VERICITY, INC. Forward-Looking Statements
This Form 10-K contains "forward-looking" statements that are intended to enhance the reader's ability to assess our future financial and business performance. Forward-looking statements include, but are not limited to, statements that represent our beliefs concerning future operations, strategies, financial results or other developments, and contain words and phrases such as "may," "expects," "should," "believes," "anticipates," "estimates," "intends" or similar expressions. In addition, statements that refer to our future financial performance, anticipated growth and trends in our business and in our industry and other characterizations of future events or circumstances are forward-looking statements. Because these forward-looking statements are based on estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our control or are subject to change, actual results could be materially different. Consequently, such forward-looking statements should be regarded solely as our current plans, estimates and beliefs with respect to, among other things, future events and financial performance. Except as required under the federal securities laws, we do not intend, and do not undertake, any obligation to update any forward-looking statements to reflect future events or circumstances after the date of such statements.
The forward-looking statements include, among other things, those items listed below:
• future economic conditions in the markets in which we compete that could
be less favorable than expected and could have impacts on demand for our
products and services;
• our ability to grow and develop our Agency business through expansion of
retail call centers, online sales, wholesale operations and other areas of
opportunity;
• our ability to grow and develop our insurance business and successfully
develop and market new products;
• our ability to enter new markets successfully and capitalize on growth
opportunities either through acquisitions or organically;
• financial market conditions, including, but not limited to, changes in
interest rates and the level and trends of stock market prices causing a
reduction of net investment income or realized losses and reduction in the
value of our investment portfolios;
• increased competition in our businesses, including the potential impacts
of aggressive price competition by other insurance companies, payment of
higher commissions to agents that could affect demand for our insurance
products and impact the ability to grow and retain agents in our Agency
Segment and the entry of new competitors and the development of new
products by new or existing competitors, resulting in a reduction in the
demand for our products and services;
• the effect of legislative, judicial, economic, demographic and regulatory
events in the jurisdictions where we do business;
• the effect of challenges to our patents and other intellectual property;
• costs, availability and collectability of reinsurance;
• the potential impact on our reported net income that could result from the
adoption of future accounting standards issued by the Financial Accounting
• the inability to maintain or grow our strategic partnerships or our
inability to realize the expected benefits from our relationship with the
Standby Purchaser;
• the inability to manage future growth and integration of our operations; and
• changes in industry trends and financial strength ratings assigned by
nationally recognized statistical rating organizations.
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the financial statements and
accompanying notes included in Item 8 of this Form 10-K. Some of the information
contained in this discussion and analysis and set forth elsewhere in this Form
10-K constitutes forward looking information that involves risks and
uncertainties. You should review "Forward Looking Statements" for a discussion
of important factors that could cause actual results to differ materially from
the results described, or implied by, the forward-looking statements contained
herein.
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Overview
We provide life insurance protection targeted to the middle American market. We believe there is a substantial unmet need for life insurance, particularly among domestic households with annual incomes of between$50,000 and$125,000 , a market we refer to as our target Middle Market. We differentiate our product and service offerings through innovative product design and sales processes, with an emphasis on rapidly issued products that are not medically underwritten at the time of sale. We conduct our business through our two operating subsidiaries, Fidelity Life, anIllinois -domiciled life insurance company, andEfinancial , a call center-based insurance agency.Efinancial sells Fidelity Life products through its own call center distribution platform, independent agents and other marketing organizations.Efinancial , in addition to offering Fidelity Life products, sells insurance products of unaffiliated carriers. We report our operating results in three segments: Agency, Insurance and Corporate. COVID-19 The outbreak of COVID-19 in many countries continues to adversely impact global commercial activity and has contributed to significant volatility in financial markets. The measures governments worldwide have enacted to combat the pandemic have resulted in disruptions in global and local supply chains and have led to adverse impacts on economic and market conditions as well as increases in unemployment. The severity of COVID-19 and duration of government containment actions have impacted both employees and customers of the Company and presented material uncertainty and risk with respect to the Company's performance, liquidity, results of operations, and financial condition. The stress and disruption placed on the global economy and financial markets from the outbreak of COVID-19 may continue to have near and long-term negative effects on investment valuations, returns, and credit allowance exposure. The Company will continue to closely monitor the situation, including potential negative impacts on sales of new policies and mortality; however, due to the highly uncertain nature of these conditions, it is not possible to reliably estimate the length and severity of COVID-19 or its impact to the Company's operations, but the effect could be material. In the twelve months endedDecember 31, 2020 , the Company had an estimated$4.3 million in net incurred policyholder claims that included COVID-19 as a contributing cause of death. The Company continues to monitor the effects of the changing economic environment on our fixed maturity securities portfolio and currently have a number of securities on our watch list, which are mainly concentrated in the oil and gas and airline sectors. Our assessment throughDecember 31, 2020 has resulted in no additional material other-than-temporary impairments (OTTI) due to COVID-19 and the recent market events. In response to the economic impact related to COVID-19, concessions were granted to certain of the Company's mortgage loan borrowers, including payment deferrals and other loan modifications. AtJune 30, 2020 , the Company held 25 mortgage loans where requests for temporary modifications were granted (23 were modified to interest only and 2 to forbearance). The total loan balance for these 25 loans amounted to$4.4 million or about 9% of the mortgage loan portfolio. AtJune 30, 2020 , 17 of the 25 temporary loan modifications had returned to full payment (both principal and interest) under the modified loan terms, including the 2 loans given forbearance. Of the remaining 8 loans that were granted loan modifications, 7 of these loans returned to full payment status as ofSeptember 30 . 2020. During the third quarter of 2020, the Company granted a loan modification throughDecember 31, 2020 on a loan that was outside of the original 25 loan modifications previously granted. The combined loan balance of the 2 loans under temporary modification status atDecember 31, 2020 amounted to$0.5 million , or less than 1% of the mortgage loan portfolio.
In the second quarter 2020, Fidelity Life entered into a General Agent's
agreement with an unaffiliated third party, National Service Group of AmeriLife,
LLC ("AmeriLife"). This agreement provides Fidelity Life access to AmeriLife
distribution channels, its commission systems and assists in streamlining
administrative processes related to commissions. This agreement also allows
Efinancial to operate as a sub agent to AmeriLife . On May 15, 2020 , the Company
began selling products using this new distribution arrangement.
Agency Segment
This segment primarily consists of the operations ofEfinancial .Efinancial is a call center-based insurance agency that markets life insurance for Fidelity Life and unaffiliated insurance companies.Efinancial's primary operations are conducted through employee agents from three call center locations, which we refer to as our retail channel. In addition,Efinancial operates as a wholesale agency, assisting independent agents that desire to work for the carriers thatEfinancial represents, which we refer to as our wholesale channel. 22 --------------------------------------------------------------------------------Efinancial also generates insurance lead sales revenue through its eCoverage web presence. For the years endedDecember 31, 2020 andDecember 31, 2019 , our Agency Segment revenue earned 85% and 78% through the retail channel, 5% and 8% through the wholesale channel, and 10% and 14% through insurance lead sales revenue, respectively. The Agency Segment's main source of revenue is commissions earned on the sale of insurance policies sold through our retail channel.Efinancial's employee agents utilize insurance sales leads to contact or be contacted by potential customers and then work with the customers to complete the sales process, which can occur during the initial contact or within 24 to 48 hours for non-medically underwritten policies. In our wholesale channel, we subcontract with our independent agents who sell throughEfinancial's contracts with its unaffiliated insurance carriers. In consideration for using our carrier contracts and services, we receive a portion of the commission earned by the independent agent from the carrier. Agency Segment expenses consist of marketing costs to acquire potential customers, salary and bonuses paid to our employee agents, salary and other costs of employees involved in managing the underwriting process for our insurance applications, sales management, agent licensing, training and compliance costs. Other Agency Segment expenses include costs associated with financial and administrative employees, facilities rent, and information technology. After payroll, the most significant Agency Segment expense is the cost of acquiring leads. We are able to partially offset our sales leads expense through advertising revenues from individuals who click on specific advertisements while viewing one of our web pages, and through the resale of leads that are not well suited for our call center. For years endedDecember 31, 2020 andDecember 31, 2019 , these offsetting revenues were$5.0 million and$6.3 million , respectively, which reduced our total agency expenses by approximately 10% and 11%, respectively. Our Agency Segment recognizes income (loss) to the extent that commissions and other revenue exceed (are less than) our marketing and overhead costs for the period.
Insurance Segment
This segment consists of the operations of Fidelity Life. Fidelity Life underwrites primarily term life insurance throughEfinancial and a diverse group of independent insurance distributors. Fidelity Life specializes in life insurance products that can be issued immediately or within a short period following a sales call, using non-medical underwriting at the time of policy issuance.
Fidelity Life engages in the following business lines:
Core Life - Our Core Life insurance business is the primary business of the Insurance Segment. Core Life represents a significant portion of the insurance business written by Fidelity Life since it resumed independent operations in 2005. Our Core Life business consists of inforce policies that are considered to be of high strategic importance to Fidelity Life. NonCore Life - Our NonCore Life business consists of: products that are currently being marketed but are not deemed to be of high strategic importance to the Company? inforce policies from product lines introduced since Fidelity Life resumed independent operations in 2005, but were subsequently discontinued? and an older annuity block of business that was not included in the Closed Block. Closed Block - Our Closed Block represents all inforce participating insurance policies of Fidelity Life. The Closed Block was established in connection with our 2007 reorganization into a mutual holding company structure and represents all in-force participating insurance policies of Fidelity Life. Annuities and assumed life represent (i) our assumed life business, which consists of policies primarily written in the 1980s and early 1990s; (ii) our direct annuity contracts, which consist of approximately 77 structured settlement contracts that remain from a group of contracts entered into in the late 1980s; and (iii) our assumed annuities, which consist of contract-holder deposits assumed from a former affiliate under two coinsurance treaties entered into in 1991 and 1992. The 2019 demutualization ofMembers Mutual Holding Company had no impact on how the Closed Block is structured. We have not accepted new policies in these legacy lines since 2006 or prior, and these lines are considered to be in "run-off" with a declining number of policies in force each period. We recognize income on the Closed Block, and annuities and assumed life to the extent that premium revenues and net investment income exceed the benefit expenses and operating expenses (including paid and accrued policyholder dividends) of these lines of business. On the two annuity lines, we recognize income (loss) to the extent that our net investment income earned exceeds (are less than) benefit expenses (direct annuities) and amounts credited on policy deposits (assumed annuities) and operating expenses of the two lines. Annuities and Assumed Life - We have assumed reinsurance commitments with respect to annuity contract-holder deposits and a block of life insurance contracts that were ceded by former affiliates of Fidelity Life. OnMarch 29, 2019 , one of these former affiliates recaptured the majority of the assumed block of life business. The annuity deposits were ceded to Fidelity Life through two contracts entered into in the early 1990s. These annuity and assumed life deposits are now largely in runoff, with only minor amounts of new deposits each year. There are minimal remaining surrender charges associated with the assumed annuity contracts. 23
-------------------------------------------------------------------------------- Our Insurance Segment revenues consist of net insurance premiums, net investment income, and net realized gains (losses) on investments. Our distributors consist ofEfinancial and the independent insurance agencies that we contract with to sell our insurance products to the customers (policyholders) who buy our insurance policies. We recognize premium revenue from our policyholders. We purchase reinsurance coverage to help manage the risk on our insurance policies by paying, or ceding, a portion of the policyholder premiums to the reinsurance companies. Our net insurance premiums reflect amounts collected from policyholders, plus premiums assumed under reinsurance agreements less premiums ceded to reinsurance companies. Net investment income represents primarily interest income earned on fixed maturity securities that we purchase with cash flows from our premium revenues. We also realize gains and losses on sales of investment securities. These investments support our liability for policy reserves and provide the capital required to operate our insurance business. Capital requirements are primarily established by regulatory authorities. See "Note 2-Investments" and "Business-Risk-Based Capital (RBC) Requirements." Insurance Segment expenses consist of benefits paid to policyholders or their beneficiaries under life insurance policies. Benefit expenses also include additions to the reserve for future policyholder benefits to recognize our estimated future obligations under the policies. Benefit expenses are shown net of amounts ceded under our reinsurance contracts. Our Insurance Segment also incurs policy acquisition costs that consist of commissions paid to agents, policy underwriting and issue costs and variable sales costs. A portion of these policy acquisition costs are deferred and expensed over the life of the insurance policies acquired during the period. In addition to policy acquisition costs, we incur expenses that vary based on the number of contracts that we have in-force, or variable policy administrative costs. These variable costs consist of expenses paid to third-party administrators based on rates for each policy administered. As the number of in-force policies increases, these expenses will increase. Conversely, when the number of in-force policies declines, variable policy expenses decline. Our insurance operations also incur overhead costs for functional and administrative staff to support insurance operations, financial reporting and information technology. We recognize income (loss) on insurance operations to the extent that premium revenues, net investment income and realized gains (losses) exceed (are less than) benefit expenses and general operating expenses for the period.
Corporate Segment
The results of this segment consist of net investment income and net realized investment gains (losses) earned on invested assets. We also include certain corporate expenses that are not allocated to our other segments, including expenses ofVericity, Inc. , board expenses, allocation of executive management time spent on corporate matters, and financial reporting and auditing costs related to our consolidation and internal controls. Our Corporate Segment recognizes income (loss) to the extent that net investment income and net realized investment gains (losses) exceed (are less than) corporate expenses.
Factors Affecting Our Results
Strategic Goals and Financial Impact of Sales of Policies Produced by
UsingEfinancial , our controlled distribution platform, we have full vertical integration for the sale and issuance of life insurance policies and are able to gather end-to-end consumer data, extending from tracking data to analyzing the characteristics of leads that generate successful marketing efforts to the associated underwriting and claims experience. Since we acquiredEfinancial in 2009, we have made significant investments in the development of our controlled distribution strategy for reaching our target market. By converting data we generate through our distribution platform into actionable insight using statistical analysis, we will seek to be more efficient in our acquisition and use of leads, improve our call center placement ratios and strive to achieve overall profitability. However, the investments made in pursuit of this strategy, among other factors, have adversely affected our historical results of operations.Efinancial agents produced 88.6% and 86.8% of the direct policies written by Fidelity Life for the years endedDecember 31, 2020 andDecember 31, 2019 , respectively. We plan to increase the number of policies sold throughEfinancial as we pursue our strategic plan to further develop our controlled distribution platform and grow our book of business. However, sales of insurance policies throughEfinancial immediately result in significantly higher consolidated expense recognition and lower consolidated net income in comparison to Fidelity Life policies distributed through an unaffiliated entity. GAAP requires that we immediately expense that portion of our policy acquisition costs for policies placed throughEfinancial that cannot be directly tied to the placement of a policy. As a result of this immediate expense recognition of the majority of policy acquisition costs of our sales throughEfinancial , we incur a net loss in the first year on each policy sold throughEfinancial . To the extent we are successful in increasing our premium writings throughEfinancial over each of the next several years or more, we expect that the impact of recognizing a majority ofEfinancial commissions as a current expense will, among other factors, continue to adversely affect our results of operations and contribute to our continuing to incur consolidated net losses and a reduction to our consolidated equity in each such year as we seek to implement our distribution strategy. Over the long term and assuming that our products perform consistent with our assumptions, once we have developed a sustainable book of business and our expected growth throughEfinancial has leveled, we expect that revenues from policy renewals may begin to offset the immediate expense recognition resulting from writing new policies throughEfinancial . See "Critical Accounting Policies-Deferred Policy Acquisition Costs (DAC)" and "Results of Operations-Analysis of Segment Results-Corporate Segment-Intercompany Eliminations." 24
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Accuracy of Our Pricing Assumptions
In order for our insurance operations to be profitable, we must achieve product
experience consistent with our pricing assumptions. We price our products using
a number of assumptions that are designed to support the desired level of
profitability. Our operating results will be affected by variances between our
pricing assumptions and our actual experience. The key pricing assumptions made
are:
• Investment Returns. We earn income on the investments held to supportreserves and capital requirements. The amount of net investment income
that we recognize will vary depending on the amount of invested assets
that we own, the types of investments we own, the interest rates earned
and amount of dividends received on our investments. If the actual amount
of net investment income earned is less than projected, our products may
not generate the desired level of profitability.
• Persistency Experience. Many of the non-medically underwritten products
that we issue have a limited amount of insurance industry information to
use in developing policy lapse rates. We are developing our own historical
experience as to expected lapse rates for these products and reflect our
emerging experience in our pricing. If actual policy lapse rates exceed
the lapse rates assumed in pricing our products, we may receive lower
premium revenues and may not receive enough premium to cover all of our
acquisition costs for the policy.
• Mortality Experience. We use our historical experience combined with
experience projections from our reinsurance partners to develop our
assumptions for the level, frequency and pattern of future claims
experience. In our Insurance Segment, we principally issue non-medically
underwritten products through underwriting processes that generally have
limited recent company and industry experience; therefore, their
performance may be less reliable and subject to greater variance thanproducts underwritten through processes with more established industry
experience.
• Operating Expenses. Our level of operating expenses affects our reported
net income (loss). Our general operating expenses include expenses that
vary based on the growth in our revenues and expenses that are fixedregardless of revenue growth. As discussed above, we have experienced
operating losses principally because our operating expenses and corporate
overhead exceed our revenues, and our inability to defer a majority of our
commission expense on policies produced by our affiliated agency,
Efinancial .
Efinancial Commission Financing
Beginning in the fourth quarter of 2017, Fidelity Life changed the commission structure related toEfinancial's sale of the RAPIDecision® Life to pay annual level commissions over the life of the product instead of heaped, or first-year-only commissions. This change reduced Fidelity Life's surplus strain associated with issuing RAPIDecision® Life business by spreading its statutory commission expenses over the life of the policy instead of incurring it all in the policy year of issue. In order to help provide liquidity forEfinancial through the receipt of larger first-year-only commissions, Fidelity Life andEfinancial entered into a financing arrangement with Hannover Life under which, on a monthly basis, Hannover Life advances toEfinancial amounts approximately equal to the first-year-only commissions on Fidelity Life RAPIDecision® Life business sold throughEfinancial . In exchange,Efinancial assigns toHannover Life its right to all future levelized commission payments on that business due from Fidelity Life, and Fidelity Life pays to Hannover Life the level commissions over the life of the contract. Our arrangement with Hannover Life allows us to finance up to$30.0 million of commission expense.Efinancial's ability to receive advances under this arrangement will terminate when the aggregate amount advanced under the arrangement equals or exceeds$30.0 million . As ofDecember 31, 2020 , we had net advances of$27.5 million under this arrangement.
Recapture of Assumed Life Business
Under an agreement withProtective Life Insurance Company (Protective Life), the successor to a former affiliate of Fidelity Life, Fidelity Life had assumed a portion of risk on a group of life insurance contracts primarily written in the 1980s and early 1990s. OnMarch 29, 2019 , Protective Life and Fidelity Life agreed that Protective Life would recapture the majority of this assumed life block of business, thereby relieving Fidelity Life from further liability under the recaptured business (except for obligations incurred prior to the recapture effective date). Under the recapture agreement, Fidelity Life paid Protective Life an amount equal to the assumed carried reserves, and in turn, Fidelity Life will receive payment from its reinsurers of this business for their portion of the related ceded reserves. We recognized a$2.2 million gain from this transaction in 2019.
Critical Accounting Policies
Our critical accounting policies are described in Note 1-Basis of Presentation
and Summary of Significant Accounting Policies to our consolidated financial
statements included elsewhere in this Form 10-K. The accounting policies
discussed in this section are those that we consider to be the most critical to
an understanding of our consolidated financial statements. The preparation of
the consolidated financial statements in conformity with GAAP requires
management to use judgment in making estimates and
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assumptions that affect reported amounts of assets, liabilities, revenues,
expenses and related disclosures. We regularly evaluate our estimates and
judgments based on historical experience, market indicators and other relevant
factors and circumstances. Actual results may differ from these estimates under
different assumptions or conditions and may affect our financial position and
results of operations.
Valuation of
Our fixed maturity securities are classified as "available-for-sale" securities, which are carried at fair value on the balance sheet. Fair value represents the price that would be received to sell an asset in an orderly transaction between market participants on the measurement date. For investments that are not actively traded, the determination of fair value requires us to make a significant number of assumptions and judgments. Fair value determinations include consideration of both observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our view of market assumptions in the absence of observable market information. Security pricing is applied using a hierarchy approach.
Level 1-Unadjusted quoted prices for identical assets in active markets the Company can access.
Level 2-This level includes fixed maturity securities priced principally by independent pricing services using observable inputs other than Level 1 prices, such as quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in inactive markets; and model-derived valuations for which all significant inputs are observable market data. Level 2 instruments include most corporate debt securities andU.S. government and agency mortgage-backed securities that are valued by models using inputs that are derived principally from or corroborated by observable market data. Level 3-Fair values are derived from valuation techniques in which one or more significant inputs are unobservable. Level 3 instruments include less liquid securities for which significant inputs are unobservable in the market, such as structured securities with complex features that require significant management assumptions or estimation in the fair value measurement. Level 3 hierarchy requires the use of observable market data when available.
At
Fair Value of Investments as of December 31, 2020
(dollars in thousands)
Total Fair
Level 1 Level 2 Level 3 Value
$ 6,518 $ 350,926 $ 10,255 $ 367,699
2 % 95 % 3 % 100 %
Fair Value of Investments as of December 31, 2019
(dollars in thousands)
Total Fair
Level 1 Level 2 Level 3 Value
$ 36,858 $ 311,836 $ 1,215 $ 349,909
11 % 89 % 0 % 100 %
Level 1 securities include principally exchange traded funds that are valued based on quoted market prices for identical assets.
All of the fair values of our fixed maturity and equity securities within Level 2 are based on prices obtained from independent pricing services. All of our prices for each security are generally sourced from multiple pricing vendors, and a vendor hierarchy is maintained by asset type and region of the world, based on historical pricing experience and vendor expertise. We ultimately use the price from the pricing service highest in the vendor hierarchy based on the respective asset type and region. For fixed maturity securities that do not trade on a daily basis, the pricing services prepare estimates of fair value measurements using their pricing applications which incorporate a variety of inputs including, but not limited to, benchmark yields, reported trades, broker/dealer quotes, issuer spreads, andU.S. Treasury curves. Specifically, for asset-backed securities, key inputs include prepayment and default projections based on past performance of the underlying collateral and current market data. Securities with validated quotes from pricing services are reflected within Level 2 of the fair value hierarchy, as they generally are based on observable pricing for similar assets or other market significant observable inputs. Level 3 fair value classification consists of investments in structured securities where the fair value of the security is determined by a pricing service using internal pricing models where one or more of the significant inputs is unobservable in the marketplace, or there is a single broker/dealer quote. The fair value of a broker-quoted asset is based solely on the receipt of an updated quote from a single market maker or a broker-dealer recognized as a market participant. The Company does not adjust broker quotes when used as the fair value measurement for an asset. 26 -------------------------------------------------------------------------------- If we believe the pricing information received from third-party pricing services is not reflective of market activity or other inputs observable in the market, we may challenge the price through a formal process with the pricing service. Historically, we have not challenged or updated the prices provided by third-party pricing services. However, any such updates by a pricing service to be more consistent with the presented market observations, or any adjustments made by us to prices provided by third-party pricing services, would be reflected in the balance sheet for the current period. When the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 or Level 2) and unobservable (Level 3).
Other-Than-Temporary Impairments on
Securities that are classified as available-for-sale are subject to market
declines below amortized cost (a gross unrealized loss position). When a gross
unrealized loss position occurs, the security is considered impaired. Quarterly
or when necessary, we review each impaired security to identify whether the
impairment may be other-than-temporary impairment ("OTTI") and require the
recognition of an impairment loss in the current period earnings. Indication of
OTTI includes potential credit deterioration whether due to ratings downgrades,
unexpected price variances, and/or other company or industry specific concerns.
A number of factors are considered in determining whether or not a decline in a
specific security is other-than-temporary, including our current intention or
need to sell the security or an indication that a credit loss exists. An
impairment loss will be recorded if our intention is to sell an impaired
security or it is considered to be more likely than not that we will be required
to sell the security.
Our review of our available-for-sale securities for impairment includes an
analysis of impaired securities in terms of severity and/or age of the gross
unrealized loss. Additionally, we consider a wide range of factors about the
issuer of the security and use our best judgment in evaluating the cause of the
decline in the estimated fair value of the security and in assessing the
likelihood for near-term recovery. Inherent in our evaluation of the security
are assumptions and estimates about the operations of the issuer and its future
earnings potential that includes the evaluation of the financial condition and
expected near-term and long-term prospects of the issuer, collateral position,
the relevant industry conditions and trends, and whether expected cash flows
will be sufficient to recover the entire amortized cost basis of the security.
The credit loss component of fixed maturity securities impairment is calculated
as the difference between amortized cost of the security and the present value
of the expected cash flows of the security. The present value is determined
using the best estimate of cash flows discounted at the effective rate implicit
to the security at the date of purchase or prior impairment. The methodology and
assumptions for estimating the cash flows vary depending on the type of
security. For mortgage-backed and asset-backed securities, cash flow estimates,
including prepayment assumptions, are based on data from widely accepted
third-party sources or internal estimates. In addition to prepayment
assumptions, cash flow estimates vary based on assumptions regarding the
underlying collateral characteristics, expectations of delinquency and default
rates, and structural support, including subordination and guarantees. If the
present value of the modeled expected cash flows equals or exceeds the amortized
cost of a security, no credit loss exists, and the security is considered to be
temporarily impaired. If the present value of the expected cash flows is less
than amortized cost, the security is determined to be other-than-temporarily
impaired for credit reasons and is recognized as an OTTI loss in earnings. The
portion of the OTTI that is not considered a credit loss, is recognized as OTTI
in accumulated comprehensive income.
There was OTTI on fixed maturity securities in the amount of
Mortgage Loans
Our mortgage loans are held on commercial real estate and are stated at the aggregate unpaid principal balances, net of any write-downs and valuation allowances. We identify loans for evaluation of impairment primarily based on the collection experience of each loan. Mortgage loans are considered impaired when, based on current information and events, it is probable that we will be unable to collect principal or interest amounts according to the contractual terms of the loan agreement. Impairment is measured on a loan-by-loan basis based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral. Impairments are included in net realized investment gains (losses) in the Consolidated Statements of Operations. Interest income from mortgage loans is recognized on an accrual basis using the effective yield method. Accrual of income is generally suspended for mortgage loans that are in default or when full and timely collection of principal and interest payments is not probable. Mortgage loans are considered past due when full principal or interest payments have not been received according to contractual terms.
At
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Deferred Policy Acquisition Costs (DAC)
For our Insurance Segment, the costs of acquiring new business are deferred to the extent that they are directly related to the successful acquisition of insurance contracts. Deferred acquisition costs include commissions paid in the first policy year that are in excess of the ultimate renewal commissions payable on the policy. For any of our policies for which we do not pay renewal commissions, the deferred acquisition costs (at the segment level) include all commissions paid in the first year. For policies for which we pay levelized commissions over the life of the policy, we expense the first-year commission and therefore do not defer any other commission expense. We also defer costs associated with policy underwriting and issuance related to the successful acquisition of insurance contracts. Non-deferred first year acquisition costs that are expensed as incurred include expenses that do not meet the definition of a deferrable cost, which includes the acquisition costs incurred on insurance applications that do not result in an in-force policy (unsuccessful efforts). The amortization of DAC for traditional life insurance products is determined as a level proportion of premium based on actuarial methods and assumptions about mortality, morbidity, lapse rates, expenses, and future yield on related investments, established by us at the time the policy is issued. GAAP requires that assumptions for these types of products not be modified while the policy is outstanding. Amortization is adjusted each period to reflect policy lapse or termination rates compared to anticipated experience. Accordingly, acceleration of DAC amortization could occur if policies terminate earlier than originally assumed. We establish the assumptions used to determine DAC amortization based on estimates using Company experience and other relevant information that is used to price the products. We monitor our actual experience and will update the actuarial factors applied to future policy issues if warranted. The selection of actuarial assumptions requires considerable judgment and has inherent uncertainty. Should actual policy lapse experience be higher than that assumed during a reporting period, we will amortize our DAC balance faster and report lower net income. We evaluate the recoverability of our DAC asset as part of our premium deficiency testing. If a premium deficiency exists, we reduce DAC by the amount of the deficiency through a charge to current period earnings (loss). If the deficiency is more than the recognized DAC balance, we reduce the DAC balance to zero and increase the reserve for future policy benefits by the excess with a corresponding charge to current period earnings (loss). See "Future Policy Benefit Reserves" below for more information on premium deficiency testing. Our consolidated DAC will be lower relative to other insurance companies that utilize unaffiliated distributors. GAAP does not permit the deferral of commission revenues paid toEfinancial , our affiliated agency, in excess of those expenses actually incurred byEfinancial in the placement of the policy. Because we are focused on increasing insurance premium volume throughEfinancial , our operating results will reflect higher current period expenses and lower current reported net income. Therefore, in consolidation, the first-year commission acquisition costs ("Commission DAC") recorded in our Insurance Segment is reduced to reflect the elimination of that portion of Commission DAC that results from expenses ofEfinancial that cannot be directly tied to the successful placement of a policy. The amount of eliminated Commission DAC is charged to current expense, and acquisition cost DAC is recorded at a reduced amount, which represents the amount of Commission DAC that is eligible for deferral. As a result of recognizing a majority of expenses for theEfinancial sales immediately, we will recognize a charge against our consolidated earnings (loss) and consolidated equity in the amount of such expenses for the period in which they are incurred. See "Results of Operations-Analysis of Segment Results-Corporate Segment-Intercompany Eliminations."
Future Policy Benefit Reserves
We calculate and maintain reserves for estimated future claims payments to
policyholders using actuarial assumptions in accordance with industry practice
and GAAP. Many factors affect these reserves, including mortality trends, policy
persistency and investment returns. We establish our reserves based on
estimates, assumptions and our analysis of historical experience.
The calculation of future policy reserves requires the use of significant
judgment and is inherently uncertain. If our actual experience differs from the
experience assumed in establishing our reserves, the impact of these differences
is reflected in the results of operations in each period. If actual claims are
higher than assumed claims experience, our reported income (loss) will be
reduced (increased) for the periods in which this experience occurs. If actual
policy lapses are higher than that assumed, our future policy benefit reserves
will be reduced for the period in which this experience occurs.
The primary reserve method that is used in calculation of our future policy
benefit reserves is the net level premium method. The net level premium method
requires that the future policy benefit reserves are accrued as a level
proportion of the premium paid by the policyholder. In applying this method, we
use a number of actuarial assumptions that represent management's best estimate
at the time the contract was issued with the addition of a margin for adverse
deviation. Actuarial assumptions include estimates of morbidity, mortality,
policy persistency, discount rates and expenses over the life of the contracts.
A premium deficiency exists if the discounted present value of future gross
premiums is not sufficient to cover anticipated future cash outflows. To assess
the adequacy of our benefit reserves, we annually perform premium deficiency
testing for each of our
28
-------------------------------------------------------------------------------- lines of business using best estimate assumptions as of the date of the test without provision for adverse deviation. If benefit reserves minus the DAC asset are less than the present value of future cash flows on the line of business, then first the DAC asset will be reduced. If reducing the DAC asset down to zero is still not sufficient to eliminate the premium deficiency, then benefit reserves will be increased. Recognizing a premium deficiency will reduce our reported net income or increase our reported loss, for the period. Under best estimate assumptions as to mortality, lapses, expenses, and investment yields, DAC is still recoverable on the Core Life and Non-Core Life products (Open Block), Closed Block, and assumed life line of business. The annuities line has no remaining DAC, and under best estimate assumptions on that line, no benefit reserve increases are needed. In connection with our premium deficiency testing, we performed sensitivity analyses on our Open Block, Closed Block, annuities, and assumed life business lines to capture the effect that certain key assumptions have on expected future cash flows, and the impact of those assumptions on the adequacy of DAC balances and GAAP benefit reserves. The sensitivity tests are performed independently, without consideration for any correlation among the key assumptions.
We performed the following sensitivity tests as of
• future lapse assumptions increased by a multiplicative factor of 1.05,
• future mortality increased by a multiplicative factor of 1.05 for all life
blocks,
• future investment yield assumptions were lowered by 50 basis points.
Regarding this sensitivity testing for the annuities line, there is no remaining
DAC due to the age of the contracts. As such, these sensitivity runs tested the
adequacy of the benefit reserves for this line. For the annuities line, a drop
in investment yield of 50 basis points would result in a required reserve
increase of $0.7 million , while for the mortality scenario and the lapse
scenario there would be no impact to benefit reserves.
For the assumed life line of business sensitivity testing, there is also no remaining DAC. Under all the sensitivity tests on this line, no benefit reserve increases are needed.
For the Open Block sensitivity testing, DAC is still recoverable under the lapse sensitivity test. However, under the mortality and investment earned rates sensitivity tests, the DAC would have to be decreased by$5.9 million and$14.1 million , respectively. Income Taxes Under applicable Federal income tax guidance, the taxation of life insurance companies is subject to special rules not applicable to other (non-life) companies. Accordingly, we have to consider the implications of these different tax rules in accounting for income tax expense, as separately applicable to our life and non-life subgroups of companies. We record federal income tax expense in our Consolidated Statements of Operations based on pre-tax income as determined using GAAP accounting. The timing of the recognition of certain income and expense items for GAAP accounting can differ from the timing of recognition of the same income and expense items in our federal tax returns. The timing of recognition in the federal tax return is based on tax laws and regulations. As a result, the annual tax expense reflected in our Consolidated Statements of Operations is different than that reported in the tax returns. We account for income taxes under the asset and liability method, which requires the recognition of deferred taxes for temporary differences between the financial statement and tax return basis of assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in future years for which we have already recorded the tax benefit in our income statement. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred or expenditures for which we have already taken a deduction in our tax return but have not yet been recognized in our financial statements. Under GAAP, we are required to evaluate the recoverability of our deferred tax assets and establish a valuation allowance if necessary, to reduce our deferred tax assets to an amount that is more likely than not to be realized. Significant judgment is required in determining whether valuation allowances should be established, as well as the amount of such allowances. To the extent that we are required to establish an additional valuation allowance against deferred income tax assets, the amount of such valuation allowance would generally be charged against our net income for the period in which that valuation allowance is established. We establish or adjust valuation allowances for deferred tax assets when we estimate that it is more likely than not that future taxable income will be insufficient to realize the value of the deferred tax asset. We evaluate all significant available positive and negative evidence as part of our analysis. Negative evidence includes the existence of losses in recent years. Positive evidence includes the forecast of future taxable income and tax-planning strategies that would result in the realization of deferred tax assets. The underlying assumptions we use in forecasting future taxable income require significant judgment and take into account our recent performance. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the periods in 29
-------------------------------------------------------------------------------- which temporary differences are deductible or creditable. If actual experience differs from these estimates and assumptions, the recognized deferred tax asset value may not be fully realized, resulting in an increase to income tax expense in our results of operations. As ofDecember 31, 2020 , we had a 100% valuation allowance recorded against the deferred tax assets related to the non-life subgroup of our tax return because we determined that it is more likely than not that these assets will not be recoverable. The recording of the valuation allowance increases our federal income tax expense which in turn reduces our reported net income or increases our net loss as applicable. Our recorded net deferred tax asset is shown in the following table. The balances for each period are shown based on the life/non-life portions of the consolidated federal tax returns and in total. December 31, 2020 December 31, 2019 Life Non-Life Total Life Non-Life Total (dollars in thousands) Deferred income tax assets, net Total deferred tax assets$ 52,646 $ 26,148 $ 78,794 $ 54,697 $ 23,517 $ 78,214 Total deferred tax liabilities 41,720 9,483 51,203 45,257 7,861 53,118 Net deferred tax asset (liability) before valuation allowance 10,926 16,665 27,591 9,440 15,656 25,096 Valuation allowance - (16,665 ) (16,665 ) - (15,656 ) (15,656 ) Deferred income tax assets, net$ 10,926 $ -$ 10,926 $ 9,440 $ -$ 9,440 Due to the valuation allowance on the non-life subgroup, the effective income tax rate reflected on our Consolidated Statements of Operations will vary depending on the portion of our pretax income (loss) that results from our life subgroup and the portion from our non-life subgroup. With the current full valuation allowance, the current tax benefit related to our non-life subgroup is limited. We continue to record tax expense (benefit) related to the pretax income (loss) of our life subgroup.
Principal Revenue & Expense Items
Revenues
Our primary revenue sources are life insurance premiums, commissions, net investment income, net realized investment gains (losses), insurance lead sales and other income.
Net Premiums
Net premiums consist of direct life insurance premiums due and collected from
our policyholders on in-force insurance policies and premiums collected on
assumed life reinsurance contracts, less reinsurance premiums paid to
reinsurers. Direct premiums are recorded in our Insurance Segment and classified
as first year premiums when they relate to the first calendar year coverage
period. Premiums for policies outside their first calendar year are called
renewal premiums.
30--------------------------------------------------------------------------------
Earned commission revenue consists of amounts received and due from insurance carriers on policies sold byEfinancial and is recorded in our Agency Segment. However, the commission revenue from sales of Fidelity Life policies is eliminated in our Consolidated Statements of Operations becauseEfinancial and Fidelity Life are affiliated.
Net Investment Income
Net investment income consists of income generated from our investment portfolio and is recorded net of related expenses incurred to manage our investments. Net investment income primarily consists of interest income earned on fixed maturity security investments and dividends earned on our equity holdings, net of related expenses incurred to manage our investments. Net investment income earned on assets required to support insurance reserves, annuity deposits and related regulatory capital requirements is allocated to our Insurance Segment. Any other net investment income is recorded in the Corporate Segment.
Net Realized Investment Gains (Losses)
Net realized investment gains (losses) result from sales of investment securities and OTTI for estimated credit losses of fixed maturity securities.
Insurance Lead Sales
In our Agency Segment, insurance lead sales revenue consists of (i) click-through revenues we generate when leads click through to our webpages to access information about life insurance options sponsored by another company and (ii) data revenues we generate through the sale of information regarding leads. Other Income
For our Insurance Segment, other income primarily consists of cost of insurance charges on universal life contracts.
Benefits and Expenses
This category consists of benefits to policyholders, which include policyholder dividends and policyholder dividend obligations (PDO), interest credited to policyholder and contract-holder balances, general operating expenses and amortization of DAC.
Life, Annuity and Health Claim Benefits
Benefit expenses are recorded in our Insurance Segment. Benefit expenses include claims paid or payable on in-force insurance policies, as well as the change in our reserves for future policy benefits during the period. Benefit expenses are reduced by amounts ceded to reinsurance companies with whom we contract to share policy risks.
Interest Credited to Policyholder Account Balances
The interest credited primarily relates to amounts that contract-holders earn on any contract-holder deposits from our assumed annuity contracts and other amounts left on deposit with us. Our universal life policies and assumed annuity contracts require Fidelity Life to periodically establish the crediting rate to be paid on policyholder and contract-holder deposits. All current assumed annuity contracts are credited with interest at the minimum interest rate guaranteed in the contract. Interest credited relates solely to our Insurance Segment. Operating Costs and Expenses Operating expenses are incurred by all of our segments. The operating expenses of our Insurance Segment include policy acquisition costs in excess of amounts that qualify for deferral, ceding commissions received on ceded reinsurance in excess of amounts deferred, variable policy administration costs, general overhead and administration costs, and insurance premium taxes and assessments paid to various states. Agency Segment expenses consist of compensation paid to employee sales agents, costs of insurance sales leads (marketing), costs of sales management and support activities, agent licensing expenses and general overhead and administration expenses. The expenses of the Corporate Segment include allocation of a portion of the compensation of senior executives related to corporate activities,Board of Director expenses related to corporate business, and other operating costs considered to be of a corporate nature and not directly related to either of our other business segments. Overhead and administrative expenses of the segments include employee costs (salaries, bonuses and benefits), office rent, information technology and costs of third-party administrators and other contractors. 31
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Amortization of Deferred Policy Acquisition Costs
DAC amortization represents the actuarially determined reduction in the DAC asset for the period. The amount of acquisition cost amortization recognized each period is based on actual factors established when the insurance contracts were written. Results of Operations
The major components of operating revenues, benefits and expenses and net (loss) income are as follows:
Vericity, Inc. Consolidated Results of Operations For the Years EndedDecember 31 , (dollars in thousands) 2020
2019
Revenues
Net insurance premiums $ 108,042 $ 94,370
Net investment income 14,121 16,076
Net realized investment (losses) gains (1,242 ) 691
Other-than-temporary impairments (68 ) (41 )
Earned commissions 21,811 17,688
Insurance lead sales 4,958 6,229
Other income 209 287
Total revenues 147,831 135,300
Benefits and expenses
Life, annuity, and health claim benefits 77,692 61,851
Interest credited to policyholder account balances 3,118 3,199
Operating costs and expenses 80,363 77,036
Amortization of deferred policy acquisition costs 13,961 13,410
Total benefits and expenses 175,134 155,496
(Loss) income from operations before income tax (27,303 ) (20,196 )
Income tax (benefit) expense (2,275 )
(872 )
Net (loss) income $ (25,028 ) $ (19,324 ) Year Ended
Total Revenues
For the year ended
Benefits and Expenses
For the year endedDecember 31, 2020 , total benefits and expenses were$175.1 million compared to$155.5 million for the year endedDecember 31, 2019 . This increase of$19.6 million was primarily due to higher life, annuity, and health claim benefits.
Loss from Operations Before Income Taxes
For the year ended
Income Taxes
For the year endedDecember 31, 2020 , our income tax benefit was$2.3 million compared to an income tax benefit of$0.9 million for the year endedDecember 31, 2019 . The increased benefit of$1.4 million reflects increased net loss attributable to the life sub-group. The non-life sub-group, which has a full valuation allowance, therefore no tax impact. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies-Income Taxes." 32
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Analysis of Segment Results
Reconciliation of Segment Results to Consolidated Results
The following analysis reconciles the reported segment results to theVericity, Inc. total consolidated results. The main difference is the intercompany eliminations. For the Years Ended December 31, (dollars in thousands) 2020 2019
(Loss) before income taxes by segment
Agency $ (866 ) $ (7,089 )
Insurance (8,347 ) (1,155 )
Corporate (10,822 ) (7,985 )
Eliminations (7,268 ) (3,967 )(Loss) income from operations before income tax (27,303 ) (20,196 )
Income tax (benefit) expense (2,275 )
(872 )
Net (loss) income $ (25,028 ) $ (19,324 )
Agency Segment
The results of our Agency Segment were as follows:
For the Years Ended
December 31,
(dollars in thousands) 2020 2019
Revenues
Earned commissions $ 43,424 $ 39,359
Insurance lead sales 4,958 6,262
Total revenues 48,382 45,621
Expenses
Operating costs and expenses 49,248 52,710
Total expenses 49,248 52,710
(Loss) income from operations before income tax
Year Ended
Earned Commissions
For the year endedDecember 31, 2020 , earned commissions were$43.4 million compared to$39.4 million for the year endedDecember 31, 2019 . This increase of$4.0 million resulted from increased sales in the retail channel, which was primarily driven by increased agent headcount, partially offset by lower sales in the wholesale channel. Insurance Lead Sales For the year endedDecember 31, 2020 , insurance lead sales were$5.0 million compared to$6.3 million for the year endedDecember 31, 2019 . This decrease of$1.3 million was primarily due to lower click and transfer revenue.
Operating Costs and Expenses
For the year endedDecember 31, 2020 , general operating expenses were$49.2 million compared to$52.7 million for the year endedDecember 31, 2019 . This decrease of$3.5 million was primarily due to lower marketing costs and the 2019 expense of$0.9 million from the accelerated vesting of incentive compensation related to the completion of the IPO.
Net (Loss) Income
For the year endedDecember 31, 2020 , the Agency Segment incurred a net loss of$0.9 million compared to a net loss of$7.1 million for the year endedDecember 31, 2019 . This decrease in net loss of$6.2 million was primarily the result of higher earned commissions and a reduction of operating costs and expenses, partially offset by lower insurance lead sales revenue. 33
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Insurance Segment
The results of our Insurance Segment were as follows:
For the Years Ended
December 31,
(dollars in thousands) 2020 2019
Revenues
Net insurance premiums $ 108,042 $ 94,370
Net investment income 13,925 15,278
Net realized investment (losses) gains (1,370 ) 645
Other-than-temporary impairments (68 ) (41 )
Other income 209 254
Total revenues 120,738 110,506
Benefits and expenses
Life, annuity, and health claim benefits 77,692 61,851
Interest credited to policyholder account balances 3,118 3,199
Operating costs and expenses 31,608 28,358
Amortization of deferred policy acquisition costs 16,667 18,253
Total benefits and expenses 129,085 111,661
(Loss) income from operations before income tax
Year Ended
Net Insurance Premiums
For the year endedDecember 31, 2020 , net insurance premiums were$108.0 million compared to$94.4 million for the year endedDecember 31, 2019 . This increase of$13.6 million was primarily due to growth in our Core Life lines of$5.9 million , mainly driven by increases in LifeTime Benefit Term (LBT) and RAPIDecision® Life and a$7.1 million increase in Closed Block and annuities of$0.5 million . Net Investment Income
See "Note 2-Investments" in the Notes to the Consolidated Financial Statements included in this Form 10-K.
Net Realized Investment Gains (Losses)
See "Note 2-Investments" in the Notes to the Consolidated Financial Statements included in this Form 10-K.
Life, Annuity and Health Claim Benefits
For the year endedDecember 31, 2020 , life, annuity and health claim benefits were$77.7 million compared with$61.9 million for the year endedDecember 31, 2019 . This increase of$15.8 million was mainly attributable to an increase of$4.8 million in net claim benefits resulting from$6.8 million higher claim activity on certain Core and Non-Core products, partially offset by a decrease of$2.1 million in annuities and assumed life. Change in benefit reserves increased$11.1 million , primarily related to$1.4 million in our Core and Non-Core lines,$5.9 million in Closed Block and$4.4 million in assumed life resulting from the recapture of the majority of an assumed life block of business, partially offset by a$0.6 million decrease in annuities.
Interest Credited to Policyholder Account Balances
For the year ended
Operating Costs and Expenses
For the year endedDecember 31, 2020 , general operating expenses were$31.6 million compared to$28.4 million for the year endedDecember 31, 2019 . This increase of$3.2 million was primarily due to a reduction in reinsurance allowances of$3.3 million , which includes$6.8 million related to the Closed Block, partially offset by increased allowances of$3.6 million in the Core Life and 34
-------------------------------------------------------------------------------- Non-Core Life lines. In addition, there was$1.0 million increase in depreciation costs and$1.1 million in staff costs. The increases were partially offset by$1.8 million costs from the accelerated vesting of incentive compensation related to the completion of the IPO in 2019. See "Closed Block" section in this Form 10-K for further discussion regarding Closed Block and "Note 8- Closed Block" in the accompanying Notes to the Consolidated Financial Statements.
Amortization of Deferred Policy Acquisition Costs
For the year endedDecember 31, 2020 , amortization of deferred acquisition costs was$16.7 million compared to$18.3 million for the year endedDecember 31, 2019 . This decrease of$1.6 million includes a$2.2 million decrease in Closed Block, primarily due to lapses partially offset by an increase in our Core and Non-Core lines of$0.6 million .
Net (Loss) Income
For the year endedDecember 31, 2020 , net loss was$8.3 million compared to a net loss of$1.2 million for the year endedDecember 31, 2019 . The increase in net loss of$7.1 million resulted primarily from higher life, annuity and health claim benefits, lower net investment income, lower net realized gains and increases in net operating expenses, partially offset by an increase in net insurance premiums and lower amortization of deferred policy acquisition costs. Closed Block The Closed Block was formed as ofOctober 1, 2006 and contains all participating policies issued or assumed by Fidelity Life. The assets and future net cash flows of the Closed Block are available only for purposes of paying benefits, expenses and dividends of the Closed Block and are not available to the Company, except for an amount of additional funding that was established at inception. The additional funding was designed to protect the block against future adverse experience, and if the funding is not required for that purpose, it is subject to reversion to the Company in the future. Any reversion of Closed Block assets to the Company must be approved by theIllinois Department of Insurance . Included in Closed Block assets atDecember 31, 2020 andDecember 31, 2019 , are$10.2 million and$9.9 million , respectively, of additional Closed Block funding, plus accrued interest, that is eligible for reversion to the Company if not needed to fund Closed Block experience. The Closed Block was funded based on a model developed to forecast the future cash flows of the Closed Block which is referred to as the "glide path." The glide path model projected the anticipated future cash flows of the Closed Block as established at the initial funding. We compare the actual results of the Closed Block to expected results from the glide path as part of the annual assessment of the current level of policyholder dividends. The assessment of policyholder dividends includes projections of future experience of the Closed Block policies and the investment experience of the Closed Block assets. The review of Closed Block experience also includes consideration of whether a policy dividend obligation should be recorded to reflect favorable Closed Block experience that has not yet been reflected in the dividend scales. See "Note 5-Closed Block" in the accompanying Notes to the Consolidated Financial Statements. The block where there are no dividends expected had a significant number of policies issued inDecember 1999 which had level premiums for the first 20 durations, followed by premiums which increased significantly in duration 21 as the premiums from that point forward go to an annually increasing scale. The approximate increase in premiums going from the 20th to the 21st duration is 1300%. Direct policies are a mixture of annual, semi-annual, quarterly, and monthly premium payment modes, whereas ceded policies are all annual premium mode. Therefore, both direct and ceded premiums increased significantly in the fourth quarter of 2019 on the Closed Block compared to the prior year as this group of policies ended their level term with larger impacts affecting ceded premiums more than direct premiums as a result of these modal differences. Most of these policies lapsed in the first quarter of 2020. This caused a reversal of ceded premiums and a reduction in the direct due and unpaid premiums on the policies which lapsed. The lapsed policies also caused reversals of items such as ceding allowances, reserves and amortization of deferred policy acquisition costs. 35
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Corporate Segment
The results of the Corporate Segment are as follows:
For the Years Ended
December 31 ,
(dollars in thousands) 2020 2019
Revenues
Net investment income $ 409 $ 1,166
Net realized investment (losses) gains 128 46
Total revenue 537 1,212
Expenses
Operating costs and expenses 11,359 9,197
Total expenses 11,359 9,197
(Loss) income from operations before income tax
Year Ended
Net Loss
The net loss for the year endedDecember 31, 2020 increased$2.8 million to$10.8 million from a net loss of$8.0 million for the year endedDecember 31, 2019 , primarily attributable to higher operating costs and expenses due to targeted growth initiatives and costs associated with being a public company and partially offset by$3.2 million of costs from the accelerated vesting of incentive compensation related to the completion of the IPO in 2019.
Intercompany Eliminations
The impact of the eliminations for intercompany transactions primarily consists of the sales by our Agency Segment of life products of our Insurance Segment. The eliminations represent the amounts required to eliminate the intercompany transactions as recorded in our segment results, and in particular, to eliminate any intersegment profits resulting from such transactions. Our segment results follow the accounting principles and methods applicable to each segment as if the intercompany transactions were with unaffiliated organizations:
Revenue-our Agency Segment recognizes all commission revenue earned in the year the policy goes in force at the carrier.
Expense-our Insurance Segment recognizes the first-year commission as a policy
acquisition cost, in proportion to the premiums earned from providing insurance
coverage throughout the first year that the policy is in force. In addition, our
Insurance Segment defers the amount by which the first-year commission
acquisition costs exceed the ultimate renewal commission and records this amount
as deferred acquisition cost that is amortized over the expected life of the
policy.
36
-------------------------------------------------------------------------------- Viewed at the segment level, because of the timing difference between the Agency Segment's immediate recognition of commission revenue and the Insurance Segment's deferral and amortization of the commission expense over the expected life of the policy, all else being equal, the sale of a policy through our Agency Segment results in an intersegment profit in an amount equal to the difference between the commission paid and the related amortization expense. However, in consolidation, two impacts occur. First, the intercompany revenue recognized by our Agency Segment and the related deferred acquisition expense recorded by our Insurance Segment are eliminated. Second, we record deferred acquisition costs equal to that portion of Commission DAC that can be tied directly toEfinancial's expenses incurred in the successful placement of a policy. Therefore, in consolidation, the Commission DAC recorded in our Insurance Segment is effectively reduced to reflect the elimination of that portion of Commission DAC that results fromEfinancial expenses that cannot be directly tied to the successful placement of a policy. The amount of eliminated Commission DAC, which represents a majority of the Commission DAC, is charged to current expense, and acquisition cost DAC is recorded at a reduced amount, which represents the amount of Commission DAC that is eligible for deferral under GAAP. See "Critical Accounting Policies-Deferred Policy Acquisition Costs (DAC)" and "Factors Affecting our Results-Strategic Goals and Financial Impact of Sales of Policies Produced byEfinancial " for more information. The results of these elimination entries were as follows: For the Years Ended December 31, (dollars in thousands) 2020 2019 Revenues Net investment income$ (213 ) $ (368 ) Earned commissions (21,613 ) (21,671 ) Total revenues (21,826 ) (22,039 ) Expenses Operating costs and expenses (11,852 )
(13,229 )
Amortization of deferred policy acquisition costs (2,706 ) (4,843 )
Total expenses (14,558 ) (18,072 )
(Loss) income from operations before income tax
Year Ended
For the year endedDecember 31, 2020 , intercompany eliminations resulted in a$7.3 million reduction in pre-tax income compared to a$4.0 million reduction in pre-tax income for the year endedDecember 31, 2019 . This decrease of$3.3 million was mainly due to lower expense credit for amortization of deferred policy acquisition costs. Investments Investment Returns We invest our available cash and funds that support our regulatory capital, surplus requirements and policy reserves in investment securities that are included in our Insurance and Corporate Segments. We earn income on these investments in the form of interest on fixed maturity securities (bonds and mortgage loans) and dividends (from equity holdings). Net investment income is recorded net of investment related expenses as revenue. The amount of net investment income that we recognize will vary depending on the amount of invested assets that we own, the types of investments we own, the interest rates earned and amount of dividends received on our investments. Gains and losses on sales of investments are classified as net realized investment gains (losses) and are recorded as revenue. Capital appreciation and depreciation caused by changes in the market value of investments classified as "available-for-sale" is recorded in accumulated other comprehensive income. The amount of investment gains and losses that we recognize depends on the amount of and the types of invested assets we own and the market conditions related to those investments. Our cash needs can vary from time to time and could require that we sell invested assets to fund cash needs.
Investment Guidelines
Our investment strategy and guidelines are developed by management and approved
by the investment committee of Fidelity Life's Board of Directors. Our
investment strategy related to our Insurance Segment is designed to maintain a
well-diversified, high quality fixed maturity portfolio that will provide
adequate levels of net investment income and liquidity to meet our policyholder
obligations under our life insurance policies and our assumed annuity deposits.
To help maintain liquidity, we establish the duration of invested assets within
a tolerance to the policy liability duration. The investments of our Insurance
Segment are managed with an emphasis on current income within quality and
diversification constraints. The focus is on book yield of the fixed maturity
portfolio as the anticipated portfolio yield is a key element used in pricing
our insurance products and establishing policyholder crediting rates on our
annuity contracts.
37
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We apply our overall investment strategy and guidelines on a consolidated basis
for purposes of monitoring compliance with our overall guidelines. Almost all of
our investments are owned by Fidelity Life and are maintained in compliance with
insurance regulations. Critical guidelines of our investment plan include:
• Asset concentration guidelines that limit the amount that we hold in any
one issuer of securities,
• Asset quality guidelines applied on a portfolio basis and for individual
issues that establish a minimum asset quality standard for portfolios and
establish minimum asset quality standards for investment purchases and
investment holdings,
• Liquidity guidelines that limit the amount of illiquid assets that can be
held at any time, and
• Diversification guidelines that limit the exposure at any time to the
total portfolio by investment sectors.
Our investment portfolios are all managed by third-party investment managers that specialize in insurance company asset management and in particular these managers are selected based upon their expertise in the particular asset classes that we own. We contract with an investment management firm to provide overall assistance with oversight of our portfolio managers, evaluation of investment performance and assistance with development and implementation of our investment strategy. This investment management firm reports to our Chief Financial Officer and to the Investment Committee of Fidelity Life's Board of Directors. On a quarterly basis, or more frequently if circumstances require, we review the performance of all portfolios and portfolio managers with the Investment Committee. The following table shows the distribution of the fixed maturity securities classified as available-for-sale by quality rating, using the rating assigned byStandard & Poor's (S&P), a nationally recognized statistical rating organization. For securities where the S&P rating is not available (not rated), theNational Association of Insurance Commissioners (NAIC) rating is used. Over the periods presented, we have maintained a consistent weighted average bond quality rating of "A." The percentage allocation of total investment grade securities has decreased to 97.9% atDecember 31, 2020 from 98.2% atDecember 31, 2019 due to the S&P ratings on certain new securities acquired in our portfolio of distressed residential mortgage-backed securities. (dollars in thousands) December 31, 2020 December 31, 2019 S&P Rating AAA$ 91,153 25.2 %$ 93,137 29.7 % AA 75,167 20.7 % 47,217 15.0 % A 95,263 26.2 % 94,776 30.1 % BBB 72,945 20.0 % 60,277 19.1 % Not rated 21,261 5.8 % 13,443 4.3 % Total investment grade 355,789 97.9 % 308,850 98.2 % BB 4,814 1.3 % 3,455 1.1 % B 2,627 0.7 % 1,707 0.5 % CCC 418 0.1 % 727 0.2 % D 5 - 7 - Not rated 198 - 175 - Total below investment grade 8,062 2.1 % 6,071 1.8 % Total$ 363,851 100.0 %$ 314,921 100.0 % The following table sets forth the maturity profile of our fixed maturity securities atDecember 31, 2020 andDecember 31, 2019 . Expected maturities could differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without penalty. December 31, 2020 December 31, 2019 Amortized Estimated Amortized Estimated (dollars in thousands) Cost % Fair Value % Cost % Fair Value %
Due in one year or less
42,301 12.9% 46,085 12.7% 37,668 12.8% 39,506 12.5%
Due after five years through
ten years 41,115 12.5% 45,997 12.6% 23,760 8.1% 25,695 8.2%
Due after ten years 119,693 36.5% 143,477 39.4% 97,506 33.1% 112,115 35.6%
Securities not due at a
single maturity
date-primarily mortgage
and asset-
backed securities 115,858 35.3% 118,921 32.7% 124,722 42.3% 126,766 40.3%
Total fixed maturity
securities $ 328,263 100.0% $ 363,851 100.0% $ 294,402 100.0% $ 314,921 100.0%
38
-------------------------------------------------------------------------------- Every quarter, we review all investments where the market value is less than the carrying value to ascertain if the impairment of the security's value is OTTI. The quarterly review is targeted to focus on securities with larger impairments and that have been in an impaired status for longer periods of time. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Polices-Other-Than-Temporary Impairments onAvailable-For-Sale Securities ".
Net Investment Income
One key measure of our net investment income is the book yield on our holdings of fixed maturity securities classified as available-for-sale, which holdings totaled$363.9 million and$314.9 million , and represented 85.7% and 77.2% of our invested assets, as ofDecember 31, 2020 andDecember 31, 2019 , respectively. Book yield is the effective interest rate, before investment expenses, that we earn on these investments. Book yield is calculated as the percent of net investment income to the average amortized cost of the underlying investments for the period. For the years endedDecember 31, 2020 andDecember 31, 2019 , our book yield on fixed maturity securities available-for-sale was 3.9% and 4.2% for the years endedDecember 31, 2020 andDecember 31, 2019 , respectively.
See "Note 2 - Investments" in the Notes to the Consolidated Financial Statements included in this Form 10-K.
Interest Credited to Policyholder Account Balances
Included with the future policy benefits is the liability for contract-holder
deposits on deferred annuity contracts assumed through two reinsurance
agreements effective in 1991 and 1992 and certain other policy funds left on
deposit with the Company. The aggregate liability for deposits is as follows:
December 31, 2020 December 31, 2019
Year to Year to
Date Average Date Average
Ending Interest Credit Ending Interest Credit
(dollars in thousands) Balance Credited Rate Balance Credited Rate
Annuity contract-holder deposits
- assumed $ 74,918 $ 2,892 3.9% $ 78,296 $ 2,965 3.8%
Dividends left on deposit 7,271 184 2.5% 7,609 195 2.6%
Other 1,680 42 2.5% 1,612 39 2.4%
Total $ 83,869 $ 3,118 3.7% $ 87,517 $ 3,199 3.7%
The liability for deferred annuity deposits represents the contract-holder
account balances. Due to the declines in market interest rates and the book
yield on our investment portfolio, we credit interest on all contract-holder
deposit liabilities at contractual rates that are currently at the minimum rate
allowed by the contract or by state regulations.
Our Insurance Segment realizes operating profit from the excess of our book
yield realized on fixed maturity securities that support our contract-holder
deposits over the amount of interest that we credit to the contract-holder. We
refer to this operating profit as the "spread" we earn on contract-holder
deposits. Our book yields on fixed maturity investments have declined in recent
periods due to current market conditions. If book yields continue to decline,
the amount of spread between the interest earned and credited will be reduced.
Net Realized Investment Gains (Losses)
Net realized investment gains (losses) are subject to general economic trends and in particular correlate generally with movements in the major equity market indexes. The amounts classified as realized gains and losses in our Consolidated Statements of Operations include amounts realized from sales of investments, mark-to-market adjustments on investments classified as equity holdings and investments that use the equity method of accounting (limited partnership interests which are included in Other invested assets on the Consolidated Balance Sheet) and other-than-temporary impairments of individual securities related to credit impairments.
See "Note 2 - Investments" in the Notes to the Consolidated Financial Statements included in this Form 10-K.
39
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Unrealized Holding Gains (Losses)
We also record capital appreciation/depreciation on our available-for-sale fixed maturity securities. AtDecember 31, 2020 andDecember 31, 2019 , we had a change in Accumulated Other Comprehensive Income (Loss) from mark-to-market adjustments of our available-for-sale fixed maturity securities totaling$7.8 million and$11.1 million (net of federal income taxes and reserve), respectively.
See "Note 13 - Accumulated Other Comprehensive Income (Loss)" in the Notes to the Consolidated Financial Statements included in this Form 10-K.
Financial Position
AtDecember 31, 2020 , we had total assets of$768.8 million compared to total assets atDecember 31, 2019 of$721.8 million , an increase of$47.0 million . The invested asset base increased$16.9 million , primarily due to an increase in fixed maturity securities of$48.9 million , which includes$15.1 million of market value changes, offset by maturity of short-term investments of$29.8 million . Reinsurance recoverables increased$25.1 million as a result of a$22.4 million increase in ceded policy and claim reserves and an increase of$2.7 million related to timing of settlements of reinsured claims. Commission and agent balances increased$8.3 million due to the timing of collections. Deferred policy acquisition costs increased$1.4 million , primarily due to deferrals on new business in excess of amortization. Deferred income taxes increased$1.5 million , primarily due to a deferred tax credit as a result of net loss, partially offset by tax on unrealized investment market gains. Cash decreased$1.6 million , primarily related to cash used from investments, partially offset by cash from operating and financing activities. Other assets decreased$4.5 million , primarily due to decreases in due premium mostly on the Closed Block, partially offset by increases in internally developed software. AtDecember 31, 2020 , we had total liabilities of$573.5 million compared to total liabilities of$509.4 million atDecember 31, 2019 , an increase of$64.1 million . Future policy benefits and claims increased$45.8 million , primarily due to a$44.9 million increase in Core and Non-Core lines due to growth and maturity of the underlying blocks of business, and a$2.4 million increase in annuities and assumed life, primarily related to the recapture of the majority of an assumed life block of business, partially offset by a decrease of$1.6 million in the Closed Block. Other policyholder liabilities increased$12.7 million , primarily due to$11.2 million in Core and Non-Core lines and$1.7 million in Closed Block. Debt increased$9.9 million related to additional net borrowings under our commission financing agreement with Hannover Life. Other liabilities increased$6.3 million , primarily related to changes in operating accruals and chargeback allowances. Policyholder dividend obligations related to the Closed Block increased$1.8 million , primarily related to changes in the market value of invested assets. Reinsurance liabilities and payables decreased$8.7 million , primarily due to timing of reinsurance settlements and$3.6 million decrease in Policyholder account balances, largely due to annuity payments. AtDecember 31, 2020 , total equity decreased to$195.2 million from$212.4 million atDecember 31, 2019 . This decrease in equity of$17.2 million consists of a net loss of$25.0 million , partially offset by an increase of$7.8 million of other comprehensive income.
Liquidity and Capital Resources
Our principal sources of funds are from premium revenues, commission revenues, net investment income and proceeds from the sale and maturity of investments. The Company's primary uses of funds are for payment of life policy benefits, contract-holder withdrawals on assumed annuity contracts, new business acquisition costs for our insurance operations (i.e., commissions, underwriting and issue costs), cost of sales for Agency operations (i.e., agent compensation, purchased lead and lead generation costs), general operating expenses and purchases of investments. Our investment portfolio is structured to provide funds periodically over time, through net investment income and maturities, to provide for the payment of policy benefits and contract-holder withdrawals. Under our commission financing arrangement with Hannover Life, Fidelity Life is able to pay level annual commissions instead of first-year-only commissions toEfinancial for sales of RAPIDecision® Life policies, and Hannover Life advances toEfinancial amounts approximately equal to first-year-only commissions for sales of those policies. This arrangement reduces Fidelity Life's surplus strain associated with issuing RAPIDecision® Life business while helping to provide liquidity forEfinancial through the receipt of larger first-year-only commissions. We are able to obtain advances up to$30.0 million under our arrangement with Hannover Life. As ofDecember 31, 2020 , we had net advances of$27.5 million under this arrangement. We are a member of theFederal Home Loan Bank of Chicago (the "FHLBC"). As a member, we are able to borrow on a collateralized basis from the FHLBC. We own FHLBC common stock with a book value of$0.1 million , which allows us to borrow up to$2.3 million . Interest on borrowed funds is charged at variable rates established from time to time by the FHLBC based on the interest rate option selected at the time of the borrowing. There have been no borrowings under this facility. Fidelity Life's ability to pay dividends toVericity Holdings, Inc. (VHI) is limited by the insurance laws of theState of Illinois . All shareholder dividends are subject to notice filings with theIllinois Director of Insurance. The maximum amount of dividends that 40 -------------------------------------------------------------------------------- can be paid byIllinois life insurance companies to shareholders without 30 days prior notice to theIllinois Director of Insurance is the greater of (i) statutory net income for the preceding year or (ii) 10% of statutory surplus as of the preceding year-end. UnderIllinois insurance statutes, dividends may be paid only from surplus, excluding unrealized appreciation in value of investments, without prior approval. Dividends in excess of these amounts require advance approval of theIllinois Director of Insurance. There are no limitations on the amount of dividends thatEfinancial can pay. During the years ended 2020 and 2019, the Board of Directors of Fidelity Life approved the payment of$0.0 million and$5.0 million , respectively, in dividends to VHI. The dividends provided operating funds to VHI to support corporate operations and initiatives. Following the Conversion, Fidelity Life has agreed not to pay any common stock dividends without the approval of a majority of the company designees. In connection with the approval of the Conversion by theIllinois Director of Insurance, we agreed, for a period of twenty-four months following the completion of the offerings, to seek the prior approval of theIllinois Department of Insurance for any declaration of an ordinary dividend by Fidelity Life. Fidelity Life is a party to various services and cost sharing agreements with VHI andEfinancial pursuant to which certain costs and expenses incurred by VHI andEfinancial on behalf of Fidelity Life are allocated to Fidelity Life and reimbursed to the entity incurring the expense. We have experienced net negative cash flows in 2020 and in most prior periods due to continued growth in sales of our life insurance products and in our Agency operations and through continued net withdrawals on assumed annuity contract-holder deposits. Our annuity deposits are in run-off because we do not market annuity contracts to generate annuity deposits to offset the withdrawal activity on in-force contracts.
Cash uses in our Insurance Segment result in negative operating cash flows related to sales of new insurance policies because:
• Policy acquisition costs (consisting of agent commissions, policy
underwriting and issue costs) exceed the amount of first year premium
received from the policyholder,
• Depending on the product sold, a portion or all of the agent's commission
may be paid as a cash advance to the agent and most of the underwriting
and policy issue costs are paid at the time the initial policy is issued,
whereas the premiums may be paid throughout the policy year, and• Amounts due from reinsurers to reimburse claims paid are usually paid at
some date after the claim has been paid.
The resulting negative first year cash flows from sales of new policies are partially offset by positive cash flows from insurance policy renewals. The continued sales growth in our Insurance operations has resulted in a net cash decrease from operations. Cash flows from reinsurance collections will vary from period to period based on claims activity.
Our Corporate Segment experienced negative cash flows as a result of the payment of allocated overhead expenses.
Cash flows from investing activities includes our fixed maturity securities and
equity holdings that are classified as available-for-sale securities. Period to
period, the cash flows associated with the changes in these portfolios will vary
between cash sources and cash uses depending on portfolio trading due to
investment market conditions and other factors.
Cash flows from financing activities primarily consists of the assumed annuity
contract-holder deposits. The annuity liabilities are reducing each period due
to cash withdrawals by contract-holders on this block of annuities that were
primarily written in the late 1980s. Cash deposits to these annuity contracts
are minimal compared to cash withdrawal activity. Also included in financing
cash flows are net proceeds from our commission financing program.
Cash Flows
For the Years Ended
December 31,
(dollars in thousands) 2020 2019Consolidated Summary of Cash Flows
Net cash provided (used) by operating activities
Net cash (used) provided by investing activities (8,754 )
(25,615 )
Net cash provided (used) by financing activities 1,851
45,263
Net increase (decrease) in cash and cash equivalents
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-------------------------------------------------------------------------------- For the year endedDecember 31, 2020 , we had a net decrease in cash of$1.6 million compared to net increase of$16.9 million for the year endedDecember 31, 2019 . Cash from operating activities increased by$8.1 million , mainly due to higher premium volume, partially offset by higher claim benefits and general operating expenses. Cash used by investing activities decreased, primarily due to net sales of short-term investments in 2020. In 2019, proceeds from the IPO were included in financing activities and partially offset in investing activities through the purchase of short-term investments.
Fidelity Life is subject to regulatory guidelines related to the ratio of its capital level compared to its RBC level as determined by formulas adopted by state insurance departments and applicable to all life insurance companies. A company's "authorized control level RBC" is a measure of the amount of capital appropriate for an insurance company to support its overall business operations in light of its size, growth and risk profile. RBC standards are used by regulators to determine appropriate regulatory actions for insurers that show signs of weak or deteriorating conditions. Companies that do not maintain total adjusted RBC in excess of 200% of the company's authorized control level RBC may be required to take specific actions at the direction of state insurance regulators. Fidelity Life's total adjusted capital atDecember 31, 2020 and 2019 was well in excess of 200% of its authorized control level. See "Business-Regulation-Risk-Based Capital (RBC) Requirements." Due to the continued growth in Fidelity Life's sales of new insurance policies and the dividends to VHI ($0.0 million in 2020 and$5.0 million in 2019 to provide working capital), Fidelity Life's statutory surplus has been declining. The accounting principles applicable to regulatory reporting require that insurance companies expense all policy acquisition costs as incurred. Acquisition expenses attributable to Fidelity Life's increasing new business growth have resulted in net losses being reported for regulatory reporting purposes. Regulatory accounting principles allow limited recognition of the future benefits of deferred tax assets. Accordingly, we recognize no income tax benefit that would offset our operating losses for regulatory reporting purposes. Fidelity Life is also subject to the model regulation entitled "Valuation of Life Insurance Policies" commonly known as "Regulation XXX." This regulation requires life insurance companies that issue insurance policies with level premium guarantees to carry reserves that can greatly exceed the amount that the insurance company believes is necessary to reflect its liability for future claims payments. Such reserves are sometimes referred to as "non-economic reserves." Many insurance companies use reinsurance, financing, formation of captive reinsurers and other reserve financing transactions to reduce the regulatory capital needs under Regulation XXX. Generally, these solutions have only been available to carriers with much larger amounts of affected liabilities than Fidelity Life. To mitigate the future impact on regulatory capital from Regulation XXX and help stabilize our regulatory capital position in light of anticipated sales increases, we entered into a reserve financing agreement with Hannover Life effectiveJuly 1, 2013 that covered certain products with policies written on or beforeSeptember 30, 2012 . This agreement was first amended and restated as ofJuly 1, 2016 and a subsequent amendment was filed with theIllinois Department of Insurance inNovember 2019 and approved by theIllinois Department of Insurance onDecember 23, 2019 . The structure of the agreement, which was first effectiveJuly 1, 2013 , involves a combination coinsurance with funds withheld and yearly renewable term reinsurance covering most of the Company's non-participating in-force life insurance business with issue dates on or beforeDecember 31, 2019 . As ofDecember 31, 2020 , the reserve credit under this arrangement was approximately$181.4 million .
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity or capital expenditures.
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