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
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
38 Table of Contents
"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.
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 were formed on
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++ in
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.
Effective
Effective on
On
39 Table of Contents
shares of authorized preferred stock with a par value of
Outstanding shares as of
All prior periods disclosed in this 10-Q have been restated to reflect the reverse stock split per share amounts.
On
Midwest used the net proceeds of the offering to support the growth of its
insurance subsidiaries, American Life, with a capital contribution of
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 early
Our management will continue to monitor our investments and cash flows to evaluate the impact as this pandemic evolves.
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 our Consolidated Financial Statements. Assets carried as
investments on American Life's financial statements for the third-party
reinsurers contained unrealized gains of approximately
40 Table of Contents
Critical Accounting Policies and Estimates
Part II - Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations included in our 2020 Form 10-K ("2020 Form 10-K MD&A") contains a detailed discussion of our critical accounting policies and estimates. This report should be read in conjunction with the "Critical Accounting Policies and Estimates" discussed in our 2020 Form 10-K MD&A.
Consolidated Results of Operations - Three Months Ended
Comprehensive Net (Loss) Income
Net loss increased during the three months ended
1.Total (losses) revenue 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. For the three months ended
b)American Life has treaties with several third-party reinsurers that have FW
and
2.Expense drivers
a)As mentioned above, the increase in interest credited and general operating
expenses related to the embedded derivatives in our FIA products of
b)Increase of
41 Table of Contents Revenues
The following summarizes the sources of our revenue for the periods indicated:
Three months ended June 30, 2021 2020 Premiums $ - $ 30 Investment income, net of expenses 3,220,026 (397,842) Net realized gains (loss)on investments (See Note 4) 4,059,926 (12,819,871) Amortization of deferred gain on reinsurance 587,737 338,269 Service fee revenue, net of expenses 671,804 385,674 Other revenue 357,814 10,387$ 8,897,307 $ (12,483,353)
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
The table below shows premium issued under statutory accounting principles ("SAP") on our two annuity products:
Three months ended June 30, 2021 2020 MYGA FIA MYGA FIA Premium Premium(1) Premium Premium(1)
Annuity Direct Written Premium
Under SAP, the MYGA and FIA premiums are treated as premium revenue. Under GAAP these products are defined as deposit-type contracts; therefore, the
(1) premium revenue that is recognized under SAP is accounted for under GAAP as
deposit-type liabilities on our Consolidated Balance Sheets and is not recognized on our Consolidated Statements of Comprehensive Income (Loss.)
Investment (Loss) Income, net of expenses: The components of our net investment (Loss) Income are as follows:
Three months ended June 30, 2021 2020 Fixed maturities income (loss)$ 4,088,461 $ (128,209) Mortgage loans 366,717 - Other invested assets 96,054 - Other interest income 81,247 - Gross investment income (loss) 4,632,479 (128,209) Less investment expenses (1,412,453) (269,633)
Investment income (loss), net of expenses
The increase in investment income for 2021 over 2020 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. Our
investment portfolio grew to
Net realized gains (losses)on investments: The net realized gains (loss) on
investments for the three months ended
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utilized to hedge the obligations to FIA policyholders; such gains were offset by increases in FIA-related interest credited expense and increases in FIA-related mark-to-market option allowance flowing through other operating expenses.
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 on investments. Assets carried as
investments on American Life's financial statements for the third-party
reinsurers contained unrealized gains of approximately
Amortization of deferred gain on reinsurance: The increase in 2021 compared to the comparative period in 2020 was due to the amortization of the ceding commission deferred from the additional reinsurance agreements, several with third-party reinsurers.
Service fee revenue, net of expenses: The increase in 2021 was due primarily to the increases in 1505 Capital's asset management services provided on the increased investment portfolio of our third-party reinsurers.
Other revenue: The increase in third-party administration ("TPA") fees earned results from providing additional administrative services to clients compared to 2020.
Expenses
Our expenses for the periods indicated are summarized in the table below:
Three months ended June 30, 2021 2020 Interest credited$ 3,931,216 $ (128,052) Benefits - 4,016 Amortization of deferred acquisition costs 524,336 100,388 Salaries and benefits 4,513,944 1,354,934 Other operating expenses 4,174,196 2,305,687$ 13,143,692 $ 3,636,973
Interest credited: The increase was primarily due to the FIA product and the
increase in the fair market value of the embedded derivative liability owned by
us to FIA policyholders. This increase is partially offset in our net realized
gain (loss) on investments, as referenced above, which saw a
Benefits: Death benefits changed insignificantly over the prior year's comparable period.
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 32% of the business in 2021 compared to the 11% 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.
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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. For the three months ended
? mark-to-market on those option allowances were in a positive position. As 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.
Other increases in other expenses related to audit and actuarial expenses of
? taxes, licenses and fees of approximately
year-end and exam fees; and consultants to assist with the growth of the
business of
Consolidated Results of Operations - Six Months Ended
Net (Loss) Income
Net loss increased during the six months ended
Total (losses) revenue drivers: 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. For the six months endedJune 30, 2021 and 2020, the change in the market value of the option
1. derivatives resulted in a realized loss of
$151,000 , respectively. The increase in the embedded liability for the six months endedJune 30, 2021 and 2020 contributed to the increase in our interest credited of$1.6 million and$83,000 , respectively. The third component related to the mark-to-market on our options allowance with the third-party reinsurers for the six months endedJune 30, 2021 and 2020, resulted in a gain of$2.8 million and$75,000 , respectively, presented in other operating expenses. As discussed above, American Life has treaties with several third-party reinsurers that have funds withheld and modified coinsurance provisions. The assets held on behalf of the third-party reinsurers had unrealized gains of approximately$3.3 million and unrealized losses of$8.5 million , respectively. The terms of the contracts with the third-party reinsurers
a) 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 realized gains or losses on our Consolidated Statements of Comprehensive Loss. We recorded the decrease in the unrealized gains sinceDecember 31, 2020 as a realized loss of$440,000 compared to a realized gain of$8.5 million during the first quarter of 2020. 2. Expense drivers
As mentioned above, the increase in interest credited and decrease in general
a) operating expenses related to the embedded derivatives in our FIA products of
$1.6 million and the mark-to-market option allowance decrease of$2.8 million was offset by our losses on our derivative assets.
b) Increase of
personnel to service our new business growth.
44 Table of Contents Revenues:
The following summarizes the sources of our revenue for the periods indicated:
Six months ended June 30, 2021 2020 Premiums $ - $ 51 Investment income, net of expenses 6,107,389 843,136 Net realized (loss) gains on investments (See Note 4) (589,179) 9,780,139 Amortization of deferred gain on reinsurance 1,048,593 520,707 Service fee revenue, net of expenses 1,109,950 765,892 Other revenue 606,783 20,213$ 8,283,536 $ 11,930,138
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
The table below shows premium issued under statutory accounting principles ("SAP") on our two annuity products:
Six months ended June 30, 2021 2020 MYGA FIA MYGA FIA Premium Premium(1) Premium Premium(1) Annuity Direct Written Premium First Quarter$ 9,368,962 $ 114,284,969 $ 31,565,506 $ 16,249,504 Second Quarter 26,191,111 99,674,226 27,400,367 72,270,636
Total Issued as of
Under statutory accounting principles, the MYGA and FIA premiums are treated as premium revenue. Under GAAP these products are defined as deposit-type
(1) contracts; therefore, the premium revenue is accounted under GAAP as
deposit-type liabilities on our balance sheet and is not recognized in our
income statement.
Investment (loss) income, net of expenses: The components of our net investment (loss) income are as follows:
Six months ended June 30, 2021 2020 Fixed maturities$ 7,068,321 $ 1,041,929 Mortgage loans 540,495 - Other invested assets 151,867 - Other interest income 152,165 - Gross investment income 7,912,848 1,041,929 Less: investment expenses (1,805,459) (198,793)
Investment income, net of expenses
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. Our investment portfolio
grew to
Net realized (loss) gains on investments: The net realized loss on investments
for the six months ended
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the obligations to FIA policyholders is offset by expenses, including interest credited expenses and other operating expenses The increase in other net realized gains on investments was primarily due to favorable trading activity.
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
Amortization of deferred gain on reinsurance: 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 46% of the business in 2021 compared to the 22% 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.
Service fee revenue, net of expenses: The increase in 2021 was due primarily to the increases in 1505 Capital's asset management services provided on the increased investment portfolio of our third-party reinsurers.
Other revenue: The increase in third-party administration ("TPA") fees earned was due to us providing other administrative services to clients.
Expenses are summarized in the table below.
Six months ended June 30, 2021 2020 Interest credited$ 1,584,813 $ 83,150 Benefits 79 (3,087) Amortization of deferred acquisition costs 1,027,073 140,897 Salaries and benefits 7,441,171 2,179,830 Other operating expenses 2,644,899 3,630,800$ 12,698,035 $ 6,031,590
Interest credited: The increase was due primarily due to the FIA product and the
increase in the fair market value of the embedded derivative liability owned by
us to FIA policyholders. This increase is partially offset in our net realized
gain (loss) on investments, as referenced above, which saw a
Benefits: Death benefits changed insignificantly over prior year.
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 46% of the business in 2021 compared to the 22% 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
46 Table of Contents Decrease:
The decrease in expenses were primarily due to our FIA product which has
embedded derivatives included in the account value. Those derivatives are
market driven. The reinsurers that reinsure the FIA products pay an option
? allowance to American Life to purchase derivatives. As of
mark-to-market on those allowances were in a positive position so American Life
incurred a decrease of
for that mark-up.
Due to the valuation completed in June of 2020 on an investment in an
? unaffiliated reinsurance company, an impairment of
the full value of the preferred stock.
Increases:
Other increases in other expenses related to taxes, licenses and fees of
approximately
? examination fees; consultants to assist with the growth of the business of
costs, and
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
The investment guidelines typically include
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 of
June 30, 2021 December 31, 2020 Carrying Percent Carrying Percent Value of Total Value of Total Fixed maturity securities: U.S. government obligations$ 2,003,134 0.2 %$ 6,164,983 0.9 % Mortgage-backed securities 41,289,415 4.6 14,757,414 2.2 Collateralized loan obligations 324,097,561 35.9 221,773,609 33.1 States and political subdivisions -- general obligations 118,184 - 117,330 - States and political subdivisions -- special revenue 6,526,126 0.7 6,202,204 0.9 Trust preferred 16,465,915 1.8 2,284,816 0.3 Corporate 198,360,926 21.9 125,863,002 18.9 Total fixed maturity securities 588,861,261 65.1 377,163,358 56.3 Mortgage loans on real estate, held for investment 130,372,068 14.4 94,989,970 14.2 Derivatives 16,422,394 1.8 11,361,034 1.7 Equity securities 46,924,170 5.2 - - Other invested assets 40,813,176 4.5 21,897,130 3.3 Investment escrow - - 3,174,047 0.5 Federal Home Loan Bank (FHLB) stock 500,000 0.1 - - Preferred stock 4,728,375 0.5 3,897,980 0.6 Notes receivable 5,810,328 0.6 5,665,487 0.8 Policy Loans 51,529 - 45,573 - Cash and cash equivalents 70,278,979 7.8 151,679,274 22.6 Total investments, including cash and cash equivalents$ 904,762,280 100.0 %$ 669,873,853 100.0 % 47 Table of Contents The following table shows the distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value as ofJune 30, 2021 andDecember 31, 2020 . June 30, 2021 December 31, 2020 Carrying Carrying Value Percent Value Percent AAA and U.S. Government$ 19,761,963 3.4 %$ 3,070,750 0.8 % AA 652,443 0.1 5,818,163 1.5 A 105,264,686 17.9 49,445,266 13.1 BBB 395,104,517 67.0 247,635,730 65.7 Total investment grade 520,783,609 88.4 305,969,909 81.1 BB and other 68,077,652 11.6 71,193,449 18.9 Total$ 588,861,261 100.0 %$ 377,163,358 100.0 %
Reflecting the quality of securities maintained by us, 88.4% and 81.1% of all
fixed maturity securities were investment grade as of
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) Income of
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American Life under SAP, see Note 14 to our Consolidated Financial Statements.
American Life maintains sufficient capital and surplus to comply with regulatory
requirements as of
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) Income and surplus as
regards policyholders, which is called stockholders' equity under GAAP.
49 Table of Contents
The following reconciles our GAAP net (Loss) Income to our SAP net (Loss) Income for the periods indicated.
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