UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

____________________

 

FORM 10-Q/A

 

____________________

 

QUARTERLY REPORT

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

 

For the quarterly period ended March 31, 2009

 

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0-1999

(Commission file number)

 

INVESTORS HERITAGE CAPITAL CORPORATION

(Exact Name of Registrant as Specified in its Charter)

 

 

200 Capital Avenue, P.O. Box 717

Frankfort, Kentucky 40602

(Address of principal executive offices)

 

(502) 223-2361

(Registrant's telephone number, including area code)

 

____________________

 

Kentucky Investors, Inc.

(Former name, former address and former fiscal year, if changed since last report)

 

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

 

Yes [X]   No [  ]

 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [   ]   No [   ]

 

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

 

        Large accelerated filer     [  ]                                                                                        Accelerated filer   [  ]

        Non-accelerated filer      [  ] (Do not check if a smaller reporting company)   Smaller reporting company  [X]

 

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

 

Yes [  ]   No [X]

 

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

 

Common Capital Stock par value $1.00 per share

(Title of Class)

 

Number of outstanding shares as of March 31, 2009 -- 1,120,686.256

 

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CONTENTS

 

 

 

 

EXPLANATORY NOTE

 

We are filing Form 10-Q/A for the period ended March 31, 2009 for the purpose of restating our condensed consolidated financial statements as of and for the period ended March 31, 2009.  The restatement reflects the correction of a clerical error dating to 1998 in the calculation of insurance reserves on certain types of life policies, principally certain reduced paid-up and extended term life policies and policy riders.  We have recorded changes in the additional insurance reserves, related reinsurance recoverables and related deferred income tax asset in the consolidated financial statements for the periods presented herein.  These changes resulted in an increase in the net loss for the three months ended March 31, 2009 of $34,938.  The changes reduced net income for the three months ended March 31, 2008 by $29,243, thereby resulting in a net loss for that period of $9,049. The cumulative changes also resulted in a reduction in stockholders' equity at March 31, 2009 and December 31, 2008, of $889,533 and $854,595, respectively.  These changes also have an effect on previously disclosed data relative to segment information and comprehensive income (loss).  Accordingly, we have revised Notes G and I to the condensed consolidated financial statements to reflect these changes.  Additionally, we have adjusted certain comparison data included in management's discussion and analysis to account for these changes.  Please refer to Note K to the condensed consolidated financial statements for detailed information on the effects of these changes on individual financial statement line items.  We have not updated this Form 10-Q/A for events or information subsequent to the date of filing of the original Form 10-Q, except in connection with the foregoing.

 

 

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ITEM 1.  Condensed Consolidated Financial Statements

 

INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Balance Sheets (Unaudited)

 

 

See notes to consolidated financial statements.

 

3

 

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INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Income Statements (Unaudited)

 

 

See notes to consolidated financial statements.

 

4

 

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INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Statements of Stockholders' Equity (Unaudited)

 

 

See notes to consolidated financial statements.

 

5

 

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INVESTORS HERITAGE CAPITAL CORPORATION

Condensed Consolidated Statements of Cash Flows (Unaudited)

 

 

See notes to consolidated financial statements.

 

6

 

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INVESTORS HERITAGE CAPITAL CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2009

(Unaudited)

 

NOTE A - Nature of Operations

Investors Heritage Capital Corporation (formerly known as Kentucky Investors, Inc. prior to the name change effective June 1, 2009) is the holding company of Investors Heritage Life Insurance Company; Investors Heritage Printing, Inc., a printing company; Investors Heritage Financial Services Group, Inc., an insurance marketing company; is the sole member of At Need Funding, LLC, a limited liability company that provides advance funding of funerals in exchange for the irrevocable assignment of life insurance policies from other nonaffiliated companies; and is the sole member of Heritage Funding, LLC, a limited liability company that invests in various business ventures. These entities are collectively hereinafter referred to as the "Company". Approximately 99% of Investors Heritage Capital's consolidated revenue is generated by Investors Heritage Life.

 

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

 

NOTE B - Basis of Presentation

On December 22, 2009, the Company announced that it would restate its consolidated financial statement.  The accompanying consolidated financial statements have been restated for all periods presented.  The nature of the restatement and the effect on the financial statement line items are discussed in Note K.  In addition, certain disclosures in the following notes have been restated consistent with the consolidated financial statements.  The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2008, as included in our Annual Report on Form 10-K.

 

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

 

NOTE C -- New Accounting Pronouncements

In April 2009, the Financial Accounting Standards Board ("FASB") issued FASB Staff Position ("FSP") FAS 115-2 and FAS 124-2, "Recognition and Presentation of Other-Than-Temporary Impairments" ("FSP FAS 115-2").  FSP FAS 115-2 requires entities to separate an other-than-temporary impairment of a fixed maturity security into two components when there are credit related losses associated with the impaired fixed maturity security for which management asserts that it does not have the intent to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of its cost basis.  The amount of the other-than-temporary impairment related to a credit loss is recognized in earnings, and the amount of the other-than-temporary impairment related to other factors is recorded in other comprehensive loss.  FSP FAS 115-2 is effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  We elected to adopt FSP FAS 115-2 effective January 1, 2009.  As a result of the adoption of this standard, we recognized a cumulative effect adjustment of $409,483 (net of deferred income tax of $137,326) to move non-credit related other-than-temporary impairments previously recognized in earnings for the year ended December 31, 2008 from retained earnings to accumulated other comprehensive income (loss) for fixed maturity securities held at the date of adoption.

 

In April 2009, the FASB issued FSP FAS 157-4, "Determining Fair Value When Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that are Not Orderly" ("FSP FAS 157-4").   Under FSP FAS 157-4, if an entity determines that there has been a significant decrease in the volume and level of activity for the asset or the liability in relation to the normal market activity for the asset or liability (or similar assets or liabilities), then transactions or quoted prices may not accurately reflect fair value.   In addition, if there is evidence that the transaction for the asset or liability is not orderly, the entity shall place little, if any weight on that transaction price as an indicator of fair value.   FSP FAS 157-4 is effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.   We elected to adopt FSP FAS 157-4 effective January 1, 2009, and its adoption did not have a material impact on our consolidated financial condition or results of operations.

 

7.

 

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In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, "Interim Disclosures about Fair Value of Financial Instruments" ("FSP FAS 107-1 and APB 28-1").   FSP FAS 107-1 and APB 28-1 require disclosures about fair value of financial instruments in interim and annual financial statements.   FSP FAS 107-1 and APB 28-1 is effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.   We will adopt FSP FAS 107-1 and APB 28-1 effective for the second quarter of 2009 and will include the required disclosures at that time.

 

NOTE D -- Investments

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

 

 

8.

 

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

 

 

As of March 31, 2009, all of the above fixed maturity securities had a fair value to cost ratio equal to or greater than 46% and the equity securities noted above had a fair value to cost ratio of over 71%.   As of December 31, 2008, all of the above fixed maturity securities had a fair value to cost ratio equal to or greater than 61% and the equity securities noted above had a fair value to cost ratio of over 65%.  At March 31, 2009 and December 31, 2008, Investors Heritage Life's fixed maturity securities were 99.4% and 99.9% investment grade, respectively, as rated by Standard & Poor's.

 

9.

 

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The Company's decision to record an impairment loss is primarily based on whether the security's fair value is likely to remain significantly below its book value in light of all the factors considered. Factors that are considered include the length of time the security's fair value has been below its carrying amount, the credit worthiness of the issuer, and the coupon and/or dividend payment history of the issuer.  For any fixed maturity securities that are other-than-temporarily impaired, the guidance in FSP FAS 115-2 is applied to determine whether the other-than-temporary impairment is credit-related or related to other factors.  Only in the case of a credit-related impairment where management cannot assert that it does not have the intent to sell the security, or it is not more likely than not that it will not be required to sell the security before recovery of its cost basis, is a fixed maturity security adjusted to fair value and the resulting losses recognized in realized gains/losses in the consolidated statements of income.  Any other-than-temporary impairments on equity securities are recorded in the consolidated statements of income in the periods incurred as the difference between fair value and cost.  Based on our review, the Company did not experience any other-than-temporary impairments during the first quarter of 2009 or the first quarter of 2008.  The Company did experience certain other-than-temporary impairments relative to Lehman Holdings bonds, Fifth Third mutual funds, and Bank of America and JP Morgan bonds during the third and fourth quarters of 2008.  Upon adoption of FSP FAS 115-2, a cumulative effect adjustment (as discussed in Note C) was made to reflect the fact that the other-than-temporary impairments on the Bank of America and JP Morgan bonds were not credit-related but rather were related to other factors in the marketplace as management asserts that it does not have the intent to sell, and it is more likely than not that it will not be required to sell the securities before recovery of their cost basis.

 

In accordance with SFAS No. 115, net unrealized gains for investments classified as available-for-sale are presented below, net of the effect on deferred income taxes and deferred acquisition costs assuming that the appreciation (depreciation) had been realized.

 

 

The amortized cost and fair value of fixed maturity securities at March 31, 2009, by contractual maturity, are presented below.  Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

10.

 

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Proceeds for the three months ended March 31, 2009 and 2008 from sales and maturities of investments in available-for-sale securities were $15,077,571 and $8,030,055, respectively.  Gross gains of $71,535 and $368 and gross losses of $1,929 and $1,839 were realized on those sales during the three month periods ended March 31, 2009 and 2008, respectively.

 

Presented below is investment information, including the accumulated and annual change in net unrealized investment gains or losses.  Additionally, the table shows the annual change in net unrealized investment gains (losses) and the amount of realized investment gains (losses) on debt and equity securities for the three months ended March 31, 2009 and 2008.

 

 

Major categories of net investment income are summarized as follows:

 

 

NOTE E -- Fair Values of Financial Instruments

Statement of Financial Accounting Standards ("SFAS") No. 157, "Fair Value Measurements" ("SFAS No. 157") defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measurements.  Fair value is defined under SFAS No. 157 as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  We also consider the impact of a significant decrease in volume and level of activity for an asset or liability when compared with normal activity in accordance with FSP FAS 157-4.

 

The Company holds fixed maturities and equity securities that are measured and reported at fair market value on the balance sheet.  The Company determines the fair market values of its financial instruments based on the fair value hierarchy established in SFAS No. 157 that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The standard describes three levels of inputs that may be used to measure fair value, as follows:

 

Level 1 - Quoted prices in active markets for identical assets or liabilities. The Company's Level 1 assets and liabilities include debt and equity securities that are traded in an active exchange market, as well as certain U.S. Treasury securities that are highly liquid and are actively traded in over-the-counter markets.

 

Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The Company's Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments or assets and liabilities whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes U.S. Government and agency mortgage-backed debt securities and corporate debt securities.

 

11.

 

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Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. The Company's Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. This category generally includes certain private equity investments and asset-backed securities where independent pricing information was not able to be obtained for a significant portion of the underlying assets.

 

In accordance with SFAS No. 157, the Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into the three-level fair value hierarchy.  If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.  A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the valuation inputs, or their ability to be observed, may result in a reclassification for certain financial assets or liabilities. Reclassifications impacting Level 3 of the fair value hierarchy are reported as transfers in/out of the Level 3 category as of the beginning of the period in which the reclassifications occur.

 

The following table presents the Company's fair value hierarchy for those financial instruments measured at fair value on a recurring basis as of March 31, 2009 and December 31, 2008, respectively.

 

 

12.

 

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At March 31, 2009, Level 3 financial instruments consisted of five corporate securities, one U.S. government obligation, two asset-backed securities, one corporate redeemable preferred stock and one common stock, where trading has been limited.  At December 31, 2008, Level 3 financial instruments consisted of four corporate securities, one U.S. government obligation, two asset-backed securities, one corporate redeemable preferred stock and one common stock, where trading has been limited.  The fair values for these securities were primarily determined through the use of non-binding broker quotes and internal models using unobservable assumptions about market participants.  The following table provides a summary of changes in fair value of our Level 3 financial instruments for the three month periods ended March 31, 2009 and 2008, respectively.

 

 

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

 

NOTE F - Earnings per Share and Stock-Based Compensation

Earnings per share of common stock were computed based on the weighted average number of common shares outstanding during each period. The weighted average number of shares outstanding for the three months ended March 31, 2009 and 2008 were 1,120,686 and 1,115,108, respectively.

 

The Company's only outstanding stock options and stock appreciation rights were issued in 1999. We account for our stock-based incentive program under SFAS No. 123(R), "Share-Based Payment," which requires all share-based payments to employees to be recognized as compensation expense in the consolidated income statement. We adopted the provisions of SFAS No. 123(R) using the modified prospective method in which compensation expense is recognized based on the requirements of SFAS No. 123, "Accounting for Stock-Based Compensation," for all awards granted to employees prior to January 1, 2006. Under this method, our stock-based compensation is reported in the balance sheets as a liability based on the intrinsic value of the award, and compensation expense is measured as the change in intrinsic value. 

 

Under our stock option and stock appreciation rights plan, there were 61,125 outstanding options, having an exercise price of $23.00 per share, as of March 31, 2009 and 2008. We recognized a decrease in compensation expense relative to the outstanding options of $213,938 for the three month period ended March 31, 2009 compared to an increase in compensation expense of $45,844 associated with such options for the three month period ended March 31, 2008. These changes in compensation expense were based on changes in the market value of the Company's stock compared to the exercise price of the options as of those dates.

 

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NOTE G - Segment Data

We operate in four segments as shown in the following table. All segments include both individual and group insurance. Identifiable revenues and expenses are assigned directly to the applicable segment. Net investment income is generally allocated to the insurance and the corporate segments in proportion to policy liabilities and stockholders' equity, respectively. Realized gains and losses, including realized losses as a result of other-than-temporary impairments, are allocated to the Corporate and Other segment.  Investors Heritage Financial revenue and income associated with credit administrative services is assigned to that segment, with any remaining revenue and income assigned to the Corporate and Other segment.  Results for the parent company, Investors Heritage Printing, At Need Funding and Heritage Funding, after elimination of intercompany amounts, are allocated to the Corporate and Other segment.

 

 

NOTE H -- Federal Income Taxes

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

 

We file U.S. federal income tax returns and income tax returns in various state jurisdictions. Our 2005 through 2008 U.S. federal tax years remain subject to income tax examination by tax authorities.  We have no known uncertain tax benefits within our provision for income taxes. In addition, we do not believe the Company will be subject to any penalties or interest relative to any open tax years and, therefore, have not accrued any such amounts.  However, should such a circumstance arise, it is our policy to classify any interest and penalties (if applicable) as income tax expense in the financial statements.

 

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NOTE I -- Comprehensive Income (Loss)

The components of comprehensive income (loss), net of related federal income taxes, are as follows:

 

 

NOTE J -- Employee Benefit Plans

We sponsor a noncontributory pension plan which covers substantially all employees. Benefits are based on years of service and the highest consecutive 60 months average earnings within the last 120 months of credited service. Benefits are funded based on actuarially-determined amounts.

 

The following table provides the components of our net periodic benefit cost:

 

 

We previously disclosed in our financial statements for the year ended December 31, 2008 that we expected to contribute $972,000 to our pension plan in 2009. As of March 31, 2009, $243,000 had been contributed. We presently anticipate contributing an additional $729,000 to fund our pension plan in 2009.

 

 

NOTE K -- Restatement of Financial Statements

 

We have restated our previously issued condensed consolidated financial statements as of and for the period ended March 31, 2009 (and comparative prior period) to account for the impact of a clerical error in the calculation of insurance reserves on certain types of life policies, principally certain reduced paid-up policies, extended term policies and policy riders.  This clerical error, which originated in 1998, has resulted in understatements of Benefit reserves and related Amounts recoverable from reinsurers, along with Deferred federal income tax assets.  We have reflected the effects of these changes in the condensed consolidated financial statements for the period presented herein.  We have also revised Notes G (segment data) and I (comprehensive income) to reflect these changes.

 

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The effect of this change on the condensed consolidated financial statements previously filed within this Form 10-Q as of and for the period ended March 31, 2009, is  as follows:

 

 

 

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

 

RESTATEMENT OF FINANCIAL STATEMENTS

We have restated our previously filed condensed consolidated financial statements for the period ended March 31, 2009 (and comparative prior period) to account for the impact of a clerical error in the calculation of reserves on certain types of life policies, principally certain reduced paid-up policies, extended term policies and policy riders.  This clerical error, which originated in 1998, has resulted in understatements of Benefit reserves and related Amounts recoverable from reinsurers along with Deferred federal income tax assets.  We have recorded changes in the additional insurance reserve, associated reinsurance amounts and deferred income tax assets in the condensed consolidated financial statements of income for the periods presented herein.  These changes resulted in an increase in net loss for the three months ended March 31, 2009 of $34,938.  The changes reduced net income for the three months ended March 31, 2008 by $29,243, thereby resulting in a net loss for that period of $9,049.  The cumulative changes resulted in a reduction in stockholders' equity at March 31, 2009 and December 31, 2008 of $889,533 and $854,595, respectively.

 

These changes have an effect on previously disclosed data relative to segment information and comprehensive income (loss).  Accordingly, we have revised Notes G and I to reflect the restatement.  Additionally, we have adjusted various comparison data within management's discussion and analysis to reflect these changes.  Please refer to Note K for detailed information on the effects of these changes on individual condensed consolidated financial statement line items.

 

GENERAL

 

Investors Heritage Capital Corporation (formerly known as Kentucky Investors, Inc. prior to name change effective June 1, 2009) is incorporated under the laws of the Commonwealth of Kentucky and wholly owns Investors Heritage Life Insurance Company, a life insurance company also incorporated under the laws of the Commonwealth of Kentucky. Investors Heritage Capital also wholly owns Investors Heritage Financial Services Group, Inc., a Kentucky insurance marketing company; Investors Heritage Printing, Inc., a Kentucky printing company that provides printing to Investors Heritage Life and other unaffiliated parties; is the sole member of At Need Funding, LLC, a Kentucky limited liability company that provides advance funding of funerals in exchange for the irrevocable assignment of life insurance policies from other nonaffiliated companies; and is the sole member of Heritage Funding, LLC, a limited liability company that invests in various business ventures.

 

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

 

In late 2007, we introduced the Legacy Gold product series, a new generation of life insurance and annuity products marketed in conjunction with prearranged funerals.  As a part of the process, we performed detailed analysis of the preneed market and of the characteristics of our particular block of business.  We believe that the result of these efforts is a very marketable product that balances profitability with competitive commissions and death benefit growth to provide adequate proceeds to cover funeral expenses and personal needs.  Underwritten and guaranteed issue options are available.  This product series replaced the Legacy Protector and Legacy Preferred series of life insurance and annuity products during early 2008.

 

The Heritage Final Expense product is sold in the final expense markets.  Introduced in 2002, it is reinsured on an 80% quota share basis exclusively with Munich American Reassurance Company.  This reinsurance arrangement has helped to reduce first year statutory surplus strain associated with new sales and should provide a stable profit stream for the future.  During the fourth quarter of 2008, this product was replaced by the new Heritage Final Expense II product, which incorporates the 2001 CSO table while also improving the marketability and profitability of the product.

 

In late 2008 we updated two of our products within this line to incorporate the 2001 CSO table while enhancing the marketability and profitability of these products.  The HLW Choice Whole Life replaced the Life Paid Up at 95 and the Heritage Protector IV replaced the Heritage Protector III.

 

Investors Heritage Life continues to market its third-party administrative ("TPA") services as an additional revenue source.  We currently have five TPA clients for which we provide tailored services to meet each client's individual business needs. We have been able to perform services for these clients using our existing in-house resources.

 

Our primary uses of cash are ongoing operating expenses, debt service and dividend payments. Our principal sources of cash are the dividends paid to us by Investors Heritage Life and Investors Heritage Financial. Investors Heritage Life's principal sources of cash are proceeds received from the sale of life insurance policies, administrative service fees and investment income, including realized gains (losses), less interest credited and benefits to policyholders and expenses.

 

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

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

 

Investments in Fixed Maturities, Equity Securities and Mortgage Loans

We hold fixed maturities and equity interests in a variety of companies.  Additionally, we originate, underwrite and manage mortgage loans.  We continuously evaluate all of our investments based on current economic conditions, credit loss experience and other developments.  We evaluate the difference between the cost/amortized cost and estimated fair value of our investments to determine whether any decline in value is other-than-temporary in nature.  This determination involves a degree of uncertainty.  If a decline in the fair value of a security is determined to be temporary, the decline is recorded as an unrealized loss in stockholders' equity. If a decline in a security's fair value is considered to be other-than-temporary, we utilize the provisions of SFAS 115 and FSP FAS 115-2 in determining the proper treatment for the other-than-temporary impairment.  Our adoption of FSP FAS 115-2 during the first quarter of 2009 amends the determination of other-than-temporary impairments for debt securities (see Note C), but not for equity securities.  For debt securities, the amount of any other-than-temporary impairment related to a credit loss is recognized in earnings and reflected as a reduction in the cost basis of the security; and the amount of any other-than-temporary impairment related to other factors is recorded in other comprehensive loss with no change to the cost basis of the security.  For equity securities, the amount of any other-than-temporary impairment is recognized in earnings and reflected as a reduction in the cost basis of the security.

 

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

 

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

 

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Deferred Acquisition Costs

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

 

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

 

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

 

Policy Liabilities

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

 

Income Taxes

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

 

Accrued Pension Expense

We maintain a defined benefit retirement plan on behalf of our employees.  Measurement of the future benefit obligations associated with this plan involves significant judgment, particularly in regard to the expected long-term rate of return on plan assets, rate of compensation increases and the current discount rate used to calculate the present value of future obligations.  Changes in these assumptions can significantly impact the accrued pension liability and net periodic benefit expense recorded in the financial statements.

 

The Pension Protection Act of 2006 was passed by legislators and signed by the President on August 17, 2006 to address the funding mechanisms of pension plans. The Act alters the traditional formula under which plan liabilities must be funded, and it may result in significantly increased future funding costs depending on investment returns.  Although increased contributions are not yet required under the funding formula, we have voluntarily increased the projected contribution to our pension plan for 2009 by approximately $100,000 above our prior year contribution.

 

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New Accounting Pronouncements

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, "Recognition and Presentation of Other-Than-Temporary Impairments" ("FSP FAS 115-2").  FSP FAS 115-2 requires entities to separate an other-than-temporary impairment of a fixed maturity security into two components when there are credit related losses associated with the impaired fixed maturity security for which management asserts that it does not have the intent to sell the security, and it is more likely than not that it will not be required to sell the security before recovery of its cost basis.  The amount of the other-than-temporary impairment related to a credit loss is recognized in earnings, and the amount of the other-than-temporary impairment related to other factors is recorded in other comprehensive loss.  FSP FAS 115-2 is effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  We elected to adopt FSP FAS 115-2 effective January 1, 2009.  As a result of the adoption of this standard, we recognized a cumulative effect adjustment of $409,483 (net of deferred income tax of $137,326) to move non-credit related other-than-temporary impairments previously recognized in earnings for the year ended December 31, 2008 from retained earnings to accumulated other comprehensive income (loss) for fixed maturity securities held at the date of adoption.

 

In April 2009, the FASB issued FSP FAS 157-4, "Determining Fair Value When Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that are Not Orderly" ("FSP FAS 157-4").   Under FSP FAS 157-4, if an entity determines that there has been a significant decrease in the volume and level of activity for the asset or the liability in relation to the normal market activity for the asset or liability (or similar assets or liabilities), then transactions or quoted prices may not accurately reflect fair value.   In addition, if there is evidence that the transaction for the asset or liability is not orderly, the entity shall place little, if any weight on that transaction price as an indicator of fair value.   FSP FAS 157-4 is effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.   We elected to adopt FSP FAS 157-4 effective January 1, 2009, and its adoption did not have a material impact on our consolidated financial condition or results of operations.

 

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, "Interim Disclosures about Fair Value of Financial Instruments" ("FSP FAS 107-1 and APB 28-1").   FSP FAS 107-1 and APB 28-1 require disclosures about fair value of financial instruments in interim and annual financial statements.   FSP FAS 107-1 and APB 28-1 is effective for periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.   We will adopt FSP FAS 107-1 and APB 28-1 effective for the second quarter of 2009 and will include the required disclosures at that time.

 

Refer to Notes D and E of the condensed consolidated financial statements for more explanation of these new pronouncements as well as for the required disclosures.

 

INVESTMENTS, LIQUIDITY AND CAPITAL RESOURCES

 

Investments

Investors Heritage Life maintains a sound, conservative investment strategy. At March 31, 2009, 89.2% of invested assets consisted of fixed income securities compared to 89.2% at December 31, 2008. At March 31, 2009 and December 31, 2008, Investors Heritage Life's fixed income investments were 99.4% and 99.9% investment grade, respectively, as rated by Standard & Poor's.

 

During 2008, we recognized an other-than-temporary impairment loss relative to the two Lehman Brothers Holdings bonds in our portfolio that are in default, each with a par value of $2,000,000.  While we have written down these securities to fair value, we continue to work with our investment advisor to estimate a recovery value on the bonds.  Our current estimates are that we will ultimately recover anywhere from approximately 21%-60% of the par value on the bonds.  We are amortizing the bond values up to the low end of this range and plan to continue to hold these securities in expectation of future recoveries.

 

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We have reviewed our investment portfolio and do not believe that there are additional securities that are other-than-temporarily impaired at March 31, 2009 beyond those impairments taken previously.  Other than the Lehman Brothers Holdings bonds, none of Investors Heritage Life's fixed income assets are in default and there has been no material change in the distribution of its fixed income portfolio.

 

We continuously monitor the investment risk within our portfolio, including the risk associated with subprime lending with our CMO investments.  As of March 31, 2009, we have only one CMO, with a fair value of approximately $47,000, which has any level of direct subprime exposure.  Based on our analysis, we believe this investment is of high quality and expect no losses as a result of the current subprime concerns.

 

Additionally, Investors Heritage Life engages in commercial and residential mortgage lending, with approximately 99.9% of these investments being in commercial properties. All mortgage loans are either originated in-house or through two mortgage brokers, and all loans are secured by first mortgages on the real estate.  Loan to value ratios of 80% or less and debt service coverage from existing cash flows of 115% or higher are generally required.  We minimize credit risk in our mortgage loan portfolio through various methods, including stringently underwriting the loan request, maintaining small average loan balances, reviewing larger mortgage loans on an annual basis and diversifying the portfolio by property type.  At March 31, 2009, 7.1% of invested assets consisted of mortgage loans compared to 7.0% at December 31, 2008. We anticipate funding several new mortgage loan investments during the remainder of 2009 to maintain a similar to slightly higher percentage of mortgage loans to total invested assets. As of March 31, 2009, Investors Heritage Life had no non-performing mortgage loans, which would include loans past due 90 days or more, loans in process of foreclosure, restructured loans and real estate acquired through foreclosure.

 

Liquidity and Capital Resources

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

 

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

 

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

 

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

 

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

 

We assess our compliance with prescribed debt covenant requirements as outlined in the terms of each debt agreement at least annually, if not otherwise required in the debt agreement.  Management has assessed our position and as of March 31, 2009, we are in compliance with all debt covenant requirements.

 

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

 

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

 

RESULTS OF OPERATIONS

 

Overview

Premiums earned (net of reinsurance) were $7,902,301 for the first quarter of 2009 (a decrease of 1.7% compared to the first quarter of 2008). This decrease was primarily due to the current poor economic conditions that have limited disposable income typically used for new sales in many of our markets.  Total revenue was $12,628,833 for the first quarter of 2009 (a decrease of 1.0% compared to the first quarter of 2008).

 

Total benefits and expenses were $12,709,461 in the first quarter of 2009 (a decrease of 0.4% compared to the first quarter of 2008). This decrease correlates with the decrease in new business generated.

 

Net investment income was $4,440,161 for the first quarter of 2009 compared to $4,440,439 for the first quarter of 2008. The fluctuating economic environment continues to put pressure on new investment yields.

 

After providing for federal income taxes, our net loss was $61,507 with a loss per share of $0.05 for the first quarter of 2009 as compared to a net loss of $9,049 and a loss per share of $0.01 for the first quarter of 2008.

 

In light of prior year losses due to other-than-temporary impairments, we elected not to pay our typical annual dividend during the first quarter of 2009.

 

Business Segments 

We internally evaluate the performance of our operations by the following four business segments:

 

Preneed and Burial Products include both life and annuity products sold by funeral directors or affiliated agents to fund prearranged funerals. Revenues for this segment were $9,734,705 for the first quarter of 2009 (an increase of 1.7% compared to the first quarter of 2008). This increase is due primarily to increased preneed sales from the Legacy Gold preneed product series.  Pre-tax loss from operations was $321,976 for the three month period ended March 31, 2009 compared to a pre-tax loss from operations of $365,613 for the three month period ended March 31, 2008.  This improvement was also driven by the increase in sales revenue.

 

Traditional and Universal Life Products include traditional life and group life insurance products, certain annuities and universal life products. Revenues for this segment were $2,478,715 for the first quarter of 2009 (a decrease of 9.7% compared to the first quarter of 2008). Revenues on this segment are primarily derived from the sale of term insurance products through banks, for which demand fluctuates along with economic conditions. New sales have suffered due to the tightening of consumer credit markets.  Pre-tax loss from operations was $104,890 for the three month period ended March 31, 2009 compared to pre-tax income of $63,084 for the three month period ended March 31, 2008. The decrease in pre-tax income is primarily attributable to lower sales and higher than anticipated death claims.

 

Credit Insurance Products and Administrative Services include the marketing and administration of credit life and credit accident and health insurance products. We reinsure 100% of the related underwriting risk currently produced within this segment.  Accordingly, revenue is generated primarily from servicing and administering the credit business for our reinsurers. Because the revenue is fee-based, segment performance is in direct relation to new premium production coupled with fees generated as premiums are earned. Premium production within this segment is also significantly affected by economic conditions within our credit markets, particularly Kentucky.  Revenues for this segment were $84,169 for the first quarter of 2009 (a decrease of 9.3% compared to the first quarter of 2008). Pre-tax income from operations was $46,164 for the three month period ended March 31, 2009 compared to $70,675 for the three month period ended March 31, 2008. These decreases in revenue and pre-tax income are directly related to lower premium production within this segment of the business due to current economic and lending conditions.

 

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Corporate and Other consists of corporate accounts measured primarily by stockholders' paid-in capital, contributed surplus, earned surplus, property and equipment, and other minor business lines which include group annuities and group and individual accident and health products. This segment also includes fees generated from our TPA arrangements. Revenues for this segment were $331,244 for the first quarter of 2009 (a decrease of 2.1% compared to the first quarter of 2008).  Pre-tax income from operations was $300,074 for the three month period ended March 31, 2009 compared to pre-tax income of $220,001 for the three month period ended March 31, 2008. The increase in pre-tax income is primarily driven by a reduction in the stock option compensation expense due to changes in market values of the options between the two periods, which is partially offset by higher general administrative expenses in the current year.

 

While we continue to expand the operations of Investors Heritage Financial, Investors Heritage Printing, At Need Funding and Heritage Funding, less than 1% of our consolidated revenues were generated by those subsidiaries. Approximately 7% of Investors Heritage Financial's revenue for the three month period ended March 31, 2009 was derived from the sale of Investors Heritage Life's credit insurance products. During the first three months of 2009, Investors Heritage Capital received dividends from Investors Heritage Financial totaling $68,000 and received distributions from At Need Funding of $33,000. We anticipate further dividend payments from Investors Heritage Financial and distributions from At Need Funding during the remainder of 2009.

 

Federal Income Taxes

The provision for federal income taxes is based on the estimated effective annual tax rate. Deferred taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Income before federal income taxes differs from taxable income principally due to the dividends-received deduction, the 404(k) dividend deduction and the small life insurance company tax deduction. The effective tax rate was 23.7% for the three month periods ended March 31, 2009 and 2008, respectively.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

We have no off-balance sheet arrangements as of March 31, 2009.

 

FORWARD LOOKING INFORMATION 

 

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

 

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

 

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Item 4T. Controls and Procedures

 

As of the end of the period covered by this Form 10-Q, we performed an evaluation, under the supervision and with the participation of management, including our Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rules 13a-15(e) of the Securities Exchange Act of 1934.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded in its original Quarterly Report on Form 10-Q for the period ended March 31, 2009 that our disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in this Quarterly Report on Form 10-Q.  Except as set forth below, there have been no significant changes in our internal controls or in other factors which could significantly affect internal controls over financial reporting during this most recent quarter or subsequent to the date we carried out our evaluation.  As a result of the restatement described in Note K to the condensed consolidated financial statements for the three months ended March 31, 2009, we have concluded that we did not maintain effective internal control over financial reporting in determining our insurance reserves for a limited block of our life policies and, as a result, a material weakness existed in our internal control over financial reporting relative to this portion of insurance reserves.  Solely as a result of this material weakness, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of March 31, 2009.  Concurrent with the filing of this quarterly report on Form 10-Q, we, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, again evaluated the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rules 13a-15(e) and 15(d)-15(e).  Based upon this subsequent evaluation, including the remedial actions described below, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.  We have implemented a new procedure to improve the control processes.  Specifically, we have instituted a control whereby key personnel involved in our financial reporting process review system reserve runs by plan code to confirm that our life insurance plans contain an appropriate insurance reserving code. 

 

Changes in Internal Control over Financial Reporting

 

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the most recent fiscal quarter ended March 31, 2009, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.  Subsequent to March 31, 2009, the Company implemented a new procedure that includes the formal review of the system reserve report by plan code to confirm proper reserve coding on all plan types. 

 

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ITEM 1. Legal Proceedings

 

Investors Heritage Capital Corporation (formerly known as Kentucky Investors, Inc. prior to name change effective June 1, 2009) is not involved in any legal proceedings. From time to time Investors Heritage Life is involved in litigation relating to claims arising out of its operations in the normal course of business. As of May 14, 2009, Investors Heritage Life is not a party to any legal proceedings, the adverse outcome of which, in management's opinion, individually or in the aggregate, would have a material adverse effect on our financial condition or results of operations. 

 

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

 

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

 

ITEM 3. Defaults Upon Senior Securities

 

None

 

ITEM 4. Submission of Matters to a Vote of Security Holders

 

None

 

ITEM 5. Other Information

 

 None

 

ITEM 6. Exhibits

 

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

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