UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT

Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2013

000-01999

(Commission file number)

INVESTORS HERITAGE CAPITAL CORPORATION

(Exact Name of Registrant as Specified in its Charter)

KENTUCKY	61-6030333
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)
200 Capital Avenue, P.O. Box 717
Frankfort, Kentucky 40602
(Address of principal executive offices)
(502) 223-2361
(Registrant’s telephone number, including area code)

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

Yes ☒   No ☐

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

Yes ☒    No ☐

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

 

Large accelerated filer     ☐	Accelerated filer   ☐
Non-accelerated filer       ☐ (Do not check if a smaller reporting company)	Smaller reporting company☒

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

Yes ☐   No ☒

1

Securities registered pursuant to Section 12(g) of the Act:

Common Capital Stock par value $1.00 per share

(Title of Class)

Number of outstanding shares as of November 14, 2013 - 1,133,161.736

2

CONTENTS

	PART I – FINANCIAL INFORMATION
		Page
ITEM 1.	Condensed Consolidated Financial Statements	4
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
ITEM 4.	Controls and Procedures	37
	PART II – OTHER INFORMATION
ITEM 1.	Legal Proceedings	38
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	38
ITEM 3.	Defaults Upon Senior Securities	38
ITEM 4.	Mine Safety Disclosures	38
ITEM 5.	Other Information	38
ITEM 6.	Exhibits	39
SIGNATURES		39
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

3

 

 PART I – FINANCIAL INFORMATION  

ITEM 1. Condensed Consolidated Financial Statements

INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Balance Sheets (Unaudited)  

	September 30, 2013		December 31, 2012
ASSETS
Investments:
Securities available-for-sale, at fair value:
Fixed maturities (amortized cost: $405,809,842 and $394,370,377)	$	424,613,943	$	438,323,413
Equity securities (cost: $5,193,826 and $1,117,051)		4,963,828		1,386,637
Mortgage loans on real estate		16,353,632		16,620,290
Policy loans		6,703,738		6,781,751
State-guaranteed receivables		8,061,055		8,111,669
Investment in derivative		-		642,600
Other invested assets		3,253,343		3,420,189
Total investments		463,949,539		475,286,549
Cash and cash equivalents		3,434,896		6,009,905
Accrued investment income		4,280,991		5,163,783
Due premiums		3,460,096		3,422,629
Deferred acquisition costs		18,553,846		16,654,246
Value of business acquired		416,121		513,667
Leased property under capital leases		364,239		577,839
Property and equipment		1,715,075		1,900,068
Cash value of company-owned life insurance		11,523,836		10,844,489
Other assets		2,247,933		1,835,666
Amounts recoverable from reinsurers		56,175,204		53,797,125
Total assets	$	566,121,776	$	576,005,966
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Policy liabilities:
Benefit reserves	$	478,388,842	$	464,449,101
Unearned premium reserves		8,667,894		9,111,514
Policy claims		4,134,431		1,894,727
Liability for deposit-type contracts		3,258,029		3,147,458
Reserves for dividends and endowments and other		432,476		446,016
Total policy liabilities		494,881,672		479,048,816
Deferred federal income tax liability		4,963,492		13,189,478
Obligations under capital leases		358,350		568,214
Notes payable		3,182,050		3,478,613
Accrued pension liability		6,038,621		7,211,519
Other liabilities		3,735,269		4,276,542
Total liabilities		513,159,454		507,773,182
STOCKHOLDERS' EQUITY
Common stock (shares issued: 1,133,162 and 1,141,886)		1,133,162		1,141,886
Paid-in surplus		8,908,243		8,908,243
Accumulated other comprehensive income		6,572,516		22,539,724
Retained earnings		36,348,401		35,642,931
Total stockholders' equity		52,962,322		68,232,784
Total liabilities and stockholders' equity	$	566,121,776	$	576,005,966

See notes to condensed consolidated financial statements.

4

INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Income Statements (Unaudited)

	Quarter Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
REVENUE
Premiums and other considerations	$	18,740,917		$	17,526,584		$	55,644,294		$	50,632,068
Premiums ceded		(3,792,363	)		(5,410,565	)		(11,373,438	)		(14,363,992	)
Net premiums earned		14,948,554			12,116,019			44,270,856			36,268,076
Investment income, net of expenses		4,985,998			5,245,110			15,516,997			15,593,997
Net realized gains on investments:
Total other-than-temporary impairment losses		-			-			-			-
Portion of loss recognized in other comprehensive income		-			-			-			-
Other net realized investment gains		2,418,806			249,927			2,482,057			448,186
Net realized gains on investments		2,418,806			249,927			2,482,057			448,186
Consideration on reinsurance assumed		-			-			-			9,523
Other income		325,180			415,825			1,071,957			1,249,727
Total revenue		22,678,538			18,026,881			63,341,867			53,569,509
BENEFITS AND EXPENSES
Death and other benefits		9,746,027			9,829,253			32,925,539			32,324,798
Guaranteed annual endowments		94,771			103,967			332,519			349,201
Dividends to policyholders		85,824			94,774			314,825			331,526
Increase in benefit reserves and unearned premiums		5,784,708			3,201,772			15,028,520			7,100,162
Acquisition costs deferred		(2,279,348	)		(2,400,294	)		(6,930,950	)		(6,362,851	)
Amortization of deferred acquisition costs		2,030,109			2,108,748			5,830,140			5,831,702
Commissions		1,956,328			1,331,913			5,624,457			3,525,307
Other general and administrative expenses		2,476,130			2,385,935			8,526,005			8,656,620
Total benefits and expenses		19,894,549			16,656,068			61,651,055			51,756,465
INCOME BEFORE FEDERAL INCOME TAXES		2,783,989			1,370,813			1,690,812			1,813,044
PROVISION (BENEFIT) FOR FEDERAL INCOME TAXES
Current		896,769			342,339			430,195			640,254
Deferred		(61,573	)		68,906			77,048			(96,340	)
Total federal income taxes		835,196			411,245			507,243			543,914
NET INCOME	$	1,948,793		$	959,568		$	1,183,569		$	1,269,130
BASIC AND DILUTED NET INCOME PER SHARE	$	1.72		$	0.83		$	1.04		$	1.10
DIVIDENDS PER SHARE	$	-		$	-		$	0.25		$	0.23

See notes to condensed consolidated financial statements.

5

INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

	Quarter Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
NET INCOME	$	1,948,793		$	959,568		$	1,183,569		$	1,269,130
OTHER COMPREHENSIVE INCOME (LOSS):
Change in net unrealized gains (losses) on available-for-sale securities:
Unrealized holding gains (losses) arising during period		(1,357,536	)		6,469,578			(23,152,456	)		13,991,611
Reclassification adjustment for gains included in income		(2,418,806	)		(249,927	)		(2,496,063	)		(448,186	)
Adjustment for effects of deferred acquisition costs		128,198			(166,471	)		798,791			(360,841	)
Net unrealized gains (losses) on investments		(3,648,144	)		6,053,180			(24,849,728	)		13,182,584
Change in defined benefit pension plan:
Amortization of actuarial net loss in net periodic pension cost		193,161			171,359			579,485			690,197
Curtailment of defined benefit pension plan		-			-			-			2,519,152
Net change in defined benefit pension plan		193,161			171,359			579,485			3,209,349
Other comprehensive income (loss) before income taxes		(3,454,983	)		6,224,539			(24,270,243	)		16,391,933
Income tax expense (benefit)		(1,215,383	)		2,124,612			(8,303,035	)		5,582,454
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAXES		(2,239,600	)		4,099,927			(15,967,208	)		10,809,479
COMPREHENSIVE INCOME (LOSS)	$	(290,807	)	$	5,059,495		$	(14,783,639	)	$	12,078,609

See notes to condensed consolidated financial statements.

6

INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Statements of Stockholders' Equity (Unaudited)

	Common Stock			Paid-in Surplus		Accumulated Other Comprehensive Income			Retained Earnings			Total Stockholders' Equity
BALANCE, JANUARY 1, 2012	$	1,152,737		$	8,832,222	$	13,605,484		$	34,073,278		$	57,663,721
Net income		-			-		-			1,269,130			1,269,130
Other comprehensive income, net		-			-		10,809,479			-			10,809,479
Cash dividends		-			-		-			(265,129	)		(265,129	)
Issuances of common stock, net		4,305			75,775		-			15,724			95,804
BALANCE, SEPTEMBER 30, 2012	$	1,157,042		$	8,907,997	$	24,414,963		$	35,093,003		$	69,573,005
BALANCE, JANUARY 1, 2013	$	1,141,886		$	8,908,243	$	22,539,724		$	35,642,931		$	68,232,784
Net income		-			-		-			1,183,569			1,183,569
Other comprehensive loss, net		-			-		(15,967,208	)		-			(15,967,208	)
Cash dividends		-			-		-			(285,471	)		(285,471	)
Repurchases of common stock, net		(8,724	)		-		-			(192,628	)		(201,352	)
BALANCE, SEPTEMBER 30, 2013	$	1,133,162		$	8,908,243	$	6,572,516		$	36,348,401		$	52,962,322

See notes to condensed consolidated financial statements.

7

INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Statements of Cash Flows (Unaudited)

	Nine Months Ended September 30,
	2013			2012
NET CASH PROVIDED BY OPERATING ACTIVITIES	$	12,964,120		$	4,146,457
INVESTING ACTIVITIES
Purchases of available-for-sale securities		(89,724,430	)		(30,571,100	)
Sales of available-for-sale securities		35,306,604			5,836,594
Maturities of available-for-sale securities		40,899,144			20,007,088
Acquisitions of mortgage loans on real estate		(1,102,901	)		(2,165,000	)
Payments of mortgage loans on real estate		1,371,915			4,125,114
Purchases of state-guaranteed receivables		-			(1,247,494	)
Payments of state-guaranteed receivables		481,280			426,780
Sale of investment in derivative		645,000			-
Acquisitions of short-term investments		-			(34,188	)
Sales and maturities of short-term investments		-			17,094
Net change in payable (receivable) for securities		219,158			(87,103	)
Net reductions of other investments		230,853			627,523
Net additions to property and equipment		(76,139	)		(623,697	)
NET CASH USED IN INVESTING ACTIVITIES		(11,749,516	)		(3,688,389	)
FINANCING ACTIVITIES
Receipts from universal life policies credited to policyholder account balances		4,002,096			4,295,466
Return of policyholder account balances on universal life policies		(7,008,323	)		(6,323,287	)
Payments on notes payable		(3,060,944	)		(3,286,553	)
Proceeds from notes payable		2,764,381			2,741,666
Dividends paid		(285,471	)		(265,129	)
Issuances (repurchases) of common stock, net		(201,352	)		95,804
NET CASH USED IN FINANCING ACTIVITIES		(3,789,613	)		(2,742,033	)
DECREASE IN CASH AND CASH EQUIVALENTS		(2,575,009	)		(2,283,965	)
Cash and cash equivalents at beginning of period		6,009,905			6,534,616
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	3,434,896		$	4,250,651

See notes to condensed consolidated financial statements.

8

INVESTORS HERITAGE CAPITAL CORPORATION 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2013

(Unaudited)

NOTE 1 - Nature of Operations

Investors Heritage Capital Corporation is the holding company of Investors Heritage Life Insurance Company; Investors Heritage Printing, Inc., a printing company; Investors Heritage Financial Services Group, Inc., an insurance marketing company; is the sole member of At Need Funding, LLC, a limited liability company that provides advance funding of funerals in exchange for the irrevocable assignment of life insurance policies from other nonaffiliated companies; and is the sole member of Heritage Funding, LLC, a limited liability company that invests in various business ventures. These entities are collectively hereinafter referred to as the “Company”. In excess of 99% of Investors Heritage Capital’s consolidated revenue is generated by Investors Heritage Life.

Our principal operations involve the sale and administration of various insurance and annuity products, including, but not limited to, participating and non-participating whole life, limited pay life, universal life, annuity contracts, credit life, credit accident and health and group insurance policies. The principal markets for the Company’s products are in Kentucky, North Carolina, Georgia, Indiana, Michigan, Ohio, Pennsylvania, South Carolina, Tennessee, Texas and Virginia.

NOTE 2 - Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the quarter and nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2012, as included in our Annual Report on Form 10-K.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Management has evaluated all events subsequent to September 30, 2013 through the date that these financial statements have been issued.

NOTE 3 – New Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board issued guidance regarding the reporting of reclassifications out of accumulated other comprehensive income. The guidance requires entities to provide information about the amounts reclassified out of accumulated other comprehensive income by component. Significant amounts reclassified out of accumulated other comprehensive income that are required under U.S. generally accepted accounting principles to be reclassified to net income in their entirety in the same reporting period must be presented either on the face of the statement, where net income is presented, or in the footnotes. For amounts that are not required under U.S. generally accepted accounting principles to be reclassified in their entirety to net income, entities are required to cross-reference to other disclosures that are required by U.S. generally accepted accounting principles that provide additional detail about those amounts. This guidance is effective prospectively for reporting periods beginning after December 15, 2012. The Company adopted this new guidance as of January 1, 2013 with no material impact to the consolidated financial statements.

9

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

NOTE 4 – Investments

Investments in available-for-sale securities are summarized as follows:

 

September 30, 2013	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Fixed maturity securities:
U.S. government obligations	$	37,820,939	$	1,321,518	$	376,113	$	38,766,344
States and political subdivisions		41,688,611		3,682,333		36,713		45,334,231
Corporate		217,067,499		13,006,952		2,210,279		227,864,172
Foreign		54,839,273		2,656,775		1,514,104		55,981,944
Asset-backed securities		3,351,821		147,493		-		3,499,314
Mortgage-backed securities (MBS):
Commercial MBS		5,009,021		205,747		-		5,214,768
Residential MBS		45,670,958		1,957,381		-		47,628,339
Corporate redeemable preferred stock		361,720		-		36,889		324,831
Total fixed maturity securities		405,809,842		22,978,199		4,174,098		424,613,943
Equity securities:
U.S. agencies		687,000		-		-		687,000
Mutual funds		318,283		7,803		-		326,086
Corporate common stock		4,033,275		268,954		486,313		3,815,916
Corporate nonredeemable preferred stock		155,268		-		20,442		134,826
Total equity securities		5,193,826		276,757		506,755		4,963,828
Total	$	411,003,668	$	23,254,956	$	4,680,853	$	429,577,771

December 31, 2012	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Fixed maturity securities:
U.S. government obligations	$	47,634,952	$	4,263,920	$	-	$	51,898,872
States and political subdivisions		46,323,487		7,522,997		-		53,846,484
Corporate		207,553,209		23,818,640		93,765		231,278,084
Foreign		50,000,420		4,748,130		11,680		54,736,870
Asset-backed securities		4,460,090		289,373		529		4,748,934
Mortgage-backed securities (MBS):
Commercial MBS		6,429,641		407,386		-		6,837,027
Residential MBS		31,968,578		3,008,564		-		34,977,142
Total fixed maturity securities		394,370,377		44,059,010		105,974		438,323,413
Equity securities:
U.S. agencies		681,300		-		-		681,300
Mutual funds		318,283		3,054		-		321,337
Corporate common stock		117,468		266,532		-		384,000
Total equity securities		1,117,051		269,586		-		1,386,637
Total	$	395,487,428	$	44,328,596	$	105,974	$	439,710,050

10

The following table summarizes, for all securities in an unrealized loss position as of the balance sheet dates, the estimated fair value, pre-tax gross unrealized loss and number of securities by length of time that those securities have been continuously in an unrealized loss position.

 

	September 30, 2013						December 31, 2012
	Estimated Fair Value		Gross Unrealized Loss		Number of Securities		Estimated Fair Value		Gross Unrealized Loss		Number of Securities
Fixed Maturities:
Less than 12 months:
U.S. government obligations	$	12,598,904	$	376,113		3	$	-	$	-		-
States and political subdivisions		713,288		36,713		1		-		-		-
Corporate		55,415,549		2,210,279		41		4,648,363		88,805		5
Foreign		27,580,179		1,514,104		16		988,320		11,680		1
Corporate redeemable preferred stock		324,831		36,889		8		-		-		-
Greater than 12 months:
Corporate		-		-		-		243,040		4,960		1
Asset-backed securities		-		-		-		59,097		529		1
Total fixed maturities		96,632,751		4,174,098		69		5,938,820		105,974		8
Equities:
Less than 12 months:
Corporate common stock		3,054,622		486,313		31		-		-		-
Corporate nonredeemable preferred stock		134,826		20,442		2		-		-		-
Total equities		3,189,448		506,755		33		-		-		-
Total	$	99,822,199	$	4,680,853		102	$	5,938,820	$	105,974		8

As of September 30, 2013, all of the above fixed maturity securities individually had a fair value to cost ratio equal to or greater than 83% and the equity securities had a fair value to cost ratio equal to or exceeding 68%. As of December 31, 2012, all of the above fixed maturity securities had a fair value to cost ratio equal to or greater than 96% and the equity securities noted above had a fair value to cost ratio equal to or exceeding 100%.

The Company’s decision to record an impairment loss is primarily based on whether the security’s fair value is likely to remain significantly below its book value in light of all the factors considered. Factors that are considered include the length of time the security’s fair value has been below its carrying amount, the severity of the decline in value, the credit worthiness of the issuer, and the coupon and/or dividend payment history of the issuer. The Company also assesses whether it intends to sell or whether it is more likely than not that it may be required to sell the security prior to its recovery in value. For any fixed maturity securities that are other-than-temporarily impaired, the Company determines the portion of the other-than-temporary impairment that is credit-related and the portion that is related to other factors. The credit-related portion is the difference between the expected future cash flows and the amortized cost basis of the fixed maturity security, and that difference is charged to earnings. The non-credit-related portion representing the remaining difference to fair value is recognized in other comprehensive income (loss). Only in the case of a credit-related impairment where management has the intent to sell the security, or it is more likely than not that it will be required to sell the security before recovery of its cost basis, is a fixed maturity security adjusted to fair value and the resulting losses recognized in realized gains (losses) in the consolidated statements of income. Any other-than-temporary impairments on equity securities are recorded in the consolidated statements of income in the periods incurred as the difference between fair value and cost. Based on our review, the Company experienced no other-than-temporary impairments during the quarters or nine months ended September 30, 2013 or 2012.

11

Management believes that the Company will fully recover its cost basis in the securities held at September 30, 2013, and management does not have the intent to sell nor is it more likely than not that the Company will be required to sell such securities until they recover or mature. The temporary impairments shown herein are primarily the result of the current interest rate environment rather than credit factors that would imply other-than-temporary impairment.

Net unrealized gains for investments classified as available-for-sale are presented below, net of the effect on deferred income taxes and deferred acquisition costs assuming that the appreciation (depreciation) had been realized.

 

	September 30, 2013			December 31, 2012
Net unrealized appreciation on available-for sale securities	$	18,574,103		$	44,222,622
Adjustment to deferred acquisition costs		(514,131	)		(1,312,922	)
Deferred income taxes		(6,321,537	)		(14,821,597	)
Net unrealized appreciation on available-for sale securities	$	11,738,435		$	28,088,103

The amortized cost and fair value of fixed maturity securities at September 30, 2013, by contractual maturity, are presented below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

	Available-for-Sale
	Amortized		Fair
	Cost		Value
Due in one year or less	$	3,501,324	$	3,551,783
Due after one year through five years		67,647,273		74,113,360
Due after five years through ten years		190,847,087		197,532,851
Due after ten years		92,772,459		96,248,011
Due at multiple maturity dates		50,679,979		52,843,107
Corporate redeemable preferred stock		361,720		324,831
Total	$	405,809,842	$	424,613,943

Proceeds for the quarters and nine months ended September 30, 2013 and 2012 from sales and maturities of investments in available-for-sale securities, as well as gross gains and gross losses realized, are presented below.

 

	Quarter Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Proceeds from sales and maturities	$	47,541,392		$	6,723,467		$	76,205,748		$	25,843,682
Gross realized gains		2,436,585			251,815			2,544,968			455,444
Gross realized losses		(17,779	)		(1,888	)		(48,905	)		(7,258	)

12

Presented below is investment information, including the accumulated quarter and year-to-date change in net unrealized investment gains or losses. Additionally, the table shows the change in net unrealized investment gains (losses) and the amount of realized investment gains (losses) on fixed maturities and equity securities for the quarters and nine months ended September 30, 2013 and 2012.

 

	Quarter Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Change in unrealized investment gains (losses):
Available-for-sale:
Fixed maturities	$	(3,668,612	)	$	6,239,402		$	(25,148,935	)	$	13,509,692
Equity securities		(107,730	)		(19,751	)		(499,584	)		33,733
Realized investment gains:
Available-for-sale:
Fixed maturities	$	2,383,513		$	186,496		$	2,473,160		$	384,755
Equity securities		35,293			63,431			22,903			63,431

In addition to the realized investment gains and losses above, the Company also experienced a realized loss of $14,006 during the nine months ended September 30, 2013 relative to the demolition of a building owned by the Company.

During the third quarter of 2013, the Company initiated a program to strategically sell certain fixed maturities to generate realized gains within the investment portfolio. The Company completed all of the identified sales prior to September 30, 2013.

The Company is required to hold assets on deposit for the benefit of policyholders in accordance with statutory rules and regulations. At September 30, 2013 and December 31, 2012, these required deposits had a total fair value of $25,562,891 and $26,169,953, respectively.

The Company owns certain investments in state-guaranteed receivables. These investments represent an assignment of the future rights to cash flows from lottery winners purchased at a discounted price. Payments on these investments are made by state run lotteries and guaranteed by the states. The state-guaranteed receivables are carried at their amortized cost basis on the balance sheet. At September 30, 2013, the amortized cost and estimated fair value of state-guaranteed receivables, by contractual maturity, are summarized as follows:

 

	Amortized Cost		Fair Value
Due in one year or less	$	700,932	$	708,325
Due after one year through five years		2,436,995		2,596,551
Due after five years through ten years		2,858,089		3,377,206
Due after ten years		2,065,039		2,738,787
Total	$	8,061,055	$	9,420,869

13

The amortized cost of state-guaranteed receivables, by state, is summarized as follows: 

	September 30, 2013		December 31, 2012
New York	$	3,861,199	$	3,973,862
Massachusetts		1,909,363		1,838,166
Georgia		1,521,928		1,531,078
Pennsylvania		284,989		270,657
California		192,369		202,563
Texas		208,900		198,260
Ohio		82,307		97,083
Total	$	8,061,055	$	8,111,669

Prior to the third quarter of 2013, the Company owned a $3,000,000 position in a Morgan Stanley market-indexed note, which paid 1% interest annually and matured in six years from the issue date. At maturity, the Company would have participated at 110% of any increase in the Dow Jones Industrial Average since the purchase date, but was guaranteed against market-related downside risk. Accordingly, a portion of the investment was classified as a derivative and bifurcated for reporting purposes. The derivative portion, having a cost basis of $645,000 calculated at 21.5% of the total value of the purchase price of the note, was reported as an investment in derivative on the balance sheet. The remaining non-derivative portion of the note was reported within fixed maturities on the balance sheet. This derivative was marked-to-market through the income statement, with the change in value reported as a component of investment income on the income statement. This investment was sold during the third quarter of 2013 for $3,918,083, generating a realized gain of $918,083. This realized gain was partially offset by the reduction in investment income previously recognized that was associated with the removal of the mark-to-market adjustment, as shown below.

Major categories of net investment income are summarized as follows:  

	Quarter Ended September 30,					Nine Months Ended September 30,
	2013			2012		2013		2012
Fixed maturities	$	4,874,638		$	4,866,812	$	14,480,549	$	14,583,269
Equity securities		50,970			13,637		100,701		41,021
Mortgage loans on real estate		264,056			356,252		816,454		1,027,434
Policy loans		121,699			123,004		357,789		367,497
State-guaranteed receivables		140,790			118,680		430,666		346,676
Gain (loss) on investment in derivative		(240,600	)		4,800		2,400		(68,100	)
Other		57,099			22,987		176,112		79,383
Gross investment income		5,268,652			5,506,172		16,364,671		16,377,180
Investment expenses		282,654			261,062		847,674		783,183
Net investment income	$	4,985,998		$	5,245,110	$	15,516,997	$	15,593,997

NOTE 5 – Fair Values of Financial Instruments

The fair value of a financial instrument is the estimated amount at which the instrument could be exchanged in an orderly transaction between knowledgeable, unrelated, willing parties, i.e., not in a forced transaction.  The estimated fair value of a financial instrument may differ from the amount that could be realized if the security was sold in an immediate sale, e.g., a forced transaction.  Additionally, the valuation of investments is more subjective when markets are less liquid due to the lack of market based inputs, which may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction would occur.

14

The Company holds fixed maturities and equity securities that are measured and reported at fair market value on the balance sheet. The Company is also required to disclose fair value estimates for other financial instruments not required to be carried at market value on the balance sheet. The Company determines the fair market values of its financial instruments based on the fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value, as follows:

Level 1 - Quoted prices in active markets for identical assets or liabilities.

Level 2 - 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 for substantially the full term of the assets or liabilities.

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. The unobservable inputs reflect the Company’s own assumptions about the inputs that market participants would use.

The Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into the three-level fair value hierarchy. If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument. 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.

Valuation of Investments Reported at Fair Value in Financial Statements

The Company’s Level 1 investments include equity securities that are traded in an active exchange market, as well as one U.S. agency equity security whose value is set by government statute.

The Company’s Level 2 investments include fixed maturities with quoted prices that are traded less frequently than exchange-traded instruments or instruments whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes the majority of our fixed maturities, where fair values are obtained from a nationally recognized, third-party pricing service.

The Company’s Level 3 investments include financial instruments whose value cannot be obtained through a pricing service and must be determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. This category currently includes one private equity investment and two fixed maturity securities where independent pricing inputs were not able to be obtained for a significant portion of the underlying assets. For the fixed maturities within this level, the Company utilizes the assistance of its third-party investment advisor to estimate the fair value based on non-binding broker quotes and internal models using unobservable assumptions about market participants. For the private equity investment, the Company establishes fair value based on the most recent trading activity as well as a review of the underlying financial statements of the entity. The Company’s Level 3 segment also included the investment in derivative related to the bifurcated equity-indexed portion of a market-indexed note prior to its sale during the third quarter of 2013. The value of the derivative portion of this investment was derived from an option pricing model that utilizes the current Dow Jones Industrial Average compared to the strike price in the note, along with various other market assumptions including those regarding volatility and dividend yields.

15

The following table presents the Company’s fair value hierarchy for those financial instruments measured and reported at fair value on a recurring basis as of September 30, 2013 and December 31, 2012.

 

	September 30, 2013
	Level 1		Level 2		Level 3		Total
Fixed maturities:
U.S. government obligations	$	-	$	38,766,344	$	-	$	38,766,344
States and political subdivisions		-		45,334,231		-		45,334,231
Corporate		-		225,909,172		1,955,000		227,864,172
Foreign		-		54,099,444		1,882,500		55,981,944
Asset-backed securities		-		3,499,314		-		3,499,314
Mortgage-backed securities:
Commercial MBS		-		5,214,768		-		5,214,768
Residential MBS		-		47,628,339		-		47,628,339
Corporate redeemable preferred stock		324,831		-		-		324,831
Total fixed maturities	$	324,831	$	420,451,612	$	3,837,500	$	424,613,943
Equity securities:
U.S. agencies	$	687,000	$	-	$	-	$	687,000
Mutual funds		326,086		-		-		326,086
Corporate common stock		3,431,916		-		384,000		3,815,916
Corporate nonredeemable preferred stock		134,826		-		-		134,826
Total equity securities	$	4,579,828	$	-	$	384,000	$	4,963,828

	December 31, 2012
	Level 1		Level 2		Level 3		Total
Fixed maturities:
U.S. government obligations	$	-	$	51,898,872	$	-	$	51,898,872
States and political subdivisions		-		53,846,484		-		53,846,484
Corporate		-		227,443,614		3,834,470		231,278,084
Foreign		-		54,736,870		-		54,736,870
Asset-backed securities		-		4,748,934		-		4,748,934
Mortgage-backed securities:
Commercial MBS		-		6,837,027		-		6,837,027
Residential MBS		-		34,977,142		-		34,977,142
Total fixed maturities	$	-	$	434,488,943	$	3,834,470	$	438,323,413
Equity securities:
U.S. agencies	$	681,300	$	-	$	-	$	681,300
Mutual funds		321,337		-		-		321,337
Corporate common stock		-		-		384,000		384,000
Total equity securities	$	1,002,637	$	-	$	384,000	$	1,386,637
Investment in derivative	$	-	$	-	$	642,600	$	642,600

16

The following table provides a summary of changes in fair value of our Level 3 financial instruments reported at fair value for the quarters and nine months ended September 30, 2013 and 2012.

 

	Quarter Ended September 30, 2013
	Corporate			Foreign			Corporate Common Stock		Investment in Derivative			Total
Beginning balance	$	1,890,000		$	1,995,000		$	384,000	$	885,600		$	5,154,600
Transfers into Level 3		-			-			-		-			-
Transfers out of Level 3		(1,887,820	)		-			-		-			(1,887,820	)
Purchases		2,001,500			-			-		-			2,001,500
Sales		(13	)		(475	)		-		(645,000	)		(645,488	)
Total gains or losses:
Included in earnings		-			-			-		(240,600	)		(240,600	)
Included in other comprehensive loss		(48,667	)		(112,025	)		-		-			(160,692	)
Ending balance	$	1,955,000		$	1,882,500		$	384,000	$	-		$	4,221,500

	Quarter Ended September 30, 2012
	Corporate			Foreign		Corporate Common Stock		Invstment in Derivative		Total
Beginning balance	$	2,089,651		$	-	$	352,000	$	679,800	$	3,121,451
Transfers into Level 3		-			-		-		-		-
Transfers out of Level 3		-			-		-		-		-
Purchases		-			-		-		-		-
Sales		(52,974	)		-		-		-		(52,974	)
Total gains or losses:
Included in earnings		-			-		-		4,800		4,800
Included in other comprehensive income		45,366			-		-		-		45,366
Ending balance	$	2,082,043		$	-	$	352,000	$	684,600	$	3,118,643

17

	Nine Months Ended September 30, 2013
	Corporate			Foreign			Corporate Common Stock		Investment in Derivative			Total
Beginning balance	$	3,834,470		$	-		$	384,000	$	642,600		$	4,861,070
Transfers into Level 3		-			-			-		-			-
Transfers out of Level 3		(5,722,290	)		-			-		-			(5,722,290	)
Purchases		4,001,500			2,025,000			-		-			6,026,500
Sales		(13	)		(810	)		-		(645,000	)		(645,823	)
Total gains or losses:
Included in earnings		-			-			-		2,400			2,400
Included in other comprehensive loss		(158,667	)		(141,690	)		-		-			(300,357	)
Ending balance	$	1,955,000		$	1,882,500		$	384,000	$	-		$	4,221,500

	Nine Months Ended September 30, 2012
	Corporate			Foreign		Corporate Common Stock		Investment in Derivative			Total
Beginning balance	$	2,133,079		$	-	$	352,000	$	752,700		$	3,237,779
Transfers into Level 3		-			-		-		-			-
Transfers out of Level 3		-			-		-		-			-
Purchases		-			-		-		-			-
Sales		(102,008	)		-		-		-			(102,008	)
Total gains or losses:
Included in earnings		-			-		-		(68,100	)		(68,100	)
Included in other comprehensive income		50,972			-		-		-			50,972
Ending balance	$	2,082,043		$	-	$	352,000	$	684,600		$	3,118,643

 

The Company experienced no transfers between Level 1 and Level 2 during the quarters or nine months ended September 30, 2013 or 2012. The Company experienced one transfer of a corporate fixed maturity from Level 3 to Level 2 during the quarter ended September 30, 2013. The Company had five corporate fixed maturities that transferred from Level 3 to Level 2 during the nine months ended September 30, 2013. The Company experienced no transfers from Level 2 to Level 3 during the quarter or nine months ended September 30, 2012. Transfers in and/or out of Level 3 are primarily attributable to changes in the availability of market observable information and re-evaluation of the observability of pricing inputs.

The unrealized gains (losses) on Level 3 investments, other than the investment in derivative, are recorded as a component of accumulated other comprehensive income (loss), net of tax, in accordance with required accounting for our available-for-sale portfolio. The unrealized gains (losses) on the investment in derivative are reported in earnings as a component of investment income.

Financial Instruments Disclosed, but not Carried, at Fair Value

The following disclosure presents the carrying values and estimated fair values of the Company’s financial instruments disclosed, but not carried, at fair value as of September 30, 2013 and December 31, 2012, and the level within the fair value hierarchy at which such assets and liabilities are measured on a recurring basis. The fair values for insurance contracts other than investment-type contracts are not required to be disclosed. The estimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, considerable judgment was required to interpret market data to develop these estimates. Accordingly, the estimates are not necessarily indicative of the amounts which could be realized in a current market exchange. The use of different market assumptions or estimation methodologies may have a material effect on the fair value amounts.

18

 

	September 30, 2013
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Assets:
Mortgage loans on real estate:
Commercial	$	15,744,254	$	16,324,172	$	-	$	16,324,172	$	-
Residential		609,378		602,513		-		602,513		-
Policy loans		6,703,738		6,703,738		-		-		6,703,738
State-guaranteed receivables		8,061,055		9,420,869		-		9,420,869		-
Other invested assets		3,253,343		3,253,343		-		-		3,253,343
Cash and cash equivalents		3,434,896		3,434,896		3,434,896		-		-
Accrued investment income		4,280,991		4,280,991		-		-		4,280,991
Cash value of company-owned life insurance		11,523,836		11,523,836		-		-		11,523,836
Liabilities:
Policyholder deposits (Investment-type contracts)		53,897,202		55,071,873		-		-		55,071,873
Policy claims		4,134,431		4,134,431		-		-		4,134,431
Obligations under capital leases		358,350		358,350		-		-		358,350
Notes payable		3,182,050		3,185,136		-		-		3,185,136

	December 31, 2012
	Carrying Amount		Fair Value		Level 1		Level 2		Level 3
Assets:
Mortgage loans on real estate:
Commercial	$	16,604,183	$	17,365,363	$	-	$	17,365,363	$	-
Residential		16,107		18,068		-		18,068		-
Policy loans		6,781,751		6,781,751		-		-		6,781,751
State-guaranteed receivables		8,111,669		10,186,226		-		10,186,226		-
Other invested assets		3,420,189		3,420,189		-		-		3,420,189
Cash and cash equivalents		6,009,905		6,009,905		6,009,905		-		-
Accrued investment income		5,163,783		5,163,783		-		-		5,163,783
Cash value of company-owned life insurance		10,844,489		10,844,489		-		-		10,844,489
Liabilities:
Policyholder deposits (Investment-type contracts)		54,602,229		58,704,154		-		-		58,704,154
Policy claims		1,894,727		1,894,727		-		-		1,894,727
Obligations under capital leases		568,214		568,214		-		-		568,214
Notes payable		3,478,613		3,485,503		-		-		3,485,503

19

The following methods and assumptions were used in estimating the fair value disclosures for financial instruments in the accompanying financial statements and notes thereto:

Mortgage loans on real estate: The fair values for mortgage loans are estimated using discounted cash flow analyses. For commercial loans, the market interest rate was determined using the actual spot rate yield curve in effect at the end of each period, as determined by recent new loan activity. For residential mortgage loans, the market interest rate was assumed to be the average yield on new purchases less an expense factor.

State-guaranteed receivables: The fair values for state-guaranteed receivables are estimated using discounted cash flow analyses, using the average Citigroup Pension Liability Index in effect at the end of each period.

Cash and cash equivalents: The carrying amounts reported for these financial instruments approximate their fair values given the highly liquid nature of the instruments.

Cash value of company-owned life insurance: The carrying values and fair values for these policies are based on the current cash surrender values of the policies.

Investment-type contracts: The fair value for liabilities under investment-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 the nonperformance risk of the liabilities.

Notes payable: The fair values for notes payable on commercial loans with fixed interest rates are estimated using discounted cash flow analyses, assuming current interest rate assumptions for similar borrowings based on information gathered from market loan brokers. The fair value for notes payable with floating interest rates and promissory notes approximate the unpaid principal balances on such notes.

Policy loans, other invested assets, accrued investment income, policy claims and obligations under capital leases: The carrying values of these instruments approximate their fair values and are disclosed in Level 3 of the hierarchy.

NOTE 6 - Earnings per Share

Earnings per share of common stock were computed based on the weighted average number of common shares outstanding during each period. The weighted average number of shares outstanding for the quarters ended September 30, 2013 and 2012 were 1,135,559 and 1,156,783, respectively. The weighted average number of shares outstanding for the nine months ended September 30, 2013 and 2012 were 1,139,164 and 1,155,083, respectively.

20

NOTE 7 - Segment Data

The Company operates in four segments as shown in the following table. All segments include both individual and group insurance. Identifiable revenues, expenses and assets are assigned directly to the applicable segment. Net investment income, realized gains and losses, and invested assets are generally allocated to the insurance and the corporate segments in proportion to policy liabilities and stockholders' equity, respectively. Certain assets, such as property and equipment and leased property under capital leases, are allocated between the Administrative and financial services segment and the Corporate and other segment. Investors Heritage Financial revenue and income associated with credit administrative services is assigned to the Administrative and financial services segment, along with fees relative to third party administrative services. Any remaining revenue and income is assigned to the Corporate and other segment. Results for the parent company, Investors Heritage Printing, At Need Funding and Heritage Funding, after elimination of intercompany amounts, are allocated to the Corporate and other segment.

 

	Quarter Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Revenue:
Preneed and burial products	$	13,121,547		$	12,433,393		$	38,382,769		$	37,401,694
Traditional and universal life products		9,318,715			5,028,839			23,448,640			14,610,689
Administrative and financial services		282,157			357,449			925,669			1,090,662
Corporate and other		(43,881	)		207,200			584,789			466,464
Total revenue	$	22,678,538		$	18,026,881		$	63,341,867		$	53,569,509
Pre-tax income (loss) from operations:
Preneed and burial products	$	555,869		$	905,756		$	563,079		$	1,074,170
Traditional and universal life products		2,353,229			403,491			953,650			734,411
Administrative and financial services		95,649			103,104			224,467			249,833
Corporate and other		(220,758	)		(41,538	)		(50,384	)		(245,370	)
Total pre-tax income	$	2,783,989		$	1,370,813		$	1,690,812		$	1,813,044

At September 30, 2013, the Company’s death and other benefits include an additional amount totaling $2,069,169 relative to a comparison of our life insurance policies against the Social Security Death Master File. This comparison was performed in compliance with a recently enacted Kentucky state law which follows a model law adopted by the National Conference of Insurance Legislators. This amount primarily affects the traditional and universal life segment, along with a much smaller impact on the final expense portion of the preneed and burial segment. The Company is in the process of researching the potential matches to determine that a valid claim exists, to locate beneficiaries and to pay benefits accordingly.

NOTE 8 – Federal Income Taxes

The provision for federal income taxes is based on the estimated effective annual tax rate. Deferred taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Income before federal income taxes differs from taxable income principally due to the dividends-received deduction; the 404(k) dividend deduction; the small life insurance company tax deduction; and non-taxable effects of company-owned life insurance premiums, cash value growth, and death benefit proceeds.

We file U.S. federal income tax returns and income tax returns in various state jurisdictions. Our 2010 through 2012 U.S. federal tax years remain subject to income tax examination by tax authorities. We have no known uncertain tax benefits within our provision for income taxes. In addition, we do not believe the Company will be subject to any penalties or interest relative to any open tax years and, therefore, have not accrued any such amounts. However, should such a circumstance arise, it is our policy to classify any interest and penalties (if applicable) as income tax expense in the financial statements.

21

NOTE 9 – Other Comprehensive Income (Loss)

The following tables present the pretax components of the Company’s other comprehensive income (loss), and the related income tax expense (benefit) for each component, for the quarters and nine months ended September 30, 2013 and 2012.

 

	Quarter Ended September 30, 2013
	Pretax			Income Tax Expense (Benefit)			Net of Tax
Other comprehensive loss:
Change in net unrealized gains on available-for-sale securities:
Unrealized holding losses arising during period	$	(1,357,536	)	$	(856,681	)	$	(500,855	)
Reclassification adjustment for gains included in income		(2,418,806	)		(467,966	)		(1,950,840	)
Adjustment for effect of deferred acquisition costs		128,198			43,589			84,609
Net unrealized losses on investments		(3,648,144	)		(1,281,058	)		(2,367,086	)
Change in defined benefit pension plan:
Amortization of actuarial net loss in net periodic pension cost		193,161			65,675			127,486
Total other comprehensive loss	$	(3,454,983	)	$	(1,215,383	)	$	(2,239,600	)

	Quarter Ended September 30, 2012
	Pretax			Income Tax Expense (Benefit)			Net of Tax
Other comprehensive income:
Change in net unrealized gains on available-for-sale securities:
Unrealized holding gains arising during period	$	6,469,578		$	2,186,414		$	4,283,164
Reclassification adjustment for gains included in income		(249,927	)		(63,464	)		(186,463	)
Adjustment for effect of deferred acquisition costs		(166,471	)		(56,600	)		(109,871	)
Net unrealized gains on investments		6,053,180			2,066,350			3,986,830
Change in defined benefit pension plan:
Amortization of actuarial net loss in net periodic pension cost		171,359			58,262			113,097
Total other comprehensive income	$	6,224,539		$	2,124,612		$	4,099,927

22

 

	Nine Months Ended September 30, 2013
	Pretax			Income Tax Expense (Benefit)			Net of Tax
Other comprehensive loss:
Change in net unrealized gains on available-for-sale securities:
Unrealized holding losses arising during period	$	(23,152,456	)	$	(8,271,465	)	$	(14,880,991	)
Reclassification adjustment for gains included in income		(2,496,063	)		(500,184	)		(1,995,879	)
Adjustment for effect of deferred acquisition costs		798,791			271,589			527,202
Net unrealized losses on investments		(24,849,728	)		(8,500,060	)		(16,349,668	)
Change in defined benefit pension plan:
Amortization of actuarial net loss in net periodic pension cost		579,485			197,025			382,460
Total other comprehensive loss	$	(24,270,243	)	$	(8,303,035	)	$	(15,967,208	)

	Nine Months Ended September 30, 2012
	Pretax			Income Tax Expense (Benefit)			Net of Tax
Other comprehensive income:
Change in net unrealized gains on available-for-sale securities:
Unrealized holding gains arising during period	$	13,991,611		$	4,744,726		$	9,246,885
Reclassification adjustment for gains included in income		(448,186	)		(130,765	)		(317,421	)
Adjustment for effect of deferred acquisition costs		(360,841	)		(122,686	)		(238,155	)
Net unrealized gains on investments		13,182,584			4,491,275			8,691,309
Change in defined benefit pension plan:
Amortization of actuarial net loss in net periodic pension cost		690,197			234,667			455,530
Curtailment of defined benefit pension plan		2,519,152			856,512			1,662,640
Net change in defined benefit pension plan		3,209,349			1,091,179			2,118,170
Total other comprehensive income	$	16,391,933		$	5,582,454		$	10,809,479

Realized gains and losses on the sales of investments are determined based upon the specific identification method and include provisions for other-than-temporary impairments where appropriate.

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The change in the components of the Company’s accumulated other comprehensive income, net of tax, for the nine months ended September 30, 2013 and 2012 are as follows:

 

	Unrealized Gains			Defined			Accumulated
	(Losses) on			Benefit			Other
	Available-For-Sale			Pension			Comprehensive
	Securities			Plans			Income
For the nine months ended September 30, 2013:
Beginning balance	$	28,088,103		$	(5,548,379	)	$	22,539,724
Other comprehensive loss before reclassifications		(14,353,789	)		-			(14,353,789	)
Amounts reclassified from accumulated other comprehensive income		(1,995,879	)		382,460			(1,613,419	)
Net current period other comprehensive income (loss)		(16,349,668	)		382,460			(15,967,208	)
Ending balance	$	11,738,435		$	(5,165,919	)	$	6,572,516
For the nine months ended September 30, 2012:
Beginning balance	$	20,334,585		$	(6,729,101	)	$	13,605,484
Other comprehensive income		8,691,309			2,118,170			10,809,479
Ending balance	$	29,025,894		$	(4,610,931	)	$	24,414,963

The following table presents the pretax and the related income tax components of the amounts reclassified from the Company’s accumulated other comprehensive income to the Company’s consolidated statement of income for the quarter and nine months ended September 30, 2013.

 

	Quarter			Nine Months
	Ended			Ended
Reclassification Adjustments	September 30, 2013			September 30, 2013
Unrealized gains on available-for-sale securities:
Realized gains on sale of securities (a)	$	2,418,806		$	2,496,063
Income tax expense (c)		(467,966	)		(500,184	)
Net of tax		1,950,840			1,995,879
Defined benefit pension plans:
Amortization of actuarial net loss (b)		(193,161	)		(579,485	)
Income tax benefit (c)		65,675			197,025
Net of tax		(127,486	)		(382,460	)
Total reclassifications for the period	$	1,823,354		$	1,613,419

(a) These items appear within net realized gains on investments in the consolidated income statements.

(b) These items are included in the computation of net periodic benefit cost (see Note 10).

(c) These items appear within federal income taxes in the consolidated income statements. 

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NOTE 10 – Employee Benefit Plans

Investors Heritage Capital Corporation sponsors a noncontributory defined benefit pension plan. Benefits under this plan were curtailed for covered employees effective as of June 30, 2012, and no further benefits are being earned under this plan. The following table provides the components of our net periodic benefit cost:

 

	Quarter Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Service cost	$	-		$	-		$	-		$	322,916
Interest cost		167,180			247,561			501,540			783,205
Expected return on plan assets		(298,146	)		(328,621	)		(894,438	)		(954,151	)
Recognized actuarial net loss		193,161			171,359			579,485			690,197
Net periodic benefit cost	$	62,195		$	90,299		$	186,587		$	842,167

We previously disclosed in our financial statements for the year ended December 31, 2012 that the Company expected to contribute $1,440,000 to our defined benefit pension plan during 2013. Based on the current analysis of our funding requirements, we anticipate reducing the contribution for 2013 to $960,000. As of September 30, 2013, the Company had contributed $780,000 to the plan.   

NOTE 11 – Notes Payable

The Company renewed the Investors Heritage Capital Corporation Line of Credit and the At Need Funding Line of Credit during the third quarter of 2013. The Investors Heritage Capital Corporation Line of Credit remains for $150,000 with a new maturity date of September 20, 2015. Likewise, the At Need Funding Line of Credit also remains for $1,000,000 with a new maturity date of September 20, 2015. Interest is paid on both notes monthly at the prime rate, with a floor of 3.25%.

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

GENERAL

Investors Heritage Capital Corporation is incorporated under the laws of the Commonwealth of Kentucky and wholly owns Investors Heritage Life Insurance Company, a life insurance company also incorporated under the laws of the Commonwealth of Kentucky. Investors Heritage Capital also wholly owns Investors Heritage Financial Services Group, Inc., a Kentucky insurance marketing company; Investors Heritage Printing, Inc., a Kentucky printing company that provides printing to Investors Heritage Life and other unaffiliated parties; is the sole member of At Need Funding, LLC, a Kentucky limited liability company that provides advance funding of funerals in exchange for the irrevocable assignment of life insurance policies from other nonaffiliated companies; and is the sole member of Heritage Funding, LLC, a limited liability company that was formed to invest in various business ventures but is currently dormant.

Investors Heritage Life offers a full line of life insurance products including, but not limited to, whole life, term life, single premium life, multi-pay life and annuities. Investors Heritage Life’s primary lines of business are insurance policies and annuities utilized to fund preneed funeral contracts, policies sold in the senior wealth transfer market, final expense insurance, credit life and credit disability insurance, and term life and reducing term life sold through financial institutions.

In our preneed and burial product segment, we currently market the Legacy Gold and Heritage Final Expense II products. The Legacy Gold life insurance and annuity product series is sold in the preneed market in conjunction with prearranged funerals. The Legacy Gold series includes both single premium and multi-pay policies, and both underwritten and guaranteed issue options are available. The Heritage Final Expense II product is sold in the final expense market. This product is a non-participating whole life insurance product with simplified underwriting.

We also market the Heritage Advantage final expense product through a third party national master general agent distribution system. The master general agent has an established record and extensive experience in this market. The product is being issued using simplified tele-underwriting techniques through an experienced third party underwriting firm.

Within our traditional and universal products segment, we currently market two products geared toward wealth preservation in the senior market – the Heritage Solution, a single premium life policy, and the Heritage Provider, a ten pay whole life and single premium immediate annuity combination. These products are currently being sold exclusively through our partnership with Puritan Financial Group and are being underwritten and issued using a third party underwriter with significant experience in that market. Prior to January 1, 2013, this business was being reinsured under a 50% coinsurance arrangement with a life insurance company affiliated with Puritan Financial Group. Effective January 1, 2013, this coinsurance agreement was amended to reinsure 25% of new business with that life insurance company. Additionally, these products were re-priced effective January 1, 2013 to account for lower required valuation rates and the current economic environment.

Beginning January 1, 2013, Investors Heritage Life began assuming 75% of the risks on policies sold by Puritan Life Insurance Company of America. The products being assumed are identical to the Heritage Solution and Heritage Provider products currently being written by Investors Heritage Life. However, this reinsurance arrangement will allow us to participate in the profitability of these products in certain states where we are not currently marketing.

Our traditional and universal life products also include the HLW Choice Whole Life product and the Heritage Protector IV product. The HLW Choice Whole Life product is designed with numerous options and with flexibility to achieve our customers’ goals. The Heritage Protector IV product is a term product marketed primarily by banks and other financial institutions in conjunction with consumer credit.

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Investors Heritage Financial markets traditional insurance products through banks and other financial institutions. Investors Heritage Financial markets Investors Heritage Life products and continues to expand the portfolio of products available to our regular ordinary insurance agents by offering products of other unaffiliated companies. For a number of years, we have provided outlets for our agents with substandard business that Investors Heritage Life will not accept. Investors Heritage Financial has provided “second to die” policies, substandard life policies, larger term policies and health insurance products through other unaffiliated insurance companies. Investors Heritage Financial receives a fee for providing those services.

In general, we utilize a combination of yearly renewable term reinsurance and coinsurance to cede life insurance coverage in excess of our $25,000 per life retention limit. Most of our business is written in the smaller face amount markets and, in the past, claims on larger-case ordinary business caused income fluctuations. This lower retention level has stabilized earnings fluctuations. The lowered retention was achieved by maintaining the established reinsurance treaties and adding additional yearly renewable term treaties for amounts between $25,000 net amount at risk and the previous retention of $100,000.

Investors Heritage Life continues to market its third party administrative (“TPA”) services as an additional revenue source. These agreements, for various levels of administrative services on behalf of each company, generate fee income for Investors Heritage Life. We currently have five TPA clients for which we provide tailored services to meet each client’s individual business needs. We have been able to perform our TPA services using our existing in-house resources.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. Preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We evaluate our estimates continually, including those related to investments, deferred acquisition costs, value of business acquired, policy liabilities, income taxes, employee benefit plans, regulatory requirements, contingencies and litigation. We base such estimates on historical experience and other assumptions believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following accounting policies, judgments and estimates are the most critical to the preparation of our consolidated financial statements.

Investments in Fixed Maturities, Equity Securities, Mortgage Loans and State-Guaranteed Receivables

We hold fixed maturities and equity interests in a variety of companies. Additionally, we originate, underwrite and manage mortgage loans. We also own certain investments in state-guaranteed receivables consisting of the future cash flow rights from lottery prize winners. We continuously evaluate all of our investments based on current economic conditions, credit loss experience and other developments. We evaluate the difference between the cost/amortized cost and estimated fair value of our investments to determine whether any decline in fair value is other-than-temporary in nature. This determination involves a degree of uncertainty. If a decline in the fair value of a security is determined to be temporary, the decline is recognized in other comprehensive income (loss) within stockholders’ equity. If a decline in a security’s fair value is considered to be other-than-temporary, we then determine the proper treatment for the other-than-temporary impairment. For fixed maturities, the amount of any other-than-temporary impairment related to a credit loss is recognized in earnings and reflected as a reduction in the cost basis of the security; and the amount of any other-than-temporary impairment related to other factors is recognized in other comprehensive income (loss) with no change to the cost basis of the security.  For equity securities, the amount of any other-than-temporary impairment is recognized in earnings and reflected as a reduction in the cost basis of the security.

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The assessment of whether a decline in fair value is considered temporary or other-than-temporary includes management’s judgment as to the financial position and future prospects of the entity issuing the security. It is not possible to accurately predict when it may be determined that a specific security will become impaired. Future adverse changes in market conditions, poor operating results of underlying investments and defaults on mortgage loan payments could result in losses or an inability to recover the current carrying value of the investments, thereby possibly requiring an impairment charge in the future. Likewise, if a change occurs in our intent to sell temporarily impaired securities prior to maturity or recovery in value, or if it becomes more likely than not that we will be required to sell such securities prior to recovery in value or maturity, a future impairment charge could result.

If an other-than-temporary impairment related to a credit loss occurs with respect to a bond, we amortize the reduced book value back to the security’s expected recovery value over the remaining term of the bond. We continue to review the security for further impairment that would prompt another write-down in the book value.

We classify our fixed maturities and equity securities as available-for-sale and carry them at fair value on the balance sheet, with unrealized appreciation (depreciation) relating to temporary market value changes recorded as an adjustment to other comprehensive income (loss), net of deferred acquisition costs and federal income taxes. Fair value for these investments is determined using Accounting Standards Codification principles covering Level 1, Level 2 and Level 3 instruments as further discussed in Note 5 to the consolidated financial statements.

The majority of our fixed maturities are Level 2 instruments, for which the fair value is derived from readily available pricing services utilizing recent trades and broker information. Certain liquid equity securities are considered Level 1 instruments and are valued based on publicly available market quotes in an active market. We hold approximately $4,222,000 in Level 3 financial instruments, comprising 1.0% of our total investments carried at fair value. Fair value for these instruments is derived from unobservable inputs such as non-binding broker quotes and internal models using unobservable assumptions about market participants.

Deferred Acquisition Costs

The recovery of deferred acquisition costs is dependent on the future profitability of the underlying business for which acquisition costs were incurred. Each reporting period, we evaluate the recoverability of the unamortized balance of deferred acquisition costs. We consider estimated future gross profits or future premiums, expected mortality or morbidity, interest earned and credited rates, persistency and expenses in determining whether the balance is recoverable. If we determine a portion of the unamortized balance is not recoverable, it is immediately charged to amortization expense. The assumptions we use to amortize and evaluate the recoverability of the deferred acquisition costs involve significant judgment. A revision to these assumptions may impact future financial results.

Deferred acquisition costs related to annuities and universal life insurance products are deferred to the extent deemed recoverable and amortized in relation to the present value of actual and expected gross profits on the policies. To the extent that realized gains and losses on securities result in adjustments to deferred acquisition costs related to annuities, such adjustments are reflected as a component of the amortization of deferred acquisition costs.

Deferred acquisition costs related to annuities are also adjusted, net of tax, for the change in amortization that would have been recorded if the unrealized gains (losses) from securities had actually been realized. This adjustment is included in the change in net unrealized appreciation (depreciation) on available-for-sale securities, a component of "Accumulated Other Comprehensive Income (Loss)" in the stockholders' equity section of the balance sheet.

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Policy Liabilities 

Estimating liabilities for our long-duration insurance contracts requires management to make various assumptions, including policyholder persistency, mortality rates, investment yields, discretionary benefit increases, new business pricing, and operating expense levels. We evaluate historical experience for these factors when assessing the need for changing current assumptions. However, since many of these factors are interdependent and subject to short-term volatility during the long-duration contract period, substantial judgment is required. Actual experience may emerge differently from that originally estimated. Any such difference would be recognized in the current year’s consolidated statement of income. We utilize in-house actuaries in developing our actuarial assumptions and estimates and in monitoring such assumptions and estimates against actual experience.

Income Taxes

We evaluate our deferred income tax assets, which partially offset our deferred tax liabilities, for any necessary valuation allowances. In doing so, we consider our ability and potential for recovering income taxes associated with such assets, which involve significant judgment. Revisions to the assumptions associated with any necessary valuation allowances would be recognized in the consolidated financial statements in the period in which such revisions are made.

Employee Benefit Plans

We maintain a defined benefit retirement plan on behalf of our employees. Measurement of the future benefit obligations associated with this plan involves significant judgment, particularly in regard to the expected long-term rate of return on plan assets and the current discount rate used to calculate the present value of future obligations. The long-term rate of return for plan assets is determined based on an analysis of historical returns on invested assets, anticipated future fixed income, equity investment markets, and diversification needs. Long term trends are evaluated relative to current market factors such as inflation, interest rates and investment strategies, including risk management, in order to assess the assumptions as applied to the plan. The discount rate utilized is determined based on reviews of market indices commonly used to measure such liabilities in the industry. Changes in our assumptions can significantly impact the accrued pension liability and net periodic benefit cost recorded in the consolidated financial statements. Additionally, funding of plan liabilities is sensitive to changes in investment returns as well as regulatory changes, which can significantly impact our consolidated financial statements.

During 2012, the Company restructured its employee benefit plans. Effective June 30, 2012, the Company ceased all future benefit accruals and compensation increases under the IHCC Employee Retirement Plan, although participants can continue to earn vesting credit towards their plan benefit subsequent to June 30, 2012. This plan curtailment resulted in a reduction in our accrued pension liability of $1,760,623, net of deferred taxes of $598,612. We continually monitor the performance of plan assets and growth in liabilities and funding necessities, utilizing independent and experienced consultants to assist in plan management.

The Company also amended the IHCC Retirement Savings Plan and Trust (the “Old 401(k) Plan”), under which, effective June 30, 2012, participants in the Old 401(k) Plan are no longer eligible to elect to defer and contribute compensation earned to the Old 401(k) Plan; the Company will not make any matching contributions to the Old 401(k) Plan; and the Old 401(k) Plan will not accept rollover contributions.

The Company adopted a new traditional 401(k) retirement plan, the IHCC 401(k) Retirement Plan (the “Retirement Plan”). Employees are eligible to participate in the Retirement Plan on the first day of employment. Under the Retirement Plan, the Company matches employee contributions dollar for dollar up to 4% of employee compensation deferrals. Employees who have met certain employment criteria may also be eligible to receive an additional allocation after the end of each plan year. The Retirement Plan became effective January 1, 2012.

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We expect these changes in our employee benefit plans to mitigate future uncertainty with respect to defined benefit pension plans while also maintaining a competitive benefit package for our employees.

We previously disclosed in our financial statements for the year ended December 31, 2012 that we expected to contribute $1,440,000 to our defined benefit pension plan during 2013. Based on the current analysis of our funding requirements, we anticipate reducing the contribution for 2013 to $960,000. As of September 30, 2013, the Company had contributed $780,000 to the plan.   

New Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board issued guidance regarding the reporting of reclassifications out of accumulated other comprehensive income. The guidance requires entities to provide information about the amounts reclassified out of accumulated other comprehensive income by component. Significant amounts reclassified out of accumulated other comprehensive income that are required under U.S. generally accepted accounting principles to be reclassified to net income in their entirety in the same reporting period must be presented either on the face of the statement, where net income is presented, or in the footnotes. For amounts that are not required under U.S. generally accepted accounting principles to be reclassified in their entirety to net income, entities are required to cross-reference to other disclosures that are required by U.S. generally accepted accounting principles that provide additional detail about those amounts. This guidance is effective prospectively for reporting periods beginning after December 15, 2012. The Company adopted this new guidance as of January 1, 2013 with no material impact to the consolidated financial statements.

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

INVESTMENTS, LIQUIDITY AND CAPITAL RESOURCES

Investments

Investors Heritage Life maintains a sound, conservative investment strategy. At September 30, 2013, 91.5% of invested assets consisted of fixed income securities compared to 92.2% at December 31, 2012. At both September 30, 2013 and December 31, 2012, Investors Heritage Life’s fixed income investments were 95.8% investment grade, as rated by Standard & Poor’s.

We have reviewed our investment portfolio and do not believe that there are any securities that are other-than-temporarily impaired at September 30, 2013. None of Investors Heritage Life’s fixed income assets are in default and there has been no material change in the distribution of its fixed income portfolio. We recorded no other-than-temporary impairment charges in the consolidated statements of income during the quarters or nine months ended September 30, 2013 or 2012.

We continuously monitor the investment risk within our portfolio, including the risk associated with subprime lending with our CMO investments. As of September 30, 2013, we have only one CMO, with a fair value of approximately $51,000, which has any level of direct subprime exposure. Based on our analysis, we believe this investment is of high quality and expect no losses as a result of the current subprime concerns.

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During the second quarter of 2013, we entered into an investment advisory agreement to purchase common and preferred stocks in stable areas with a history of strong performance within the real estate sector. The investment advisor has a history of strong performance within these markets. We have limited our participation to an initial investment of approximately $5,000,000. The majority of these funds have been invested in a diversified assortment of regularly traded, exchange listed common stocks along with a limited number of redeemable and nonredeemable preferred stocks. As of September 30, 2013, the largest individual stock position is approximately $192,000. As of September 30, 2013, most of these securities are in an unrealized loss position due to changes in the market subsequent to our investment date. However, we believe these unrealized losses are temporary in nature given the credit quality of the issuers. We believe that this investment will generate positive future results by providing a slightly increased and fully managed exposure to equity markets.

Additionally, Investors Heritage Life engages in commercial and residential mortgage lending, with 96.3% of these investments in commercial properties. All commercial mortgage loans are either originated in-house or through two mortgage brokers, are secured by first mortgages on the real estate and generally carry personal guarantees by the borrowers. Loan to value ratios of 80% or less and debt service coverage from existing cash flows of 115% or higher are generally required. We minimize credit risk in our mortgage loan portfolio through various methods, including stringently underwriting the loan request, maintaining small average loan balances, and reviewing larger mortgage loans on an annual basis.

During the third quarter of 2013, we began evaluating and purchasing residential mortgage loans through the secondary market. We review each mortgage loan opportunity individually, considering both the value of the underlying property and the credit worthiness of the borrower. These loans are typically purchased at a discount to their unpaid principal balance. We purchased three residential mortgages during the quarter totaling approximately $597,000. We currently anticipate evaluating and make additional residential mortgage loan investments over the remainder of 2013 assuming they meet our investment goals and criteria.

At September 30, 2013 and December 31, 2012, 3.5% of invested assets consisted of mortgage loans. As of September 30, 2013, Investors Heritage Life had no non-performing mortgage loans, which would include loans past due 180 days or more, loans in process of foreclosure, restructured loans and real estate acquired through foreclosure.

We own certain investments in state-guaranteed receivables. These investments represent an assignment of the future rights to cash flows from lottery winners purchased at a discounted price. Payments on these investments are made by state run lotteries and guaranteed by the states. As these payment streams are secured by the states themselves, a key function of our due diligence is the assessment of the states’ ability to meet these obligations. Additionally, each state generally withholds income tax from each payment for which we must file for reimbursement of such tax annually. We carry the state-guaranteed receivables at their amortized cost basis on the balance sheet. As of September 30, 2013, we held approximately $8,061,000 in state-guaranteed receivables, with the largest concentrations in the states of New York, Massachusetts and Georgia totaling approximately $3,861,000, $1,909,000 and $1,522,000, respectively. At September 30, 2013 and December 31, 2012, 1.7% and 1.8%, respectively, of invested assets consisted of state-guaranteed receivables.

Prior to the third quarter of 2013, we owned a $3,000,000 position in a Morgan Stanley market-indexed note, which paid 1% interest annually and matured in six years from the issue date. In exchange for the reduced interest rate, the investment provided a protected level of equity market exposure. At the maturity date, we would have participated at 110% of any increase in the Dow Jones Industrial Average as compared to the purchase date, but our principal was guaranteed against market-related downside risk. We remained subject to counterparty credit risk associated with the issuer, Morgan Stanley, just as we would with any other fixed maturity or equity security within our portfolio. The equity-linked portion of the investment was classified as a derivative and bifurcated for reporting purposes. The derivative portion was reported as an investment in derivative on the balance sheet. This derivative was required to be marked-to-market through the income statement, with the change in value reported as a component of investment income on the income statement. As of December 31, 2012, the derivative investment was valued at $642,600, respectively. We recognized an increase in investment income of $4,800 relative to the mark-to-market adjustment on this investment during the quarter ended September 30, 2012 and a decrease in investment income of $68,100 during the nine months ended September 30, 2012.

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During the third quarter of 2013, we initiated a program to strategically sell certain fixed maturities to generate realized gains within the investment portfolio. Through September 30, 2013, we generated total realized gains on fixed maturity sales, including the effects of the strategic sales, of approximately $2,545,000 on fixed maturity sales and maturity proceeds totaling approximately $75,600,000. Included within these amounts is the sale of our $3,000,000 Morgan Stanley market-indexed note for $3,918,083, generating a realized gain of $918,083. This realized gain was partially offset by the reduction in investment income previously recognized that was associated with the removal of the mark-to-market adjustment.

Liquidity and Capital Resources

Investors Heritage Life’s primary sources of cash flow used to meet short-term and long-term cash requirements are primarily insurance premiums, which include mortality and expense charges, investment income, and administrative service fees.

Investors Heritage Life’s short-term obligations consist primarily of policyholder benefits and operating expenses. Investors Heritage Life has historically been able to meet these obligations out of operating cash, premiums and investment income.

Investors Heritage Life’s principal long-term obligations are fixed contractual obligations incurred in the sale of its life insurance products. The premiums charged for these products are based on conservative and actuarially sound assumptions as to mortality, persistency and interest. We believe these assumptions will produce revenues sufficient to meet our future contractual benefit obligations and operating expenses, and provide an adequate profit margin.

Investors Heritage Capital’s principal sources of cash flow are rental income and dividends from its subsidiaries. Investors Heritage Capital’s principal long-term obligations are payments on long-term debt.

Investors Heritage Life’s conservative approach in the product development area and the strength and stability of its fixed income and mortgage loan portfolios provide adequate liquidity both in the short-term and the long-term.

We assess our compliance with prescribed debt covenant requirements as outlined in the terms of each debt agreement at least annually, if not otherwise required in the debt agreement. Management has assessed our position and as of September 30, 2013, we are in compliance with all debt covenant requirements.

We are not aware of any commitments or unusual events that could materially affect capital resources. We have the option to prepay certain notes payable at our discretion prior to their maturity dates.

We will continue to explore various opportunities including mergers and acquisitions and purchasing blocks of business from other companies, which may dictate a need for either long-term or short-term debt. There are no restrictions as to use of funds except the restriction on Investors Heritage Life as to the payment of cash dividends to Investors Heritage Capital.

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RESULTS OF OPERATIONS

Overview

Premiums earned (net of reinsurance) were $14,948,554 for the third quarter of 2013 (an increase of 23.4% compared to the third quarter of 2012) and $44,270,856 for the nine months ended September 30, 2013 (an increase of 22.1% compared to the corresponding period in 2012). This increase is predominantly due to increased sales of our current product offerings, including our final expense products and the Puritan Financial product offering, in addition to premiums assumed from Puritan Life Insurance Company of America beginning January 1, 2013.

Net investment income was $4,985,998 for the third quarter of 2013 (a decrease of 4.9% compared to the third quarter of 2012) and $15,516,997 for the nine months ended September 30, 2013 (a decrease of 0.5% compared to the corresponding period in 2012). This decrease is primarily driven by the reversal of previously recorded mark-to-market adjustments relative to our investment in derivative, which flows through investment income. As this investment was sold during the third quarter, the entire gain was instead recorded within realized investment gains.

Net realized gains were $2,418,806 and $2,482,057 for the quarter and nine months ended September 30, 2013, respectively, compared to $249,927 and $448,186 for the quarter and nine months ended September 30, 2012, respectively. The realized gains recognized during the quarter ended September 30, 2013 included those gains that we earmarked as part of our strategic initiative to take certain unrealized gains into operations. We also recognized a realized loss of $14,006 relative to the demolition of a Company-owned building during the nine months ended September 30, 2013. All of the activity during the quarter and nine months ended September 30, 2012 was in the normal course of business. We experienced no other-than-temporary impairments during the quarters or nine months ended September 30, 2013 or 2012.

Other income was $325,180 for the third quarter of 2013 (a decrease of 21.8% compared to the third quarter of 2012) and $1,071,957 for the nine months ended September 30, 2013 (a decrease of 14.2% compared to the corresponding period in 2012). This decrease is due to the termination of certain smaller TPA relationships subsequent to the first quarter of 2012. In addition, two TPA clients exercised a buyout of their contract during the first quarter of 2012 that resulted in increased fees for that prior year period. As expected, two of our TPA clients exercised their termination option effective June 15, 2013. Additionally, we generated increased fees during the third quarter of 2012 due to the system conversion efforts for one new client. We currently expect no further client terminations and anticipate adding additional clients in the future.

Total benefits and expenses were $19,894,549 for the third quarter of 2013 (an increase of 19.4% compared to the third quarter of 2012) and $61,651,055 for the nine months ended September 30, 2013 (an increase of 19.1% compared to the corresponding period in 2012). This increase is primarily driven by increasing reserves, including reserves relative to business assumed from Puritan Life Insurance Company of America, increased commissions associated with our higher sales volume, and an increase in our policy claims liability.

At September 30, 2013, death and other benefits includes an additional amount totaling $2,069,169 relative to a comparison of our life insurance policies against the Social Security Death Master File. This comparison was performed in compliance with a recently enacted Kentucky state law which follows a model law adopted by the National Conference of Insurance Legislators. This amount primarily affects the traditional and universal life segment, along with a much smaller impact on the final expense portion of the preneed and burial segment. We are in the process of researching the potential matches to determine that a valid claim exists, to locate beneficiaries and to pay benefits accordingly.

After providing for federal income taxes, our net income was $1,948,793 with net income per share of $1.72 for the third quarter of 2013 as compared to net income of $959,568 with net income per share of $0.83 for the third quarter of 2012. Our net income for the nine months ended September 30, 2013 was $1,183,569 with net income per share of $1.04 as compared to net income of $1,269,130 with net income per share of $1.10 for the nine months ended September 30, 2012.

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We declared a dividend of $0.25 per share on February 14, 2013 to shareholders of record on March 15, 2013. This dividend was paid on April 7, 2013.

Business Segments 

FASB guidance requires a "management approach" in the presentation of business segments based on how management internally evaluates the operating performance of business units. The discussion of segment operating results that follows is being provided based on segment data prepared using this methodology.

Preneed & Burial Products

Preneed and Burial Products include both life and annuity products sold by funeral directors or affiliated agents to fund prearranged funerals. Revenues for this segment were $13,121,547 for the third quarter of 2013 (an increase of 5.5% compared to the third quarter of 2012) and $38,382,769 for the nine months ended September 30, 2013 (an increase of 2.6% compared to the corresponding period in 2012). This increase is predominantly due to strong sales of our existing preneed and final expense products as well as ongoing premium income generated as a result of recent acquisitions.

Pre-tax income from operations was $555,869 and $563,079 for the quarter and nine months ended September 30, 2013, respectively, compared to pre-tax income of $905,756 and $1,074,170 for the quarter and nine months ended September 30, 2012, respectively. This reduction in pre-tax income was driven primarily by the previously mentioned increase in our claims liability and reduced net investment income within the segment given the current interest rate environment.

Traditional & Universal Life Products

Traditional and Universal Life Products include traditional life and group life insurance products, certain annuities and universal life products. Revenues for this segment were $9,318,715 for the third quarter of 2013 (an increase of 85.3% compared to the third quarter of 2012) and $23,448,640 for the nine months ended September 30, 2013 (an increase of 60.5% compared to the corresponding period in 2012). This increase is primarily due to the premiums assumed from Puritan Life Insurance Company of America under the reinsurance agreement effective January 1, 2013. Additionally, our Puritan Financial product offering continues to contribute to our sales growth.

Pre-tax income from operations was $2,353,229 and $953,650 for the quarter and nine months ended September 30, 2013, respectively, compared to pre-tax income of $403,491 and $734,411 for the quarter and nine months ended September 30, 2012, respectively. This increase in pre-tax income was driven primarily by strong sales increases and our strategic sales effort of certain fixed maturities, whereby we were able to realize investment gains. This income was partially offset by the increase in our claims liability, as previously discussed.

Administrative & Financial Services

Administrative and Financial Services includes the administration of credit life and credit accident and health insurance products. We reinsure 100% of the related underwriting risk currently produced within this segment. Accordingly, credit product revenue is generated primarily from initiation fees as well as fees for servicing and administering the credit business for our reinsurers. Because the credit product revenue is fee-based, performance is in direct relation to new premium production coupled with fees generated as premiums are earned. Premium production within this segment is also significantly affected by economic conditions within our credit markets, particularly Kentucky.

In addition to credit administration, this segment includes fees generated relative to our third party administrative relationships. Subsequent to the termination of our agreement with two clients effective June 15, 2013, we currently provide tailored administrative services for five unaffiliated companies, comprised of four life insurance companies and one holding company. Services provided to each company vary based on their needs and can include some or all aspects of back-office accounting, actuarial services and policy administration.

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Revenues for this segment were $282,157 for the third quarter of 2013 (a decrease of 21.1% compared to the third quarter of 2012) and $925,669 for the nine months ended September 30, 2013 (a decrease of 15.1% compared to the corresponding period in 2012). Pre-tax income from operations was $95,649 and $224,467 for the quarter and nine months ended September 30, 2013, respectively, compared to pre-tax income of $103,104 and $249,833 for the quarter and nine months ended September 30, 2012, respectively. The revenue and pre-tax income decreases are primarily related to the amount and timing of service fees generated from our third party administration relationships compared to the prior period.

Corporate & Other

Corporate and Other consists of corporate accounts measured primarily by stockholders’ paid-in capital, contributed surplus, earned surplus, property and equipment, corporate-owned life insurance and other minor business lines which include group annuities and group and individual accident and health products. Revenues for this segment were ($43,881) and $584,789 for the quarter and nine months ended September 30, 2013, respectively, compared to $207,200 and $466,464 for the quarter and nine months ended September 30, 2012, respectively. Pre-tax loss from operations was $220,758 and $50,384 for the quarter and nine months ended September 30, 2013, respectively, compared to a pre-tax loss from operations of $41,538 and $245,370 for the quarter and nine months ended September 30, 2012, respectively. These changes are primarily due to the changes associated with mark-to-market adjustment relative to our investment in derivative. This adjustment was completely reversed during the third quarter of 2013 in conjunction with the sale of the market-linked note as part of our strategic sales effort.

While we continue to expand the operations of Investors Heritage Financial, Investors Heritage Printing, At Need Funding and Heritage Funding, less than 1% of our consolidated revenues were generated by those subsidiaries. During the nine months ended September 30, 2013, Investors Heritage Capital received dividends of $235,000 and $115,000 from Investors Heritage Financial and Investors Heritage Printing, respectively, and received $180,000 in distributions from At Need Funding. The potential exists for further dividend payments and distributions over the remainder of 2013 as any needs arise.

Federal Income Taxes 

The provision (benefit) for federal income taxes is based on the estimated effective annual tax rate. Deferred taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Income before federal income taxes differs from taxable income principally due to the dividends-received deduction; the 404(k) dividend deduction; the small life insurance company tax deduction; and non-taxable effects of company-owned life insurance premiums, cash value growth and death benefit proceeds. Our effective tax rate was 30.0% for the quarters and nine months ended September 30, 2013 and 2012, respectively.

OFF-BALANCE SHEET ARRANGEMENTS

We have no off-balance sheet arrangements as of September 30, 2013.

FORWARD LOOKING INFORMATION 

We caution readers regarding certain forward-looking statements contained in this report and in any other statements made by us or on our behalf, whether or not in future filings with the Securities and Exchange Commission. Forward-looking statements are statements not based on historical information and which relate to future operations, strategies, financial results, or other developments. Statements using verbs such as “expect”, “anticipate”, “believe” or words of similar import generally involve forward-looking statements. Without limiting the foregoing, forward-looking statements include statements which represent our beliefs concerning future levels of sales and redemptions of Investors Heritage Life’s products, investment spreads and yields, or our earnings and profitability.

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Forward-looking statements are necessarily based on estimates and assumptions that are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and many of which are subject to change. These uncertainties and contingencies could cause actual results to differ materially from those expressed in any forward-looking statements made by us or on our behalf. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable factors and developments. Some of these may be national in scope, such as general economic conditions, changes in tax law and changes in interest rates. Some may be related to the insurance industry generally, such as pricing competition, regulatory developments, industry consolidation and the effects of competition in the insurance business from other insurance companies and other financial institutions operating in our market area and elsewhere. Others may relate to us specifically, such as credit, volatility and other risks associated with our investment portfolio. We caution that such factors are not exclusive. We disclaim any obligation to update forward-looking information. 

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ITEM 4. Controls and Procedures

As of the end of the period covered by this Form 10-Q, we performed an evaluation, under the supervision and with the participation of management, including our Company’s Chief Executive Officer and Chief Financial Officer, 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) of the Securities Exchange Act of 1934. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in this Quarterly Report on Form 10-Q. There have been no changes in our internal control over financial reporting identified by that evaluation that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during this most recent quarter or subsequent to the date we carried out our evaluation.

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PART II – OTHER INFORMATION

ITEM 1. Legal Proceedings

Investors Heritage Capital is not involved in any legal proceedings. From time to time Investors Heritage Life is involved in litigation relating to claims arising out of its operations in the normal course of business. As of November 14, 2013, Investors Heritage Life is not a party to any legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, would have a material adverse effect on our financial condition or results of operations. 

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

No share repurchases were made pursuant to a publicly announced plan or program. All share repurchases were shares tendered by original stockholders under our right of first refusal or by employees as part of our 401(k) plan. 

ITEM 3. Defaults Upon Senior Securities

None 

ITEM 4. Mine Safety Disclosures

None 

ITEM 5. Other Information

None 

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ITEM 6. Exhibits

3 (ii)	Amended and Restated By-laws of Investors Heritage Capital Corporation filed with Form 8-K dated May 10, 2013, reporting the event occurring May 9, 2013, which are incorporated herein by reference.
31.1 & 31.2	Certifications pursuant to Securities and Exchange Act Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certifications Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS**	XBRL Instance
101.SCH**	XBRL Taxonomy Extension Schema
101.CAL**	XBRL Taxonomy Extension Calculation
101.DEF**	XBRL Taxonomy Extension Definition
101.LAB**	XBRL Taxonomy Extension Labels
101.PRE**	XBRL Taxonomy Extension Presentation

 

** XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

SIGNATURES 

Pursuant to the requirements 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. 

	INVESTORS HERITAGE CAPITAL CORPORATION
	BY: /s/Harry Lee Waterfield II
	Harry Lee Waterfield II
DATE: November 14, 2013	President
	BY: /s/Larry Johnson
	Larry Johnson
DATE: November 14, 2013	Vice President - Chief Financial Officer

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