SECURITY NATIONAL FINANCIAL CORPORATION Overview
The Company's operations over the last several years generally reflect three trends or events which the Company expects to continue: (i) increased attention to "niche" insurance products, such as the Company's funeral plan policies and traditional whole life products; (ii) emphasis on cemetery and mortuary business; and (iii) capitalizing on relatively low interest rates by originating mortgage loans. Insurance Operations
The following table shows the condensed financial results for the Company's
insurance operations for the years ended
Years ended December 31
(in thousands of dollars)
2019 vs 2018
% Increase
2019 2018 (Decrease)
Revenues from external customers:
Insurance premiums $ 81,861 $ 75,929 8 %
Net investment income 41,611 38,720 7 %
Gains (losses) on investments and other assets 138 21,396 (99 %)
Other 2,129 1,637 30 %
Total $ 125,739 $ 137,682 (9 %)
Intersegment revenue $ 4,455 $ 3,973 12 %
Earnings before income taxes $ 6,565 $ 30,124 (78 %)
Intersegment revenues for the Company's insurance operations were primarily
interest income from the warehouse lines provided to its mortgage lending
affiliates to fund loans held for sale. Profitability in 2019 decreased due to
the one-time gain of
Cemetery and Mortuary Operations
The following table shows the condensed financial results for the Company's
cemetery and mortuary operations for the years ended
Years ended December 31
(in thousands of dollars)
2019 vs 2018
% Increase
2019 2018 (Decrease)
Revenues from external customers:
Mortuary revenues $ 6,541 $ 5,514 19 %
Cemetery revenues 8,755 8,213 7 %
Net investment income 580 283 105 %
Gains on investments and other assets 530 2,301 (77 %)
Other 95 129 (26 %)
Total $ 16,501 $ 16,440 0 %
Earnings before income taxes $ 2,660 $ 3,916 (32 %)
18-------------------------------------------------------------------------------- Included in net investment income was net rental income from residential and commercial properties purchased from Security National Life.Memorial Estates purchased these properties from financing provided by Security National Life. The rental income was offset by property insurance, taxes, maintenance expenses and depreciation.Memorial Estates recorded depreciation on these properties of$452,000 and$598,000 for the twelve months endedDecember 31, 2019 and 2018, respectively. Profitability in 2019 has decreased due to a one-time gain on the sale of assets ofDeseret Mortuary recognized in 2018, offset by increases in cemetery and mortuary revenues for 2019.
Mortgage Operations
The Company's wholly owned subsidiaries,SecurityNational Mortgage andEverLEND Mortgage Company , are mortgage lenders incorporated under the laws of theState of Utah and approved and regulated by theFederal Housing Administration (FHA), a department of theU.S. Department of Housing and Urban Development (HUD), which originate mortgage loans that qualify for government insurance in the event of default by the borrower, in addition to various conventional mortgage loan products.SecurityNational Mortgage and EverLEND Mortgage originate and refinance mortgage loans on a retail basis. Mortgage loans originated or refinanced by the Company's mortgage subsidiaries are funded through loan purchase agreements with Security National Life and unaffiliated financial institutions. The Company's mortgage subsidiaries receive fees from borrowers that are involved in mortgage loan originations and refinancings, and secondary fees earned from third party investors that purchase the mortgage loans originated by the mortgage subsidiaries. Mortgage loans originated by the mortgage subsidiaries are generally sold with mortgage servicing rights released to third-party investors or retained bySecurityNational Mortgage .SecurityNational Mortgage currently retains the mortgage servicing rights on approximately 19% of its loan origination volume. These mortgage loans are serviced by eitherSecurityNational Mortgage or an approved third-party sub-servicer. For the twelve months endedDecember 31, 2019 and 2018,SecurityNational Mortgage originated 10,885 loans ($2,534,399,000 total volume) and 10,252 loans ($2,150,933,000 total volume), respectively. For the twelve months endedDecember 31, 2019 and 2018, EverLEND Mortgage originated 275 loans ($72,440,000 total volume) and 173 loans ($43,675,000 total volume), respectively.
The following table shows the condensed financial results for the Company's mortgage operations for the years ended 2019 and 2018. See Note 15 of the Notes to Consolidated Financial Statements.
Years ended December 31
(in thousands of dollars)
2019 vs 2018
% Increase
2019 2018 (Decrease)
Revenues from external customers:
Income from loan originations $ 38,394 $ 35,769 7 %
Secondary gains from investors 93,582 80,417 16 %
Net investment income 829 910 (9 %)
Gains on investments and other assets 60 243 (75 %)
Other 7,956 8,157 (2 %)
Total $ 140,821 $ 125,496 12 %
Earnings before income taxes $ 4,718 $ (7,860 ) 160 %
Included in other revenues is service fee income. The increase in revenues for
the Company's mortgage operations for the twelve months ended December 31, 2019
as compared to December 31, 2018 was due to an increase in mortgage loan
originations and refinancings, and subsequent sales into the secondary market.
Mortgage Loan Loss Settlements
Future loan losses can be extremely difficult to estimate. However, management believes that the Company's reserve methodology and its current practice of property preservation allow it to estimate potential losses on loans sold. The estimated liability for indemnification losses is included in other liabilities and accrued expenses and, as ofDecember 31, 2019 and 2018, the balances were$4,046,000 and$3,605,000 , respectively. 19
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Mortgage Loan Loss Litigation
For a description of the litigation involving
Significant Accounting Policies
The following is a brief summary of the Company's significant accounting policies and a review of the Company's most critical accounting estimates. See Note 1 of the Notes to Consolidated Financial Statements.
Insurance Operations
In accordance with generally accepted accounting principles inthe United States of America ("GAAP"), premiums and other considerations received for interest sensitive products are reflected as increases in liabilities for policyholder account balances and not as revenues. Revenues reported for these products consist of policy charges for the cost of insurance, administration charges, amortization of policy initiation fees and surrender charges assessed against policyholder account balances. Surrender benefits paid relating to these products are reflected as decreases in liabilities for policyholder account balances and not as expenses.
The Company receives investment income earned from the funds deposited into account balances, a portion of which is passed through to the policyholders in the form of interest credited. Interest credited to policyholder account balances and benefit claims in excess of policyholder account balances are reported as expenses in the consolidated financial statements.
Premiums and other considerations received for traditional life insurance products are recognized as revenues when due. Future policy benefits are recognized as expenses over the life of the policy by means of the provision for future policy benefits.
The costs related to acquiring new business, including certain costs of issuing policies and other variable selling expenses (principally commissions), defined as deferred policy acquisition costs, are capitalized and amortized into expense. For nonparticipating traditional life products, these costs are amortized over the premium paying period of the related policies, in proportion to the ratio of annual premium revenues to total anticipated premium revenues. Such anticipated premium revenues are estimated using the same assumptions used for computing liabilities for future policy benefits and are generally "locked in" at the date the policies are issued. For interest sensitive products, these costs are amortized generally in proportion to expected gross profits from surrender charges and investment, mortality and expense margins. This amortization is adjusted when the Company revises the estimate of current or future gross profits or margins. For example, deferred policy acquisition costs are amortized earlier than originally estimated when policy terminations are higher than originally estimated or when investments backing the related policyholder liabilities are sold at a gain prior to their anticipated maturity. Death and other policyholder benefits reflect exposure to mortality risk and fluctuate from year to year on the level of claims incurred under insurance retention limits. The profitability of the Company is primarily affected by fluctuations in mortality, other policyholder benefits, expense levels, interest spreads (i.e., the difference between interest earned on investments and interest credited to policyholders) and persistency. The Company has the ability to mitigate adverse experience through sound underwriting, asset and liability duration matching, sound actuarial practices, adjustments to credited interest rates, policyholder dividends and cost of insurance charges.
Cemetery and Mortuary Operations
Pre-need sales of funeral services and caskets, including revenue and costs associated with the sales of pre-need funeral services and caskets, are deferred until the services are performed or the caskets are delivered.
Pre-need sales of cemetery interment rights (cemetery burial property),
including revenue and costs associated with the sales of pre-need cemetery
interment rights, are recognized in accordance with the retail land sales
provisions of GAAP. Under GAAP, recognition of revenue and associated costs from
constructed cemetery property must be deferred until a minimum percentage of the
sales price has been collected. Revenues related to the pre-need sale of
unconstructed cemetery property will be deferred until such property is
constructed and meets the criteria of GAAP, described above.
Pre-need sales of cemetery merchandise (primarily markers and vaults), including
revenue and costs associated with the sales of pre-need cemetery merchandise,
are deferred until the merchandise is delivered, fulfilling the performance
obligation.
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Pre-need sales of cemetery services (primarily merchandise delivery and installation fees and burial opening and closing fees), including revenue and costs associated with the sales of pre-need cemetery services, are deferred until the services are performed.
Prearranged funeral and pre-need cemetery customer obtaining costs, including costs incurred related to obtaining new pre-need cemetery and prearranged funeral business are accounted for under the guidance of the provisions of GAAP. Obtaining costs, which include only costs that vary with and are primarily related to the acquisition of new pre-need cemetery and prearranged funeral business, are deferred until the merchandise is delivered or services are performed. Revenues and costs for atneed sales are recorded when a valid contract exists, the services are performed, collection is reasonably assured, and there are no significant company obligations remaining.
Mortgage Operations
Mortgage fee income consists of origination fees, processing fees, interest income and certain other income related to the origination and sale of mortgage loans. The Company has elected to use fair value accounting for all mortgage loans that are held for sale. Accordingly, all revenues and costs are now recognized when the mortgage loan is funded and any changes in fair value are shown as a component of mortgage fee income. The Company, through its mortgage subsidiaries, sells mortgage loans to third-party investors without recourse, unless defects are identified in the representations and warranties made at loan sale. It may be required, however, to repurchase a loan or pay a fee instead of repurchase under certain events, which include the following:
• Failure to deliver original documents specified by the investor,
• The existence of misrepresentation or fraud in the origination of the loan,
• The loan becomes delinquent due to nonpayment during the first several
months after it is sold,
• Early pay-off of a loan, as defined by the agreements, • Excessive time to settle a loan, • Investor declines purchase, and • Discontinued product and expired commitment. Loan purchase commitments generally specify a date 30 to 45 days after delivery upon which the underlying loans should be settled. Depending on market conditions, these commitment settlement dates can be extended at a cost to the Company. It is the Company's policy to cure any documentation problems regarding such loans at a minimal cost for up to a six-month time period and to pursue efforts to enforce loan purchase commitments from third-party investors concerning the loans. The Company believes that six months allows adequate time to remedy any documentation issues, to enforce purchase commitments, and to exhaust other alternatives. Remedial methods include the following:
• Research reasons for rejection,
• Provide additional documents,
• Request investor exceptions,
• Appeal rejection decision to purchase committee, and
• Commit to secondary investors.
Once purchase commitments have expired and other alternatives to remedy are exhausted, which could be earlier than the six-month time period, the loans are repurchased and transferred to mortgage loans held for investment at the lower of cost or fair value and the previously recorded sales revenue that was to be received from a third-party investor is written off against the loan loss reserve. Any loan that later becomes delinquent is evaluated by the Company at that time and any impairment is adjusted accordingly. Determining lower of cost or market. Cost for loans held for sale is equal to the amount paid to the warehouse bank and the amount originally funded by the Company. Market value, while often difficult to determine, is based on the following guidelines:
• For loans that are committed, the Company uses the commitment price.
• For loans that are non-committed that have an active market, the Company
uses the market price.
• For loans that are non-committed where there is no market but there is a
similar product, the Company uses the market value for the similar product.
• For loans that are non-committed where no active market exists, the Company
determines that the unpaid principal balance best approximates the market
value, after considering the fair value of the underlying real estate
collateral, estimated future cash flows, and loan interest rate.
21-------------------------------------------------------------------------------- The appraised value of the real estate underlying the original mortgage loan adds significance to the Company's determination of fair value because, if the loan becomes delinquent, the Company has sufficient value to collect the unpaid principal balance or the carrying value of the loan, thus minimizing credit risk. The majority of loans originated are sold to third-party investors. The amounts expected to be sold to investors are shown on the consolidated balance sheets as loans held for sale.
Use of Significant Accounting Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts and disclosures. It is reasonably possible that actual experience could differ from the estimates and assumptions utilized which could have a material impact on the financial statements. The following is a summary of our significant accounting estimates, and critical issues that impact them:
Loan Commitments
The Company estimates the fair value of a mortgage loan commitment based on the
change in estimated fair value of the underlying mortgage loan, quoted mortgage
backed security ("MBS") prices, estimates of the fair value of mortgage
servicing rights, and an estimate of the probability that the mortgage loan will
fund within the terms of the commitment net of estimated commission expense. The
change in fair value of the underlying mortgage loan is measured from the date
the mortgage loan commitment is issued and is shown net of related expenses.
Following issuance, the value of a loan commitment can be either positive or
negative depending upon the change in value of the underlying mortgage loans.
Fallout rates and other factors from the Company's recent historical data are
used to estimate the quantity and value of mortgage loans that will fund within
the terms of the commitments.
Deferred Acquisition Costs
Amortization of deferred policy acquisition costs for interest sensitive products is dependent upon estimates of current and future gross profits or margins on this business. Key assumptions used include the following: yield on investments supporting the liabilities, amount of interest or dividends credited to the policies, amount of policy fees and charges, amount of expenses necessary to maintain the policies, amount of death and surrender benefits, and the length of time the policies will stay in force. For nonparticipating traditional life products, these costs are amortized over the premium paying period of the related policies in proportion to the ratio of annual premium revenues to total anticipated premium revenues. Such anticipated premium revenues are estimated using the same assumption used for computing liabilities for future policy benefits and are generally "locked in" at the date the policies are issued. Value of Business Acquired Value of business acquired is the present value of estimated future profits of the acquired business and is amortized similar to deferred acquisition costs. The critical issues explained for deferred acquisition costs would also apply for value of business acquired.
Mortgage Loans Foreclosed to Real Estate Held for Investment
These properties are recorded at the lower of cost or fair value upon
foreclosure. The Company believes that in an orderly market, fair value
approximates the replacement cost of a home and the rental income provides a
cash flow stream for investment analysis. The Company believes the highest and
best use of the properties are as income producing assets since it is the
Company's intent to hold the properties as rental properties, matching the
income from the investment in rental properties with the funds required for
estimated future policy benefits. Accordingly, the fair value determination is
generally weighted more heavily toward the rental analysis. The fair value is
also estimated by obtaining an independent appraisal, which typically considers
area comparables and property condition.
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Future Policy Benefits
Reserves for future policy benefits for traditional life insurance products requires the use of many assumptions, including the duration of the policies, mortality experience, expenses, investment yield, lapse rates, surrender rates, and dividend crediting rates. These assumptions are made based upon historical experience, industry standards and a best estimate of future results and, for traditional life products, include a provision for adverse deviation. For traditional life insurance, once established for a particular series of products, these assumptions are generally held constant. Unearned Revenue The universal life products the Company sells have significant policy initiation fees (front-end load) that are deferred and amortized into revenues over the estimated expected gross profits from surrender charges and investment, mortality and expense margins. The same issues that impact deferred acquisition costs would apply to unearned revenue.
The revenue and cost associated with the sales of pre-need cemetery merchandise and funeral services are deferred until the merchandise is delivered or the service is performed.
The Company, through its cemetery and mortuary operations, provides a guaranteed funeral arrangement wherein a prospective customer can receive future goods and services at guaranteed prices. To accomplish this, the Company, through its life insurance operations, sells to the customer an increasing benefit life insurance policy that is assigned to the mortuaries. If, at the time of need, the policyholder or potential mortuary customer utilizes one of the Company's facilities, the guaranteed funeral arrangement contract that has been assigned will provide the funeral goods and services at the contracted price. The increasing life insurance policy will cover the difference between the original contract prices and current prices. Risks may arise if the difference cannot be fully met by the life insurance policy.
Mortgage Servicing Rights
Mortgage Service Rights ("MSR") arise from contractual agreements between the
Company and third-party investors (or their agents) when mortgage loans are
sold. Under these contracts, the Company is obligated to retain and provide loan
servicing functions on the loans sold, in exchange for fees and other
remuneration. The servicing functions typically performed include, among other
responsibilities, collecting and remitting loan payments; responding to borrower
inquiries; accounting for principal and interest; holding custodial (impound)
funds for payment of property taxes and insurance premiums; counseling
delinquent mortgagors; and supervising the acquisition of real estate owned and
property dispositions. The Company initially accounts for MSRs at fair value and
subsequently accounts for them using the amortization method. MSR amortization
is determined by amortizing the MSR balance in proportion to, and over the
period of the estimated future net servicing income of the underlying financial
assets. The Company periodically assesses MSRs accounted for using the
amortization method for impairment.
Mortgage Allowance for Loan Losses and Loan Loss Reserve
The Company provides for losses on its mortgage loans held for investment
through an allowance for loan losses (a contra-asset account) and through the
mortgage loan loss reserve (a liability account). The allowance for loan losses
is an allowance for losses on the Company's mortgage loans held for investment.
The allowance is comprised of two components. The first component is an
allowance for collectively evaluated impairment that is based upon the Company's
historical experience in collecting similar receivables. The second component is
based upon individual evaluation of loans that are determined to be impaired.
Upon determining impairment, the Company establishes an individual impairment
allowance based upon an assessment of the fair value of the underlying
collateral. In addition, when a mortgage loan is past due more than 90 days, the
Company does not accrue any interest income. When a loan becomes delinquent, the
Company proceeds to foreclose on the real estate and all expenses for
foreclosure are expensed as incurred. Once foreclosed, an adjustment for the
lower of cost or fair value is made, if necessary, and the amount is classified
as real estate held for investment. The Company will rent the properties until
it is deemed desirable to sell them.
The mortgage loan loss reserve is an estimate of probable losses at the balance
sheet date that the Company will realize in the future on mortgage loans sold to
third-party investors. The Company may be required to reimburse third-party
investors for costs associated with early payoff of loans within the first six
months of such loans and to repurchase loans where there is a default in any of
the first four monthly payments to the investors or, in lieu of repurchase, to
pay a negotiated fee to the investors. The Company's estimates are based upon
historical loss experience and the best estimate of the probable loan loss
liabilities.
23
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Upon completion of a transfer that satisfies the conditions to be accounted for
as a sale, the Company initially measures at fair value liabilities incurred in
a sale relating to any guarantee or recourse provisions in the event of defects
in the representations and warranties made at loan sale. The Company accrues a
monthly allowance for indemnification losses to investors based on total
production. This estimate is based on the Company's historical experience and is
included as a component of mortgage fee income. Subsequent updates to the
recorded liability from changes in assumptions are recorded in selling, general
and administrative expenses. The estimated liability for indemnification losses
is included in other liabilities and accrued expenses.
The Company believes the allowance for loan losses and the loan loss reserve represent probable loan losses incurred as of the balance sheet date.
Deferred Tax Assets and Liabilities
Deferred tax assets and liabilities require various estimates and judgments and may be affected favorably or unfavorably by various internal and external factors. These estimates and judgments occur in the calculation of certain deferred tax assets and liabilities that arise from temporary differences in the recognition of revenues and expenses for tax and financial reporting purposes and in estimating the ultimate amount of deferred tax assets recoverable in future periods. Factors affecting the deferred tax assets and liabilities include, but are not limited to, changes in tax laws, regulations and/or rates, changing interpretations of existing tax laws or regulations, and changes to overall levels of pre-tax earnings. Changes in these estimates, judgments or factors may result in an increase or decrease to the Company's deferred tax assets and liabilities with a related increase or decrease in the Company's provision for income taxes.
Results of Consolidated Operations
2019 Compared to 2018
Total revenues increased by$3,442,000 , or 1.2%, to$283,061,000 for 2019 from$279,619,000 for the fiscal year 2018. Contributing to this increase in total revenues was a$15,490,000 increase in mortgage fee income, a$5,932,000 increase in insurance premiums and other considerations, a$3,106,000 increase in net investment income, a$1,570,000 increase in net cemetery and mortuary sales, and a$257,000 increase in other revenues. This increase in total revenues was offset by a$23,213,000 decrease in gains on investments and other assets. Insurance premiums and other considerations increased by$5,932,000 , or 7.8%, to$81,861,000 for 2018, from$75,929,000 for the comparable period in 2018. This increase was primarily due to an increase in renewal premiums due to the growth of the Company in recent years, particularly in whole life products, which resulted in more premium paying business in force. Net investment income increased by$3,106,000 , or 7.8%, to$43,019,000 for 2019, from$39,913,000 for the comparable period in 2018. This increase was primarily attributable to a$1,315,000 increase in insurance assignment income, a$625,000 decrease in investment expenses, a$560,000 increase in interest income from cash and cash equivalents, a$408,000 increase in rental income from real estate held for investment, a$331,000 increase in fixed maturity securities income, a$145,000 increase in policy loan income, and a$76,000 increase in equity securities income. This increase was partially offset by a$311,000 decrease in interest from mortgage loans held for investment and a$43,000 decrease in income from other investments. Net mortuary and cemetery sales increased by$1,570,000 , or 11.4%, to$15,296,000 for 2019, from$13,726,000 for the comparable period in 2018. This increase was primarily due to a$1,019,000 increase in at-need sales in the mortuary operations and a$915,000 increase in at-need sales in the cemetery operations. This increase was partially offset by a$364,000 decrease in pre-need sales in the cemetery operations. Gains on investments and other assets decreased by$23,213,000 , or 97.0%, to$728,000 in gains for 2019, from$23,941,000 in gains for the comparable period in 2018. This decrease in gains on investments and other assets was primarily attributable to the$22,252,000 gain that was realized on the sale ofDry Creek atEast Village Apartments in the first quarter of 2018 and an impairment loss of$2,769,000 recognized in 2019 on a commercial real estate property held for investment. The Company elected to conduct a review of the property's value after it received an unsolicited offer to buy and also obtained an independent appraisal from an outside commercial real estate valuation firm. This decrease was also the result of a$1,556,000 gain that was realized on the sale of assets ofDeseret Mortuary in the second quarter of 2018. This decrease was partially offset by a$2,570,000 increase in gains on equity securities mostly attributable to increases in the fair value of these securities. Due to the adoption of Accounting Standards Update ("ASU") 2016-01 onJanuary 1, 2018 , these changes in fair value are now recognized in earnings instead of other comprehensive income. This decrease was also partially offset by a$443,000 increase in gains on fixed maturity securities and a$351,000 increase in gains on other assets. 24 -------------------------------------------------------------------------------- Mortgage fee income increased by$15,790,000 , or 13.6%, to$131,976,000 for 2019, from$116,186,000 for the comparable period in 2018. This increase was primarily due to$13,165,000 increase in secondary gains on loans sold to third-party investors from increased lending volumes, a$2,054,000 increase in other loan fees and interest income, a$505,000 decrease in the provision for loan loss reserve, and a net increase of$66,000 in the fair value of loans held for sale and loan commitments. Other revenues increased by$257,000 , or 2.6%, to$10,180,000 for 2019 from$9,923,000 for the comparable period in 2018. This increase was primarily due to a$630,000 increase in experience refunds on reinsurance due to the coinsurance agreement withKilpatrick Life Insurance Company ("Kilpatrick") prior to the acquisition of Kilpatrick by the Company. This increase was partially offset by a$349,000 decrease in mortgage loan servicing fee revenue.
Total benefits and expenses were
Death benefits, surrenders and other policy benefits, and future policy benefits increased by an aggregate of$4,963,000 , or 7.8%, to$68,480,000 for 2019, from$63,517,000 for the comparable period in 2018. This increase was primarily the result of a$5,292,000 increase in death benefits and a$434,000 increase in surrenders and other policy benefits. This increase was partially offset by a$763,000 decrease in future policy benefits. Amortization of deferred policy and pre-need acquisition costs and value of business acquired increased by$3,003,000 , or 25.8%, to$14,634,000 for 2019, from$11,631,000 for the comparable period in 2018. This increase was primarily due to an increase in the average outstanding balance of deferred policy and pre-need acquisition costs. Selling, general and administrative expenses increased by$6,563,000 , or 3.9%, to$175,737,000 for 2019, from$169,174,000 for the comparable period in 2018. This increase was primarily due to a$6,472,000 increase in commission expenses due to an increase in mortgage loan originations, a$3,908,000 increase in other expenses, and a$182,000 increase in advertising expenses. This increase was partially offset by a$3,148,000 decrease in personnel expenses due to the efforts of the Mortgage segment to reduce costs and restructure internal processes, a$550,000 decrease in rent and rent related expenses, a$156,000 decrease in depreciation on property and equipment, and a$145,000 decrease in costs related to funding mortgage loans. Interest expense increased by$430,000 , or 6.2%, to$7,387,000 for 2019, from$6,957,000 for the comparable period in 2018. This increase was primarily due to a$373,000 increase in interest expense on mortgage warehouse lines and a$163,000 increase in interest expense on bank loans for real estate held for investment. This increase was partially offset by a decrease of$105,000 in interest on funds withheld reinsurance. Cost of goods and services sold of the cemeteries and mortuaries increased by$719,000 , or 33.3%, to$2,878,000 for 2019, from$2,159,000 for the comparable period in 2018. This increase was primarily due to a$292,000 increase in costs related to cemetery at-need sales, a$268,000 increase in costs related to mortuary at-need sales, and a$159,000 increase in costs related to cemetery pre-need sales. Income tax expense decreased by$1,444,000 , or 32.1%, to$3,050,000 for 2019, from$4,494,00 for the comparable period in 2018. This decrease was primarily due to a decrease in earnings before income taxes for 2019 compared to 2018.
Risks
The following is a description of the most significant risks facing the Company and how it mitigates those risks:
Legal and Regulatory Risks. Changes in the legal or regulatory environment in
which the Company operates may create additional expenses and risks not
anticipated by the Company in developing and pricing its products. Regulatory
initiatives designed to reduce insurer profits, new legal theories or insurance
company insolvencies through guaranty fund assessments may create costs for the
insurer beyond those recorded in the consolidated financial statements. In
addition, changes in tax law with respect to mortgage interest deductions or
other public policy or legislative changes may affect the Company's mortgage
sales. Also, the Company may be subject to further regulations in the cemetery
and mortuary business. The Company mitigates these risks by offering a wide
range of products and by diversifying its operations, thus reducing its exposure
to any single product or jurisdiction, and also by employing underwriting
practices that identify and minimize the adverse impact of such risks.
25
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Mortgage Industry Risks. Developments in the mortgage industry and credit
markets can adversely affect the Company's ability to sell its mortgage loans to
investors, which can impact the Company's financial results by requiring it to
assume the risk of holding and servicing any unsold loans.
The mortgage loan loss reserve is an estimate of probable losses at the balance
sheet date that the Company could realize in the future on mortgage loans sold
to third-party investors. The Company's mortgage subsidiaries may be required to
reimburse third-party investors for costs associated with early payoff of loans
within the first six months of such loans and to repurchase loans where there is
a default in any of the first four monthly payments to the investors or, in lieu
of repurchase, to pay a negotiated fee to the investors. The Company's estimates
are based upon historical loss experience and the best estimate of the probable
loan loss liabilities.
Upon completion of a transfer that satisfies the conditions to be accounted for
as a sale, the Company initially measures at fair value liabilities incurred in
a sale relating to any guarantee or recourse provisions. The initial reserve for
loan losses in years ended December 31, 2019 and 2018 were $643,000 and
$1,148,000 , respectively, and the charge has been included in mortgage fee
income. The estimated liability for indemnification losses is included in other
liabilities and accrued expenses and, as of December 31, 2019 and 2018, the
balances were $4,046,000 and $3,605,000 , respectively. The Company believes the
loan loss reserve represent probable loan losses incurred as of December 31,
2019 . There is a risk, however, that future loan losses may exceed the loan loss
reserve.
At various times third-party investors have asserted that SecurityNational
Mortgage sold mortgage loans that allegedly contained borrower
misrepresentations or experienced early payment defaults, or that were otherwise
allegedly defective or not in compliance with loan purchase agreements involving
SecurityNational Mortgage . As a result of these claims, third-party investors
have made demands at times that SecurityNational Mortgage repurchase certain
alleged defective mortgage loans that were sold to such investors or indemnify
them against any losses related to such loans.
The total amount of potential claims by third-party investors is difficult to
determine. The Company has reserved and accrued $4,046,000 as of December 31,
2019 to settle all such investor related claims. The Company believes that the
reserve for mortgage loan losses, which includes provisions for probable losses
and indemnification on loans held for sale, is reasonable based on available
information. Moreover, the Company has successfully negotiated acceptable
settlement terms with other third-party investors that asserted claims for
mortgage loan losses against SecurityNational Mortgage .
SecurityNational Mortgage disagrees with the repurchase demands and notices of
potential claims from third-party investors. Furthermore, SecurityNational
Mortgage believes there is potential to resolve the alleged claims by the
third-party investors on acceptable terms. If SecurityNational Mortgage is
unable to resolve such claims on acceptable terms, legal action may ensue. In
the event of legal action by any third-party investor, SecurityNational Mortgage
believes it has significant defenses to any such action and intends to
vigorously defend itself against such action.
As of December 31, 2019 , the Company's mortgage loans held for investment
portfolio consisted of $8,895,000 in mortgage loans with delinquencies more than
90 days. Of this amount, $1,651,000 of the loans were in foreclosure
proceedings. The Company has not received or recognized any interest income on
the $8,895,000 in mortgage loans with delinquencies more than 90 days. During
the twelve months ended December 31, 2019 , the Company increased its allowance
for loan losses by $105,000 and during the twelve months ended December 31,
2018 , the Company decreased its allowance for loan losses by $415,000 , which was
charged to bad debt expense and included in selling, general and administrative
expenses for the period. The allowances for loan losses as of December 31, 2019
and 2018 were $1,453,000 and $1,348,000 , respectively.
Interest Rate Risk. The risk that interest rates will change, which may cause a
decrease in the value of the Company's investments or impair the ability of the
Company to market its mortgage and cemetery and mortuary products. This change
in rates may cause certain interest-sensitive products to become uncompetitive
or may cause disintermediation. The Company mitigates this risk by charging fees
for non-conformance with certain policy provisions, by offering products that
transfer this risk to the purchaser, and by attempting to match the maturity
schedule of its assets with the expected payouts of its liabilities. To the
extent that liabilities come due more quickly than assets mature, the Company
might have to borrow funds or sell assets prior to maturity and potentially
recognize a loss on the sale.
26
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Mortality and Morbidity Risks. The risk that the Company's actuarial assumptions
may differ from actual mortality and morbidity experiences may cause the
Company's products to be underpriced, may cause the Company to liquidate
insurance or other claims earlier than anticipated, and other potentially
adverse consequences to the business. The Company minimizes this risk through
sound underwriting practices, asset and liability duration matching, and sound
actuarial practices.
COVID-19. Since December 31, 2019 , the outbreak of the novel strain of
coronavirus, specifically identified as "COVID-19", has resulted in governments
worldwide enacting emergency measures to combat the spread of the virus. These
measures, which include the implementation of travel bans, self-imposed
quarantine periods and social distancing, have caused material disruption to
businesses globally resulting in an economic slowdown. Global equity markets
have experienced significant volatility and weakness. Governments and central
banks have reacted with significant monetary and fiscal interventions designed
to stabilize economic conditions. The duration and impact of the COVID-19
outbreak is unknown at this time, as is the efficacy of the government and
central bank interventions. It is not possible to reliably estimate the length
and severity of these developments and the impact on the financial results and
condition of the Company and its operating subsidiaries in future periods.
Further, these uncertainties have the potential to negatively affect the risk of
credit default for the issuers of the Company's debt securities and individual
borrowers with mortgage loans held by the Company.
Estimates. The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes. Actual
results could differ from those estimates.
Material estimates that are particularly susceptible to significant changes in
the near term are those used in determining the value of derivative assets and
liabilities; those used in determining deferred acquisition costs and the value
of business acquired; those used in determining the value of mortgage loans
foreclosed to real estate held for investment; those used in determining the
liability for future policy benefits and unearned revenue; those used in
determining the estimated future costs for pre-need sales; those used in
determining the value of mortgage servicing rights; those used in determining
allowances for loan losses for mortgage loans held for investment; those used in
determining loan loss reserve; and those used in determining deferred tax assets
and liabilities. Although some variability is inherent in these estimates,
management believes the amounts provided are fairly stated in all material
respects.
Liquidity and Capital Resources
The Company's life insurance subsidiaries and cemetery and mortuary subsidiaries realize cash flow from premiums, contract payments and sales on personal services rendered for cemetery and mortuary business, from interest and dividends on invested assets, and from the proceeds from the maturity of held to maturity investments or sale of other investments. The mortgage subsidiaries realize cash flow from fees generated by originating and refinancing mortgage loans and fees on mortgage loans held for sale that are sold to investors. The Company considers these sources of cash flow to be adequate to fund future policyholder and cemetery and mortuary liabilities, which generally are long-term, and adequate to pay current policyholder claims, annuity payments, expenses related to the issuance of new policies, the maintenance of existing policies, debt service, and to meet current operating expenses. During the twelve months endedDecember 31, 2019 , the Company's operations used cash of$75,602,000 . This increase was primarily due to originations of mortgage loans held for sale. During the twelve months endedDecember 31, 2018 , the Company's operations provided cash of$7,009,000 . This was primarily due to an increase in cash collected on loans held for sale. The Company's liability for future policy benefits is expected to be paid out over the long-term due to the Company's market niche of selling funeral plans. Funeral plans are small face value life insurance that will pay the costs and expenses incurred at the time of a person's death. A person generally will keep these policies in force and will not surrender them prior to a person's death. Because of the long-term nature of these liabilities, the Company is able to hold to maturity its bonds, real estate and mortgage loans thus reducing the risk of liquidating these long-term investments as a result of any sudden changes in market values. The Company attempts to match the duration of invested assets with its policyholder and cemetery and mortuary liabilities. The Company may sell investments other than those held to maturity in the portfolio to help in this timing. The Company purchases short-term investments on a temporary basis to meet the expectations of short-term requirements of the Company's products. The Company's investment philosophy is intended to provide a rate of return, which will persist during the expected duration of policyholder and cemetery and mortuary liabilities regardless of future interest rate movements. The Company's investment policy is also to invest predominantly in fixed maturity securities, real estate, mortgage loans, and warehousing of mortgage loans held for sale on a short-term basis before selling the loans to investors in accordance with the requirements and laws governing the life insurance subsidiaries. Bonds owned by the insurance subsidiaries amounted to$355,613,000 (at estimated fair value) and$231,976,000 (at amortized cost) as ofDecember 31, 2019 and 2018, respectively. This represents 45.5% and 38.9% of the total investments as ofDecember 31, 2019 , and 2018, respectively. Generally, all bonds owned by the life insurance subsidiaries are rated by theNational Association of Insurance Commissioners . Under this rating system, there are six categories used for rating bonds. AtDecember 31, 2019 , 2.2% (or$7,633,000 ) and atDecember 31, 2018 , 3.6% (or$8,413,000 ) of the Company's total bond investments were invested in bonds in rating categories three through six, which are considered noninvestment grade. 27 -------------------------------------------------------------------------------- OnDecember 31, 2019 , the Company changed the classification of its bonds to available for sale from held to maturity. As a result, bonds available for sale are carried at estimated fair value instead of amortized cost. See Note 2 of the Notes to Consolidated Financial Statements for additional disclosures regarding the change in classification.
See Note 2 of the Notes to Consolidated Financial Statements for the schedule of the maturity of fixed maturity securities and for the schedule of principal payments for mortgage loans held for investment.
See Note 7 of the Notes to Consolidated Financial Statements for a description of the Company's sources of liquidity.
If market conditions were to cause interest rates to change, the fair value of
the Company's fixed income portfolio, which includes bonds, preferred stocks and
mortgage loans held for investment, could change by the following amounts based
on the respective basis point swing (the change in the fair values were
calculated using a modeling technique):
-200 bps -100 bps +100 bps
+200 bps
Change in Fair Value (in thousands)
The Company is subject to risk-based capital guidelines established by statutory regulators requiring minimum capital levels based on the perceived risk of assets, liabilities, disintermediation, and business risk. AtDecember 31, 2019 and 2018, the capital levels of the life insurance subsidiaries exceeded the regulatory criteria. The Company's total capitalization of stockholders' equity, and bank loans and other loans payable was$414,283,000 as ofDecember 31, 2019 , as compared to$359,172,000 as ofDecember 31, 2018 . Stockholders' equity as a percent of total capitalization was 47.5% and 47.8% as ofDecember 31, 2019 andDecember 31, 2018 , respectively. Bank loans and other loans payable increased by$30,051,000 for the twelve months endedDecember 31, 2019 as compared toDecember 31, 2018 , thus limiting the increase in the stockholders' equity percentage.
Lapse rates measure the amount of insurance terminated during a particular period. The Company's lapse rate for life insurance was 9.8% in 2019 as compared to a rate of 9.9% for 2018.
At
Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements to encourage companies to provide prospective
information about their businesses without fear of litigation so long as those
statements are identified as forward-looking and are accompanied by meaningful
cautionary statements identifying important factors that could cause actual
results to differ materially from those projected in such statements. The
Company desires to take advantage of the "safe harbor" provisions of the act.
This Annual Report on Form 10-K contains forward-looking statements, together
with related data and projections, about the Company's projected financial
results and its future plans and strategies. However, actual results and needs
of the Company may vary materially from forward-looking statements and
projections made from time to time by the Company on the basis of management's
then-current expectations. The business in which the Company is engaged involves
changing and competitive markets, which may involve a high degree of risk, and
there can be no assurance that forward-looking statements and projections will
prove accurate.
Factors that may cause the Company's actual results to differ materially from
those contemplated or projected, forecast, estimated or budgeted in such forward
looking statements include among others, the following possibilities: (i)
heightened competition, including the intensification of price competition, the
entry of new competitors, and the introduction of new products by new and
existing competitors; (ii) adverse state and federal legislation or regulation,
including decreases in rates, limitations on premium levels, increases in
minimum capital and reserve requirements, benefit mandates and tax treatment of
insurance products; (iii) fluctuations in interest rates causing a reduction of
investment income or increase in interest expense and in the market value of
interest rate sensitive investment; (iv) failure to obtain new customers, retain
existing customers or reductions in policies in force by existing customers; (v)
higher service, administrative, or general expenses due to the need for
additional advertising, marketing, administrative or management information
systems expenditures; (vi) loss or retirement of key executives or employees;
(vii) increases in medical costs; (viii) changes in the Company's liquidity due
to changes in asset and liability matching; (ix) restrictions on insurance
underwriting based on genetic testing and other criteria; (x) adverse changes in
the ratings obtained by independent rating agencies; (xi) failure to maintain
adequate reinsurance; (xii) possible claims relating to sales practices for
insurance products and claim denials; (xiii) adverse trends in mortality and
morbidity; (xiv) deterioration of real estate markets; and (xv) lawsuits in the
ordinary course of business.
28--------------------------------------------------------------------------------
Off-Balance Sheet Agreements
AtDecember 31, 2019 , the Company was contingently liable under a standby letter of credit aggregating$625,405 , to be used as collateral to cover any contingency related to additional risk assessments pertaining to the Company's captive insurance program. The Company does not expect any material losses to result from the issuance of the standby letter of credit because claims are not expected to exceed premiums paid.
The total of the Company's unfunded residential construction loan and land
development loan commitments as of
In 2016, the Company, through its wholly-owned subsidiary 5300Development, LLC , entered into a Construction Loan Agreement with a bank. Under the terms of this Agreement, the Company agrees to pay the bank the current outstanding principal up to$40,740,000 plus interest. These funds are being used for the construction of phase 1 of the Company's new Center53 corporate campus development inSalt Lake City, Utah . As ofDecember 31, 2019 , the Company has used$33,913,000 of these funds. Contractual Obligations
The Company's contractual obligations as of
Less than over
1 year 1-3 years 4-5 years 5 years Total
Bank and other loans payable 192,985,602 5,408,387 2,466,203 16,712,420 217,572,612
Non-cancelable operating leases 4,241,547 4,712,587 2,445,058 2,919,074 14,318,266
Future policy benefits (1) 8,630,570 36,211,003 50,924,810 718,220,779 813,987,162
$ 205,857,719 $ 46,331,977 $ 55,836,071 $ 737,852,273 $ 1,045,878,040
________
(1) Amounts represent the present value of future policy benefits, net of
estimated future premiums.
Casualty Insurance Program
In conjunction with the Company's casualty insurance program, limited equity interests are held in a captive insurance entity. This program permits the Company to self-insure a portion of losses, to gain access to a wide array of safety-related services, to pool insurance risks and resources in order to obtain more competitive pricing for administration and reinsurance and to limit its risk of loss in any particular year. The maximum exposure to loss related to the Company's involvement with this entity is limited to approximately$625,405 , which is collateralized under a standby letter of credit issued on the insurance entity's behalf. See Note 10, "Reinsurance, Commitments and Contingencies," for additional discussion of commitments associated with the insurance program.
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