of $.90 per share on that date as reported
by the OTC Bulletin Board. As of March 27, 2002, 2,248,605 shares of the
registrant's common stock, $.01 par value, were issued and outstanding, and
422,200 shares of common stock were subscribed and unissued but deemed to be
issued and outstanding.
Transitional Small Business Disclosure Format (check one): Yes No X
--- ---
DOCUMENTS INCORPORATED BY REFERENCE: Registrant's Proxy Statement for the 2002
Annual Meeting of Stockholders is incorporated by reference in Part III, Items 9
through 12, of this Form 10-KSB.
SUMMIT LIFE CORPORATION
FORM 10-KSB
For the Fiscal Year Ended December 31, 2001
TABLE OF CONTENTS
Part I.
Item 1. Description of Business....................................... 1
Item 2. Description of Property....................................... 10
Item 3. Legal Proceedings............................................. 11
Item 4. Submission of Matters to a Vote of Security Holders........... 11
Part II.
Item 5. Market for Common Equity and Related Stockholder Matters...... 11
Item 6. Management's Discussion and Analysis or Plan of Operation..... 12
Item 7. Financial Statements.......................................... 19
Item 8. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosure...................................... 19
Part III.
Item 9. Directors, Executive Officers, Promoters and Control Persons,
Compliance With Section 16(a) of the Exchange Act............. 21
Item 10. Executive Compensation........................................ 21
Item 11. Security Ownership of Certain Beneficial Owners
and Management................................................ 21
Item 12. Certain Relationships and Related Transactions................ 21
Item 13. Exhibits and Reports on Form 8-K.............................. 21
Signatures .............................................................. 23
-i-
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Annual Report on Form 10-KSB includes "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as
amended. All statements other than statements of historical facts included in
this Report, including, without limitation, statements regarding the Company's
future financial position, business strategy, budgets, projected costs and plans
and objectives of Management for future operations, are forward-looking
statements. In addition, forward-looking statements generally can be identified
by the use of forward-looking terminology such as "may," "will," "expect,"
"intend," "estimate," "anticipate" or "believe" or the negative thereof or
variations thereon or similar terminology. Although the Company believes that
the expectations reflected in such forward-looking statements are reasonable, it
can give no assurance that such expectations will prove to have been correct.
Such statements are based upon numerous assumptions about future conditions
which may ultimately prove to be inaccurate and actual events and results may
materially differ from anticipated results described in such statements.
Important factors that could cause actual results to differ materially from the
Company's expectations ("cautionary statements") include the risks inherent
generally in the insurance and financial services industries, the impact of
competition and product pricing, changing market conditions, the risks disclosed
in the Company's Annual Report on Form 10-KSB for the Year Ended December 31,
2001 under "ITEM 6--Management's Discussion and Analysis or Plan of Operation,"
and elsewhere in this Report. All subsequent written and oral forward-looking
statements attributable to the Company, or persons acting on its behalf, are
expressly qualified in their entirety by these cautionary statements. The
Company assumes no duty to update or revise its forward-looking statements based
on changes in internal estimates or expectations or otherwise. As a result, the
reader is cautioned not to place reliance on these forward-looking statements.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
Summit Life Corporation, an Oklahoma corporation formed in 1994 (the
"Company"), is an insurance holding company. The Company's primary focus is its
life insurance operations.
The Company's growth has been fueled primarily through acquisitions,
starting in 1994 when it acquired an Oklahoma-chartered life insurance company.
Since then, the Company has acquired three additional life insurance companies
in Texas and Louisiana. The Company consolidated its operations in 1999 by
combining three of the four companies into one company operating in both Texas
and Oklahoma. The fourth company, which operated in Louisiana, was also sold in
1999.
On August 1, 2001, the Company's wholly owned subsidiary, Great Midwest
Life Insurance Company ("Great Midwest"), acquired from Presidential Life
Insurance Company of Dallas, Texas ("Presidential"), a block of approximately
1,400 life insurance policies with estimated annual premium of $120,000.
Liabilities of $712,000 and assets of $634,392 were transferred to Great Midwest
for a purchase price of $77,608.
The Company's net premium revenue increased from $152,624 in 2000 to
$359,533 in 2001, and the Company believes that continued internal growth,
coupled with strategic acquisitions made available by the current consolidation
of the insurance industry, present the Company with good opportunities to
achieve its operating strategy. SEE "ITEM 6-MANAGEMENT'S DISCUSSION AND ANALYSIS
OR PLAN OF OPERATION."
The Company's operating strategy is to continue to make acquisitions of
small, marginally profitable or unprofitable insurance companies, consolidate
and streamline the administrative functions of these small companies, improve
1
their investment yields through active asset management in a centralized
investment operation and eliminate their unprofitable products and distribution
channels. The Company believes that it is particularly well suited to make such
acquisitions and to capitalize on the cost savings that can be realized by
consolidating the administrative functions of the acquired companies.
As of December 31, 2001, the Company had approximately 2,150 life insurance
policies and annuity contracts outstanding and individual life insurance in
force of approximately $27 million. As of December 31, 2001, the Company had
total assets of approximately $6.84 million and total shareholders' equity of
approximately $1.27 million.
The Company's principal office is located at 3021 Epperly Dr., P.O. Box
15808, Oklahoma City, Oklahoma, 73155, and its telephone number is (405)
677-0781.
History
The Company was formed in 1994 and, since inception, has acquired four life
insurance companies with operations in, variously, Oklahoma, Texas and
Louisiana, and has acquired one block of business. Three of these companies were
combined in 1999 to form the Company's flagship company, Great Midwest, a
Texas-domiciled life insurance company operating in Texas and Oklahoma. The
Louisiana-domiciled subsidiary was sold in December 1999 as a result of the
Company's decision to concentrate its focus on Oklahoma and Texas.
Recent Events
The Company began a public offering of 1,000,000 shares of its common stock
in May 2001. The offering was terminated March 31, 2002. A total of 445,200
shares of common stock were sold pursuant to the offering..
Operations
Insurance Products
General
Through its insurance subsidiary, the Company offers a portfolio of
permanent and term life products as well as flexible premium and single premium
annuities designed to meet the needs of its customers for supplemental
retirement income, estate planning and protection from unexpected death. The
target niche is middle-income individuals, families and small businesses
throughout its marketing territory. The Company's business strategy is to
continue to expand its marketing territory through subsidiary growth and/or
company acquisition, and to increase shareholder value by managing certain
operating fundamentals inherent to the insurance business. The Company intends
to utilize these operating fundamentals to differentiate its products by
maintaining its position as a low-cost producer that provides high-value
products to its life insurance and annuity customers, while also providing
superior service to both agents and customers. In addition, the Company intends
to continue to seek new business opportunities through mergers, acquisitions and
strategic alliances.
The Company has realized very low entry costs in its purchases of small
insurance companies. The Company minimizes operating expenses by centralizing,
standardizing and more efficiently performing many functions common to most life
insurance companies. The operations performed by the Company include
underwriting and policy administration, accounting and financial reporting,
marketing, regulatory compliance and asset management. The Company believes that
it is currently utilizing just over 5% of its information technology systems
capability in the administration of these back office operations.
2
Factors Affecting Insurance Operations
The Company believes that its operating performance is significantly
impacted by four basic elements: mortality, persistency, operating expenses and
investment yield. The Company believes that its results for each of these four
elements for the last several years have been good.
The Company believes its conservative risk selection practices and its
disciplined field underwriting have resulted in the Company realizing favorable
mortality experience for the last several years. The Company fully underwrites
each regular application and has no group underwriting and maintains very little
guaranteed issue business.
The Company has consistently achieved favorable persistency on its life
insurance products (i.e., lower lapse rates). This high persistency has been
achieved by providing quality service to its policyholders, incentives to agents
by, among other things, grading production bonuses by actual persistency, paying
persistency bonuses, awarding recognition for both agency and agent persistency
achievements, and monitoring agency persistency on a quarterly and annual basis.
Persistency is the extent to which policies sold remain in force. Policy lapses
over those actuarially anticipated could have an adverse effect on the financial
performance of the Company. Policy acquisition costs are deferred and expensed
over the premium-paying period of a policy. Excess policy lapses, however, cause
the immediate expensing or amortizing of deferred policy acquisition costs.
Provided the Company maintains lapse and surrender rates within its pricing
assumptions for its insurance policies, the Company believes that the present
lapse and surrender rate should not have a material adverse effect on the
Company's financial results. For the years ended December 31, 2000 and 2001, the
Company's lapse ratio on ordinary business was 8% and 3%, respectively.
The Company has aggressively managed its cost structure, while realizing
certain operating efficiencies from minimal personnel and reduced overall costs
as a result of the various acquisitions it has effected since 1994. Other
factors contributing to the Company's lower cost structure include: a flat
organizational structure which allows the Company to be responsive to changing
business conditions; the location of the Company in a geographic area which
provides lower cost operations than found in many other areas of the country; a
well-trained experienced workforce; and efficient use of technology.
The Company attempts to maintain competitive portfolio yields, while at the
same time maintaining a conservative approach with respect to its investment
criteria. Ultimately, the Company's objective with respect to its insurance
operations is to price each of its products to earn an adequate margin between
the return to the policyholder and the return earned by the Company on its
investments. To the extent that the Company is able to realize higher portfolio
yields on its investments, it will be in a position to offer more attractive
pricing on its insurance products.
Fixed Rate Annuities
Annuities are long term savings vehicles that are particularly attractive
to customers over the age of 50 who are or may be planning for retirement and
seek a secure, tax deferred savings product. The individual annuity business is
a growing segment of the savings and retirement market and among the fastest
growing segments of the life insurance industry. Annuity products currently
enjoy an advantage over certain other retirement savings products because the
payment of federal income taxes on interest credited on annuity policies is
deferred during the investment accumulation period.
Through GMLIC, the Company markets, issues and administers a variety of
fixed rate deferred annuity products, including single premium and flexible
premium deferred annuities. In a fixed rate deferred annuity, the insurance
company assumes the risk of interest fluctuations and pays a minimum fixed rate
of interest, usually 3% to 4% per year, with an excess amount payable based on
investment yields of its investment portfolio. Single premium deferred annuities
("SPDAs"), in general, are savings vehicles in which the policyholder makes a
single premium payment to an insurance company. The insurance company credits
3
the account of the annuitant with earnings at an interest rate (the "crediting
rate"), which is declared by the insurance company from time to time and may
exceed but may not be lower than any contractually guaranteed minimum crediting
rate. All of the Company's annuities have a minimum guaranteed crediting rate.
The Company also offers flexible premium deferred annuities ("FPDAs"). FPDAs are
deferred annuities in which the policyholder may elect to make more than one
premium payment. The Company currently does not offer variable annuity products.
The Company periodically establishes an interest-crediting rate for its new
annuity policies. In determining the Company's interest crediting rate on new
policies, management considers the competitive position of the Company,
prevailing market rates and the profitability of the annuity product. The
Company maintains the initial crediting rate for a minimum period of one year.
Thereafter, the Company may adjust the crediting rate at its discretion,
although historically such adjustments have generally been made on a quarterly
basis. In establishing renewal-crediting rates, the Company primarily considers
the anticipated yield on its investment portfolio. Interest rates credited on
the Company's in force annuity policies ranged from 3.0% to 7.8% at December 31,
2001. All of the Company's annuity products have minimum guaranteed crediting
rates of 3.0% for the life of the policy. At December 31, 2001, more than 98% of
the Company's in force annuity policies were beyond the initial crediting rate
period.
Certain of the Company's annuity policies have a bonus-crediting rate for
the first year of the policy, which typically exceeds the annual crediting rate
by 1% to 3%. The bonus and the base crediting rates are fully disclosed in the
annuity contract. The Company incorporates a number of features in its annuity
products designed to reduce the early withdrawal or surrender of the policies
and to partially compensate the Company for lost investment opportunities and
costs if policies are withdrawn early. Certain of the Company's deferred annuity
contracts provide for penalty free partial withdrawals, typically up to 10% of
the accumulation value annually. Surrender charge periods on annuity policies
currently range from five years to the term of the policy, with the majority of
such policies being issued with a surrender charge period of more than seven
years. The average length of the surrender period on the Company's deferred
annuity policies issued during 2000 and 2001 was eight years. The initial
surrender charge on annuity policies generally is 8% of the premium and
decreases over the surrender charge period (of up to nine years). At December
31, 2001, 19% of the Company's annuity liabilities were subject to a surrender
charge of 5% or more.
Tax Qualified Annuities
General. The Company also markets to employees of public schools and
certain other tax-exempt organizations certain tax qualified retirement
annuities that meet the requirements of Section 403(b) of the Internal Revenue
Code of 1986 and are known as "tax sheltered annuities" or "403(b) annuities"
("TSAs"). Teachers, school employees and employees of other tax-exempt
organizations purchase TSAs through automatic payroll deductions. TSA products
tend to be purchased by customers who are younger than purchasers of the
Company's other annuity products. Therefore, the Company's specialty TSA
products tend to incorporate features that are attractive to customers in this
younger age bracket who have longer to accumulate before retirement, such as
combining a more competitive crediting interest rate offset with a longer
surrender charge period. The Company believes that the market for TSAs is
attractive because TSAs broaden its customer base and provide an ongoing source
of premium renewals. Additionally, because of their tax features and transfer
restrictions, TSAs are less likely to be surrendered, making them a more stable
and dependable source of profits for the Company. In addition to TSAs, the
Company also sells other tax qualified retirement annuities such as Individual
Retirement Annuities and other Employee Pension type programs. Tax qualified
retirement annuity values totaled almost $1,100,000 or approximately 27% of the
total annuities sold by the Company since inception.
Favorable Tax Treatment. Under the Internal Revenue Code ("Code"), income
taxes otherwise payable on investment earnings are deferred on earnings unpaid
during the accumulation period of certain life insurance and annuity policies.
This favorable tax treatment may give the Company's annuity policies a
4
competitive advantage over other investment or savings vehicles that do not
offer this benefit. To the extent that the Code may be revised to eliminate or
reduce the tax-deferred status of life deferred payment annuity products, or to
establish a tax-deferred status to any competing policies, the Company's
competitive advantage may be adversely affected.
Traditional Life Insurance
Term Life. The Company's subsidiary offers a low cost 10-year level term
life insurance product with level premiums for periods of ten years and an
annually renewable level term product which provides for increasing premiums in
five year durations, both utilizing a low indeterminate premium structure
afforded to it by its primary reinsurance company. The Company generally retains
a small fixed portion of the insurance risk, then sells or cedes a portion of
its risks to its reinsurer, who in turn pays an additional allowance or
commission to the Company. This allows the Company to transfer a portion of its
risk and continue to grow its premium revenues and surplus. These term products
are designed for and sold to individuals ages 20 through 60 and terminate at age
70. While term life normally is bought very inexpensively by consumers, it is
also priced by companies using historical data that illustrates certain of these
coverages, when using adequate reinsurance, will not result in adverse claims.
Whole Life. The Company's subsidiary markets low cost guaranteed premium
products in which premiums are payable for the life of the insured and insurance
protection (upon certain conditions being met) is afforded for the insured's
lifetime. The premium paid for such whole life policies is generally higher than
the premium for comparable amounts of term insurance in the policy's early years
but is generally lower in the later years of the policy's life. The policyholder
may borrow against the policy, provided there are sufficient cash values, at a
rate that is comparable or lower than other conventional lending sources. The
Company generally holds all cash values and if a death occurs it pays death
claims then collects from the reinsurer to recover the excess of its retention
limits and benefits paid.
The Company's life insurance subsidiaries have sold annuity products since
1994. Beginning in January 1999 with the purchase of GMLIC and the consolidation
of the other subsidiaries, the life insurance products of GMLIC were combined
with annuity products from the other subsidiaries. GMLIC previously offered a
graded benefit life product that was offered on an individual basis in amounts
of $1,000 to $5,000, without evidence of insurability. Benefits paid are less
than the face amount of the policy during the first two years, except in cases
of accidental death.
Insurance Underwriting
The Company follows detailed, uniform underwriting practices and procedures
in its insurance business which are designed to assess risks before issuing
coverage to qualified applicants. The Company contracts with professional
underwriters who evaluate policy applications on the basis of information
provided by applicants and others. Management believes that its actual mortality
results are attributable to, among other things, the geographic location of its
customer base in rural and suburban areas (as opposed to urban areas), as well
as its consistent application of appropriate underwriting criteria to the
processing of new customer applications.
Reinsurance
Consistent with the general practice of the life insurance industry, the
Company's subsidiary reinsures portions of coverage provided by their insurance
products with other insurance companies under agreements of indemnity
reinsurance.
Indemnity 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. Indemnity reinsurance does not discharge the original
insurer's primary liability to the insured. The Company's reinsured business is
5
ceded to numerous reinsurers, and 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.
As of December 31, 2001, the policy risk retention limit of the Company's
subsidiary on the life of any one individual did not exceed $5,000; reinsurance
ceded by the Company's subsidiary represented 87% of gross combined life
insurance in force. At December 31, 2001, the Company's largest reinsurer,
Optimum Re Insurance Company, reinsured approximately 98% of the $27 million of
the total insurance in force.
Investments
Investment activities are an integral part of the Company's business;
investment income is a significant component of the Company's revenues. Upon the
purchase by a policyholder of an annuity or life contract and payment of the
premium, the policy is issued and delivered to the new policyholder. The funds
are then invested as the Company determines based on certain guidelines
including those set by the National Association of Insurance Commissioners
("NAIC") as to the percentage of investments that are placed in any one category
of investments. The Company has historically invested a majority of its
available assets in securities that are issued, secured, guaranteed or backed by
federal, state or local governments, their agencies or instrumentalities.
Profitability is significantly affected by spreads between interest yields
on investments and rates credited on insurance liabilities. Although all
credited rates on single premium deferred annuities and flexible premium
deferred annuities may be changed as often as quarterly, after their first year,
changes in credited rates may not be sufficient to maintain targeted investment
spreads in all economic and market environments. In addition, competition and
other factors, including the impact of the level of surrenders and withdrawals,
may limit the Company's ability to adjust or maintain crediting rates at levels
necessary to avoid narrowing of spreads under certain market conditions. For the
year ended December 31, 2001, the average gross yield of the Company's invested
assets was approximately 6.0% and the average credited rate was 5.0%.
The Company balances the duration of its invested assets with the expected
duration of benefit payments arising from insurance liabilities. At December 31,
2001, the adjusted modified duration of debt securities and short-term
investments was 6.0 years. At December 31, 2001, the average duration of the
Company's insurance liabilities was 7.0 years.
For information regarding the composition and diversification of the
investment portfolio of the Company and its subsidiary, see Note B to the
Company's Consolidated Financial Statements.
Acquisitions and Consolidations
General
The Company's operating strategy is to continue to make acquisitions of
small, marginally profitable or unprofitable insurance companies, consolidate
and streamline the administrative functions of these small companies, improve
their investment yields through active asset management by a centralized
investment operation and eliminate their unprofitable products and distribution
channels. Because of their small size, such companies are often overlooked as
potential acquisition candidates by other companies in the industry. The Company
believes that it is particularly well suited to make such acquisitions and to
capitalize on the cost savings that can be realized by consolidating the
administrative functions of the acquired companies.
6
Historical Acquisitions
The Company's growth to date has been fueled primarily through
acquisitions. Since 1994, the Company has acquired four life insurance
companies. During 1999, three of these companies were combined, either by merger
or through transfer of operations, into Great Midwest, while a fourth company
was sold. The Company intends to continue its strategy of pursuing similar
acquisitions of blocks of insurance business and small insurance companies and
other insurance-related opportunities. Management believes that such
acquisitions will continue to lower unit costs by increasing the number of
policies and the amount of premiums over which fixed expenses are spread.
Targeted Future Acquisitions
The Company has typically sought companies that are underdeveloped, overly
burdened with expenses or owned by financially troubled companies. The Company
believes that the small insurance company marketplace is highly fragmented and
faces numerous hurdles to its survival and growth over the coming years. Some of
those hurdles include technological obsolescence, the need for additional
capital and surplus due to the changing regulatory environment and lack of
sufficient exit strategies for owners of small, closely-held companies. The
Company believes these factors have created acquisition opportunities often
overlooked by the large insurance companies. The Company intends to capitalize
on these opportunities as it continues to execute its growth plans. The Company
has no agreements, understandings or arrangements with respect to any other
acquisitions at this time.
Employees
As of December 31, 2001, the Company had five full-time employees, most of
whom perform both managerial and administrative functions. The Company's
employees also perform services for Great Midwest, which has no employees. The
Company's controller function is outsourced. It can be anticipated that the
Company will have a need for more employees as the size of its business grows.
None of the Company's employees is represented by a labor union. Management
believes that the Company's relations with its employees are good.
Marketing
The Company's target markets are individuals in middle-income brackets in
addition to small businesses in the states of Texas and Oklahoma. The Company
believes that this market is severely underserved as more major companies target
their products and agency force toward the upper income and large policy sales.
Many large companies no longer offer insurance in face amounts under $100,000.
Although the Company does write multi-million dollar policies, its average life
policy is approximately $13,000.
The pricing of the Company's products is generally determined by reference
to actuarial calculations and statistical assumptions principally relating to
mortality, persistency, investment yield assumptions, estimates of expenses and
management's judgment as to market and competitive conditions. The premiums and
deposits received, together with assumed investment earnings, are designed to
cover policy benefits, expenses and policyowner dividends plus return a profit
to the Company. These profits arise from the margin between mortality charges
and insurance benefits paid, the margin between actual investment results and
the investment income credited to policies (either directly or through dividends
to policyowners) and the margin between expense charges and actual expenses. The
level of profits also depends on persistency because policy acquisition costs,
particularly agent commissions, are recovered over the life of the policy.
Dividends and interest credited on policies may vary from time to time
reflecting changes in investment, mortality, persistency, expenses and other
factors. Interest rate fluctuations have an effect on investment income and may
have an impact on policyowner behavior. Increased lapses in policies may be
experienced if the Company does not maintain interest rates and dividend scales
that are competitive with other products in the marketplace.
7
The Company markets its products primarily through personal producing
general agents ("PPGAs") and small independent property and casualty agencies.
The PPGAs include the Company's founders and principal stockholders, James L.
Smith and Charles L. Smith. James L. Smith and Charles L. Smith are the sole
stockholders of the Smith Agency, which undertakes life insurance and financial
planning for estates, trusts and corporations. The Smith Agency was and is
presently a general agent for several insurance companies, including the
Company. The Smith Agency has sold a majority of the Company's deferred
annuities since the Company's inception. Additionally, the companies acquired by
the Company generally have in place PPGAs who are capable and qualified to
generate the sales desired by the Company, thereby eliminating part of the
expense of recruiting and training a new agency force.
Competition
The life insurance business is highly competitive and consists of a number
of companies, many of which have greater financial resources, longer business
histories and more diversified lines of insurance products than the Company. The
Company may encounter increased competition from existing competitors or new
market entrants, some of which may be significantly larger and have greater
business resources. Companies typically compete for policyholders on the basis
of benefits, rates, financial strength and customer service and compete for
agents and brokers on the basis of commissions, financial strength and customer
service. The Company, although smaller than most of its competitors, provides
competitive benefits and rates. The Company believes that its ability to
administer its functions at a lower cost allows it to maintain low internal cost
products.
The Company has identified additional areas where it has very little
competition due to the size of the Company as well as the size of its target.
One such area is the consolidation field. The Company's strategy has been to
consolidate and streamline the administrative functions of small life insurance
companies. Most large life companies have high fixed costs when performing
acquisitions restricting them in the minimum size of purchase they can pursue.
The Company believes that the consolidation of the industry will continue, and
the Company intends to participate in the process.
Regulation
The Company's insurance subsidiary is subject to regulation and supervision
by the states in which it transacts business. The laws of these jurisdictions
generally establish agencies with broad regulatory authority, including powers
to: (1) grant and revoke licenses to transact business; (2) regulate and
supervise trade practices and market conduct; (3) establish guaranty
associations; (4) license agents; (5) approve policy forms; (6) approve premium
rates for some lines of business; (7) establish reserving requirements; (8)
prescribe the form and content of required financial statements and reports; (9)
determine the reasonableness and adequacy of statutory capital and surplus; and
(10) regulate the type and amount of permitted investments. Because Great
Midwest is licensed to sell insurance in Oklahoma and Texas, it is subject to
regulation by the insurance regulatory agencies of both states. SEE "ITEM
6-MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION--Liquidity and
Capital Resources."
Most states also have enacted legislation that regulates insurance holding
company groups, including acquisitions, extraordinary dividends, the terms of
surplus debentures, the terms of affiliate transactions and other related
matters. Currently, the Company and its insurance subsidiary are registered as a
holding company group pursuant to such legislation in Texas and Oklahoma.
The federal government does not directly regulate the insurance business.
However, federal legislation and administrative policies in several areas,
including pension regulation, age and sex discrimination, financial services
regulation and federal taxation, do affect the insurance business. Recently,
increased scrutiny has been placed upon the insurance regulatory framework, and
a number of state legislatures have considered or enacted legislative proposals
that alter, and in many cases increase, the authority of state agencies to
8
regulate insurance companies and holding company groups. In addition,
legislation has been introduced from time to time in recent years which, if
enacted, could result in the federal government assuming a more direct role in
the regulation of the insurance industry.
State insurance regulators and the NAIC are continually re-examining
existing laws and regulations and their application to insurance companies. From
time to time the NAIC has adopted, and recommended to the states for adoption
and implementation, several regulatory initiatives designed to decrease the risk
of insolvency of insurance companies in general. These initiatives include
risk-based capital ("RBC") requirements for determining the levels of capital
and surplus an insurer must maintain in relation to its insurance and investment
risks. The NAIC regulatory initiatives also impose restrictions on an insurance
company's ability to pay dividends to its stockholders. These initiatives may be
adopted by the various states in which the Company's subsidiary is licensed, but
the ultimate content and timing of any statutes and regulations to be adopted by
the states cannot be determined at this time. It is not possible to predict the
future impact of changing state and federal regulations on the operations of the
Company, and there can be no assurance that existing insurance related laws and
regulations will not become more restrictive in the future or that laws and
regulations enacted in the future will not be more restrictive.
Most states have enacted legislation or adopted administrative regulations
which affect the acquisition of control of insurance companies as well as
transactions between insurance companies and persons controlling them. The
nature and extent of such legislation and regulations vary from state to state.
Most states, however, require administrative approval of: (1) the acquisition of
10 percent or more of the outstanding shares of an insurance company
incorporated in the state; or (2) the acquisition of 10 percent or more of the
outstanding stock of an insurance holding company whose insurance subsidiary is
incorporated in the state. The acquisition of 10 percent of such shares is
generally deemed to be the acquisition of control for purposes of the holding
company statutes. It requires not only the filing of detailed information
concerning the acquiring parties and the plan of acquisition, but also the
receipt of administrative approval prior to the acquisition. In many states, an
insurance authority may find that control does not, in fact, exist in
circumstances in which a person owns or controls 10 percent or a greater amount
of securities.
Under the solvency or guaranty laws of most states in which they do
business, the Company's insurance subsidiary may be required to pay assessments
(up to certain prescribed limits) to fund policyowner losses or the liabilities
of insolvent or rehabilitated insurance companies. These assessments may be
deferred or forgiven under most guaranty laws if they would threaten an
insurer's financial strength. In certain instances, the assessments may be
offset against future premium taxes. The Company's subsidiaries historically
have not been required to pay assessments in any significant amounts. The
likelihood and amount of any future assessments cannot be estimated, as they are
beyond the control of the Company.
As part of their routine regulatory oversight process, insurance
departments conduct periodic detailed examinations of the books, records and
accounts of insurance companies domiciled in their states. Texas conducts such
examinations on a three to five year cycle under guidelines promulgated by the
NAIC. The Company incurred examination expenses in 2001 for an examination of
Great Midwest in the amount of $16,110. See Note I to the Company's Consolidated
Financial Statements.
Federal Income Taxation
The annuity and life insurance products marketed and issued by the
Company's subsidiary generally provide the policyowner with an income tax
advantage, as compared to other savings investments such as certificates of
deposit and bonds, in that income taxation on the increase in value of the
product is deferred until receipt by the policyowner. With other savings
investments, the increase in value is taxed as earned. Annuity benefits and life
insurance benefits which accrue prior to the death of the policyowner are
generally not taxed until paid. Life insurance death benefits are generally
exempt from income tax, but not estate tax. Also, benefits received on immediate
annuities (other than structured settlements) are recognized as taxable income
9
ratably as opposed to the economic accrual methods, which tend to accelerate
taxable income into earlier years and which are required for other investments.
The tax advantage for annuities and life insurance is provided in the Internal
Revenue Code ("the Code"), and is generally followed in all states and other
United States taxing jurisdictions. Accordingly, it is subject to change by
Congress and the legislatures of the respective taxing jurisdictions.
The Company's insurance company subsidiary is taxed under the life
insurance company provisions of the Code. Provisions in the Code require a
portion of the expenses incurred in selling insurance products to be deducted
over a period of years, as opposed to immediate deduction in the year incurred.
This provision increases the tax for statutory accounting purposes, which
reduces statutory surplus and, accordingly, decreases the amount of cash
dividends that may be paid by the life insurance subsidiary. Great Midwest also
qualifies under the small life insurance company rules for taxation which may
further reduce taxes.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's administrative, marketing and production facilities consist
of approximately 3,000 square feet at a single location in Del City, Oklahoma.
The Company owns and occupies this facility and owns the approximate 30,000
square feet of raw land adjacent to the property. This facility will provide
room for possible expansion, which will likely be utilized within the next few
years.
The Company has leased 2,400 square feet of space within the internal
boundaries of its property to Nextel Westcorp, Inc., on which space the lessee
has erected a communications tower. Terms of the lease agreement (the "Lease
Agreement"), which was entered into in March 2001, provide for monthly payments
to the Company of approximately $1,300 per month during the initial five-year
term of the lease. The lease is renewable at the option of the lessee for five
additional five-year terms. If all renewals are exercised, the Company expects
to receive over $600,000 over the life of the agreement.
On March 6, 2001, the Company sold the Lease Agreement. In connection with
the sale, the Company had a disagreement with Grant Thornton LLP, its then
auditors, regarding the Company's proposed accounting treatment of the sale. SEE
"ITEM 8 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE," and Note H of the Notes to the Financial Statements." The
Company interpreted certain provisions relating to Statement of Financial
Accounting Standards ("FAS") 13 to allow the recording of a gain on the sale of
the Lease Agreement as of the effective date of the sale in the amount of
$186,000 because the Company did not retain any ownership in the lease revenue
stream and the buyer had no recourse against the Company if the lease revenue
stream did not continue. Grant Thornton LLP's review of the transaction
indicated that the Lease Agreement was an operating lease and that pursuant to
FAS 13 paragraph 22, the sale or assignment by the lessor of lease payments due
under an operating lease should be accounted for as a borrowing. As such, Grant
Thornton LLP recommended that the Company record the sale of the Lease Agreement
as a borrowing as of the effective date of the sale. The effect on the Company's
first quarter financial statements was to eliminate $186,000 from income and
record a like amount as a liability.
During the Company's discussions with Grant Thornton LLP, the Company was
informed of certain requirements that had to be satisfied in order for the gain
on the sale of the Lease Agreement to be recognized as income. Pursuant to the
information provided by Grant Thornton LLP, the Company subsequently structured
the transaction to meet the requirements necessary for the gain on the sale of
the Lease Agreement to be recognized as income and the Company recorded a gain
of $186,000 in June 2001. The effect on the Company's financial statements was
to delay recording $186,000 of income from the first quarter of 2001 to the
second quarter of 2001.
10
As a result of events subsequent to the sale, the Company came to the
conclusion that the tower property and lease were more attractive investments
than when they were sold by the Company. Accordingly, on December 17, 2001, the
Company repurchased the property, together with the underlying communications
tower lease, for $213,500. SEE "ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS OR
PLAN OF OPERATION--Liquidity and Capital Resources" and Note H of the Notes to
the Financial Statements.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved from time to time in various legal proceedings and
claims incident to the normal conduct of its business. The Company believes that
such legal proceedings and claims, individually and in the aggregate, are not
likely to have a material adverse effect on its financial condition or results
of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders during the
fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Trading Market
There is currently a limited market for the common stock of the Company.
The common stock began trading on the OTC Bulletin Board on October 27, 1999,
under the symbol SUMC. The following table sets forth, for the periods
indicated, the high and low bid prices of the Company's common stock during the
periods indicated, as reported by the OTC Bulletin Board:
2000 2001
----------------------- --------------------
High Low High Low
----------- ---------- ----------- --------
First Quarter................... $ 5.00 $ 2.00 $ .53 $ .25
Second Quarter.................. $ 2.50 $ 1.50 $1.05 $ .10
Third Quarter................... $ 1.75 $ .44 $ .80 $ .75
Fourth Quarter.................. $ .56 $ .27 $ .90 $ .10
OTC Bulletin Board quotations reflect interdealer prices, without retail
mark-up, mark-down or commission and may not represent actual transactions. The
Company intends to make application to list the common stock on the Nasdaq
SmallCap Market when it qualifies for listing.
Number of stockholders
As of the close of business on March 27, 2002, 2,248,605 shares of common
stock were issued and outstanding, 422,200 shares of common stock were
subscribed and unissued but deemed to be issued and outstanding, 5,000 shares of
Series A preferred stock were issued and outstanding and 350,000 shares of
Series B preferred stock were issued and outstanding. Great Midwest has been
issued 19,000 shares of common stock, but such shares are not taken into account
when determining the number of shares of common stock that are outstanding. At
such date, there were approximately 1,429 stockholders of record of the common
stock.
11
Dividend Policy
To date, the Company has declared no cash dividends on its common stock,
and does not expect to pay cash dividends in the near term. The Company intends
to retain future earnings, if any, to provide funds for operations and the
continued expansion of its business.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion and analysis reviews the Company's operations for
the years ended December 31, 2001 and 2000. Certain statements contained in this
discussion are not based on historical facts, but are based upon numerous
assumptions about future conditions that may ultimately prove to be inaccurate,
and actual events and results may differ materially from anticipated results
described in such statements. The Company's ability to achieve such results is
subject to certain risks and uncertainties such as those inherent generally in
the insurance industry, the impact of competition, changing market conditions
and other risks. The following discussion and analysis should be read in
conjunction with the financial statements of the Company and the notes related
thereto included elsewhere in this Report.
Currently, the Company's only business segment is its life insurance
operations. However, in the past the Company has also provided residential
mortgage loan processing services to individuals and financing to medical
accounts receivable factoring entities.
Operating Data
The following table sets forth selected information regarding operating
results for the periods indicated:
Year Ended December 31,
2001 2000
---------- ----------
(dollars in thousands)
Statement of Operations Data:
Revenues $ 610 $ 571
Benefits and expenses 933 975
---------- ----------
Net loss $ (324) $ (404)
========== ==========
Balance Sheet Data:
Cash and cash equivalents $ 1,661 $ 1,436
Total assets $ 6,629 $ 6,163
Total liabilities $ 5,572 $ 5,187
Stockholders equity $ 1,057 $ 975
Results of Operations
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Assets/Liabilities/Stockholders' Equity. Total assets were $6,629,095 at
December 31, 2001, compared to $6,162,682 at December 31, 2000, an increase of
8%. The increase was due to the acquisition of the Presidential block of
policies during 2001. See "ITEM 1. DESCRIPTION OF BUSINESS-General."
Total liabilities (primarily insurance reserves for future policyholder
benefits) were $5,572,208 at December 31, 2001, compared to $5,187,382 at
December 31, 2000, an increase of 7%. The increase was due primarily to the
Presidential acquisition, but was offset in part by repayment of a portion of
the Company's outstanding debt.
12
Total stockholders' equity was $1,056,887 at December 31, 2001, compared to
$975,300 at December 31, 2000, an increase of 8%. The increase was primarily due
to the sale of the Company's common stock pursuant to the Company's public
offering, which became effective in May 2001. The offering, which was terminated
effective March 31, 2002, resulted in the sale of 445,200 shares of common stock
for gross aggregate proceeds of $445,200.
The average rate of return on investments, including cash and cash
equivalents, was approximately 6.1% for 2001 and 6.5% for 2000, while the
average rate credited to policyowner accounts was approximately 5.0% and 5.2%,
respectively.
Revenue. Revenues attributable to life insurance increased 136% from
$152,624 to $359,533 for the year ended December 31, 2001, compared to the year
ended December 31, 2000. The increase was due to the acquisition of the
Presidential block in August 2001 as well as the Company's increased success in
marketing. The Company appointed a new marketing director in late 2000 and
appointed 40 new agents during 2001 which led to a significant increase in new
business written for the Company.
Investment income decreased 10%, from $377,184 for the year ended December
31, 2000 to $338,670 for the year ended December 31, 2001, primarily as a result
of a series of interest rate reductions during the year by the Federal Reserve.
Net losses on trading securities of $139,527, mainly unrealized holding
losses, were reported for the period ended December 31, 2001 as compared to
losses on trading securities of $159,755 for the period ended December 31, 2000.
The Company recovered more than $38,000 in losses during the fourth quarter and
anticipates continued recovery in the valuation of its equity portfolio. The
Company began trading securities in the fourth quarter of 2000 and is required
to report unrealized gains and losses in operations. The realized gain or loss
for each trading security may differ materially depending on the date of sale,
the underlying performance of the represented company and other market
conditions.
Other income decreased 46%, from $109,025 for the year ended December 31,
2000 to $58,730 for the year ended December 31, 2001, primarily as a result of a
gain on the sale of real estate which was recognized during the second quarter
of 2000.
Costs and Expenses. Total expenses decreased 4% from $975,178 to $933,818
for the years ended December 31, 2000 and December 31, 2001, respectively. Such
decrease was primarily attributable to management's cost containment programs,
which reduced general, administrative and other operating expenses by $69,000
during the year 2001.
Policy benefits increased 48% from $96,397 to $142,413 for the years ended
December 31, 2000 and December 31, 2001, respectively, due to the acquisition of
Presidential policies, which tripled the number of policies serviced by the
Company. Change in policy reserves, interest expenses and expenses associated
with taxes, licenses and fees all decreased slightly during 2001 compared to
2000 while depreciation and amortization increased slightly to reflect the
amortization of the goodwill associated with the Presidential acquisition.
Management believes the Presidential purchase has been successfully integrated
into Great Midwest's operations and will contribute toward the profitability of
the Company.
Losses. The Company reported a net loss for the year ended December 31,
2001 of $324,204, compared to a net loss for the year ended December 31, 2000 of
$404,421, a 20% decrease. This was due, in part, to management's efforts to
increase premium revenues through both the Presidential acquisition and
increased marketing activities and to continued cost containment measures
instituted two years ago. The Company's loss per share decreased to $0.15 per
share for the year ended December 31, 2001, compared to a loss of $0.20 per
share for the year ended December 31, 2000.
13
Liquidity and Capital Resources
Liquidity
The principal requirements for liquidity in connection with the Company's
operations are in contractual obligations to policyowners and annuitants. The
Company's contractual obligations include payments of surrender benefits,
contract withdrawals, claims under outstanding insurance policies and annuities,
and policy loans. Payment of surrender benefits is a function of "persistency",
which is the extent to which insurance policies are maintained by the
policyowner. Policyowners, at times, do not pay premiums, thus causing their
policies to lapse, or policyowners may choose to surrender their policies for
their cash surrender value. If actual experience of a policy or block of
policies is different from the initial or acquisition date assumptions, a gain
or loss could result. Depending on the nature of the underlying policy, a lapse
or surrender may result in surrender charge revenue or surrender benefit
expense. Such amounts may be less than, or greater than, unamortized acquisition
expenses and/or the related policy reserves; accordingly, current period
earnings may either increase or decrease. Additionally, policy lapses and
surrenders may result in lost future revenues and possible profitability
associated with the policy.
Capital Resources
On January 13, 1999, the Company acquired 100% of the outstanding common
stock of Great Midwest, a Texas-chartered life insurance company. The total cost
of the acquisition was approximately $939,000. Of the purchase price, cash of
$607,000 was paid to seven of eight stockholders with the eighth stockholder
receiving a promissory note for a principal amount of $332,000, payable in three
equal annual installments at an annual interest rate of 6% on the unpaid
principal balance. The Company partially funded the cash portion of the purchase
price with a $350,000 loan from a bank. The loan accrued interest at an index
rate plus .5%, payable monthly, and originally matured on July 9, 1999, at which
time the Company paid $100,000 of the principal amount owed and renewed the
balance for a six-month term maturing January 9, 2000. The balance of the loan
was paid December 31, 1999 using operating cash flow and the proceeds from the
sale of Benefit Capital Life Insurance Company. During 2001, the Company paid
the last of the three installments due on the promissory note held by the former
stockholder.
On August 1, 2001, Great Midwest acquired a block of approximately 1,400
life insurance policies. Reserves of $712,000 and assets of $634,392 were
transferred to Great Midwest for a purchase price of $77,608. The purchase was
funded with cash flow from operations. The purchase increased policies serviced
over 200% and in-force life insurance by $14.8 million, or 106%.
On September 28, 2001, the investor who had subscribed for an aggregate
1,000,000 shares of the Company's Series B preferred stock did not make the
final payment due with respect to his subscription. Under the terms of his
subscription agreement, pursuant to which the investor was deemed to have been
issued only that number of shares that were fully paid, a total of 350,000
shares of Series B preferred stock was deemed to be sold, and the subscription
receivable of $650,000 was canceled.
The Company has made and intends to make ongoing expenditures in connection
with its subsidiary's marketing programs. Historically, the Company has funded
these expenditures from cash flow from operations.
In preparing its financial statements for the 2001 fiscal year, the Company
requested a review by the Securities and Exchange Commission (the "SEC") of its
accounting treatment of the sale of certain real estate subject to an operating
lease, reported during the second quarter of 2001, as well as its proposed
accounting treatment of the December 2001 repurchase of such property. SEE "ITEM
2-DESCRIPTION OF PROPERTY" for a description of the property and accompanying
lease, "ITEM 8- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE," and Note H of the Notes to the Financial Statements. As a
14
result of its discussion with the SEC, the Company decided to reverse the
$186,000 of income reported on the sale of real estate subject to an operating
lease previously reported in the second quarter of 2001.
Great Midwest intends to request from state insurance regulators a review
and approval of the accounting treatment used by the company in its statutory
financial statements. Should the regulators require restatement, Great Midwest
may fail to meet the minimum capital and surplus required by applicable
statutes. In such event, the Company has the option of requesting an increase to
the valuation of the property based on independent appraisals and/or
contributing additional funds as surplus to the subsidiary to comply with
statutory capital and surplus requirement. The Company believes that if an
additional capital contribution is required, it will be able to obtain the
necessary capital.
The Company believes that anticipated cash from continuing operations
should be sufficient to fund its operations and the annual 10% dividend on the
Series A Preferred Stock for at least the next twelve months. The Company may
not, however, generate sufficient cash flow for these purposes. The Company's
ability to fund its operations and to make scheduled dividend payments will
depend on its future performance, which, to a certain extent, is subject to
general economic, financial, competitive, legislative, regulatory and other
factors that are beyond its control. The risk factors to which the Company's
operations are subject include the following:
Business Outlook and Risk Factors
The Company's future operating results may be affected by various trends,
developments and factors that the Company must successfully manage in order to
achieve favorable operating results. In addition, there are trends, developments
and factors beyond the Company's control that may affect its operations. In
accordance with the provisions of the Private Securities Litigation Reform Act
of 1995, the cautionary statements and risk factors set forth below and in the
Company's other filings with the Securities and Exchange Commission, identify
important trends, factors and currently known developments that could cause
actual results to differ materially from those in any forward-looking statements
contained in this Report and in any written or oral statements of the Company.
Forward-looking statements in this Report include revenue, expense and earnings
analysis for the remainder of 2002 as well as the Company's expectations
relating to its business strategy. Risk factors include the following:
The Company operates in a highly competitive industry, which could limit
its ability to gain or maintain its position.
The Company is in direct competition with a large number of insurance
companies, many of which offer a greater number of products through a greater
number of agents and have greater resources than the Company. In addition, the
Company may be subject, from time to time, to new competition resulting from
additional private insurance carriers introducing products similar to those
offered by it. Moreover, as a result of recent federal legislation, commercial
banks, insurance companies, and investment banks may now combine, provided
certain requirements are satisfied, and the Company expects to encounter
increased competition from these providers of financial services. This
competitive environment could result in lower premiums, less favorable
underwriting terms and conditions, loss of sales and reduced profitability.
Over the past three fiscal years, substantially all of the Company's
premiums were from sales of policies in Oklahoma and Texas. The Company's
ability to compete successfully may suffer from competitive changes in these
particular markets.
The Company's lack of a rating could adversely affect its ability to
compete.
Ratings of insurance companies are typical within the industry. Increased
public and regulatory concerns regarding the financial stability of insurance
companies have resulted in policyholders placing greater emphasis upon company
15
ratings and have created some measure of competitive advantage for insurance
carriers with higher ratings. Rating organizations assign ratings based upon
several factors. While most of the considered factors relate to the rated
company, some of the factors relate to general economic conditions and
circumstances outside the rated company's control. As of March 29, 2002, the
Company has not been rated by any rating organization. The absence of any rating
could adversely affect the Company's ability to sell its products or retain
existing business, as well as in its ability to compete for attractive
acquisition opportunities.
The Company may not be able to compete successfully if it cannot recruit
and retain insurance agents.
The Company continuously recruits and trains independent agents to market
and sell its products. The Company may not be able to continue to attract and
retain independent agents to sell its products. The Company also engages
marketing general agents from time to time to recruit independent agents and
develop networks of agents in various states. The Company's business and ability
to compete may suffer from the inability to recruit and retain insurance agents
and from the loss of services provided by its marketing agents.
The Company's policy claims fluctuate from year to year, and future benefit
payments may exceed reserves.
The Company's results may fluctuate from year to year due to fluctuations
in policy claims received by its life insurance subsidiary. Great Midwest has
established reserves for claims and future policy benefits based on accepted
actuarial practices. By care in underwriting new policies and sharing risk with
reinsurance companies, Great Midwest has attempted to limit the risk that its
actual payments of death and other benefits will exceed its reserves. The
reserves are, however, only actuarial estimates and it is possible that Great
Midwest's claims experience could be worse than anticipated, so that its
reserves may prove to be insufficient. If this were to happen, it could result
in increased operating losses.
The Company could be forced to sell illiquid investments at a loss to cover
policyholder withdrawals.
Many of the products offered by Great Midwest allow policyholders and
contractholders to withdraw their funds under defined circumstances. Great
Midwest manages its liabilities and configures its investment portfolio so as to
provide and maintain sufficient liquidity to support anticipated withdrawal
demands, contract benefits and maturities. While Great Midwest owns a
significant amount of liquid assets, a certain portion of its assets are
relatively illiquid. Unanticipated withdrawal or surrender activity could, under
some circumstances, compel Great Midwest to dispose of illiquid assets on
unfavorable terms, which could have an adverse effect on the Company.
Interest-rate fluctuations could negatively affect our spread income.
Significant changes in interest rates expose insurance companies to the
risk of not earning anticipated spreads between the interest rate earned on
investments and the credited interest rates paid on outstanding policies. Both
rising and declining interest rates can negatively affect the Company's spread
income. While the Company develops and maintains asset/liability management
programs and procedures designed to preserve spread income in rising or falling
interest rate environments, changes in interest rates could adversely affect
such spreads.
Lower interest rates may result in lower sales of certain of the Company's
insurance and investment products. In addition, certain of the Company's
insurance products guarantee a minimum credited interest rate.
16
The Company's insurance subsidiary is highly regulated, and government
regulation may affect profitability or market value.
The Company's insurance subsidiary is subject to government regulation in
each of the states in which it conducts business. Such regulation is vested in
state agencies having broad administrative power dealing with many aspects of
the insurance business, which may include premium rates, marketing practices,
advertising, policy forms, and capital adequacy, and is concerned primarily with
the protection of policyholders rather than share owners. Changes in these
regulations could affect the Company's profitability or the market value of its
shares.
The Company's insurance subsidiary acts as a fiduciary and is subject to
regulation by the United States Department of Labor when providing a variety of
products and services to employee benefit plans governed by the Employment
Retirement Income Security Act, or ERISA. Severe penalties are imposed on
insurers that breach their fiduciary duties to the plans under ERISA. If the
Company were fined or a penalty was imposed on the Company by a governmental
agency having jurisdiction over it, the Company might not have the financial
resources to pay the fine or penalty.
The Company cannot predict the effect of recent insurance regulatory
changes.
The National Association of Insurance Commissioners, or the NAIC, has
adopted the Codification of Statutory Accounting Principles ("Codification")
effective on January 1, 2001. The Company has determined that the primary effect
of Codification is that goodwill can now be recorded as an admitted asset on its
subsidiary's statutory financial statements.
A tax law change could adversely affect the Company's ability to compete
with non-insurance products.
Under the Internal Revenue Code of 1986, as amended (the "Code"), income
tax payable by policyholders on investment earnings is deferred during the
accumulation period of certain life insurance and annuity products. This
favorable tax treatment may give certain of the Company's products a competitive
advantage over other non-insurance products. To the extent that the Code is
revised to reduce the tax-deferred status of life insurance and annuity
products, or to increase the tax-deferred status of competing products, all life
insurance companies, including Great Midwest, would be adversely affected with
respect to their ability to sell such products, and, depending on grandfathering
provisions, the surrenders of existing annuity contracts and life insurance
policies. In addition, life insurance products are often used to fund estate tax
obligations. If the estate tax were eliminated, the demand for certain life
insurance products could be adversely affected. The Company cannot predict what
tax initiatives may be enacted which could adversely affect us.
The Company's investments are subject to risks.
The Company's invested assets are subject to customary risks of credit
defaults and changes in market values. The value of the Company's investment
portfolio depends in part on the financial condition of the companies in which
it has made investments. Factors that may affect the overall market value of the
Company's invested assets include interest rate levels, financial market
performance, and general economic conditions, as well as particular
circumstances affecting the businesses of individual companies.
The Company's growth from acquisitions involves risks.
The Company's acquisitions have benefited it in part by allowing it to
enter new markets and to position the Company to realize certain operating
efficiencies associated with economies of scale. There can be no assurance,
however, that the Company will realize the anticipated financial results from
its acquisitions or that suitable acquisitions, presenting opportunities for
continued growth and operating efficiencies, or capital to fund acquisitions
will continue to be available to it.
17
The Company is dependent on the performance of others.
The Company's results may be affected by the performance of others because
the Company has entered into various arrangements involving other parties. For
instance, many of the Company's products are sold through independent
distribution channels. Additionally, a portion of the Company's life insurance
sales comes from arrangements with unrelated marketing organizations. As with
all financial services companies, the Company's ability to conduct business is
dependent upon consumer confidence in the industry and its products. Actions of
competitors, and financial difficulties of other companies in the industry,
could undermine consumer confidence and adversely affect the Company's business.
A decline in the Company's stock price may limit our ability to raise
capital.
During 2000 and 2001, many financial services companies, including the
Company, experienced a decrease in the market price of their common stock.
Although the Company believes it has sufficient, internally generated cash flow
to fund its day-to-day operations, a lower stock price may limit its ability to
raise capital to fund other growth opportunities and acquisitions. In fact, the
lower stock prices suffered by the Company's stock during 2001 had an adverse
effect on its ability to fully sell all 1,000,000 shares offered in its public
offering that commenced in May 2001.
The Company's reinsurance program involves risks.
Great Midwest is able to assume insurance risks beyond the level which its
capital and surplus would support by transferring substantial portions of such
risks to other, larger insurers through reinsurance contracts. These reinsurance
arrangements, which are the usual practice in the insurance industry, leave
Great Midwest exposed to two risks:
-- The credit risk, which exists because reinsurance does not fully
relieve Great Midwest of its liability to its insureds for the portion
of the risks ceded to reinsurers. Although Great Midwest places its
reinsurance with reinsurers it believes to be financially stable, a
reinsurer's subsequent insolvency or inability to make payments under
the terms of a reinsurance treaty could have a materially adverse
effect on our financial condition.
-- The amount and cost of reinsurance available to Great Midwest is
subject, in large part, to prevailing market conditions beyond its
control. Non-renewal or cancellation of a reinsurance arrangement
affects only new business and the reinsurer remains liable on business
reinsured prior to non-renewal or cancellation. If Great Midwest were
to be unable to maintain or replace its reinsurance facilities on
acceptable terms upon their expiration and were unwilling or unable to
bear the associated increase in exposure on new business, it would
have to reduce the amount of its new business.
The Company is dependent on dividends and management fees from its
insurance subsidiary, Great Midwest, to fund its operations.
The Company's ability to fund its operations is affected by the ability of
its insurance company subsidiary, Great Midwest, to declare and distribute
dividends to the Company as its sole shareholder, as well as on its ability to
pay the Company management fees for the administrative services the Company
provides to it. Insurance company subsidiaries like Great Midwest are subject to
various state statutory and regulatory restrictions, applicable to insurance
companies generally, that limit the amount of cash dividends, loans and advances
that those subsidiaries may pay to their parent companies. Under Texas insurance
laws, our principal operating subsidiary, Great Midwest, generally may pay
dividends to us only out of its unassigned surplus as reflected in its statutory
financial statements filed in that state. In addition, the Texas Commissioner of
Insurance must approve, or not disapprove within 30 days of notice, payment of
an "extraordinary" dividend from Great Midwest. Under Texas insurance laws, that
18
term generally refers to a dividend that exceeds, together with all dividends
paid by Great Midwest within the previous 12 months, the greater of:
-- 10% of Great Midwest's statutory capital and surplus at the preceding
December 31; or
-- the net gain from operations of Great Midwest for the 12 months ended
on such December 31.
It is possible that more stringent restrictions will be adopted from time
to time, which could have the effect, under certain circumstances, of
significantly reducing dividends or other amounts payable to the Company by its
insurance subsidiary without affirmative prior approval by state insurance
regulatory authorities.
In the event of the insolvency, liquidation, reorganization, dissolution or
other winding-up of an insurance subsidiary of the Company, all creditors of the
subsidiary, including holders of life insurance policies, would be entitled to
payment in full out of the assets of such subsidiary before the Company, as
shareholder, would be entitled to any payment.
ITEM 7. FINANCIAL STATEMENTS
The consolidated financial statements of the Company are incorporated by
reference from pages F-1 through F-22 of the attached Appendix, and include the
following:
Consolidated Financial Statements of Summit Life Corporation and
Subsidiaries
(1) Report of Independent Certified Public Accountants (Gary Skibicki CPA,
P.C.);
(2) Report of Independent Certified Public Accountants (Grant Thornton
LLP);
(3) Consolidated Balance Sheets as of December 31, 2001 and 2000;
(4) Consolidated Statements of Operations for Years Ended December 31,
2001 and 2000;
(5) Consolidated Statement of Stockholders' Equity for Years Ended
December 31, 2001 and 2000;
(6) Consolidated Statements of Cash Flows for Years Ended December 31,
2001 and 2000; and
(7) Notes to Consolidated Financial Statements.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
As of June 29, 2001, the Company's Board of Directors dismissed Grant
Thornton LLP as the Company's independent accountants and appointed Gary
Skibicki CPA, P.C. as the Company's independent accountants.
The reports of Grant Thornton LLP on the Company's consolidated financial
statements as of and for the years ended December 31, 2000 and 1999 did not
contain any adverse opinion or disclaimer of opinion, and neither report was
qualified or modified as to uncertainty, audit scope or accounting principles.
The decision to change independent accountants was recommended by the
Company's Audit Committee, and approved by the Company's Board of Directors on
June 29, 2001.
During the two most recent fiscal years and through the date of this
report, the Company has not had any disagreements with Grant Thornton LLP,
except as set forth below in this paragraph, on any matter of accounting
principles or practices, financial statement disclosure or auditing scope or
procedure, which disagreement(s), if not resolved to the satisfaction of Grant
Thornton LLP would have caused Grant Thornton LLP to make reference thereto in
their report on the consolidated financial statements of the Company for such
periods. During the two most recent fiscal years and through the date of this
report, the Company has had one disagreement with Grant Thornton LLP regarding
19
the Company recording a gain on the March 6, 2001, sale of a communications site
lease agreement (the "Lease Agreement"). SEE "ITEM 2-DESCRIPTION OF PROPERTY."
The Company interpreted certain provisions relating to Statement of Financial
Accounting Standards ("FAS") 13 to allow the recording of a gain on the sale of
the Lease Agreement as of the effective date of the sale in the amount of
$186,000 because the Company did not retain any ownership in the lease revenue
stream and the buyer had no recourse against the Company if the lease revenue
stream did not continue. Grant Thornton LLP's review of the transaction
indicated that the Lease Agreement was an operating lease and that pursuant to
FAS 13 paragraph 22, the sale or assignment by the lessor of lease payments due
under an operating lease should be accounted for as a borrowing. As such, Grant
Thornton LLP recommended that the Company record the sale of the Lease Agreement
as a borrowing as of the effective date of the sale.
The Company's Audit Committee was informed of the disagreement by letter
from Grant Thornton LLP. After considerable discussion, the Company accepted the
recommendations of Grant Thornton LLP and did not record the gain as of the
effective date of the sale of the Lease Agreement. The matter was resolved to
the satisfaction of Grant Thornton LLP. The discussions between the Company and
Grant Thornton LLP covered the accounting principles and literature related to
the different types of leases and revenue recognition. The effect on the
Company's first quarter financial statements was to eliminate $186,000 from
income and record a like amount as a liability.
The Company, during the course of evaluating Grant Thornton LLP's
recommendation, discussed the recording of the gain on the sale of the Lease
Agreement with Gary Skibicki CPA, P.C. The discussions between the Company and
Gary Skibicki CPA, P.C. covered the accounting principles and literature related
to the different types of leases and revenue recognition. Gary Skibicki CPA,
P.C. concurred with the recommendations of Grant Thornton LLP regarding the
manner in which the sale should be recorded and, as stated above, the Company
did record the sale of the Lease Agreement as a borrowing in accordance with the
recommendations of Grant Thornton LLP. The Company authorized Grant Thornton LLP
to respond fully to inquiries of Gary Skibicki CPA, P.C., regarding the subject
matter of the disagreement.
The Company has requested Gary Skibicki CPA, P.C. to review the disclosure
required by this Item 8 and Gary Skibicki CPA, P.C. has informed the Company
that it concurs with the disclosure as set forth in this Item 8 concerning Gary
Skibicki CPA, P.C.
Other than the disagreement set forth above, during the Company's two most
recent fiscal years and through the date of this report, the Company has not had
any reportable events as defined in Item 304 (a) (l) (iv) of Regulation S-B and
there has not been a transaction similar to the sale of the Lease Agreement
during the two most recent fiscal years or the subsequent interim period.
The Company requested that Grant Thornton LLP furnish it with a letter
addressed to the Securities and Exchange Commission stating whether it agrees
with the above statements. A copy of the letter dated July 13, 2001 is filed as
Exhibit 16 to Form 8-K/A filed on July 13, 2001.
20
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS, COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT
The information required will be contained in the Company's Proxy Statement
for the 2002 Annual Meeting of Stockholders and is incorporated herein by
reference.
ITEM 10. EXECUTIVE COMPENSATION
The information required will be contained in the Company's Proxy Statement
for the 2002 Annual Meeting of Stockholders and is incorporated herein by
reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required will be contained in the Company's Proxy Statement
for the 2002 Annual Meeting of Stockholders and is incorporated herein by
reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required will be contained in the Company's Proxy Statement
for the 2002 Annual Meeting of Stockholders and is incorporated herein by
reference.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(1) Financial Statements are attached hereto as Appendix A and
included herein on pages F-1 through F-22.
(2) The exhibits set forth on the following Exhibit Index are filed
with this Report or are incorporated by reference as set forth therein.
Exhibit
Number Name of Exhibit
------- ---------------
3.1* First Amended and Restated Certificate of Incorporation (filed
as Exhibit 3.1 to the Company's Registration Statement on Form
SB-2, file number 333-65097 and incorporated herein by
reference).
3.2* First Amended and Restated Bylaws (filed as Exhibit 3.2 to the
Company's Registration Statement on Form SB-2, file number
333-65097 and incorporated herein by reference).
4.1* Specimen Certificate of the common stock (filed as Exhibit 4.1
to the Company's Registration Statement on Form SB-2, file
number 333-65097 and incorporated herein by reference).
4.2* See Articles V and X of the Company's Certificate of
Incorporation and Article VI of the Company's Bylaws (filed as
Exhibit 4.2 to the Company's Registration Statement on Form
SB-2, file number 333-65097 and incorporated herein by
reference).
4.3* Specimen Certificate of the Series A Preferred Stock (filed as
Exhibit 4.1 to the Company's Quarterly Report on Form 10-QSB
for the Quarter ended June 30, 1999 and incorporated herein by
reference).
21
4.4* Certificate of Designation of Series A Preferred Stock (filed
as Exhibit 4.2 to the Company's Quarterly Report on Form
10-QSB for the Quarter ended June 30, 1999 and incorporated
herein by reference).
4.5* Certificate of Designation of Series B Convertible Preferred
Stock (filed as Exhibit 4.1 to the Company's Quarterly Report
on Form 10-QSB for the Quarter ended September 30, 2000 and
incorporated herein by reference).
10.1* Employment Agreement by and between the Company and James L.
Smith (filed as Exhibit 10.1 to the Company's Registration
Statement on Form SB-2, file number 333-65097 and incorporated
herein by reference).
10.2* Employment Agreement by and between the Company and Charles L.
Smith (filed as Exhibit 10.2 to the Company's Registration
Statement on Form SB-2, file number 333-65097 and incorporated
herein by reference).
10.3* Stock Purchase Agreement by and between the Company and BCLIC
(filed as Exhibit 10.3 to the Company's Registration Statement
on Form SB-2, file number 333-65097 and incorporated herein by
reference).
10.4* Stock Purchase Agreement between the Company and Orville Homer
Miller et al. (filed as Exhibit 10.4 to the Company's
Registration Statement on Form SB-2, file number 333-65097 and
incorporated herein by reference).
10.5* Stock Purchase Agreement between Summit Life Corporation,
Seller, and First Alliance Insurance Company, Buyer, dated
November 10, 1999 (filed as Exhibit 2.1 to the Company's
Current Report on Form 8-K filed November 24, 1999 and
incorporated herein by reference).
10.6* Escrow Agreement between the Company and UMB Bank (filed as
Exhibit 10.5 to the Company's Registration Statement on Form
SB-2, file number 333-55722 and incorporated herein by
reference).
10.7* Designated Agency Officer Agreement (filed as Exhibit 10.7 to
the Company's Registration Statement on Form SB-2, file number
333-65097 and incorporated herein by reference).
10.8 Communications Site Lease Agreement dated March 6, 2001
between the Company and Nextel West Corp. and Amendment No. 1
thereto.
16* Letter to SEC from Grant Thornton LLP dated July 13, 2001
(filed as Exhibit 2.1 to the Company's Current Report on Form
8-K filed July 13, 2001 and incorporated herein by reference).
21.1* List of subsidiaries (filed as Exhibit 21.1 to the Company's
Annual Report on Form 10-KSB for the year ended December 31,
2000 and incorporated herein by reference).
* Previously filed.
(b) There was no Form 8-K filed by the Company during the
fourth quarter of 2001.
22
SIGNATURES
In accordance with the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
April 10, 2002 SUMMIT LIFE CORPORATION
an Oklahoma corporation
By: /s/ Charles L. Smith
---------------------------
Charles L. Smith, President
Pursuant to the requirement 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:
NAME AND TITLE DATE
-------------- ----
/s/ James L. Smith April 10, 2002
-----------------------------------------------
James L. Smith,
Chairman of the Board of Directors
Chief Executive Officer and Secretary
(Principal Executive Officer)
/s/ Charles L. Smith April 10, 2002
-----------------------------------------------
Charles L. Smith,
President, Chief Operating Officer and
Director
(Principal Executive Officer)
/s/ Quinton Hiebert April 10, 2002
-----------------------------------------------
Quinton Hiebert,
Controller
(Principal Accounting Officer)
/s/ Gary L. Ellis April 10, 2002
-----------------------------------------------
Gary L. Ellis,
Director
/s/ M. Dean Brown April 10, 2002
-----------------------------------------------
M. Dean Brown,
Director
/s/ Thomas D. Sanders April 10, 2002
-----------------------------------------------
Thomas D. Sanders,
Director
23
INDEX TO EXHIBITS
Exhibit
Number Name of Exhibit
------- ---------------
3.1* First Amended and Restated Certificate of Incorporation (filed
as Exhibit 3.1 to the Company's Registration Statement on Form
SB-2, file number 333-65097 and incorporated herein by
reference).
3.2* First Amended and Restated Bylaws (filed as Exhibit 3.2 to the
Company's Registration Statement on Form SB-2, file number
333-65097 and incorporated herein by reference).
4.1* Specimen Certificate of the common stock (filed as Exhibit 4.1
to the Company's Registration Statement on Form SB-2, file
number 333-65097 and incorporated herein by reference).
4.2* See Articles V and X of the Company's Certificate of
Incorporation and Article VI of the Company's Bylaws (filed as
Exhibit 4.2 to the Company's Registration Statement on Form
SB-2, file number 333-65097 and incorporated herein by
reference).
4.3* Specimen Certificate of the Series A Preferred Stock (filed as
Exhibit 4.1 to the Company's Quarterly Report on Form 10-QSB
for the Quarter ended June 30, 1999 and incorporated herein by
reference).
4.4* Certificate of Designation of Series A Preferred Stock (filed
as Exhibit 4.2 to the Company's Quarterly Report on Form
10-QSB for the Quarter ended June 30, 1999 and incorporated
herein by reference).
4.5* Certificate of Designation of Series B Convertible Preferred
Stock (filed as Exhibit 4.1 to the Company's Quarterly Report
on Form 10-QSB for the Quarter ended September 30, 2000 and
incorporated herein by reference).
10.1* Employment Agreement by and between the Company and James L.
Smith (filed as Exhibit 10.1 to the Company's Registration
Statement on Form SB-2, file number 333-65097 and incorporated
herein by reference).
10.2* Employment Agreement by and between the Company and Charles L.
Smith (filed as Exhibit 10.2 to the Company's Registration
Statement on Form SB-2, file number 333-65097 and incorporated
herein by reference).
10.3* Stock Purchase Agreement by and between the Company and BCLIC
(filed as Exhibit 10.3 to the Company's Registration Statement
on Form SB-2, file number 333-65097 and incorporated herein by
reference).
10.4* Stock Purchase Agreement between the Company and Orville Homer
Miller et al. (filed as Exhibit 10.4 to the Company's
Registration Statement on Form SB-2, file number 333-65097 and
incorporated herein by reference).
10.5* Stock Purchase Agreement between Summit Life Corporation,
Seller, and First Alliance Insurance Company, Buyer, dated
November 10, 1999 (filed as Exhibit 2.1 to the Company's
Current Report on Form 8-K filed November 24, 1999 and
incorporated herein by reference).
10.6* Escrow Agreement between the Company and UMB Bank (filed as
Exhibit 10.5 to the Company's Registration Statement on Form
SB-2, file number 333-55722 and incorporated herein by
reference).
24
10.7* Designated Agency Officer Agreement (filed as Exhibit 10.7 to
the Company's Registration Statement on Form SB-2, file number
333-65097 and incorporated herein by reference).
10.8 Communications Site Lease Agreement dated March 6, 2001
between the Company and Nextel West Corp. and Amendment No. 1
thereto.
16* Letter to SEC from Grant Thornton LLP dated July 13, 2001
(filed as Exhibit 2.1 to the Company's Current Report on Form
8-K filed July 13, 2001 and incorporated herein by reference).
21.1* List of subsidiaries (filed as Exhibit 21.1 to the Company's
Annual Report on Form 10-KSB for the year ended December 31,
2000 and incorporated herein by reference).
* Previously filed.
25
APPENDIX A
Consolidated Financial Statements
Summit Life Corporation and Subsidiaries
Years ended December 31, 2001 and 2000
with Reports of Independent Auditors
Summit Life Corporation and Subsidiaries
Consolidated Financial Statements
Years ended December 31, 2001 and 2000
Contents
Reports of Independent Certified Public Accountants..........................F-1
Consolidated Financial Statements:
Consolidated Balance Sheets...............................................F-3
Consolidated Statements of Operations.....................................F-5
Consolidated Statement of Stockholders' Equity............................F-6
Consolidated Statements of Cash Flows.....................................F-7
Notes to Consolidated Financial Statements................................F-9
Report of Independent Certified Public Accountant
-------------------------------------------------
Board of Directors
Summit Life Corporation
I have audited the accompanying consolidated balance sheet of Summit Life
Corporation and its Subsidiary, as of December 31, 2001, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the year then ended. These financial statements are the responsibility of the
Company's management. My responsibility is to express an opinion on these
financial statements based on my audit.
I conducted my audit in accordance with auditing standards generally accepted in
the United States of America. Those standards require that I 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. I believe that my audit provides a reasonable basis for
my opinion.
In my opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Summit
Life Corporation and its Subsidiary, as of December 31, 2001, and the
consolidated results of their operations and their consolidated cash flows for
the year then ended in conformity with accounting principles generally accepted
in the United States of America.
GARY SKIBICKI
CERTIFIED PUBLIC ACCOUNTANT
F-1
Oklahoma City, Oklahoma
March 11, 2002
Report of Independent Certified Public Accountants
--------------------------------------------------
Board of Directors
Summit Life Corporation
We have audited the accompanying consolidated balance sheet of Summit Life
Corporation and Subsidiaries as of December 31, 2000, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the year then ended. 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 audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. 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 audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Summit Life
Corporation and Subsidiaries as of December 31, 2000, and the results of their
operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America.
GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 21, 2001
F-2
Summit Life Corporation and Subsidiaries
CONSOLIDATED BALANCE SHEETS
December 31,
ASSETS 2001 2000
---------- ----------
INVESTMENTS
Debt and equity securities $2,903,470 $2,939,740
Notes receivable 992,033 941,878
Policy loans 113,865 33,382
Investments in limited partnerships 30,800 57,300
---------- ----------
4,040,168 3,972,300
CASH AND CASH EQUIVALENTS 1,661,410 1,436,338
RECEIVABLES
Accrued investment income 54,993 41,984
Other 37,583 9,928
---------- ----------
92,576 51,912
PROPERTY AND EQUIPMENT - AT COST
Building and improvements 129,419 129,419
Furniture and equipment 119,198 116,570
Automobiles 22,015 22,015
---------- ----------
270,632 268,004
Less accumulated depreciation 130,870 102,638
---------- ----------
139,762 165,366
Land 56,000 56,000
---------- ----------
195,762 221,366
OTHER ASSETS
Cost in excess of net assets of business acquired, less
accumulated amortization of $15,000 in 2001 and
$10,000 in 2000 35,000 40,000
Deferred policy acquisition costs 107,765 57,527
Value of purchased insurance business, less
accumulated amortization of $145,364 in 2001
and $101,872 in 2000 355,966 321,851
Deferred income taxes 37,240 37,241
Public offering costs 56,653 --
Other 46,555 24,147
---------- ----------
639,179 480,766
---------- ----------
$6,629,095 $6,162,682
========== ==========
The accompanying notes are an integral part of these statements
F-3
Summit Life Corporation and Subsidiaries
CONSOLIDATED BALANCE SHEETS - CONTINUED
December 31,
LIABILITIES AND STOCKHOLDERS' EQUITY 2001 2000
----------- -----------
LIABILITIES
Policy reserves and policyholder funds $ 5,364,682 $ 4,708,295
Unpaid claims 24,971 175,951
accounts payable 63,116 39,458
accrued and other liabilities 8,233 15,424
Notes payable 111,206 248,254
----------- -----------
5,572,208 5,187,382
COMMITMENTS AND CONTINGENCIES -- --
STOCKHOLDERS' EQUITY
Common stock, $.01 par value - authorized, 5,000,000
shares; issued 2,267,605 shares 22,676 22,676
Common stock subscribed 422,200 --
Series A cumulative nonvoting preferred stock,$.001
par value - authorized, issued, and outstanding,
5,000 shares; stated at liquidation value 500,000 500,000
Series B noncumulative, nonvoting, convertible
preferred stock, $.001 par value - authorized,
1,000,000 shares; issued 350,000anding,
shares;stated at liquidation value 350,000 350,000
Additional paid-in capital 2,923,596 2,923,596
Common stock of parent held by subsidiary - 19,000
shares (95,000) (95,000)
Series B convertible preferred stock subscribed -- 650,000
Accumulated other comprehensive income (loss) 13,709 (19,882)
Accumulated deficit (3,080,294) (2,706,090)
----------- -----------
1,056,887 1,625,300
Less stock subscriptions receivable -- 650,000
----------- -----------
1,056,887 975,300
----------- -----------
$ 6,629,095 $ 6,162,682
=========== ===========
The accompanying notes are an integral part of these statements.
F-4
Summit Life Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
2001 2000
----------- -----------
Revenues
Insurance premiums and other considerations, net of reinsurance $ 359,533 $ 152,624
Investment income 338,670 377,184
Net realized gains (losses) on sale of available for sale securities (7,792) 91,679
Net losses on trading securities (139,527) (159,755)
Other 58,730 109,025
----------- -----------
609,614 570,757
Benefits, losses, and expenses
Policy benefits 142,413 96,397
Increase in policy reserves 220,251 235,033
Interest 13,658 22,838
Taxes, licenses, and fees 35,290 43,071
Depreciation and amortization 101,312 93,431
General, administrative, and other operating 420,894 484,408
----------- -----------
933,818 975,178
----------- -----------
Loss before income taxes (324,204) (404,421)
Provisions for income taxes -- --
----------- -----------
Net loss (324,204) (404,421)
Preferred stock dividends 50,000 50,000
----------- -----------
NET LOSS TO COMMON STOCKHOLDERS $ (374,204) $ (454,421)
=========== ===========
Basic and diluted net loss per common share $ (.15) $ (.20)
=========== ===========
Weighted average outstanding common shares, basic and diluted 2,419,037 2,248,605
=========== ===========
The accompanying notes are an integral part of these statements.
F-5
Summit Life Corporation and Subsidiaries
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Years ended December 31, 2001 and 2000
Series A cumulative Series B convertible
Common stock preferred stock preferred stock
---------------------- ------------------------- ---------------------
Shares Par Shares Liquidation Shares Liquidation
Total issued value issued value issued value
---------- ---------- ---------- ---------- ----------- ---------- ----------
Balance at January 1, 2000 $1,016,038 2,267,605 $ 22,676 5,000 $ 500,000 -- $ --
Sale of preferred stock 350,000 -- -- -- -- 350,000 350,000
Dividends on Series A preferred stock (50,000) -- -- -- -- -- --
Comprehensive loss
Net loss (404,421) -- -- -- -- -- --
Other comprehensive income
Unrealized gain on investments, net 63,683
----------
Comprehensive loss (340,738)
---------- ---------- ---------- ---------- ----------- ---------- ----------
Balance at December 31, 2000 975,300 2,267,605 22,676 5,000 500,000 350,000 350,000
Common stock subscribed, not issued 422,200 -- -- -- -- -- --
Cancellation of preferred stock subscription -- -- -- -- -- -- --
Dividends on Series A preferred stock (50,000) -- -- -- -- -- --
Comprehensive loss
Net loss (324,204) -- -- -- -- -- --
Other comprehensive income
Unrealized gain on investments, net 33,591
----------
Comprehensive loss (290,613)
---------- ---------- ---------- ---------- ----------- ---------- ----------
Balance at December 31, 2001 $1,056,887 2,267,605 $ 22,676 5,000 $ 500,000 350,000 $ 350,000
========== ========== ========== ========== =========== ========== ==========
The accompanying notes are an integral part of these statements.
F-6
Summit Life Corporation and Subsidiaries
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY - CONTINUED
Years ended December 31, 2001 and 2000
Common
stock of Accumulated
Additional parent other Stock
paid-in held by Stock Comprehensive Accumulated subscription
capital subsidiary subscribed Income (loss) deficit receivable
---------- ---------- ---------- ---------- ----------- ----------
Balance at January 1, 2000 $2,923,596 $ (95,000) $ -- $ (83,565) $(2,251,669) $ --
Sale of preferred stock -- -- 650,000 (650,000)
Dividends on Series A preferred stock -- -- -- -- (50,000) --
Comprehensive loss
Net loss -- -- -- -- (404,421) --
Other comprehensive income
Unrealized gain on investments, net 63,683
Comprehensive loss
---------- ---------- ---------- ---------- ----------- ----------
Balance at December 31, 2000 2,923,596 (95,000) 650,000 (19,882) (2,706,090) (650,000)
Common stock subscribed, not issued -- -- 422,200 --
Cancellation of preferred stock subscripti -- -- (650,000) -- -- 650,000
Dividends on Series A preferred stock -- -- -- -- (50,000) --
Comprehensive loss
Net loss -- -- -- -- (324,204) --
Other comprehensive income
Unrealized gain on investments, net 33,591
Comprehensive loss
---------- ---------- ---------- ---------- ----------- ----------
Balance at December 31, 2001 $2,923,596 $ (95,000) $ 422,200 $ 13,709 $(3,080,294) $ --
========== ========== ========== ========== =========== ==========
The accompanying notes are an integral part of these statements.
F-6
Summit Life Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
2001 2000
----------- -----------
Increase (Decrease) in Cash and Cash Equivalents
Cash flows from operating activities
Net loss $ (324,204) $ (404,421)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization 75,133 86,627
Deferral of policy acquisition costs (60,323) (22,105)
Amortization of deferred policy acquisition costs 26,179 6,804
Interest credited to policyholder account balances 183,144 211,030
Gain on sale of investment securities, other than trading -- (91,679)
Gain on sale of assets -- (83,805)
Other (23,608) 26,604
(Increase) decrease in
Trading securities (139,527) (113,643)
Accrued investment income (13,009) 43,769
Other receivables (27,655) 4,808
Other assets (22,408) (5,449)
Increase (decrease) in
Policy reserves (81,491) 6,880
Unpaid claims (150,980) 68,951
Accounts payable 23,658 (47,311)
Accrued and other liabilities (7,191) (13,289)
----------- -----------
Net cash used in operating activities (542,282) (326,229)
Cash flows from investing activities
Purchases of investment securities, other than trading (897,584) (3,728,505)
Proceeds from disposition or maturities of investment securities, other than trading 1,231,025 5,808,035
Net investment in limited partnerships 26,500 (57,300)
Issuance of notes receivable (250,000) (517,000)
Payments received on notes receivable 199,845 49,297
Increase (decrease) in policy loans 80,483 4,565
Purchase of property and equipment (2,628) (2,100)
Proceeds from sale of assets 16,713 8,491
----------- -----------
Net cash provided by investing activities 404,354 1,565,483
Cash flows from financing activities
Deposits to policyholder account balances 166,783 166,857
Withdrawals from policyholder account balances (415,675) (1,012,443)
Payments on notes payable (475,395) (213,965)
Payments on advances from affiliates -- (11,138)
Proceeds from issuance of notes payable 338,347 20,000
Proceeds from acquisition of business 433,392 --
Proceeds from sale of common and preferred stock 422,200 350,000
Dividends paid on preferred stock (50,000) (37,973)
Public offering costs (56,652) --
----------- -----------
Net cash provided by (used in) financing activities 363,000 (738,662)
----------- -----------
NET INCREASE IN CASH
AND CASH EQUIVALENTS 225,072 500,592
Cash and cash equivalents at beginning of year 1,436,338 935,746
----------- -----------
Cash and cash equivalents at end of year $ 1,661,410 $ 1,436,338
=========== ===========
The accompanying notes are an integral part of these statements.
F-7
Summit Life Corporation and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
Year ended December 31,
2001 2000
----------- -----------
Cash paid (received) during the year for:
-----------------------------------------
Interest $ 13,658 $ 32,000
Income taxes $ -- $ --
Noncash investing and financing activities:
-------------------------------------------
Notes receivable acquired on sale of investment real estate $ -- $ 94,000
The accompanying notes are an integral part of these statements.
F-8
Summit Life Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
NOTE A - NATURE OF OPERATIONS AND SUMMARY OF ACCOUNTING POLICIES
1. Basis of Consolidation and Nature of Operations
-----------------------------------------------
Summit Life Corporation ("SLC") is an Oklahoma corporation chartered on April
12, 1994 that primarily markets life insurance and annuity policies through its
wholly owned insurance subsidiary, Great Midwest Life Insurance Company
("GMLIC"), a Texas corporation acquired on January 13, 1999. The consolidated
financial statements include the accounts of each of these corporations with
inter-company transactions and balances eliminated.
SLC is a holding company and manages its operations as well as GMLIC's which
primarily include marketing/servicing life insurance and annuity products in
Texas and Oklahoma. GMLIC is required to maintain an investment portfolio to
cover potential claims plus preserve a minimum $800,000 statutory capital and
surplus and for management services paid SLC a fee of $95,379 in 2001.
2. Use of Estimates
----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect financial statements and disclosures; accordingly, actual results could
differ from those estimates.
3. Cash and Cash Equivalents
-------------------------
Cash equivalents include time deposits and certificates of deposit with
maturities when acquired of three months or less and money market funds.
The Company maintains its cash and cash equivalents in accounts which may not be
federally insured. The company has not experienced any losses in such accounts
and believes it is not exposed to any significant credit risks on these
accounts.
4. Investments
-----------
The Company accounts for certain investments in debt and equity securities as
follow:
* Debt securities that the Company has the positive intent and ability
to hold to maturity are classified as held-to-maturity securities and
reported at amortized cost.
* Debt and equity securities that are bought and held principally for
the purpose of selling in the near term are classified as trading
securities and reported at fair value, with unrealized gains and
losses included in earnings.
F-9
Summit Life Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2001 AND 2000
NOTE A - NATURE OF OPERATIONS AND SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
* Debt and equity securities not classified as either held to maturity
securities or trading securities are classified as available-for-sale
securities and reported at fair value, with unrealized gains and
losses excluded from earnings and reported in a separate component of
shareholder equity as other comprehensive income (loss).
For individual securities classified as available-for-sale or held to maturity
non temporary declines in specifically identified securities below cost or
amortized cost result in write-downs included in operations. The specific
identification method is followed for determining the cost of securities sold.
Notes receivable and policy loans are stated at the total of unpaid balances
less estimated uncollectible amounts.
Investments in limited partnerships are accounted for on the equity method.
Accordingly, the Company's share of the partnerships earnings or losses are
included in the consolidated operating statement with corresponding adjustments
made to the carrying amounts on the balance sheet.
Investments in real estate are carried at depreciated cost.
5. Property and Equipment
----------------------
Depreciation is allocated to assets over estimated economic lives using the
straight-line method. Estimates of economic lives range from five to forty
years.
Investment and operating assets are reviewed for impairment whenever events,
circumstances or changes in market value indicate that the related carrying
amount(s) may not be recoverable. Any required write-downs are based upon the
current fair value of the asset.
F-10
Summit Life Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2001 AND 2000
NOTE A - NATURE OF OPERATIONS AND SUMMARY OF ACCOUNTING POLICIES
(CONTINUED)
6. Cost in Excess of Net Assets of Business Acquired
-------------------------------------------------
Cost in excess of net assets of business acquired is amortized over 10 years on
a straight-line basis. In 1999 Great Midwest Life Insurance Company was
purchased with a $50,000 commission being amortized at $5,000 per year.
Management reviews acquisition, amortization and valuation amounts for
impairment by evaluating future benefits of the net income earned to determine
whether impairment has occurred.
7. Income Taxes
------------
SLC and its subsidiary file separate income tax returns, Forms 1120 and 1120L ,
respectively.
The Company recognizes current tax expense based on estimated taxes payable or
refundable on current year tax returns.
Deferred tax liabilities or assets are recognized for the estimated future tax
effects attributable to temporary differences and carry forwards. The
measurement of deferred tax assets is based on provisions of enacted law and are
reduced by the amount of any tax benefits that, based on available evidence may
not be realized.
8. Deferred Policy Acquisition Costs
---------------------------------
Deferred acquisition costs are those costs that vary with and are primarily
related to the acquisition of new and renewal insurance contracts. The Company
considers commissions and other costs such as underwriting and medical exam fees
that are principally related to insurance contracts issued or renewed during the
year as acquisition costs. Acquisition costs are capitalized and amortized to
operating expenses in proportion to premium revenue recognized over the
estimated lives of the policies. Deferred policy acquisition costs for
investment products, mainly single premium deferred annuities, are amortized
with interest in proportion to the value of expected gross profits as determined
by estimated investment yields, mortality, surrender expenses and persistency
experience over the lives of the policies. Deferred policy acquisition costs are
examined periodically to insure that the unamortized balance does not exceed
amounts expected to be recovered from future profits. Acquisition costs that
vary in a constant relationship to premiums or insurance in force, are recurring
in nature or incurred in level amounts from period to period are charged to
expense in that period.
F-11
Summit Life Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2001 AND 2000
NOTE A - NATURE OF OPERATIONS AND SUMMARY OF ACCOUNTING POLICIES
(CONTINUED)
9. Value of Purchased Insurance Business
-------------------------------------
Value of purchased insurance business represents the actuarially determined
present value of estimated net cash flows embedded in existing insurance
contracts when acquired. The company estimates that insurance contracts have an
average economic life of twenty years and purchased insurance contracts are
amortized over that time period in proportion to the expected decline in net
cash flows of that year. Interest is calculated on unamortized values at the
annual rate of 6.5%. At December 31, 2001, approximately 13% of the unamortized
value of purchased insurance business is expected to be amortized in each of the
next five years, based on current conditions and assumptions as to future events
on acquired policies in force.
A summary of the value of purchased insurance business for the years ended
December 31:
2001 2000
--------- ---------
Balance, beginning of year $ 321,851 $ 370,758
6.5% on Unamortized Balance 20,920 24,099
Amortization on Beginning Balance (62,649) (73,006)
Cost of Acquired Policies From
Presidential Life Insurance Co.-2001 77,608 --
Presidential Amortization (5 Months) (1,764) --
--------- ---------
Balance, end of year $ 355,966 $ 321,851
--------- ---------
10. Revenues, Policy Reserves and Policyholder Funds
------------------------------------------------
Premiums received on deferred annuities and annuities without life contingencies
are recorded as liabilities (deposits) into policyholder account balances. The
Company earns revenues from these contracts primarily from surrender charges and
administrative fees. Premiums for life insurance products and annuities with
life contingencies including annuities with life contingency settlement options
are recognized when due.
Policyholder account balances include amounts received from policyholders plus
interest credited less withdrawals and administrative fees deducted by the
Company. The liabilities for future policy benefits for annuities with life
contingencies are actuarially computed at the present value of future benefits
which includes investment yields and mortality assumptions.
Policy reserves for life insurance contracts are computed based on mortality,
morbidity, withdrawals, investment yields and prior company experience or other
contingencies that could unfavorably increase reserves. Reserve interest
assumptions range from 3.0% to 5.5%. Policy reserves for life insurance products
are the same for financial and statutory reporting purposes. Life insurance
benefit claims are charged to operating expenses in the period that the claims
are incurred. All life insurance related benefits, claims, losses and expenses
are reported net of reinsurance ceded.
F-12
Summit Life Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2001 AND 2000
NOTE A - NATURE OF OPERATIONS AND SUMMARY OF ACCOUNTING POLICIES
(CONTINUED)
11. Earnings (Loss) Per Share Common
--------------------------------
Earnings (loss) per common share is computed based upon net earnings (loss),
after deduction of preferred stock dividends, divided by the weighted average
number of common shares outstanding during each period. For both 2001 and 2000,
Series B convertible preferred stock (see Note D) is antidilutive and therefore
basic and diluted loss per common share are the same. Additionally, in 2001,
$422,000 was received for common stock sold in the public offering that
commenced in May 2001, but the shares for which have not been issued. It is
reported as common stock subscribed.
12. Other Comprehensive Income (Loss)
---------------------------------
Accumulated other comprehensive income (loss) consists solely of net unrealized
investment gains (losses).
Unrealized gain (loss) on investments consists of the following for the years
ended December 31:
2001 2000
----------------------
Beginning Other Comprehensive Income (Loss) $ (19,882) $ (83,565)
----------------------
Unrealized Appreciation Of Securities 33,591 155,362
Less reclassification for gains included
in net loss (91,679)
----------------------
Change During the Year 33,591 63,683
----------------------
Accumulated Other Comprehensive Income (Loss) $ 13,709 $ (19,882)
----------------------
NOTE B - INVESTMENTS
Investments in securities are summarized as follows for December 31, 2001:
COST/ GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
TYPE OF INVESTMENT COST GAINS LOSSES FAIR VALUE
--------------------------------------------------------------------------------
Debt Securities -
Held to Maturity $ 279,871 $ 13,115 $ -- $ 292,986
Debt Securities -
Available For Sale
US Treasury & Other
US Govt. Agencies 2,018,884 17,682 -- 2,036,566
Industrial and
Miscellaneous 148,036 -- (3,973) 144,063
--------------------------------------------------
Total Debt Securities
Available For Sale $2,166,920 $ 17,682 $ (3,973) $2,180,629
==================================================
Equity Securities -
Available For Sale $ 292,451 -- $ (1,105) $ 291,346
Equity Securities -
Other $ 66,788 -- -- $ 66,788
F-13
Summit Life Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2001 AND 2000
NOTE B - INVESTMENTS (CONTINUED)
Investments in securities are summarized as follows for December 31, 2000:
COST/ GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
TYPE OF INVESTMENT COST GAINS LOSSES FAIR VALUE
------------------------------------------------------------------------------------------
Debt Securities -
Held to Maturity
U.S. Treasury & Other
U.S. Govt. Agencies $ 177,788 $ 14,312 $ $ 192,100
Mortgage-backed securities 150,287 -- (662) 149,625
-------------------------------------------------------
$ 328,075 $ 14,312 $ (662) $ 341,725
=======================================================
Debt Securities -
Available For Sale
Mortgage-backed $ 2,158,672 $ 11,576 $ (12,657) $ 2,157,591
Industrial and Miscellaneous 281,732 -- (12,716) 269,016
-------------------------------------------------------
$ 2,440,404 $ 11,576 $ (25,373) $ 2,426,607
=======================================================
Equity Securities -
Available For Sale $ 15,000 $ -- $ (6,085) $ 8,915
=======================================================
Equity Securities-
Trading $ 113,643
===========
Equity Securities -
Other $ 62,500
===========
Equity Securities - Other - consists of First Alliance Corporation (FAC) common
stock carried at cost, plus stock dividends received. Through December 30, 2000
this stock is restricted as to sale or transfer and FAC retained the right of
first refusal to purchase the shares through December 30, 2001. From issuance
through 2001, fair market value has not been readily determinable.
The amortized cost and estimated fair values of debt securities, by contractual
maturity, at December 31, 2001, are summarized below. Actual maturities may
differ from contractual maturities because borrowers may have the right to call
or prepay indebtedness without prepayment penalties.
Held to Maturity Available for Sale
-------------------------- -------------------------
Amortized Estimated Amortized Estimated
Cost Fair Value Cost Fair Value
-----------------------------------------------------
Due Six to Ten Years $ -- $ -- $ -- $ --
Due after Ten Years 178,566 187,906 -- --
Mortgage Backed
Securities 101,305 105,080 2,018,884 2,036,566
-----------------------------------------------------
Total $ 279,871 $ 292,986 $2,018,884 $2,036,566
-----------------------------------------------------
F-14
Summit Life Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2001 AND 2000
NOTE B - INVESTMENTS (CONTINUED)
Proceeds from sales of available-for-sale securities were approximately
$1,231,000 for 2001 and $3,609,000 for 2000. Gross gains of $4,310 for 2001 and
$146,958 for 2000 and gross losses of $0 for 2001 and $55,279 for 2000 were
realized on those sales.
Net losses on trading securities totaled $139,527 for 2001 and $118,763 for 2000
and related to trading securities held at December 31 of each respective year.
For 2000, gross losses of $18,789 were included in net losses on trading
securities as a result of transfers of securities from the available-for-sale
category to the trading category.
F-15
Summit Life Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2001 AND 2000
NOTE B - INVESTMENTS (CONTINUED)
Notes receivable consist of the following at December 31:
Original Pct 2001 2000
Type of Loan Date Amount Int Term Status Balance Balance
------------ ---- -------- --- ---- ------ ------- -------
Secured
Real Estate 1/5/98 $240,000 8.00% 10 Yrs Current $167,870 $188,478
Secured
Real Estate 7/30/98 59,200 9.75% 10 Yrs Current 38,495 46,322
Secured
Real Estate 4/29/00 47,000 6.50% 30 Yrs Current 46,152 46,698
Secured
Real Estate 4/29/00 47,000 6.50% 30 Yrs Current 46,152 46,698
Secured
Real Estate 11/10/00 42,000 7.00% 10 Yrs Current 38,733 41,757
Secured
Real Estate 7/11/00 225,000 7.50% 18 Mos Current 225,000 225,000
Secured
Real Estate 2/1/00 100,000 6.25% 10 Yrs Current 100,000 100,000
Secured
Real Estate 1/5/98 50,000 8.00% 10 Yrs Current 34,973 39,266
Unsecured
Individual 11/1/00 41,345 7.00% 4 Yrs Current 32,065 41,345
Unsecured
Corporate 3/30/01 12,594 8.00% 1 Yr Current 12,593 12,593
Unsecured
Corporate 12/5/01 100,000 5.75% 1 Yr Current 100,000 --
Unsecured
Corporate 8/23/01 150,000 7.00% 1 Yr Current 150,000 150,000
-------
Other -- 3,721
=======================
$1,114,139 $992,033 $941,878
========== ========================
F-16
Summit Life Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2001 AND 2000
NOTE C - NOTE PAYABLE
Note payables consisted of the following at December 31:
2001 2000
-------------------
-Uncollateralized Loan From Shareholder $ 79,000 $ --
-Uncollateralized Loan From Corporation 27,998 --
-Bank line of credit, interest payable quarterly
(10.0% at December 31, 2000), due July 1, 2001;
guaranteed by certain officers and directors -- 130,000
-Note payable to corporation, interest payable at
6%, due with annual principal installments of
approximately $111,000 through June 1, 2001 -- 110,602
-Six and 95/100% note payable to bank, payable
in $337 monthly installments through
January 2003 collateralized by vehicle 4,208 7,652
-------------------
Total Note Payables $111,206 $248,254
===================
NOTE D - STOCKHOLDERS EQUITY
On April 23, 1999, non-voting Series A Cumulative Preferred Stock was created
with 5,000 shares issued and outstanding on December 31, 2001. The Series A
Preferred Stock has liquidation priority ($100 per share plus dividend
arrearages, if any) over common stock upon dissolution.
On September 29, 2000, Series B Convertible Preferred Stock was created. The
Series B Preferred Stock is noncumulative, non voting and is convertible on a
one-to-one basis into shares of common stock at the option of the holders after
March 31, 2003. The Series B Preferred Stock is senior to common stock and
junior to Series A Preferred Stock in dividend priority. At December 31, 2001
there were 350,000 shares of Series B Preferred outstanding and upon liquidation
is ranked equivalent to Series A Preferred Stock as to per share liquidation
value ($1.00 per share) and unpaid dividends.
NOTE E - INCOME TAXES
The Company's net operating loss carryforwards for tax purposes which begin
expiring in 2010 are as follows:
2001 2000
-----------------------
SLC $1,834,653 $1,595,000
GMLIC 75,605 329,000
-----------------------
$1,910,258 $1,924,000
=======================
F-17
Summit Life Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2001 AND 2000
NOTE E - INCOME TAXES (CONTINUED)
SLC and GMLIC file separate tax returns, Form 1120 and Form 1120L respectively.
In 2000 SLC reported a taxable loss while GMLIC incurred taxable income and the
same will occur in 2001 which causes SLC's loss carryforward to increase and
GMLIC's to decrease. The primary operating income of SLC is a management fee
paid by GMLIC which requires prior approval from the Texas Insurance Department
to increase which makes it uncertain that all of the $1,834,653 will be used.
The components of net deferred tax assets and changes in the related valuation
allowance are as follows:
2001 2000
----------------------
Deferred Tax Assets
Net Operating Loss Carryforwards $ 288,600 $ 284,002
Capital Loss Carryforward 63,650 63,501
Policy Reserves and Policyholder Funds 7,397 14,835
Other 1,167 18,170
Valuation Allowance for Deferred Taxes (263,258) (293,666)
----------------------
97,556 86,842
----------------------
Deferred Tax Liabilities
Value of Purchased Insurance Business (54,445) (43,772)
Depreciation (832) (2,182)
Other (5,039) (3,647)
----------------------
(60,316) (49,601)
----------------------
Net Deferred Tax Asset $ 37,240 $ 37,241
======================
Increase (Decrease) in Valuation Allowance $ (30,408) $ 64,147
======================
A reconciliation of income tax benefit at the statutory rate to the Company's
effective rate at December 31 is as follows:
2001 2000
----------------------
Expected Statutory Rate 34% 34%
Small Life Insurance Company Deduction (60%) (20) (20)
Net Effect Tax Loss Carryforwards (14) (17)
Other -- 3
----------------------
Effective Tax Rate 0% 0%
======================
F-18
Summit Life Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2001 AND 2000
NOTE F - RELATED PARTY TRANSACTIONS
From time to time, the Company makes advances to and receives advances from
affiliates, generally officers and stockholders. Such advances have no specified
repayment terms but are generally short-term in nature.
NOTE G - COMMITMENTS AND CONTINGENCIES
Under its annuity contracts, the Company is committed to credit interest on
policyholder account balances at guaranteed rates. During the first policy year,
the guaranteed rates range up to 7.8%. After the first year, the lowest
guaranteed rate is 3%.
Most states have established guaranty fund associations to ensure that
policyholders receive the benefit of the insurance products they have purchased.
The guaranty funds receive their funding through assessments to companies which
write business in the respective states. The Company is liable for such
mandatory assessments upon notification by the states; however, such assessments
may be partially recovered through a reduction in future premium taxes.
Certain investments with carrying values of $279,871 and $277,979 were pledged
to regulatory authorities in accordance with regulatory requirements at December
31, 2001 and 2000, respectively.
The Company leases certain equipment used in operations and storage space. Rent
expense under these leases for 2001 and 2000 totaled $1,560 and $1,851,
respectively and was paid on a month to month basis.
The Company is involved in various legal actions relating to its operation.
Management believes that losses, if any, arising from such actions will not be
material to the Company's consolidated financial statements.
NOTE H - STATUTORY CAPITAL AND SURPLUS
SLC's insurance company subsidiary prepares its statutory-basis financial
statements in accordance with accounting practices prescribed or permitted by
the domiciliary state insurance department. "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, may differ from company to company within a state, and may
F-19
Summit Life Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2001 AND 2000
NOTE H - CAPITAL AND SURPLUS (CONTINUED)
change in the future. The NAIC has approved the Codification of Statutory
Accounting Practices effective on January 1, 2001. The Company has determined
that the primary effect of Codification is that goodwill can now be recorded as
an admitted asset on its subsidiary's statutory financial statements.
GMLIC is required to maintain statutory capital and surplus of at least
$800,000. GMLIC's statutory capital and surplus, as reported at December 31,
2001, was $853,192. Failure to meet the capital requirements could expose GMLIC
to regulatory actions that may include restrictions on operations and growth,
among other things. GMLIC cannot declare dividends which exceed the greater of
10% of statutory capital and surplus or the gain from operations of the
preceding 12 months without the prior consent of the Texas Commissioner of
Insurance. The maximum dividend which may be paid in 2002 without prior consent
is $53,192.
As a part of the regulatory process, SLC requested a review by the Securities
and Exchange Commission (the "SEC") of its accounting treatment of the sale and
repurchase of real estate subject to an operating lease. After review, the SEC
advised SLC that, although SLC's proposed accounting treatment was consistent
with the literal application of applicable accounting principles, the SEC
requested that SLC restate certain items relating to the transactions. This
reversed income reported on the sale of real estate subject to an operating
lease of $186,000 previously reported in the second quarter of 2001.
The transactions also affect the statutory financial statements prepared by the
subsidiary company and GMLIC will request a review and approval of its
accounting treatment by the Texas Department of Insurance. GMLIC believes its
presentation complies with statutory rules and regulations as outlined in the
NAIC's Accounting Practices and Procedures Manual and adopted by the Texas
Department of Insurance.
If the Texas Department of Insurance requests that GMLIC restate all or part of
the tranactions, in such event, GMLIC may fail to meet the minimum capital and
surplus required by Texas statutes. The Company has the option of requesting
approval of the Commissioner to increase the valuation of the property based on
independent appraisals and/or contributing additional funds as surplus to the
subsidiary to comply with the statutes.
NOTE I - REGULATORY MATTERS
At periodic intervals, the domiciliary state insurance department routinely
examines the insurance company subsidiaries' statutory financial statements as
part of their legally prescribed oversight of the insurance industry. Based on
these examinations, the regulators can direct that the subsidiaries' statutory
financial statements be adjusted in accordance with their findings.
F-20
Summit Life Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2001 AND 2000
NOTE J - REINSURANCE
The Company reinsures that portion of insurance risk which is in excess of its
retention limits, generally under yearly renewable term contracts. Retention
limits range up to $5,000 on life policies. Reinsurance premiums are recognized
as a reduction of insurance premiums and other considerations over the policy
term and totaled $47,000 for 2001 and $37,000 for 2000.
Reinsurance does not discharge or diminish the primary liability of the Company
on the risks reinsured; however, it does serve to limit the Company's maximum
loss on risks. The Company would be liable for the reinsurance risks ceded to
other companies in the event that reinsurers were unable to meet their
obligations.
At December 31, 2001, reinsurance recoverables on policy claims were $25,000 and
was received January 2002. No recoverable was due the Company at December 31,
2000.
NOTE K - EMPLOYMENT AGREEMENTS
The Company has employment agreements with its Chief Executive Officer and
President, both Company stockholders. The employment agreements provide, among
other things, for terms through March 2003, base and maximum salaries, increases
to base salaries subject to Board of Director approval, annual bonuses, and
benefits.
The agreements may be terminated by mutual consent, by the Company at its sole
discretion without cause, or by the Company for cause, as defined. If the
agreements are terminated for cause, as defined, severance payments of $50,000
are payable to each employee. If the agreements are terminated without cause,
severance payments to each employee will be equivalent to the maximum salary
over the term of the agreements less amounts previously paid, but not less than
$360,000 for the President and $450,000 for the Chief Executive Officer.
NOTE L - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments as of December 31, 2001 and 2000,
respectively. Such information, which pertains to the Company's financial
instruments, does not purport to represent the aggregate net fair value of the
Company. The carrying amounts in the table are the amounts at which the
financial instruments are reported in the consolidated financial statements.
Except as identified, all of the Company's financial instruments are held for
purposes other than trading. The fair values of debt and equity securities are
estimated based on quoted market prices for those or similar investments. The
carrying value of certain notes receivable and policy loans approximate fair
F-21
Summit Life Corporation and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
DECEMBER 31, 2001 AND 2000
value due to nominal interest rate changes subsequent to issuance. The carrying
amounts of cash, cash equivalents, short-term investments, and receivables
approximate fair values because of the short maturity of those assets. Net cash
surrender value is used in determining the fair value of investment contracts.
Estimated fair value of notes payable is the discounted amount of future cash
flows using the Company's current incremental rate of borrowing for similar
liabilities.
NOTE L - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
2001 2000
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
FINANCIAL ASSETS ---------- ---------- ---------- ----------
Debt Securities - Held to Maturity $ 279,871 $ 279,871 $ 328,075 $ 341,725
Debt Securities - Available For Sale 2,180,629 2,180,629 2,426,607 2,426,607
Equity Securities - Available For Sale 291,248 291,248 8,915 8,915
Equity Securities - Trading 84,934 84,934 113,643 113,643
Equity Securities - Other 66,788 * 62,500 *
Notes Receivable 992,033 937,389 941,878 887,308
Policy Loans 113,865 113,865 33,382 33,382
Cash And Cash Equivalents 1,661,410 1,661,410 1,436,338 1,436,388
Receivables 92,576 92,576 51,912 51,912
FINANCIAL LIABILITIES
Policy Holder Account
Balances - Investment Contracts $4,063,756 $3,933,403 $4,256,203 $4,101,159
Notes Payable 111,206 111,206 248,254 248,254
* Market prices for First Alliance Corporation are not quoted on public
exchanges. See Note B - Investments.
NOTE M - BUSINESS ACQUISITIONS
In August 2001 the Company acquired 100% of the life insurance business of
Presidential Life Insurance Company in Dallas, Texas. The cost of the
acquisition was approximately $78,000 paid in cash.
F-22