UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
(Mark One) | |
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the fiscal year ended | |
or | |
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| TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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As of March 27, 2023, there were
DOCUMENTS INCORPORATED BY REFERENCE
Document | Incorporated as to | |
Proxy Statement for the | Part III | |
2023 Annual Meeting of Stockholders |
MIDWEST HOLDING INC.
FORM 10-K
TABLE OF CONTENTS
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SPECIAL CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this Form 10-K constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and we intend that all forward-looking statements that we make will be subject to the safe harbor protections created thereby. These statements are based on management’s expectations, estimates, projections and assumptions. In some cases, you can identify forward-looking statements by terminology including “could,” “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “intend,” or “continue,” the negative of these terms, or other comparable terminology used in connection with any discussion of future operating results or financial performance. These statements are only predictions and reflect our management’s good faith present expectation of future events and are subject to a number of important factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.
Factors that may cause our actual results to differ materially from those contemplated or projected, forecast, estimated or budgeted in such forward-looking statements include among others, the following possibilities:
| ● | our business plan, particularly including our reinsurance strategy, may not prove to be successful in the long run; |
| ● | the success of changes in executive leadership; |
| ● | our reliance on third-party insurance marketing organizations to market and sell our insurance products through a network of independent agents; |
| ● | adverse changes in the ratings obtained from independent rating agencies; |
| ● | failure to maintain adequate reinsurance; |
| ● | our inability to expand our insurance operations outside the 24 states and the District of Columbia in which we are currently licensed; |
| ● | our annuity products may not achieve significant market acceptance; |
| ● | we may continue to experience operating losses in the future; |
| ● | the possible loss or retirement of one or more of our key executive personnel; |
| ● | intense competition, including pricing competition, the entry of new competitors, and the introduction of new products by new and existing competitors, many of whom have capital and human resources in excess of ours; |
| ● | adverse state and federal legislation or regulation, including limitations on premium levels, increases in minimum capital and reserve requirements, benefit mandates and tax treatment of insurance products; |
| ● | the effects of inflation; |
| ● | fluctuations in interest rates causing a reduction of investment income or increase in interest expense and in the market value of interest-rate sensitive investments; |
| ● | the effect of adverse economic factors, including bank failures and concerns of a potential economic downturn or recession; |
| ● | failure to obtain new customers, retain existing customers, or reductions in policies in force by existing customers; |
| ● | higher service, administrative, or general expense due to the need for additional marketing, administrative or management information systems expenditures related to implementation of our business plan; |
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| ● | the effect of cybersecurity risks, including technology breaches or failure; |
| ● | changes in our liquidity due to changes in asset and liability matching; |
| ● | possible claims relating to sales practices for insurance products; |
| ● | accuracy of management’s assumptions and estimates; |
| ● | variability of statutory capital required to be held by insurance or reinsurance entities; and |
| ● | lawsuits in the ordinary course of business. |
See “Risk Factors” beginning on page 18 for further discussion of the material risks associated with our business.
You should not place undue reliance on any forward-looking statements. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date of this Form 10-K or to reflect the occurrence of unanticipated events.
Unless the context otherwise requires, we use the terms “Midwest Holding,” the “Company,” “we,” “us” and “our” in this Form 10-K to refer to Midwest Holding Inc. together with its consolidated subsidiaries and any reference to “Midwest” relates to Midwest Holding Inc. (parent) only.
Summary of Risks Associated with our Business and Voting Common Stock
Our business is subject to risks of which you should be aware before making an investment decision. These risks are discussed more fully in the “Risk Factors” section of this report. A summary of these risks include, but are not limited to, the following:
| ● | Our use of IMOs (as defined below) could face several difficulties that could adversely affect our results of operations and financial condition. |
| ● | Our reinsurance program was designed to enable us to write larger amounts of business while limiting our risk exposure and maximizing the use of our available regulatory capital. Market conditions beyond our control impact the availability and cost of the reinsurance we purchase. No assurances can be given that reinsurance will remain continuously available to us to the same extent and on the same terms and rates as currently available. We remain liable with respect to ceded insurance should any reinsurer fail to meet the obligations assumed by that reinsurer. |
| ● | The inability to obtain upgrades to our financial strength and other ratings from A.M. Best, or the possibility of a downgrade in our ratings, may have a material adverse effect on our competitive position, the marketability of our annuity product offerings, and our liquidity, operating results, financial condition, and prospects. |
| ● | Our new insurance products and other products we may develop may not achieve market penetration. |
| ● | Fluctuations in interest rates could cause a reduction in investment income or adversely affect the market value of interest-rate sensitive investments, which could adversely affect our business and could cause our debt service obligations to increase significantly. |
| ● | The insurance industry is highly regulated and our activities are restricted as a result. State insurance regulators are charged with protecting policyholders and have broad regulatory, supervisory and administrative powers over our business practices, including, among other things, the power to grant and revoke licenses to transact business, and the power to regulate and approve underwriting practices and rate changes, which may delay the implementation of premium rate changes or prevent us from making changes we believe are necessary to match rate to risk. |
| ● | The domiciliary regulator of American Life, the Nebraska Department of Insurance, imposes risk-based capital requirements on insurance companies to ensure they maintain appropriate levels of surplus to support their overall business operations |
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| and to protect customers against adverse developments. If the amount of our capital falls below this minimum, we may face restrictions with respect to soliciting new business and/or keeping existing business. Similar regulations may apply in other states in which American Life currently does or may operate. |
| ● | We are highly dependent upon Georgette Nicholas, our Chief Executive Officer, and Mike Minnich, our President, and the loss of either of these officers could materially and adversely affect our business. |
| ● | We operate in a highly competitive industry, and our business will suffer if we are unable to compete effectively. |
| ● | The ongoing events resulting from the COVID-19 pandemic, and the uncertainty regarding future similar events, could have an adverse impact on our financial condition, results of operations, cash flows, liquidity, and prospects. |
| ● | Our business plan, seeking to become a capital efficient, technology-enabled and service-oriented solutions provider to the annuity and life markets, may not be successful. |
| ● | We have experienced significant operating losses due to expected, upfront expenses. Failure to scale our company may result in non-recovery of upfront operating costs and continued operating losses. |
| ● | The impact on potential customers and vendors of sustained or significant deterioration in national or worldwide economic conditions, including due to concerns of a potential economic downturn or recession, could adversely affect our business. |
| ● | We are exposed to significant financial and capital markets risk, including changes in interest rates, equity prices, market volatility, inflation, the performance of the economy in general, the performance of the specific obligors included in our investment portfolio and other factors outside our control. Our exposure to interest rate risk relates primarily to the market price of our investment portfolio and cash flow variability associated with changes in interest rates which may lead to spread compression between our assets and liabilities, or cause our debt service obligations to increase significantly. |
| ● | Our business success depends, in part, on effective information technology systems and on continuing to develop and implement improvements in our technology. |
| ● | The market price and trading volume of our voting common stock have been volatile, which has resulted in, and could continue to result in, rapid and substantial losses for our stockholders. |
| ● | Our failure to meet the continued listing requirements of The Nasdaq Capital Market could result in a delisting of our voting common stock. |
| ● | There may be future issuances or resales of our voting common stock, which may materially and adversely affect the market price of our voting common stock. |
| ● | Guarantees within certain of our products may adversely affect our financial condition or results of operations. |
| ● | Deviations from assumptions regarding future persistency, mortality, morbidity, and interest rates used in calculating reserve amounts could have a material adverse impact on our results of operations or financial condition. |
ITEM 1. BUSINESS.
Our Company and Business Model
We are a financial services company focused on helping individuals plan and secure their future by providing technology-enabled and services-oriented solutions through our annuity products. We currently distribute our annuities through independent distributors who are primarily independent marketing organizations (“IMOs”). Our operations are comprised of three distinct, interconnected businesses – insurance, reinsurance, and asset management. We seek to reinsure our annuity policies using a reinsurance platform that is attractive to traditional reinsurance entities and other institutional investors seeking above average risk-adjusted returns uncorrelated to the equity
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markets. We have developed relationships with reinsurers who capitalize and manage their own reinsurance capital vehicles utilizing our infrastructure and expertise, as well as through our own captive reinsurer. Our long-term goal is to build a platform that provides competitive annuity and life insurance products via efficient technology resulting in a seamless customer experience.
We believe that our operating capabilities and technology platform provides annuity distributors and reinsurers with flexible and cost-effective solutions. We seek to create value through our ability to provide the distributors and reinsurers with annuity product innovation, speed to market for new products, competitive rates and commissions, and streamlined customer and agent experiences. Our capital model allows us to support increasing annuity sales volumes with capital capacity provided by reinsurers.
We work to provide an end-to-end solution to manage annuity products that includes a broad set of product development, distribution support, policy administration, and asset/liability management services. Our platform enables us to efficiently develop, sell and administer a wide range of products. Our asset management services are also provided to third-party insurers and reinsurers.
We currently offer annuity products, consisting of multi-year guaranteed annuity (“MYGA”) and fixed indexed annuity (“FIA”) policies, through IMOs that in turn distribute our products and services to independent insurance agents in 24 states and the District of Columbia. We further provide IMOs with our product development expertise, administrative capabilities and technology platform.
We seek to reinsure a significant portion of the risk associated with our annuity policies with third-party reinsurers and our captive reinsurance subsidiary, Seneca Reinsurance Company, LLC (“Seneca Re”). Our third-party reinsurers include both traditional reinsurers and capital markets reinsurers, who are seeking exposure to reinsurance revenue and typically do not have their own reinsurance platforms or insurance-related operations. We also have the flexibility to selectively retain assets and liabilities associated with our policies for a period of time when we expect that doing so will provide an attractive return on our capital.
We were formed in 2003 as a financial services company and began our insurance operations in 2009. Following a change in control transaction in 2018, we began implementing our current business model and strategic plan. In December 2020, our voting common stock was listed on The Nasdaq Capital Market under the ticker symbol “MDWT.”
We operate our core business through four subsidiaries under one reportable segment. American Life & Security Corp. (“American Life”) is a Nebraska-domiciled life insurance company, currently licensed to sell, underwrite, and market life insurance and annuity products in 24 states and the District of Columbia. American Life obtained a financial strength rating of B++ (“Good”) from A.M. Best Company (“A.M. Best”), a leading rating agency for insurance companies, in December 2018. That rating was affirmed in March 2023 when A.M. Best also revised their outlook for American Life from Positive to Stable. All of our annuities are written by American Life.
Our other insurance subsidiary, Seneca Re, is a Vermont-domiciled sponsored captive reinsurance company established in early 2020 to reinsure various types of risks on behalf of American Life and third-party capital providers through special purpose reinsurance entities known as “protected cells.” Through Seneca Re, we assist capital market investors in establishing and licensing new protected cells.
Midwest Capital Corp., a Delaware corporation, was established as a holding company and is the immediate parent of Seneca Incorporated Cell, LLC 2021-03 (“SRC3”), both of which are consolidated into our financials.
1505 Capital LLC, a Delaware limited liability company (“1505 Capital”), is an SEC registered investment adviser providing financial, investment advisory, and management services.
We seek to deliver long-term value by growing our annuity volumes and generating profitable fee-based revenue. We generate fees and other revenue based on the gross deposits received on the annuity policies we issue, reinsure, and administer.
By reinsuring a significant portion of the annuity policies we issue, the level of capital needed for American Life is significantly less than what would be required if we retained all of the business on our books. We believe this “capital light” approach has the potential to produce enhanced returns for our business compared to a traditional insurance company capital structure. This strategy helps reduce our insurance regulatory capital requirements because policies that are reinsured require substantially less capital and surplus than policies retained by us.
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We utilize our insurance and ancillary services businesses to develop and issue annuities through IMOs. We generally seek to reinsure a significant portion of the financial risk associated with our policies to third-party reinsurers, including traditional and capital markets reinsurers, and Seneca Re.
Through our ancillary services businesses we administer the policies we issue and offer asset management services to our reinsurance partners for fees. Through Seneca Re, we also assist capital markets investors in establishing and licensing new special purpose reinsurance entities. We believe our broad service offering provides a growing and valuable fee stream, and expect that our policy administration and asset management fee income will increase as we grow our number of administered policies and the associated assets that we manage. In the future, we expect to have opportunities to increase our policy administration and asset management revenue by providing these services on a stand-alone basis to new customers.
We seek to create value for our distribution and reinsurance partners by facilitating product innovation, rapid speed to market for new products, competitively-priced products, streamlined customer and agent experience, and efficient technology-enabled operations. We generate fee income from reinsurers in the form of ceding commissions, policy administration fees, and asset management fees. We typically receive upfront ceding commissions and expense reimbursements at the time the policies are reinsured and policy administration fees over the policy lifetimes. We also earn asset management fees on the assets we hold that support the obligations of many of our reinsurers.
In investing on behalf of our insurance and reinsurance company subsidiaries, we seek to maximize yield by constructing portfolios that include a diversified portfolio of bonds, mortgages, private credit and structured securities, including collateralized loan obligations, while minimizing the difference in duration between our investment assets and liabilities.
Our Products
Through American Life we presently issue several MYGA and FIA products (including two FIA bonus options). We presently are not offering any traditional life insurance products.
Fixed indexed annuities are a type of insurance contract in which the policyholder makes one or more premium deposits, earning interest at a crediting rate determined in relation to a specific market index, on a tax-deferred basis. Multi-year guaranteed annuities are insurance contracts under which the policyholder makes deposits and earns a crediting rate guaranteed for a specified number of years before it may be changed. American Life’s MYGA products are three- and five-year single premium deferred individual annuity contracts, providing consumers with an attractive, low-risk, predictable, and tax-deferred investment option. American Life’s FIA products are long-term (7- and 10-year) annuity products with interest rates that are tied, in part, to published stock market indices selected by customers from designated indices. The FIA products are modified single premium annuity contracts designed for individuals seeking to benefit from potential market gains with fully protected principal. American Life began selling its MYGA and FIA products in 2019.
Depending on market demand American Life may consider offering a variety of insurance products, including but not limited to fixed deferred, fixed indexed or registered index-linked annuities or hybrids thereof. Any new insurance or annuity products we create will be filed with and approved by appropriate state insurance regulatory authorities before being offered to the public. American Life’s MYGA and FIA products were developed using an independent consulting actuary, and we expect that any new products will utilize similar services. Our long-term plan is to broaden the distribution of our products to new states as well as new distribution partners and channels.
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The table below sets forth American Life’s MYGA and FIA deposits received during the years ended December 31, 2022 and 2021:
Year ended December 31, | |||||
2022 | 2021 | ||||
(In thousands) | Deposits Received(1) | Deposits Received(1) | |||
Annuity Premium | |||||
MYGA | $ | 397,353 | $ | 126,588 | |
FIA | 318,480 | 345,058 | |||
Total issued | $ | 715,833 | $ | 471,646 | |
| 1) | Under generally accepted accounting principles in the United States of America (“GAAP”), these products are defined as deposit-type contracts; therefore, the deposits received are accounted for under GAAP as deposit-type liabilities on our balance sheet and are not recognized as revenue in our Consolidated Statements of Comprehensive Loss. Under Statutory Accounting Principles (“SAP”), the MYGA and FIA premiums are treated as premiums written and as revenue when earned. SAP primarily differs from GAAP by charging policy acquisition costs to expense as incurred, establishing future benefit liabilities using actuarial assumptions as well as valuing investments and certain assets and accounting for deferred taxes on a different basis. |
Our Ancillary Services
Policy Administration
We provide a cloud-based policy administration solution called “m.pas,” which operates as a division of American Life. We built m.pas to provide a scalable policy administration solution for annuity products. This platform is a flexible solution designed to aggregate and manage structured and unstructured data, and provide operational efficiencies leading to lower policy administration costs relative to traditional insurance carriers. This technology-enabled solution also provides relatively shortened new product launch capabilities and our platform facilitates integration of asset/liability management into traditional asset portfolio risk systems. We are under contract with most of our reinsurers to administer all policies ceded under our various reinsurance agreements. We believe this solution creates an opportunity to expand these services in the future into a broader business as a third-party administrator (“TPA”) for other insurers.
Asset Management
1505 Capital provides asset-liability management services to American Life, third-party reinsurers and third-party insurance clients. 1505 Capital provides its expertise and infrastructure to develop and implement customized solutions for clients seeking to optimize risk-adjusted portfolio yields, liquidity, maturity profile, risk and capital monitoring, and asset-liability management. 1505 Capital also focuses on originating and managing commercial mortgages, private credit, and structured products. We generally require reinsurers to secure their obligations to American Life in the form of assets deposited on American Life’s balance sheet or via assets held in trust to provide security for potential claims. Reinsurers may appoint 1505 Capital to manage these assets pursuant to guidelines adopted by us that are consistent with state investment statutes and reinsurance regulations. As of December 31, 2022, 1505 Capital had approximately $501.9 million total third-party reinsurer assets under management.
Our Partners
Distributors
We currently have selling agreements with 27 IMOs that contract with numerous independent agents to sell our annuity policies. The IMOs recruit, train and support independent agents who sell annuities, life insurance and other financial products to consumers. Although we contract with the IMOs, we also generally have a producer agreement with each agent. We require agents who distribute our policies to complete our product and compliance training in anti-money laundering, annuity products and annuity suitability, and the annuity products we offer. As of December 31, 2022, we had more than 2,900 active agents under contract.
We support our distribution partners by enabling them to introduce additional products, meet the needs of independent agents and consumers, implement flexible policy designs, and bring new products to market quickly. Our technology capabilities allow for flexible
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product design with speed to market to meet the needs of independent agents and consumers. We believe that if we are able to achieve an upgrade of American Life’s A.M. Best rating to A-, it would increase the demand for our annuities, and would attract additional distribution and reinsurance partners, including small- to mid-sized banks and broker-dealers.
Reinsurance.
As indicated above, reinsurance is an integral part of our business plan. We market, underwrite, and issue annuity products through American Life and seek to reinsure the policies with third-party reinsurers and Seneca Re. We partner with traditional third-party reinsurers and reinsurers sponsored by capital markets investors, including asset managers and institutional investors. We believe this strategy helps us preserve our capital while supporting sales growth because we have lower capital requirements when the policy liabilities are reinsured than when we retain all of the policy liabilities.
In some cases, we will retain our policies for a period of time in our captive reinsurance company in order to create block reinsurance transactions. We expect that our ability to accumulate and reinsure larger portfolios of policies over time should increase the size and number of reinsurers who seek to reinsure our liabilities.
Seneca Re was formed to operate as a sponsored captive insurance company for the purpose of reinsuring insurance policies through protected cells, under Vermont insurance regulations. Seneca Re provides an efficient structure for capital markets investors to reinsure our policies through protected cells that we manage. As of December 31, 2022, through Seneca Re and American Life we had six reinsurance agreements with third parties and a reinsurance agreement with an affiliate of Crestline Assurance Holdings LLC.
Our Technology
Our business model utilizes a modern, end-to-end, cloud-based technology platform that we began implementing in 2018. This platform enables us to develop, sell and administer a broad range of competitive annuity products. We license key components of our technology from third-party software providers, including product development, new business, distribution management, and policy administration applications. We believe this strategy allows us to provide high quality technology capabilities with limited capital investment and increased flexibility. In addition, we have added several core technology integrations to optimize the speed and efficiency of our interactions with IMOs, their agents, and policyholders, including document management, electronic application capability, secure log-ins, and an agent and policyholder portal. We believe our technology platform provides cost effective product development, sales, and administration that enables us to control the growth of our operating and other expenses while expanding our operations and growing our sales volume.
Our Market Opportunity
We participate in a large U.S. market that we expect to grow in part due to a number of demographic trends. As measured by annual premiums written, annuities are the largest product line in the life, annuity, and accident and health sector. Annuities play an important role in retirement planning by providing individuals with stable, tax-efficient sources of income. In 2021 annuity premiums, totalled $319 billion, or approximately 30% of the $1.1 trillion of total annual life, annuity, and accident and health premiums that year according to the Insurance Information Institute. The most common annuities are fixed and variable and may be written on an individual or group basis. Our current products are fixed annuities written on an individual basis.
An increasing portion of the U.S. population is of retirement age and is expected to increase the retirement income needs of retirees. The number of people of retirement age has increased significantly since 2010, driven by the aging of the “Baby Boomer” generation. The U.S. population over 65 years old is forecast to grow from 56 million in 2020 to an estimated 81 million in the next 20 years, according to the U.S. Census Bureau, Population Estimates and Projections. This study also forecasted that the U.S. population aged over 65 years old is expected to grow by 44% from 2020 to 2040, while the total U.S. population is expected to grow by only 12%.
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Annuities in the U.S. are distributed through a number of channels, most of which are independent from the insurance companies that issue annuities. Independent distribution channels serve as the primary, and a growing, source of annuity distribution. In 2021, approximately 77% of U.S. individual annuity sales occurred through independent distributors, including independent agents, broker-dealers, and banks, representing an increase from approximately 70% in 2017 according to U.S. Individual Annuities, 2021 Year in Review, Life Insurance Marketing and Research Association (“LIMRA”), 2022. Independent agents are the second largest distribution channel, behind independent broker-dealers, accounting for approximately 19% of U.S. individual annuity sales in 2021. IMOs provide independent agents with access to annuity products along with operational support services and functionality to support the distribution services of the agents. The infrastructure and support services provided by IMOs to independent agents are critical to the success of independent agents and their ability to serve their customers and generate additional sales.
We believe that capital markets investors have been actively seeking, investing in, and acquiring insurance and reinsurance companies in recent years. Fixed annuities provide upfront premiums and stable, long-term payment obligations and are thus attractive sources of liability-funded assets for a variety of traditional and alternative asset managers and investors. However, there are significant regulatory and operational hurdles for capital providers looking to enter the insurance market. These hurdles are exacerbated by the limited legacy administrative capabilities, product development processes, and technology systems, of traditional insurers and reinsurers. We provide asset managers and investors the ability to seamlessly access funding from annuities through a variety of reinsurance entities that we are able to form quickly and operate efficiently with lower upfront and ongoing regulatory and operating costs.
We operate in highly competitive markets with a variety of participants, including insurance companies, financial institutions, asset managers, and reinsurance companies. These companies compete in various forms in the annuity market, for investment assets and for services. We seek to build strong relationships along with offering technology-enabled and services-oriented solutions for our partners.
Our Competitive Strengths
Differentiated Value Proposition
We provide annuity product development and asset management services, enhanced by American Life’s A.M. Best financial strength rating and licenses to sell annuity products in 24 states and the District of Columbia. We have developed and implemented a technology platform and administrative services that we believe provides us with the opportunity to expand our revenue opportunities, lower our operating costs on a per policy basis and increase customer value for our distribution partners. We believe our business model and multi-service capabilities provide our reinsurance and capital provider participants with attractive capital deployment opportunities.
We also believe our ongoing strategy to have American Life become licensed to sell insurance in additional states and seek a higher A.M. Best rating will further strengthen our value.
Multiple Revenue Sources
Our business model generates upfront ceding commissions and fee-based revenue from recurring policy administration and asset management fees. We receive ceding commissions and expense reimbursement from reinsurers at the time we cede our primary insurance liabilities to them, providing meaningful cash flow. During the years ended December 31, 2022 and 2021, we generated $11.5 and $11.2 million, respectively, in upfront ceding commissions. On our balance sheet is an item “deferred gains on reinsurance” equaling $38.1 million and $28.6 million as of December 31, 2022 and 2021, respectively, which will be earned as revenue over the contract periods. Amortization of the deferred gain on reinsurance was $4.8 million and $3.0 million for the years ended December 31, 2022, and 2021, respectively, and was recognized as revenue under GAAP. We also receive policy administration fees on annuities that we issue and manage, and we receive asset management fees from most of our third-party reinsurers relating to assets they deposit as collateral to cover claims on the policies they reinsure. These fees are typically received over the life of our annuity products, usually over five to ten years, thereby providing a stable revenue stream. We may also earn investment income (spread income) on assets not ceded to reinsurers.
Capital Structure
Our business model utilizes our regulated insurance and reinsurance subsidiaries to transfer assets and liabilities associated with our issued annuities to third-party capital providers and Seneca Re via reinsurance agreements. This strategy reduces our regulatory capital
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and surplus requirements because policies that are reinsured require less capital and surplus reserves than policies retained by us, allowing us to grow our business without significant capital constraints.
Effective Use of Technology
We believe we are well-positioned to capitalize on the accelerating trend of digital transformation across the insurance industry. We believe our modern, fully functional technology platform provides us a significant opportunity to penetrate large addressable markets with our compressed product development cycles.
Scalable, Low-Cost Operations
We focus on investing in technology-enhanced processes that improve the efficiency and effectiveness of developing, distributing, issuing, and managing our annuity products. We believe our model allows us to develop attractively priced products that are desirable for our IMOs to market. We currently operate on a small scale in a large addressable market. Going forward, our technology platform and streamlined processes should enable us to be scalable and allow us to produce incremental premium volumes without significant additional investment in infrastructure and with low incremental fixed operating costs.
Lower-Risk, Business Model
We believe our business model enables us to operate with reduced risk because we reinsure a substantial portion of our business. While we would have to pay policy claims in the event of non-payment by any of our reinsurers, we often obtain collateral for policy claims from reinsurers or use reinsurers who have creditworthy ratings. Further, we have designed American Life’s MYGA and FIA products to have fixed, predictable costs with low volatility and surrender charges that discourage redemptions prior to maturity and contain features to reward persistency.
We generate revenue through the ceding commissions and other fee income we receive from our reinsurance providers and the ancillary services we provide. Also, we incur minimal direct expenses associated with the ceding commissions we generate, and we incur low incremental expenses on additional policy volumes we produce. As a result, we believe we will be able to achieve profitable incremental fee-based revenue from additional premium volume. Because we have a fully integrated technology platform, we also expect that we will be able to increase our operating margins as we continue to scale our business.
Entrepreneurial, Highly Experienced and Aligned Management Team
Our highly experienced, entrepreneurial senior management team has extensive experience in insurance, technology, and investment management. Georgette Nicholas, our Chief Executive Officer, has more than 30 years’ experience in the global financial services industry including insurance, reinsurance, and capital markets. She has a commitment to developing strong culture and leadership in organizations, supporting diversity and inclusion to grow engagement. Ms. Nicholas previously held the position of CEO and Managing Director for Genworth Mortgage Insurance Australia, a publicly listed Australian Securities Exchange Ltd company in Sydney, Australia. She also held various investor relations roles with Genworth Financial, Inc. and chief financial officer roles in Genworth Financial, Inc.’s mortgage insurance business and controllership. Ms. Nicholas also worked in public accounting, including as a firm director with Deloitte.
Mike Minnich, our President, has over 25 years of experience in asset management, insurance company management, technology and risk management. Mr. Minnich also serves as managing member of Rendezvous Capital LLC, a New York firm advising insurers on capital and investments. Previously, he was a Managing Director at Swiss Re, where he managed a multibillion-dollar investment portfolio.
Our Growth Strategy
Expand Market Presence
We believe that our current product offerings should enable us to achieve policy sales growth as we increase the number of states in which we become licensed to sell insurance. Many of our IMOs distribute to insurance agents throughout the United States, and we expect they will increase their sales volume as American Life enters new states.
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On December 22, 2022, American Life was approved for business in the state of Florida, expanding our operating footprint to 23 states and the District of Columbia. On February 24, 2023, American Life was approved for business in the state of Georgia, adding a 24th state to our operating footprint.
The 24 states in which we operate and the District of Columbia represented over $113 billion in total annuity premiums during 2021. By comparison, we generated $715.8 million of total annuity premiums under SAP for the year ended December 31, 2022.
Develop Additional Distribution and Reinsurance Relationships
We currently distribute annuity products through 27 third-party IMOs. We believe our product development, prompt policy processing, operating flexibility and speed to market make us a desirable partner for insurance distributors. We seek to grow by increasing volumes with our current IMOs and by establishing new IMO relationships.
We are seeking to leverage the relationships we have with reinsurers, capital markets investors, and reinsurance intermediaries to develop additional reinsurance relationships. In addition, as indicated above, we established Seneca Re in early 2020 to operate as a sponsored captive insurance company for the purpose of insuring and reinsuring various types of insurance risks for American Life and various third-party capital providers through protected cells. Also, in early 2020, we developed a strategic relationship with Crestline Assurance Holdings LLC and its affiliates (discussed below) to provide reinsurance capital and access to quality assets with attractive risk-adjusted returns.
Exploit Established Corporate Platform
We believe that we have the leadership and corporate culture, industry relationships, infrastructure, and technology to achieve growth and improve operating margins with increased annuity sales. We believe we have an efficient corporate platform to support increased sales volumes, expansion of our distribution relationships, and the development of new annuity products without significant additional incremental costs.
Revenue from Policy Administration and Asset Management Services
In addition to the ceding commissions we receive through our reinsurance strategy, we generate recurring fee income for providing policy administration and asset management services to third-party reinsurers. We are contracted to administer all our policies ceded under various reinsurance agreements. We also provide asset management services for most of our third-party reinsurers. We believe these complementary services provide a differentiated solution to third-party reinsurers that should assist us in developing additional reinsurer relationships.
Continue to Invest in Technology Capabilities
Our business strategy is centered upon our commitment to apply technology to improve and expand our business. We have developed a modern technology platform with a combination of proprietary and third-party systems enabling us to efficiently develop, sell and administer a broad range of annuity products. We expect to continue developing our platform to expand the technology-enabled capabilities we offer to distributors and reinsurers.
History
Midwest Holding Inc. is a financial services holding company that was originally incorporated in Nebraska in October 2003. In September 2009, our subsidiary American Life was issued a certificate of authority to conduct life insurance business in Nebraska. In June 2018, we underwent a change in control with a then non-affiliated third-party, Xenith Holdings LLC (“Xenith”) and its parent Vespoint LLC (“Vespoint”). Midwest contributed $20.5 million of capital to American Life from the funds received in the change of control transaction. Following the 2018 change of control and capital infusion we embarked on implementing our current business plan.
In April 2020, we entered into an agreement with Crestline Assurance Holdings LLC (“Crestline”), an institutional alternative investment management firm, under which we issued 444,444 shares of our voting common stock to Crestline for proceeds of $10.0 million. Also, in April 2020, we issued 231,655 shares of our voting common stock to various other investors in separate transactions
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for approximately $5.3 million. We contributed $5.0 million of the net proceeds to American Life and used $3.3 million of the proceeds to capitalize Seneca Re and its first protected cell.
In August 2020, we effected a 500 for one reverse stock split of our issued and outstanding shares of voting common stock, and reincorporated in Delaware.
On December 17, 2020, our voting common stock was listed on The Nasdaq Capital Market under the symbol “MDWT.” On December 21, 2020, we completed a public offering of 1,000,000 shares of our voting common stock at a price to the public of $70.00 per share. The aggregate net proceeds of the offering totalled approximately $65.1 million, after deducting underwriting discounts and commissions.
On November 10, 2021, Midwest purchased 1,000 shares of Common Stock, $.01 par value per share for a total purchase price of $5.7 million, for 100% ownership in Midwest Capital Corporation (“MCC”), an intermediary holding company. Also, on November 10, 2021, Seneca Re Incorporated Cell 2021-03 (“SRC3”) was granted a Certificate of Authority by the Vermont Department of Financial Regulation (“VDFR”). MCC contributed capital of $5.5 million to purchase 100% of SRC3 Class A and B capital stock. Also, on November 10, 2021, American Life and SRC3 entered into a Funds Withheld and Modified Coinsurance Agreement, whereby SRC3 agreed to provide reinsurance funding for a quota share percentage of 45% of the liabilities of American Life arising from its MYGA products and a quota share percentage of 45% of the liabilities of American Life arising from its FIA products. In the fourth quarter of 2022, the agreement with SRC3 was amended to provide a one time reinsurance funding for a quota share of $10.0 million of premiums related to American Life’s FIA products. The quota share reverted to 0% of FIA products in January 2023.
As discussed elsewhere, Midwest owned a 100% interest in SRC1 by contributing a total of $21.4 million. On December 30, 2021, Midwest closed the sale of approximately 70% of Seneca Incorporated Cell, LLC 2020-01 (“SRC1”) to a subsidiary of ORIX Corporation USA (“ORIX USA”) for $15.0 million. Under the terms of the agreement, Midwest holds a 30% ownership interest in SRC1. ORIX Advisers, LLC, another subsidiary of ORIX USA, became the manager of the assets underlying SRC1’s reinsurance obligations, replacing Midwest’s asset management arm, 1505 Capital LLC.
Crestline Relationship
On April 24, 2020, we entered into the Securities Purchase Agreement with Crestline under which we issued 444,444 shares of our voting common stock to Crestline for aggregate proceeds of $10.0 million, and also issued 231,655 shares of our voting common stock to various other investors in separate transactions for approximately $5.3 million. We contributed $5.0 million of the net proceeds to American Life and used $3.3 million of the proceeds to capitalize Seneca Re and its first protected cell. We also entered into a Stockholders Agreement along with Xenith and Vespoint that grants Crestline certain rights. Also, Douglas K. Bratton, a principal of Crestline, was appointed as a director of both the Midwest Holding Inc. Board of Directors (the “Board”) and the American Life Board of Directors.
In addition, on April 24, 2020, American Life entered into a three-year master letter agreement and related reinsurance, trust, and asset management agreement with Seneca Re and a Crestline affiliate regarding the flow of annuity reinsurance and related asset management, whereby Crestline agreed to provide reinsurance funding for a quota share percentage of 25% of the liabilities of American Life arising from its MYGA products and a quota share percentage of 40% of the liabilities of American Life arising from its FIA products. The Crestline affiliate contributed $40.0 million of assets to capitalize SRC2, now known as Crestline Re SP1 (“Crestline SP1”). Through December 31, 2022, American Life had ceded $440.9 million face amount of annuities to Crestline SP1. American Life received total ceding commissions of $2.6 million and expense reimbursements of $8.8 million in connection with these transactions for the year ended December 31, 2022. Effective December 8, 2020, American Life entered into a novation agreement with SRC2 and Crestline Re SPC, an exempted segregated portfolio company incorporated under the laws of the Cayman Islands, for and on behalf of Crestline SP1, a segregated portfolio company of Crestline Re SPC, under which the above described reinsurance, trust, and related asset management agreements were novated and replaced with substantially similar agreements entered into by American Life and Crestline SP1.
On September 16, 2022, Midwest Holding and Crestline executed a Letter of Understanding relating to the Stockholders Agreement. Midwest and Crestline agreed that Mr. Bratton would resign from the Boards of Directors of Midwest and American Life. Notwithstanding the foregoing, the parties agreed that Mr. Bratton’s resignation and Crestline’s decision to no longer appoint a director does not constitute a permanent waiver of Crestline’s rights under the Stockholders Agreement to appoint a director. Midwest and
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Crestline agreed that the foregoing described agreement will remain in place until the earlier to occur of the date (i) that the parties reach written agreement otherwise, (ii) that Crestline is no longer an affiliate of a life insurance entity it recently acquired and (iii) on which Crestline no longer has the right to elect or appoint a designated director and observer to the Boards of Directors of Midwest and American Life.
Employees
As of December 31, 2022, we had 93 total employees, including 91 full time employees. Our headquarters is in Lincoln, Nebraska and we have an office in New York, New York. We consider our relations with our employees to be good.
We are committed to creating an environment of diversity, equity, and inclusion as part of our foundational values. Recruiting, developing, and retaining talent is a key to succeeding in growing our business.
Available Information
The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements, and amendments to those reports are available free of charge through the Company’s website at http://www.midwestholding.com as soon as reasonably practicable after such reports are electronically filed with the SEC. The information contained on, or that can be accessed through, our website is deemed not to be incorporated in this Annual Report on Form 10-K or to be part of this Annual Report on Form 10-K.
Regulation
General
Our insurance subsidiaries are subject to extensive regulation and supervision by the states in which they are domiciled, particularly with respect to their financial condition. American Life is domiciled in Nebraska, where it is regulated and supervised by the Nebraska Department of Insurance (“NDOI”). Seneca Re is domiciled in Vermont where it is regulated and supervised by the VDFR. Our insurance subsidiaries are also subject to regulation by all states in which they transact business, which oversight in practice often focuses on review of their market conduct. American Life is licensed to conduct insurance business, and is therefore subject to regulation and supervision by insurance regulators, in 24 states and the District of Columbia. Seneca Re, a Vermont limited liability company, was formed by Midwest to operate as a sponsored captive insurance company for the purpose of reinsuring various types of risks of its participants through one or more special purpose reinsurance or “protected cell” entities and to conduct any other business that is permitted for sponsored captive insurance companies under Vermont insurance regulations. The extent and scope of insurance regulation varies between jurisdictions, but most jurisdictions have laws and regulations governing the financial security of insurers, including admittance of assets for purposes of calculating statutory surplus, standards of solvency, reserves, reinsurance, capital adequacy, and the business conduct of insurers.
In addition, statutes and regulations require the licensing of insurers and their agents, the approval of policy forms and related materials, and the approval of rates. State statutes and regulations also prescribe the permitted types and concentrations of investments by insurers. The primary purpose of this insurance industry regulation is to protect policyholders. Life insurance companies are required to file detailed quarterly and annual financial statements with insurance regulatory authorities in each of the jurisdictions in which they are licensed to do business, and their operations are subject to periodic examination by such authorities. Regulators have discretionary authority, in connection with the continued licensing of insurance companies, to limit or prohibit the ability to continue to do business if, in their judgment, the regulators determine that an insurer is not maintaining necessary statutory surplus or capital or if the further transaction of business will be detrimental to its policyholders.
The amount of dividends that our insurance subsidiaries may pay in any twelve-month period, without prior approval by their respective domestic insurance regulators, is restricted under the laws of Nebraska and Vermont.
Under Nebraska law, dividends payable from American Life during any twelve-month period without the prior approval of the state’s Insurance Director are limited to the greater of 10% of American Life’s surplus as shown on the immediately preceding calendar year’s statutory financial statement on file with the NDOI or 100% of net gain from operations for the prior calendar year. Any dividend in excess of such limitation must be approved by the Insurance Director.
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Insurance holding company regulation
We are an insurance holding company and, together with our insurance subsidiaries and our other subsidiaries and affiliates, are subject to the insurance holding company system laws of Nebraska and Vermont. These laws vary across jurisdictions, but generally require insurers that are members of such insurance holding company’s system to register with the jurisdiction’s insurance regulatory authorities, to file reports disclosing certain information, including their capital structure, ownership, management, financial condition, enterprise risk, and own risk and solvency assessment.
These laws also require disclosure of certain qualifying transactions between or among our insurance subsidiaries and us or any of our other subsidiaries or affiliates to which one or more of our insurance subsidiaries is a party. Such transactions could include loans, investments, sales, service agreements, and reinsurance agreements among other similar inter-affiliate transactions. These laws also require that intercompany transactions be fair and reasonable and not adversely affect the interests of policyholders. In certain circumstances, the insurance company must give prior notice of the transaction to the insurance department in its state of domicile, and the insurance department must either approve or disapprove the subject intercompany transaction within defined periods. Further, these laws require that an insurer’s surplus following any dividends or distributions to shareholder affiliates is reasonable in relation to the insurer’s outstanding liabilities and its financial needs.
The insurance holding company laws in some states, including Nebraska and Vermont, require regulatory approval of a direct or indirect change of control of an insurer or an insurer’s parent company. Generally, to obtain approval from the insurance commissioner for any acquisition of control of an insurance company or its parent company, the proposed acquirer must file with the applicable commissioner an application containing information regarding: (i) the identity and background of the acquirer and its affiliates; (ii) the nature, source and amount of funds to be used to carry out the acquisition; (iii) the financial statements of the acquirer and its affiliates; (iv) any potential plans for disposition of the securities or business of the insurer; (v) the number and type of securities to be acquired; (vi) any contracts with respect to the securities to be acquired; (vii) any agreements with broker-dealers; and (viii) other relevant matters. Different jurisdictions may have similar or additional requirements for prior approval of any acquisition of control of an insurance or reinsurance company licensed or authorized to transact business in those jurisdictions. Additional requirements may include re-licensing or subsequent approval for renewal of existing licenses upon an acquisition of control.
Credit for reinsurance
State insurance laws permit U.S. insurance companies, as ceding insurers, to take financial statement credit for reinsurance that is ceded, so long as the assuming reinsurer satisfies the state’s credit for reinsurance laws. Credit for reinsurance means the ceding company is permitted to reflect in its statutory financial statements a credit in an amount equal to the ceding company’s liability that is reinsured. In general, credit for reinsurance is allowed if the reinsurer is licensed or “accredited” in the state in which the ceding insurer is domiciled; or if neither of the above applies, to the extent that the reinsurance obligations of the reinsurer are collateralized appropriately, typically through the posting of a letter of credit for the benefit of the ceding insurer, or the deposit of assets into a trust fund established for the benefit of the ceding insurer.
Statutory examinations
Our insurance subsidiaries are required to file detailed quarterly and annual financial statements, prepared in accordance with SAP, with regulatory officials in each of the jurisdictions in which they conduct business. As part of their routine regulatory oversight process, the NDOI and the VDFR conduct periodic detailed examinations, generally once every three to five years, of the books, records, accounts and operations of our insurance subsidiaries domiciled in their states. The NDOI began a scheduled examination of American Life for the period of 2017-2019 in January 2021, completing its examination and issuing its final report on September 30, 2021. The NDOI and VDFR are now scheduled to commence concurrent routine examinations of American Life and Seneca Re, respectively, for the period of 2020-2022.
Financial tests
The NAIC has developed a set of financial relationships or “tests,” known as the Insurance Regulatory Information System or IRIS, which is designed for early identification of companies that may require special attention or action by insurance regulatory authorities. Insurance companies submit data annually to the NAIC, which in turn analyzes the data by utilizing ratios. State insurance regulators review this statistical report, which is available to the public, together with an analytical report, prepared by and available only to state
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insurance regulators, to identify insurance companies that appear to require immediate regulatory attention. A “usual range” of results for each ratio is used as a benchmark.
Risk-based capital requirements
In order to enhance the regulation of insurers’ solvency, the National Association of Insurance Commissioners (“ NAIC”) adopted a model law to implement Risk Based Capital (“RBC”) requirements for life insurers. All states have adopted the NAIC’s model law or a substantively similar law. The NAIC Risk-Based Capital Model Act requires insurance companies to submit an annual RBC Report, which compares an insurer’s total adjusted capital with its authorized control level RBC. A company’s RBC is calculated by using a specified formula that applies factors to various specified assets, premium, claim, expense, and reserve items. The factors are higher for those items with greater underlying risk and lower for items with less underlying risk.
The RBC Report is used by insurance regulators to set in motion appropriate regulatory actions relating to insurers that show indications of weak or deteriorating conditions. RBC is an additional standard for minimum capital requirements that insurers must meet to avoid being placed in receivership by regulators. The annual RBC Report, and the information contained therein, is not intended by the NAIC as a means to rank insurers.
RBC is a method of measuring the minimum amount of capital appropriate for an insurance company to support its overall business operations in light of its size and risk profile. It provides a means of setting the capital requirement in which the degree of risk taken by the insurer is the primary determinant. The value of an insurer’s Total Adjusted Capital, which is the sum of its year-end statutory capital and surplus, in relation to its RBC, together with its trend in its Total Adjusted Capital, is used as a basis for determining regulatory action that a state insurance regulator may be authorized or required to take with respect to an insurer.
Market conduct exams
Our insurance subsidiaries are subject to periodic market conduct exams (“MCE”) in any jurisdiction where they do business. An MCE typically entails review of business activities, such as operations and management, complaint handling, marketing and sales, producer licensing, policyholder service, underwriting, and claims handling. Regulators may impose fines and penalties upon finding violations of regulations governing such business activities. To date, neither American Life nor Seneca Re have been the subject of such an MCE.
Form approvals
Our insurance subsidiaries are subject to state laws and regulations regarding form approvals. In most states, insurance policies are subject to prior regulatory approval in the state in which the policy is sold.
Unfair claims practices
Insurance companies are prohibited by state statutes from engaging in unfair claims practice. Unfair claims practices include, but are not limited to, misrepresenting pertinent facts or insurance policy provisions; failing to acknowledge and act reasonably promptly upon communications with respect to claims arising under insurance policies; and attempting to settle a claim for less than the amount to which a reasonable person would have believed such person was entitled.
Assessments against insurers
Under the insurance guaranty fund laws, which exist in each state and the District of Columbia, licensed insurers may be assessed by insurance guaranty associations for certain obligations of insolvent insurance companies to policyholders and claimants. Most of these laws provide for annual limits on the assessments and for an offset against state premium taxes. These premium tax offsets must be spread over future periods ranging from five to 20 years. Since these assessments typically are not made for several years after an insurer fails and depend upon the final outcome of liquidation or rehabilitation proceedings, we cannot accurately determine the amount or timing of any future assessments.
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Regulation of investments
Our insurance subsidiaries are subject to state laws that restrict the kinds of investments they may make. These laws require diversification of our investment portfolios and limit the amounts of investments in certain asset categories, such as below-investment grade fixed income securities, equity real estate, other equity investments, and derivatives. Failure to comply with these requirements and limitations cause affected investments to be treated as non-admitted assets for purposes of measuring statutory surplus and, in some instances, could require the divestiture of such nonqualifying investments. American Life’s investment guidelines, including its Derivative Use Plan, have been filed with the Nebraska Department of Insurance.
Statutory accounting practices
Statutory accounting practices (“SAP”) are a basis of accounting developed to assist insurance regulators in monitoring and regulating the solvency of insurance companies. SAP is primarily concerned with measuring an insurer’s solvency. Statutory accounting focuses on valuing assets and liabilities of insurers at financial reporting dates in accordance with appropriate insurance law and regulatory provisions applicable in each insurer’s domiciliary state.
GAAP is concerned with a company’s solvency, but is also concerned with other financial measurements, principally income and cash flows. Accordingly, GAAP gives more consideration to appropriately matching revenue and expenses and accounting for management’s stewardship of assets than does SAP. As a result, different assets and liabilities and different amounts of assets and liabilities will be reflected in financial statements prepared in accordance with GAAP as compared to SAP.
Unfair trade practices
State insurance laws prohibit insurers from engaging in unfair trade practices. The kinds of practices addressed include (i) misrepresentation and false advertising, (ii) unfair discrimination in premiums and policy benefits, (iii) boycott, coercion and intimidation, (iv) discrimination based on race, color, creed or national origin, sex or marital status, and (v) rebating of premium.
Enterprise risk and other developments
The NAIC, as part of its solvency modernization initiative, has engaged in a concerted effort to strengthen the ability of U.S. state insurance regulators to monitor U.S. insurance holding company groups. The holding company reform efforts at the NAIC culminated in December 2010 in the adoption of significant amendments to the NAIC’s Insurance Holding Company System Regulatory Act (the “Model Holding Company Act”) and its Insurance Holding Company System Model Regulation (the “Model Holding Company Regulation”). Among other things, the revised Model Holding Company Act and Model Holding Company Regulation explicitly address “enterprise” risk — the risk that an activity, circumstance, event, or series of events involving one or more affiliates of an insurer will, if not remedied promptly, be likely to have a material adverse effect upon the financial condition or liquidity of the insurer or its insurance holding company system as a whole - and require annual reporting of potential enterprise risk as well as access to information to allow the state insurance regulator to assess such risk. In addition, the Model Holding Company Act amendments include a requirement to the effect that any person divesting control over an insurer must provide 30 days’ notice to the regulator and the insurer (with an exception for cases where a Form A is being filed). The amendments direct the domestic state insurance regulator to determine those instances in which a divesting person will be required to file for and obtain approval of the transaction. Some form of the 2010 amendments to the Model Holding Company Act and the Model Holding Company Act Regulation has been adopted in all states.
In 2012, the NAIC adopted the Risk Management and Own Risk and Solvency Assessment (“ORSA”) Model Act, which requires domestic insurers to maintain a risk management framework and establishes a legal requirement for domestic insurers to conduct an ORSA in accordance with the NAIC’s ORSA Guidance Manual. The ORSA Model Act provides that domestic insurers, or their insurance group, must regularly conduct an ORSA consistent with a process comparable to the ORSA Guidance Manual process. The ORSA Model Act also provides that, no more than once a year, an insurer’s domiciliary regulator may request that an insurer submit an ORSA summary report, or any combination of reports that together contain the information described in the ORSA Guidance Manual, with respect to the insurer and the insurance group of which it is a member. The ORSA Model Act imposes more extensive filing requirements on parents and other affiliates of domestic insurers and exempts an insurer with annual direct written and unaffiliated assumed premiums less than $500 million. Prior to 2022, American Life’s direct written premium was less than $500 million. For the year ended December 31, 2022, American Life had direct written premiums of approximately $715.8 million; as such, we will begin complying with the ORSA Model Act in 2023.
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Privacy regulation
Federal and state law and regulation require financial institutions to protect the security and confidentiality of personal information, including health-related and customer information, and to notify customers and other individuals about their policies and practices relating to their collection and disclosure of health-related and customer information and their practices relating to protecting the security and confidentiality of that information. State laws regulate the use and disclosure of social security numbers and federal and state laws require notice to affected individuals, law enforcement, regulators, and others if there is a breach of the security of certain personal information, including social security numbers. Federal and state laws and regulations regulate the ability of financial institutions to make telemarketing calls and to send unsolicited e-mail or fax messages to consumers and customers. Federal and state lawmakers and regulatory bodies may be expected to consider additional or more detailed regulation regarding these subjects and the privacy and security of personal information.
Cybersecurity regulation
The NAIC adopted the Insurance Data Security Model Law in October 2017. This law establishes standards for data security and for the investigation and notification of certain cybersecurity events. As of the date of this filing, 11 states have adopted the model law or a variation of it. We expect that additional regulations could be enacted in other jurisdictions that could impact our cybersecurity program. Depending on these and other potential implementation requirements, we will likely incur additional costs of compliance.
ITEM 1A. RISK FACTORS.
We face many significant risks in the operation of our business and may face significant unforeseen risks as well. Also, in the second half of 2018 we embarked upon our new business plan and, therefore, we face all of the risks of doing business with a model in which our Company does not have a significant history. The material risks of this business plan are set forth below, but there may be additional risks that we do not anticipate, which could materially adversely affect our results of operations and financial condition. An investment in our voting common stock should be considered speculative.
Business Plan Risks
We have a limited operating history under our business plan and our business plan may not be successful.
We face all of the risks inherent in establishing an unseasoned business, including limited capital, unanticipated administrative costs, uncertain product markets, possible lack of market acceptance of new annuity products, and corresponding lack of significant revenues, as well as intense competition from better-capitalized and more seasoned annuity issuers with respect to any annuity products we may seek to create and distribute. We have no control over general economic conditions, competitors’ products, or their pricing and customer demand and we have limited control over necessary costs of marketing in seeking to build and expand our business. Such costs may be significantly higher than we anticipate. For example, our general and administrative costs in 2022 were higher than we expected. There can be no assurance that our proposed business plan will be economically successful or result in significant revenues to the extent that we achieve profits, and the likelihood of any success must be considered in light of our lack of operating history under our recently reconstituted executive leadership, our business plan, and our limited capital. The lack of a seasoned operating history makes it difficult to predict our future revenues or results of operations.
Our business plan provides that we will seek to utilize American Life and its technology, product development and administration capabilities to distribute insurance products through third-party marketing organizations. As part of this plan, American Life has obtained a “B++” (“Good”) A.M. Best financial strength rating and an A.M. Best bbb+ long-term issuer credit rating. American Life is seeking to become licensed to sell insurance in additional states. We cannot make any assurance that our business plan will achieve economic success and we anticipate that full implementation of our business plan will take place over several years. Some of these material risks include market non-acceptance of our new products, non-acceptance of our products by our IMOs and their agents, shortcomings or failures in our technology or encountering other problems that we may not be able to overcome, and unforeseen difficulties in obtaining coverage from financially capable reinsurance providers.
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Our use of IMOs could face several difficulties that could adversely affect our results of operations and financial condition.
We create and sell annuity products through IMOs that provide the sales agents and infrastructure in order to sell our products. This strategy entails several significant risks, including the possibility that our IMOs will not be able to successfully sell our products or will not devote sufficient time and attention to sell our products. We have no control over any IMOs and, therefore, any sales success regarding our products will be substantially dependent upon the efforts of those organizations and their sales agents. Also, we have concentrated channels of product distribution because although we have 27 IMOs as of December 31, 2022, we presently do not distribute our products through other distribution channels such as banks and broker-dealers. If any one of our IMOs does not perform within our expectations, our results of operation could be materially adversely affected and our financial condition would suffer.
Our strategy to reinsure the annuity policies we write may not be successful.
As part of our business plan, American Life intends to cede its annuity policies to other companies through reinsurance agreements. However, American Life will remain liable with respect to ceded insurance should any reinsurer fail to meet the obligations assumed by that reinsurer. The failure of any one of American Life’s reinsurers would likely have a material adverse economic effect on American Life, and the value of our voting common stock would likely decline significantly as well. Thus, it is critical that we adequately assess the financial strength of our reinsurers on an ongoing basis. If we fail to adequately assess reinsurer payment risk including the sufficiency of any amounts of collateral we may hold as security for claims payments we may require them to back up their potential obligations, we could be faced with severe economic consequences in the event any reinsurer does not meet its financial obligations to the policyholders of the annuities that we cede to the reinsurer. Also, we have a concentrated group of reinsurers, which heightens the risks we face should any reinsurer not meet its obligations to annuitants who purchase annuities from us.
We face a risk of unavailability and increased cost of reinsurance.
Market conditions beyond our control determine the availability and cost of the reinsurance we may seek to purchase. We can offer no assurance that reinsurance will remain continuously available to us to the same extent and on the same terms and rates as are currently available to us. If we are unable to maintain our current level of reinsurance or to purchase new reinsurance in amounts that we consider sufficient and at prices that we consider acceptable, we would either have to accept an increase in our net insurance liability exposures or reduce our annuity issuances. A reinsurer’s insolvency or inability to make payments under the terms of a reinsurance treaty could subject us to credit risk with respect to our ability to recover amounts due from reinsurers. Because of these risks, we may not be able to collect all amounts due to us from reinsurers. Further, reinsurance coverage may not be available to us in the future at commercially reasonable rates or at all.
We may be unable to expand insurance operations to other states to any significant degree.
A significant part of our business plan is expanding the ability of American Life to sell insurance in more states. At present, American Life is licensed to sell insurance in 24 states and the District of Columbia. While we are seeking to expand to additional states, we cannot assure you that these efforts will be successful, and to the extent they are not, our ability to achieve product scale and significant annuity sales will be adversely affected. Our results of operations and future prospects will in turn be adversely affected.
Our business success depends, in part, on effective information technology systems and on continuing to develop and implement improvements in our technology.
We depend in large part on our technology systems for conducting our business, as well as for providing the data and analytics we utilize to manage our business. Our business success is dependent on maintaining the effectiveness of existing technology systems and on continuing to develop and enhance technology systems in a cost efficient manner. System development projects may not deliver the benefits we expect, or may be replaced or become obsolete more quickly than expected, which could result in increased expenses. If we do not effectively and efficiently manage and upgrade our technology systems, or if the costs of doing so are higher than we expect, our ability to provide services to new and existing customers in a cost-effective manner and our ability to implement our business plan could be adversely impacted.
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We are faced with credit risks of our counterparties, which may have a material adverse effect on our operating results and financial condition.
In our investments we are exposed to many different industries, issuers and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, and other institutions. Many of these transactions expose us to credit risk in the event of default of the counterparty. In addition, with respect to secured transactions, our credit risk may be exacerbated when the collateral that we hold cannot be realized upon or is liquidated at prices not sufficient to recover the full amount due to us. We may have further exposure to these issuers in our holdings in unsecured debt instruments and derivative transactions of these issuers. There can be no guarantee that any such realized losses or impairments to the carrying value of these assets would not materially and adversely affect our results of operations and financial condition.
In addition to exposure to credit risks related to our investment portfolio, we are exposed to credit risks in several other areas of our business operations as discussed above and credit risks in our operations related to reinsurance. The collectability of reinsurance recoverables is subject to uncertainty arising from a number of factors, including changes in market conditions, whether insured losses meet the qualifying conditions of the reinsurance contract, and whether reinsurers, or their affiliates, have the financial capacity and willingness to make payments under the terms of a reinsurance treaty or contract. Since we are primarily liable to an insured for the full amount of insurance coverage, our inability to collect a material recovery from a reinsurer could have a material adverse effect on our operating results and financial condition.
We operate in a highly competitive industry, and our business will suffer if we are unable to compete effectively.
The operating results of insurance companies are subject to significant fluctuations due to competition, economic conditions, interest rates, investment performance, maintenance of insurance ratings from rating agencies such as A.M. Best and other factors. The insurance business is intensely competitive. Our ability to compete with other insurance companies is dependent upon, among other things, our ability to attract and retain IMOs to market our insurance products, our ability to develop competitive and profitable products, and our ability to obtain acceptable financial strength ratings. In connection with the development and sale of products, American Life encounters competition from other insurance companies, most of whom offer annuity products and have financial and human resources substantially greater than American Life’s, as well as competition from other investment alternatives available to potential annuitants.
American Life competes with several hundred other insurance companies in the United States. Most of these companies have greater financial resources, longer business histories, and more diversified lines of insurance and annuity product offerings than American Life. These larger companies also generally have large sales forces. We also face competition from direct mail and email sales marketers. We may not be able to compete successfully against these competitors.
Changes in the tax laws could adversely affect our business.
Congress has from time to time considered possible legislation that would eliminate the deferral of taxation on the accretion of value within certain annuity products. This and similar legislation could adversely affect the sale of annuities and life insurance compared with other financial products if such legislation were to be enacted. In addition, we could be unable to attract reinsurance capital. There can be no assurance as to whether any such legislation will be enacted or, if enacted, whether such legislation would contain provisions with possible adverse effects on any annuity products that we develop.
Under the Internal Revenue Code of 1986, income taxes payable by policyholders on investment earnings is deferred during the accumulation period of certain annuity and life insurance products. This favorable tax treatment may give certain insurance products a competitive advantage over other non-insurance products. To the extent that the Internal Revenue Code may be revised to reduce the tax-deferred status of annuity and life insurance products, or to increase the tax-deferred status of competing products, American Life and its industry as a whole would be adversely affected with respect to their ability to sell products. In addition, annuity and related life insurance products are often used to fund estate tax obligations. We cannot predict what future tax initiatives may be proposed with respect to the estate tax or other taxes that may materially adversely affect us.
Some of our investments are relatively illiquid.
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We hold certain investments that may lack liquidity, such as certain fixed maturity securities (including collateralized loan obligations and mortgage loans). We do not have the present intent to sell, nor is it more likely than not that we will be required to sell, debt securities in an unrealized loss position. Investment losses, however, may be realized to the extent liquidity needs require the disposition of debt securities in unfavorable interest rate, liquidity, or credit spread environments.
We have exposure to mortgage loans on real estate, which could cause declines in the value of our investment portfolio.
Securities and other capital markets products with respect to mortgage lending may become less liquid than conventional securities such as stocks and bonds. The value of our investments in mortgage loans may be negatively impacted by an unfavorable change in or increased uncertainty regarding delinquency rates, and refinancing availability. In addition, commercial mortgages are sensitive to the strength of the related underlying mortgage loans, the U.S. economy, and the supply and demand for commercial real estate. The value of our investments in mortgage loans and determination in loss allowances regarding such investments may be negatively impacted by declining loan to value ratios, especially with respect to loan to value ratios that exceed 80%. For the year ended December 31, 2022, our commercial mortgage loans investment portfolio had approximately $4.7 million in loans at or exceeding an 80% loan-to-value ratio compared to zero for the preceding year. Deterioration in the performance of the residential and commercial mortgage sector, including as a result of the COVID-19 pandemic or additional risk of loss in connection with increasing loan-to-value ratios, could cause declines in the value of that portion of our investment portfolio. The carrying value of our mortgage loans on real estate as of December 31, 2022 and 2021, was $227 million and $183.2 million, respectively. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Changes in regulations regarding suitability of product sales and fiduciary/best interest standards may affect our operations and profitability.
Our annuity sales practices are subject to strict regulation. State insurance regulators are becoming more active in adopting and enforcing suitability standards with respect to sales of annuities. In addition, our insurance operations may be impacted by actions taken by the NAIC, the U.S. standard setting and regulatory support organization created and governed by the chief insurance regulatory authorities of the 50 states, the District of Columbia and the five U.S. territories. Some states have enacted or proposed legislation to impose new or expanded fiduciary/best interest standards on broker dealers, investment advisors and/or insurance agents providing services to customers. At the federal level, the U.S. Department of Labor (the “DOL”) adopted a new prohibited transaction exemption, effective on February 16, 2021, which allows the payment of compensation to investment advice fiduciaries who comply with the exemption’s requirements and imposes a best interest standard of conduct for retail investment advice, including recommendations to “roll over” assets from a qualified retirement plan to an individual retirement account (“IRA”) or from one IRA to another IRA. The DOL has also indicated in its regulatory agenda that it plans to issue proposed rulemaking related to fiduciary advice. Any material changes to the standards governing our sales practices, including applicable laws and regulations, could adversely affect our business, results of operations and financial condition.
The inability to obtain upgrades to our financial strength and other ratings from A.M. Best, or the possibility of a downgrade in our ratings, may have a material adverse effect on our competitive position, the marketability of our annuity product offerings, and our liquidity, operating results, financial condition, and prospects.
Financial strength ratings are important factors in establishing the competitive position of insurance companies and generally have an effect on an insurance company’s business. Many insurance buyers, agents, brokers, and secured lenders use the ratings assigned by A.M. Best and other agencies to assist them in assessing the financial strength and overall quality of the companies from which they are considering purchasing insurance or in determining the financial strength of the company that provides insurance with respect to the collateral they hold. American Life currently has an A.M. Best financial strength rating of B++ (Good) and long-term issuer credit rating of bbb+. A.M. Best ratings are derived from an in-depth evaluation of an insurance company’s balance sheet strengths, operating performances, and business profiles. A.M. Best evaluates, among other factors, the company’s capitalization, underwriting leverage, financial leverage, asset leverage, capital structure, quality and appropriateness of reinsurance, adequacy of reserves, quality and diversification of assets, liquidity, profitability, spread of risk, revenue composition, market position, management, market risk, and event risk. On an ongoing basis, rating agencies such as A.M. Best review the financial performance and condition of insurers and may downgrade or change the outlook on an insurer’s ratings due to, for example, a change in an insurer’s statutory capital, a reduced confidence in management, or a host of other considerations that may or may not be under the insurer’s control. All ratings are subject to continuous review; therefore, the retention of these ratings cannot be assured. A downgrade in any of these ratings could have a material adverse effect on our competitiveness, the marketability of our product offerings, and our ability to grow in the marketplace.
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Our new insurance products and other products we may develop may not achieve market penetration.
As discussed elsewhere in this Annual Report on Form 10-K, our marketing strategy is focused on the sale of MYGA and FIA products through IMOs. These products may not achieve market acceptance or penetration to any meaningful degree, and any significant sales of these products cannot be assured, nor can we assure that any other insurance products we attempt to sell will achieve any degree of sustained marketing success. We are seeking to streamline the costs of developing and placing our annuity products into the marketplace to be sold by IMOs. We may encounter unexpected development costs or lack of IMO acceptance of our products, in which case our financial results would be disappointing.
We are highly dependent upon Georgette Nicholas, our Chief Executive Officer, and Mike Minnich, our President, and the loss of either of these officers could materially and adversely affect our business.
Our ability to operate successfully is dependent primarily upon the efforts of Georgette Nicholas and Mike Minnich, our key executive officers. The loss of the services of either of these individuals could have a material adverse effect on our ability to pursue our business plan. We have employment agreements with Ms. Nicholas and Mr. Minnich and we have limited “key person” life insurance on Mr. Minnich, but there are no restrictions on their termination of employment with us.
Midwest is a holding company whose principal operating subsidiary is American Life.
Midwest depends primarily on reimbursement of costs from American Life, Seneca Re, and 1505 Capital and has no other significant source of revenue. Our change in control that occurred in 2018 with the infusion of capital from Xenith, discussed above, along with net proceeds of the 2020 public offering of our voting common stock, may not provide adequate long-term financing to support our contemplated expansion of American Life’s business or any continued reimbursements to Midwest. If there is not a substantial expansion of American Life’s business, it may not be able to provide funds to Midwest to enable Midwest to meet its obligations. American Life is also restricted by state insurance laws as to fund transfers, by way of dividends or otherwise, to Midwest.
Our investment adviser subsidiary is subject to numerous laws and regulations with substantial compliance costs.
Our wholly owned investment adviser subsidiary, 1505 Capital, is subject to substantial regulation. It is registered with the SEC as an investment adviser, is subject to examination by the SEC, and is required to file detailed reports with the SEC concerning its business. It is subject to the Investment Advisers Act of 1940 as well as other state securities laws regarding the conduct of its business. Compliance with these regulations is time consuming and is a burden on the operations of 1505 Capital. There can be no assurance that 1505 Capital will not be adversely affected by the results of any future examination.
We have experienced significant operating losses and may not be able to reverse them in the foreseeable future.
We commenced our business plan in mid-2018 and introduced our first annuity products in 2019. We incurred substantial operating losses in 2021 and 2020, and there can be no assurance of our future profitability. Because ceding commissions from reinsurance are amortized over the life of the policy, we expect several years of insurance policy sales growth will be necessary until we consistently achieve net income on a GAAP basis.
American Life may encounter regulatory difficulties or fail as a result of being inadequately capitalized.
American Life must have adequate capital and surplus capital, calculated in accordance with SAP prescribed by state insurance regulatory authorities to meet regulatory requirements in Nebraska, the state of domicile of American Life. It had approximately $69.9 million of capital and surplus (based upon SAP) as of December 31, 2022. Because we have embarked upon a business plan under which we write new insurance business and seek to cede a substantial amount of the risk to third-party reinsurers, the NDOI may require additional amounts of capital and surplus to support the expanded business of American Life going forward. The amount of capital and surplus of American Life ultimately required will be based on certain “risk-based capital” standards established by statute and regulation administered by the NDOI. The “risk-based capital” system establishes a framework for evaluating the adequacy of the minimum amount of capital and surplus, calculated in accordance with SAP, necessary for an insurance company to support its overall business operations. It identifies insurers that may be inadequately capitalized by reviewing certain inherent risks of each insurer’s
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assets and liabilities and its mix of net premiums written. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action, including supervision, rehabilitation, or liquidation. If American Life fails to maintain required capital levels in accordance with the “risk-based capital” system, its ability to conduct business would be compromised and our ability to expand our insurance business would be significantly reduced absent a prompt infusion of capital into American Life.
We may execute an acquisition strategy, which could cause our business and future growth prospects to suffer.
We may at some time pursue acquisitions of insurance-related companies. If we were to pursue acquisitions, we would compete with other companies, most of which have greater financial and other resources than us. Further, if we were to succeed in consummating acquisitions, our business, financial condition, and results of operations may be negatively affected because:
| ● | some of the acquired businesses may not achieve anticipated revenues, earnings, or cash flows; |
| ● | we may have to assume liabilities that were not disclosed or exceed estimates; |
| ● | we may be unable to integrate acquired businesses successfully and realize anticipated economic, operational, and other benefits in a timely manner; |
| ● | acquisitions could disrupt our on-going business, distract our management, and divert our financial and human resources; |
| ● | we may experience difficulties operating in markets in which we have no or only limited direct experience; and |
| ● | of the potential for loss of customers and key employees of any acquired company. |
Risks Related to Our Voting Common Stock
Ownership of shares of Midwest voting common stock involves substantial risk, and the entire value of those shares may be lost.
Shares of our voting common stock constitute a high-risk, speculative investment in a business that has incurred substantial losses in the past and may incur losses in the future. No assurance can be given that any of the potential benefits envisioned by our business plan will prove to be available to our stockholders, nor can any assurance be given as to the financial return, if any, which may result from ownership of our voting common stock. The entire value of your shares of Midwest voting common stock may be lost.
The market price and trading volume of our voting common stock have been volatile, which has resulted in, and could continue to result in rapid and substantial losses for our stockholders.
Trading and prices of our voting common stock were highly volatile in 2022 and could be subject to wide fluctuations in the future. There are many factors that will impact our stock price and trading volume, including, but not limited to, the factors listed above under “Risks Related to Our Business.” In addition, the low trading volume in our voting common stock may fluctuate and cause significant price variations to occur. If the market price of our voting common stock declines significantly, you may be unable to resell your shares at or above your purchase price, if at all. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our voting common stock include:
| ● | operating results that vary from the expectations of investors and securities analysts; |
| ● | significant sales of our voting common stock or other securities in the open market; |
| ● | lack of interest in our voting common stock from institutions, securities analysts, and retail investors; |
| ● | quarterly variations in our operating results; |
| ● | the financial projections we may provide to the public, any changes in these projections or our ability to meet these projections; |
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| ● | changes in investment valuations; |
| ● | changes (including legislative and regulatory changes) in the industries in which we operate; |
| ● | announcements by us or companies in our industries of significant contracts, acquisitions, dispositions, strategic partnerships, joint ventures, capital commitments, plans, prospects, service offerings or operating results; |
| ● | additions or departures of key personnel; |
| ● | future sales of our securities; |
| ● | developments in the financial markets and worldwide or regional economies, including bank failures and concerns of an economic downturn or recession; |
| ● | announcements of innovations or new products, solutions, or services by us or our competitors; |
| ● | variations in interest rates; and |
| ● | changes in accounting principles. |
Stock markets in the United States have experienced significant price and volume fluctuations. Market fluctuations, as well as general political and economic conditions such as the global COVID-19 pandemic and the associated economic and market disruption, acts of terrorism, war, such as the conflict between Russia and Ukraine, prolonged economic uncertainty, a recession, or interest rate or currency rate fluctuations, could adversely affect the market price of our voting common stock.
Our failure to meet the continued listing requirements of The Nasdaq Capital Market could result in a delisting of our voting common stock.
Our shares of voting common stock are listed on The Nasdaq Capital Market. If we fail to satisfy the continued listing requirements of The Nasdaq Capital Market, Nasdaq may take steps to delist our voting common stock. Such a delisting would likely have a negative effect on the price of our voting common stock, and would impair your ability to sell our voting common stock when you wish to do so. In the event of a delisting, we would take actions to restore our compliance with Nasdaq’s listing requirements, but we can provide no assurance that any such action taken by us would allow our voting common stock to become listed again, stabilize the market price or improve the liquidity of our voting common stock, or prevent future non-compliance with Nasdaq’s listing requirements.
As a smaller reporting company, we are subject to scaled disclosure requirements that may make it more challenging for investors to analyze our results of operations and financial prospects.
Currently, we are a “smaller reporting company,” which generally means that our outstanding common stock held by non-affiliates had a market value of less than $250 million as of the last business day of our second fiscal quarter. As a “smaller reporting company,” we are able to provide simplified executive compensation disclosures in our filings; are exempt from the provisions of Section 404(b) of the Sarbanes Oxley Act requiring that independent registered public accounting firms provide an attestation report on the effectiveness of internal control over financial reporting; and have certain other decreased disclosure obligations in our filings with the SEC, including being required to provide only two years of audited financial statements in annual reports. Consequently, for so long as we qualify as a “smaller reporting company,” we may continue to take advantage of these exemptions and it may be more challenging for investors to analyze our results of operations and financial prospects. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile. Further, a material weakness in internal controls may remain undetected for a longer period because of our extended exemption from the auditor attestation requirements under Section 404(b) of the Sarbanes-Oxley Act.
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There may be future issuances or resales of our voting common stock which may materially and adversely affect the market price of our voting common stock.
Subject to any required state insurance regulatory approvals, we are not restricted from issuing additional shares of our voting common stock in the future, including securities convertible into, or exchangeable or exercisable for, shares of our voting common stock. Our issuance of additional shares of voting common stock in the future will dilute the ownership interests of our then existing stockholders.
The sale of a substantial number of shares of our voting common stock or securities convertible into, or exchangeable or exercisable for, shares of our voting common stock, whether directly by us in future offerings or by our existing stockholders in the secondary market, the perception that such issuances or resales could occur or the availability for future issuances or resale of shares of our voting common stock or securities convertible into, or exchangeable or exercisable for, shares of our voting common stock could materially and adversely affect the market price of our voting common stock and our ability to raise capital through future offerings of equity or equity-related securities on attractive terms or at all.
In addition, our Board is authorized to designate and issue preferred stock without further stockholder approval, and we may issue other equity and equity-related securities that are senior to our voting common stock in the future for a number of reasons, including, without limitation, to support operations and growth, to maintain our capital ratios, and to comply with any future changes in regulatory standards.
Our executive officers and directors own a substantial number of shares of our voting common stock. This will enable them to significantly influence the vote on all matters submitted to a vote of our stockholders.
As of December 31, 2022, our executive officers and directors beneficially owned 603,547 shares of our voting common stock, representing approximately 16.2% of the outstanding shares of our voting common stock.
Accordingly, our executive officers and directors, through their beneficial ownership of our voting common stock, will be able to significantly influence the vote on all matters submitted to a vote of our stockholders, including the election of directors, amendments to our certificate of incorporation or bylaws, mergers or other business combination transactions, and certain sales of assets outside the regular course of business. The interests of our executive officers and directors may not coincide with the interests of our other stockholders, and they could take actions that advance their own interests to the detriment of our other stockholders.
The indemnification rights provided to our directors, officers, and employees may result in substantial expenditures by us and may discourage lawsuits against them.
Our certificate of incorporation and Delaware law provide for broad indemnification of our directors, officers and employees. Our indemnification obligations could result in us incurring substantial expenditures to cover the costs of settlement or damage awards against directors, officers and employees, which we may be unable to recoup. These provisions and resultant costs may also discourage us from bringing an action against our directors and officers for breaches of their fiduciary duties, and may similarly discourage the filing of derivative litigation by our stockholders against our directors or officers even though such actions, if successful, might otherwise benefit us and our stockholders.
We do not expect to pay any cash dividends to stockholders.
To date, we have never declared or paid any cash dividends to our stockholders and do not expect to do so for the foreseeable future. The declaration, payment, and amount of any future dividends will be made at the discretion of our Board, and will depend upon, among other things, the results of our operations, cash flows and financial conditions, operating and capital requirements, and other factors as the Board considers relevant. In addition, our ability to pay cash dividends depends, in part, upon on the ability of American Life to provide us with payments from its operations, which are subject to prior regulatory approval for the most part. As an insurance company, American Life is subject to significant regulatory restrictions limiting its ability to declare and make payments or dividends to Midwest.
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If securities or industry analysts do not publish research or reports about our business, or if they issue adverse or misleading opinions regarding us, our voting common stock price and trading value could decline.
The trading market for our voting common stock is influenced by research and reports that industry or securities analysts publish about us or our business. If any of the analysts who cover us issue an adverse or misleading opinion regarding us, our business model, or our voting common stock performance, or if our target operating results fail to meet the expectations of analysts, our voting common stock price would likely decline. If one or more of these analysts cease coverage of us or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price and trading volume to decline.
Anti-takeover provisions and the regulations to which we may be subject may make it more difficult for a third- party to acquire control of us, even if the change in control would be beneficial to our stockholders.
We are a holding company incorporated in Delaware. Anti-takeover provisions in Delaware law and our certificate of incorporation and bylaws, as well as regulatory approvals required under state insurance laws, could make it more difficult for a third- party to acquire control of us and may prevent stockholders from receiving a premium for their shares of voting common stock. Our certificate of incorporation provides that our Board may issue up to 2,000,000 shares of preferred stock, in one or more series, without stockholder approval and with such terms, preferences, rights, and privileges as the Board may deem appropriate. These provisions, the control of our executive officers and directors over the election of our directors, and other factors may hinder or prevent a change in control, even if the change in control would be beneficial to, or sought by, our stockholders.
Eight individuals currently serve on our Board, which is divided into three classes with staggered three-year terms. At each annual meeting of stockholders, a class of directors is to be elected for a three-year term to succeed the directors of the same class whose terms are then expiring. As a result, a portion of our Board will be elected each year. Our certificate of incorporation authorizes our Board to fix the number of directors from time to time by a resolution of the majority of our Board. Any additional directorships resulting from an increase in the number of directors will be distributed among the three classes so that, as nearly as possible, each class shall consist of one-third of the directors. The division of our Board into three classes with staggered three-year terms may delay or prevent a change of our management or a change in control. Between stockholder meetings, directors may be removed by our stockholders only for cause, and the Board may appoint new directors to fill the vacancies. These provisions may prevent a stockholder from removing incumbent directors and simultaneously gaining control of the Board by filling the resulting vacancies with its own nominees. Consequently, the existence of these provisions may have the effect of deterring hostile takeovers, which could depress the market price of our voting common stock.
General Risks
The ongoing events resulting from the COVID-19 pandemic, and the uncertainty regarding future similar events, could have an adverse impact on our financial condition, results of operations, cash flows, liquidity, and prospects.
We continue to closely monitor developments related to the coronavirus (COVID-19) pandemic to assess potential adverse impacts on our business. Due to the evolving and highly uncertain nature of this pandemic, it currently is not possible provide a longer-term estimate of potential insurance or reinsurance exposure or the indirect effects the pandemic may have on our results of operations, financial condition, or liquidity. Management implemented the Company’s business continuity plan in early March 2020 and operated through July 2020 with the majority of employees working remotely. Operations continued as normal despite a sharp increase in sales during the period. We continue to monitor the Centers for Disease Control and Prevention and Nebraska guidelines regarding employee safety.
If the COVID-19 pandemic and associated economic slowdown continues it could adversely impact our future results of operations, financial condition, cash flows, liquidity, and prospects in a number of ways, including:
| ● | Our investment portfolio (and, specifically, the valuations of investment assets we hold) could be materially and adversely affected as a result of market developments from the pandemic and uncertainty regarding its outcome. Moreover, changes in interest rates, reduced liquidity, or a slowdown in the U.S. or global economic conditions may also adversely affect the values and cash flows of these assets. Our investments in mortgages and asset-backed securities could be negatively affected by |
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| delays or failures of borrowers to make payments of principal and interest when due or delays or moratoriums on foreclosures or enforcement actions with respect to delinquent or defaulted mortgages imposed by governmental authorities. Further, extreme market volatility may leave us unable to react to market events in a prudent manner consistent with accepted investment practices in dealing with more orderly markets; |
| ● | Potential impacts on our operations due to efforts to mitigate the pandemic, including government mandated shutdowns, requests or orders for employees to work remotely, and other social distancing measures, which could result in an adverse impact on our ability to conduct our business, including our ability to sell policies, and adjust certain claims; |
| ● | Potential impacts on morbidity could adversely affect the potential profitability of our annuity products; |
| ● | We also outsource certain critical business activities to third parties such as our IMOs. As a result, we rely upon the successful implementation and execution of the business continuity planning of such entities in the current environment. While we monitor the business continuity activities of these third parties, successful implementation and execution of their business continuity strategies are largely outside our control. If one or more of the third parties on whom we rely for critical business activities experience operational difficulties or failures as a result of the impacts from the spread of COVID-19, it may have a material adverse effect on our business, financial condition, results of operations, liquidity, and cash flows; and |
| ● | Potential impacts of COVID-19 on reinsurers and the cost and availability of reinsurance. |
Finally, we cannot predict how legal and regulatory responses to concerns about COVID-19 and related public health issues, including responses to any future outbreaks of communicable diseases, will impact our business. The continued spread of COVID-19 and its variants has led to disruption and volatility in the global capital markets which could increase our funding costs and limit our access to the capital markets. Accordingly, we may in the future have difficulty accessing capital on attractive terms, or at all, which could have a material adverse effect on our business, results of operations, financial condition and liquidity.
Catastrophes may adversely impact liabilities for policyholder claims and reinsurance availability.
Claims resulting from catastrophic events could harm our financial results, profitability, and financial condition. Catastrophic events could impact our insurance business by significantly impacting our assumptions as to mortality, morbidity, and other rates, as well as product sales. Catastrophic events may also reduce economic activity in affected areas, which could harm our prospects for new business. In addition, catastrophes could cause unanticipated financial strain on our insureds as well as increase the cost of reinsurance to us and decrease the availability of reinsurance, which could in turn harm our business, results of operations, or financial condition.
Claims loss reserves may be inadequate.
We maintain loss reserves to cover estimated liabilities for unpaid losses and loss expenses, including legal and other fees, as well as other claims and settlement costs for reported and unreported claims incurred as of the end of each accounting period. Loss reserves do not represent an exact calculation of liability. Rather, reserves represent an estimate of what we expect the ultimate settlement and administration of claims will cost. These estimates, which generally involve actuarial projections, are based on the assessment of facts and circumstances then known, as well as estimates of future trends in claims severity, frequency, and other factors. The variables described above are affected by both internal and external events, such as changes in claims handling procedures, economic inflation, judicial and litigation trends, and legislative changes. Many of these items are not directly quantifiable in advance. Additionally, there may be a significant delay between the occurrence of the insured event and the time it is reported to us.
Reserve estimates are continually refined as experience develops and further claims are reported and settled. Adjustments to reserves are reflected in the results of the periods in which such estimates are changed. Because setting reserves is inherently uncertain, we cannot assure that our current reserves will prove adequate in light of subsequent events, including for example the uncertainties relating to the COVID-19 pandemic. Accordingly, the ultimate settlement of losses may be significantly greater or less than the loss and loss expense reserves as of the date of the balance sheet. If our loss reserves are determined to be inadequate, we will be required to increase loss reserves at the time of such determination with a corresponding decrease in our profitability. If the increase in loss reserves is large enough, we could incur a net loss and a net reduction of our capital.
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Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs and access the capital required to operate our business.
In the insurance industry, liquidity refers to the ability of an insurance company to generate adequate amounts of cash from its normal operations, including from its investment portfolio, in order to meet its financial commitments, which are principally obligations under the insurance policies it has written.
The capital and credit markets have historically experienced significant volatility and disruption. In some cases, the markets have exerted downward pressure on the availability of liquidity and credit capacity. In the event that we need access to additional capital to pay our operating expenses, or increase the amount of insurance that we seek to underwrite, or otherwise grow our business, our ability to obtain such capital may be limited and the cost of any such capital may be significant. In addition, the availability of additional financing will depend on a variety of factors, including capital and credit market conditions, the availability of credit generally and specifically to the financial services industries, market liquidity, our creditworthiness, as well as the possibility that customers or capital providers could develop a negative perception of our long or short-term financial prospects if we incur large investment losses or if our level of business activity decreases. Similarly, our access to capital may be impaired if regulatory authorities or rating agencies take negative actions against us. Our internal sources of liquidity may prove to be insufficient, and we may not be able to successfully obtain additional financing on favorable terms, or at all. As such, we may be forced to issue securities with terms and conditions that may be unfavorable to us, to accept an unattractive cost of capital or to sell certain assets, any of which could decrease our profitability and significantly reduce our financial flexibility. If a combination of these factors occurs, our internal sources of liquidity may prove to be insufficient and, in such case, we may not be able to successfully obtain additional financing on terms favorable to us.
The transition from LIBOR to alternative reference “benchmark” interest rates is uncertain and could adversely affect the value of or the interest rates on our investments and obligations indexed to LIBOR, as well as the revenue and expenses associated with those assets and obligations.
LIBOR is an interest rate benchmark that has been widely used in financial contracts around the world for decades. In July 2017, the United Kingdom’s Financial Conduct Authority (“FCA”), which regulates the London Interbank Offered Rate (“LIBOR”), announced that it intended to phase out LIBOR by the end of 2021. Following discussions with the FCA and other official sector bodies, the Intercontinental Exchange Benchmark Administration announced in March 2021 that the publication of certain USD LIBOR settings will continue through June 30, 2023. The Alternative Reference Rates Committee of the Federal Reserve Board (“ARRC”), a group of market participants convened to help ensure a successful transition away from LIBOR, has recommended the Secured Overnight Financing Rate (“SOFR”) as its preferred alternative reference rate and has proposed a transition plan and timeline designed to encourage the adoption of SOFR from LIBOR.
We are in the process of analyzing and identifying our population of securities, financial instruments, and contracts that utilize LIBOR (collectively “LIBOR Instruments”) to determine if we have any material exposure to the transition from LIBOR. To the extent we hold LIBOR Instruments, the terms of these instruments may have fallback provisions that provide for an alternative reference rate when LIBOR ceases to exist. For securities without adequate fallback provisions already in place, federal legislation has been enacted to provide a safe harbor for transition to the recommended alternative reference rate.
Notwithstanding the availability of statutory guidance on fallback procedures, in preparation for the phase out of LIBOR, we may need to renegotiate our LIBOR Instruments that utilize LIBOR. However, these efforts may not be successful in mitigating the legal and financial risk from changing the reference rate in our LIBOR Instruments. Furthermore, the discontinuation of LIBOR may adversely impact our ability to manage and hedge exposures to fluctuations in interest rates using derivative instruments.
As a result, the transition of our LIBOR Instruments to alternative reference rates, including SOFR, may result in adverse changes to the net investment income, fair market value and return on those investments. We intend to continue evaluating and monitoring the risks associated with the LIBOR transition which include identifying and monitoring our exposure to LIBOR and ensuring operational processes are updated to accommodate alternative rates. Due to uncertainty surrounding the effect of adopting or transitioning to alternative rates, such as SOFR, we are unable to predict the overall impact of this change at this time.
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The insurance industry is subject to numerous laws and regulations, and compliance costs and/or changes in the regulatory environment that could adversely affect our business.
Our insurance operations are subject to government regulation in each of the states in which we conduct business. Such regulatory authority is vested in state agencies that are concerned primarily with the protection of policyholders rather than shareholders. These state insurance regulatory authorities have broad administrative powers dealing with all aspects of the insurance business, including, among other areas, regulation of the advertising and marketing of insurance, privacy of policyholders, acquisitions of regulated insurance entities, payment of dividends, reinsurance, the form and content of insurance policies (including pricing), operating and agent licenses, regulation of premium rates, premium tax increases, rating and underwriting restrictions and limitations, asset and reserve valuation requirements, enterprise risk management, surplus requirements, the type or amount of investments, accounting standards, Risk-Based Capital (“RBC”) requirements, statutory reserve and capital requirements, assessments by guaranty associations, affiliate transactions, and unfair trade and claims practice.
In addition, our insurance operations may be impacted by actions taken by the NAIC. A primary mandate of the NAIC is to benefit state insurance regulatory authorities and consumers by promulgating model insurance laws and regulations for adoption by the states. The NAIC also provides standardized insurance industry accounting and reporting guidance through the NAIC Accounting Manual. However, model insurance laws and regulations are only effective when adopted by the states, and statutory accounting and reporting principles continue to be established by individual state laws, regulations, and permitted practices. Changes to the NAIC Accounting Manual or modifications by the various state insurance departments may adversely affect the statutory capital and surplus of American Life. See “Regulation” for further discussion.
The NAIC and state insurance regulators reexamine existing laws and regulations on an ongoing basis, and focus on insurance company investments and solvency issues, risk-based capital guidelines, interpretations of existing laws, the development of new laws, the implementation of non-statutory guidelines, and the circumstances under which dividends may be paid. Future NAIC initiatives, and other regulatory changes, could have a material adverse impact on our insurance business. There can be no assurance that American Life will be able to satisfy the regulatory requirements of the NDOI or a similar department in any other state in which it transacts business. A significant component of our business plan is to reinsure a significant portion of the insurance policies that we issue. It should be assumed that state regulators will monitor carefully the financial strength of any third-party reinsurer and in certain instances may require that sufficient funds be reserved by us in order to alleviate risks associated with reinsurers being unable to meet their financial commitments in the case of claims on insurance policies with a reinsurer. This oversight may result in our operations being less economically successful than we are seeking and could adversely affect our result of operations and therefore the value of our voting common stock.
In addition, as the owner of a life insurance subsidiary, Midwest is itself regulated by the NDOI and, to a lesser extent, by the various state insurance regulatory authorities of those U.S. jurisdictions where American Life is licensed. All U.S. states have enacted legislation requiring each insurance holding company and each insurance company in an insurance holding company system to register with the insurance regulatory authority of the insurance company’s state of domicile (in the case of American Life, Nebraska) and to furnish annually financial and other information concerning the operations of companies within the holding company system that materially affect the operations, management, or financial condition of the insurers within such system (generally referred to as “insurance holding company acts”). Under such laws, among other requirements, transactions between Midwest and its regulated insurance subsidiaries and affiliates must be fair and reasonable and, if material or of a specified category, they require prior notice and approval or non-disapproval by the state of domicile of each insurance company that is party to the transaction. In addition, under such laws, a state insurance authority usually must approve in advance the direct or indirect acquisition of 10% or more of the voting securities of an insurance company domiciled in its state.
In addition, American Life generally may not pay dividends without giving prior notice thereof to the NDOI and generally may not pay extraordinary dividends without obtaining the prior approval or non-disapproval of such regulators. The laws and regulations prohibit an insurer from, without regulatory approval, paying an “extraordinary” dividend, which is generally defined as any dividend paid from other than earned surplus or exceeding certain thresholds specified in the applicable state insurance laws.
As a component of its ongoing efforts to remain compliant with the U.S. insurance regulatory regime, we file detailed annual reports with respect to American Life with the NDOI and all of the states in which American Life is licensed. Also, the business and accounts of American Life are subject to examination by the NDOI, as well as inquiries including investigations of the various insurance regulatory authorities of the states in which American Life is licensed.
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Development of annuity and life insurance products involves the use of certain assumptions, and the inaccuracy of these assumptions could adversely affect profitability.
In our insurance business, we must make certain assumptions as to expected mortality, lapse rates, and other factors in developing the pricing and other terms of insurance products. These assumptions are based on industry experience and are reviewed and revised regularly to reflect actual experience on a current basis. However, variation of actual experience from that assumed in developing such terms may affect a product’s profitability or sales volume and in turn adversely impact our revenues and profitability.
If we underestimate our liability for future policy benefits, our results of operations could suffer.
Liabilities established for future life insurance policy benefits are based upon a number of factors, including certain assumptions such as mortality, morbidity, lapse rates, and crediting rates. Unforeseen events like epidemics or pandemics could arise and have an adverse effect on our assumptions as to morbidity and mortality. If we underestimate future policy benefits, we will incur additional expenses at the time we become aware of the inadequacy. As a result, our losses would increase and our ability to achieve profits would suffer.
Fluctuations in interest rates could cause a reduction in investment income or adversely affect the market value of interest-rate sensitive investments, which could adversely affect our business and could cause our debt service obligations to increase significantly.
Interest rate fluctuations may impair an insurance company’s ability to pay policyholder benefits with operating and investment cash flows, cash on hand and other cash sources. Our annuity products expose us to the risk that changes in interest rates will reduce any spread, or the difference between the amounts that American Life is required to pay under the contracts and the amounts American Life is able to earn on its investments intended to support its obligations under its annuity contracts. Spread is a key component of net revenues.
To the extent that interest rates credited are less than those generally available in the marketplace, policyholder lapses, policy loans and surrenders, and withdrawals of annuity contracts may increase as contract holders seek to purchase products with perceived higher returns. This process may result in cash outflows requiring that American Life sell investments at a time when the prices of those investments are adversely affected by the increase in market interest rates, which may result in realized investment losses.
Increases in market interest rates may also negatively affect profitability. In periods of increasing interest rates (such as those the U.S. and certain foreign markets are currently experiencing), we may not be able to replace invested assets with higher yielding assets needed to fund the higher crediting rates that may be necessary to keep interest sensitive products competitive. American Life, therefore, may have to accept a lower spread and thus lower profitability or face a decline in sales and greater surrender of existing annuity contracts.
Additionally, borrowings under our Revolving Credit Facility (as defined below) are at variable rates of interest and expose us to interest rate risk. The recent rise in interest rates has increased our cost of borrowing.
We are subject to extensive regulation.
As stated above, we are subject to extensive state regulatory oversight in the jurisdictions in which we do business, as well as federal oversight with respect to certain portions of our business. Changes in state regulations, or in the interpretation or application of existing state laws or regulations, may adversely impact our pricing, capital requirements, reserve adequacy, or exposure to litigation and could increase the costs of our regulatory compliance.
Changes are often implemented by state regulators in order to benefit policyholders to the detriment of insurers. State insurance regulators and the NAIC continually reexamine existing laws and regulations and may impose changes in the future that put further regulatory burdens on us and, thus, could have an adverse effect on our results of operations and financial condition.
In addition, state insurance laws, rather than federal bankruptcy laws, govern the liquidation or restructuring of insurance companies. Virtually all states in which we operate require that we bear a portion of the loss suffered by some insureds as the result of impaired or insolvent insurance companies via participation in state guaranty associations. The effect of these and similar arrangements could reduce our profitability in any given period and/or limit our ability to grow our business. Finally, some insurers of the programs or
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associations to make payments to insureds for losses could have a material adverse effect on our results of operations and financial condition.
From time to time, increased scrutiny has been placed upon the U.S. insurance regulatory framework by both federal and state legislators and regulators. A number of state legislatures have considered or enacted legislative measures that alter, and in many cases increase, state authority to regulate insurance and reinsurance companies. In addition to legislative initiatives of this type, the NAIC and insurance regulators are regularly involved in a process of reexamining existing laws and regulations and their application to insurance and reinsurance companies.
We cannot predict the effect that any proposed or future federal or state legislation or change in the interpretation or application of existing laws or regulations may have on our financial condition or results of operations.
A failure to comply with rules and regulations in a jurisdiction could lead to disciplinary action, the imposition of fines or the revocation of the license, permission or authorization necessary to conduct our businesses in that jurisdiction, all of which could have a material adverse effect on the continued conduct of business in a particular jurisdiction.
The impact on potential customers and vendors of sustained or significant deterioration in economic conditions, including due to concerns of a potential economic downturn or recession, could adversely affect our business.
We are exposed to risks associated with the potential financial instability of our customers, many of whom may be adversely affected by an economic slowdown or recession, inflation, or rising interest rates. As a result of macroeconomic challenges currently or potentially affecting the economy of the U.S. and other parts of the world, customers may experience serious cash flow problems and other financial difficulties. In addition, events in the U.S. or foreign markets, such as the COVID-19 pandemic, the rising rate of inflation that the U.S. is currently experiencing, bank failures, and the conflict between Russia and Ukraine, may continue to impact the global economy and capital markets. The impact of such events is difficult to predict. As a result, customers and potential customers may modify, delay, or cancel plans to purchase our products. Additionally, if customers are not successful in generating sufficient incomes, they may not be able to pay, or may delay payment of, premiums and other amounts that are owed to us. Any liability of current or potential customers to pay us for our products may adversely affect our earnings and cash flow.
A general economic slowdown or recession could potentially adversely affect us in the form of consumer behavior, particularly through decreased demand for our products. In addition, we are susceptible to risks associated with the potential financial instability of the vendors on which we rely to provide services or to whom we delegate certain functions. The same conditions that may affect our customers also could adversely affect our vendors, causing them to significantly and quickly increase their prices or reduce their output. Our business depends on our ability to perform, in an efficient and uninterrupted fashion, our necessary business functions, and any interruption in the services provided by third parties could also adversely affect us.
Defaults on commercial mortgage loans and volatility in performance may adversely affect our results of operations and financial condition.
A decline in the commercial real estate market within the U.S. resulting from changes in interest rates, real estate market conditions or an economic downturn or recession may have a negative impact on the value of our commercial mortgage loan portfolio. Negative developments across a certain property type or the occurrence of a negative event within a geographic region may have a significant negative impact, based on concentration within that property type or geographic region. Our operations and financial condition may be adversely affected from an increase in borrower defaults within our commercial mortgage loan portfolio. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Our valuation of investments and the determinations of the amount of allowances and impairments taken on our investments may include methodologies, estimations and assumptions that are subject to differing interpretations and, if changed, could materially adversely affect our results of operations or financial condition.
Fixed maturities, equity securities and derivatives represent the majority of assets and liabilities reported at fair value on our Consolidated Balance Sheets. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). Fair value estimates are made based on available market information and judgments about the financial instrument at a specific point in time. Considerable judgment is often
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required to develop estimates of fair value, and the use of different assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.
As an example, our registered independent accounting firm has identified the valuation of embedded derivatives of fixed indexed annuities as a critical audit matter. Our FIA contracts allow the policyholder to elect a fixed interest rate return or an equity market component for which interest credited is based on the performance of certain stock market indices. The equity market option is an embedded derivative. The fair value of the embedded derivatives is computed as the present value of death, surrender, and partial withdrawal benefits attributable to the excess of the projected policy contract values over the projected minimum guaranteed contract values. The projections of policy contract values are based on assumptions for future policy growth, which included assumptions for expected index credits on the next policy anniversary date, future equity option cost developed based on the participation rate, cap rate, strike rate, volatility assumption, time to expiration, and risk-free rates using the Black Scholes formula and grow at the risk-free interest rates over the term of the index period, guaranteed minimum renewal interest rate, and policyholder assumptions including mortality, lapses, partial withdrawal rates, and the utilization of benefit riders. Because of the significant subjectivity and estimation of the valuation inputs, the valuation of our embedded derivatives could vary significantly as conditions change and new information and becomes available. Decreases in value may have a material adverse effect on our results of operation or financial condition.
Our determination of the amount of allowances and impairments varies by investment type and is based on our periodic evaluations and assessments of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. We update our evaluations regularly and make changes in allowances and impairments in operations. Market volatility, including as a result of the COVID-19 pandemic, inflation, bank failures, and the conflict between Russia and Ukraine, can make it more difficult to value our securities if trading in such securities becomes less frequent. In addition, a forced sale by holders of large amounts of a security, whether due to insolvency, liquidity, or other issues with respect to such holders, could result in declines in the price of a security. There can be no guarantee that we have accurately assessed the level of impairments taken and allowances reflected in our financial statements. Furthermore, additional impairments may need to be taken or allowances provided for in the future. Impairments result in charges to earnings in the period taken, and historical trends may not be indicative of future impairments or allowances.
A breach of information security or other unauthorized data access could have an adverse impact on our business and reputation.
In the ordinary course of business, we collect, process, transmit, and store large quantities of personally identifiable information, customer financial and health information, and proprietary business information (“Sensitive Information”). The secure processing, storage, maintenance, and transmission of Sensitive Information are vital to our operations and business strategies. Although we undertake substantial efforts to reasonably protect Sensitive Information, including internal processes and technological defenses that are preventative, and other commercially reasonable controls designed to provide multiple layers of security and detection, Sensitive Information maintained by us may be vulnerable to attacks by computer hackers, to physical theft by other third-party criminals, or to other compromise due to employee error or malfeasance. Attacks may include both sophisticated cyber-attacks perpetrated by organized crime groups, “activists,” or state sponsored groups, as well as non-technical attacks ranging from sophisticated social engineering to simple extortion or threats, which can lead to unauthorized access or disclosure, disruption or further attacks. Such events may expose us to civil and criminal liability, or regulatory action, harm our reputation among customers, deter people from purchasing our products, cause system interruptions, require significant technical, legal, and other remediation expenses, and otherwise have an adverse impact on our business. Third parties to whom we outsource certain functions are also subject to the risks outlined above, and if a third-party suffers a breach of information security involving our Sensitive Information, the breach may result in substantial costs and other negative consequences, including a material adverse effect on our business, financial condition, results of operations, and liquidity. We offer no guarantees that we will be able to implement information security measures to prevent all breaches of information security.
Employee error, misconduct, or excessive risks may be difficult to detect and prevent and could adversely affect us.
Persons who conduct our business, including executive officers and other members of management, other employees and our IMOs and their sales agents, do so in part by making decisions and choices that involve exposing us to risk. These include decisions such as setting underwriting guidelines and standards, product design and pricing, determining what assets to purchase for investment and when to sell them, deciding which business opportunities to pursue, and other business decisions. Losses may result from, among other things, excessive risk, fraud, errors, failure to document transactions properly, failure to obtain proper internal authorization, or failure to comply with regulatory requirements. Although we employ controls and procedures designed to monitor business decisions and
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prevent us from taking excessive risks, it is not always possible to deter or prevent employee misconduct or errors in judgment, and the precautions that we take to prevent and detect this activity may not be effective in all cases. The impact of those losses and excessive risks could harm our reputation and have a material adverse effect on our financial condition and business operations.
We face a risk of noncompliance with and enforcement action under the anti-money laundering statutes and regulations.
A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA PATRIOT Act of 2001 substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra territorial jurisdiction of the United States, and by expanding the categories of financial institutions to which such laws and regulations apply to include some categories of insurance companies. Certain financial institutions are also prohibited from entering into specified financial transactions and account relationships and must use enhanced due diligence procedures in their dealings with certain types of high risk clients and implement a written client identification program. Financial institutions must take certain steps to assist government agencies in detecting and preventing money laundering and report certain types of suspicious transactions without notifying the affected clients. Regulatory authorities routinely examine financial institutions to ensure that they have policies and procedures reasonably designed to comply with applicable requirements and for compliance with the policies and procedures and these substantive obligations. Failure of a financial institution to maintain and implement adequate programs, including policies and procedures, to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution. Regulatory authorities have imposed cease and desist orders and civil money penalties against institutions found to be violating these obligations. We and our subsidiaries are subject to anti-money laundering statutes and certain regulations, and our compliance obligations under these rules may result in increased costs and allocation of internal resources.
Litigation or regulatory actions could have a material adverse impact on us.
Current and future litigation or regulatory investigations and actions in the ordinary course of operating our business, including class action lawsuits, may negatively affect us by resulting in the payment of substantial awards or settlements, increasing legal and compliance costs, requiring us to change certain aspects of our business operations, diverting management attention from other business issues, harming our reputation with customers, or making it more difficult to retain current customers and to recruit and retain employees or IMOs.
Guarantees within certain of our products may adversely affect our financial condition or results of operations.
We offer guarantees which may include a return of no less than the total deposits made on the contract less any customer withdrawals, total deposits made on the contract less any customer withdrawals plus a minimum return, or the highest contract value on a specified anniversary date minus any customer withdrawals following the contract anniversary. These guarantees can also include benefits payable in the event of death, upon annuitization, upon periodic withdrawal, or at specified dates during the accumulation period.
Periods of significant and sustained downturns in equity markets, increased equity volatility, and/or reduced interest rates could result in an increase in the valuation of the future policy benefit or policyholder account balance liabilities associated with such products, resulting in a reduction of our potential profitability. We use risk management techniques including product design, asset liability management, reinsurance and hedge strategies to manage the risk associated with liability exposures and the volatility of net income associated with these liabilities.
We remain ultimately liable for the specific guaranteed benefits and are subject to the risk that reinsurers or derivative counterparties are unable or unwilling to pay. In addition, we are subject to the risk that hedging and other risk management procedures prove ineffective, or the estimates and assumptions made in connection with their use fail to reflect or correspond to the actual liability exposure, or that unanticipated policyholder behavior or mortality, combined with adverse market events, produces economic losses beyond the scope of the risk management techniques employed. We are also subject to the risk that the cost of hedging these guaranteed minimum benefits may materially increase. These risks, individually or collectively, may have a material adverse effect on our financial condition or results of operations.
We regularly analyze overall risk position at the enterprise level and decide how much risk to retain (that is, to hold capital) and how much risk to transfer off the balance sheet. This decision considers the cost of transferring risk, the concentration of the risk, and our
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tolerance for volatility. Residual risk for which we hold capital may lead to earnings volatility. We cannot assure you that our hedging strategy will successfully mitigate any risks we may hedge.
Deviations from assumptions regarding future persistency, mortality, morbidity, and interest rates used in calculating reserve amounts could have a material adverse impact on our results of operations or financial condition.
Our profitability depends significantly upon the extent to which the actual experience is consistent with the assumptions we use in setting prices for our products and establishing liabilities for future policy benefits and claims. Such amounts are established based on estimates by actuaries of how much we will need to pay for future benefits and claims. The process of calculating reserve amounts for a life insurance company involves the use of a number of assumptions, including those related to persistency (how long a contract stays with a company), mortality (the likelihood of death or the likelihood of survival), morbidity (likelihood of sickness or disability), and interest rates (the rates expected to be paid or received on financial instruments, including insurance or investment contracts).
Pricing of our annuity products is also based in part upon expected persistency of these products, which is the probability that a policy or contract will remain in force from one period to the next. Persistency within our annuities business may be significantly impacted by the value of guaranteed minimum benefits contained in many of our annuity products being higher than current account values, in light of poor equity market performance or extended periods of low interest rates, as well as other factors. Persistency could be adversely affected generally by developments affecting client perceptions of us, including perceptions arising from adverse publicity. Many of our products also provide our customers with wide flexibility with respect to the amount and timing of premium deposits and the amount and timing of withdrawals from the policy’s value.
Some of our products and services are complex and are sold through IMOs and their agents, and a failure of the IMOs and their agents to properly explain our products and services or their misrepresentation in connection therewith could have an adverse effect on our business, results of operations and financial condition.
Some of our products are complex and all of our products are presently sold through IMOs and their agents. Therefore, we are primarily reliant on our IMOs and their agents in our distribution channel to describe and explain our products to potential customers. The intentional or unintentional misrepresentation of our products and services in advertising materials or other external communications, or inappropriate activities by the IMOs or their agents, could adversely affect our business reputation and prospects, as well as lead to potential regulatory actions or litigation.
Expectations relating to environmental, social, and governance (“ESG”) considerations could expose us to potential liabilities, increased costs, and reputational harm.
Governmental authorities, non-governmental organizations, customers, investors, external stakeholders and employees are increas-ingly sensitive to ESG considerations, such as diversity and inclusion, sustainability, climate change, cyber-security and data privacy. This focus on ESG considerations may lead to increased compliance costs associated with running our business. Responding to ESG concerns, implementing ESG initiatives and achieving ESG goals involves risks and uncertainties, requires investment, and depends in part on third-party performance or data that is outside of our control. We risk negative stockholder reaction, including from proxy advisory services, as well as damage to our brands and reputation, if we fail, or are perceived to fail, to adhere to any public statements about ESG matters, comply fully with developing interpretations of ESG laws and regulations or meet evolving and varied stakeholder expectations and standards. In addition, some stakeholders may disagree with any of our ESG goals and initiatives. If we do not meet the evolving and varied ESG expectations of our customers, investors and other stakeholders, we could experience reduced demand for our products and services, loss of customers and other negative effects on our business, results of operations and the market price of our common stock, and could be exposed to government enforcement actions or private litigation.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
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ITEM 2. PROPERTIES.
We currently lease approximately 15,831 square feet of office space at 2900 South 70th Street, Suites 350 and 400, Lincoln, Nebraska 68506. This lease was executed October 16, 2021 and expires on October 16, 2031. We also rent approximately 455 square feet of office space at 405 Lexington Avenue, Floor 9, New York, New York, 10174. This rental agreement was executed September 1, 2021 and renews on a month--to--month basis.
ITEM 3. LEGAL PROCEEDINGS.
We are involved in litigation incidental to our operations from time to time. We are not presently a party to any legal proceedings other than litigation arising in the ordinary course of our business, and we are not aware of any claims that could materially adversely affect our financial position or results of operations.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
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PART II.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
Historically our voting common stock was listed on the OTCQB Marketplace under the symbol “MDWT’’ but had experienced very limited trading. On August 27, 2020, we completed a 500 for one reverse stock split and minimal trading of our voting common stock occurred after that date until December 17, 2020, when our voting common stock was listed on The Nasdaq Capital Market under the symbol “MDWT.” The following table shows the high and low bid prices of our voting common stock as reported by Nasdaq. As of March 22, 2023, the closing price of our common stock on The Nasdaq Capital Market was $17.21 per share.
Bid Price | ||||||||
Period |
| Year |
| High |
| Low | ||
First Quarter | 2021 | $ | 50.29 |
| 49.14 | |||
Second Quarter | 2021 | 39.81 |
| 39.21 | ||||
Third Quarter |
| 2021 | 39.80 |
| 38.90 | |||
Fourth Quarter |
| 2021 |
| 17.56 |
| 16.73 | ||
First Quarter |
| 2022 |
| 24.19 |
| 21.76 | ||
Second Quarter |
| 2022 |
| 17.60 |
| 16.10 | ||
Third Quarter |
| 2022 |
| 16.69 |
| 15.54 | ||
Fourth Quarter |
| 2022 |
| 16.95 |
| 16.80 | ||
On March 13, 2023, there were approximately 4,195 holders of record of our voting common stock.
Dividend Policy
Holders of our voting common stock are entitled to cash dividends when, as, and if declared by our Board out of funds legally available therefor. We have never paid cash dividends on our voting common stock. Future dividend policy will be subject to the discretion of our Board and will be contingent upon future earnings, if any, our financial condition, capital requirements, general business conditions, and other factors. Therefore, we can give no assurance that future cash dividends of any kind will be paid to holders of our voting common stock. Our ability to pay cash dividends depends, in part, upon on the ability of American Life to pay cash dividends to us. American Life, as an insurance subsidiary, is subject to significant regulatory restrictions limiting its ability to declare and pay cash dividends. These restrictions are related to surplus and net investment income.
ITEM 6. [RESERVED].
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and the notes to those statements included in this Annual Report on Form 10-K and it includes many forward-looking statements which involve many risks and uncertainties including those referred to herein. Our actual results could differ materially from those indicated in such forward-looking statements as a result of certain factors, such as those set forth herein under “Special Cautionary Note Regarding Forward-Looking Statements,” “Summary of Risks Associated with our Business and Voting Common Stock” and “Risk Factors.” We are under no duty to update any of the forward-looking statements after the date of this annual report to conform these statements to actual results.
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Overview of Company and Business Model
Midwest Holding Inc. (“Midwest,” “the Company,” “we,” “our,” or “us”) was incorporated on October 31, 2003 for the purpose of operating a financial services company. We are in the annuity insurance business and operate through our wholly owned subsidiaries, American Life & Security Corp. (“American Life”), 1505 Capital LLC (“1505 Capital”), and our sponsored captive reinsurance company, Seneca Reinsurance Company, LLC (“Seneca Re”).
We are a financial services company focused on helping people plan and secure their future by providing technology-enabled and services-oriented solutions to support individuals’ retirement through our annuity products. We distribute our annuities through independent distributors who are primarily independent marketing organizations (“IMOs”). Our operations are comprised of three distinct, inter-connected businesses – insurance, reinsurance, and asset management. We seek to reinsure a significant portion of our annuity policies with third-party reinsurers and our captive reinsurance subsidiary, Seneca Re. Our third-party reinsurers include traditional reinsurers and capital markets reinsurers, who are investors seeking exposure to reinsurance revenue and typically do not have their own reinsurance platforms or insurance-related operations. We also have the flexibility to selectively retain assets and liabilities associated with our policies for a period of time when we expect that doing so will provide an attractive return on our capital.
We believe that our operating capabilities and technology platform provide annuity distributors and reinsurers with flexible and cost-effective solutions. We seek to create value through our ability to provide the distributors and reinsurers with annuity product innovation, speed to market for new products, competitive rates and commissions, and streamlined customer and agent experiences. Our capital model allows us to support increasing annuity sales volumes with capital capacity provided by reinsurers although, in connection with plans for future growth, we continue to monitor any need for additional capital. By reinsuring a significant portion of the annuity policies issued, the level of capital needed for American Life is significantly less than retaining all of the business on its books. We believe this “capital light” approach has the potential to produce enhanced returns for our business compared to a traditional insurance company capital structure. This strategy helps reduce our insurance regulatory capital requirements because policies that are reinsured require substantially less capital and surplus than policies retained by us.
As of December 31, 2022, approximately 43% of the deposits received in 2022 for our annuity products were ceded to reinsurance vehicles capitalized by third party reinsurers or held in protected cells within Seneca Re for future reinsurance transactions.
We operate our core business through four subsidiaries under one reportable segment. American Life & Security Corp. (“American Life”) is a Nebraska-domiciled life insurance company, currently licensed to sell, underwrite, and market life insurance and annuity products in 24 states and the District of Columbia. American Life obtained a financial strength rating of B++ (“Good”) from A.M. Best Company (“A.M. Best”), a leading rating agency for insurance companies, in December 2018. That rating was affirmed in March 2023 when A.M. Best also revised its outlook for American Life from Positive to Stable. All of our annuities are written by American Life.
Our other insurance subsidiary, Seneca Re, is a Vermont-domiciled sponsored captive reinsurance company established in early 2020 to reinsure various types of risks on behalf of American Life and third-party capital providers through special purpose reinsurance entities known as “protected cells.” Through Seneca Re, we assist capital market investors in establishing and licensing new protected cells.
Midwest Capital Corp was established as a holding company and is the immediate parent of Seneca Incorporated Cell, LLC 2021-03 (“SRC3”), both of which are consolidated into our financial statements.
Our fourth subsidiary, 1505 Capital, is an SEC registered investment adviser providing financial, investment advisory, and management services. Our asset management services are available to third-party insurers and reinsurers. At December 31, 2022, 1505 Capital had approximately $501.9 million total third-party assets under management.
We seek to deliver long-term value by growing our annuity volumes and generating profitable fee-based revenue. We generate fees and other revenue based on the gross deposits received on the annuity policies we issue, reinsure, and administer. We provide an end-to-end solution to manage annuity products that includes a broad set of product development, distribution support, policy administration, and asset/liability management services. Our platform enables us to efficiently develop, sell and administer a wide range of annuity products.
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Industry Trends and Market Conditions
Market
We participate in a large U.S. market that we expect to grow in part due to a number of demographic trends. As measured by annual premiums written, annuities are the largest product line in the life, annuity, and accident and health sector. Annuities play an important role in retirement planning by providing individuals with stable, tax-efficient sources of income. In 2021, annuity premiums accounted for $319 billion of annual premiums, or approximately 30% of the $1.1 trillion of total annual life, annuity, and accident and health premiums according to the Insurance Information Institute. The most common annuities are fixed and variable and can be written on an individual or group basis. Our current products are MYGAs and FIAs written on an individual basis.
An increasing portion of the U.S. population is of retirement age and is expected to increase the retirement income needs of retirees. The number of people of retirement age has increased significantly since 2010, driven by the aging of the “Baby Boomer” generation. The U.S. population over 65 years old is forecasted to grow from 56 million in 2020 to an estimated 81 million by 2040, according to the U.S. Census Bureau, Population Estimates and Projections. This study also forecasted that U.S. population aged over 65 years old is expected to grow by 44% from 2020 to 2040, while the total U.S. population is expected to grow by only 12%. Annuities in the U.S. are distributed through a number of channels, most of which are independent from the insurance companies that issue annuities. Independent distribution channels serve as the primary and a growing source of annuity distribution. In 2021, approximately 77% of U.S. individual annuity sales occurred through independent distributors, including independent agents, broker-dealers, and banks, representing an increase from approximately 70% in 2017 according to U.S. Individual Annuities, 2021 Year in Review, Life Insurance Marketing and Research Association (“LIMRA”), 2022. Independent agents are the second largest distribution channel, behind independent broker-dealers, accounting for approximately 19% of U.S. individual annuity sales in 2021. IMOs provide independent agents with access to annuity products along with operational support services and functionality to support the distribution services of the agents. The infrastructure and support services provided by IMOs to independent agents are critical to the success of independent agents and their ability to serve their customers and generate additional sales.
We believe that capital markets investors have been actively seeking investing in and acquiring insurance and reinsurance companies in recent years. Fixed annuities provide upfront premiums and stable, long-term payment obligations and are thus attractive sources of liability-funded assets for a variety of traditional and alternative asset managers and investors. However, there are significant regulatory and operational hurdles for capital providers looking to enter the insurance market. These hurdles are exacerbated by the limited legacy administrative capabilities, product development processes and technology systems, of traditional insurers and reinsurers. We provide asset managers and investors the ability to seamlessly access funding from annuities through a variety of reinsurance entities that we can form quickly and operate efficiently with lower upfront and ongoing regulatory and operating costs.
State expansion efforts have taken more time than anticipated, as state insurance regulators would like to see a more fully developed historical financial footprint. We are working diligently to file in more states, responding and providing increased information to regulators and discussing how our business model ensures policyholders are protected, given the capital held and supported by the use of reinsurance.
We currently distribute annuity products through 27 third-party IMOs. We believe our product development, prompt policy processing, operating flexibility and speed to market make us a desirable partner for insurance distributors. We are seeking to grow by increasing volumes with our current IMOs and by establishing new IMO relationships.
Competition
We operate in highly competitive markets with a variety of participants, including insurance companies, financial institutions, asset managers, and reinsurance companies. These companies compete in various forms in the annuity market, for investment assets and for services. We seek to build strong relationships along with offering technology-enabled and services-oriented solutions for our partners. Our experience indicates that the market for annuities is dynamic. The combination of the treasury market experiencing the unprecedented rate increases and the volatility in the market resulting from the war in Ukraine and related economic uncertainties due to inflation has opened up investment opportunities that allow us, and our reinsurance partners, to support more competitive rates for annuities. Based on our experience with COVID, we expect this investment environment to be conducive to our business model. We have been reviewing policy pricing along with reinsurer appetite to ensure we continue to grow our business while managing risk. We have recently taken pricing action on both our FIA and MYGA products and continue to monitor our competitiveness in the market.
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We have also increased our focus on marketing, reestablishing, and expanding our relationships on the distribution side through various channels and are reallocating or adding resources relating to this initiative. As a result, we experienced encouraging sales as 2022 unfolded. However, we expect competition in our market to remain intense particularly from other well established entities providing annuity products.
Interest Rate Environment
The Federal Reserve has continued increasing short-term interest rates, compared to the historically low levels in 2021 and the expectation communicated from U.S. federal banking officials is for rate increases to continue. We seek to address our interest rate risk through managing the duration of the liabilities and purchasing and holding quality, long-term assets mirroring that duration.
If interest rates were to rise, we believe the yield on our floating rate investments and the yield on new investment purchases would rise. We also believe our products would therefore be more attractive to consumers and our annuities sales would increase.
Discontinuation of LIBOR
The Financial Conduct Authority (“FCA”), the United Kingdom regulator of the London Interbank Offered Rate ("LIBOR"), previously indicated that it intends to stop compelling panel banks to submit quotes used to determine LIBOR after 2021. On November 30, 2020, the Intercontinental Exchange (“ICE”) Benchmark Administration (“IBA”), the administrator of LIBOR, announced a consultation regarding its intention to cease the publication of one week and two-month U.S. Dollar LIBOR settings at the end of December 2021, but to extend the publication of the remaining U.S. Dollar LIBOR settings (overnight and one, three, six, and 12-month U.S. Dollar LIBOR) until the end of June 2023. The IBA intends to share the results of the consultation with the FCA and publish a summary of the responses. U.S. bank regulators acknowledged the announcement and, subject to certain limited exceptions, advised banks to cease writing new U.S. Dollar LIBOR contracts by the end of 2021.
We are in the process of analyzing and identifying our securities, financial instruments, and contracts that utilize LIBOR (collectively “LIBOR Instruments”) to determine if we have any material exposure to the transition from LIBOR. To the extent we hold LIBOR Instruments, the terms of these instruments may have fallback provisions that provide for an alternative reference rate when LIBOR ceases to exist. For securities without adequate fallback provisions already in place, federal legislation has been enacted to provide a safe harbor for transition to the recommended alternative reference rate.
Notwithstanding the availability of statutory guidance on fallback procedures, in preparation for the phase out of LIBOR, we may need to renegotiate our LIBOR Instruments that utilize LIBOR. However, these efforts may not be successful in mitigating the legal and financial risk from changing the reference rate in our LIBOR Instruments. Furthermore, the discontinuation of LIBOR may adversely impact our ability to manage and hedge exposures to fluctuations in interest rates using derivative instruments.
As a result, the transition of our LIBOR Instruments to alternative reference rates, including the Secured Overnight Financing Rate (“SOFR”), may result in adverse changes to the net investment income, fair market value and return on those investments. We in-tend to continue evaluating and monitoring the risks associated with the LIBOR transition which include identifying and monitoring our exposure to LIBOR and ensuring operational processes are updated to accommodate alternative rates. Due to uncertainty surrounding the effect of adopting or transitioning to alternative rates such as SOFR, we are unable to predict the overall impact of this change at this time.
Critical Accounting Policies and Estimates
Our accounting and reporting policies are in accordance with GAAP. Preparation of our Consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The following is a summary of our significant accounting policies and estimates. These accounting policies inherently require significant judgment and assumptions, and actual operating results could differ significantly from management’s estimates determined using these policies. We believe the following accounting policies, judgments, and estimates are the most critical to the understanding of our results of operations and financial position. Our accounting policies, judgments, and estimates have not changed significantly over our disclosed accounting periods. For further discussion of our accounting policies and estimates see “Note 1 — Nature of Operations and Summary of Significant Accounting Policies” to our Consolidated financial statements.
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Valuation of Investments
All fixed maturities owned by the Company are considered available-for-sale and are included in the Consolidated financial statements at their fair value as of the financial statement date. Premiums and discounts on fixed maturity debt instruments are amortized using the scientific-yield method over the term of the bonds. Realized gains and losses on securities sold during the year are determined using the specific identification method. Unrealized holding gains and losses, net of applicable income taxes, are included in accumulated other comprehensive income.
Declines in the fair value of available-for-sale securities below their amortized cost are evaluated to assess whether any other-than-temporary impairment loss should be recorded. In determining if these losses are expected to be other-than-temporary, the Company considers severity of impairment, duration of impairment, forecasted recovery period, issuer credit ratings, and the intent and ability of the Company to hold the investment until the recovery of the cost.
The recognition of other-than-temporary impairment losses on debt securities is dependent on the facts and circumstances related to the specific security. If the Company intends to sell a security or it is more likely than not that the Company would be required to sell a security prior to recovery of the amortized cost, the difference between amortized cost and fair value is recognized in the statement of comprehensive income as an impairment. If the Company does not expect to recover the amortized basis, does not plan to sell the security, and if it is not more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, the recognition of the impairment is bifurcated. The Company recognizes the credit loss portion as realized losses and the noncredit loss portion in accumulated other comprehensive loss. The credit component of other-than-temporary impairment is determined by comparing the net present value of projected cash flows with the amortized cost basis of the debt security. The net present value is calculated by discounting the Company’s best estimate of projected future cash flows at the effective interest rate implicit in the fixed income security at the date of acquisition. Cash flow estimates are driven by assumptions regarding probability of default, including changes in credit ratings, and estimates regarding timing and amount of recoveries associated with a default. As of December 31, 2020, the Company analyzed its securities portfolio and determined that an impairment of approximately $35,000 should be recorded for one debt security, an impairment of $500,000 was recognized on a preferred stock, and a valuation allowance of $777,000 established on one lease. The valuation allowance on the lease of $777,000 was released as of March 31, 2021 due to the sale of the investment. As of December 31, 2022, the Company held one asset valued at $7.7 million with a total impairment of $1.4 million. No such impairments were recognized as of December 31, 2021.
Investment income consists of interest, dividends, gains and losses, and real estate income, which are recognized on an accrual basis along with the amortization of premiums and discounts.
Certain available-for-sale investments are maintained as collateral under funds withheld (“FW”) and modified coinsurance (“Modco”) agreements but the assets and total returns or losses on the asset portfolios belong to the third-party reinsurers. American Life has treaties with several third-party reinsurers that have FW and Modco provisions. In a Modco agreement, the ceding entity retains the assets equal to the modified coinsurance reserves retained. In a FW agreement, assets that would normally be paid over to a reinsurer are withheld by the ceding company to permit statutory credit for unauthorized reinsurers to reduce the potential credit risk. The unrealized gains/losses on those investments are passed through to the third-party reinsurers, through the fair value of our total return swap, as either a realized gain or loss on the Consolidated Statements of Comprehensive Loss.
Intangibles
We assess the recoverability of indefinite-lived intangible assets at least annually or whenever events or circumstances suggest that the carrying value of an identifiable indefinite-lived intangible asset may exceed the sum of the future discounted cash flows expected to result from its use and eventual disposition. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset.
Our indefinite-lived intangible assets consist of American Life’s state licenses. We compared the carrying value to the current costs of obtaining licenses in those states. As of December 31, 2022, the sum of the fair value of those licenses exceeded the carrying value of the indefinite-lived intangible assets. These amounts are carried on our balance sheet in Other Assets.
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Reinsurance
We expect to reinsure most of the risks associated with our issued annuities. Our reinsurers may be domestic, foreign or capital markets investors seeking to assume U.S. insurance business. In most reinsurance transactions, American Life will remain exposed to the credit risk of reinsurers, or the risk that one or more reinsurers may become insolvent or otherwise unable or unwilling to pay for policyholder claims. We seek to mitigate the credit risk relating to reinsurers by generally either requiring that the reinsurer post substantial collateral or make other financial commitments as a security for the reinsured risks. Under these reinsurance agreements, there typically is a monthly or quarterly settlement of premiums, claims, surrenders, collateral, and other administration fees.
In a typical reinsurance transaction, we receive a ceding commission and reimbursement of certain expenses at the time liabilities are reinsured, plus ongoing fees for the administration of the business ceded. Our reinsurers are typically not “accredited” or qualified as reinsurers under Nebraska law. In order to receive credit for reinsurance for transactions with these reinsurers and to reduce potential credit risk, we usually hold collateral from the reinsurer on a FW basis or require the reinsurer to maintain a trust that holds assets backing up its obligation to pay claims on the business it assumes. In some cases, the reinsurer may appoint an investment manager to manage these assets pursuant to guidelines approved by us that are consistent with state investment statutes and regulations relating to reinsurance. When our investment advisor subsidiary, 1505 Capital, is appointed to manage these assets, we receive additional ongoing asset management fees.
Future Policy Benefits
We establish liabilities for amounts payable under our policies, including annuities. Generally, amounts are payable over an extended period of time. Under GAAP, our annuities are treated as deposit liabilities, where we use account value in lieu of future policy reserves. Our FIA reserves are calculated by an independent consulting actuary and our MYGA reserves equal the account value from our policy administration system. We currently do not offer traditional life insurance products.
Income Taxes
Deferred tax assets are recorded based on the differences between the financial statement and tax basis of assets and liabilities at the applicable tax rates. The principal assets and liabilities giving rise to these differences are investments, insurance reserves, and deferred acquisition costs. A deferred tax asset valuation allowance is established when there is uncertainty that such tax assets would be realized. We have no uncertain tax positions that we believe are more-likely-than not that the benefit will not be realized.
Recognition of Revenues
Amounts received as payment for annuities are recognized as deposits to policyholder account balances and included deposit-type contract liabilities. Annuity premiums are shown as a financing activity in the Consolidated Statements of Cash Flows. Revenues from these contracts are comprised of fees earned for administrative and policyholder services, which are recognized over the period of the annuity contracts and included in other revenue. Through our reinsurance contracts, revenues are earned through ceding commissions, which are capitalized, and our independent consulting actuary determines the amounts to be recognized as income over the period of the annuity contracts. Deferred coinsurance ceding commissions are shown as an operating activity in the Consolidated Statements of Cash Flows. Revenues from asset management services are recognized as earned.
Derivative Instruments
Derivatives are used to hedge the risks experienced in our ongoing operations, such as equity, interest rate, and cash flow risks, or for other risk management purposes, which primarily involve managing liability risks associated with our FIA product and reinsurance agreements. Derivatives are financial instruments whose values are derived from interest rates, foreign exchange rates, financial indices, or other underlying notional amounts. Derivative assets and liabilities are carried at fair value on the Consolidated Balance Sheets.
To qualify for hedge accounting, at the inception of the hedging relationship, we formally document our designation of the hedge as a cash flow or fair value hedge and our risk management objective and strategy for undertaking the hedging transaction identifying how the hedging instrument is expected to hedge the designated risks related to the hedged item, the method to retrospectively, and prospectively assess the hedging instrument’s effectiveness and the method to be used to measure ineffectiveness. A derivative
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designated as a hedging instrument must be assessed as being highly effective in offsetting the designated risk of the hedged item. Hedge effectiveness is also assessed periodically throughout the life of the designated hedging relationship.
In late 2019, we began investing in options to hedge our interest rate risks on our FIA product. Options typically do not qualify for hedge accounting; therefore, we chose not to use hedge accounting for the related options that we currently have. We value our derivatives at fair market value with the offset being recorded on our Consolidated Statements of Comprehensive Loss as a realized gain or (loss).
Additionally, reinsurance agreements written on a FW basis contain embedded derivatives on our FIA product. Gains or (losses) associated with the performance of assets maintained in the relevant deposit and funds withheld accounts are reflected as realized gains or (losses) in our Consolidated Statements of Comprehensive Loss.
Derivatives
The Company has entered into certain derivative instruments to hedge FIA products that guarantee the return of principal to our policyholders and credit interest based on a percentage of the gain in a specified market index. To hedge against adverse changes in equity indices, the Company entered into contracts to buy equity indexed options. The change in fair value of the derivatives for hedging the FIA index credits and the related embedded derivative liability fluctuate from period to period based on the change in the market interest rates. The indexed reserves are measured at fair value for the current period and future periods. We hedge with options that align with the terms of our FIA products which are between seven and ten years. We have analyzed our hedging strategy on our FIA products and, while the correlation of the hedges to the FIA products is not matched dollar for dollar, we believe the hedges are effective as of December 31, 2022.
American Life also has agreements with several third-party reinsurers that have FW and Modco provisions under which the assets related to the reinsured business are maintained by American Life as collateral; however, ownership of the assets and the total return on the asset portfolios belong to the third-party reinsurers. Under GAAP, this arrangement is considered an embedded derivative as discussed in “Note 4 — Derivative Instruments” to our Consolidated financial statements. Assets carried as investments on American Life’s financial statements for the third-party reinsurers contained cumulative unrealized losses as of December 31, 2022 and cumulative unrealized gains as of December 31, 2021, of approximately $10.5 million and $0.2 million, respectively. The terms of the contracts with the third-party reinsurers provide that the changes in unrealized gains and losses on the portfolios accrue to the third-party reinsurers. We account for these unrealized gains by recording equivalent realized gains or losses on our Consolidated Statements of Comprehensive Loss. Accordingly, the unrealized gains on the assets held by American Life on behalf of the third-party reinsurers were offset by recording an embedded derivative gain of $10.6 million and loss of $2.8 million as of December 31, 2022 and 2021, respectively. If prices of investments fluctuate, the unrealized gains or losses of the third-party reinsurers may also fluctuate; therefore, the associated embedded derivative gain (loss) recognized by us would be increased or decreased accordingly.
Net Income (Loss)
In this section, unless otherwise noted the discussion below compares the year ended December 31, 2022 to the year ended December 31, 2021.
We incurred a comprehensive loss of $46.9 million including unrealized loss of $54.0 million, mainly from the fixed maturity portfolio, resulting in net income to Midwest of $7.1 million for the year ended December 31, 2022. This compares to a comprehensive loss of $20.4 million including unrealized loss of $3.8 million, resulting in net loss of $16.6 million to Midwest last year.
Overall, revenues were flat year over year being impacted by realized losses of $14.9 million for the year ended December 31, 2022 versus a gain of $7.8 million in the prior year. Investment income increased due to the growth in the retained portfolio and from higher interest rates. Policy administration fees were up due to the increase in deposit liabilities through annuity premiums written in 2022 of $715.8 million versus $471.6 million in the prior year. Amortization of deferred ceded premium grew as we added new reinsurers and the portfolio continues to age. Service fee revenue was consistent with prior years as AUM was $502 million versus $405 million in the prior year.
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Overall, expenses were down, driven by negative interest credited and benefitting from the option allowance (see point 3 below). Controllable expenses increased 42% from $41.3 million to $58.8 million compared to 62% growth in deposit liabilities through annuity premiums written for the year. Salaries and benefits increased (after the exclusion of a one-time accelerated vesting of stock options) with additional personnel, repositioning and retaining of personnel to support growth and given tight labor market. Increase in Other expenses was driven by consulting, legal and accounting fees to support distribution, state expansion, and capital initiatives, along with technology initiatives.
The effective tax rate was 90.6% compared to 40.1% for the year ended December 31, 2022 and 2021, respectively. Our primary insurance entities, American Life, SRC1, and SRC3, are taxed on a statutory basis. GAAP defers the recognition of income related to premiums received until they are earned across the life of the contract. Statutory principles though recognize premiums as income in the period they are received, creating the difference between the two statements of income. See Note 9 to our financial statements for further information related to the income tax expense.
Our FIA products have three components influencing our Consolidated Statements of Comprehensive Loss:
| 1) | The embedded derivative in our FIAs. We carry this derivative at fair value, with the change in fair value recorded in the interest credited line of our Consolidated Statements of Comprehensive Loss. Across our FIA products, interest credited was negative $17.2 million in 2022 compared with positive $4.2 million in 2021. Reflecting our risk management, the change in the value of the embedded derivative corresponds to the change in the value of option contracts we use to hedge this exposure. |
| 2) | The derivatives we purchase to hedge stock market risk we would otherwise face from our FIA. We carry these derivatives at fair value on our balance sheet, recording the change in fair value in our Consolidated Statements of Comprehensive Loss as either a realized gain or realized loss. In 2022, the market value of the derivative assets was $15.9 million compared to $2.7 million in 2021 in our net unrealized gain on investments. |
| 3) | The option budget reinsurers pay us to purchase derivative assets. We mark these assets to market each period. Separately, we record a payable to the reinsurers that is owed to a reinsurer when a policy is surrendered, an annuitant dies, or a policy lapses. We compare what the reinsurer paid for the original option budget to the market value at the end of the period. The change in the market value is added to or subtracted from the payable to the reinsurer to cover the reinsurer’s obligations to the policyholder. This change in market value resulted in a negative $11.2 million expense and was included in our other operating expense in 2022 compared to a $2.4 million expense in the prior year. |
American Life has treaties with several third-party reinsurers that have funds withheld and modified coinsurance provisions. As a result of changes in interest rates, assets held on behalf of the third-party reinsurers had unrealized losses of approximately $10.5 million and gains of $0.2 million at December 31, 2022 and 2021, respectively. The terms of the contracts with the third-party reinsurers provide that unrealized gains or losses on the asset portfolio accrue to the reinsurers. We account for the change in these unrealized gains or losses by recording equivalent realized gains or losses on our Consolidated Statements of Comprehensive Loss. We recorded the decrease in the unrealized gains as a realized gain of $10.6 million in 2022 compared to a realized loss of $2.8 million in 2021.
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Consolidated Results of Operations - Years Ended December 31, 2022 and 2021
Revenues
The following summarizes the sources of our revenue:
Year ended December 31, | ||||||
(In thousands) | 2022 |
| 2021 | |||
Premiums | $ | — | $ | — | ||
Investment income, net of expenses | 35,115 | $ | 15,737 | |||
Net realized (losses) gains on investments |
| (14,878) |
| 7,752 | ||
Amortization of deferred gain on reinsurance |
| 4,816 |
| 3,022 | ||
Policy administration fees | 2,130 |
| 842 | |||
Service fee revenue, net of expenses | 2,366 | 2,343 | ||||
Other revenue |
| 500 |
| 367 | ||
$ | 30,049 | $ | 30,063 | |||
Premium revenue: Sales of our MYGA and FIA products generated a large volume of new business in 2022 and 2021; however, these products are defined as investment contracts under GAAP. Accordingly the funds we received from our customers under these contracts were recorded on our balance sheet as a deposit-type liability – and not as premium revenue.
Investment income, net of expenses: The components of net investment income for 2022 and 2021 were as follows:
Year ended December 31, | ||||||
(In thousands) | 2022 |
| 2021 | |||
Fixed maturities | $ | 38,299 | $ | 16,443 | ||
Mortgage loans |
| 2,456 |
| 185 | ||
Other invested assets | 1,854 | 665 | ||||
Other interest (expense) income |
| (1,517) |
| 298 | ||
Gross investment income |
| 41,092 |
| 17,591 | ||
Less: investment expenses |
| (5,977) |
| (1,854) | ||
Investment income, net of expenses | $ | 35,115 | $ | 15,737 | ||
Investment income, net of expenses consisted of investment income generated from our retained investment assets that are not ceded to reinsurers. The increase was due to the investment income earned on our bonds and mortgage loans purchased with the sales of our MYGA and FIA products that were not ceded to reinsurers during the period, as well as deployment of excess cash towards credit investments with attractive yields and risk-return profiles. As of December 31, 2022 and 2021, on a gross consolidated basis, our investment portfolio (excluding cash) was $1,615.0 million and $975.5 million, respectively, as a result of proceeds from our MYGA and FIA product sales, reflecting both retained premium proceeds as well as assets held on behalf of our reinsurers.
Net realized losses on investments: Net realized losses on investments were $14.9 million in 2022 compared with gains of $7.8 million in 2021. The figures include a gain of $10.6 million and a loss of $2.8 million from a total return swap embedded derivative in 2022 and 2021, respectively. In 2022, there were net realized losses of $14.5 million related to derivatives we own to hedge the obligations to FIA policyholders; such losses were partially offset by an increase in the mark-to-market change in embedded derivative liability within interest credited expense and an increase in FIA-related mark-to-market option allowance expense flowing through other operating expenses. The change in fair value of FIA hedging derivatives is driven by the performance of the indices upon which our call options are based.
American Life has treaties with several reinsurers that have funds withheld coinsurance provisions, under which the assets backing the treaties are maintained by American Life as collateral but the assets and total return on the asset portfolios belong to the reinsurers. Under GAAP this arrangement is considered an embedded derivative as discussed in Note 4 — Derivative Instruments to our Consolidated financial statements. The change in fair value of the total return swap is included in net realized gains or losses on investments. Assets carried as investments on American Life’s financial statements for the third-party reinsurers contained unrealized losses of approximately $10.5 million and gains of approximately $0.2 million for the years ended December 31, 2022 and 2021,
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respectively. The terms of the contracts with the third-party reinsurers provide that unrealized gains or losses on the portfolios accrue to the third-party reinsurers. We recorded the unrealized gains and losses accruing to third-party reinsurers via a total return swap resulting in a realized gain of $10.6 million and a realized loss of $2.8 million in 2022 and 2021, respectively.
Amortization of deferred gain on reinsurance: The increase in 2022 to $4.8 million from $3.0 million in 2021 was due to higher deferred gain on reinsurance, driven in part by higher reinsured premiums during 2022.
Policy administration fees: Policy administration fees includes fees received for the servicing and initiation of policies ceded to our reinsurers. Also included are fees surrendered by policy holders for early termination of their contracts. The increase of revenue to $2.1 million in 2022 from $0.8 million in 2021 was driven primarily by the increase in policies written and ceded, as well as additional policy holder early termination.
Service fee revenue, net of expenses: Service fee revenue, net of expenses, consists of fee revenue generated by 1505 Capital, for asset management services provided to third-party clients, some of whom are our reinsurers. The increase in this revenue, to $2.4 million in 2022 from $2.3 million in 2021, was due primarily to the level of asset management services provided by 1505 Capital to third-party clients.
Other revenue: Other revenue consists of revenue generated by us for providing administrative services for clients.
Expenses
Our expenses for the periods indicated are summarized in the table below:
Year ended December 31, | |||||
(In thousands) | 2022 |
| 2021 | ||
Interest credited | $ | (10,193) | $ | 7,012 | |
Benefits | 3,206 | 6 | |||
Amortization of deferred acquisition costs |
| 4,788 |
| 2,886 | |
Salaries and benefits |
| 16,196 |
| 16,926 | |
Other operating expenses |
| 7,661 |
| 15,104 | |
$ | 21,658 | $ | 41,934 | ||
Interest credited: The decrease was primarily due to the interest credited across all our products in 2022. Interest credited for our retained MYGA products was positive $7.2 million while interest credited related to our retained FIA policies was negative $17.2 million in 2022. MYGA and FIA interest credited were positive $2.8 million and $4.2 million for 2021, respectively. The FIA interest credited is related to the fair market value of the embedded derivative which is owed to policyholders. This was partially offset by the realized gain on our total return swap that is included in the net realized gain on investment above.
Benefits: This refers to death benefits on our policies, which saw an increase to $3.2 million in 2022 compared with 2021’s death benefits.
Amortization of deferred acquisition costs: The increase was due to the acquisition costs relating to the sale of American Life’s MYGA and FIA products where we retained approximately 57% of the business in 2022 compared to the 50% retained in 2021. These figures include the Seneca Re protected cells, SRC1 and SRC3, and DAC amortization.
Salaries and benefits The slight decrease to $16.2 million compared with $16.9 million was due to changes in upper management, offset by continued costs incurred to attract and add personnel to service our business growth combined with significantly lower costs related to non-cash stock consideration. We are hiring more in-house expertise to service our growth initiatives and reduce the reliance on third-party providers.
Other operating expenses: Other operating expenses were approximately $7.4 million lower due primarily to:
| ● | Our FIA product has embedded derivatives included in the account value. Those derivatives are market driven. The reinsurers that reinsure the FIA products pay an option allowance to American Life to purchase derivatives. As of December 31, 2022, |
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| the mark-to-market adjustment on those allowances was in a positive position so American Life incurred a negative $11.2 million expense payable to the reinsurers for that mark-up. As the market fluctuates going forward, the mark up of the option allowance could go up or down. |
| ● | Increases of other expenses related to legal and consulting fees of $2.1 million related primarily to efforts to secure new additional capital sources and the expansion of our business into new jurisdictions. |
Taxes
Income tax expense increased by $2.8 million to $7.6 million in 2022 from $4.8 million in 2021. This change was primarily driven by the change in the reinsurance modified coinsurance tax reserves.
Investments
Most investments on our Consolidated balance sheets are held on behalf of our reinsurers as collateral under our reinsurance agreements. As a result, our investment allocations are largely a function of our collective reinsurer investment allocations. While the reinsurers own the investment risk on these assets, we typically restrict their investment allocations via control over the selection of the asset manager as well as asset restrictions set forth in investment guidelines and control over the investment manager. In many of our reinsurance agreements, 1505 Capital acts as the asset manager for a fee.
Our investment guidelines typically include U.S. government bonds, corporate bonds, commercial mortgages, asset backed securities, municipal bonds, and collateral loans. The duration of our investments is 5 to 10 years in line with that of our liabilities. We do allow non-U.S. dollar denominated investments where the foreign exchange risk is hedged back to U.S. dollars.
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The following table shows the carrying value of our investments by investment category and cash and cash equivalents, and the percentage of each to total invested assets as of December 31, 2022 and 2021. Increases in fixed maturity securities primarily resulted from the sale of our MYGA and FIA products during 2022.
December 31, 2022 | December 31, 2021 |
| |||||||||
Carrying | Percent | Carrying | Percent |
| |||||||
(In thousands) |
| Value |
| of Total |
| Value |
| of Total |
| ||
Fixed maturity securities: |
|
|
|
|
|
|
|
| |||
Bonds: | |||||||||||
U.S. government obligations | $ | 1,262 |
| 0.1 | % | $ | 1,882 |
| 0.2 | % | |
Mortgage-backed securities |
| 294,066 |
| 16.3 |
| 55,280 |
| 4.9 | |||
Asset-backed securities | 30,756 | 1.7 | 24,951 | 2.2 | |||||||
Collateralized loan obligations | 287,673 | 15.9 | 274,523 | 24.6 | |||||||
States and political subdivisions-general obligations |
| 101 |
| — |
| 114 |
| — | |||
States and political subdivisions-special revenue |
| 205 |
| — |
| 5,612 |
| 0.5 | |||
Corporate |
| 41,600 |
| 2.3 |
| 37,139 |
| 3.3 | |||
Term loans | 558,972 | 30.9 | 267,468 | 23.9 | |||||||
Trust preferred | — | — | 2,237 | 0.2 | |||||||
Redeemable preferred stock | — | — | 14,090 | 1.3 | |||||||
Total fixed maturity securities |
| 1,214,635 |
| 67.2 |
| 683,296 |
| 61.1 | |||
Mortgage loans on real estate, held for investment | 227,047 | 12.6 | 183,203 | 16.4 | |||||||
Derivatives | 15,934 | 0.9 | 23,022 | 2.1 | |||||||
Equity securities | 5,111 | 0.3 | 21,869 | 2.0 | |||||||
Other invested assets | 112,431 | 6.2 | 35,293 | 3.2 | |||||||
Investment escrow | 784 | — | 3,611 | 0.3 | |||||||
Federal Home Loan Bank stock | 1,306 | 0.2 | 500 | — | |||||||
Preferred stock | 31,415 | 1.7 | 18,686 | 1.7 | |||||||
Notes receivable | 6,269 | 0.3 | 5,960 | 0.5 | |||||||
Policy Loans |
| 25 |
| — |
| 87 |
| — | |||
Cash and cash equivalents | 191,414 | 10.6 | 142,013 | 12.7 | |||||||
Total investments, including cash and cash equivalents | $ | 1,806,371 |
| 100.0 | % | $ | 1,117,540 |
| 100.0 | % | |
The following table shows the distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value as of December 31, 2022 and 2021.
December 31, 2022 | December 31, 2021 |
| |||||||||
Carrying | Carrying |
| |||||||||
(In thousands) |
| Value |
| Percent |
| Value |
| Percent |
| ||
AAA and U.S. Government | $ | 124,183 |
| 10.2 | % | $ | 2,674 |
| 0.4 | % | |
AA |
| 815 |
| 0.1 |
| 482 |
| 0.1 | |||
A |
| 371,371 |
| 30.6 |
| 168,141 |
| 24.6 | |||
BBB |
| 619,516 |
| 51.0 |
| 462,699 |
| 67.7 | |||
Total investment grade |
| 1,115,885 |
| 91.9 |
| 633,996 |
| 92.8 | |||
BB and below |
| 98,750 |
| 8.1 |
| 49,300 |
| 7.2 | |||
Total | $ | 1,214,635 |
| 100.0 | % | $ | 683,296 |
| 100.0 | % | |
Reflecting the quality of securities maintained by us, 91.9% and 92.8% of all fixed maturity securities were investment grade as of December 31, 2022 and 2021, respectively.
We expect that our MYGA and FIA products sales will result in an increase in investable assets in future periods.
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Market Risks of Financial Instruments
The primary market risks affecting the investment portfolio are interest rate risk, credit risk, and liquidity risk. With respect to investments that we hold on our balance sheet as collateral, our reinsurers bear the market risks related to these investments, while we bear the market risks on any net retained investments.
Interest Rate Risk
Interest rate risk arises from the price sensitivity of investments to changes in interest rates. Interest and dividend income represent the greatest portion of an investment’s return for most fixed maturity securities in stable interest rate environments. The changes in the fair value of such investments are inversely related to changes in market interest rates. As interest rates fall, the interest and dividend streams of existing fixed-rate investments become more valuable and fair values rise. As interest rates rise, the opposite effect occurs. Our liabilities also have interest rate risk though GAAP does not require our liabilities to be marked to market. We mitigate interest rate risk by monitoring and matching the duration of assets compared to the duration of liabilities.
Credit Risk
We are exposed to credit risk through counterparties and within the investment portfolio. Credit risk relates to the uncertainty associated with an obligor’s ability to make timely payments of principal and interest in accordance with the contractual terms of an instrument or contract. We manage our credit risk through diversification of investments amongst many corporations and numerous industries. Additionally, our investment policy limits the size of holding in any particular issuer.
Liquidity Risk
We are exposed to liquidity risk when liabilities come due. In order to pay a policyholder, we may need to liquidate assets. If our assets are illiquid assets, we might be unable to convert an asset into cash without giving up capital and income due to a lack of buyers or an inefficient market. We seek to mitigate this risk by keeping a portion of our investment portfolio in liquid investments.
Statutory Accounting and Regulations
Our primary insurance subsidiary, American Life, is required to prepare statutory financial statements in accordance with SAP prescribed by the NDOI. SAP primarily differs from GAAP by charging policy acquisition costs to expense as incurred, establishing future benefit liabilities using actuarial assumptions as well as valuing investments and certain assets and accounting for deferred taxes on a different basis. For further discussion regarding SAP as well as net income (loss) of American Life under SAP, see Note 13 to our consolidated financial statements. As of December 31, 2022, American Life maintained sufficient capital and surplus to comply with regulatory requirements.
State insurance laws and regulations govern the operations of all insurers and reinsurers such as our insurance and reinsurance company subsidiaries. These various laws and regulations require that insurance companies maintain minimum amounts of statutory surplus as regards policyholders and risk-based capital and determine the dividends that insurers can pay without prior approval from regulators. The statutory net income of American Life is one of the primary sources of additions to our statutory surplus as regards policyholders, in addition to capital contributions from us.
We have reported our insurance subsidiaries’ assets, liabilities and results of operations in accordance with GAAP, which varies from SAP. The following items are principal differences between SAP and GAAP. SAP:
| ● | requires that we exclude certain assets, called non-admitted assets, from the balance sheet. |
| ● | requires us to expense policy acquisition costs when incurred, while GAAP allows us to defer and amortize policy acquisition costs over the estimated life of the policies. |
| ● | dictates how much of a deferred income tax asset that we can admit on a statutory balance sheet. |
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| ● | requires that we record certain investments at cost or amortized cost, while we record other investments at fair value; however, GAAP requires that we record all investments at fair value. |
| ● | allows bonds to be carried at amortized cost or fair value based on the rating received from the Securities Valuation Office of the NAIC, while they are recorded at fair value for GAAP. |
| ● | allows ceding commission income to be recognized when written if the cost of acquiring and renewing the associated business exceeds the ceding commissions, but under GAAP such income is deferred and recognized over the coverage period. |
| ● | requires that we record reserves in liabilities and expense for policies written, while we record all transactions related to the annuity products under GAAP as deposit-type contract liabilities. |
| ● | requires a provision for reinsurance liability be established for reinsurance recoverable on paid losses aged over 90 days and for unsecured amounts recoverable from unauthorized reinsurers. Under GAAP there is no charge for uncollateralized amounts ceded to a company not licensed in the insurance affiliate’s domiciliary state and a reserve for uncollectable reinsurance is charged through earnings rather than surplus or equity. |
| ● | requires an additional admissibility test outlined in Statements on Statutory Accounting Principles, No. 101 and the change in deferred income tax is reported directly in capital and surplus, rather than being reported as a component of income tax expense under GAAP. Our insurance subsidiaries must file with the insurance regulatory authorities an “Annual Statement” which reports, among other items, net income (loss) and surplus as regards policyholders, which is called stockholders’ equity under GAAP. |
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The table below sets forth our SAP net income (loss) for 2022 and 2021 for each of our insurance subsidiaries and then reconciled to GAAP.
Year ended December 31, | |||||
(In thousands) | 2022 | 2021 | |||
Consolidated GAAP net income (loss) | $ | 7,140 | $ | (16,637) | |
Exclude: Midwest non-insurance transaction entities (American Life & Seneca Re) | 6,680 | (6,961) | |||
GAAP net gain (loss) of statutory insurance entities | $ | 460 | $ | (9,676) | |
GAAP net income (loss) by statutory insurance entity: | |||||
American Life | $ | 12,459 | $ | (8,742) | |
Seneca Re Incorporated Cell 01 | (10,426) | (321) | |||
Seneca Re Incorporated Cell 03 | (1,573) | (613) | |||
GAAP net gain (loss) | $ | 460 | $ | (9,676) | |
Reconciliation of GAAP and SAP | |||||
GAAP net income (loss) of American Life | 12,459 | (8,742) | |||
Increase (decrease) due to: | |||||
Deferred acquisition costs | (36,003) | (34,451) | |||
Coinsurance transactions | 435,413 | 171,687 | |||
Carrying value of reserves | (405,565) | (133,028) | |||
Foreign exchange and derivatives | 35,025 | — | |||
Gain (loss) on sale of investments, net of asset valuation reserve | (33,935) | (1,861) | |||
Other | (5,064) | 40 | |||
SAP net income (loss) of American Life | $ | 2,330 | $ | (6,355) | |
GAAP net loss of Seneca Re Incorporated Cell 01 | (10,426) | (321) | |||
Increase (decrease) due to: | |||||
Deferred acquisition costs | 2,730 | (3,343) | |||
Coinsurance transactions | 222 | 37,763 | |||
Carrying value of reserves | (9,996) | (36,995) | |||
Gain on sale of investments, net of asset valuation reserve | 19,815 | 1,847 | |||
Other gain (loss) | (1,146) | 45 | |||
SAP net income (loss) of Seneca Re Incorporated Cell | $ | 1,199 | $ | (1,004) | |
GAAP net loss of Seneca Re Incorporated Cell 03 | (1,573) | (613) | |||
Increase (decrease) due to: | |||||
Deferred acquisition costs | (3,649) | (10,325) | |||
Coinsurance transactions | 35,773 | 88,704 | |||
Carrying value of reserves | (37,717) | (84,865) | |||
Gain on sale of investments, net of asset valuation reserve | 8,633 | 282 | |||
Other | (111) | (34) | |||
SAP net income (loss) of Seneca Re Incorporated Cell 03 | $ | 1,356 | $ | (6,851) | |
SAP net gain (loss) of statutory insurance entities | $ | 4,885 | $ | (14,210) | |
Key Operating and Non-GAAP Measures
We discuss below non-GAAP financial measures that management uses in conjunction with GAAP financial measures as an integral part of managing our business and to, among other things:
• monitor and evaluate the performance of our business operations and financial performance;
• facilitate internal comparisons of the historical operating performance of our business operations;
• review and assess the operating performance of our management team;
• analyze and evaluate financial and strategic planning decisions regarding future operations; and
• plan for and prepare future annual operating budgets and determine appropriate levels of operating investments.
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Management believes the use of these non-GAAP measures, together with the relevant GAAP measures provides information that may enhance understanding of our results by investors. Non-GAAP financial measures used by us may be calculated differently from, and therefore may not be comparable to, similarly titled measures used by other companies. These non-GAAP financial measures should be considered along with, but not as alternatives to, our operating performance measures as prescribed by GAAP.
Operating Metric – Annuity Premiums
We monitor annuity premiums as a key operating metric in evaluating the performance of our business. Annuity premiums, also referred to as sales or direct written premiums, do not correspond to revenues under GAAP, but are relevant metrics to understand our business performance. Under SAP, our annuity premiums received are treated as premium revenue. Our premium metrics include all sums paid into an individual annuity in a given period. We typically transfer all or a substantial portion of the premium and policy obligations to reinsurers. Ceded premium represents the premium we transfer to reinsurers in a given period. Retained premium represents the portion of premium received during a given period that was not ceded to reinsurers and will either be reinsured in a subsequent period or retained by us. We typically retain premiums prior to transferring them to reinsurers to facilitate block and other reinsurance transactions involving portfolios of annuity premiums.
The following table sets forth premiums received under SAP. Under GAAP these products are defined as deposit-type contracts; therefore, the premium revenue is accounted under GAAP as deposit-type liabilities on our Consolidated balance sheets and is not recognized in our Consolidated Statements of Comprehensive Loss.
Year ended December 31, | |||||
(In thousands) | 2022 | 2021 | |||
Annuity Premiums (SAP) | |||||
Annuity direct written premiums | $ | 715,833 | $ | 471,646 | |
Ceded premiums | (311,257) | (237,411) | |||
Net premiums retained | $ | 404,576 | $ | 234,235 | |
The increase in annuity direct written premiums reflect strong sales throughout 2022, even in a challenging sales environment, in which competitors were pricing rates on annuity products aggressively. We sell annuities through the IMO channel. We aim to grow annuity direct written premiums by further developing our relationships with existing IMOs and increasing the number of IMO partners that distribute our annuity products, as well as increasing the number of states in which we are licensed to sell our annuity products. We also aim to distribute to new channels, including the registered investment advisor (RIA) channel as well as the bank and broker-dealer channels. The increase in ceded premiums was attributable primarily to the increase in annuity direct written premiums.
Operating Metric – Fees Received for Reinsurance
Year ended December 31, | ||||||
(In thousands) | 2022 |
| 2021 | |||
Fees received for reinsurance(1) | ||||||
Fees received for reinsurance - total | $ | 14,290 | $ | 13,412 | ||
(1) Consists of: 1) amortization of deferred gain on reinsurance, which is a line item from our GAAP Consolidated Statements of Comprehensive Loss; and 2) deferred coinsurance ceding commission, which is a line item from our GAAP Consolidated Statements of Cash Flows.
For the year ended December 31, 2022, fees received for reinsurance increased by $0.9 million compared to the prior year period due to higher ceded premiums. For the year ended December 31, 2022, the components of fees received for reinsurance included $4.8 million of amortization of deferred gain on reinsurance from our Consolidated Statements of Comprehensive Loss and $9.5 million of deferred coinsurance ceding commission from our Consolidated Statements of Cash Flows.
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Reconciliation – Management Expenses to GAAP Expenses
Year ended December 31, | ||||||
| 2022 |
| 2021 | |||
Management Expenses |
|
|
| |||
G&A | $ | 35,015 | $ | 24,632 | ||
Management interest credited | 15,811 | 8,757 | ||||
Amortization of deferred acquisition costs | 4,788 | 2,886 | ||||
Expenses related to retained business | 20,599 | 11,643 | ||||
Management expenses - total | $ | 55,614 | $ | 36,275 | ||
Year ended December 31, | ||||||
| 2022 |
| 2021 | |||
G&A | ||||||
Salaries and benefits - GAAP | $ | 16,196 | $ | 16,926 | ||
Other operating expenses - GAAP | 7,661 | 15,104 | ||||
Subtotal | 23,857 | 32,030 | ||||
Adjustments: | ||||||
Less: Stock-based compensation | (29) | (4,981) | ||||
Less: Mark-to-market option allowance | 11,187 | (2,417) | ||||
G&A | $ | 35,015 | $ | 24,632 | ||
Year ended December 31, | ||||||
| 2022 |
| 2021 | |||
Management Interest Credited | ||||||
Interest credited - GAAP | $ | (10,193) | $ | 7,012 | ||
Adjustments: | ||||||
Less: FIA interest credited - GAAP | 17,171 | (4,169) | ||||
Add: FIA options cost - amortized - GAAP | 8,833 | 5,914 | ||||
Management interest credited | $ | 15,811 | $ | 8,757 | ||
Year ended December 31, | ||||||
| 2022 |
| 2021 | |||
Reconciliation - Management Expenses to GAAP Expenses | ||||||
Total expenses - GAAP | $ | 21,658 | $ | 41,934 | ||
Adjustments: | ||||||
Less: Benefits | (3,206) | (6) | ||||
Less: Stock-based compensation | (29) | (4,981) | ||||
Less: Mark-to-market option allowance | 11,187 | (2,417) | ||||
Less: FIA interest credited - GAAP | 17,171 | (4,169) | ||||
Add: FIA options cost - amortized - GAAP | 8,833 | 5,914 | ||||
Management expenses - total | $ | 55,614 | $ | 36,275 | ||
Operating Metric – Management and G&A Expenses
In addition to total expenses, we utilize management expenses as an economic measure to evaluate our financial performance. Management expenses consist of total GAAP expenses adjusted to eliminate items that fluctuate from quarter to quarter in a manner unrelated to core operations, which we believe are useful in analyzing operating trends. The most significant adjustments to arrive at management expenses include the use of management interest credited (as discussed below), the exclusion of stock-based compensation and the exclusion of the mark-to-market option allowance expense (included in other operating expenses) payable to reinsurers to cover their obligations under FIA policies we have reinsured with them. We believe the combined presentation and evaluation of total expenses together with management expenses provides information that can enhance an investor’s understanding of our underlying operating results.
For the year ended December 31, 2022, GAAP general and administrative expenses totaled $35.0 million compared to $24.6 million for the prior year. For the year ended December 31, 2022, as disclosed above, included in these expenses is mainly salaries, benefits
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and other operating expenses, along with less than $0.1 million of non-cash stock-based compensation and $11.2 million of non-cash mark-to-market expense of our derivative option allowance, which we exclude in our management G&A.
Operating Metric – Management Interest Credited
We utilize management interest credited, a component of management expenses, as an economic measure to evaluate our financial performance. GAAP interest credited contains significant technical considerations related to fair value accounting with respect to the mark-to-market change in the FIA embedded derivative liability and change in actuarial valuation of the FIA reserve, both of which are sensitive to changes in the market as well as changes in actuarial assumptions. Due to these technical considerations that we believe are less meaningful to management and investors, we exclude the GAAP interest credited expense related to our FIA products and include the amortized cost of options we purchase to service our FIA policy obligations. The sum of GAAP interest credited related to our multi-year guaranteed annuity (“MYGA”) products and the amortized cost of options we purchase to service our FIA products constitutes management interest credited.
For the year ended December 31, 2022, GAAP interest credited totaled negative $10.2 million compared to positive $ 7.0 million for the prior year. For the year ended December 31, 2022, as disclosed above, included in these expenses is GAAP interest credited related to our retained FIA policies of approximately negative $17.2 million.
Liquidity and Capital Resources
Investments
Information regarding our investment portfolio, which is comprised primarily of investment grade, fixed maturity securities, is presented in Part IV - Item 15, Exhibits and Financial Statement Schedules and in Part II - Item 8, Note 3 of the Consolidated Financial Statements in this report.
Comparative Cash Flows
At December 31, 2022 and 2021, we had cash and cash equivalents totaling $191.4 and $142.0 million, respectively. Our short-term liquidity requirements, within a 12 month operating cycle, are for the timely payment of claims and benefits to policyholders, operating expenses, interest payments and federal income taxes. Cash flow generated from operations has been, and is expected to be, adequate to meet our operating cash needs in the next 12 months. Cash flow in excess of operational needs has been used to fund business growth. Long-term liquidity requirements, beyond one year, are principally for the payment of future insurance and annuity benefits.
We believe that our existing cash and cash equivalents will be sufficient to fund our anticipated operating expenses and capital transaction expenditures for the foreseeable future. As our state expansion continues, we expect an increase in our sales of our MYGA and FIA products. However, our ability to continue to meet our future liquidity requirements will depend on, among other things, our ability to achieve anticipated levels of cash flows generated from operations and our ability to manage costs and working capital successfully, all of which are subject to general economic, financial, competitive and other factors beyond our control. In the event we require any additional capital, we may be required to raise additional funds, including through the sale of capital stock or debt in the public capital markets or in privately negotiated transactions, and there can be no assurance that we will be able to raise any such financing on terms acceptable to us or at all. If such funds are not available in the future, we may be required to delay or significantly modify our operations, each of which could have a material adverse impact on our results of operations or financial condition. For additional information, refer to Part I, Item 1A. Risk Factors—General Risks—Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs and access the capital required to operate our business.
Cash flow is an important component of our business model because we receive annuity premiums and invest them upon receipt for our reinsurers and us and for the benefit of our policyholders.
53
The following table summarizes our cash flows from operational, investing and financing activities for the periods indicated. See the Consolidated Statements of Cash Flow in our Consolidated financial statements for more detailed information.
Year ended December 31, | ||||||
2022 |
| 2021 | ||||
(In thousands) | ||||||
Net cash provided by (used in) operating activities | $ | 73,162 | $ | (25,338) | ||
Net cash (used in) investing activities | (708,708) | (452,407) | ||||
Net cash provided by financing activities | 684,947 | 468,079 | ||||
Net increase (decrease) in cash and cash equivalents | 49,401 | (9,666) | ||||
Cash and cash equivalents: | ||||||
Beginning of period | 142,013 | 151,679 | ||||
End of period | $ | 191,414 | $ | 142,013 | ||
Cash Provided by Operating Activities
Net cash provided by operating activities was $73.2 million for the year ended December 31, 2022, which was comprised primarily of a decrease in receivable and payable for securities of $12.5 million, capitalized DAC of $23.9 million, net realized loss on investments of $14.9 million, accrued investment income of $11.5 million, and amounts recoverable from reinsurers of $29.0 million. These were offset by deposit-type liabilities of $3.4 million, and an increase in deferred coinsurance ceding commission to $9.5 million.
Cash Used in Investing Activities
Net cash used for investing activities for 2022 was $708.7 million. The primary source of cash used was from our purchase of investments from sales of the MYGA and FIA products of $1,258.3 million. Offsetting this use of cash was our sale of investments of $573.2 million.
Cash Flow Provided by Financing Activities
Net cash provided by financing activities in 2022 was $684.9 million. The primary source of cash was net receipts on the MYGA and FIA products of $715.8 million.
As of December 31, 2022, we held $198.1 million of cash, U.S. government and agency fixed maturity securities and public equity securities (excluding non-redeemable preferred stocks and foreign equity securities) which, under normal market conditions, could be rapidly liquidated. Certain remote events and circumstances could constrain our liquidity. Those events and circumstances include, for example, a catastrophe resulting in extraordinary losses, a downgrade of our Senior Notes rating to noninvestment grade status or a downgrade in our insurance subsidiaries' financial strength ratings. The rating agencies also consider the interdependence of our individually rated entities; therefore, a rating change in one entity could potentially affect the ratings of other related entities.
Capital Resources
We have determined the amount of capital which is needed to adequately fund and support business growth, primarily based on risk-based capital formulas including those developed by the NAIC. Historically, our insurance subsidiary has generated capital in excess of such needed levels. If necessary, we also have other potential sources of liquidity that could provide for additional funding to meet corporate obligations. Our regulated insurance subsidiary is subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to us without prior approval of the insurance regulatory authorities. The aggregate amount of dividends that may be paid in 2023 from our insurance subsidiary without prior regulatory approval is approximately $7.4 million. We anticipate that our sources of capital will continue to generate sufficient capital to meet the needs for business growth and debt interest payments. Additional information is contained in Part II - Item 8, Note 13 of the Consolidated Financial Statements in this report.
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Total capital was $1,806.4 million at December 31, 2022, including $25.0 million of short-term and long-term debt. Total debt represented 1.38% of total capital including net unrealized investment gains on fixed maturity securities (1.39% of total capital excluding net unrealized investment gains on fixed maturity securities*) at December 31, 2022.
Stockholders’ equity was $34.4 million at December 31, 2022, including net unrealized investment gains on fixed maturity securities of negative $51.4 million after taxes and the related impact of DAC associated with annuity contracts with account values. The market value of our common stock and the market value per share were $47.0 million and $12.62, respectively, at December 31, 2022.
The Company did not pay dividends in the year ended December 31, 2022.
The NAIC has established minimum capital requirements in the form of RBC that factors the type of business written by an insurance company, the quality of its assets and various other aspects of its business to develop a minimum level of capital known as “authorized control level risk-based capital” and compares this level to adjusted statutory capital that includes capital and surplus as reported under SAP, plus certain investment reserves. Should the ratio of adjusted statutory capital to control level RBC fall below 200%, a series of remedial actions by the affected company would be required. As of December 31, 2022, and 2021, the RBC ratio of American Life was 558% and 764%, respectively.
On November 22, 2022, the Company entered into a three-year senior secured revolving credit agreement (“Credit Agreement”) with Royal Bank of Canada and other lenders with a capacity of $30 million (the “Revolving Credit Facility”). The maturity date of the Credit Agreement is November 22, 2025. The obligations under the Credit Agreement are secured by a first priority lien on a variety of our assets. The balance of the revolving credit was $25.0 million at December 31, 2022, with $5.0 million unutilized credit.
Under the terms of the Credit Agreement, the Company has the option of selecting an applicable variable interest rate of (a) an adjusted term standard overnight financing rate (“SOFR”), plus an applicable margin or (b) a base rate, plus an applicable margin. Depending on our debt to capitalization ratio, the applicable margin can range from 2.50% to 3.25% for the base rate and from 3.50% to 4.25% for an adjusted term SOFR loan.
At its November 2022 meeting, the Company’s Board of Directors approved the “FHLB Program Recommendations and Strategy Document” that allowed for FHLB funding to be used for spread lending business, beginning in the fourth quarter of 2022. The strategy initially utilizes FHLB advances of up to 5% of American Life’s balance sheet. As of December 31, 2022, we had $29.0 million of borrowings outstanding with the Federal Home Loan Bank (“FHLB”).
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As a smaller reporting company, we are not required to provide disclosure pursuant to this Item.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company’s audited Consolidated financial statements are included as a part of this report beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
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ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
We have established disclosure controls and procedures to ensure, among other things, material information relating to our Company, including our consolidated subsidiaries, is made known to our officers who certify our financial reports and to the other members of our senior management and the Board.
As required by Rule 13a-15(b) under the Exchange Act, management (with the participation of our chief executive officer and prin-cipal financial officer) carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and pro-cedures, as defined in Rules 13a 15(e) and 15d 15(e) under the Exchange Act as of December 31, 2022. Based on this evaluation, our principal executive and financial officers concluded that, as of the end of the period covered in this report, our disclosure controls and procedures along with the related internal controls over financial reporting were effective to provide reasonable assurance that the information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. Management, (with the participation of our chief executive officer and principal financial officer), carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of December 31, 2022. Based on this evaluation, our principal executive and financial officers concluded that, as of the end of the period covered in this report, our disclosure controls and procedures along with the related internal controls over financial reporting were effective to provide reasonable assurance that the information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to our management, including our -principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with GAAP. A company’s internal control over financial reporting includes policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management, under the supervision and with the participation of our principal executive officer, performed an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2022. Based on management's assessment, we have concluded that our internal control over financial reporting was effective as of December 31, 2022.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the three months ended December 31, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
56
ITEM 9B. OTHER INFORMATION.
None.
ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS
Not applicable.
57
PART III.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The information provided by this Item 10 is incorporated herein by reference to our Notice of 2023 Annual Meeting of Stockholders and definitive Proxy Statement for our 2023 Annual Meeting of Stockholders (our “Proxy Statement”), to be filed within 120 days of December 31, 2022.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated herein by reference to our Proxy Statement, to be filed within 120 days of December 31, 2022.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The information required by this Item 12 is incorporated herein by reference to our Proxy Statement, to be filed within 120 days of December 31, 2022.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
The information required by this Item 13 is incorporated herein by reference to our Proxy Statement, to be filed within 120 days of December 31, 2022.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item 14 is incorporated herein by reference to our Proxy Statement, to be filed within 120 days of December 31, 2022.
58
PART IV.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) 1. Consolidated Financial Statements:
The list of financial statements filed as part of this Annual Report on Form 10-K is provided on page F-1.
2. Financial Statement Schedules:
The list of financial statement schedules filed as part of this Annual Report on Form 10-K is provided on page FS-1.
(b) Exhibits:
Exhibit No. | Description | |
3.1 | ||
3.2 | ||
3.3 | ||
3.4 | Plan of Domestication (as filed with the Nebraska Secretary of State) (Incorporated by reference to Exhibit 2.1 to the Company’s Form 8-K, filed on August 21, 2020.) | |
3.5 | ||
3.6 | ||
4.1 | ||
10.1 | ||
10.2 | ||
10.3 |
59
10.4 | ||
10.5 | ||
10.6 | ||
10.7 | Assumption and Indemnity Reinsurance Agreement — American Life & Security Corporation and Unified Life Insurance Company dated November 30, 2018 (Incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K, filed December 6, 2018.) | |
10.8 | ||
10.9 | ||
10.10 | ||
10.11 | ||
10.12 | ||
10.13 | ||
10.14 | ||
10.15† | ||
10.16 | ||
10.17† |
60
10.18† | ||
10.19† | ||
10.20 | ||
10.21 | ||
10.22 | ||
10.23 | ||
10.24† | ||
10.25† | ||
10.26† | ||
10.27† | ||
10.28 | ||
10.29† | ||
10.30† | ||
10.31† | ||
10.32 |
61
10.33† | ||
10.34* | Revolving Credit Facility between Midwest Holding Inc., the lenders party thereto and Royal Bank of Canada dated November 22, 2022. | |
14.1* | Code of Ethics | |
21.1* | List of Subsidiaries. | |
24 | Power of Attorney (see Signature Page to this Report on Form 10-K.) | |
31.1* | Certification of Principal Executive Officers pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2* | Certification of Principal Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1* | Certification of Principal Executive Officers pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2* | Certification of Principal Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
101.INS | Inline XBRL Instance Document. | |
101.SCH | Inline XBRL Taxonomy Extension Schema Document. | |
101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase Document. | |
101.LAB | Inline XBRL Taxonomy Extension Label Linkbase Document. | |
101.PRE | Inline XBRL Taxonomy Extension Presentation Linkbase Document. |
* Filed herewith.
† Management contract or compensatory plan or arrangement.
ITEM 16. Form 10-K Summary.
None.
62
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 27, 2023
MIDWEST HOLDING INC. | ||
| ||
By: | /s/ Georgette Nicholas | |
Name: | Georgette Nicholas | |
Title: | Chief Executive Officer | |
We, the undersigned, hereby severally constitute and appoint Georgette Nicholas, our true and lawful attorney with full power to sign for us, and in our names in the capacities indicated below, any and all amendments to the annual report on Form 10-K filed with the Securities and Exchange Commission, hereby ratifying and confirming her signature as she may be signed by our said attorney to any and all amendments to said Annual Report on Form 10-K.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the dates indicated.
Signature | Title | Date | ||
/s/ Georgette Nicholas | Chief Executive Officer, Director | March 27, 2023 | ||
Georgette Nicholas | (Principal Executive Officer) | |||
/s/ Mike Minnich | President and Chief Investment Officer, Director | March 27, 2023 | ||
Mike Minnich | ||||
/s/ Daniel Maloney | Executive Vice President of Accounting and Finance, | March 27, 2023 | ||
Daniel Maloney | Principal Accounting Officer, and Treasurer | |||
/s/ John Hompe | Director and Independent Board Chair | March 27, 2023 | ||
John Hompe | ||||
/s/ Firman Leung | Director | March 27, 2023 | ||
Firman Leung | ||||
/s/Nancy Callahan | Director | March 27, 2023 | ||
Nancy Callahan | ||||
/s/Diane Davis | Director | March 27, 2023 | ||
Diane Davis | ||||
/s/Kevin Sheehan | Director | March 27, 2023 | ||
Kevin Sheehan | ||||
/s/Yadin Rozov | Director | March 27, 2023 | ||
Yadin Rozov |
63
MIDWEST HOLDING INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
F-1
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of Midwest Holding Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Midwest Holding Inc. and Subsidiaries (collectively, the “Company”) as of December 31, 2022 and 2021, the related consolidated statements of comprehensive loss, stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2022, and the related notes and the schedules (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Valuation of embedded derivatives of fixed indexed annuities
As described in Notes 1 and 5 to the consolidated financial statements, the Company issues fixed indexed annuity products that contain embedded derivatives, valued at $111.618 million as of December 31, 2022. Fixed indexed annuity contracts allow the policyholder to elect a fixed interest rate return or an equity market component for which interest credited is based on the performance of certain stock market indices. The equity market option is an embedded derivative. The fair value of the embedded derivatives is computed as the present value of death, surrender and partial withdrawal benefits attributable to the excess of the projected policy contract values over the projected minimum guaranteed contract values. The projections of policy contract values
F-2
are based on assumptions for future policy growth, which included assumptions for expected index credits on the next policy anniversary date, future equity option cost developed based on the participation rate, cap rate, strike rate, volatility assumption, time to expiration, and risk-free rates using the Black Scholes formula and grow at the risk-free interest rates over the term of the index period, guaranteed minimum renewal interest rate, and policyholder assumptions including mortality, lapses, partial withdrawal rates, and the utilization of benefit riders.
The principal considerations for our determination that performing procedures relating to the valuation of embedded derivatives of fixed indexed annuities is a critical audit matter are (i) the significant judgment by management in estimating the fair value of embedded derivatives, specifically the significant policyholder behavior assumptions related to deaths, lapses, partial withdrawals, and the utilization of benefit riders, which in turn led to a high degree of auditor judgment, subjectivity and effort in evaluating the audit evidence relating to the significant assumptions, and (ii) the audit effort involved the use of professionals with specialized skill and knowledge.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated financial statements. These procedures included, among others, testing the completeness and accuracy of key data underlying the development of the significant assumptions, and the involvement of professionals with specialized skill and knowledge to assist in testing management’s process for determining the valuation of embedded derivatives for fixed indexed annuities, which included (i) evaluating the appropriateness of the methods used in the valuation of the embedded derivatives of fixed indexed annuities, and (ii) evaluating the reasonableness of management’s significant assumptions of policyholder behavior assumptions related to deaths, lapses, partial withdrawals, and the use of benefit riders.
/s/
We have served as the Company’s auditor since 2019.
March 27, 2023
F-3
Midwest Holding Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 2022 and 2021
| December 31, 2022 |
| December 31, 2021 | |||
(In thousands, except share information) | ||||||
Assets |
|
|
|
| ||
Fixed maturities, available for sale, at fair value | $ | $ | ||||
Mortgage loans on real estate, held for investment |
|
| ||||
Derivative instruments (See Note 4) | ||||||
Equity securities, at fair value (cost: $ | ||||||
Other invested assets | ||||||
Preferred stock | ||||||
Deposits and notes receivable | ||||||
Policy loans |
|
| ||||
Total investments |
|
| ||||
Cash and cash equivalents |
|
| ||||
Deferred acquisition costs, net | ||||||
Premiums receivable | ||||||
Accrued investment income | ||||||
Reinsurance recoverables (See Note 8) | ||||||
Property and equipment, net |
|
| ||||
Receivable for securities sold | ||||||
Other assets |
|
| ||||
Total assets | $ | $ | ||||
Liabilities and Stockholders’ Equity |
|
|
|
| ||
Liabilities: |
|
|
|
| ||
Benefit reserves | $ | $ | ||||
Deposit-type contracts (See Note 6) |
|
| ||||
Other policy-holder funds | ||||||
Notes payable (See Note 7) | — | |||||
Deferred gain on coinsurance transactions |
|
| ||||
Payable for securities purchased | ||||||
Other liabilities | ||||||
Total liabilities |
|
| ||||
Stockholders’ Equity: |
|
| ||||
Preferred stock, $ |
|
| ||||
Voting common stock, $ |
| |
| |||
Additional paid-in capital |
| |
| |||
Treasury stock | ( | ( | ||||
Accumulated deficit |
| ( |
| ( | ||
Accumulated other comprehensive (loss) income |
| ( |
| |||
Total Midwest Holding Inc.'s stockholders' equity | | |||||
Noncontrolling interests | ||||||
Total stockholders' equity |
|
| ||||
Total liabilities and stockholders' equity | $ | $ | ||||
See Notes to Consolidated Financial Statements.
F-4
Midwest Holding Inc. and Subsidiaries
Consolidated Statements of Comprehensive Loss
Years Ended December 31, 2022 and 2021
Year ended December 31, | |||||||
(In thousands, except per share data) |
| 2022 |
| 2021 | |||
Revenues |
|
|
| ||||
Investment income, net of expenses | $ | | $ | | |||
Net realized (loss) gain on investments (See Note 3) |
| ( | | ||||
Amortization of deferred gain on reinsurance transactions | | | |||||
Policy administration fees | | | |||||
Service fee revenue, net of expenses | | | |||||
Other revenue |
| | | ||||
Total revenue |
| |
| | |||
Expenses |
|
|
|
| |||
Interest credited |
| ( | | ||||
Benefits | | | |||||
Amortization of deferred acquisition costs |
| | | ||||
Salaries and benefits |
| | | ||||
Other operating expenses |
| | | ||||
Total expenses |
| |
| | |||
Net income (loss) before income tax expense |
| |
| ( | |||
Income tax expense (See Note 9) |
| ( | ( | ||||
Net income (loss) after income tax benefit (expense) | | ( | |||||
Less: Income (loss) attributable to noncontrolling interest | ( | — | |||||
Net income (loss) attributable to Midwest Holding Inc. | | ( | |||||
Comprehensive income (loss): |
|
|
|
| |||
Unrealized (losses) on investments arising during the year ended December 31, 2022 and 2021, net of offsets, net of tax ($ |
| ( | ( | ||||
Less: Reclassification adjustment for net realized losses on investments, net of offsets during the year ended December 31, 2022 and 2021 (net of tax ($ |
| | ( | ||||
Other comprehensive loss |
| ( |
| ( | |||
Comprehensive loss | $ | ( | $ | ( | |||
Impairment | |||||||
Total other-than-temporary impairment | $ | | $ | — | |||
Net other-than-temporary impairment loss recognized in net income | $ | | $ | — | |||
Income (Loss) per common share | |||||||
Basic | $ | | $ | ( | |||
Diluted | $ | | $ | ( | |||
See Notes to Consolidated Financial Statements.
F-5
Midwest Holding Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity
Years Ended December 31, 2022 and 2021
Year ended December 31, 2022 | |||||||||||||||||||||
Additional | |||||||||||||||||||||
Treasury | Common | Paid-In | Accumulated | Noncontrolling | Total | ||||||||||||||||
(In thousands) |
| Stock |
| Stock |
| Capital |
| Deficit |
| AOCI* |
| Interest |
| Equity | |||||||
Balance, December 31, 2021 | $ | ( | $ | | $ | | $ | ( | $ | | $ | | $ | | |||||||
Net income | — | — | — | | — | — | | ||||||||||||||
Employee stock options | — | — | — | — | — | | |||||||||||||||
Unrealized gains on investments, net of taxes | — | — | — | — | ( | — | ( | ||||||||||||||
Noncontrolling interest | — | — | — | — | — | ( | ( | ||||||||||||||
Balance, December 31, 2022 | $ | ( | $ | | $ | | $ | ( | $ | ( | $ | | $ | | |||||||
Balance at December 31, 2020 | $ | ( | $ | | $ | | $ | ( | $ | | $ | — | $ | | |||||||
Net (loss) |
| — |
| — |
| — |
| ( |
| — |
| — |
| ( | |||||||
Additional capital raise related expenses | — | — | ( | — | — | — | ( | ||||||||||||||
Employee stock options | — | — | | — | — | — | | ||||||||||||||
Unrealized losses on investments, net of taxes | — | — | — | — | ( | — | ( | ||||||||||||||
Noncontrolling interest | — | — | — | — | — | | | ||||||||||||||
Balance, December 31, 2021 | $ | ( | $ | | $ | | $ | ( | $ | | $ | | $ | | |||||||
* Accumulated other comprehensive income (loss)
See Notes to Consolidated Financial Statements.
F-6
Midwest Holding Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2022 and 2021
| Year ended December 31, | |||||
(In thousands) | 2022 |
| 2021 | |||
Cash Flows from Operating Activities: |
|
|
|
| ||
Income (loss) attributable to Midwest Holding Inc. | $ | | $ | ( | ||
Adjustments to arrive at cash provided by operating activities: |
|
|
|
| ||
Net premium and discount on investments |
| ( |
| ( | ||
Depreciation and amortization |
| |
| | ||
Stock options |
| |
| | ||
Amortization of deferred acquisition costs | | | ||||
Deferred acquisition costs capitalized | ( | ( | ||||
Net realized gain (loss) on investments |
| |
| ( | ||
Deferred gain on coinsurance transactions |
| |
| | ||
Changes in operating assets and liabilities: |
|
|
|
| ||
Reinsurance recoverable | | ( | ||||
Interest and dividends due and accrued |
| ( |
| ( | ||
Premiums receivable |
| ( |
| ( | ||
Deposit-type liabilities | | | ||||
Policy liabilities |
| |
| | ||
Receivable and payable for securities | | ( | ||||
Other assets and liabilities |
| |
| ( | ||
Net cash provided by (used in) operating activities |
| |
| ( | ||
Cash Flows from Investing Activities: |
|
|
|
| ||
Fixed maturities available for sale: |
|
|
|
| ||
Purchases |
| ( |
| ( | ||
Proceeds from sale or maturity |
| |
| | ||
Mortgage loans on real estate, held for investment |
|
| ||||
Purchases | ( | ( | ||||
Proceeds from sale | | | ||||
Derivatives | ||||||
Purchases | ( | ( | ||||
Proceeds from sale | | | ||||
Equity securities | ||||||
Purchases | — | ( | ||||
Proceeds from sale | | — | ||||
Other invested assets | ||||||
Purchases | ( | ( | ||||
Proceeds from sale | | | ||||
Purchase of restricted common stock | ( | ( | ||||
Preferred stock | ||||||
Purchases | — | ( | ||||
Proceeds from sale | | — | ||||
Net change in policy loans |
| |
| ( | ||
Net purchases of property and equipment |
| ( |
| ( | ||
Net cash used in investing activities |
| ( |
| ( | ||
Cash Flows from Financing Activities: |
|
|
|
| ||
Net transfer to noncontrolling interest | ( | | ||||
Proceeds from term debt | | — | ||||
Capital contribution | — | ( | ||||
Receipts on deposit-type contracts |
| |
| | ||
Withdrawals on deposit-type contracts |
| ( |
| ( | ||
Net cash provided by financing activities |
| |
| | ||
Net increase (decrease) in cash and cash equivalents |
| |
| ( | ||
Cash and cash equivalents: |
|
|
|
| ||
Beginning |
| |
| | ||
Ending | $ | | $ | | ||
Supplementary information |
|
|
|
| ||
Cash paid for taxes | $ | | $ | | ||
See Notes to Consolidated Financial Statements.
F-7
Note 1. Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Midwest Holding Inc. (“Midwest,” “the Company,” “we,” “our,” or “us”) was incorporated in Nebraska on October 31, 2003 for the primary purpose of operating a financial services company. The Company redomesticated from the State of Nebraska to the State of Delaware on August 27, 2020. The Company is in the life and annuity insurance business and operates through its wholly owned subsidiaries, American Life & Security Corp. (“American Life”), and 1505 Capital LLC (“1505 Capital”) as well as through its sponsored captive reinsurance company, Seneca Reinsurance Company, LLC (“Seneca Re”).
American Life is a Nebraska-domiciled life insurance company, that was licensed to sell, underwrite, and market life insurance and annuity products in 23 states and the District of Columbia as of December 31, 2022. American Life received authorization to do business in Georgia as of February 24, 2023, bringing our operating jurisdictions to 24 states and the District of Columbia.
Effective March 12, 2020, Seneca Re, a Vermont limited liability company, was formed by Midwest to operate as a sponsored captive insurance company for the purpose of insuring and reinsuring various types of risks of its participants through one or more protected cells and to conduct any other business or activity that is permitted for sponsored captive insurance companies under Vermont insurance regulations. On March 30, 2020, Seneca Re received its Certification of Authority to transact the business of a captive insurance company. On May 12, 2020, Midwest contributed $
Midwest initially owned a
On July 27, 2020, American Life entered into a reinsurance agreement (the “Reinsurance Agreement”) with a new protected cell formed by Seneca Re (Seneca Incorporated Cell, LLC 2020-02 (“SRC2”)). SRC2 was capitalized by Crestline Management, L.P. (“Crestline”), a significant shareholder of Midwest via a Crestline subsidiary, Crestline Re SPC1. The Reinsurance Agreement, which was effective as of April 24, 2020, was entered into pursuant to a Master Letter Agreement (the “Master Agreement”) dated and effective as of April 24, 2020, among American Life, Seneca Re and Crestline. The Reinsurance Agreement supports American Life’s new business production by providing reinsurance capacity for American Life to write certain kinds of fixed and multi-year guaranteed annuity products. Concurrently with the Reinsurance Agreement:
| ● | American Life and SRC2 each entered into investment management agreements with Crestline, pursuant to which Crestline manages the assets that support the reinsured business; and |
| ● | American Life and SRC2 entered into a trust agreement whereby SRC2 maintains for American Life’s benefit a trust account that supports the reinsured business. |
Under the Master Agreement, Crestline agreed to provide reinsurance funding for a quota share percentage of
In addition, pursuant to the Master Agreement, the parties thereto have agreed to enter into one or more separate agreements whereby, among other things and subject to certain conditions, American Life will agree to reinsure additional new business production to one or more reinsurers formed and/or capitalized by Crestline, Midwest or an appropriate affiliate will be compensated for providing administrative services to certain advisory clients of Crestline, and American Life will consider investing in certain assets originated or sourced by Crestline.
On June 26, 2021, the Nebraska Department of Insurance (‘NDOI”) issued its non-disapproval of the Modified Coinsurance Agreement (“Modco AEG Agreement”) of American Life with American Republic Insurance Company (“AEG”), an Iowa domiciled reinsurance
F-8
company. The agreement closed on June 30, 2021. Under the Modco AEG Agreement, American Life cedes to AEG, on a modified coinsurance basis,
On November 10, 2021, Midwest purchased
On September 30, 2022, American Life entered into a reinsurance agreement (the “Reinsurance Agreement”) with a new protected cell formed by Seneca Re (Seneca Incorporated Cell, LLC 2022-04 (“SRC4”)). SRC4 was capitalized by loans from Embrace Software, Inc (“Embrace”) and Tillman Networks LLC (“Tillman”). The Reinsurance Agreement was effective as of July 1, 2022, among American Life and Seneca Re. The Reinsurance Agreement supports American Life’s new business production by providing reinsurance capacity for American Life to write certain kinds of fixed indexed and multi-year guaranteed annuity products. Under the Reinsurance Agreement, SRC4 agreed to provide reinsurance funding for a quota share percentage of
Also on September 30, 2022, American Life entered into an Investment Management Agreement (“IMA”) with CoVenture Management, LLC (“CoVenture”) naming CoVenture as the manager of certain assets held by American Life on behalf of SRC4.
Management evaluates the Company as
Basis of Presentation
These consolidated financial statements for the year ended December 31, 2022 and 2021 have been prepared in conformity with generally accepted accounting principles in the United States of America (“GAAP”). Preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The following is a summary of our significant accounting policies and estimates. These accounting policies inherently require significant judgment and assumptions, and actual operating results could differ significantly from management’s estimates determined using these policies. We believe the following accounting policies, judgments and estimates are the most critical to the understanding of our results of operations and financial position. All intercompany accounts and transactions have been eliminated in consolidation and certain immaterial reclassifications have been made to the prior period results to conform to the current period’s presentation with no impact on results of operations or total stockholders’ equity.
F-9
Fixed Maturities
All fixed maturities owned by the Company are considered available-for-sale and are included in the consolidated financial statements at their fair value as of the financial statement date. Premiums and discounts on fixed maturity debt instruments are amortized using the scientific-yield method over the term of the instruments. Realized gains and losses on securities sold during the year are determined using the specific identification method. Unrealized holding gains and losses, net of applicable income taxes, are included in accumulated other comprehensive (loss) income.
Declines in the fair value of available-for-sale securities below their amortized cost are evaluated to assess whether any other-than-temporary impairment loss should be recorded. In determining if these losses are expected to be other-than-temporary, the Company considers severity of impairment, duration of impairment, forecasted recovery period, industry outlook, the financial condition of the issuer, issuer credit ratings, and the intent and ability of the Company to hold the investment until the recovery of the cost.
Investment income consists of interest, dividends, gains and losses from investments, and real estate income, which are recognized on an accrual basis along with the amortization of premiums and discounts.
Certain available-for-sale investments are maintained as collateral under Funds Withheld (“FW”) and Modified Coinsurance (“Modco”) agreements but the assets and total returns or losses on the asset portfolios belong to the third-party reinsurers. American Life has treaties with several third-party reinsurers that have FW and Modco provisions. In a Modco agreement, the ceding entity retains the assets equal to the modified coinsurance reserves retained. In a FW agreement, assets that would normally be paid over to a reinsurer are withheld by the ceding company to permit statutory credit for unauthorized reinsurers to reduce the potential credit risk. The unrealized gains/losses on those investments are passed through to the third-party reinsurers as either a realized gain or loss on the Consolidated Statements of Comprehensive Loss.
Mortgage Loans on Real Estate
Mortgage loans on real estate, held for investment are carried at unpaid principal balances. Interest income is recognized in net investment income at the contract interest rate when earned. A mortgage loan is considered to be impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the mortgage agreement. Valuation allowances for impairments on mortgage loans are established based upon losses expected by management to be realized in connection with future dispositions or settlements of mortgage loans, including foreclosures. The Company establishes valuation allowances for estimated impairments on an individual loan basis as of the balance sheet date. Such valuation allowances are based on the excess carrying value of the loan over the present value of expected future cash flows discounted at the loan’s original effective interest rate and disposition of collateral. These evaluations are revised as conditions change and new information becomes available. As of December 31, 2022, the Company held one asset valued at $
Derivative Instruments
Derivatives are used to hedge the risks experienced in our ongoing operations, such as equity, interest rate and cash flow risks, or for other risk management purposes, which primarily involve managing liability risks associated with our indexed annuity products and reinsurance agreements. Derivatives are financial instruments whose values are derived from interest rates, foreign exchange rates, financial indices, or other underlying notional amounts. Derivative assets and liabilities are carried at fair value on the consolidated balance sheets.
To qualify for hedge accounting, at the inception of the hedging relationship, the Company must formally document our designation of the hedge as a cash flow or fair value hedge and our risk management objective and strategy for undertaking the hedging transaction. In this documentation, we would identify how the hedging instrument is expected to hedge the designated risks related to the hedged item, the method that would be used to retrospectively and prospectively assess the hedging instrument’s effectiveness and the method which would be used to measure ineffectiveness. A derivative designated as a hedging instrument must be assessed as being highly effective in offsetting the designated risk of the hedged item. Hedge effectiveness would be formally assessed at inception and periodically throughout the life of the designated hedging relationship.
During the last quarter of 2020, the Company began investing in futures to hedge the fluctuations in various aspects of our business. The formal documentation and hedge effectiveness was not completed at the date we entered into those futures contracts; therefore, they
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do not qualify for hedge accounting. The futures change in fair market values were recorded on our Consolidated Statements of Comprehensive Loss as realized gains or (losses).
Additionally, reinsurance agreements written on a FW or Modco basis contain embedded derivatives on our annuity products. Gains or (losses) associated with the performance of assets maintained in the modified coinsurance deposit and funds withheld accounts are reflected as realized gains or (losses) in the Consolidated Statements of Comprehensive Loss.
Equity Securities
Equity securities at December 31, 2022, consisted of exchange traded funds (“ETFs”). The ETFs are carried at fair value with the change in fair value recorded through realized gains and losses in the Consolidated Statements of Comprehensive Loss. As of December 31, 2022, we held $
Preferred Stock
The company held a perpetual preferred stock investment of $
In 2020 American Life entered into a series of transactions with an unaffiliated entity, Ascona Group Holdings Ltd (“AGH”). Through these transactions American Life acquired preferred equity in AGH in British Pound Sterling (“GBP”)
Other Invested Assets
Other invested assets consists of approximately $
Deposits and notes receivable
Investment escrow
The Company held in escrow $
Federal Home Loan Bank stock
American Life initially purchased Federal Home Loan Bank of Topeka (“FHLB”) common stock on May 5, 2021. This investment was to solidify our membership with FHLB Topeka. The carrying value of FHLB stock approximates fair value since the Company can redeem the stock with FHLB at cost. As a member of the FHLB, the Company is required to purchase this stock, which is carried at cost and classified as restricted equity securities.
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Membership allows access to various funding arrangements to provide a source of additional liquidity. As of December 31, 2022, the Company had pledged assets with a market value of $
Notes Receivable
The Company held notes receivable carried at fair value of $
Policy Loans
Policy loans are carried at unpaid principal balances. Interest income on policy loans is recognized in net investment income at the contract interest rate when earned.
Cash and Cash Equivalents
The Company considers all liquid investments with original maturities of three months or less when purchased to be cash equivalents. As of December 31, 2022 and 2021, the Company held less than GBP
Deferred Acquisition Costs
Deferred acquisition costs (“DAC”) consist of incremental direct costs, net of amounts ceded to third-party reinsurers, that result directly from and are essential to the contract acquisition transaction and would not have been incurred by the Company had the contract acquisition not occurred. These costs are capitalized, to the extent recoverable, and amortized over the life of the premiums produced. The Company evaluates the types of acquisition costs it capitalizes. The Company capitalizes agent compensation and benefits and other expenses that are directly related to the successful acquisition of contracts. The Company also capitalizes expenses directly related to activities performed by the Company, such as underwriting, policy issuance, and processing fees incurred in connection with successful contract acquisitions.
The following table represents a roll forward of DAC, net of reinsurance:
(In thousands) |
| December 31, 2022 | December 31, 2021 | |||
Beginning balance | $ | $ | ||||
Additions | ||||||
Amortization | ( | ( | ||||
Interest | ( | |||||
Impact of unrealized investment losses | ( | ( | ||||
Ending Balance | $ | $ | ||||
Recoverability of deferred acquisition costs is evaluated periodically by comparing the current estimate of the present value of expected pretax future profits to the unamortized asset balance. If this current estimate is less than the existing balance, the difference is charged to expense. The Company performs a recoverability analysis annually in the fourth quarter unless events occur which in management’s
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judgment require an immediate review. The Company performed a recoverability analysis during the fourth quarter of 2022 and determined that all DAC balances were recoverable as of December 31, 2022.
Premiums Receivable
Premiums receivable consists of premiums earned on our legacy insurance business which have been earned, but have not yet been collected. Amounts are receivable from our legacy business partners and were consistent at $
Property and Equipment
Property and equipment are stated at cost net of accumulated depreciation. Annual depreciation is primarily computed using straight-line methods for financial reporting and straight-line and accelerated methods for tax purposes. Furniture and equipment is depreciated over to
During the first quarter of 2021, the Company began the implementation of a new cloud-based enterprise resource planning and enterprise performance management system. The Company expects to capitalize related consultation and support expenses relating to this system and will begin amortizing these fees over a period of
Maintenance and repairs are expensed as incurred. Replacements and improvements which extend the useful life of the asset are capitalized. The net book value of assets sold or retired are removed from the accounts, and any resulting gain or loss is reflected in earnings.
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognized if the carrying amount of an asset may not be recoverable and exceeds estimated future undiscounted cash flows of the asset. A recognized impairment loss reduces the carrying amount of the asset to its fair value. The Company determined that no such events occurred in the periods covered by the Consolidated Financial Statements that would indicate the carrying amounts may not be recoverable.
Reinsurance
We seek to reinsure a significant portion of our new annuity policies with a variety of reinsurers in exchange for upfront ceding commissions, expense reimbursements and administrative fees. Under these reinsurance agreements, we expect there will be a monthly or quarterly settlement of premiums, claims, surrenders, collateral, and other administration fees. We believe this will help preserve American Life’s capital while supporting its growth because American Life will have lower capital requirements when its business is reinsured due to lower overall financial exposure versus retaining the insurance policy business itself. See Note 8 below for further discussion of our reinsurance activities.
There are two main categories of reinsurance transactions: 1) “indemnity,” where we cede a portion of our risk but retain the legal responsibility to our policyholders should our reinsurers not meet their financial obligations; and 2) “assumption,” where we transfer the risk and legal responsibilities to the reinsurers. The reinsurers are required to acquire the appropriate regulatory and policyholder approvals to convert indemnity policies to assumption policies.
Our reinsurers may be domestic or foreign capital markets investors or traditional reinsurance companies seeking to assume U.S. insurance business. We plan to mitigate the credit risk relating to reinsurers generally by requiring other financial commitments from the reinsurers to secure the reinsured risks (such as posting substantial collateral). It should be noted that under indemnity reinsurance agreements American Life remains exposed to the credit risk of its reinsurers. If one or more reinsurers become insolvent or are otherwise unable or unwilling to pay claims under the terms of the applicable reinsurance agreement, American Life retains legal responsibility to pay policyholder claims, which in such event would likely materially and adversely affect the capital and surplus of American Life.
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Midwest formed Seneca Re in early 2020, followed by Seneca Incorporated Cell, LLC 2020-01 (“SRC1”) and Seneca Incorporated Cell, LLC 2021-03 (“SRC3”) which are consolidated in these financial statements. Midwest sold
Some reinsurers are not and may not be “accredited” or qualified as reinsurers under Nebraska law and regulations. In order to enter into reinsurance agreements with such reinsurers and to reduce potential credit risk, American Life holds a deposit or withholds funds from the reinsurer or requires the reinsurer to maintain a trust that holds assets backing up the reinsurer’s obligation to pay claims on the business it assumes. The reinsurer may also appoint an investment manager for such funds, which in some cases may be our investment adviser subsidiary, 1505 Capital, to manage these assets pursuant to guidelines adopted by us that are consistent with Nebraska investment statutes and reinsurance regulations.
American Life currently has treaties with several third-party reinsurers and one related party reinsurer. In a Modco agreement, the ceding entity retains the assets equal to the modified coinsurance reserves retained. In a FW agreement, assets that would normally be paid over to a reinsurer are withheld by the ceding company to permit statutory credit for unauthorized reinsurers, to reduce the potential credit risk. Under those provisions with third-party reinsurers, the assets backing the treaties are maintained by American Life as investments but the assets and total returns or losses on the investments are owned by the reinsurers. Under GAAP, this arrangement is considered an embedded derivative as discussed in Comprehensive Loss and Note 4 below.
Assets carried as investments on American Life’s financial statements for the third-party reinsurers contained cumulative unrealized losses of approximately $
Benefit Reserves
The Company establishes liabilities for amounts payable under insurance policies, including traditional life insurance and annuities. Generally, amounts are payable over an extended period of time. Liabilities for future policy benefits of traditional life insurance have been computed by a net level premium method based upon estimates at the time of issue for investment yields, mortality and withdrawals. These estimates include provisions for experience less favorable than initially expected. Mortality assumptions are based on industry experience expressed as a percentage of standard mortality tables.
Policy Claims
Policy claims are based on reported claims plus estimated incurred but not reported claims developed from trends of historical data applied to current exposure.
Deposit-type Contracts
Deposit-type contracts consist of amounts on deposit associated with deferred annuity riders, premium deposit funds and supplemental contracts without life contingencies.
Deposit-type contracts also include balances outstanding under funding agreements with the Federal Home Loan Bank of Topeka (“FHLB”). The funding agreements are carried at cost. Amounts received and repaid under FHLB funding agreements are classified as financing activities in the Company's Consolidated Statements of Cash Flows.
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In 2021, the Company became a member of FHLB, which provides access to collateralized borrowings and other FHLB products. Any borrowing from FHLB requires the purchase of FHLB activity-based common stock in an amount equal to
As of December 31, 2022, scheduled maturity dates for outstanding FHLB funding agreements were as follows:
(Dollar amounts in thousands) | Interest | |||||
Maturity Date | Rate |
| Amount | |||
January 22, 2025 | $ | |||||
August 16, 2025 | ||||||
September 15, 2027 | ||||||
| $ | |||||
Note Payable
On November 22, 2022, the Company entered into a
Deferred Gain on Coinsurance Transactions
American Life has entered into several reinsurance contracts where it has earned or is earning ceding commissions. These ceding commissions are recorded as a deferred liability and amortized over the life of the business ceded. American Life receives commission and administrative expenses from reinsurance transactions that represent recovery of acquisition costs. These remittances first reduce the DAC associated with the reinsured blocks of business with the remainder being included in the deferred gain on coinsurance transactions that is also being amortized.
Revenue Recognition and Related Expenses
Amounts received as payment for annuities are recognized as deposits to policyholder account balances and are included in deposit-type liabilities. Revenues from these contracts are comprised of fees earned for administrative and contract-holder services and cost of insurance, which are recognized over the period of the contracts, and included in revenue. Deposits are shown as a financing activity in the Consolidated Statements of Cash Flows.
Revenues on traditional life insurance products consist of direct and assumed premiums reported as earned when due.
Liabilities for future policy benefits provided and acquisition costs are amortized by associating benefits and expenses with earned premiums to recognize related profits over the life of the contracts. Acquisition costs are amortized over the expected life of the annuity contracts.
Service fee revenue is comprised of third-party administration (“TPA”) fees and investment management fees:
| ● | The TPA fees are related to accounting services performed based on service agreements with varying lengths. Revenue associated with TPA fees are only recognized when the services are performed, which is typically on a monthly or quarterly basis. |
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| ● | Fees for investment management fees are based on the total assets managed for each client at a contracted rate. The length of term on the contracts varies by client. The Company accrues investment advisory fees and recognizes revenue based on the market value of the client’s assets at the end of the applicable period, at the client’s contracted rate. |
Income Taxes
The Company is subject to income taxes in the U.S. federal and various state jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. With few exceptions, the Company is no longer subject to U.S. federal, state, or local tax examinations by tax authorities for the years before 2019. The Company is not currently under examination for any open years for income taxes. The provision for income taxes is based on income as reported in the financial statements. The income tax provision is calculated under the asset and liability method. Deferred tax assets are recorded based on the differences between the financial statement and tax basis of assets and liabilities at the enacted tax rates. The principal assets and liabilities giving rise to such differences are investments, insurance reserves, and DAC. A deferred tax asset valuation allowance is established when there is uncertainty that such assets would be realized. The Company has no uncertain tax positions that it believes are more-likely-than not that the benefit will not to be realized. When applicable, the Company recognizes interest accrued related to unrecognized tax benefits and penal-ties in income tax expense.
Comprehensive Loss
Comprehensive Loss is comprised of net income (loss) and other comprehensive loss. Other comprehensive loss includes unrealized gains and losses from fixed maturities classified as available for sale and unrealized gains and losses from foreign currency transactions, net of applicable taxes. American Life has treaties with several third-party reinsurers that have FW and Modco provisions. Under those provisions, the assets backing the treaties are maintained by American Life as collateral but are owned by the third-party reinsurers, thus, the total return on the asset portfolio belongs to the third-party reinsurers. Under GAAP this is considered an embedded derivative as discussed above under “Reinsurance” and in Note 8 below.
Assets carried as investments on American Life’s financial statements for the third-party reinsurers contained cumulative unrealized losses of approximately $
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Earnings (Loss) Per Share
Basic income (loss) per share for the year ended December 31, 2022 and 2021 was income of $
The Company has
Year ended December 31, | ||||||
| 2022 |
| 2021 | |||
(In thousands, except per share amounts) | ||||||
Numerator: | ||||||
Net income (loss) attributable to Midwest Holding Inc. | $ | | $ | ( | ||
Denominator: | ||||||
Weighted average common shares outstanding | | | ||||
Effect of dilutive securities: | ||||||
Stock options and deferred compensation agreements | | — | ||||
Denominator for earnings (loss) per common share | | | ||||
Income (loss) per common share | $ | | $ | ( | ||
Income (loss) per common share, diluted | $ | | $ | ( | ||
Adoption of New Accounting Standards
In January 2020, the FASB issued ASU No. 2020-1, Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815)-Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. The amendments in this update clarify certain interactions between the guidance to account for certain equity securities under Topic 321, the guidance to account for investments under the equity method of accounting in Topic 323, and the guidance in Topic 815, which could change how an entity accounts for an equity security under the measurement alternative or a forward contract or purchased option to purchase securities that, upon settlement of the forward contract or exercise of the purchased option, would be accounted for under the equity method of accounting or the fair value option in accordance with Topic 825, Financial Instruments. This amendment was adopted effective January 1, 2021 with no impact to our financial statements.
In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computer Arrangement That is a Service Contract. Under ASU No. 2018-15, the amendment aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments in this update. In order to determine which costs can be capitalized, we are to follow the guidance in Subtopic 350-40. Cost for implementation activities in the application development stage are capitalized depending on the nature of the costs, while costs incurred during the preliminary project and the post-implementation stage are expensed as the activities are performed. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The amendments in this update should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. As of December 31, 2022 and December 31, 2021, the Company had analyzed and capitalized $
In December 2022, the FASB issued ASU no. 2022-06, Reference Rate Reform (Topic 846): Deferral of the Sunset Date of Topic 848. In 2020, the Board issued Accounting Standards Update No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides optional guidance to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. The objective of the guidance in Topic 848 is to provide temporary relief during the transition period. The FASB included a sunset provision within Topic 848 based on expectations of when
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the London Interbank Offered Rate (LIBOR) would cease being published. At the time that Update 2020-04 was issued, the UK Financial Conduct Authority (FCA) had established its intent that it would no longer be necessary to persuade, or compel, banks to submit to LIBOR after December 31, 2021. As a result, the sunset provision was set for December 31, 2022—12 months after the expected cessation date of all currencies and tenors of LIBOR. In March 2021, the FCA announced that the intended cessation date of the overnight 1-, 3-, 6-, and 12-month tenors of USD LIBOR would be June 30, 2023, which is beyond the current sunset date of Topic 848. Because the current relief in Topic 848 may not cover a period of time during which a significant number of modifications may take place, the amendments in ASU 2022-06 defer the sunset date of Topic 848 from December 31, 2022, to December 31, 2024, after which entities will no longer be permitted to apply the relief in Topic 848.
Future Adoption of New Accounting Standards
In August 2018, the FASB issued ASU No. 2018-12, Financial Services—Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts, as amended by ASU 2019-09, Financial Services —Insurance (Topic 944). The new guidance (i) prescribes the discount rate to be used in measuring the liability for future policy benefits for traditional and limited payment long-duration contracts, and requires assumptions for those liability valuations to be updated after contract inception, (ii) requires more market-based product guarantees on certain separate account and other account balance long-duration contracts to be accounted for at fair value, (iii) simplifies the amortization of DAC for virtually all long duration contracts, and (iv) introduces certain financial statement presentation requirements, as well as significant additional quantitative and qualitative disclosures. The new standard becomes effective for reporting periods after December 15, 2024, and interim periods within fiscal years beginning after December 15, 2024 for companies eligible as smaller reporting companies. Early application of the amendments in Update 2018-12 is permitted. We anticipate that the adoption of ASU 2018-12 will have a broad impact on our consolidated financial statements and related disclosures and will require us to make changes to certain of our processes, systems and controls. The Company is evaluating the impact this guidance will have on its results of operations and financial position.
In November 2019, the FASB issued ASU No. 2019-11, Codification Improvements to Topic 326, Financial Instruments—Credit Losses. The amendments in this update include items brought to the FASB’s attention by stakeholders to clarify the guidance in the amendments in ASU 2016-13, Financial Instruments – Credit Losses (Topic 326) which was issued in June 2016. These updated amendments clarify that receivables arising from operating leases are not within the scope of Subtopic 326-20. Under ASU 2016-13, the incurred loss impairment methodology in current GAAP is replaced with a methodology that reflects expected credit losses that is referred to as the current expected credit loss (“CECL”) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and held-to maturity debt securities. It also applies to off-balance sheet credit exposures, not accounted for as insurance (loan commitments, standby letters of credit financial guarantees, and other instruments). In addition, ASU 2016-13 made changes to the accounting for available for sale debt securities. One such change is to require credit losses to be presented as an allowance rather than a write-down on available for sale debt securities management does not intend to sell or believes that it is not more likely than not they will be required to sell. The new standard becomes effective for reporting periods beginning after December 15, 2022, and for most affected instruments must be adopted using a modified retrospective approach, with a cumulative effect adjustment recorded to beginning retained earnings. The segment of the Company’s investment portfolio that is not marked to market was approximately $
The Company’s implementation activities continue to be performed to evaluate the impact this guidance will have on the results of operations and financial position. The Company intends to utilize the modified retrospective method and the prospective transition approach for fixed maturities for which other-than-temporary impairment has been recognized prior to January 1, 2023. As of December 31, 2022, $
Note 2. Non-controlling Interest
Disposal
On December 30, 2021, Midwest closed the sale of approximately
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1505 Capital LLC. As of December 31, 2022, Midwest recognized the original purchase of $
Purchase
In 2020 American Life entered into a series of transactions with an unaffiliated entity, Ascona Group Holdings Ltd (“AGH”). Through these transactions American Life acquired preferred equity in AGH in British Pound Sterling (“GBP”) of
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Note 3. Investments
The amortized cost and estimated fair value of investments classified as available-for-sale as of December 31, 2022 and 2021 are as follows:
Gross | Gross | |||||||||||
Amortized | Unrealized | Unrealized | Estimated | |||||||||
(In thousands) |
| Cost |
| Gains |
| Losses |
| Fair Value | ||||
December 31, 2022: |
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Fixed maturities: |
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Bonds: | ||||||||||||
U.S. government obligations | $ | | $ | — | $ | | $ | | ||||
Mortgage-backed securities |
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Asset-backed securities | | | | | ||||||||
Collateralized loan obligations | | | | | ||||||||
States and political subdivisions-general obligations |
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| — |
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States and political subdivisions-special revenue |
| |
| — |
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| | ||||
Corporate |
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| |
| |
| | ||||
Term loans | | | | | ||||||||
Total fixed maturities | $ | | $ | | $ | | $ | | ||||
Mortgage loans on real estate, held for investment | | — | — | | ||||||||
Derivatives | | | | | ||||||||
Equity securities | | — | | | ||||||||
Other invested assets | | | | | ||||||||
Preferred stock | | | | | ||||||||
Deposits and notes receivable | | — | — | | ||||||||
Policy loans | | — | — | | ||||||||
Total investments | $ | | $ | | $ | | $ | | ||||
December 31, 2021: |
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Fixed maturities: |
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Bonds: | ||||||||||||
U.S. government obligations | $ | | $ | | $ | | $ | | ||||
Mortgage-backed securities |
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Asset-backed securities | | | | | ||||||||
Collateralized loan obligations | | | | | ||||||||
States and political subdivisions-general obligations |
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| — |
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States and political subdivisions-special revenue |
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Corporate |
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Term loans | | | | | ||||||||
Trust preferred | | | — | | ||||||||
Redeemable preferred stock | | | | | ||||||||
Total fixed maturities | $ | | $ | | $ | | $ | | ||||
Mortgage loans on real estate, held for investment | | — | — | | ||||||||
Derivatives | | | | | ||||||||
Equity securities | | — | | | ||||||||
Other invested assets | | | | | ||||||||
Preferred stock | | | — | | ||||||||
Deposits and notes receivable | | — | — | | ||||||||
Policy loans | | — | — | | ||||||||
Total investments | $ | | $ | | $ | | $ | | ||||
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The following table shows the distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value as of December 31, 2022 and 2021.
December 31, 2022 | December 31, 2021 |
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Carrying | Carrying |
| |||||||||
(In thousands) |
| Value |
| Percent |
| Value |
| Percent |
| ||
AAA and U.S. Government | $ | |
| | % | $ | |
| | % | |
AA |
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A |
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BBB |
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Total investment grade |
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BB and below |
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Total | $ | |
| | % | $ | |
| | % | |
Reflecting the quality of securities maintained by us, as of December 31, 2022 and 2021,
The following table summarizes, for all fixed maturity securities in an unrealized loss position as of December 31, 2022 and 2021 and the estimated fair value, pre-tax gross unrealized loss, and number of securities by consecutive months they have been in an unrealized loss position.
December 31, 2022 | December 31, 2021 | |||||||||||||||||
Gross | Number | Gross | Number | |||||||||||||||
Estimated | Unrealized | of | Estimated | Unrealized | of | |||||||||||||
(In thousands) |
| Fair Value |
| Loss |
| Securities(1) |
| Fair Value |
| Loss |
| Securities(1) | ||||||
Fixed Maturities: | ||||||||||||||||||
Less than 12 months: |
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U.S. government obligations | $ | $ |
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Asset-backed securities | | |||||||||||||||||
Collateralized loan obligations | | | | |||||||||||||||
States and political subdivisions-general obligations | — |
| — |
| — | |||||||||||||
States and political subdivisions-special revenue |
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Term loans | | | | |||||||||||||||
Redeemable preferred stock | — | — | — | | | | ||||||||||||
Corporate |
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Greater than 12 months: |
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U.S. government obligations |
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Asset-backed securities |
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| — |
| — |
| — | |||||||||
Collateralized loan obligations |
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| — |
| — |
| — | ||||||||
States and political subdivisions-special revenue | — |
| — |
| — | |||||||||||||
Mortgage-backed securities | — |
| — |
| — | |||||||||||||
Corporate |
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Total fixed maturities | $ | $ |
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| $ | $ | | |||||||||||
Our securities positions resulted in a gross unrealized loss position as of December 31, 2022 that was greater than the gross unrealized loss position at December 31, 2021 due to increases in the Federal Reserve interest rates. We performed an analysis and determined that
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there were no additional indicators other than the increase in the interest rates that would indicate a cash flow testing analysis should be performed.
See the discussion above under “Comprehensive Loss” in Note 1 regarding unrealized gains/losses on investments that are owned by our reinsurers and the corresponding offset carried as a gain in the associated embedded derivatives.
The Company purchases and sells equipment leases in its investment portfolio. As of December 31, 2022, the Company owned several leases, all of which were performing. No impairment was required as of December 31, 2022.
The amortized cost and estimated fair value of fixed maturities as of December 31, 2022, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized | Estimated | |||||
(In thousands) |
| Cost |
| Fair Value | ||
Due in one year or less | $ | $ | ||||
Due after one year through five years |
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Due after five years through ten years |
|
| ||||
Due after ten years through twenty years | ||||||
Due after twenty years | ||||||
$ | $ | |||||
The Company is required to hold assets on deposit for the benefit of policyholders in accordance with statutory rules and regulations. At December 31, 2022 and 2021, these required deposits had a total amortized cost of $
Mortgage loans consist of the following:
(In thousands) | December 31, 2022 | December 31, 2021 | ||||
1-4 Family | $ | $ | | |||
Hospitality | ||||||
Land | | |||||
Multifamily (5+) | ||||||
Retail | ||||||
Other | ||||||
Total mortgage loans | $ | $ | ||||
Geographic Location:
As of December 31, 2022, the commercial mortgages loans were secured by properties geographically dispersed (with the largest concentrations in loans secured by properties in New York (
The loan-to-value ratio is expressed as a percentage of the amount of the loan relative to the value of the underlying property. A loan-to-value ratio in excess of 100% indicates the unpaid loan amount exceeds the underlying collateral. The following represents the loan-to-value ratio of the commercial mortgage loan portfolio, excluding those under development, net of valuation allowances. As of December 31, 2022, the Company held one asset valued at $
F-22
Commercial Mortgage Loans
(In thousands) | December 31, 2022 | December 31, 2021 | |||
Loan-to-Value Ratio: | |||||
0%-59.99% | $ | $ | |||
60%-69.99% | |||||
70%-79.99% | |||||
80% or greater | | ||||
Total mortgage loans | $ | $ | |||
The components of net investment income for the years ended December 31, 2022 and 2021 are as follows:
Year ended December 31, | ||||||
(In thousands) |
| 2022 |
| 2021 | ||
Fixed maturities | $ | $ | | |||
Mortgage loans | | |||||
Other invested assets | | |||||
Other interest income |
| ( |
| | ||
Gross investment income |
|
| | |||
Less: investment expenses |
| ( |
| ( | ||
Investment income, net of expenses | $ | $ | | |||
Proceeds for the years ended December 31, 2022 and 2021 from sales of investments classified as available-for-sale were $
The proceeds included those assets associated with the third-party reinsurers. The gains and losses relate only to the assets retained by American Life. Unrealized gain/loss included as part of net investment income were $
Note 4. Derivative Instruments
The Company enters into derivative instruments to manage risk, primarily equity, interest rate, credit, foreign currency and market volatility. Some of these derivative instruments are to hedge fixed indexed annuity products that guarantee the return of principal to the policyholders and credit interest based on a percentage of the gain in a specified market index. To hedge against adverse changes in equity indices, the Company entered into contracts to buy equity indexed options.
The following is a summary of the asset derivatives not designated as hedges embedded derivatives in our FIA product as of December 31, 2022 and 2021:
| December 31, 2022 | December 31, 2021 | |||||||||||||||
(In thousands, except number of contracts) | Location in the | ||||||||||||||||
Derivatives Not Designated | Consolidated | Notional | Number of | Estimated | Notional | Number of | Estimated | ||||||||||
as Hedging Instruments | Balance Sheets | Amount | Contracts | Fair Value | Amount | Contracts | Fair Value | ||||||||||
Equity-indexed options | Derivatives | $ | $ | $ | $ | ||||||||||||
Equity-indexed | Deposit-type | ||||||||||||||||
At December 31, 2022, the value of the embedded derivative considers all amounts projected to be paid in excess of the minimum guarantee (the amounts payable without any indexation increases) over future periods. The host contract reflects the minimum guaranteed values.
Due to price changes in the capital markets, our securities positions resulted in decreased unrealized gains at December 31, 2022, compared to 2021, reported in accumulated other comprehensive income on the balance sheet. The embedded derivative related to the
F-23
asset portfolio belonging to the third-party reinsurers offset these unrealized gains. The unrealized losses as of December 31, 2022 were $
The following table summarizes the impact of those embedded derivatives related to the funds withheld provision where the total return on the asset portfolio is passed through to the third-party reinsurers:
| December 31, 2022 | December 31, 2021 | ||||||||||||||||
(In thousands) | Book Value | Market Value | Total Return | Book Value | Market Value | Total Return | ||||||||||||
Portfolio | Assets | Assets | Swap Value | Assets | Assets | Swap Value | ||||||||||||
American Republic Insurance Company | $ | $ | $ | | $ | $ | $ | | ||||||||||
Crestline Re SP1 | ( | |||||||||||||||||
Ironbound | | ( | ||||||||||||||||
Ascendent Re | | |||||||||||||||||
SRC4 | ( | - | - | - | ||||||||||||||
US Alliance | - | - | - | |||||||||||||||
Total | $ | $ | $ | | $ | $ | $ | ( | ||||||||||
Assets carried as investments on American Life’s financial statements for the third-party reinsurers contained cumulative unrealized losses of approximately $
Note 5. Fair Values of Financial Instruments
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. We use valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, accounting standards establish a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
| ● | Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. |
| ● | Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. |
| ● | Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability. |
A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the valuation inputs, or their ability to be observed, may result in a reclassification for certain financial assets or liabilities. Reclassifications impacting Level 3 of the fair value hierarchy are reported as transfers in/out of the Level 3 category as of the beginning of the period in which the reclassifications occur.
A description of the valuation methodologies used for assets measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
F-24
Level 1 measurements
Cash equivalents: Money market funds are valued at the closing price reported by the fund sponsor from an actively traded exchange. These are included within cash equivalents as Level 1 measurements in the table below.
Level 2 measurements
Fixed maturity securities: Fixed maturity securities are recorded at fair value on a recurring basis utilizing a third-party pricing source such as the Clearwater Automated Valuation Service (“AVS”) Securities Valuation Office (“SVO”) pricing. The valuations are reviewed and validated quarterly through random testing by comparisons to separate pricing models or other third-party pricing services. For the years ended December 31, 2022 and 2021, there were no material changes to the valuation methods or assumptions used to determine fair values, and no broker or third-party prices were changed from the values received.
Derivatives: Derivatives are reported at fair market value utilizing a third-party pricing source such as the Standard & Poor’s (“S&P”) 500 index and the S&P Multi-Asset Risk Control (“MARC”) 5% index.
Equity securities: Equity securities at December 31, 2022 consist of exchange traded funds (“ETFs”). The ETFs are considered equity securities and recorded at fair value on a recurring basis utilizing a third-party pricing source with the change in fair value recorded through realized gains and losses on the statement of operations. As of December 31, 2022 we had purchased $
Preferred stock: The Company’s preferred stock investments classified as Level 2 were valued at $
Deposits and notes receivable: The Company had escrow funds of as of December 31, 2022 and 2021, of $
Level 3 measurements
Term Loans – The assets classified as term loans are carried at unpaid principal net of amortization of discount or accretion, which ap-proximates fair value or carried at fair market value based on a valuation using market standard valuation methodologies. The inputs used to measure the fair value of these assets are classified as Level 3 within the fair value hierarchy.
Mortgage Loans – Mortgage loans are generally stated at principal amounts outstanding, net of deferred expenses and allowance for loan loss. Interest on loans is recognized on an accrual basis at the applicable interest rate on the principal amount outstanding. Loan origination fees and direct costs, as well as premiums and discounts, are amortized as level yield adjustments over the respective loan terms. Unamortized net fees or costs are recognized upon early repayment of the loans. Loan commitment fees are generally deferred and amortized on an effective yield basis over the term of the loan. Impaired loans are generally carried on a non-accrual status. Loans are ordinarily placed on non-accrual status when, in management’s opinion, the collection of principal or interest is unlikely, or when the collection of principal or interest is 90 days or more past due. As of December 31, 2022, the Company held one asset valued at $
Other Invested Assets – Other invested assets include collateral loans, private credit investments, equipment leases, and a private fund investment. The collateral loans, private credit investments, and equipment leases are carried at amortized cost which approximates fair value. The private fund investment is carried at statement value with approximates fair value of the fund. The inputs used to measure these assets are classified as Level 3 within the fair value hierarchy.
F-25
Deposits and notes receivable: The carrying value of FHLB stock approximates fair value since the Company can redeem such stock with FHLB at cost. As a member of the FHLB, the Company is required to purchase this stock, which is carried at cost and classified as restricted equity securities.
Preferred Stock – The Company’s preferred stock investment was valued at $
Policy loans: Policy loans are stated at unpaid principal balances. As these loans are fully collateralized by the cash surrender value of the underlying insurance policies, the carrying value of the policy loans approximates their fair value.
Deposit-type contracts: The fair value for direct and assumed liabilities under deposit-type insurance contracts (accumulation annuities) is calculated using a discounted cash flow approach. Cash flows are projected using actuarial assumptions and discounted to the valuation date using risk-free rates adjusted for credit risk and nonperformance risk of the liabilities. The fair values for insurance contracts other than deposit-type contracts are not required to be disclosed.
Embedded derivative for equity-indexed contracts: The Company has embedded derivatives in its FIA policyholder obligations. These embedded derivatives are carried at the fair market value as of December 31, 2022 and 2021. The fair value of the embedded derivative component of our FIA obligation is estimated at each valuation date by projecting policy contract values and minimum guaranteed contract values over the expected lives of the contracts and discounting the excess of projected contract value amounts at the applicable risk-free interest rates adjusted for our nonperformance risk related to those obligations. The projections of FIA policy contract values are based on best estimate assumptions for future policy growth and decrements including lapse, partial withdrawal and mortality rates. The best estimate assumptions for future policy growth include assumptions for expected index credits on the next policy anniversary date which are derived from fair values of the underlying equity call options purchased to fund such index credits and the present value of expected costs of annual call options purchased in the future by us to fund index credits beyond the next policy anniversary. The projections of minimum guaranteed contract values include the same best estimate assumptions for policy decrements as assumptions used to project policy contract values.
F-26
The following table presents the Company’s fair value hierarchy for those financial instruments measured at fair value on a recurring basis as of December 31, 2022 and 2021.
Significant | |||||||||||||||
Quoted | Other | Significant | |||||||||||||
In Active | Observable | Unobservable | Estimated | ||||||||||||
Markets | Inputs | Inputs | Net Asset | Fair | |||||||||||
(In thousands) |
| (Level 1) |
| (Level 2) |
| (Level 3) | Value |
| Value | ||||||
December 31, 2022 |
|
|
|
|
|
|
|
| |||||||
Financial assets | |||||||||||||||
Fixed maturity securities: |
|
|
|
|
|
|
|
| |||||||
Bonds | |||||||||||||||
U.S. government obligations | $ | — | $ | $ | — | $ | — | $ | |||||||
Mortgage-backed securities | — | — | — | ||||||||||||
Asset-backed securities | — | — | — | ||||||||||||
Collateralized loan obligations | — | — | — | ||||||||||||
States and political subdivisions-general obligations |
| — |
|
| — |
| — |
| |||||||
States and political subdivisions-special revenue |
| — |
|
| — |
| — |
| |||||||
Corporate |
| — |
|
| — |
| — |
| |||||||
Term loans | — | — |
| — |
| ||||||||||
Total fixed maturity securities | — | — | |||||||||||||
Mortgage loans on real estate, held for investment | — | — | — | ||||||||||||
Derivatives | — | — | — | ||||||||||||
Equity securities | — | — | — | ||||||||||||
Other invested assets | — | — | |||||||||||||
Preferred stock | — | — | |||||||||||||
Deposits and notes receivable | — | — | |||||||||||||
Policy loans | — | — | — |
| |||||||||||
Total Investments | $ | — | $ | $ | $ | ||||||||||
Financial liabilities | |||||||||||||||
Embedded derivative for equity-indexed contracts | $ | — | $ | — | $ | $ | — | ||||||||
December 31, 2021 |
|
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|
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| ||||||||
Financial assets |
|
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| ||||||||
Fixed maturity securities: | |||||||||||||||
Bonds | |||||||||||||||
U.S. government obligations | $ | — | $ | $ | — | $ | — | $ | |||||||
Mortgage-backed securities | — | — | — | ||||||||||||
Asset-backed securities | — | — | — | ||||||||||||
Collateralized loan obligations | — | — | — | ||||||||||||
States and political subdivisions-general obligations | — |
|
| — | — |
| |||||||||
States and political subdivisions-special revenue | — |
|
| — | — |
| |||||||||
Corporate | — |
|
| — | — |
| |||||||||
Term loans |
| — | — |
| — |
| |||||||||
Trust preferred |
| — | — | — | |||||||||||
Redeemable preferred stock | — | — | — | ||||||||||||
Total fixed maturity securities | — | — | |||||||||||||
Mortgage loans on real estate, held for investment | — | — | — | ||||||||||||
Derivatives | — | — | — | ||||||||||||
Equity securities | — | — | |||||||||||||
Other invested assets | — | — | — | ||||||||||||
Preferred stock | — | — | — | ||||||||||||
Deposits and notes receivable | — | — | |||||||||||||
Policy loans | — | — | — |
| |||||||||||
Total Investments | $ | — | $ | $ | — | $ | |||||||||
Financial liabilities | |||||||||||||||
Embedded derivative for equity-indexed contracts | $ | — | $ | — | $ | $ | — | $ | |||||||
There were
F-27
Accounting standards require disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring basis are discussed above. As of December 31, 2022 or 2021, there were no financial assets or financial liabilities measured at fair value on a non-recurring basis.
The following disclosure contains the carrying values, estimated fair values and their corresponding placement in the fair value hierarchy, for financial assets and financial liabilities as of December 31, 2022 and 2021, respectively:
December 31, 2022 | |||||||||||||||
Fair Value Measurements Using | |||||||||||||||
Quoted Prices in | |||||||||||||||
Active Markets | Significant Other | Significant | |||||||||||||
for Identical Assets | Observable | Unobservable | |||||||||||||
Carrying | and Liabilities | Inputs | Inputs | Fair | |||||||||||
(In thousands) |
| Amount |
| (Level 1) |
| (Level 2) |
| (Level 3) |
| Value | |||||
Assets: | |||||||||||||||
Policy loans | $ | $ | — | $ | — | $ | $ | ||||||||
Cash equivalents |
|
| — |
|
| — |
| ||||||||
Liabilities: |
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| |||||
Policyholder deposits (deposit-type contracts) |
|
| — |
| — |
|
| ||||||||
December 31, 2021 | |||||||||||||||
Fair Value Measurements Using | |||||||||||||||
Quoted Prices in | |||||||||||||||
Active Markets | Significant Other | Significant | |||||||||||||
for Identical Assets | Observable | Unobservable | |||||||||||||
Carrying | and Liabilities | Inputs | Inputs | Fair | |||||||||||
(In thousands) |
| Amount |
| (Level 1) |
| (Level 2) |
| (Level 3) |
| Value | |||||
Assets: | |||||||||||||||
Policy loans | $ | $ | — | $ | — | $ | $ | ||||||||
Cash equivalents |
|
| — |
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| — |
| ||||||||
Liabilities: |
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Policyholder deposits (deposit-type contracts) |
|
| — |
| — |
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| ||||||||
F-28
The following table presents a reconciliation of the beginning balance for all assets and liabilities measured at fair value on a recurring basis using level three inputs during the year ended December 31, 2022:
| December 31, 2022 | ||||||||||||||
Total realized and unrealized gains (losses) | |||||||||||||||
Beginning Balance |
| Net Purchases, | Ending Balance | ||||||||||||
(In thousands) | |||||||||||||||
Assets |
|
|
|
|
|
|
| ||||||||
Term loans | $ | | $ | — | $ | ( | $ | | | ||||||
Mortgage loans on real estate, | |||||||||||||||
held for investment | | — | — | | | ||||||||||
Deposits and notes receivable | | — | — | | | ||||||||||
Other invested assets | | — | | | |||||||||||
Preferred stock | | — | ( | | | ||||||||||
Policy loans | | — | — | ( | | ||||||||||
Total level 3 assets | $ | | $ | — | $ | ( | $ | | $ | | |||||
Liabilities | |||||||||||||||
Embedded derivative for equity-indexed contracts | ( | ( | — | | ( | ||||||||||
Total level 3 liabilities | $ | ( | $ | ( | $ | — | $ | | $ | ( | |||||
The following tables present a reconciliation of the beginning balance for all investments measured at fair value on a recurring basis using level three inputs during the year ended December 31, 2021:
| December 31, 2021 | ||||||||||||||
Total realized and unrealized gains (losses) | |||||||||||||||
(In thousands) |
| Beginning Balance |
| Included in OCI | Net Purchases, | Ending Balance | |||||||||
Assets |
|
|
|
|
|
| |||||||||
Term loans | $ | | $ | ( | $ | | $ | $ | |||||||
Mortgage loans on real estate, | |||||||||||||||
held for investment | | — | — | ||||||||||||
Deposits and notes receivable | — | — | — | ||||||||||||
Other invested assets | | | ( | ||||||||||||
Preferred stock | | — | | ||||||||||||
Policy loans | | — | — | ||||||||||||
Total level 3 assets | $ | | $ | ( | $ | ( | $ | | $ | | |||||
Liabilities | |||||||||||||||
Embedded derivative for equity-indexed contracts | ( | ( | — | ( | ( | ||||||||||
Total level 3 liabilities | $ | ( | $ | ( | $ | — | $ | ( | $ | ( | |||||
Significant Unobservable Inputs—Significant unobservable inputs occur when we could not obtain or corroborate the quantitative detail of the inputs. This applies to fixed maturity securities, preferred stock, mortgage loans and certain derivatives, as well as embedded derivatives in liabilities. Additional significant unobservable inputs are described below.
Interest sensitive contract liabilities – embedded derivative – Significant unobservable inputs we use in the fixed indexed annuities embedded derivative of the interest sensitive contract liabilities valuation include:
F-29
| ● | Nonperformance risk – For contracts we issue, we use the credit spread, relative to the US Department of the Treasury (Treasury) curve based on our public credit rating as of the valuation date. This represents our credit risk for use in the estimate of the fair value of embedded derivatives. |
| ● | Option budget – We assume future hedge costs in the derivative’s fair value estimate. The level of option budgets determines the future costs of the options and impacts future policyholder account value growth. |
| ● | Policyholder behavior – We regularly review the lapse and withdrawal assumptions (surrender rate). These are based on our initial pricing assumptions updated for actual experience. Actual experience may be limited for recently issued products. |
Preferred equity and warrants – Significant unobservable inputs we use include surrender rate, discount rates, and EBITDA Multiples.
| ● | EBITDA Multiple -The warrants valued using a market approach guideline public company method ("GCPM") using a multiplier of EBITDA. |
| ● | Discount Rates - For the preferred equity, discounted cash flow models are used to assist with the calculation the fair value. |
Other Invested Assets – Valuations are performed through a combination of EBITDA analysis, comparable transaction analysis, and discounted cash flow analysis. Unobservable inputs for these approaches include recent actual or pending transactions, yields of similar debt instruments, and subject company leverage and financial.
| ● | EBITDA Multiple -The other invested assets valued using a market approach guideline public company method ("GCPM") using a multiplier of EBITDA. |
| ● | Discount Rates - For the other invested assets, discounted cash flow models are used to assist with the calculation the fair value. |
Term Loans – Significant unobservable inputs include yield analysis. Significant unobservable inputs we use include discount rates.
Preferred Stock – Significant unobservable inputs include current performance data, proprietary pricing models, real-time quotes from contributing dealers, and other market data.
Mortgage Loans – Fair value of mortgage loan assets are valued at principal funded, plus any property related direct expenses that contractually can be added.
F-30
The following summarizes the unobservable inputs for available for sale and trading securities and the embedded derivatives of fixed indexed annuities and preferred stock (with associated detachable warrants):
December 31, 2022 | ||||||||||||||
(In millions, except for percentages and multiples) | Fair value | Valuation technique | Unobservable inputs | Minimum | Maximum | Weighted average* | Impact of an increase in the input on fair value | |||||||
Term loans | $ | Decrease | ||||||||||||
Mortgage loans on real estate | $ | NA | NA | NA | Decrease | |||||||||
Interest sensitive contract liabilities - fixed indexed annuities embedded derivatives | $ | Nonperformance risk | Decrease | |||||||||||
Option budget | Increase | |||||||||||||
Surrender rate | Decrease | |||||||||||||
Other invested assets | $ | EBITDA Multiples | NA | |||||||||||
Discount rates | NA | |||||||||||||
Preferred equity | $ | Increase | ||||||||||||
Detachable warrants | $ | Decrease | ||||||||||||
Preferred stock | $ | NA | NA | NA | Decrease | |||||||||
* Weighted by account value | ||||||||||||||
December 31, 2021 | ||||||||||||||
(In millions, except for percentages and multiples) | Fair value | Valuation technique | Unobservable inputs | Minimum | Maximum | Weighted average* | Impact of an increase in the input on fair value | |||||||
Interest sensitive contract liabilities - fixed indexed annuities embedded derivatives | $ | Nonperformance risk | Decrease | |||||||||||
Option budget | Increase | |||||||||||||
Surrender rate | Decrease | |||||||||||||
Preferred equity | $ | Increase | ||||||||||||
Detachable warrants | $ | Increase | ||||||||||||
* Weighted by account value | ||||||||||||||
Note 6. Deposit-Type Contracts
The Company’s deposit-type contracts represent the contract value that has accrued to the benefit of the policyholder as of the balance sheet date. Liabilities for these deposit-type contracts are included without reduction for potential surrender charges. This liability is
F-31
equal to the accumulated account deposits, plus interest credited, and less policyholder withdrawals. The following table provides information about deposit-type contracts for the years ended December 31, 2022 and 2021:
| ||||||
(In thousands) |
| December 31, 2022 |
| December 31, 2021 | ||
Beginning balance | $ | | $ | |||
US Alliance |
| ( |
| |||
Unified Life Insurance Company | ( | |||||
Ironbound Reinsurance Company Limited |
| |
| |||
Ascendant Re | ( | |||||
Crestline SP1 | ( | |||||
American Republic Insurance Company | ( | |||||
SRC4 | | — | ||||
Deposits received |
| |
| |||
Investment earnings (includes embedded derivative) |
| ( |
| |||
Withdrawals |
| ( |
| ( | ||
Policy charges | ( | ( | ||||
Ending balance | $ | | $ | |||
In addition, membership in FHLB provides the Company with access to additional short-term liquidity based on the level of investment in FHLB stock and pledged collateral. At December 31, 2022, a funding agreement of $
Note 7. Debt
On November 22, 2022, the Company entered into a
Under the terms of the Credit Agreement, the Company has the option of selecting an applicable variable interest rate of (a) an adjusted term standard overnight financing rate (“SOFR”), plus an applicable margin or (b) a base rate, plus an applicable margin. Depending on our debt to capitalization ratio, the applicable margin can range from
The terms of the Credit Agreement require the Company to maintain, among other things, certain financial measures including:
| ● | Consolidated debt to capitalization must not be greater than |
| ● | Risk-based capital of American Life & Security Corp. must not be less than |
| ● | Consolidated liquidity must not be less than $ |
| ● | The strength rating of American Life & Security Corp. from A.M. Best must not fall below “B++”. |
F-32
Note 8. Reinsurance
A summary of significant reinsurance amounts affecting the accompanying consolidated financial statements as of December 31, 2022 and 2021 is as follows:
(In thousands) |
| December 31, 2022 |
| December 31, 2021 | ||
Assets: |
|
|
|
| ||
Reinsurance recoverables | $ | | $ | | ||
Liabilities: | ||||||
Deposit-type contracts | ||||||
Direct | $ | | | |||
Reinsurance ceded | ( | ( | ||||
Retained deposit-type contracts | $ | | $ | | ||
Year ended December 31, | |||||
2022 |
| 2021 | |||
(In thousands) |
|
|
| ||
Premiums | |||||
Direct | $ | $ | | ||
Reinsurance ceded | ( | ( | |||
Total Premiums | $ | — | $ | — | |
Future policy and other policy benefits | |||||
Direct | $ | | $ | | |
Reinsurance ceded |
| ( |
| ( | |
Total future policy and other policy benefits | $ | — | $ | — | |
The following table provides a summary of the significant reinsurance balances recoverable on paid and unpaid policy claims by third-party reinsurers as of December 31, 2022:
Recoverable/ | Total Amount | |||||||||||||||||
Recoverable | Recoverable | (Payable) on Benefit | Ceded | Recoverable/ | ||||||||||||||
(In thousands) | AM Best | on Paid | on Unpaid | Reserves/Deposit- | Due | (Payable) to/from | ||||||||||||
Reinsurer |
| Rating |
| Losses |
| Losses |
| type Contracts |
| Premiums |
| Reinsurer | ||||||
Ironbound Reinsurance Company Limited | $ | — | $ | — | $ | ( | $ | — | $ | ( | ||||||||
Optimum Re Insurance Company |
| — | — | — | | |||||||||||||
Sagicor Life Insurance Company |
|
| — |
|
|
| ( |
| | |||||||||
Ascendant Re | — | — | ( | — | ( | |||||||||||||
Crestline SP1 | — | — | ( | — | ( | |||||||||||||
American Republic Insurance Company | — | — | — | | ||||||||||||||
SRC4 | — | — | ( | — | ( | |||||||||||||
Unified Life Insurance Company | — | ( | | |||||||||||||||
US Alliance Life and Security Company |
|
| — |
| — |
|
| ( |
| | ||||||||
$ | — | $ | $ | $ | ( | $ | | |||||||||||
F-33
The following table provides a summary of the significant reinsurance balances recoverable on paid and unpaid policy claims by third-party reinsurers as of December 31, 2021:
Recoverable on | Total Amount | |||||||||||||||||
Recoverable | Recoverable | Benefit | Ceded | Recoverable | ||||||||||||||
(In thousands) | AM Best | on Paid | on Unpaid | Reserves/Deposit- | Due | from | ||||||||||||
Reinsurer |
| Rating |
| Losses |
| Losses |
| type Contracts |
| Premiums |
| Reinsurer | ||||||
Ironbound Reinsurance Company Limited | $ | — | $ | — | $ | ( | $ | — | $ | ( | ||||||||
Optimum Re Insurance Company |
| — | — | | — | | ||||||||||||
Sagicor Life Insurance Company |
|
| — |
| |
| |
| ( |
| | |||||||
Ascendant Re | — | — | | — | | |||||||||||||
Crestline SP1 | — | — | | — | | |||||||||||||
American Republic Insurance Company | — | — | | — | | |||||||||||||
Unified Life Insurance Company | — | | ( | | ||||||||||||||
US Alliance Life and Security Company |
|
| — |
| — |
| |
| ( |
| | |||||||
$ | — | $ | | $ | | $ | ( | $ | | |||||||||
Our securities positions resulted in changes in the unrealized gains position as of December 31, 2022, compared to December 31, 2021, that is reported in accumulated other comprehensive (loss) income on the Consolidated Balance Sheets. As discussed in Note 1, American Life has treaties with several third-party reinsurers that have FW and Modco provisions. Under those provisions, the assets backing the treaties are maintained by American Life as collateral but the assets and total returns or losses on the asset portfolios belong to the third-party reinsurers. Under GAAP this arrangement is considered an embedded derivative as discussed in Note 4. Assets carried as investments on American Life’s financial statements for the third-party reinsurers contained cumulative unrealized losses of approximately $
On June 26, 2021, the NDOI issued its non-disapproval of the Modified Coinsurance Agreement (“Modco AEG Agreement”) with American Republic Insurance Company (“AEG”), an Iowa domiciled reinsurance company. The agreement closed on June 30, 2021. Under the Modco AEG Agreement, American Life cedes to AEG, on a modified coinsurance basis, a
On November 10, 2021, the NDOI issued its non-disapproval of the Funds Withheld and Modified Coinsurance Agreement with SRC3, whereby, SRC3 agreed to provide reinsurance funding for a quota share percentage of
On September 21, 2022, the NDOI issued its non-disapproval of the conversion of American Life’s agreement with US Alliance to convert its block of business from a Funds Withheld agreement to a Funds Paid Coinsurance agreement. The conversion was effective as of October 1, 2022, and was triggered by US Alliance becoming a Qualified Institutional Buyer as specified in the original agreement. Upon conversion, American Life began transferring assets held on behalf of US Alliance to the reinsurer, with a corresponding entry made to Amounts Recoverable. The approximate value of assets transferred was $
F-34
On September 30, 2022, American Life entered into a reinsurance agreement (the “Reinsurance Agreement”) with a new protected cell formed by Seneca Re (Seneca Incorporated Cell, LLC 2022-04 (“SRC4”)). SRC4 was capitalized by loans from Embrace Software, Inc (“Embrace”) and Tillman Networks LLC (“Tillman”). The Reinsurance Agreement was effective as of July 1, 2022, among American Life and Seneca Re. The Reinsurance Agreement supports American Life’s new business production by providing reinsurance capacity for American Life to write certain kinds of fixed indexed and multi-year guaranteed annuity products. Under the Reinsurance Agreement, SRC4 agreed to provide reinsurance funding for a quota share percentage of
Also on September 30, 2022, American Life entered into an Investment Management Agreement (“IMA”) with CoVenture Management, LLC (“CoVenture”) naming CoVenture as the manager of certain assets held by American Life on behalf of SRC4.
The tables below shows the ceding commissions from the reinsurers excluding SRC1 and what was earned on a GAAP basis for the years ended December 31, 2022 and 2021:
Year ended December 31, | ||||||||||||||||||||||||
(In thousands) | 2022 | 2021 | ||||||||||||||||||||||
Reinsurer | Gross Ceding Commission | Expense | Interest on Ceding Commission | Earned | Gross Ceding Commission | Expense | Interest on Ceding Commission | Earned | ||||||||||||||||
Unified Life Insurance Company | $ | — | $ | — | $ | — | $ | | $ | — | $ | — | $ | — | $ | | ||||||||
Ironbound Reinsurance Company Limited | — | — | — | ( | | |||||||||||||||||||
Ascendant Re | — | — | | | ||||||||||||||||||||
US Alliance Life and Security Company | — | — | ( | | ||||||||||||||||||||
Crestline SP1 | | |||||||||||||||||||||||
American Republic Insurance Company | | |||||||||||||||||||||||
SRC4 | — | — | — | — | ||||||||||||||||||||
$ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||
(1) Includes: acquisition and administrative expenses, commission expense allowance and product development fees.
The table below shows the ceding commissions deferred on each reinsurance transaction on a GAAP basis:
(In thousands) | December 31, 2022 | December 31, 2021 | ||||
Reinsurer |
| Deferred Gain on Reinsurance Transactions | Deferred Gain on Reinsurance Transactions | |||
US Alliance Life and Security Company(1) |
| $ | | $ | | |
Unified Life Insurance Company(1) |
| | | |||
Ironbound Reinsurance Company Limited(2) | | | ||||
Ascendant Re |
| | | |||
US Alliance Life and Security Company(2) | | | ||||
American Republic Insurance Company(2) | | | ||||
Crestline SP1(2) | | | ||||
SRC4(2) | | — | ||||
$ | | $ | ||||
| 1) | These reinsurance transactions on our legacy life insurance business received gross ceding commissions on the effective dates of the transaction. The difference between the statutory net adjusted reserves and the GAAP adjusted reserves plus the elimination of DAC and value of business acquired related to these businesses reduces the gross ceding commission with the remaining deferred and amortized over the lifetime of the blocks of business. |
| 2) | These reinsurance transactions include the ceding commissions and expense allowances which are accounted for as described in (1). |
F-35
The use of reinsurance does not relieve American Life of its primary liability to pay the full amount of the insurance benefit in the event of the failure of a reinsurer to honor its contractual obligation for all blocks of business except what is included in the Unified transaction. The reinsurance agreement with Unified discharges American Life’s responsibilities once all the policies have changed from indemnity to assumptive reinsurance. No reinsurer of business ceded by American Life has failed to pay policy claims (individually or in the aggregate) with respect to our ceded business.
American Life monitors several factors that it considers relevant to satisfy itself as to the ongoing ability of a reinsurer to meet all obligations of the reinsurance agreements. These factors include the credit rating of the reinsurer, the financial strength of the reinsurer, significant changes or events of the reinsurer, and any other relevant factors. If American Life believes that any reinsurer would not be able to satisfy its obligations with American Life, separate contingency reserves may be established. As of December 31, 2022 and 2021,
American Life expects to reinsure a significant portion of its new insurance policies with a variety of reinsurers in exchange for upfront ceding commissions, expense reimbursements and administrative fees. American Life may retain some business with the intent to reinsure some or all at a future date.
Retained and Reinsured Balance Sheets
The tables below shows the retained and reinsurance consolidated balance sheets:
| December 31, 2022 | December 31, 2021 | ||||||||||||||||
(In thousands) | Retained | Reinsured | Consolidated | Retained | Reinsured | Consolidated | ||||||||||||
Assets |
|
|
|
| ||||||||||||||
Total investments | $ | $ | $ | $ | $ | $ | ||||||||||||
Cash and cash equivalents | ||||||||||||||||||
Accrued investment income | ||||||||||||||||||
Deferred acquisition costs, net | — | — | ||||||||||||||||
Reinsurance recoverables | ( | — | ||||||||||||||||
Other assets | ( | |||||||||||||||||
Total assets | $ | $ | $ | $ | $ | $ | ||||||||||||
Liabilities and Stockholders’ Equity |
|
|
| |||||||||||||||
Liabilities: |
|
|
| |||||||||||||||
Policyholder liabilities | $ | $ | $ | $ | $ | $ | ||||||||||||
Note payable | — | — | — | — | ||||||||||||||
Deferred gain on coinsurance transactions | — | — | ||||||||||||||||
Payable for securities purchased | — | — | ||||||||||||||||
Other liabilities | ( | |||||||||||||||||
Total liabilities | $ | $ | $ | $ | $ | $ | ||||||||||||
Stockholders’ Equity: |
|
|
| |||||||||||||||
Voting common stock | — | — | ||||||||||||||||
Additional paid-in capital | — | — | ||||||||||||||||
Accumulated deficit | ( | — | ( | ( | — | ( | ||||||||||||
Accumulated other comprehensive income (loss) | ( | — | ( | — | ||||||||||||||
Total Midwest Holding Inc.'s stockholders' equity | $ | $ | — | $ | $ | $ | — | $ | ||||||||||
Noncontrolling interest | | — | | — | ||||||||||||||
Total stockholders' equity | — | — | ||||||||||||||||
Total liabilities and stockholders' equity | $ | $ | $ | $ | $ | $ | ||||||||||||
F-36
Note 9. Income Tax Matters
Significant components of the Company’s deferred tax assets and liabilities as of December 31, 2022 and 2021 are as follows:
(In thousands) |
| December 31, 2022 |
| December 31, 2021 | ||
Deferred tax assets: |
|
|
|
| ||
Loss carryforwards | $ | | $ | | ||
Capitalized costs |
| |
| | ||
Stock option granted | | | ||||
Policy acquisition costs | | | ||||
General business credits | | | ||||
Derivative option allowance | — | | ||||
Sec 163(j) limitation | | | ||||
Benefit reserves |
| |
| | ||
Property and equipment | — | | ||||
Impairments | | — | ||||
Unrealized losses on investments | | | ||||
Other | | | ||||
Total deferred tax assets |
| |
| | ||
Less valuation allowance |
| ( |
| ( | ||
Total deferred tax assets, net of valuation allowance |
| |
| | ||
Deferred tax liabilities: |
|
|
|
| ||
Unrealized losses on investments |
| — |
| | ||
Intangible assets |
| |
| | ||
Derivative option allowance |
| |
| — | ||
Bond Discount | | | ||||
Property and equipment |
| ( |
| — | ||
Total deferred tax liabilities |
| |
| | ||
Net deferred tax assets | $ | $ | ||||
At December 31, 2022 and 2021, the Company recorded a valuation allowance of $
There was income tax expense of $
Year ended December 31, | ||||||
(In thousands) |
| 2022 |
| 2021 | ||
Computed expected income tax benefit (expense) | $ | ( | $ | |||
Reduction (increase) in income taxes resulting from: |
|
|
| |||
Interest maintenance reserve and reinsurance | | ( | ||||
Nondeductible expenses | ( | ( | ||||
Gain on sale of SRC1 | — | ( | ||||
Change in valuation allowance |
| ( | ( | |||
Amended Return - 2019/2020 | — | ( | ||||
Adjustment to payable | — | |||||
Deferred tax adjustment | | |||||
Prior year true-up | | |||||
Subtotal of increases |
| ( |
| ( | ||
Tax benefit (expense) | $ | ( | $ | ( | ||
Section 382 of the Internal Revenue Code limits the utilization of U.S. net operating loss (“NOL”) carryforwards following a change of control, which occurred on June 28, 2018. As of December 31, 2022, the deferred tax assets included the expected tax benefit attributable to federal NOLs of $
F-37
The NOLs generated by SRC1 prior to December 30, 2021 of $
Note 10. Leases
Our operating lease activities consist of leases for office space and equipment and do not include variable lease payments.
Supplemental balance sheet information for our leases for the years ended December 31, 2022 and 2021, is as follows:
(In thousands) |
| Classification |
| December 31, 2022 |
| December 31, 2021 | ||
Assets |
|
|
|
|
|
| ||
Operating |
| lease | $ | $ | ||||
Liabilities |
|
|
|
|
|
| ||
Operating lease |
| lease | $ | $ | ||||
Our operating lease expense for the years ended December 31, 2022 and 2021, is as follows:
Year ended December 31, | ||||||||
(In thousands) |
| Classification |
| 2022 |
| 2021 | ||
Operating |
| General and administrative expense | $ | $ | ||||
Minimum contractual obligations for our leases as of December 31, 2022 are as follows:
(In thousands) |
| Operating Leases | |
2023 | $ | ||
2024 |
| ||
2025 |
| ||
2026 | |||
2027 | |||
2028 and after | |||
Total remaining lease payments | $ | ||
The cash flows related to operating leases was approximately $
The weighted average remaining lease terms of our operating leases were approximately and
F-38
Note 11. Equity
Preferred stock
As of December 31, 2022 and 2021, the Company had
Common Stock
Our voting common stock is traded on The Nasdaq Capital Market under the symbol “MDWT.” Midwest has authorized
Midwest holds approximately
Additional paid-in capital
Additional paid-in capital is primarily comprised of the cumulative cash that exceeds the par value received by the Company in conjunction with past issuances of its shares. It also is increased by the amortization expense of the consideration calculated at inception of the stock option grants as discussed in Note 12 – Long-Term Incentive Plans below.
Accumulated Other Comprehensive Income (AOCI)
AOCI represents the cumulative other comprehensive income (loss) items that are reported separate from net loss and detailed on the Consolidated Statements of Comprehensive Loss. AOCI includes the unrealized gains and losses on investments and DAC, net of offsets and taxes as follows:
(In thousands) | Unrealized | ||
Balance at December 31, 2020 | $ | ||
Other comprehensive (loss) before reclassifications, net of tax |
| ( | |
Less: Reclassification adjustments for losses realized in net income | ( | ||
Balance, December 31, 2021 | |||
Other comprehensive (loss) before reclassifications, net of tax | ( | ||
Less: Reclassification adjustments for losses realized in net income, net of tax | |||
Balance, December 31, 2022 | $ | ( | |
Note 12. Long-Term Incentive Plans
In 2019, the Board approved the Midwest Holding Inc. (“MHI”) Long-Term Incentive Plan (the “2019 Plan”) that reserves up to
In 2020, the Board adopted a new equity incentive plan titled the 2020 Long-Term Incentive Plan (the “2020 Plan”) that reserves up to
F-39
Stock Options
In accordance with the stockholder-approved equity incentive plans above, the Company grants stock options to employees and directors for the purchase of common stock at exercise prices established at the date of the grants. Fair value and compensation at grant date are calculated using the Black Scholes Model. Compensation expense for option shares is expensed on a straight-line basis over the requisite service periods, accounting for forfeitures as they occur. Stock options become exercisable under various vesting schedules (typically to
Changes in outstanding options were as follows:
Weighted Average Exercise Price Per Share | Range of Option Exercise Prices per Share | Total Outstanding | Outstanding, Non-vested | Vested and Exercisable | |||
December 31, 2021 | $ | $ | | | | ||
Granted | $ | | | - | |||
Vested | $ | - | ( | | |||
Exercised | - | - | - | - | - | ||
Forfeited | $ | ( | ( | ( | |||
Expired | $ | ( | - | ( | |||
December 31, 2022 | $ | $ | | | |
Option information segregated by ranges of exercise prices were as follows:
December 31, 2022 | |||||||||
Total Outstanding Options | Vested and Exercisable | ||||||||
Range of Option Exercise Prices per Share | Options | Weighted Average Exercise Price per Share | Weighted Average Remaining Term | Options | Weighted Average Exercise Price per Share | Weighted Average Remaining Term | |||
> $ | | $ | | - | $ | - | - | ||
$ | | | | | |||||
$ | - | - | - | - | - | - | |||
$ | | | | | |||||
$ | | | | | |||||
< $ | - | $ | - | - | - | $ | - | - | |
The weighted average exercise prices of vested and exercisable options as of December 31, 2022 were $
As of December 31, 2022, based on a closing stock price of $
Restricted Stock and Restricted Stock Units
In 2020, the Company awarded
The restricted stock award shares had a grant date fair value of $
F-40
The
On June 14, 2022, the Company granted
Total Outstanding Units | Vested Units | |||||||
Units | Weighted Average Grand Date Fair Value | Units | Weighted Average Grant Date Fair Value | |||||
December 31, 2021 | | $ | - | $ | - | |||
Granted | | - | - | |||||
Vested | ( | | | |||||
Forfeited | ( | - | - | |||||
Released | ( | - | - | |||||
December 31, 2022 | | $ | | $ | ||||
The table below identifies the assumptions used in the Black Scholes Model to calculate the compensation expense:
December 31, | December 31, | |||
2022 | 2021 | |||
Volatility | ||||
Weighted-average volatility | ||||
Expected term (in years) | | | ||
Risk-free rate |
For the years ended December 31, 2022 and 2021, we amortized the compensation expense related to the 2019 and 2020 Plans, from the stock grants above, over vesting tranches which resulted in expense and an increase in additional paid in capital of less than $
F-41
The tables below shows the remaining non-vested shares under the 2019 and 2020 Plans as of December 31, 2022 and 2021, respectively:
| December 31, 2022 | |||||||
Awards | Weighted Average Grant-Date Fair Value | Weighted Average Exercise Price | ||||||
Nonvested stock options and restricted | ||||||||
stock unit awards at December 31, 2021 | | $ | | $ | | |||
Options granted | | | | |||||
Restricted stock units granted | | — | — | |||||
Vested | ( | | | |||||
Forfeited | ( | | | |||||
Ending Balance at December 31, 2022 |
| | $ | | $ | | ||
| December 31, 2021 | |||||||
Stock Options | Weighted Average Grant-Date Fair Value | Weighted Average Exercise Price | ||||||
Nonvested stock options and restricted | ||||||||
stock unit awards at December 31, 2020 | | $ | | $ | | |||
Options granted | | | | |||||
Restricted stock units granted | | — | — | |||||
Vested | ( | | | |||||
Forfeited | ( | | | |||||
Ending Balance at December 31, 2021 |
| | $ | | $ | | ||
Note 13. Statutory Net Income and Surplus
American Life and Seneca Re are required to prepare statutory financial statements in accordance with statutory accounting practices prescribed or permitted by the Nebraska Department of Insurance and the Vermont Department of Insurance. Statutory practices primarily differ from GAAP by charging policy acquisition costs to expense as incurred, establishing future policy benefit liabilities using different actuarial assumptions as well as valuing investments and certain assets and accounting for deferred taxes on a different basis.
The following table represents the net gains or (losses) as filed in the statutory-basis annual statement with the Nebraska Department of Insurance for American Life and the Vermont Department of Insurance for SRC1 and SRC3:
Year ended December 31, | |||||||
(In thousands) | 2022 |
| 2021 | ||||
American Life | $ | | $ | ( | |||
SRC1 | $ | | $ | ( | |||
SRC3 | $ | | $ | ( | |||
The following table represents the Capital and Surplus as filed in the statutory-basis annual statement with the Nebraska Department of Insurance for American Life and the Vermont Department of Insurance for SRC1 and SRC3:
(In thousands) | December 31, 2022 | December 31, 2021 | |||||
American Life | $ | | $ | | |||
SRC1 | $ | | $ | | |||
SRC3 | $ | | $ | | |||
F-42
The following table represents the premiums sales as filed in the statutory-basis annual statement with the Nebraska Department of Insurance for American Life and the Vermont Department of Insurance for SRC1 and SRC3:
Year ended December 31, | |||||||
(In thousands) | 2022 |
| 2021 | ||||
American Life | $ | | $ | | |||
SRC1 | $ | - | $ | | |||
SRC3 | $ | | $ | | |||
State insurance laws require American Life to maintain certain minimum capital and surplus amounts on a statutory basis. American Life is subject to regulations that restrict the payment of dividends from statutory surplus and may require prior approval from its domiciliary insurance regulatory authorities. American Life is also subject to risk-based capital (“RBC”) requirements that may further affect its ability to pay dividends. American Life’s statutory capital and surplus as of December 31, 2022 and 2021, exceeded the amount of statutory capital and surplus necessary to satisfy regulatory requirements, including the RBC requirements as of those dates.
As of December 31, 2020, American Life had an invested asset that was impaired as a result of the fair market of the underlying collateral being valued less that the book value. This was a non-admitted asset for statutory accounting purposes. This asset was held in our modified coinsurance account for Ironbound Reinsurance Company Limited so it was passed through to the third-party reinsurer through as a reduction of the investment income earned by the third-party reinsurer. As of March 31, 2021, this invested asset was sold for a loss of $
As of December 31, 2022 and 2021, American Life did not hold any participating policyholder contracts where dividends were required to be paid.
Note 14. Third-party Administration
The Company commenced its third-party administrative (“TPA”) services in 2012 as an additional revenue source. These services are offered to non-affiliated entities. These agreements, for various levels of administrative services on behalf of each customer, generate fee income for the Company. Services provided vary based on each customer’s needs and can include some or all aspects of back-office accounting and policy administration. TPA fee income earned for TPA services for the year ended December 31, 2022 and 2021 were $
Note 15. Related Party
Crestline
On April 24, 2020, we entered into a Securities Purchase Agreement with Crestline Assurance Holdings LLC (“Crestline”) an institutional alternative investment management firm under which we issued
In addition, on April 24, 2020, American Life entered into a
The Reinsurance Agreement also contains the following agreements:
F-43
| ● | American Life and Crestline SP1 each entered into investment management agreements with Crestline, pursuant to which Crestline manages the assets that support the reinsured business; and |
| ● | American Life and Crestline SP1 entered into a trust agreement whereby Crestline maintains for American Life’s benefit a trust account that supports the reinsured business. |
On September 16, 2022, Midwest Holding and Crestline executed a Letter of Understanding relating to the Stockholders Agreement. The Company and Crestline agreed that Crestline’s representative on would resign from the Boards of Directors of the Company and American Life. Notwithstanding the foregoing, the parties agreed that the resignation and Crestline’s decision to no longer appoint a director does not constitute a permanent waiver of Crestline’s rights under the Stockholders Agreement to appoint a Crestline Designated Director. The Company and Crestline agreed that the foregoing described agreement will remain in place until the earlier to occur of the date (i) the parties reach written agreement otherwise, (ii) that Crestline is no longer an affiliate of a life insurance entity it recently acquired and (iii) on which Crestline no longer has the right to elect or appoint a Designated Director and Observer to the Board.
Currently, Crestline has approximately $
Chelsea
On June 29, 2020, Midwest’s subsidiary, American Life, purchased a
Note 16. Commitments and Contingencies
Contingent Commitments: We have entered into commitments related to certain investments, where draws or additional funding can be requested under the terms of the agreements. These commitments are inclusive of third-party reinsurer commitments, and were approximately $
(In thousands) | December 31, 2022 | December 31, 2021 | |||
Due in one year or less | $ | $ | |||
Due in two years |
|
| |||
Due in three years |
|
| |||
Due in four years | |||||
Due in five years and after | |||||
$ | $ | ||||
Legal Proceedings: We are involved in litigation incidental to our operations from time to time. We are not presently a party to any legal proceedings other than litigation arising in the ordinary course of our business, and we are not aware of any claims that could materially affect our financial position or results of operations.
Regulatory Matters: State regulatory bodies and other regulatory bodies regularly make inquiries and conduct examinations or investigations concerning the Company’s compliance with laws in relation to, but not limited to, insurance and securities matters. American Life is licensed in
F-44
MIDWEST HOLDING INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENT SCHEDULES
I — Summary of Investments — Other Than Investments in Related Parties |
| FS-46 |
FS-47 | ||
FS-50 | ||
FS-51 | ||
FS-52 |
F-45
Schedule I
Midwest Holding Inc. and Subsidiaries
Summary of Investments — Other Than Investments in Related Parties
December 31, 2022
Amount | |||||||||
Recognized in | |||||||||
Amortized | Consolidated | ||||||||
(In thousands) |
| Cost |
| Fair Value |
| Balance Sheets | |||
Type of Investment |
|
|
|
|
|
| |||
Fixed maturities: |
|
|
|
|
|
| |||
U.S. government obligations | $ | | $ | | $ | | |||
Foreign governments | — | — | — | ||||||
Mortgage-backed securities |
| |
| |
| | |||
Asset-backed securities | | | | ||||||
Collateralized loan obligations | | | | ||||||
States and political subdivisions-general obligations |
| |
| |
| | |||
States and political subdivisions-special revenue |
| |
| |
| | |||
Corporate |
| |
| |
| | |||
Term loans | | | | ||||||
Trust preferred | — | — | — | ||||||
Redeemable preferred stock | — | — | — | ||||||
Total fixed maturity securities | $ | | $ | | $ | | |||
Mortgage loans on real estate, held for investment | | | | ||||||
Derivatives | | | | ||||||
Equity securities | | | | ||||||
Other invested assets | | | | ||||||
Preferred stock | | | | ||||||
Deposits and notes payable | | | | ||||||
Policy loans |
| | | | |||||
Total Investments | $ | $ | |||||||
FS-46
Schedule II
Midwest Holding Inc. (Parent Company)
Condensed Financial Information of Parent
Balance Sheets
As of December 31, | ||||||
(In thousands) |
| 2022 |
| 2021 | ||
Assets: | ||||||
Investment in subsidiaries (1) | $ | | $ | | ||
Preferred stock | | — | ||||
Cash and cash equivalents |
| |
| | ||
Notes receivable | | | ||||
Property and equipment, net |
| |
| | ||
Right of use assets | | | ||||
Other assets |
| |
| | ||
Total assets | $ | | $ | | ||
Liabilities and Stockholders’ Equity |
|
|
|
| ||
Liabilities: |
|
|
|
| ||
Notes payable |
| |
| | ||
Lease liability | | | ||||
Accounts payable and accrued expenses |
| |
| | ||
Total liabilities | $ | | $ | | ||
Stockholders’ Equity: |
|
|
|
| ||
Preferred stock, $ |
|
| ||||
Voting common stock, $ |
| |
| | ||
Additional paid-in capital |
| |
| | ||
Treasury stock | ( | ( | ||||
Accumulated deficit |
| ( |
| ( | ||
Accumulated other comprehensive (loss) income |
| ( |
| | ||
Total Midwest Holding Inc.'s stockholders' equity | $ | | $ | | ||
Noncontrolling interest |
| |
| | ||
Total stockholders' equity | $ | | $ | | ||
Total liabilities and stockholders' equity | $ | | $ | | ||
| (1) | eliminated in consolidation. |
FS-47
Schedule II (Continued)
Midwest Holding Inc. (Parent Company)
Condensed Financial Information of Parent
Statements of Comprehensive Loss
As of December 31, | ||||||
(In thousands) |
| 2022 |
| 2021 | ||
Income: |
|
|
|
| ||
Investment loss, net of expenses | $ | — | $ | — | ||
Miscellaneous income |
| |
| | ||
| |
| | |||
Expenses: |
|
|
|
| ||
General |
| |
| | ||
Loss from continuing operations before taxes |
| ( |
| ( | ||
Income tax expense (See Note 9) |
| — |
| ( | ||
Loss before equity in loss of consolidated subsidiaries |
| ( |
| ( | ||
Equity in loss of consolidated subsidiaries |
| |
| ( | ||
Net gain (loss) | | ( | ||||
Less: gain (loss) attributable to noncontrolling interest | | — | ||||
Net loss | | ( | ||||
Comprehensive income: |
|
|
|
| ||
Unrealized gains on investments arising during period, net of tax |
| ( |
| ( | ||
Unrealized gains on foreign currency, net of tax | — | — | ||||
Less: reclassification adjustment for net realized gains on investments |
| |
| ( | ||
Other comprehensive income, net of tax |
| ( |
| ( | ||
Comprehensive loss | $ | ( | $ | ( | ||
FS-48
Schedule II (Continued)
Midwest Holding Inc. (Parent Company)
Condensed Financial Information of Parent
Statements of Cash Flows
Year Ended December 31, | ||||||
(In thousands) |
| 2022 |
| 2021 | ||
Cash Flows from Operating Activities: |
|
|
|
| ||
Net income (loss) | $ | | $ | ( | ||
Adjustments to reconcile net loss to net cash and cash equivalents used in operating activities: |
|
|
|
| ||
Equity in net loss of consolidated subsidiaries |
| |
| | ||
Depreciation |
| ( |
| ( | ||
Stock options | | | ||||
Net transfers to noncontrolling interest | — | — | ||||
Other assets and liabilities |
| ( |
| | ||
Net cash used by operating activities |
| ( |
| ( | ||
Cash Flows from Investing Activities: |
|
|
|
| ||
Purchase of preferred stock |
| ( |
| — | ||
Net (purchases) disposals of property and equipment |
| ( |
| — | ||
Net cash used by investing activities |
| ( |
| — | ||
Cash Flows from Financing Activities: |
|
|
|
| ||
Capital contributions to consolidated subsidiaries |
| ( |
| ( | ||
Notes payable | | — | ||||
Net transfers to noncontrolling interest | ( | | ||||
Net cash (used in) provided by financing activities |
| ( |
| | ||
Net decrease in cash and cash equivalents |
| ( |
| ( | ||
Cash and cash equivalents: |
|
|
|
| ||
Beginning |
| |
| | ||
Ending | $ | | $ | | ||
Supplementary information |
|
|
|
| ||
Cash paid for taxes | $ | — | $ | — | ||
FS-49
Schedule III
Midwest Holding Inc. and Subsidiaries
Supplementary Insurance Information
(In thousands) | As of December 31, 2022 | For the Year Ended December 31, 2022 | |||||||||||||||||||
Future Policy | Death and | ||||||||||||||||||||
Benefits, | Deferred | Other Benefits | |||||||||||||||||||
Claims and | Gain on | Net | and Increase | Other | |||||||||||||||||
Deposit-type | Advance | Coinsurance | Premium | Investment | in Benefit | Operating | |||||||||||||||
| Contracts |
| Premiums |
| Transaction |
| Revenue |
| Income |
| Reserves |
| Expenses | ||||||||
Life Insurance | $ | | $ | — | $ | | $ | — | $ | | $ | ( | $ | | |||||||
(In thousands) | As of December 31, 2021 | For the Year Ended December 31, 2021 | |||||||||||||||||||
Future Policy | Death and | ||||||||||||||||||||
Benefits, | Deferred | Other Benefits | |||||||||||||||||||
Claims and | Gain on | Net | and Increase | Other | |||||||||||||||||
Deposit-type | Advance | Coinsurance | Premium | Investment | in Benefit | Operating | |||||||||||||||
| Contracts |
| Premiums |
| Transaction |
| Revenue |
| Income |
| Reserves |
| Expenses | ||||||||
Life Insurance | $ | | $ | | $ | | $ | — | $ | | $ | | $ | | |||||||
FS-50
Schedule IV
Midwest Holding Inc. and Subsidiaries
Reinsurance Information
Ceded to Other | |||||||||
(In thousands) |
| Gross Amount |
| Companies |
| Net Amount | |||
Year ended December 31, 2022 |
|
|
|
|
|
| |||
Life insurance in force | $ | | $ | | $ | | |||
Life insurance premiums | $ | | $ | | $ | — | |||
Year ended December 31, 2021 |
|
|
|
|
|
| |||
Life insurance in force | $ | | $ | | $ | | |||
Life insurance premiums | $ | | | $ | — | ||||
FS-51
