Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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 investment 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 Standards Board or other standard-setting bodies;
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.
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, an Illinois-domiciled life insurance company, and Efinancial, 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 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.
War in Ukraine and Israel
The Company believes the war in Ukraine and in and around Israel do not have a material impact on the condensed consolidated financial statements of the Company at December 31, 2023 .
National Service Group of AmeriLife, LLC
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”). The President of this entity, Scott Perry also sits on the Company’s Board of Directors. 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. Due to the large amount of the Company’s insurance policies now being sold through AmeriLife, dissolution of this agency arrangement could have a material impact on the Company’s financial statements. The Company has additional arrangements with AmeriLife wherein Efinancial’s sub- agents may sell third party products through AmeriLife. To date it is not believed that any of these arrangements will exceed the related party thresholds described in 17 CFR § 229.404. Should these or other arrangements change or exceed the aforementioned threshold, after review by the CFO and General Counsel, the Company’s Chairman will be advised and written sign-off will be required from the Chairman.
Agency Segment
This segment primarily consists of the operations of Efinancial. Efinancial is a physical call center and remote employee 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 that Efinancial represents, which we refer to as our wholesale channel. Efinancial also generates insurance lead sales revenue through its eCoverage web presence. For the years ended December 31, 2023 and December 31, 2022, our Agency Segment revenue earned 90% and 86% through the retail channel, 4% and 5% through the wholesale channel, and 6% and 9% 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 through Efinancial’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 ended December 31, 2023 and December 31, 2022, these offsetting revenues were $4.0 million and $4.5 million, respectively, which reduced our total agency expenses by approximately 6% and 8%, 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 through Efinancial 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.
Non Core 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 of Members Mutual 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. On March 29, 2019, the majority of the assumed block of life business was recaptured. 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.
Our Insurance Segment revenues consist of net insurance premiums, net investment income, and net gains (losses) on investments. Our distributors consist of the independent insurance agencies and Efinancial 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 () on insurance operations to the extent that premium revenues, net investment income and investment () exceed (are less than) expenses and general operating expenses for the period.
Corporate & Other Segment
The results of this segment consist of net investment income and net gains (losses) on investments earned on invested assets. We also include certain corporate expenses that are not allocated to our other segments, including expenses of Vericity, Inc., Board of Director's 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 & Other Segment recognizes income (loss) to the extent that net investment income and net gains (losses) on investments exceed (are less than) corporate expenses.
Included in the Corporate & Other Segment is the elimination of intercompany transactions which 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:. See "Corporate & Other " segment results included in this Management Discussion & Analysis for further discussion.
Factors Affecting Our Results
Strategic Goals and Financial Impact of Sales of Policies Produced by Efinancial
Using Efinancial as both a direct writing and sub-agent of AmeriLife 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 acquired Efinancial 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. Additionally, while unlikely, changes in the relationship between Efinancial and Amerilfe could also negatively impact our financial condition and results of operations.
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 support reserves 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 than products 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 fixed regardless 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
In instances where Efinancial has agreed to accept the receipt of levelized commissions on the successful placement of an insurance policy. Efinancial has entered into a commission financing arrangement with Hannover Life. Under this arrangement, Efinancial receives an upfront commission from Hannover Life and agrees to pay a levelized commission back to Hannover Life. This payment stream is over the level premium period the policy stays in-force and premiums are received. This arrangement covered certain RD Life business issued October 2017 through December 2020 and issued January 2022 through December 2023. This arrangement has been terminated for new business effective December 31, 2023.
Critical Accounting Policies
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, and include valuation of fixed maturity securities, allowance for credit losses on available-for-sale securities, mortgage loans, deferred policy acquisition costs (DAC), future policy benefit reserves and income taxes. Our significant 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 preparation of the consolidated financial statements in conformity with GAAP requires management to use judgment in making estimates and 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 Fixed Maturity Securities
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 and U.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 December 31, 2023 the estimated fair value of our fixed maturity securities by fair value hierarchy was as follows:
Fair Value of Investments at December 31, 2023
(dollars in thousands)
Level 1
Level 2
Level 3
Total Fair
Value
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 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, and U.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.
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).
Change in Allowance for Credit Losses
The Company regularly reviews its fixed income portfolio to identify and evaluate whether a security may require a credit loss allowance. For each fixed income security in an unrealized loss position, the Company assesses whether management with the appropriate authority has made the decision to sell or whether it is more likely than not the Company will be required to sell the security before recovery of the amortized cost basis for reasons such as liquidity, contractual or regulatory purposes. If a security meets either of these criteria, any existing credit loss allowance would be written-off against the amortized cost basis of the asset along with any remaining unrealized losses, with incremental losses recorded in earnings. For all other securities in an unrealized loss position in which the Company does not expect to recover the entire amortized cost basis, the security is deemed to have a credit loss.
Significant judgment is required in the determination of whether a credit loss has occurred for a security. The Company has developed a consistent methodology and has identified significant inputs for determining whether a credit loss has occurred. Some of the factors considered in evaluating whether a decline in fair value is a credit loss are the financial condition and prospects of the issuer, payment status, the probability of collecting scheduled principal and interest payments when due, credit ratings of the securities, and the duration and severity of the decline.
The credit loss component of a fixed maturity security impairment is calculated as the difference between amortized cost 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 Company does not expect to receive cash flows sufficient to recover the entire amortized cost basis of the fixed maturity security, a credit loss allowance is recorded in
earnings for the shortfall in expected cash flows; however, the amortized cost, net of the credit loss allowance, may not be lower than the fair value of the security. If the present value of the modeled expected cash flows equals or exceeds the amortized cost of a security, no credit loss exists. The non-credit component, determined as the difference between the adjusted amortized cost basis and fair value, is recognized in other comprehensive (loss) income. If the present value of the modeled expected cash flows equals or exceeds the amortized cost of a security, no credit loss exists.
The measurement of credit losses for available-for-sale fixed income securities measured at fair value is not affected except that credit losses recognized are limited to the amount by which fair value is below amortized cost and the credit loss adjustment is recognized through an allowance which may change over time but once recorded cannot subsequently be reduced to an amount below zero. Previously these credit loss adjustments were recorded as OTTI and were not reversed once recorded.
Mortgage Loans
Our mortgage loans are held on commercial real estate and are stated at the aggregate unpaid principal balances, net of any credit losses and valuation allowances. We identify loans for evaluation of credit loss primarily based on the collection experience of each loan. Mortgage loans are considered to have a credit loss 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. Credit losses are 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. Credit losses are included in net gains (losses) on investments 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 December 31, 2023 and December 31, 2022, there was a valuation allowance of $573 thousand and $83 thousand, respectively.
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.
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 generally 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 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 December 31, 2023:
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.
Under all tests described above, the DAC was still recoverable on the Core Life plus Non-Core Life and assumed life lines of business. 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 $0.3 million, while for the mortality scenario and the lapse scenario there would be no impact to benefit reserves.
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 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 of December 31, 2023, we had a 100% valuation allowance recorded against the deferred tax assets related to the non-life subgroup of our tax return. The Company also maintains a valuation allowance against a portion of the unrealized investment losses at December 31, 2022 in the life group. Valuation allowances are established because we determined that it is more likely than not that these assets will not be recoverable. The recording of the valuation allowance not related to investment losses, 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.
December 31, 2023
December 31, 2022
Life
Non-Life
Total
Life
Non-Life
Total
(dollars in thousands)
Deferred income tax assets, net
Total deferred tax assets
Total deferred tax liabilities
Net deferred tax asset (liability)
before valuation allowance
Valuation allowance
Deferred income tax asset, net
Principal Revenue & Expense Items
Revenues
Our primary revenue sources are net insurance premiums, commissions, net investment income, net gains (losses) on investments, insurance lead sales and other income.
Net Insurance 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.
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 & Other Segment.
Earned Commissions
Earned commission revenue consists of amounts received and due from insurance carriers on policies sold by Efinancial and is recorded in our Agency Segment. However, the commission revenue from sales of Fidelity Life policies, not included in the AmeriLife agreement, are eliminated in our Consolidated Statements of Operations, because Efinancial and Fidelity Life are affiliated.
Net Gains (Losses) on Investments
Net gains (losses) on investments result from sales of investment securities and net of allowances for 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. Included in other income are fees received from the licensing of our patented worksite product where the licensee is required under the agreement to pay a licensing fee as premiums are earned. The license of intellectual property rights for a licensing transaction in which consideration is tied to the subsequent sale or usage of intellectual property, the revenue recognition standard provides an exception to the recognition principle that is part of step 5 (i.e., recognize revenue when or as control of the goods or services is transferred to the customer). Under this sales- or usage-based royalty exception, an entity would not estimate the variable consideration from sales- or usage-based royalties. Instead, the entity would wait until the subsequent sale or usage occurs to determine the amount of revenue to recognize. Accordingly, licensing fee income under this arrangement is recognized as the licensee earns premiums.
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 & Other 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.
A mortization 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
Year Ended December 31,
(dollars in thousands)
Revenues
Net insurance premiums
Net investment income
Net (losses) gains on investments
Earned commissions
Insurance lead sales
Other income
Total revenues
Benefits and expenses
Life, annuity, and health claim benefits
Interest credited to policyholder account balances
Operating costs and expenses
Amortization of deferred policy acquisition costs
Total benefits and expenses
(Loss) income before income taxes
Income tax (benefit) expense
Net (loss) income
Year Ended December 31, 2023 Compared to Year Ended December 31, 2022
Total Revenues
For the year ended December 31, 2023, total revenues were $177.6 million compared to $163.9 million for the year ended December 31, 2022. This increase of $13.7 was primarily due to an increase in earned commissions and net investment income, partially offset by a decrease in net insurance premiums, a higher net loss on investments and a decrease in insurance lead sales.
Benefits and Expenses
For the year ended December 31, 2023, total benefits and expenses were $188.4 million compared to $186.5 million for the year ended December 31, 2022. This increase of $1.9 million was primarily due to higher operating expenses partially offset by amortization of deferred policy acquisition expenses.
Loss from Operations Before Income Taxes
For the year ended December 31, 2023, we had a loss before taxes of $10.9 million compared to a loss before taxes of $22.6 million for the year ended December 31, 2022. This decrease in loss of $11.7 million was primarily due to increases in earned commission, net investment income and lower deferred policy acquisition costs, partially offset by higher operating costs and expenses, lower net insurance premiums and higher net losses on investments.
Income Taxes
For the year ended December 31, 2023, our income tax benefit was $1.0 million compared to an income tax benefit of $2.1 million for the year ended December 31, 2022. The decreased benefit of $1.1 million reflects a smaller loss attributable to the life sub-group. The non-life sub-group has a full valuation allowance, therefore no income tax impact. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Income Taxes.”
Analysis of Segment Results
Reconciliation of Segment Results to Consolidated Results
The following analysis reconciles the reported segment results to the Vericity, Inc. total consolidated results.
Year Ended December 31,
(dollars in thousands)
(Loss) income before income tax by segment
Agency
Insurance
Corporate & Other
(Loss) income from operations before income tax
Income tax (benefit) expense
Net (loss) income
Agency Segment
The results of our Agency Segment were as follows:
Year Ended December 31,
(dollars in thousands)
Revenues
Earned commissions
Insurance lead sales & other
Total revenues
Expenses
Operating costs and expenses
Total expenses
Income (loss) before income taxes
Year Ended December 31, 2023 Compared to Year Ended December 31, 2022
Earned Commissions
For the year ended December 31, 2023, earned commissions were $60.3 million compared to $43.1 million for the year ended December 31, 2022. This increase of $17.2 million resulted primarily from increased sales in the retail channel.
Insurance Lead Sales & other
For the year ended December 31, 2023, insurance lead sales and other were $5.6 million compared to $4.9 million for the year ended December 31, 2022. This increase of $0.7 million was primarily due to higher click-through revenue.
Operating Costs and Expenses
For the year ended December 31, 2023, general operating expenses were $64.4 million compared to $56.7 million for the year ended December 31, 2022. This increase of $7.7 million was primarily due to an increase in variable costs.
Net (Loss) Income
For the year ended December 31, 2023, the Agency Segment had a net gain of $1.4 million compared to a net loss of $8.7 million for the year ended December 31, 2022. This increase in net income of $10.2 million was the result of higher earned commissions and insurance lead sales, partially offset by increased operating costs and expenses.
Insurance Segment
The results of our Insurance Segment were as follows:
Year Ended December 31,
(dollars in thousands)
Revenues
Net insurance premiums
Net investment income
Net (losses) gains on investments
Other income
Total revenues
Benefits and expenses
Life, annuity, and health claim benefits
Interest credited to policyholder account balances
Operating costs and expenses
Amortization of deferred policy acquisition costs
Total benefits and expenses
(Loss) income before income taxes
Year Ended December 31, 2023 Compared to Year Ended December 31, 2022
Net Insurance Premiums
For the year ended December 31, 2023, net insurance premiums were $96.8 million compared to $100.1 million for the year ended December 31, 2022. The decrease of $3.3 million was primarily due to a decrease in Core of $5.1 million driven mostly by a decrease in LBT of $8.8 million and RDL of $1.0 million, offset by Final Expense increase of $4.8 million and increases in Non-Core of $1.0 million and Closed Block of $1.0 million. The Swiss Re deal (see discussion earlier in this Management Discussion and Analysis of Financial Condition and Results of Operations) contributed a positive $7.3 million increase to the net premium from 2022 to 2023.
Net Investment Income
For the year ended December 31, 2023, net investment income was $16.3 million compared to $15.6 million for the year ended December 31, 2022. This increase was mainly due to higher reinvestment yields in the fixed maturities portfolio. For more information on net investment income, see “Note 2– Investments” in the Notes to the Interim Condensed Consolidated Financial Statements included in this Form 10-K.
Net (Losses) Gains on Investments
For the year ended December 31, 2023, net loss on investments was $2.1 million compared to a loss of $0.6 million for the year ended December 31, 2022. The $1.5 million decrease was mainly due to valuation changes of other invested assets. For more information on net gains (losses) on investments, see “Note 2– Investments” in the Notes to the Interim Condensed Consolidated Financial Statements included in this Form 10-K .
Life, Annuity and Health Claim Benefits
For the year ended December 31, 2023, life, annuity and health claim benefits were $67.7 million compared with $67.5 million for the year ended December 31, 2022. The increase of $0.2 million was primarily due to a $3.0 million increase in our Core lines and a $0.6 million increase in FKLA, partially offset by $3.2 million decrease in Non-Core lines and a decrease in $0.3 million in annuities. The impact of the reinsurance agreement with Swiss Re was a decrease in ceded benefits of $7.0 million (see discussion earlier in this Management Discussion and Analysis of Financial Condition and Results of Operations).
Interest Credited to Policyholder Account Balances
For the year ended December 31, 2023, interest credited was $2.6 million compared to $2.8 million for the year ended December 31, 2022. This decrease of $0.2 million was due to lower interest credited on assumed fixed annuity contract-holder account balances.
Operating Costs and Expenses
For the year ended December 31, 2023, general operating expenses were $31.3 million compared to $34.6 million for the year ended December 31, 2022. This decrease of $3.3 million was attributable , primarily to higher ceded allowances.
Amortization of Deferred Policy Acquisition Costs
For the year ended December 31, 2023, amortization of deferred acquisition costs was $13.9 million compared to $18.4 million for the year ended December 31, 2022. This decrease of $4.5 million includes a decrease in the Closed Block of $2.5 million and $3.9 million in our Core lines, partially offset by an increase of $1.9 million in our Non-Core lines.
Net (Loss) Income
For the year ended December 31, 2023, net loss was $3.5 million compared to a net loss of $7.7 million for the year ended December 31, 2022. The decrease in net loss of $4.2 million resulted from lower operating costs and expenses and amortization of deferred policy acquisition costs, partially offset by lower net insurance premiums and lower net gains on investments.
Closed Block
The Closed Block was formed as of October 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 the Illinois Department of Insurance.
Included in Closed Block assets at December 31, 2023 and December 31, 2022 are $11.1 million and $10.8 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.
Corporate & Other Segment
The results of the Corporate & Other Segment are as follows:
Year Ended December 31,
(dollars in thousands)
Revenues
Net investment income
Net (losses) gains on investments
Earned commissions
Total revenues
Expenses
Operating costs and expenses
Total expenses
(Loss) income from operations before income tax
Year Ended December 31, 2023 Compared to Year Ended December 31, 2022
Net Gains (Losses) on Investments
For the year ended December 31, 2023, net losses on investments were $0.4 million compared to a gain of $0.3 million for the year ended December 31, 2022. This change is attributable to net asset valuation changes of other invested assets.
Operating Expenses
For the year ended December 31, 2023, operating expenses were $8.4 million compared to $6.5 million for the year ended December 31, 2022. primarily related to $3.4 million of transaction costs related to the recent merger agreement with iA American Holdings, Inc., partially offset with lower staff 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 & Other 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 gains (losses) on investments 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.
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 by Standard & Poor’s (S&P), a nationally recognized statistical rating organization. For securities where the S&P rating is not available (not rated), the National 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 increased to 96.0% at December 31, 2023 from 95.1% at December 31, 2022 due to the S&P ratings on certain new securities acquired in our portfolio of distressed residential mortgage-backed securities.
Estimated Fair Value
December 31, 2023
December 31, 2022
(dollars in thousands)
S&P Rating
AAA
BBB
Not rated
Total investment grade
CCC
Not Rated
Total below investment grade
Total
The following table sets forth the maturity profile of our fixed maturity securities at December 31, 2023 and December 31, 2022. Expected maturities could differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without penalty.
December 31, 2023
December 31, 2022
(dollars in thousands)
Amortized
Cost
Fair Value
Amortized
Cost
Fair Value
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Securities not due at a single
maturity date-primarily mortgage
and asset-backed securities
Total fixed maturities
Every quarter, we review all investments where the market value is less than the carrying value to determine if a credit loss has occurred. 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—Change in Allowance for Credit Losses”.
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 $313.4 million and $298.1 million, and represented 86.2% and 84.3% of our invested assets, as of December 31, 2023 and December 31, 2022, 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 ended December 31, 2023 and December 31, 2022, our book yield on fixed maturity securities available-for-sale was 4.5% for the years ended December 31, 2023 and December 31, 2022.
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, 2023
December 31, 2022
Ending
Balance
Year to Date
Interest
Credited
Average Credit Rate
Ending
Balance
Year to Date
Interest
Credited
Average Credit Rate
(dollars in thousands)
Annuity contract holder deposits—assumed
Dividends left on deposit
Other
Total
The liability for deferred annuity deposits represents the contract-holder account balances. 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 Gains (Losses) on Investments
Net gains (losses) on investments are subject to general economic trends and in particular correlate generally with movements in the major equity market indexes. The amounts classified as investment 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 individual securities related to credit losses.
See “Note 2 – Investments” in the Notes to the Consolidated Financial Statements included in this Form 10-K.
Unrealized Holding Gains (Losses)
We also record capital appreciation/depreciation on our available-for-sale fixed maturity securities. We had Accumulated Other Comprehensive income of $9.0 million and a loss of $41.1 million, net of federal income taxes and reserve, for years ended December 31, 2023 and December 31, 2022, respectively.
At December 31, 2023 our fixed maturity securities had an unrealized loss of $22.8 million compared to an unrealized loss of $33.8 million at December 31, 2022. Duration measures the sensitivity of a bond’s price to changes in market yields and convexity measures a bond’s duration sensitivity to changes in market yields. The Company’s unrealized gain incurred in 2023 was $11.0 million in our fixed maturities portfolio which has a duration of 7.1, convexity of 0.791, and current yield of 5.6%, is accounted for by the fluctuation of the 10-year treasury bill yield in 2023 .
Financial Position
At December 31, 2023, we had total assets of $822.8 million compared to total assets at December 31, 2022 of $770.1 million, an increase of $52.7 million. Reinsurance recoverables increased $23.7 million as a result of a $22.4 million increase in ceded policy and claim reserves and $1.3 million related to timing of settlements of reinsured claims. Commission and agent balances increased $18.7 million mainly due to increased commission receivables in the Agency segment and increased agent debit balances in the insurance segment. The invested asset base increased $9.6 million, mainly due to $11.0 million in net unrealized gains partially offset by net sales of investments. Deferred income tax assets increased $4.0 million due to tax credits of $5.9 million as a result of a net loss, partially offset by $1.9 million of unrealized investment market gains. Accrued investment income increased $0.6 million due to timing of receipt of investment income. The above increases were partially offset by the following: Deferred policy acquisition costs decreased $2.1 million, resulting from amortization of $14.0 million being higher than deferrals of new business of $11.8 million and cash decreased $1.7 million primarily related to cash used from investing, offset by inflows from operating and financing.
At December 31, 2023, we had total liabilities of $712.6 million compared to total liabilities of $658.7 million at December 31, 2022, an increase of $53.9 million. Future policy benefits and claims increased $48.7 million, primarily due to a $49.8 million increase in Core Life and Non-Core Life lines, resulting from growth of the underlying blocks of business, partially offset by decreases in
Annuities and assumed life of $1.0 million and Closed Block of $0.1 million. Debt increased $11.8 million due increase in net borrowing of $9.2 million and interest accrued of $2.6 million under our commission financing agreement with Hannover Life. Other liabilities increased $6.0 million, due to an increase in operating liabilities. The above increases were partially offset by decreases in policyholder account balances of $6.7 million largely due to annuity payments and Other policyholder liabilities of $6.0 million due to a decrease in claim liabilities.
At December 31, 2023, total equity decreased to $110.2 million from $111.3 million at December 31, 2022. This decrease in equity of $1.1 million primarily consists of a net loss of $9.9 million and a increase of $8.9 million in 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 segment (i.e., commissions, underwriting and issue costs), cost of sales for Agency segment (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, Efinancial receives an upfront commission from Hannover Life on certain insurance products and agrees to pay levelized commissions back to Hannover Life over the period the policy stays in-force and premiums are received. On March 31, 2022, Efinancial entered into a new commission financing arrangement and is taking new advances on this financing arrangement. As of December 31, 2023 and December 31, 2022, we had net advances of $40.4 million and $31.1 million, respectively, under this arrangement.
We are a member of the Federal 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 $0.3 million, The Company's ability to borrow under this facility is subject to the FHLBC's discretion and requires the availability of qualifying assets. 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 borrowing. The Company borrowed and repaid $21 million and $4 million in 2023 and 2022, respectively.
Fidelity Life’s ability to pay dividends to Vericity Holdings, Inc. (VHI) is limited by the insurance laws of the State of Illinois. All shareholder dividends are subject to notice filings with the Illinois Director of Insurance. The maximum amount of dividends that can be paid by Illinois life insurance companies to shareholders without 30 days prior notice to the Illinois 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. Under Illinois 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 the Illinois Director of Insurance. There are no limitations on the amount of dividends that Efinancial can pay.
Cash inflows from operating activities come primarily from net insurance premiums, earned commissions and net investment income. Cash outflows from operations are the result of life, annuity and health claim benefits, operating expenses and income taxes.
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 is activity from our commission financing program.
Cash Flows
For the for the year ended December 31, 2023, the Company had a net decrease in cash of $1.7 million compared to a net decrease of $12.6 million for the year ended December 31, 2022.
The increase in cash flows from operating activities is primarily due to timing related to reinsurance recoverables and an increase in other policyholder liabilities.
Cash flows from investing activities mainly includes our fixed maturities and mortgage loans. Period to period, the cash flows associated with the changes in these portfolios will vary between cash sources and cash uses depending on the need for cash or the excess of cash from operating activities, as well as portfolio trading due to investment market conditions. In the year ended December 31, 2023, $6.7 million was used principally to acquire $5.6 million of capitalized software and $1.1 million of investment purchases net of sales and maturities.
Cash flows from financing activities was $0.1 million which includes $9.3 million net proceeds from our commission financing program, partially offset by $9.2 million, net of deposits by contract holders of annuities that were primarily written in the late 1980s.
The following table summarizes our cash flows for the years ended December 31, 2023 and 2022.
Year Ended December 31,
(dollars in thousands)
Consolidated Summary of Cash Flows
Net cash provided (used) by operating activities
Net cash (used) provided by investing activities
Net cash provided (used) by financing activities
Net (decrease) in cash, cash equivalents and restricted cash
Risk-Based Capital
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 at December 31, 2023 and 2022 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, 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 claim 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 effective July 1, 2013 that covered certain products with policies written on or before September 30, 2012. This agreement was first amended and restated as of July 1, 2016 and a subsequent amendment was filed with the Illinois Department of Insurance in November 2019 and approved by the Illinois Department of Insurance on December 23, 2019. The structure of the agreement, which was first effective July 1, 2013, involves a combination coinsurance with funds withheld and yearly renewable term reinsurance covering most of the Company’s non-participating in- life insurance business with issue dates on or before December 31, 2019. As of December 31, 2023 and December 31, 2022, the reserve credit net of funds held of ($67.6 million and $69.2 million for 2023 and 2022), respectively under this arrangement was approximately $145.3 million and $136.0 million, respectively.
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.
Quantitative and Qualitative Information about Market Risk
We own a diversified portfolio of investments including cash, bonds, commercial mortgages, and common stock. Each of these investments is subject, in varying degree, to market risk that can affect their return and their fair value. Bonds are the majority of our investments and include debt issues of corporations, residential and commercial mortgage-backed securities or other asset-backed securities, U.S. Treasury securities, or obligations of U.S. Government Sponsored Enterprises and are classified as fixed maturity investments in our financial statements. Our investment portfolios are subject to market risks.
Market risk is the risk that we will incur losses due to adverse changes in market rates and prices on the fair value of the investment securities that we own. We have exposure to market risk through our investment activities, including interest rate risk, credit risk, equity risk and foreign currency risk. We have not and do not plan to enter into any derivative financial instruments for trading or speculative purposes.
Interest Rate Risk
Interest rate risk arises from the price sensitivity of investments to changes in interest rates. The changes in the fair value of our fixed maturity investments are inversely related to changes in market interest rates. As market interest rates fall the fixed income streams of fixed maturity investments held become more valuable and market values rise. As market interest rates rise, the opposite effect occurs. Interest rate risk can also arise if market rates fall, which can result in lower interest spreads on our assumed annuity deposits, which are our primary interest rate sensitive liability.
We review the interest rate sensitivity of our available-for-sale fixed maturity securities by calculating the impact on the market value of our holdings that would result from a hypothetical instantaneous shift in market interest rates across all maturities, which we consider to be reasonably possible. The impact of such a parallel shift upward in the yield curve of 200 basis points would reduce the market value of our fixed maturity securities portfolio by $41.3 million (13.2%) and $39.4 million (13.2%) as of December 31, 2023 and December 31, 2022, respectively. The estimated market value changes assume all other factors are held constant and do not attempt to estimate any offsetting change in the value of our liabilities.
With regard to our assumed annuity deposits, we are subject to risk from contract-holder behavior resulting from changes in interest rates. The assumed annuity contracts have virtually no surrender charges remaining that could be assessed against withdrawals. When market interest rates exceed the amount that we are crediting on deposits, we are subject to higher contract-holder withdrawals or an increase in contract loans, both of which could force the Company to sell assets prematurely and could lead to the realization of capital losses on such sales. As of December 31, 2023, we were crediting interest at the minimum contract interest rate, which on a composite basis is approximately 3.9% annually. We manage our exposure to rising interest rates through our ability to increase the contract crediting rate. Our ability to increase our crediting rate is constrained by our portfolio yield at the time of the decision to increase rates. Increases in the contract crediting rates could reduce our income unless we are able to maintain a constant interest spread on our assets.
Credit Risk
Credit risk is the risk of loss due to an adverse change in the financial condition of a specific debt issuer or, in the case of a securitized investment, adverse change in the assets being securitized. We address credit risk by establishing minimum rating standards for investments that our portfolio managers can acquire and, in the case of a downgrade, continue to hold the investment. For our core fixed maturity portfolio, which comprises a significant majority of our invested assets, only investment grade securities (minimum credit rating for new investments is BBB- as established by Standard & Poor’s or a comparable nationally recognized statistical rating organization) can be purchased and such portfolio managers must maintain an overall credit rating for the portfolio of at least A-. Through our portfolio managers, we monitor the financial condition of all the issues of securities that we own. As an additional step to reduce our exposure to credit risk, we have established diversification guidelines limiting the total amount of holding by issuer and by investment sector.
Recent Accounting Pronouncements
All applicable adopted accounting pronouncements have been reflected in our consolidated financial statements as of and for the years ended December 31, 2023 and December 31, 2022.
