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KCLI > SEC Filings for KCLI > Form 10-K on 26-Feb-2014All Recent SEC Filings

Show all filings for KANSAS CITY LIFE INSURANCE CO

Form 10-K for KANSAS CITY LIFE INSURANCE CO


26-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Amounts are stated in thousands, except share data, or as otherwise noted. Management's Discussion and Analysis of Financial Condition and Results of Operations for the three years ended December 31, 2013 is intended to provide in narrative form the perspective of the management of Kansas City Life Insurance Company (the Company) on its financial condition, results of operations, liquidity, and certain other factors that may affect its future results. This discussion should be read in conjunction with the consolidated financial statements and accompanying notes included in this document. Overview
Kansas City Life Insurance Company is a financial services company that is predominantly focused on the underwriting, sales, and administration of life insurance and annuity products. The consolidated entity (the Company) primarily consists of three life insurance companies. Kansas City Life Insurance Company (Kansas City Life) is the parent company. Sunset Life Insurance Company of America (Sunset Life) and Old American Insurance Company (Old American) are wholly-owned subsidiaries.
Kansas City Life markets individual insurance products, including traditional, interest sensitive, and variable products through a nationwide sales force of independent general agents, agents, and third-party marketing arrangements. Kansas City Life also markets group insurance products, which include life, dental, vision, and disability products through its sales force of independent general agents, agents, group brokers, and third-party marketing arrangements. Kansas City Life operates in 48 states and the District of Columbia. Sunset Life is a life insurance company that maintains its current block of business, but does not solicit new sales. Sunset Life is included in the Individual Insurance segment and its individual insurance products include traditional and interest sensitive products. Sunset Life operates in 43 states and the District of Columbia.
Old American focuses on selling final expense life insurance products to the senior market. Old American markets its products nationwide through a general agency system, with exclusive territories, using direct response marketing to supply agents with leads. Old American's administrative and accounting operations are part of the Company's home office but it operates and maintains a separate marketing function and independent field force. Old American operates in 47 states and the District of Columbia.
The Company offers investment products and broker-dealer services through its subsidiary Sunset Financial Services, Inc. (SFS) for both proprietary and non-proprietary variable insurance products, mutual funds, and other securities. The Company operates in the life insurance sector of the financial services industry in the United States. This industry is highly competitive with respect to pricing, selection of products, and quality of service. No single competitor or any small group of competitors dominates any of the markets in which the Company operates.
The Company earns revenues primarily from premiums received from the sale of life insurance, immediate annuities, and accident and health policies; from earnings on its investment portfolio; and from the sale of investment assets. Insurance revenues from the sale of traditional life insurance, immediate annuity products, and accident and health products are reported as premium income for financial statement purposes. Considerations for supplementary contracts with life contingencies are reported as other revenues. However, deposits received from the sale of interest sensitive products, namely universal life insurance products, fixed deferred annuities, variable universal life, variable annuities, and supplementary contracts without life contingencies, are not reported as premium revenues. These are instead reported as additions to the policyholders' account balances and are reflected as deposits in Financing Activities section of the Consolidated Statements of Cash Flows. Accordingly, insurance revenues on these products are recognized over time in the form of contract charges assessed against policyholder account balances, charges assessed on the early surrender of policyholder account balances, and other charges deducted from policyholder balances.


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The Company's profitability depends on many factors, which include but are not limited to:
The sale of life, interest sensitive, annuity, and accident and health products;

The rate of mortality, lapse, and surrenders of future policy benefits and policyholder account balances;

The rate of morbidity, disability, and incurrence of other policyholder benefits;

Persistency of existing insurance policies;

Interest rates credited to policyholders;

The effectiveness of reinsurance programs;

The amount of investment assets under management;

The ability to maximize investment returns and minimize risks such as interest rate risk, credit risk, and equity risk;

Timely and cost-effective access to liquidity; and

Management of distribution costs and operating expenses.

Strong sales competition, highly competitive products, and an ever-changing economic environment present significant challenges to the Company from a new sales perspective. The Company's primary emphasis is on expanding sales of individual life insurance products. The Company's continued focus is on delivering competitive products for a reasonable cost, prompt customer service, excellent financial strength, and effective sales and marketing support to the field force.
The Company generates cash largely through premiums collected from the sale of insurance products, deposits through the sale of universal life-type and deposit-type products, and through investment activity. The principal uses of cash are for the insurance operations, including the purchase of investments, payment of insurance benefits and other withdrawals from policyholder accounts, operating expenses, premium taxes, and costs related to acquiring new business. In addition, cash is used to pay income taxes and stockholder dividends, as well as to fund potential acquisition opportunities.
General economic conditions may affect future results. Market fluctuations, often extreme in nature, have significantly impacted the financial markets and the Company's investments, revenues, and policyholder benefits in recent periods. The sustained low interest rate environment and volatile equity markets have presented significant challenges to the financial markets as a whole and specifically to companies invested in fixed maturity securities and other fixed income investments. These conditions may continue and the stressed economic and market environment may persist into the future, affecting the Company's revenue, net income, and financial position.
Reinsurance Transaction
In April 2013, the Company acquired a block of variable universal life insurance policies and variable annuity contracts from American Family Life Insurance Company. The transfer was comprised of a 100% modified coinsurance transaction for the separate account business and a 100% coinsurance transaction for the corresponding fixed account business. Included in the transaction are ongoing servicing arrangements for this business. During 2013, this transaction contributed contract charges of $13.0 million, policyholder benefits and interest credited to policyholder account balances of $3.1 million, and amortization of deferred acquisition costs of $3.6 million. Immaterial Correction of Errors
During the first quarter of 2012, the Company identified an error related to the amortization period for unrecognized actuarial gains and losses for its pension plan resulting in a reduction to net periodic pension expense of $2.0 million before applicable income taxes and an after-tax increase of $1.3 million to net income and stockholders' equity. The excess amortization had been previously recorded during 2011. Please refer to Note 13 - Pensions and Other Postretirement Benefits for additional information.
During the second quarter of 2012, the Company identified an error in the presentation of treasury stock held for the benefit of the Company's deferred compensation plans. This treasury stock was previously recorded as a component of other assets but should have been recorded in stockholders' equity as treasury stock. The Company reclassified $6.2 million (188,621 shares) from other assets to treasury stock. This error had no material impact on net income in the current or prior reporting periods.
Management has evaluated these errors both quantitatively and qualitatively, and concluded that these corrections were not material to the consolidated financial statements.
Cautionary Statement on Forward-Looking Information This report reviews the Company's financial condition and results of operations, and historical information is presented and discussed. Where appropriate, factors that may affect future financial performance are also identified and discussed. Certain statements made in this report include "forward-looking statements" that fall within the meaning of the Private Securities Litigation


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Reform Act of 1995. Forward-looking statements include any statement that may predict, forecast, indicate or imply future results, performance, or achievements rather than historical facts and may contain words like "believe," "expect," "estimate," "project," "forecast," "anticipate," "plan," "will," "shall," and other words, phrases, or expressions with similar meaning. Forward-looking statements are subject to known and unknown risks, uncertainties, and other factors that may cause actual results to differ materially from those contemplated by the forward-looking statements. Factors that could cause the Company's future results to differ materially from expected results include, but are not limited to:
Changes in general economic conditions, including the performance of financial markets and interest rates;

Increasing competition and changes in consumer behavior, which may affect the Company's ability to sell its products and retain business;

Increasing competition in the recruiting of new general agents and agents;

Customer and agent response to new products, distribution channels, and marketing initiatives;

Fluctuations in experience regarding current mortality, morbidity, persistency, and interest rates relative to expected amounts used in pricing the Company's products;

Changes in assumptions related to DAC and VOBA;

Regulatory, accounting, or tax changes that may affect the cost of, or the demand for, the Company's products or services; and

Unanticipated changes in industry trends and ratings assigned by nationally recognized rating organizations.

The Company cannot give assurances that such statements will prove to be correct. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. Critical Accounting Policies
The preparation of the financial statements requires management to use a variety of assumptions and estimates. Actual results may differ from these estimates under different assumptions or conditions. The profitability of life insurance and annuity products is dependent on actual experience, and differences between actual experience and pricing assumptions may result in variability of net income in amounts which may be material. On an ongoing basis, the Company evaluates the estimates, assumptions, and judgments based on historical experience and other information that the Company believes to be relevant under the circumstances. A detailed discussion of significant accounting policies is provided in Note 1 - Nature of Operations and Significant Accounting Policies in the Notes to Consolidated Financial Statements. Valuation of Investments and Impairments Securities
Fixed maturity and equity securities, which are classified as available for sale, are carried at fair value in the Company's Consolidated Balance Sheets, with unrealized gains or losses recorded in accumulated other comprehensive income. The Company's fair value of fixed maturity and equity securities is derived from external pricing services, brokers, and internal matrices and calculations. At December 31, 2013, approximately 97% of the carrying value of these investments was from external pricing services and 3% was derived from brokers and internal matrices or calculations.
The Company monitors the various markets in which its investments are traded. The Company uses various methodologies and techniques to determine a best-estimate of fair value of its investments. However, all factors may not be known or publicly available from which to determine a value and, as such, the fair value used by the Company may not be truly indicative of the actual value available in an active market or an actual exit price if the Company were to sell the security in the current market. See further discussion of the valuation techniques and processes identified in Notes 4 and 5 to the Consolidated Financial Statements.
The Company has a policy and process in place to identify securities that could potentially have an impairment that is other-than-temporary. All securities are reviewed to determine whether impairments exist and whether other-than-temporary impairments should be recorded. The Company considers relevant facts and circumstances in evaluating whether the impairment of a security is other-than-temporary. There are a number of significant risks and uncertainties inherent in the process of monitoring impairments, determining if an impairment is other-than-temporary, and determining the portion of an other-than-temporary impairment that is due to credit. Please refer to Note 1 for information concerning these factors and a description of these risks and uncertainties. The Company may selectively determine that it no longer intends to hold a specific issue to its maturity. If the Company makes this determination and the fair value is less than the cost basis, the investment is written down to the fair value and an other-than-temporary impairment is recorded on this particular position. Subsequently, the Company seeks to obtain the best possible outcome available for this specific issue and records an investment gain or loss at the disposal date.
The evaluation of loan-backed and similar asset-backed securities, particularly including residential mortgage-backed securities (MBS), with significant indications of potential other-than-temporary impairment requires considerable use of estimates and


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judgment. Specifically, the Company performs discounted cash flow projections on these securities to evaluate whether the value of the investment is expected to be fully realized. If the present value of the expected future cash flows is determined to be below the Company's carrying value, the Company recognizes an other-than-temporary impairment on the portion of the carrying value that exceeds the projected expected future cash flows. To the extent that the loan-backed or other asset-backed securities were high quality investments at the time of acquisition, and they remain high quality investments and do not otherwise demonstrate characteristics of impairment, the Company performs other initial evaluations to determine whether other-than-temporary cash flow evaluations need to be performed. Please see the Analysis of Investments section for additional information.
Mortgage Loans
Mortgage loans are stated at cost, net of an allowance for potential future losses. The allowance is maintained at a level believed by management to be adequate to absorb estimated credit losses. Management's periodic evaluation and assessment of the adequacy of the reserve is based on known and inherent risks in the portfolio, historical and industry data, current economic conditions, and other relevant factors. The Company assesses the amount it maintains in the mortgage loan allowance through an assessment of what the Company believes are relevant factors at both the macro-environmental level and specific loan basis, which are detailed in Note 6. Generally, the Company establishes the allowance for potential future losses using a collective impairment methodology at an overall portfolio level that relies on monitoring certain metrics such as debt service coverage and loan-to-value, as well as other qualitative factors. If the Company determines through its evaluation that a loan has an elevated specific risk profile or it does not expect to collect all contractual cash flows, it then individually assesses the loan's risk profile and may assign an additional specific allowance value.
To the extent the Company's review and valuation determines a loan is impaired, that amount is charged to the allowance for loss and the loan balance is reduced. In the event that a property is foreclosed upon, the carrying value is written down to the lesser of the current fair value less costs to sell or book value of the property with a charge to the allowance for potential future losses and a corresponding reduction to the mortgage loan asset. Deferred Acquisition Costs and Value of Business Acquired Deferred acquisition costs (DAC), principally agent commissions and other selling, selection and issue costs, which are related directly to the successful acquisition of new or renewal insurance contracts, are capitalized as incurred. These costs for life insurance products are generally deferred and amortized over the premium paying period. Policy acquisition costs that relate to interest sensitive and variable insurance products are deferred and amortized in relation to the estimated gross profits to be realized over the lives of the contracts.
Historically, when a new block of business was acquired or when an insurance company was purchased, a portion of the purchase price was allocated to a separately identifiable intangible asset, called value of business acquired (VOBA). VOBA is established as the actuarially determined present value of future gross profits of the business acquired and is amortized with interest in proportion to future premium revenues or the expected future profits, depending on the type of business acquired.
For additional information pertaining to DAC and VOBA, please see Note 1.


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The following table illustrates the estimated sensitivity on a pre-tax basis to DAC on interest sensitive products that could occur in a twelve-month period for an unlocking adjustment due to potential changes in significant assumptions. Changes in assumptions of the same magnitude in the opposite direction would have an impact of a similar magnitude but opposite direction of the examples provided. Information included in the table is intended to illustrate potential sensitivity of future expected gross profits or amortization trends.

                                                        Potential One-Time Effect
   Critical Accounting                                         on DAC and
        Estimate            Determination Methodology         Related Items

Mortality Experience        Based on Company            A 2.5% increase in
                            mortality experience.       expected mortality
                            Industry experience and     experience for all future
                            trends are also             years would result in a
                            considered.                 reduction in DAC and an
                                                        increase in current
                                                        period amortization
                                                        expense of $2.5 million.

Surrender Rates             Based on Company            A 10% increase in
                            surrender experience.       expected surrender rates
                            Industry experience and     for all future years
                            trends are also             would result in a
                            considered.                 reduction in DAC and an
                                                        increase in current
                                                        period amortization
                                                        expense of $1.6 million.

Interest Spreads            Based on expected future    A 10 basis point
                            investment returns and      reduction in future
                            expected future crediting   interest rate spreads
                            rates applied to            would result in a
                            policyholder account        reduction in DAC and an
                            balances; future            increase in current
                            crediting rates include     period amortization
                            constraints imposed by      expense of $2.7 million.
                            policy guarantees.

Maintenance Expenses        Based on Company            A 10% increase in future
                            experience using an         maintenance expenses
                            internal expense            would result in a
                            allocation methodology.     reduction in DAC and an
                                                        increase in current
                                                        period amortization
                                                        expense of $1.7 million.

The following table illustrates the estimated sensitivity on a pre-tax basis to VOBA on interest sensitive products that could occur in a twelve-month period for an unlocking adjustment due to potential changes in significant assumptions. Changes in assumptions of the same magnitude in the opposite direction would have an impact of a similar magnitude but opposite direction of the examples provided. Information included in the table is intended to illustrate potential sensitivity of future expected gross profits or amortization trends.

                                                       Potential One-Time Effect
  Critical Accounting                                         on VOBA and
        Estimate           Determination Methodology         Related Items

Mortality Experience       Based on Company            A 2.5% increase in
                           mortality experience.       expected mortality
                           Industry experience and     experience for all future
                           trends are also             years would result in a
                           considered.                 reduction in VOBA and an
                                                       increase in current period
                                                       amortization expense of
                                                       $1.1 million.

Surrender Rates            Based on Company            A 10% increase in expected
                           surrender experience.       surrender rates for all
                           Industry experience and     future years would result
                           trends are also             in a reduction in VOBA and
                           considered.                 an increase in current
                                                       period amortization
                                                       expense of $0.6 million.

Interest Spreads           Based on expected future    A 10 basis point reduction
                           investment returns and      in future interest rate
                           expected future crediting   spreads would result in a
                           rates applied to            reduction in VOBA and an
                           policyholder account        increase in current period
                           balances; future            amortization expense of
                           crediting rates include     $0.6 million.
                           constraints imposed by
                           policy guarantees.

Maintenance Expenses       Based on Company            A 10% increase in future
                           experience using an         maintenance expenses would
                           internal expense            result in a reduction in
                           allocation methodology.     VOBA and an increase in
                                                       current period
                                                       amortization expense of
                                                       $0.3 million.


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Reinsurance Ceded
A variety of reinsurance ceded arrangements are currently in use by the Company, including individual and bulk arrangements on both coinsurance and mortality/morbidity-only basis. Reinsurance is an actively managed tool for the Company that supports several objectives, including managing statutory capital and reducing volatility and surplus strain. At the customer level, reinsurance increases the Company's capacity, provides access to additional underwriting expertise, and generally makes it possible for the Company to offer products at competitive levels that could not otherwise be made available.
The Company remains contingently liable if the reinsurer should be unable to meet obligations under the reinsurance contract. The Company monitors the relative financial strength and viability of its reinsurance partners. Reinsurance recoverables include amounts related to paid benefits and estimated amounts related to unpaid policy and contract claims and future policy benefits. Liabilities for reinsurance are calculated on an actuarial present value method consistent with the risks being transferred. Future Policy Benefits
The Company establishes liabilities for amounts payable under insurance policies, including traditional life insurance, immediate annuities with life contingencies, supplementary contracts with life contingencies, and accident and health insurance. These liabilities originate from new premiums, as well as conversions from other products, and are generally payable over an extended period of time.
Liabilities for future policy benefits of traditional life insurance have been computed using a net level premium method, based upon estimates at the time of issue for investment yields, mortality, and withdrawals. These estimates include provisions for experience less favorable than initially expected. Mortality assumptions are based on Company experience expressed as a percentage of standard mortality tables. The 2001 Valuation Basic Table and the 1975-1980 Select and Ultimate Basic Table serve as the basis for most mortality assumptions.
Liabilities for future policy benefits of immediate annuities and supplementary contracts with life contingencies are computed by calculating an actuarial present value of future policy benefits, based upon estimates for investment yields and mortality at the time of issue. Liabilities for future policy benefits of immediate annuities and supplementary contracts with life contingencies are also computed by a net level premium method, based upon estimates at the time of issue for investment yields and mortality. The 1971 Individual Annuity Mortality Table, the 1983 Individual Annuity Mortality Table, and the Annuity 2000 Table serve as the bases for most immediate annuity and supplementary contract mortality assumptions.
Liabilities for future policy benefits of accident and health insurance represent estimates of payments to be made on reported insurance claims, as well . . .

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