Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations.
Overview
The Company's operations over the last several years generally reflect three trends or events which the Company expects to continue: (i) increased attention to "niche" insurance products, such as the Company's funeral plan policies and traditional whole life products; (ii) emphasis on cemetery and mortuary business; and (iii) capitalizing on an improving housing market by originating mortgage loans.
Insurance Operations
The Company's life insurance business includes funeral plans and interest-sensitive life insurance, as well as other traditional life, accident and health insurance products. The Company places specific marketing emphasis on funeral plans through pre-need planning.
A funeral plan is a small face value life insurance policy that generally has face coverage of up to $25,000. The Company believes that funeral plans represent a marketing niche that is less competitive because most insurance companies do not offer similar coverage. The purpose of the funeral plan policy is to pay the costs and expenses incurred at the time of a person's death. On a per thousand-dollar cost of insurance basis, these policies can be more expensive to the policyholder than many types of non-burial insurance due to their low face amount, requiring the fixed cost of the policy administration to be distributed over a smaller policy size, and the simplified underwriting practices that result in higher mortality costs.
The following table shows the condensed financial results of the insurance operations for three and six months ended June 30, 2018 and 2017. See Note 7 to the condensed consolidated financial statements.
|
|
Three months ended June 30
(in thousands of dollars)
|
|
|
Six months ended June 30
(in thousands of dollars)
|
|
|
|
2018
|
|
|
2017
|
|
|
% Increase
(Decrease)
|
|
|
2018
|
|
|
2017
|
|
|
% Increase
(Decrease)
|
|
Revenues from external customers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance premiums
|
|
$
|
19,192
|
|
|
$
|
17,498
|
|
|
|
10
|
%
|
|
$
|
38,002
|
|
|
$
|
34,855
|
|
|
|
9
|
%
|
Net investment income
|
|
|
9,416
|
|
|
|
7,812
|
|
|
|
21
|
%
|
|
|
19,199
|
|
|
|
15,403
|
|
|
|
25
|
%
|
Gains on investments and other assets
|
|
|
460
|
|
|
|
282
|
|
|
|
63
|
%
|
|
|
22,320
|
|
|
|
1,470
|
|
|
|
1418
|
%
|
Other
|
|
|
304
|
|
|
|
278
|
|
|
|
9
|
%
|
|
|
716
|
|
|
|
306
|
|
|
|
134
|
%
|
Total
|
|
$
|
29,372
|
|
|
$
|
25,870
|
|
|
|
14
|
%
|
|
$
|
80,237
|
|
|
$
|
52,034
|
|
|
|
54
|
%
|
Intersegment revenue
|
|
$
|
988
|
|
|
$
|
1,589
|
|
|
|
(38
|
%)
|
|
$
|
1,807
|
|
|
$
|
3,050
|
|
|
|
(41
|
%)
|
Earnings before income taxes
|
|
$
|
2,937
|
|
|
$
|
2,799
|
|
|
|
5
|
%
|
|
$
|
26,649
|
|
|
$
|
4,283
|
|
|
|
522
|
%
|
Intersegment revenues are primarily interest income from the warehouse line provided to SecurityNational Mortgage Company ("SecurityNational Mortgage"). Profitability in the three and six months ended June 30, 2018 has increased due to the realized of $22,252,000 gain on the sale of Dry Creek at East Village Apartments, increases in investment income and increases in insurance premiums. These increases were partially offset by increases in benefits and expenses.
Cemetery and Mortuary Operations
The Company sells mortuary services and products through its eight mortuaries in Utah. The Company also sells cemetery products and services through its five cemeteries in Utah and one cemetery in San Diego County, California. At-need product sales and services are recognized as revenue when the services are performed or when the products are delivered. Pre-need cemetery product sales are deferred until the merchandise is delivered and services performed. Recognition of revenue for cemetery land sales occurs when 10% of the purchase price is received.
The following table shows the condensed financial results of the cemetery and mortuary operations for the three and six months ended June 30, 2018 and 2017. See Note 7 to the condensed consolidated financial statements.
|
|
Three months ended June 30
(in thousands of dollars)
|
|
|
Six months ended June 30
(in thousands of dollars)
|
|
|
|
2018
|
|
|
2017
|
|
|
% Increase
(Decrease)
|
|
|
2018
|
|
|
2017
|
|
|
% Increase
(Decrease)
|
|
Revenues from external customers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortuary revenues
|
|
$
|
1,274
|
|
|
$
|
1,182
|
|
|
|
8
|
%
|
|
$
|
2,665
|
|
|
$
|
2,588
|
|
|
|
3
|
%
|
Cemetery revenues
|
|
|
2,860
|
|
|
|
2,213
|
|
|
|
29
|
%
|
|
|
4,811
|
|
|
|
4,344
|
|
|
|
11
|
%
|
Gains on investments and other assets
|
|
|
1,236
|
|
|
|
(88
|
)
|
|
|
(1505
|
%)
|
|
|
1,645
|
|
|
|
16
|
|
|
|
10181
|
%
|
Other
|
|
|
(89
|
)
|
|
|
1
|
|
|
|
(9000
|
%)
|
|
|
(70
|
)
|
|
|
(40
|
)
|
|
|
75
|
%
|
Total
|
|
$
|
5,281
|
|
|
$
|
3,308
|
|
|
|
60
|
%
|
|
$
|
9,051
|
|
|
$
|
6,908
|
|
|
|
31
|
%
|
Earnings before income taxes
|
|
$
|
2,071
|
|
|
$
|
325
|
|
|
|
537
|
%
|
|
$
|
2,932
|
|
|
$
|
1,084
|
|
|
|
170
|
%
|
Included in other revenue is rental income from residential and commercial properties purchased from Security National Life. Memorial Estates purchased these properties from financing provided by Security National Life. The rental income is offset by property insurance, taxes and maintenance expenses. Memorial Estates has recorded depreciation on these properties of $155,000 and $163,000 for the three months ended June 30, 2018 and 2017, respectively, and $309,000 and $333,000 for the six months ended June 30, 2018 and 2017, respectively. Profitability in the three and six months ended June 30, 2018 has increased due to a realized gain on the sale of assets of Deseret Mortuary and an increase in cemetery revenues.
Mortgage Operations
The Company's wholly owned subsidiaries, SecurityNational Mortgage and EverLEND Mortgage Company (formerly known as Green Street Mortgage Services, Inc.), are mortgage lenders incorporated under the laws of the State of Utah and approved and regulated by the Federal Housing Administration (FHA), a department of the U.S. Department of Housing and Urban Development (HUD), which originate mortgage loans that qualify for government insurance in the event of default by the borrower, in addition to various conventional mortgage loan products. SecurityNational Mortgage and EverLEND Mortgage originate and refinance mortgage loans on a retail basis. Mortgage loans originated or refinanced by the Company's mortgage subsidiaries are funded through loan purchase agreements with Security National Life and unaffiliated financial institutions.
The Company's mortgage subsidiaries receive fees from borrowers that are involved in mortgage loan originations and refinancings, and secondary fees earned from third party investors that purchase the mortgage loans originated by the mortgage subsidiaries. Mortgage loans originated by the mortgage subsidiaries are generally sold with mortgage servicing rights released to third-party investors or retained by SecurityNational Mortgage. SecurityNational Mortgage currently retains the mortgage servicing rights on approximately 30% of its loan origination volume. These mortgage loans are serviced by either SecurityNational Mortgage or an approved third-party sub-servicer.
For the six months ended June 30, 2018 and 2017, SecurityNational Mortgage originated 5,183 loans ($1,072,863,000 total volume) and 6,551 loans ($1,271,565,000 total volume), respectively. For the six months ended June 30, 2018 and 2017, EverLEND Mortgage originated 80 loans ($22,510,000 total volume) and six loans ($1,202,000 total volume), respectively.
The following table shows the condensed financial results of the mortgage operations for the three and six months ended June 30, 2018 and 2017. See Note 7 to the condensed consolidated financial statements.
|
|
Three months ended June 30
(in thousands of dollars)
|
|
|
Six months ended June 30
(in thousands of dollars)
|
|
|
|
2018
|
|
|
2017
|
|
|
% Increase
(Decrease)
|
|
|
2018
|
|
|
2017
|
|
|
% Increase
(Decrease)
|
|
Revenues from external customers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from loan originations
|
|
$
|
13,473
|
|
|
$
|
11,688
|
|
|
|
15
|
%
|
|
$
|
25,335
|
|
|
$
|
26,559
|
|
|
|
(5
|
%)
|
Secondary gains from investors
|
|
|
20,740
|
|
|
|
32,446
|
|
|
|
(36
|
%)
|
|
|
36,318
|
|
|
|
58,641
|
|
|
|
(38
|
%)
|
Total
|
|
$
|
34,213
|
|
|
$
|
44,134
|
|
|
|
(22
|
%)
|
|
$
|
61,653
|
|
|
$
|
85,200
|
|
|
|
(28
|
%)
|
Earnings before income taxes
|
|
$
|
(847
|
)
|
|
$
|
870
|
|
|
|
(197
|
%)
|
|
$
|
(4,232
|
)
|
|
$
|
1,525
|
|
|
|
(378
|
%)
|
The decrease in earnings for the three and six months ended June 30, 2018 was due to a reduction in mortgage loan originations and refinancings, and subsequent sales into the secondary market.
Mortgage Loan Loss Settlements
Future mortgage loan losses can be extremely difficult to estimate. However, management believes that the Company's reserve methodology and its current practice of property preservation allow it to estimate its potential losses on mortgage loans sold. The estimated liability for indemnification losses was included in other liabilities and accrued expenses and, as of June 30, 2018 and December 31, 2017, the balances were $3,180,000 and $2,572,000, respectively.
Mortgage Loan Loss Litigation
For a description of the litigation involving SecurityNational Mortgage and Lehman Brothers Holdings, see Part I, Item 1. Notes to Condensed Consolidated Financial Statements (unaudited) in Note 11.
Consolidation
Three months ended June 30, 2018 Compared to Three months Ended June 30, 2017
Total revenues decreased by $4,448,000, or 6.1%, to $68,865,000 for the three months ended June 30, 2018, from $73,313,000 for the comparable period in 2017. Contributing to this decrease in total revenues was a $9,805,000 decrease in mortgage fee income. This decrease in total revenues was partially offset by a $1,692,000 increase in insurance premiums and other considerations, a $1,440,000 increase in gains on investments and other assets, a $1,420,000 increase in net investment income, a $271,000 increase in net mortuary and cemetery sales, a $268,000 increase in other revenues, and a $266,000 decrease in other than temporary impairments on investments.
Insurance premiums and other considerations increased by $1,692,000, or 9.7%, to $19,191,000 for the three months ended June 30, 2018, from $17,499,000 for the comparable period in 2017. This increase was primarily due to an increase in renewal premiums due to the growth of the Company in recent years, particularly in whole life products, which resulted in more premium paying business in force.
Net investment income increased by $1,420,000, or 17.1%, to $9,742,000 for the three months ended June 30, 2018, from $8,322,000 for the comparable period in 2017. This increase was primarily attributable to a $2,462,000 increase in mortgage loan interest, a $411,000 increase in insurance assignment income, an $85,000 increase interest on cash and cash equivalents, and a $63,000 increase in income from other investments. This increase was partially offset by a $1,211,000 decrease in rental income from real estate held for investment, a $342,000 increase in investment expenses, and a $45,000 decrease in policy loan income.
Net mortuary and cemetery sales increased by $271,000, or 8.3%, to $3,551,000 for the three months ended June 30, 2018, from $3,280,000 for the comparable period in 2017. This increase was primarily due to a $195,000 increase in cemetery preneed sales and an $88,000 increase in mortuary at-need sales. This increase was partially offset by a $12,000 decrease in cemetery at-need sales.
Gains on investments and other assets increased by $1,441,000, or 162.4%, to $2,328,000 in gains for the three months ended June 30, 2018, from $887,000 in gains for the comparable period in 2017. This increase in gains on investments and other assets was primarily attributable to a gain of $1,603,000 realized on the sale of assets of Deseret Mortuary and a $127,000 increase in gains on equity securities mostly attributable to increases in the fair value of these securities. Due to the adoption of Accounting Standards Update ("ASU") 2016-01, these changes in fair value are now recognized in earnings instead of other comprehensive income. See the discussion of the adoption of this ASU in Note 2 of the notes to condensed consolidated financial statements. This increase was partially offset by a $272,000 decrease in gains on other assets and a $17,000 decrease in gains on fixed maturity securities.
Mortgage fee income decreased by $9,805,000, or 23.6%, to $31,709,000, for the three months ended June 30, 2018, from $41,514,000 for the comparable period in 2017. This decrease was primarily due to a decline in mortgage loan originations that was indicative of the mortgage loan industry as a whole. The decline in mortgage loan originations was primarily caused by a national shortage of available new housing for mortgage loan origination transactions, and the decline in mortgage loan refinancings, which were primarily caused by recent increases in interest rates on mortgage loans. Additionally, the decline in mortgage originations by SecurityNational Mortgage has resulted in a decline in fees earned from third-party investors that purchase mortgage loans from SecurityNational Mortgage.
Other revenues increased by $268,000, or 12.9%, to $2,344,000 for the three months ended June 30, 2018, from $2,076,000 for the comparable period in 2017. This increase was due to an increase in mortgage servicing fees.
Total benefits and expenses were $64,703,000, or 94.0% of total revenues, for the three months ended June 30, 2018, as compared to $69,318,000, or 94.6% of total revenues, for the comparable period in 2017.
Death benefits, surrenders and other policy benefits, and future policy benefits increased by an aggregate of $1,607,000 or 11.0%, to $16,200,000 for the three months ended June 30, 2018, from $14,593,000 for the comparable period in 2017. This increase was primarily the result of a $808,000 increase in death benefits, a $783,000 increase in surrender and other policy benefits, and a $16,000 increase in future policy benefits.
Amortization of deferred policy and pre-need acquisition costs and value of business acquired increased by $342,000, or 19.3%, to $2,111,000 for the three months ended June 30, 2018, from $1,769,000 for the comparable period in 2017. This increase was primarily due to an increase in the average outstanding balance of deferred policy and pre-need acquisition costs.
Selling, general and administrative expenses decreased by $6,877,000, or 13.5%, to $44,162,000 for the three months ended June 30, 2018, from $51,039,000 for the comparable period in 2017. This decrease was primarily the result of a $4,063,000 decrease in commissions due to the decline in mortgage loan originations, a $1,200,000 decrease in personnel expenses due to a reduction in mortgage loan originators, a $710,000 decrease in other expenses, a $292,000 decrease in advertising, a $283,000 decrease in rent and rent related expenses, a $240,000 decrease in costs related to funding mortgage loans, and a $89,000 decrease in depreciation on property and equipment.
Interest expense increased by $295,000, or 21.3%, to $1,680,000 for the three months ended June 30, 2018, from $1,385,000 for the comparable period in 2017. This increase was primarily due to an increase in interest expense on mortgage warehouse lines and interest expense on bank loans for real estate held for investment.
Six months ended June 30, 2018 Compared to Six months Ended June 30, 2017
Total revenues increased by $6,799,000, or 4.7%, to $150,941,000 for the six months ended June 30, 2018, from $144,142,000 for the comparable period in 2017. Contributing to this increase in total revenues was a $23,316,000 increase in gains on investments and other assets, a $3,146,000 increase in insurance premiums and other considerations, a $2,478,000 increase in net investment income, a $717,000 increase in other revenues, a $318,000 decrease in other than temporary impairments on investments, and a $144,000 increase in net mortuary and cemetery sales. This increase in total revenues was partially offset by a $23,320,000 decrease in mortgage fee income.
Insurance premiums and other considerations increased by $3,146,000, or 9.0%, to $38,001,000 for the six months ended June 30, 2018, from $34,855,000 for the comparable period in 2017. This increase was primarily due to an increase in renewal premiums due to the growth of the Company in recent years, particularly in whole life products, which resulted in more premium paying business in force.
Net investment income increased by $2,478,000, or 14.3%, to $19,816,000 for the six months ended June 30, 2018, from $17,338,000 for the comparable period in 2017. This increase was primarily attributable to a $3,966,000 increase in mortgage loan interest, a $990,000 increase in insurance assignment income, a $120,000 increase interest on cash and cash equivalents, a $110,000 increase in income from other investments, and a $107,000 increase in fixed maturity securities income. This increase was partially offset by a $1,422,000 decrease in rental income from real estate held for investment, a $1,332,000 increase in investment expenses, and a $59,000 decrease in policy loan income.
Net mortuary and cemetery sales increased by $144,000, or 2.2%, to $6,784,000 for the six months ended June 30, 2018, from $6,640,000 for the comparable period in 2017. This increase was primarily due to an increase of $88,000 in mortuary at-need sales and an increase of $87,000 in cemetery preneed sales. This increase was partially offset by a $31,000 decrease in cemetery at-need sales.
Gains on investments and other assets increased by $23,316,000, or 2,257.7%, to $24,349,000 in gains for the six months ended June 30, 2018, from $1,033,000 in gains for the comparable period in 2017. This increase in gains on investments and other assets was primarily attributable to a gain of $22,252,000 realized from the sale of Dry Creek at East Village Apartments, a gain of $1,603,000 realized on the sale of assets of Deseret Mortuary, and a $47,000 increase in gains on other assets due to the sale of various other residential real estate properties. This increase was partially offset by a $300,000 increase in losses on fixed maturity securities, and a $286,000 increase in losses on equity securities mostly attributable to decreases in the fair value of these securities. Due to the adoption of Accounting Standards Update ("ASU") 2016-01, these changes in fair value are now recognized in earnings instead of other comprehensive income. See the discussion of the adoption of this ASU in Note 2 of the notes to condensed consolidated financial statements.
Mortgage fee income decreased by $23,320,000, or 29.0%, to $57,169,000, for the six months ended June 30, 2018, from $80,489,000 for the comparable period in 2017. This decrease was primarily due to a decline in mortgage loan originations that was indicative of the mortgage loan industry as a whole. The decline in mortgage loan originations was primarily caused by a national shortage of available new housing for mortgage loan origination transactions, and the decline in mortgage loan refinancings, which were primarily caused by recent increases in interest rates on mortgage loans. Additionally, the decline in mortgage originations by SecurityNational Mortgage has resulted in a decline in fees earned from third-party investors that purchase mortgage loans from SecurityNational Mortgage.
Other revenues increased by $717,000, or 17.5%, to $4,822,000 for the six months ended June 30, 2018, from $4,105,000 for the comparable period in 2017. This increase was due to an increase in mortgage servicing fees.
Total benefits and expenses were $125,592,000, or 83.2% of total revenues, for the six months ended June 30, 2018, as compared to $137,250,000, or 95.2% of total revenues, for the comparable period in 2017.
Death benefits, surrenders and other policy benefits, and future policy benefits increased by an aggregate of $2,390,000 or 8.0%, to $32,203,000 for the six months ended June 30, 2018, from $29,813,000 for the comparable period in 2017. This increase was primarily the result of a $1,622,000 increase in death benefits and a $800,000 increase in future policy benefits. This increase was partially offset by a $32,000 decrease in surrender and other policy benefits.
Amortization of deferred policy and pre-need acquisition costs and value of business acquired increased by $1,188,000, or 29.5%, to $5,221,000 for the six months ended June 30, 2018, from $4,033,000 for the comparable period in 2017. This increase was primarily due to an increase in the average outstanding balance of deferred policy and pre-need acquisition costs.
Selling, general and administrative expenses decreased by $16,050,000, or 16.1%, to $83,660,000 for the six months ended June 30, 2018, from $99,710,000 for the comparable period in 2017. This decrease was primarily the result of a $9,136,000 decrease in commissions due to the decline in mortgage loan originations, a $3,223,000 decrease in personnel expenses due to a reduction in mortgage loan originators, a $1,246,000 decrease in other expenses, a $1,090,000 decrease in costs related to funding mortgage loans, a $573,000 decrease in advertising, a $544,000 decrease in rent and rent related expenses, and a $238,000 decrease in depreciation on property and equipment.
Interest expense increased by $802,000, or 30.4%, to $3,442,000 for the six months ended June 30, 2018, from $2,640,000 for the comparable period in 2017. This increase was primarily due to an increase in interest expense on mortgage warehouse lines and interest expense on bank loans for real estate held for investment.
Liquidity and Capital Resources
The Company's life insurance subsidiaries and cemetery and mortuary subsidiaries realize cash flow from premiums, contract payments and sales on personal services rendered for cemetery and mortuary business, from interest and dividends on invested assets, and from the proceeds from the maturity of held to maturity investments or sale of other investments. The mortgage subsidiaries realize cash flow from fees generated by originating and refinancing mortgage loans, and fees earned from mortgage loans held for sale that are sold to investors. The Company considers these sources of cash flow to be adequate to fund future policyholder and cemetery and mortuary liabilities, which generally are long-term and adequate to pay current policyholder claims, annuity payments, expenses related to the issuance of new policies, the maintenance of existing policies, and debt service, and to meet current operating expenses.
During the six months ended June 30, 2018 and 2017, the Company's operations used cash of $27,787,000 and provided cash of $20,042,000, respectively. This decrease was due primarily to an increase in cash used to fund mortgage loans held for sale.
The Company's liability for future policy benefits is expected to be paid out over the long-term due to the Company's market niche of selling funeral plans. Funeral plans are small face value life insurance that will pay the costs and expenses incurred at the time of a person's death. A person generally will keep these policies in force and will not surrender them prior to a person's death. Because of the long-term nature of these liabilities, the Company is able to hold to maturity its bonds, real estate and mortgage loans, thus reducing the risk of having to liquidate these long-term investments as a result of any sudden changes in fair values.
The Company attempts to match the duration of invested assets with its policyholder and cemetery and mortuary liabilities. The Company may sell investments other than those held to maturity in the portfolio to help in this timing. The Company purchases short-term investments on a temporary basis to meet the expectations of short-term requirements of the Company's products. The Company's investment philosophy is intended to provide a rate of return that will persist during the expected duration of policyholder and cemetery and mortuary liabilities regardless of future interest rate movements.
The Company's investment policy is to invest predominantly in fixed maturity securities, real estate, mortgage loans, and warehousing of mortgage loans on a short-term basis before selling the loans to investors in accordance with the requirements and laws governing the life insurance subsidiaries. Bonds owned by the insurance subsidiaries amounted to $217,786,000 and $227,774,000 as of June 30, 2018 and December 31, 2017, respectively. This represents 36.9% and 35.1% of the total investments as of June 30, 2018 and December 31, 2017, respectively. Generally, all bonds owned by the life insurance subsidiaries are rated by the National Association of Insurance Commissioners. Under this rating system, there are six categories used for rating bonds. At June 30, 2018, 4.5% (or $9,765,000) and at December 31, 2017, 5.4% (or $12,293,000) of the Company's total bond investments were invested in bonds in rating categories three through six, which were considered non‑investment grade.
The Company has classified its fixed income securities as held to maturity. Notwithstanding, business conditions may develop in the future which may indicate a need for a higher level of liquidity in the investment portfolio. In that event, the Company believes it could sell short-term investment grade securities before liquidating higher yielding longer-term securities.
The Company is subject to risk-based capital guidelines established by statutory regulators requiring minimum capital levels based on the perceived risk of assets, liabilities, disintermediation, and business risk. At June 30, 2018 and December 31, 2017, the life insurance subsidiaries were in compliance with the regulatory criteria.
The Company's total capitalization of stockholders' equity, bank and other loans payable was $378,856,000 as of June 30, 2018, as compared to $306,019,000 as of December 31, 2017. Stockholders' equity as a percent of total capitalization was 44.9% and 48.5% as of June 30, 2018 and December 31, 2017, respectively.
Lapse rates measure the amount of insurance terminated during a particular period. The Company's lapse rate for life insurance in 2017 was 10.6% as compared to a rate of 9.6% for 2016. The 2018 lapse rate to date has been approximately the same as 2017.
At June 30, 2018, the statutory capital and surplus of the Company's life insurance subsidiaries was $55,063,000. The life insurance subsidiaries cannot pay a dividend to its parent company without approval of state insurance regulatory authorities.