MIDWEST HOLDING INC. The following Management's Discussion and Analysis ("MD&A") is intended to
assist the reader in understanding the financial condition of the Company as of
September 30, 2021 , compared with December 31, 2020 , and the results of
operations for the three and nine months ended September 30, 2021 , compared with
corresponding periods in 2020 of Midwest Holding Inc. and its consolidated
subsidiaries. The MD&A is provided as a supplement to, and should be read in
conjunction with, our Consolidated Financial Statements and the accompanying
notes to the Consolidated Financial Statements ("Notes") presented in "Part 1 -
Item 1. Financial Statements" of this Report and our Form 10-K for the year
ended December 31, 2020 ("2020 Form 10-K"), including the sections entitled
"Part I - Item 1A. Risk Factors," and "Part II - Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations."
Cautionary Note Regarding Forward-Looking Statements and Risk Factors
Except for certain historical information contained herein, this report contains
certain statements that may be considered "forward-looking statements" within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), and Section 27A of the Securities Act of 1933, as amended
(the "Securities Act"), and such statements are subject to the safe harbor
created by those sections. All statements, other than statements of historical
fact, are statements that could be deemed forward-looking statements, including
without limitation: any projections of revenues, earnings, cash flows, capital
expenditures, or other financial items; any statement of plans, strategies, and
objectives of management for future operations; any statements concerning new
products or services, or developments; any statements regarding future economic
conditions or performance; and any statements of belief and any statement of
assumptions underlying any of the foregoing. Words such as "believe," "may,"
"could," "expects," "hopes," "estimates," "projects," "intends," "anticipates,"
and "likely," and variations of these words, or similar expressions, terms, or
phrases, are intended to identify such forward-looking statements.
Forward-looking statements are inherently subject to risks, assumptions, and
uncertainties, many of which cannot be predicted or quantified, which could
cause future events and actual results to differ materially from those set forth
in, contemplated by, or underlying the forward-looking statements. Factors that
could cause or contribute to such differences include, but are not limited to,
those discussed in "Item 1A. Risk Factors" of our 2020 Form 10-K and below in
Part III - Other Information - Item 1A Risk Factors.
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All such forward-looking statements speak only as of the date of this report.
You are cautioned not to place undue reliance on such forward-looking
statements. We expressly disclaim any obligation or undertaking to release
publicly any updates or revisions to any forward-looking statements contained
herein to reflect any change in our expectations with regard thereto or any
change in the events, conditions, or circumstances on which any such statements
are based.
Overview
We are a technology-enabled, services-oriented annuity platform and financial
services company formed on October 31, 2003 . We design and develops in-demand
annuity products that are distributed through independent distribution channels,
to a large and growing demographic of U.S. retirees. We originate, manage and
transfer these annuities through reinsurance arrangements to asset managers and
other third-party investors, who are seeking financially attractive products. We
also provide the operational and regulatory infrastructure and expertise to
enable asset managers and third-party investors to form, capitalize and manage
their own reinsurance capital vehicles. We operate our business primarily
through three subsidiaries, American Life, 1505 Capital, and Seneca Re. American
Life is licensed to sell, underwrite, and market life insurance and annuity
products in 22 states and the District of Columbia and has pending applications
in additional states. We also provide insurance company administrative services
through a division known as "m.pas" that was formed in 2019. 1505 Capital
provides investment advisory and related asset management services. Seneca Re
reinsures various types of the life insurance risks through one or more single
purposes entities or "protected cells."
In 2018, we began implementation of a new business plan with the purpose of leveraging technology and reinsurance to distribute insurance products through independent marketing organizations ("IMOs").
American Life's sales force continues to grow, with eight third-party IMOs presently offering our products. American Life obtained an A.M. Best Rating of B++ inDecember 2018 that was affirmed in 2020.A.M. Best also upgraded American Life's long-term issuer credit rating to bbb+ from bbb inDecember 2020 . Beginning in mid-2019, American Life began ceding portions of its MYGA and FIA annuity business to third-party insurance companies and Seneca Re that we refer to as "quota shares." For detailed information see "Note 9 - Reinsurance" to our Consolidated Financial Statements included in this Form 10-Q. EffectiveMarch 12, 2020 , we formed Seneca Re for the purpose of reinsuring various types of risks through one or more single purpose entitles, or "protected cells." OnMarch 30, 2020 , Seneca Re received its certificate of authority to transact business as a captive insurance company. OnMay 12, 2020 , we contributed$300 to Seneca Re for a 100% ownership interest. Seneca Re has one incorporated cell,Seneca Incorporated Cell, LLC 2020-01 ("SRC1") as ofSeptember 30, 2021 . We contributed a total of$15.0 million throughDecember 31, 2020 to capitalize SRC1, which is consolidated in our financial statements. EffectiveApril 24, 2020 , we raised capital of$5.2 million from various third-party investors and issued 231,655 shares of voting common stock at$22.50 per share. Also, onApril 24, 2020 , we signed a securities purchase agreement withCrestline Assurance Holdings LLC ("Crestline") for additional capital of$10.0 million and issued 444,444 shares of our voting common stock to Crestline at$22.50 per share. OnAugust 10, 2020 , Midwest filed Articles of Amendment of Amended and Restated Articles of Incorporation ("Amendment") that changed the total number of shares it is authorized to issue to 22 million shares of common stock, of which 20 million were designated as voting common stock with a par value of$0.001 per share and two million shares were designated as non-voting common stock with a par value of$0.001 per share. The Amendment also provides for two million shares of authorized preferred stock with a par value of$0.001 per share. The Amendment provided that upon effectiveness, each 500 shares of common stock either issued or outstanding would be converted into one share of voting common stock through a reverse stock split. The Amendment was effective as ofAugust 27, 2020 . Fractional shares were not issued in connection with the reverse stock split but were paid in cash. The Company paid approximately$175 for those fractional shares and is now holding treasury stock represented by that amount. Outstanding shares as ofSeptember 30, 2021 andDecember 31, 2020 were 3,737,564. All prior periods disclosed in this report have been restated to reflect the reverse stock split per share amounts. OnDecember 21, 2020 , Midwest completed a$70 million public offering of one million shares of its voting common stock at a price of$70.00 per share. OnDecember 17, 2020 , the voting common stock was listed on theNasdaq Capital
Market under
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the ticker symbol "MDWT." The aggregate net proceeds from the offering were
approximately
Midwest used the net proceeds of the offering to support the growth of its
insurance subsidiaries, American Life, with a capital contribution of
OnJune 26, 2021 , the NDOI issued its non-disapproval of the Modified Coinsurance Agreement ("Modco AEG Agreement") withAmerican Republic Insurance Company ("AEG"), anIowa domiciled reinsurance company. The agreement closed onJune 30, 2021 . Under the Modco AEG Agreement, American Life ceded toAEG , on a modified coinsurance ("Modco") basis, 20% quota share of certain liabilities with respect to its multi-year guaranteed annuity MYGA-5 business and an initial 20% quota share of certain liabilities with respect to its fixed indexed annuity FIA. American Life has established a Modco Deposit Account to hold the assets for the Modco AEG Agreement.
Also on
COVID-19
We continue to closely monitor developments related to the COVID-19 pandemic to assess any potential adverse impact on our business. Due to the evolving and highly uncertain nature of this pandemic, it currently is not possible to provide a longer-term estimate of potential insurance or reinsurance exposure or the indirect effects the pandemic may have on our results of operations, financial condition or liquidity. Management implemented the Company's business continuity plan in earlyMarch 2020 and operated throughJuly 2020 with the majority of employees working remotely. The employees returned to the office onJuly 8, 2020 . Operations continued as normal despite a sharp increase in sales during the period. We continue to monitor theCenter for Disease Control and Prevention andState of Nebraska guidelines regarding employee safety. Market conditions in the third quarter of 2021 resulted in continued low interest rate spreads and positive equity markets. The overall economy continued to look positive, but concerns rose around employment participation, consumer confidence and the housing market beginning to show signs of slowing down. The spread of theCovid-19 Delta variant continued to impact certain areas of theU.S.
Our management will continue to monitor our investments and cash flows to evaluate the impact as this pandemic evolves.
Industry Trends and Market Conditions
Interest Rate Environment
Overall, interest rates remain at low levels and are expected to remain there in the short term given the market support occurring through buying and seeking higher yields by investors. We seek to address our interest rate risk through managing the duration of the liabilities and purchasing and holding high quality, long-term assets that mirror that duration.
Competition
We are operating in a highly competitive market with various sizes of diversified financial institutions, established insurance and reinsurance companies. Our annuity market is being impacted by the growing aging population and the need to evaluate their retirement options. We believe our technology and customer service along with our ability to structure solutions position us to provide value to annuity consumers through various distribution channels.
Unrealized Losses; Embedded Derivatives
American Life has agreements with several third-party reinsurers that have funds
withheld ("FW") and modified coinsurance ("Modco") provisions under which the
assets related to the reinsured business are maintained by American Life as
collateral; however, ownership of the assets and the total return on the asset
portfolios belong to the third-party reinsurers. Under GAAP, this arrangement is
considered an embedded derivative as discussed in "Note 5 - Derivative
Instruments" to
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our Consolidated Financial Statements. Assets carried as investments on American
Life's financial statements for the third-party reinsurers contained unrealized
gains of approximately $2.0 million as of September 30, 2021 compared to
unrealized gains of approximately $4.4 million as of September 30, 2020 . The
terms of the contracts with the third-party reinsurers provide that unrealized
gains on the portfolios accrue to the third-party reinsurers. We account for
these unrealized gains by recording equivalent realized losses on our
Consolidated Statements of Comprehensive Loss. Accordingly, the unrealized gains
on the assets held by American Life on behalf of the third-party reinsurers were
offset by recording an embedded derivative gain of $900 and $4.4 million ,
respectively. If prices of investments fluctuate, the unrealized losses of the
third-party reinsurers may also fluctuate; therefore, the associated embedded
derivative gain (loss) recognized by us for September 30, 2021 and December 31,
2020 , would be reduced accordingly.
Consolidated Results of Operations - Three Months Ended
Comprehensive Net Loss
In this section, unless otherwise noted the discussion compares the three months
ended
A net loss was incurred compared to net income primarily due to the following:
1. Total loss drivers: a)There are three components associated with our FIA products: 1) the fair market value of the derivative asset entered into in order to mitigate the fluctuation of the embedded liability on our policyholder contracts, 2) the change in the fair market value of the embedded liability, and 3) the option allowance related to our third-party reinsurers that are marked to market at the end of the period. The change in the market value of the option derivative assets decreased, resulting in a realized loss of$2.6 million compared to a gain of approximately$1.9 million . The interest credited was$300 and$400 , respectively. The embedded derivative liability decrease was included in the overall interest credited. The decrease in the embedded liability resulted in an decrease in our interest credited of approximately$41 . In 2020, interest credited was higher due to the increase in the embedded liability. The third component resulted in a loss resulting from the mark-to-market increase of the embedded liability of approximately$900 on our options allowance with the third-party reinsurers which is presented in other operating expenses compared to a mark-to-market decrease of approximately$100 . b)American Life has treaties with several third-party reinsurers that have FW andModco provisions. As a result of the changes in market prices, the assets held on behalf of the third-party reinsurers had unrealized gains of approximately$2.0 million and$4.4 million atSeptember 30, 2021 andSeptember 30, 2020 , respectively. The terms of the contracts with the third-party reinsurers provide that unrealized gains or losses on the asset portfolios accrue to the third-party reinsurers. We account for the change in these unrealized gains or losses by recording equivalent realized gains or losses on our Consolidated Statements of Comprehensive Loss. We recorded the decrease in the unrealized gains as a realized gain of$1.3 million compared to a realized loss of$4.1 million . c)Certain assets are recorded on a statutory basis at the lower of cost or market. We have unrealized gains on these assets of approximately$2.0 million which were passed through to the reinsurers through the settlement process as a realized loss on our consolidated financials outside the GAAP embedded derivative total return swap discussed above. We did not have any unrealized gains or losses in 2020 that were recorded at the lower of cost or market.
Expense drivers: Our most material expense is salaries and benefits which
2. increased
operating expenses benefits due to increasing our personnel and expenses to
service our new business growth.
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Revenues
The following summarizes the sources of our revenue for the periods indicated:
Three months ended September 30,
(In thousands) 2021 2020Investment income, net of expenses $ 6,196 $ 434 Net realized gains (loss)on investments (See Note 4) (2,115) (1,951) Amortization of deferred gain on reinsurance 662 293 Service fee revenue, net of expenses 628
590
Other revenue 400 117
$ 5,771 $ (517)
Premium revenue: The introduction of our MYGA and FIA products discussed below
generated a large volume of new business; however, these products are defined as
investment contracts and U.S. GAAP requires that premiums be deferred as
deposit-type liabilities on our Consolidated Balance Sheets. American Life
expects to introduce additional versions of these annuity products later in
2021.
Investment Loss, net of expenses: The components of our net investment loss are
as follows:
Three months ended September 30,
(In thousands) 2021 2020
Fixed maturities income $ 6,373 $ 322
Mortgage loans 938 81
Other invested assets 74 63
Gross investment income 7,385 466
Less investment expenses (1,189) (32)Investment income, net of expenses $ 6,196 $
434
Investment income, net of expenses, was$6.2 million , compared to$400 . Investment income, net of expenses, consists of investment income generated from our retained investment assets that are not ceded to reinsurers. The increase in investment income was due to the investment income earned on the bonds and mortgage loans purchased with the sales of our MYGA and FIA products that were not ceded to reinsurers during the period, as well as deployment of excess cash towards credit investments with attractive yields and risk-return profiles. On a gross consolidated basis, our investment portfolio (excluding cash) was$942.8 million as ofSeptember 30, 2021 compared to$518.2 million as ofDecember 31, 2020 , as a result of proceeds from our MYGA and FIA product sales. Net realized losses on investments: Net realized losses on investments were losses of$2.1 million compared to$2.0 million , which included a gain of$1.3 million and a loss of$4.1 million from a total return swap embedded derivative in 2021 and 2020, respectively. In 2021, there were net realized losses of$2.6 million related to derivatives we own to hedge the obligations to FIA policyholders; such losses were partially offset by a decrease in the mark-to-market change in embedded derivative liability within interest credited expense and increase in FIA-related mark-to-market option allowance expense flowing through other operating expenses. The change in fair value of FIA hedging derivatives is driven by the performance of the indices upon which our call options are based. The majority of our call options are based on the S&P 500 index which increased 1% in 2021, compared to an increase of 8% in 2020; the value of our FIA hedging options tends to increase in rising equity markets and decrease in declining markets, such as the stock market sell-off experienced towards the end of the third quarter of 2021. Also included in the realized losses is the lower of cost or market realized loss of$2.0 million . American Life has treaties with several reinsurers that have FW coinsurance provisions, under which the assets backing the treaties are maintained by American Life as collateral but the assets and total return on the asset portfolios belong to the reinsurers. Under GAAP this arrangement is considered an embedded derivative as discussed in Note 5 - Derivative Instruments to our Consolidated Financial Statements. The change in fair value of the total return swap is included in net realized gains or losses on investments. Assets carried as investments on American Life's financial statements for the third-party reinsurers contained unrealized gains of approximately$2.0 million and$4.1 million as ofSeptember 30, 2021 and 2020, respectively. The terms of the contracts with the third-party reinsurers provide that unrealized gains or
losses on the portfolios
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accrue to the third-party reinsurers. We recorded the unrealized gains accrued
to third-party reinsurers via a total return swap a realized gain of
Amortization of deferred gain on reinsurance: The flat performance or slight
increase in 2021 was due to higher amortization of the deferred gain on
reinsurance, driven in part by slightly higher reinsured premiums during the
period.
Service fee revenue, net of expenses: Service fee revenue, net of expenses,
consists of fee revenue generated by our internal asset manager 1505 Capital for
asset management services provided to third-party clients, some of whom are our
reinsurers. The flat performance was due primarily to the flat performance in
the level of asset management services provided by 1505 Capital to third-party
clients.
Other revenue: Other revenue consists of revenue generated by us for providing
ancillary services such as third-party administration ("TPA") to clients. The
increase in 2021 was due to the increased provision of ancillary services,
including TPA, to clients.
Expenses
Our expenses for the periods indicated are summarized in the table below:
Three months ended September 30,
(In thousands) 2021 2020
Interest credited $ 284 $ 380
Benefits - (3)Amortization of deferred acquisition costs 753
235
Salaries and benefits 4,025 1,444
Other operating expenses 4,124 1,706
$ 9,186 $ 3,762
Interest credited: The decrease was primarily due to the FIA product and the
decrease in the fair market value of the embedded derivative liability owned by
us to FIA policyholders, offset by interest credited related to the MYGA product
This decrease in this liability owed to FIA policyholders is partially hedged by
our net realized loss on investments, as referenced above, which resulted in a
$2.6 million decrease in the fair market value of derivative assets used to
partially hedge this obligation to FIA policyholders. Interest credited related
to our retained FIA policies was approximately negative $500 and approximately
positive $100 , respectively. Management's estimated, amortized cost of servicing
our retained FIA policies was approximately $2.4 million and $400 , respectively.
Benefits: Death benefits changed insignificantly.
Amortization of deferred acquisition costs: The increase was due to the deferred acquisition costs deferred on the sale of American Life's MYGA and FIA products where we retained approximately 49% of the business in 2021 compared to the 55% retained in 2020.
Salaries and benefits: The increase was due to the addition of personnel to service our new business growth. We continue to hire more in-house expertise to service our growth initiatives.
Other operating expenses: Other operating expenses were approximately
FIA products contain embedded derivative liabilities, which are market driven.
The reinsurers that reinsure our FIA products pay an option allowance to
American Life to purchase derivative assets used to hedge the FIA embedded
? derivative liabilities. The mark-to-market on those option allowances increased
during the period. As a result, American Life incurred
to the reinsurers. The derivative assets utilized to partially hedge this
mark-to-market option allowance resulted in a
net realized (loss) gains on investments, as referenced above.
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Other increases in other expenses related to legal fees of
initiatives; taxes, licenses and fees of approximately
?
to increased audit costs resulting from the auditing complexities involved in
implementing on our business plan.
Consolidated Results of Operations - Nine months ended
In this section, unless otherwise noted the discussion compares the nine months
ended
Net Loss
Net loss increased compared to net income primarily due to the following:
1. Total losses drivers:
a)As indicated above, there are three components associated with our FIA products: 1) the fair market value of the derivative asset entered into in order to mitigate the fluctuation of the embedded liability on our policyholder contracts, 2) the change in the fair market value of the embedded liability, and 3) the option allowance related to our third-party reinsurers that are marked to market at the end of the period. The change in the market value of the option derivative assets decreased resulting in a realized loss of$4.3 million compared to a gain of$2.0 million . The interest credited was$1.9 million compared to$500 . The embedded derivative liability increase was included in the overall interest credited. The third component resulted in a gain resulting from the mark-to-market decrease of the embedded liability of$1.9 million on our options allowance with the third-party reinsurers which is presented in other operating expenses compared to a mark-to-market decrease of approximately$200 . b)As discussed above, American Life has treaties with several third-party reinsurers that have FW andModco provisions. The assets held on behalf of the third-party reinsurers had unrealized gains of approximately$2.0 million atSeptember 30, 2021 and$4.4 million atSeptember 30, 2020 . The terms of the contracts with the third-party reinsurers provide that unrealized gains or losses on the asset portfolios accrue to the third-party reinsurers. We account for the change in unrealized gains or losses related to the third-party reinsurers by recording equivalent but opposite realized gains or losses on our Consolidated Statements of Comprehensive Loss. We recorded the decrease in the unrealized gains as a realized gain of$900 compared to a realized gain of$4.4 million . c)Certain assets are recorded on a statutory basis at the lower of cost or market. We have unrealized gains on these assets of approximately$2.0 million which were passed through to the reinsurers through the settlement process as a realized loss on our consolidated financials outside the GAAP embedded derivative total return swap discussed above. We did not have any unrealized gains or losses in 2020 that were recorded at the lower of cost or market.
Expense drivers: Increase of
2. increase of
due to increasing our personnel and expenses to implement our business growth
plan.
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Revenues:
The following summarizes the sources of our revenue for the periods indicated:
Nine months ended September 30,
(In thousands) 2021 2020
Investment income, net of expenses $ 12,303 $ 1,277
Net realized (loss) gains on investments (See Note 4) (2,704) 7,829
Amortization of deferred gain on reinsurance 1,711 814
Service fee revenue, net of expenses
1,738 1,359
Other revenue 1,007 134
$ 14,055 $ 11,413
Premium revenue: The introduction of our MYGA and FIA products discussed above
generated a large volume of new business; however, these products are defined as
investment contracts and U.S. GAAP requires that premiums be deferred as
deposit-type liabilities on our Consolidated Balance Sheets. American Life
expects to introduce additional versions of these annuity products in the later
in 2021.
Investment loss, net of expenses: The components of our net investment loss are
as follows:
Nine months ended September 30,
(In thousands) 2021 2020
Fixed maturities $ 13,103 $ 1,364
Mortgage loans 1,479 81
Other invested assets 225 63
Other interest income 266 -
Gross investment income 15,073 1,508
Less: investment expenses (2,770) (231)Investment income, net of expenses $ 12,303$ 1,277 Investment income, net of expenses, consists of investment income generated from our retained investment assets that are not ceded to reinsurers. The increase in investment income was due to the investment income earned on the bonds and mortgage loans purchased with the sales of our MYGA and FIA products that were not ceded to reinsurers during the period, as well as deployment of excess cash towards credit investments with attractive yields and risk-return profiles.
On a gross consolidated basis, our investment portfolio (excluding cash) was
American Life ceded
Net realized (loss) gains on investments: Net realized losses on investments were$2.7 million compared to a gain of$7.8 million , which included a gain of$900 and$4.4 million , respectively, from a total return swap embedded derivative in 2021 and 2020, respectively. There were net realized losses in 2021 of$4.3 million related to equity derivatives we own to hedge the obligations to FIA policyholders; such losses were partially offset by a decrease in the mark-to-market change in embedded derivative liability within interest credited expense and decrease in FIA-related mark-to-market option allowance expense flowing through other operating expenses. The change in fair value of FIA hedging derivatives are driven by the performance of the indices upon which our call options are based. Also included in the realized losses for 2021 is the lower of cost or market realized loss of$2.0 million . The majority of our call options are based on the S&P 500 index which increased 16% in 2021, compared to an increase of 4% in 2020; the value of our FIA hedging options tends to increase in rising equity markets and decrease in declining markets, such as the stock market sell-off experienced towards the end of the third quarter of 2021. American Life has treaties with several reinsurers that have FW coinsurance provisions, under which the assets backing the treaties are maintained by American Life as collateral but the assets and total return on the asset portfolios belong to the reinsurers. Assets carried as investments on American Life's financial statements for the third-party reinsurers contained unrealized gains of approximately$2.0 million and unrealized losses of approximately$4.4 million as ofSeptember 30, 2021 46 Table of Contents and 2020, respectively. We recorded the unrealized loss accrued to third-party reinsurers via a total return swap sinceDecember 30, 2021 , as a realized gain of$900 compared to a realized loss of$4.4 million in 2020. Amortization of deferred gain on reinsurance: The increase was due to higher amortization of the deferred gain on reinsurance, driven in part by slightly higher reinsured premiums. Service fee revenue, net of expenses: Service fee revenue, net of expenses, consists of fee revenue generated by our internal asset manager 1505 Capital for asset management services provided to clients, some of whom are our reinsurers. The slight increase was due primarily to the slight increase in the level of asset management services provided by 1505 Capital to clients. Other revenue: Other revenue consists of revenue generated by us for providing ancillary services such as third-party administration ("TPA") to clients. The increase was due to the increased provision of ancillary services, including TPA, to clients.
Expenses are summarized in the table below.
Nine months ended September 30,
(In thousands) 2021 2020
Interest credited $ 1,868 $ 464
Benefits - (6)Amortization of deferred acquisition costs 1,780
376
Salaries and benefits 11,466 3,624
Other operating expenses 6,769 5,337
$ 21,883 $ 9,795
Interest credited: The increase was due primarily due interest credited relating
to the MYGA product, offset by the decrease in the fair market value of the
embedded derivative liability owned by us to FIA policyholder, partially hedged
by our net realized loss on the investments, as referenced above, which saw a
$4.3 million decrease in the fair market value of derivative assets used to
partially hedge this obligation to the FIA policyholders. Interest credited
related to our retained FIA policies was approximately positive $38 and $100 ,
respectively. Management's estimated, amortized cost of servicing our retained
FIA policies was $4.3 million and $500 , respectively.
Benefits: Death benefits changed insignificantly.
Amortization of deferred acquisition costs: The increase was due to the deferred acquisition costs deferred on the sale of American Life's MYGA and FIA products where we retained approximately 47% of the business in 2021 compared to the 36% retained in 2020. Management expects the retained business to decrease during the last half of 2021 as we cede this business to new third-party reinsurers.
Salaries and benefits: The increase was due to the addition of personnel to service our new business growth. We continue to hire more in-house expertise to service our growth initiatives.
Other operating expenses: Other operating expenses were approximately
Decrease:
Due to the valuation completed in June of 2020 on an investment in an
? unaffiliated reinsurance company, an impairment of
full value of the preferred stock whereas no impairment was recorded in 2021.
FIA products contain embedded derivative liabilities, which are market driven.
The reinsurers that reinsure our FIA products pay an option allowance to
? American Life to purchase derivative assets used to hedge the FIA embedded
derivative liabilities. The mark-to-market on those option allowances decreased
during the period. As
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a result, American Life incurred
reinsurers. The derivative assets utilized to partially hedge this
mark-to-market option allowance saw a
realized (loss) gains on investments, as referenced above.
Increases:
Increases in other expenses related to taxes, licenses and fees of
approximately
? examination fees; audit and actuarial expenses of
costs, legal fees of
assist implementing our business plan, and
support our growth of the business.
Investments
A majority of the investments on our Consolidated Balance Sheets are held on behalf of our reinsurers as collateral under our reinsurance agreements. As a result, our investment allocations are largely a function of our collective reinsurer investment allocations. While the reinsurers own the investment risk on these assets, we typically restrict their investment allocations via control over the selection of the asset manager as well as asset restrictions set forth in investment guidelines. Additionally, in many of our reinsurance agreements, our affiliate investment manager, 1505 Capital, is selected as the asset manager. 1505 Capital had approximately$407 million of total third-party assets under management as ofSeptember 30, 2021 . The investment guidelines typically includeU.S. government bonds, corporate bonds, commercial mortgages, asset backed securities, municipal bonds, mutual funds and collateral loans. The duration of our investments is 5 to 10 years in line with that of our liabilities. We do allow non-U.S. dollar denominated investments where the foreign exchange risk is hedged back toU.S. dollars. The following table shows the carrying value of our investments by investment category and cash and cash equivalents, and the percentage of each to total invested assets as ofSeptember 30, 2021 andDecember 31, 2020 . Increases in fixed maturity securities primarily resulted from the sale of our new MYGA and FIA products during 2021. A majority of the investments as ofSeptember 30, 2021 andDecember 31, 2020 are held as collateral for our reinsurers. September 30, 2021 December 31, 2020 Carrying Percent Carrying Percent (In thousands) Value of Total Value of Total Fixed maturity securities: U.S. government obligations$ 1,981 0.2 %$ 6,164 0.9 % Mortgage-backed securities 55,245 5.4 14,757 2.2 Collateralized loan obligations 310,653 30.3 221,774 33.1 States and political subdivisions -- general obligations 117 - 118 - States and political subdivisions -- special revenue 6,230 0.6 6,202 0.9 Trust preferred 16,397 1.6 2,285 0.3 Corporate 266,158 26.0 125,863 18.9 Total fixed maturity securities 656,781 64.1 377,163 56.3 Mortgage loans on real estate, held for investment 168,184 16.4 94,990 14.2 Derivatives 17,262 1.7 11,361 1.7 Equity securities 38,910 3.8 - - Other invested assets 47,021 4.6 21,897 3.3 Investment escrow 1,307 0.1 3,174 0.5
Federal Home Loan Bank (FHLB) stock 500 -
- -
Preferred stock 6,934 0.7 3,898 0.6
Notes receivable 5,885 0.6 5,666 0.8
Policy Loans 55 - 46 -
Cash and cash equivalents 81,487 8.0 151,679 22.6
Total investments, including cash and
cash equivalents $ 1,024,326 100.0 % $ 669,874 100.0 %
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The following table shows the distribution of the credit ratings of our
portfolio of fixed maturity securities by carrying value as of
September 30, 2021 December 31, 2020
Carrying Carrying
(In thousands) Value Percent Value Percent
AAA and U.S. Government $ 2,892 0.4 % $ 3,071 0.8 %
AA 573 0.1 5,818 1.5
A 144,482 22.0 49,445 13.1
BBB 386,980 58.9 247,636 65.7
Total investment grade 534,927 81.4 305,970 81.1
BB and other 121,854 18.6 71,193 18.9
Total $ 656,781 100.0 % $ 377,163 100.0 %
Reflecting the quality of securities maintained by us, 81.4% and 81.1% of all
fixed maturity securities were investment grade as of September 30, 2021 and
December 31, 2020 , respectively.
We expect that our MYGA and FIA products sales will continue to result in an increase in investable assets in future periods.
Market Risks of Financial Instruments
The primary market risks affecting the investment portfolio are interest rate risk, credit risk and liquidity risk. With respect to investments that we hold on our Consolidated Balance Sheets as collateral, our reinsurers bear the market risks related to these investments, while we bear the market risks on any net retained investments. Interest Rate Risk Interest rate risk arises from the price sensitivity of investments to changes in interest rates. Interest and dividend income represent the greatest portion of an investment's return for most fixed maturity securities in stable interest rate environments. The changes in the fair value of such investments are inversely related to changes in market interest rates. As interest rates fall, the interest and dividend streams of existing fixed-rate investments become more valuable and fair values rise. As interest rates rise, the opposite effect occurs. Our liabilities also have interest rate risk though are not required to be marked to market. We mitigate interest rate risk by monitoring and matching the duration of assets compared to the duration of liabilities.
Credit Risk
We are exposed to credit risk through counterparties and within the investment portfolio. Credit risk relates to the uncertainty associated with an obligor's ability to make timely payments of principal and interest in accordance with the contractual terms of an instrument or contract. We manage our credit risk through diversification of investments amongst many corporations and numerous industries. Additionally, our investment policy limits the size of holding
in any particular issuer. Liquidity Risk
We are exposed to liquidity risk when liabilities come due. In order to pay a policyholder, we may need to liquidate assets. If our assets are illiquid assets, we might be unable to convert an asset into cash without giving up capital and income due to a lack of buyers or an inefficient market. We seek to mitigate this risk by keeping a portion of our investment portfolio in liquid investments.
Statutory Accounting and Regulations
Our primary insurance subsidiary, American Life, is required to prepare statutory financial statements in accordance with SAP prescribed by the NDOI. SAP primarily differs from GAAP by charging policy acquisition costs to expense as incurred, establishing future benefit liabilities using actuarial assumptions as well as valuing investments and certain assets and accounting for deferred taxes on a different basis. For further discussion regarding SAP as well as
net
loss of American Life
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under SAP, see Note 14 to our Consolidated Financial Statements. American Life
maintains sufficient capital and surplus to comply with regulatory requirements
as of September 30, 2021 .
State insurance laws and regulations govern the operations of all insurers and
reinsurers such as our insurance and reinsurance company subsidiaries. These
various laws and regulations require that insurance companies maintain minimum
amounts of statutory surplus as regards policyholders and risk-based capital and
determine the dividends that insurers can pay without prior approval from
regulators. The statutory net income of American Life is one of the primary
sources of additions to our statutory surplus as regards policyholders, in
addition to capital contributions from us.
We have reported our insurance subsidiaries' assets, liabilities and results of
operations in accordance with GAAP, which varies from SAP. The following items
are principal differences between SAP and GAAP as SAP:
• requires that we exclude certain assets, called non-admitted assets, from the
Consolidated Balance Sheets.
requires us to expense policy acquisition costs when incurred, while GAAP
• allows us to defer and amortize policy acquisition costs over the estimated
life of the policies.
• dictates how much of a deferred income tax asset can be admitted on a statutory
Consolidated Balance Sheets.
requires that we record certain investments at cost or amortized cost, while we
• record other investments at fair value; however, GAAP requires that we record
all investments at fair value.
allows bonds to be carried at amortized cost or fair value based on the rating
• received from the
recorded at fair value for GAAP.
allows ceding commission income to be recognized when written if the cost of
• acquiring and renewing the associated business exceeds the ceding commissions,
but under GAAP such income is deferred and recognized over the coverage period.
• requires that unearned premiums and loss reserves are presented net of related
reinsurance rather than on a gross basis as reported under GAAP.
requires that we record reserves liabilities and expenses, while we record all
• transactions related to the annuity products under GAAP as a deposit-type
contract liability.
requires a provision for reinsurance liability be established for reinsurance
recoverable on paid losses aged over 90 days and for unsecured amounts
• recoverable from unauthorized reinsurers. Under GAAP there is no charge for
uncollateralized amounts ceded to a company not licensed in the insurance
affiliate's domiciliary state and a reserve for uncollectable reinsurance is
charged through earnings rather than surplus or equity.
requires an additional admissibility test outlined in Statements on Statutory
Accounting Principles, No. 101 and the change in deferred income tax is
reported directly in capital and surplus, rather than being reported as a
• component of income tax expense as it is reported under GAAP. Our insurance
subsidiaries must file with the insurance regulatory authorities an "Annual
Statement" which reports, among other items, net loss and surplus as regards
policyholders, which is called stockholders' equity under GAAP.
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The following reconciles our GAAP net loss to our SAP net loss for the periods indicated.
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