SECURITY NATIONAL FINANCIAL CORP 10-Q

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 to focus on: (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. The Company has adjusted its strategy to respond to the changing economic circumstances resulting from the COVID-19 pandemic. 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. In response to the COVID-19 pandemic, the life insurance sales force has transitioned to virtual and tele sales processes and transitioned approximately 95% of office staff to work remotely. The following table shows the condensed financial results of the insurance operations for three months ended March 31, 2021 and 2020. See Note 7 to the condensed consolidated financial statements. Three months ended March 31 (in thousands of dollars) 2021 2020 % Increase (Decrease) Revenues from external customers Insurance premiums $ 23,350 $ 22,291 5% Net investment income 13,939 13,051 7% Gains (losses) on investments and other assets 1,162 (2,545) 146% Other 493 408 21% Total $ 38,944 $ 33,205 17% Intersegment revenue $ 1,902 $ 908 109% Earnings before income taxes $ 2,695 $ (3,069) 188% Intersegment revenues are primarily interest income from the warehouse line for loans held for sale provided to SecurityNational Mortgage Company (“SecurityNational Mortgage”). Profitability for the three months ended March 31, 2021 has increased due to a $3,707,000 increase in gains on investments and other assets primarily due to an increase in the fair value of equity securities, a $2,783,000 decrease in future policy benefits, a $1,059,000 increase in insurance premiums and other considerations, a $994,000 increase in intersegment revenue, a $980,000 decrease in selling, general and administrative expenses, a $887,000 increase in net investment income, a $253,000 decrease in interest expense, an $85,000 increase in other revenues, and a $59,000 decrease in intersegment interest expense and other expenses. This increase was partially offset by a $4,912,000 increase in death, surrenders and other policy benefits and a $131,000 increase in amortization of deferred policy acquisition costs primarily due to an increase in the average outstanding balance of deferred policy and pre-need acquisition costs. 50 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. As a result of the COVID-19 pandemic, the Company has seen a decrease in its average case size as funeral services have been limited. The Company has transitioned its pre-need sales force to virtual selling and has done in home sales as local regulations permit. The following table shows the condensed financial results of the cemetery and mortuary operations for the three months ended March 31, 2021 and 2020. See Note 7 to the condensed consolidated financial statements. Three months ended March 31 (in thousands of dollars) 2021 2020 % Increase (Decrease) Revenues from external customers Mortuary revenues $ 2,020 $ 1,762 15% Cemetery revenues 3,922 2,696 45% Net investment income 230 205 12% Gains (losses) on investments and other assets 798 (660) 221% Other 29 11 164% Total $ 6,999 $ 4,014 74% Earnings before income taxes $ 2,701 $ 105 2472% Profitability in the three months ended March 31, 2021 has increased due to a $1,458,000 increase in gains on investments and other assets primarily attributable to a $649,000 increase in gains on real estate sales and an $810,000 increase in the fair value of equity securities classified as restricted assets and cemetery perpetual care trust investments, an $827,000 increase in cemetery pre-need sales, a $398,000 increase in cemetery at-need sales, a $259,000 increase in mortuary at-need sales, a $69,000 decrease in amortization of deferred policy acquisition costs, a $48,000 decrease in interest expense, a $25,000 increase in net investment income, a $19,000 decrease in intersegment interest expense and other expenses, and a $17,000 increase in other revenues. This increase was partially offset by a $242,000 increase in selling, general and administrative expenses, a $258,000 increase in costs of goods sold, and a $26,000 decrease in intersegment revenues. Mortgage Operations The Company’s wholly owned subsidiaries, SecurityNational Mortgage and EverLEND Mortgage Company, 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, Kilpatrick 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 70% of its loan origination volume. These mortgage loans are serviced by either SecurityNational Mortgage or an approved third-party sub-servicer. 51 For the three months ended March 31, 2021 and 2020, SecurityNational Mortgage originated 5,361 loans ($1,415,821,000 total volume) and 3,067 loans ($769,309,000 total volume), respectively. For the three months ended March 31, 2021 and 2020, EverLEND Mortgage originated 110 loans ($34,020,000 total volume) and 86 loans ($22,885,000 total volume), respectively. During the COVID-19 pandemic, the demand for mortgage loans has increased. The Company has seen most markets increase their demand for new homes and refinances on existing homes. The Company has transitioned 90% of its processes to a work from home environment. The following table shows the condensed financial results of the mortgage operations for the three months ended March 31, 2021 and 2020. See Note 7 to the condensed consolidated financial statements. Three months ended March 31 (in thousands of dollars) 2021 2020 % Increase (Decrease) Revenues from external customers Secondary gains from investors $ 68,439 $ 26,641 157% Income from loan originations 11,192 9,984 12% Change in fair value of loans held for sale (6,946) 382 (1918%) Change in fair value of loan commitments 314 3,275 (90%) Net investment income 125 144 (13%) Gains on investments and other assets - (7) (100%) Other 3,592 1,970 82% Total $ 8,277 $ 15,748 81% Earnings before income taxes $ 10,959 $ 4,439 147% Included in other revenues is service fee income. The increase in earnings for the three months ended March 31, 2021 was due to an increase in mortgage loan originations and refinancings, and subsequent sales of mortgage loans into the secondary market. This increase in earnings is primarily attributable to a $41,798,000 increase in secondary gains from investors, a $1,622,000 increase in other revenues, and a $1,208,000 increase in income from loan originations. This increase was partially offset by a $16,264,000 increase in commissions, by a $7,328,000 decrease in the fair value of loans held for sale, a $2,960,000 decrease in the fair value of loan commitments, a $5,666,000 increase in personnel expenses, a $2,548,000 increase in other expenses, a $1,008,000 increase in intersegment interest expense, a $981,000 increase in costs related to funding mortgage loans, a $735,000 increase in advertising expenses, a $308,000 increase in interest expense, and a $252,000 increase in rent and rent related expenses. 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 March 31, 2021 and December 31, 2020, the balances were $2,204,983 and $20,583,618, respectively. Consolidation Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020 Total revenues increased by $43,050,000, or 54.1%, to $122,659,000 for the three months ended March 31, 2021, from $79,609,000 for the comparable period in 2020. Contributing to this increase in total revenues was a $32,717,000 increase in mortgage fee income, a $5,172,000 increase in gains on investments and other assets, a $1,484,000 increase in net mortuary and cemetery sales, a $1,724,000 increase in other revenues, a $1,059,000 increase in insurance premiums and other considerations, and an $894,000 increase in net investment income. 52 Insurance premiums and other considerations increased by $1,059,000, or 4.8%, to $23,350,000 for the three months ended March 31, 2021, from $22,291,000 for the comparable period in 2020. This increase was 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 $894,000, or 6.7%, to $14,294,000 for the three months ended March 31, 2021, from $13,400,000 for the comparable period in 2020. This increase was primarily attributable to a $1,047,000 increase in insurance assignment income, a $431,000 increase in mortgage loan interest, and a $36,000 increase in equity securities income. This increase was partially offset by a $258,000 decrease in interest on cash and cash equivalents, a $137,000 increase in investment expenses, a $111,000 decrease in rental income from real estate held for investment, a $101,000 decrease in fixed maturity securities income, an $11,000 decrease in income on other investments, and a $2,000 decrease in policy loan income. Net mortuary and cemetery sales increased by $1,484,000, or 33.3%, to $5,942,000 for the three months ended March 31, 2021, from $4,458,000 for the comparable period in 2020. This increase was primarily due to an $827,000 increase in cemetery pre-need sales, a $398,000 increase in cemetery at-need sales, and a $259,000 increase in mortuary at-need sales. Gains on investments and other assets increased by $5,172,000, or 161.0%, to gains of $1,960,000 for the three months ended March 31, 2021, from losses of $3,212,000 for the comparable period in 2020. This increase in gains on investments and other assets was primarily due a $1,318,000 increase in gains on other assets mostly attributable to increases in the the fair value of call and put option derivatives. This increase in gains on investments and other assets was also due to a $3,878,000 increase in gains on equity securities mostly attributable to increases in the fair value of these equity securities. This increase in gains on investments and other assets was partially offset by a $23,000 decrease in gains on fixed maturity securities. Mortgage fee income increased by $32,717,000, or 81.2%, to $72,999,000, for the three months ended March 31, 2021, from $40,282,000 for the comparable period in 2020. This increase was primarily due to a $41,798,000 increase in secondary gains from mortgage loans sold to third-party investors into the secondary market and a $1,208,000 increase in loan fees and interest income net of an increase in the provision for loan loss reserve. This increase in mortgage fee income was partially offset by a $7,328,000 decrease in the fair value of loans held for sale and a $2,960,000 decrease in the the fair value of loan commitments. Other revenues increased by $1,724,000, or 72.2%, to $4,114,000 for the three months ended March 31, 2021, from $2,390,000 for the comparable period in 2020. This increase was primarily attributable to an increase in servicing fee revenue. Total benefits and expenses were $106,304,000, or 86.7% of total revenues, for the three months ended March 31, 2021, as compared to $78,135,000, or 98.1% of total revenues, for the comparable period in 2020. Death benefits, surrenders and other policy benefits, and future policy benefits increased by an aggregate of $2,128,000 or 9.9%, to $23,644,000 for the three months ended March 31, 2021, from $21,516,000 for the comparable period in 2020. This increase was primarily the result of a $4,904,000 increase in death benefits (approximately $4,100,000 for COVID-19 related deaths) and a $7,000 increase in surrender and other policy benefits. This increase was partially offset by a $2,783,000 decrease in future policy benefits. Amortization of deferred policy and pre-need acquisition costs and value of business acquired increased by $62,000, or 1.8%, to $3,577,000 for the three months ended March 31, 2021, from $3,515,000 for the comparable period in 2020. This increase was primarily due to an increase in the average outstanding balance of deferred policy and pre-need acquisition costs Selling, general and administrative expenses increased by $25,714,000, or 51.0%, to $76,157,000 for the three months ended March 31, 2021, from $50,443,000 for the comparable period in 2020. This increase was primarily the result of a $16,175,000 increase in commissions, a $5,652,000 increase in personnel expenses, a $1,874,000 increase in other expenses, a $981,000 increase in costs related to funding mortgage loans, a $796,000 increase in advertising expenses, and a $251,000 increase in rent and rent related expenses. Most of these increases are 53 attributable to the mortgage segment due to the increase in mortgage loan originations and refinancings, most notably $16,264,000 in commissions, $5,666,000 in personnel expenses, $2,548,000 in other expenses, $735,000 in advertising expenses, and $252,000 in rent and rent related expenses. Interest expense increased by $7,000, or 0.4%, to $1,826,000 for the three months ended March 31, 2021, from $1,819,000 for the comparable period in 2020. This increase was primarily due to an increase of $308,000 in interest expense on mortgage warehouse lines for loans held for sale. This increase was partially offset by a $301,000 decrease in interest expense on bank loans collateralized by real estate held for investment. Cost of goods and services sold-mortuaries and cemeteries increased by $258,000, or 30.6%, to $1,100,000 for the three months ended March 31, 2021, from $842,000 for the comparable period in 2020. This increase was primarily due to a $163,000 increase in cemetery pre-need sales, a $58,000 increase in cemetery at-need sales, and a $37,000 increase in mortuary at-need sales. 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 or sale of 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 into the secondary market. 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. It should be noted that current conditions in the financial markets and economy caused by the COVID-19 pandemic may affect the cash flows of the Company. During the three months ended March 31, 2021 and 2020, the Company's operations provided cash of $100,976,000 and used cash of $63,771,000, respectively. This increase was due primarily to sales of 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 their 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 and classified as fixed maturity securities available for sale carried at estimated fair value amounted to $279,268,000 (at estimated fair value) and $294,384,000 (at estimated fair value) as of March 31, 2021 and December 31, 2020, respectively. This represents 35.8% and 38.0% of the total investments as of March 31, 2021 and December 31, 2020, 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 March 31, 2021, 4.1% (or $11,460,000) and at December 31, 2020, 4.2% (or $12,418,000) of the Company’s total bond investments were invested in bonds in rating categories three through six, which were considered non-investment grade. 54 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 March 31, 2021 and December 31, 2020, 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 $517,841,000 as of March 31, 2021, as compared to $561,811,000 as of December 31, 2020. Stockholders’ equity as a percent of total capitalization was 52.5% and 47.0% as of March 31, 2021 and December 31, 2020, respectively. Lapse rates measure the amount of insurance terminated during a particular period. The Company’s lapse rate for life insurance in 2020 was 5.9% as compared to a rate of 9.8% for 2019. The 2021 lapse rate to date has been approximately the same as 2020. At March 31, 2021, the combined statutory capital and surplus of the Company’s life insurance subsidiaries was $75,104,000. The life insurance subsidiaries cannot pay a dividend to its parent company without approval of state insurance regulatory authorities. COVID-19 Pandemic During 2020, the outbreak of COVID-19 had spread worldwide and was declared a global pandemic by the World Health Organization on March 11, 2020. COVID-19 poses a threat to the health and economic well-being of the Company’s employees, customers, and vendors. The Company is closely monitoring developments relating to the COVID-19 pandemic and assessing its impact on the Company’s business. The COVID-19 pandemic has had and continues to have a major impact on the global economy and financial markets. Governments and businesses have taken numerous measures to try to contain the virus, which include the implementation of travel bans, self-imposed quarantine periods, and social distancing. These measures have disrupted and will continue to disrupt businesses globally. Governments and central banks have reacted with significant monetary and fiscal interventions designed to stabilize the economic conditions. Like most businesses, COVID-19 has impacted the Company. However, the Company cannot, with any certainty predict the severity or duration with which COVID-19 will impact the Company’s business, financial condition, results of operations, and cash flows. To the extent the COVID-19 pandemic adversely affects the Company’s business, financial condition, and results of operations, it may also have the effect of heightening many of the other Company risks. These uncertainties have the potential to negatively affect the risk of credit default for the issuers of the Company’s fixed maturity debt securities and individual borrowers with mortgage loans held by the Company. The Company has implemented risk management, business continuity plans and has taken preventive measures and other precautions, such as business travel restrictions and remote work arrangements. Such measures and precautions have enabled the Company to continue to conduct business. Item 3. Quantitative and Qualitative Disclosures A bout Market Risk . As a smaller reporting company, the Company is not required to provide information typically disclosed under this item.