Item 7. Management’s Discussion and Analysis
Item
7. 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 strategies 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) increased emphasis on cemetery and mortuary business; and (iii) capitalizing on an improving housing market by originating
mortgage loans.
Insurance
Operations
The
following table shows the condensed financial results for the Company’s insurance operations for 2023 and 2022. See Note 15 of
the Notes to Consolidated Financial Statements.
Years
ended December 31
(in thousands of dollars)
2023
2022
2023
vs 2022 % Increase (Decrease)
Revenues from external customers:
Insurance premiums
$ 114,658
$ 105,002
9 %
Net investment income
67,812
62,565
8 %
Mortgage fee income
77
143
(46 %)
Gains (losses) on investments and other assets
963
(459 )
310 %
Other
1,666
1,932
(14 %)
Total
$ 185,176
$ 169,183
9 %
Intersegment revenue
$ 8,203
$ 6,601
24 %
Earnings before income
taxes
$ 25,272
$ 14,196
78 %
Profitability
for 2023 increased due to (a) a $9,656,000 increase in insurance premiums and other considerations, (b) a $5,247,000 increase in net
investment income, (c) a $1,602,000 increase in intersegment revenue, (d) a $1,422,000 increase in gains on investments and other assets
primarily due to an increase in the fair value of equity securities, and (e) a $987,000 decrease in selling, general and administrative
expenses, which were partially offset by (i) a $5,150,000 increase in future policy benefits, (ii) a $1,936,000 increase in death, surrenders
and other policy benefits, (iii) a $266,000 decrease in other revenues, (iv) a $176,000 increase in intersegment interest expense and
other expenses, (v) a $133,000 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, (vi) a $111,000 increase in interest expense, and (vii) a $66,000
decrease in mortgage fee income.
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Cemetery
and Mortuary Operations
The
following table shows the condensed financial results for the Company’s cemetery and mortuary operations for 2023 and 2022. See
Note 15 of the Notes to Consolidated Financial Statements.
Years
ended December 31
(in thousands of dollars)
2023
2022
2023
vs 2022 % Increase (Decrease)
Revenues from external customers:
Cemetery revenues
$ 15,189
$ 13,871
10 %
Mortuary revenues
12,676
13,123
(3 %)
Net investment income
2,952
2,445
21 %
Gains (losses) on investments and other assets
717
(796 )
190 %
Other
404
305
32 %
Total
$ 31,938
$ 28,948
10 %
Earnings before income
taxes
$ 8,445
$ 6,094
39 %
Profitability
in 2023 increased due to (a) a $2,196,000 increase in cemetery pre-need sales, (b) a $1,513,000 increase in gains on investments and
other assets (primarily attributable to an increase in the fair value of equity securities classified as restricted assets and cemetery
perpetual care trust investments), (c) a $507,000 increase in net investment income, (d) a $99,000 increase in other revenues, (e) a
$59,000 decrease in amortization of deferred policy acquisition costs, and (f) a $44,000 decrease in intersegment interest expense and
other expenses, which were partially offset by (i) a $878,000 decrease in cemetery at-need sales, (ii) a $546,000 increase in selling,
general and administrative expenses, (iii) a $447,000 decrease in mortuary at-need sales, (iv) a $111,000 decrease in intersegment revenues,
and (v) a $85,000 increase in costs of goods sold.
Mortgage
Operations
The
Company’s wholly owned subsidiary, SecurityNational Mortgage, is a mortgage lender 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 originates 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 originates and refinances mortgage loans on a retail
basis. Mortgage loans originated or refinanced by SecurityNational Mortgage are funded through loan purchase agreements with Security
National Life, Kilpatrick Life and unaffiliated financial institutions.
SecurityNational
Mortgage receives 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. Mortgage loans are generally sold with mortgage servicing rights (“MSRs”)
released to third-party investors or retained by SecurityNational Mortgage. SecurityNational Mortgage currently retains the MSRs on approximately
4% of its loan origination volume. These mortgage loans are serviced by either SecurityNational Mortgage or an approved third-party sub-servicer.
On October 31, 2022, the Company sold certain of its MSRs. The MSRs related to mortgage loans previously originated by the Company in
aggregate unpaid principal amount of approximately $7.02 billion. As a result of the sale, the book value of the Company’s MSRs
decreased $51,185,906.
Mortgage
rates have followed the US Treasury yields up in response to the higher-than-expected inflation and the expectation that the Federal
Reserve will continue to raise rates in the near term. As expected, the rapid increase in mortgage rates has resulted in a decrease in
loan originations classified as ‘refinance’. Higher mortgage rates have also had a negative effect on loan originations classified
as ‘purchases’, although not as significant as those in the refinance classification.
For
2023 and 2022, SecurityNational Mortgage originated 7,185 loans ($2,173,081,000 total volume) and 10,663 loans ($3,373,554,000 total
volume), respectively.
20
The
following table shows the condensed financial results for the Company’s mortgage operations for 2023 and 2022. See Note 15 of the
Notes to Consolidated Financial Statements.
Years
ended December 31
(in thousands of dollars)
2023
2022
2023
vs 2022 % Increase (Decrease)
Revenues from external customers:
Secondary gains
from investors
$ 68,428
$ 153,728
(55 %)
Income from loan originations
31,245
32,772
(5 %)
Change in fair value of
loans held for sale
(478 )
(8,835 )
(95 %)
Change in fair value of loan commitments
(1,124 )
(4,309 )
(74 %)
Net investment income
1,580
1,188
33 %
Gains on investments and other assets
157
398
(61 %)
Other
1,576
16,580
(90 %)
Total
$ 101,384
$ 191,522
(47 %)
Earnings (loss) before
income taxes
$ (17,416 )
$ 14,088
(224 %)
Included
in other revenues is service fee income. Profitability in 2023 decreased due to (a) an $85,300,000 decrease in secondary gains from investors,
(b) a $15,004,000 decrease in other revenues due to the sale of certain MSRs in October 2022, (c) a $1,535,000 increase in intersegment
interest expense and other expenses, (d) a $1,527,000 decrease in income from loan originations, and (e) a $241,000 decrease in gains
on investments and other assets, which were partially offset by (i) a $23,662,000 decrease in commissions, (ii) a $17,871,000 decrease
in personnel expenses, (iii) a $13,180,000 decrease in other expenses, (iv) an $8,356,000 increase in the fair value of loans held for
sale, (v) a $3,185,000 increase in the fair value of loan commitments, (vi) a $3,077,000 decrease in interest expense, (vii) a $1,100,000
decrease in costs related to funding mortgage loans, (viii) a $1,011,000 decrease in advertising expenses, (ix) a $392,000 increase in
net investment income, (x) a $175,000 increase in intersegment revenues, (xi) a $42,000 decrease in depreciation on property and equipment,
and (xii) a $52,000 decrease in rent and rent related expenses.
Critical
Accounting Policies and Estimates
The
following is a summary of the Company’s significant accounting policies and a review of the Company’s most critical accounting
estimates. See Note 1 of the Notes to Consolidated Financial Statements.
Insurance
Operations
In
accordance with generally accepted accounting principles in the United States of America (“GAAP”), premiums and other considerations
received for interest sensitive products are reflected as increases in liabilities for policyholder account balances and not as revenues.
Revenues reported for these products consist of policy charges for the cost of insurance, administration charges, amortization of policy
initiation fees and surrender charges assessed against policyholder account balances. Surrender benefits paid relating to these products
are reflected as decreases in liabilities for policyholder account balances and not as expenses.
The
Company receives investment income earned from the funds deposited into account balances, a portion of which is passed through to the
policyholders in the form of interest credited. Interest credited to policyholder account balances and benefit claims more than policyholder
account balances are reported as expenses in the consolidated financial statements.
Premiums
and other considerations received for traditional life insurance products are recognized as revenues when due. Future policy benefits
are recognized as expenses over the life of the policy by means of the provision for future policy benefits.
The
costs related to acquiring new business, including certain costs of issuing policies and other variable selling expenses (principally
commissions), defined as deferred policy acquisition costs, are capitalized, and amortized into expenses. For nonparticipating traditional
life products, these costs are amortized over the premium paying period of the related policies, in proportion to the ratio of annual
premium revenues to total anticipated premium revenues. Such anticipated premium revenues are estimated using the same assumptions used
for computing liabilities for future policy benefits and are generally “locked in” at the date the policies are issued. For
interest sensitive products, these costs are amortized generally in proportion to expected gross profits from surrender charges and investment,
mortality, and expense margins. This amortization is adjusted when the Company revises the estimate of current or future gross profits
or margins. For example, deferred policy acquisition costs are amortized earlier than originally estimated when policy terminations are
higher than originally estimated or when investments backing the related policyholder liabilities are sold at a gain prior to their anticipated
maturity.
21
Death
and other policyholder benefits reflect exposure to mortality risk and fluctuate from year to year on the level of claims incurred under
insurance retention limits. The profitability of the Company is primarily affected by fluctuations in mortality, other policyholder benefits,
expense levels, interest spreads (i.e., the difference between interest earned on investments and interest credited to policyholders)
and persistency. The Company can mitigate adverse experiences through sound underwriting, asset and liability duration matching, sound
actuarial practices, adjustments to credited interest rates, policyholder dividends and cost of insurance charges.
Cemetery
and Mortuary Operations
Pre-need
sales of funeral services and caskets, including revenue and costs associated with the sales of pre-need funeral services and caskets,
are deferred until the services are performed or the caskets are delivered.
Pre-need
sales of cemetery interment rights (cemetery burial property), including revenue and costs associated with the sales of pre-need cemetery
interment rights, are recognized in accordance with the retail land sales provisions of GAAP. Under GAAP, recognition of revenue and
associated costs from constructed cemetery property must be deferred until a minimum percentage of the sales price has been collected.
Revenues related to the pre-need sale of unconstructed cemetery property will be deferred until such property is constructed and meets
the criteria of GAAP, described above.
Pre-need
sales of cemetery merchandise (primarily markers and vaults), including revenue and costs associated with the sales of pre-need cemetery
merchandise, are deferred until the merchandise is delivered, fulfilling the performance obligation.
Pre-need
sales of cemetery services (primarily merchandise delivery and installation fees and burial opening and closing fees), including revenue
and costs associated with the sales of pre-need cemetery services, are deferred until the services are performed.
Prearranged
funeral and pre-need cemetery customer obtaining costs, including costs incurred related to obtaining new pre-need cemetery and prearranged
funeral business are accounted for under the guidance of the provisions of GAAP. Obtaining costs, which include only costs that vary
with and are primarily related to the acquisition of new pre-need cemetery and prearranged funeral business, are deferred until the merchandise
is delivered or services are performed.
Revenues
and costs for at-need sales are recorded when a valid contract exists, the services are performed, collection is reasonably assured,
and there are no significant company obligations remaining.
Mortgage
Operations
Mortgage
fee income consists of origination fees, processing fees, interest income and certain other income related to the origination and sale
of mortgage loans. The Company has elected to use fair value accounting for all mortgage loans that are held for sale. Accordingly, all
revenues and costs are now recognized when the mortgage loan is funded and any changes in fair value are shown as a component of mortgage
fee income.
The
Company, through its mortgage subsidiaries, sells mortgage loans to third-party investors without recourse, unless defects are identified
in the representations and warranties made at loan sale. It may be required, however, to repurchase a loan or pay a fee instead of repurchasing
under certain events, which include the following:
● Failure
to deliver original documents specified by the investor,
● The
existence of misrepresentation or fraud in the origination of the loan,
● The
loan becomes delinquent due to nonpayment during the first several months after it is sold,
● Early
pay-off of a loan, as defined by the agreements,
● Excessive
time to settle a loan,
● Investor
declines purchase, and
● Discontinued
product and expired commitment.
22
Loan
purchase commitments generally specify a date 30 to 45 days after delivery upon which the underlying loans should be settled. Depending
on market conditions, these commitment settlement dates can be extended at a cost to the Company.
It
is the Company’s policy to cure any documentation problems regarding such loans at a minimal cost for up to a six-month period
and to pursue efforts to enforce loan purchase commitments from third-party investors concerning the loans. The Company believes that
six months allows adequate time to remedy any documentation issues, to enforce purchase commitments, and to exhaust other alternatives.
Remedial methods include the following:
● Research
reasons for rejection,
● Provide
additional documents,
● Request
investor exceptions,
● Appeal
rejection decision to purchase committee, and
● Commit
to secondary investors.
Once
purchase commitments have expired and other alternatives to remedy are exhausted, which could be earlier than the six-month period, the
loans are repurchased and transferred to mortgage loans held for investment at the lower of cost or fair value and the previously recorded
sales revenue that was to be received from a third-party investor is written off against the loan loss reserve. Any loan that later becomes
delinquent is evaluated by the Company at that time and any impairment is adjusted accordingly.
Determining
fair value . The cost for loans held for sale is equal to the amount paid to the warehouse bank and the amount originally funded by
the Company. Market value, while often difficult to determine and may contain significant unobservable inputs, is based on the following
guidelines:
● For
loans that are committed, the Company uses the commitment price.
● For
loans that are non-committed that have an active market, the Company uses the market price.
● For
loans that are non-committed where there is no market but there is a similar product, the
Company uses the market value for the similar product.
● For
loans that are non-committed where no active market exists, the Company determines that the
unpaid principal balance best approximates the market value, after considering the fair value
of the underlying real estate collateral, estimated future cash flows, and loan interest
rate.
The
appraised value of the real estate underlying the original mortgage loan adds significance to the Company’s determination of fair
value because, if the loan becomes delinquent, the Company has sufficient value to collect the unpaid principal balance or the carrying
value of the loan, thus minimizing credit risk. Most loans originated are sold to third-party investors. The amounts expected to be sold
to investors are shown on the consolidated balance sheets as loans held for sale.
Use
of Significant Accounting Estimates
The
preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported
amounts and disclosures. It is reasonably possible that actual experience could differ from the estimates and assumptions utilized which
could have a material impact on the financial statements. The following is a summary of our significant accounting estimates, and critical
issues that impact them:
Loan
Commitments
The
Company estimates the fair value of a mortgage loan commitment based on the change in estimated fair value of the underlying mortgage
loan, quoted mortgage-backed security (“MBS”) prices, estimates of the fair value of mortgage servicing rights, and an estimate
of the probability that the mortgage loan will fund within the terms of the commitment net of estimated commission expense. The change
in fair value of the underlying mortgage loan is measured from the date the mortgage loan commitment is issued and is shown net of related
expenses. Following issuance, the value of a loan commitment can be either positive or negative depending upon the change in value of
the underlying mortgage loans. Fallout rates and other factors from the Company’s recent historical data are used to estimate the
quantity and value of mortgage loans that will be funded within the terms of the commitments.
23
Deferred
Acquisition Costs
Amortization
of deferred policy acquisition costs (“DAC”) for interest sensitive products is dependent upon estimates of current and future
gross profits or margins on this business. Key assumptions used include the following: yield on investments supporting the liabilities,
amount of interest or dividends credited to the policies, amount of policy fees and charges, amount of expenses necessary to maintain
the policies, amount of death and surrender benefits, and the length of time the policies will stay in force.
For
nonparticipating traditional life products, these costs are amortized over the premium paying period of the related policies in proportion
to the ratio of annual premium revenues to total anticipated premium revenues. Such anticipated premium revenues are estimated using
the same assumption used for computing liabilities for future policy benefits and are generally “locked in” at the date the
policies are issued.
Value
of Business Acquired
Value
of business acquired (“VOBA”) is the present value of estimated future profits of the acquired business and is amortized
like deferred acquisition costs. The critical issues explained for deferred acquisition costs would also apply for value of business
acquired.
Mortgage
Loans Foreclosed to Real Estate Held for Investment or Sale
These
properties are recorded at the lower of cost or fair value upon foreclosure. The Company believes that in an orderly market, fair value
approximates the replacement cost of a home, and the rental income provides a cash flow stream for investment analysis. The Company believes
the highest and best use of the properties are as income producing assets since it is the Company’s intent to hold the properties
as rental properties, matching the income from the investment in rental properties with the funds required for estimated future policy
benefits. Accordingly, the fair value determination is generally weighted more heavily toward the rental analysis. The fair value is
also estimated by obtaining an independent appraisal, which typically considers area comparable properties and property condition.
Future
Policy Benefits
Reserves
for future policy benefits for traditional life insurance products requires the use of many assumptions, including the duration of the
policies, mortality experience, expenses, investment yield, lapse rates, surrender rates, and dividend crediting rates.
These
assumptions are made based upon historical experience, industry standards and a best estimate of future results and, for traditional
life products, include a provision for adverse deviation. For traditional life insurance, once established for a particular series of
products, these assumptions are generally held constant.
24
Unearned
Premium Reserve
The
universal life products the Company sells have significant policy initiation fees (front-end load) that are deferred and amortized into
revenues over the estimated expected gross profits from surrender charges and investment, mortality, and expense margins. The same issues
that impact deferred acquisition costs apply to unearned revenue.
Premium
Deficiency and Loss Recognition Testing
At
least annually, the Company tests the adequacy of the net benefit reserves (liability for future policy benefits, net of DAC and VOBA)
recorded for life insurance and annuity products. The Company tests for recoverability by using the Company’s current best-estimate
assumptions as to policyholder mortality, persistency, maintenance expenses and invested asset returns. These tests evaluate whether
the present value of future contract-related cash flows will support the capitalized DAC and VOBA assets. These cash flows consist primarily
of premium income, less benefits, and expenses. If the current contract liabilities plus the present value of future premiums is greater
than the sum of the present values of future policy benefits, commissions, and expenses plus the current DAC and VOBA less unearned premium
reserve balances, then the capitalized assets are deemed recoverable. The present values are calculated using the best estimate of the
after-tax net investment earned rate.
Deferred
Pre-need Cemetery and Funeral Contracts Revenues and Estimated Future Cost of Pre-need Sales
The
revenue and cost associated with the sales of pre-need cemetery merchandise and funeral services are deferred until the merchandise is
delivered or the service is performed.
The
Company, through its cemetery and mortuary operations, provides a guaranteed funeral arrangement wherein a prospective customer can receive
future goods and services at guaranteed prices. To accomplish this, the Company, through its life insurance operations, sells to the
customer an increasing benefit life insurance policy that is assigned to the mortuaries. If, at the time of need, the policyholder or
potential mortuary customer utilizes one of the Company’s facilities, the guaranteed funeral arrangement contract that has been
assigned will provide the funeral goods and services at the contracted price. The increasing life insurance policy will cover the difference
between the original contract prices and current prices. Risks may arise if the difference cannot be fully met by the life insurance
policy.
Mortgage
Servicing Rights
Mortgage
Service Rights (“MSR”) arise from contractual agreements between the Company and third-party investors (or their agents)
when mortgage loans are sold. Under these contracts, the Company is obligated to retain and provide loan servicing functions on the loans
sold, in exchange for fees and other remuneration. The servicing functions typically performed include, among other responsibilities,
collecting and remitting loan payments; responding to borrower inquiries; accounting for principal and interest; holding custodial (impound)
funds for payment of property taxes and insurance premiums; counseling delinquent mortgagors; and supervising the acquisition of real
estate owned and property dispositions. The Company initially accounts for MSRs at fair value and subsequently accounts for them using
the amortization method. MSR amortization is determined by amortizing the MSR balance in proportion to, and over the period of the estimated
future net servicing income of the underlying financial assets. The Company periodically assesses MSRs accounted for using the amortization
method for impairment.
Mortgage
Allowance for Credit Losses and Loan Loss Reserve
The
Company provides for losses on its mortgage loans held for investment through an allowance for credit losses (a contra-asset account)
and through the mortgage loan loss reserve (a liability account).
The
mortgage allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the Company’s mortgage
loans held for investment to present the net amount expected to be collected. When a loan becomes delinquent, the Company proceeds to
foreclose on the real estate and all expenses for foreclosure are expensed as incurred. Once foreclosed, an adjustment for the lower
of cost or fair value is made, if necessary, and the amount is classified as real estate held for investment. The Company will rent the
properties until it is deemed desirable to sell them.
25
The
mortgage loan loss reserve is an estimate of probable losses at the balance sheet date that the Company will realize in the future on
mortgage loans sold to third-party investors. The Company may be required to reimburse third-party investors for costs associated with
early payoff of loans within six months of origination of such loans and to repurchase loans where there is a default in any of the first
four monthly payments to the investors or, in lieu of repurchase, to pay a negotiated fee to the investors. The Company’s estimates
are based upon historical loss experience and the best estimate of the probable loan loss liabilities.
Upon
completion of a transfer that satisfies the conditions to be accounted for as a sale, the Company initially measures at fair value liabilities
incurred in a sale relating to any guarantee or recourse provisions in the event of defects in the representations and warranties made
at loan sale. The Company accrues a monthly allowance for indemnification losses to investors based on total production. This estimate
is based on the Company’s historical experience and is included as a component of mortgage fee income. Subsequent updates to the
recorded liability from changes in assumptions are recorded in selling, general and administrative expenses. The estimated liability
for indemnification losses is included in other liabilities and accrued expenses.
Deferred
Tax Assets and Liabilities
Deferred
tax assets and liabilities require various estimates and judgments and may be affected favorably or unfavorably by various internal and
external factors. These estimates and judgments occur in the calculation of certain deferred tax assets and liabilities that arise from
temporary differences in the recognition of revenues and expenses for tax and financial reporting purposes and in estimating the ultimate
amount of deferred tax assets recoverable in future periods. Factors affecting the deferred tax assets and liabilities include, but are
not limited to, changes in tax laws, regulations and/or rates, changing interpretations of existing tax laws or regulations, and changes
to overall levels of pre-tax earnings. Changes in these estimates, judgments or factors may result in an increase or decrease to the
Company’s deferred tax assets and liabilities with a related increase or decrease in the Company’s provision for income taxes.
Results
of Consolidated Operations
2023
Compared to 2022
Total
revenues decreased by $71,155,000, or 18.3%, to $318,497,000 for 2023 from $389,652,000 for 2022. Contributing to this decrease in total
revenues was primarily a $75,352,000 decrease in mortgage fee income and a $15,171,000 decrease in other revenues. This decrease in total
revenues was offset by a $9,657,000 increase in insurance premiums and other considerations, a $6,145,000 increase in net investment
income, a $2,695,000 increase in gains on investments and other assets, and an $871,000 increase in net cemetery and mortuary sales.
Mortgage
fee income decreased by $75,352,000, or 43.4%, to $98,148,000 for 2023, from $173,500,000 for 2022. This decrease was primarily due to
an $85,366,000 decrease in secondary gains from mortgage loans sold to third-party investors into the secondary market, and a $2,579,000
decrease in loan fees and interest income. This decrease in mortgage fee income was partially offset by a $11,541,000 increase in the
fair value of loans held for sale and loan commitments and a $1,052,000 decrease in the provision for loan loss reserve.
Insurance
premiums and other considerations increased by $9,657,000, or 9.2%, to $114,658,000 for 2023, from $105,002,000 for 2022. This increase
was due to an increase of $9,238,000 in first year premiums because of increased preneed insurance sales and an increase of $419,000
in renewal premiums due to the growth of the Company in recent years, particularly in whole life products, which resulted in more premium
paying policies in force.
Net
investment income increased by $6,145,000, or 9.3%, to $72,343,000 for 2023, from $66,198,000 for 2022. This increase was primarily attributable
to a $4,476,000 increase in fixed maturity securities income, a $2,583,000 increase in interest on cash and cash equivalents, a $477,000
decrease in investment expenses, a $223,000 increase in rental income from real estate held for investment, a $106,000 increase in equity
securities income, a $99,000 increase in income in other investments, and a $5,000 increase in insurance assignment income. This increase
was partially offset by a $1,708,000 decrease in mortgage loan interest and a $116,000 decrease in policy loan income.
26
Net
mortuary and cemetery sales increased by $871,000, or 3.2%, to $27,865,000 for 2023, from $26,994,000 for 2022. This increase was primarily
due to a $2,196,000 increase in cemetery pre-need sales. This increase was partially offset by a $878,000 decrease in cemetery at-need
sales and a $447,000 decrease in mortuary at-need sales.
Gains
on investments and other assets increased by $2,695,000, or 314.3%, to $1,837,000 in gains for 2023, from $858,000 in losses for 2022.
This increase in gains on investments and other assets was primarily due to a $4,157,000 increase in gains on equity securities mostly
attributable to increases in the fair value of these equity securities. This increase was partially offset by a $527,000 decrease in
gains on fixed maturity securities, a $485,000 decrease in gains on other assets, and a $450,000 decrease in gains on real estate held
for investment.
Other
revenues decreased by $15,171,000, or 80.6%, to $3,646,000 for 2023 from $18,817,000 for 2022. This decrease was primarily attributable
to a decrease in servicing fee revenue because of the sale of certain mortgage servicing rights in October 2022.
Total
benefits and expenses were $302,197,000, or 94.9% of total revenues for 2023, as compared to $355,275,000, or 91.2% of total revenues
for 2022.
Death
benefits, surrenders and other policy benefits, and future policy benefits increased by an aggregate of $7,086,000, or 7.6%, to $100,012,000
for 2023, from $92,926,000 for 2022. This increase was primarily the result of a $5,150,000 increase in future policy benefits and a
$2,012,000 increase in death benefits. This increase was partially offset by a $76,000 decrease in surrender and other policy benefits.
Amortization
of deferred policy and pre-need acquisition costs and value of business acquired increased by $74,000, or 0.4%, to $18,024,000 for 2023,
from $17,950,000 for 2022. 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 an aggregate of $57,358,000, or 24.7%, to $174,490,000 for 2023, from $231,848,000 for
2022. This decrease was primarily the result of a $23,391,000 decrease in commissions, a $16,970,000 decrease in personnel expenses,
a $13,739,000 decrease in other expenses, a $1,987,000 decrease in advertising expenses, a $1,100,000 decrease in costs related to funding
mortgage loans, a $145,000 decrease in depreciation on property and equipment, and a $26,000 decrease in rent and rent related expenses.
Interest
expense decreased by $2,965,000, or 37.9%, to $4,865,000 for 2023, from $7,830,000 for 2022. This decrease was primarily due to a decrease
of $3,077,000 in interest expense on mortgage warehouse lines of credit for loans held for sale, which was partially offset by a $112,000
increase in interest expense on bank loans.
Cost
of goods and services sold of the cemeteries and mortuaries increased by $85,000, or 1.8%, to $4,806,000 for 2023, from $4,721,000 for
2022. This increase was primarily due to a $218,000 increase in cemetery at-need sales and a $40,000 increase in cemetery pre-need sales,
which was partially offset by a $173,000 decrease in mortuary at-need sales.
Income
tax expense decreased by $6,881,000, or 79.2%, to $1,805,000 for 2023, from $8,687,000 for 2022. This decrease was primarily due to
a decrease in earnings before income taxes for 2023 compared to 2022. The Company’s overall effective tax rate decreased from
25.3% for 2022 to 11.1% in 2023, a 14.2% decrease in the effective tax rate or a 56.1% change.
Risks
The
following is a description of the material risks facing the Company and how it mitigates those risks:
Legal
and Regulatory Risks . Changes in the legal or regulatory environment in which the Company operates may create additional expenses
and risks not anticipated by the Company in developing and pricing its products. Regulatory initiatives designed to reduce insurer profits,
new legal theories or insurance company insolvencies through guaranty fund assessments may create costs for the insurer beyond those
recorded in the consolidated financial statements. In addition, changes in tax law with respect to mortgage interest deductions or other
public policy or legislative changes may affect the Company’s mortgage sales. Also, the Company may be subject to further regulations
in the cemetery and mortuary business. The Company aims to mitigate these risks by offering a wide range of products and by diversifying
its operations, thus reducing its exposure to any single product or jurisdiction, and also by employing underwriting practices that identify
and minimize the adverse impact of such risks.
27
Mortgage
Industry Risks . Developments in the mortgage industry and credit markets can adversely affect the Company’s ability to sell
its mortgage loans to investors, which can impact the Company’s financial results by requiring it to assume the risk of holding
and servicing any unsold loans.
The
mortgage loan loss reserve is an estimate of probable losses at the balance sheet date that the Company could realize in the future on
mortgage loans sold to third-party investors. The Company’s mortgage subsidiary may be required to reimburse third-party investors
for costs associated with early payoff of loans within the first six months of such loans and to repurchase loans where there is a default
in any of the first four monthly payments to the investors or, in lieu of repurchase, to pay a negotiated fee to the investors. The Company’s
estimates are based upon historical loss experience and the best estimate of the probable loan loss liabilities.
During
2023 and 2022 the Company decreased its loan loss reserve by $1,178,000 and increased its loan loss reserve by $1,079,000, respectively,
for loan originations, and the charges have been included in mortgage fee income. The estimated liability for indemnification losses
is included in other liabilities and accrued expenses and, as of December 31, 2023 and 2022, the balances were $547,000 and $1,726,000,
respectively. The Company believes the loan loss reserve represents probable loan losses incurred as of December 31, 2023. There is a
risk, however, that future loan losses may exceed the loan loss reserve.
As
of December 31, 2023, the Company’s mortgage loans held for investment portfolio consisted of mortgage loans in an aggregate principal
amount of $6,149,000 with delinquencies exceeding 90 days. Of this amount, loans with an aggregate principal amount of $2,263,000 were
in foreclosure proceedings. The Company has not received or recognized any interest income on the $6,149,000 in mortgage loans with delinquencies
exceeding 90 days. During 2023 and 2022, the Company increased its allowance for credit losses by $1,184,000 and by $270,000, respectively,
which was charged to bad debt expense and included in selling, general and administrative expenses for the period. The Company also increased
its allowance for credit losses by $665,000 at the beginning of 2023 due to the adoption of the new accounting standard (Refer to Note
1 of the Notes to the Consolidated Financial Statements). The allowances for credit losses on the Company’s mortgage loans held
for investment portfolio as of December 31, 2023 and 2022 were $3,819,000 and $1,970,000, respectively.
Interest
Rate Risk . Fluctuations in interest rates may cause a decrease in the value of the Company’s investments or impair the ability
of the Company to market its mortgage and cemetery and mortuary products. This change in rates may cause certain interest-sensitive products
to become uncompetitive or may cause disintermediation. The Company aims to mitigate this risk by charging fees for non-conformance with
certain policy provisions, by offering products that transfer this risk to the purchaser, and by attempting to match the maturity schedule
of its assets with the expected payouts of its liabilities. To the extent that liabilities come due more quickly than assets mature,
the Company might have to borrow funds or sell assets prior to maturity and potentially recognize a loss on the sale.
Mortality
and Morbidity Risks . The Company’s actuarial assumptions differing from actual mortality and morbidity experienced may mean
that the Company’s relevant products sold were underpriced, may require the Company to liquidate insurance or other claims earlier
than planned, and have other potentially adverse consequences to the business. The Company aims to minimize this risk through sound underwriting
practices, asset and liability duration matching, and sound actuarial practices.
Banking
Environment .
On
March 10, 2023, and March 12, 2023, Silicon Valley Bank and Signature Bank were placed in receivership with the Federal Deposit Insurance
Corporation (FDIC). Normal banking activities resumed shortly thereafter. On May 1, 2023, First Republic Bank was placed in receivership
with the FDIC and was immediately purchased by a national bank.
The
Company does not maintain any deposit or other accounts or credit facilities with Silicon Valley Bank, Signature Bank or First Republic
Bank. The Company may periodically transfer funds to these banks to pay for services rendered by third party vendors that continue to
maintain banking relationships with these banks. The Company continues to monitor the banking industry and its relationships with regional
and community banks.
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Estimates .
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the
amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Material
estimates that are particularly susceptible to significant changes in the near term are those used in determining the value of
derivative assets and liabilities; those used in determining deferred acquisition costs and the value of business acquired; those
used in determining the value of mortgage loans foreclosed to real estate held for investment or sale; those used in determining the
liability for future policy benefits and unearned revenue; those used in determining the estimated future costs for pre-need sales;
those used in determining the value of mortgage servicing rights; those used in determining the value of loans held for sale; those
used in determining allowances for credit losses; those used in determining loan loss reserve; and those used in determining
deferred tax assets and liabilities. Although some variability is inherent in these estimates, management believes the amounts
provided are fairly stated in all material respects.
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 sale or maturity of investments. The mortgage subsidiaries realize cash flow from fees generated by originating
and refinancing mortgage loans and fees on mortgage loans held for sale that are sold to investors into the secondary market. It should
be noted that current conditions in the financial markets and economy may affect the realization of these expected cash flows. 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, debt service, and to meet current operating expenses.
As
of December 31, 2023, the Company’s subsidiary SecurityNational Mortgage was not in compliance with the net income covenants under
its warehouse lines of credit and its operating cash flow covenant for its standby letter of credit with its primary bank. SecurityNational
Mortgage has received or is in the process of receiving waivers from the warehouse banks. In the unlikely event SecurityNational Mortgage
is required to repay the outstanding advances of approximately $7,732,000 on the warehouse line of credit that has not provided a covenant
waiver, SecurityNational Mortgage has sufficient cash and borrowing capacity on the warehouse lines of credit that have provided covenant
waivers to fund its origination activities. The Company has done an internal analysis of the funding capacities of both internal and
external sources and has determined that there are sufficient funds to continue its business model. The Company continues to negotiate
other warehouse lines of credit with other lenders.
During
2023 and 2022, the Company’s operations provided cash of $54,008,000 and of $130,450,000, respectively. The decrease in cash provided
by operations was due primarily to decreased proceeds from the sale of loans held for sale.
The
Company expects to pay out liabilities under its funeral plans over the long term given the nature of those plans. Funeral plans are
small face value life insurance policies that payout upon a person’s death to cover funeral burial costs; policyholders generally
keep these policies in force until, and do not surrender prior to, death. Because of the long-term nature of these liabilities, the Company
can hold to maturity or for the targeted investment period its corresponding bond, real estate, and mortgage loan investments, thus reducing
the risk of liquidating these long-term investments because 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 matching. The Company purchases short-term
investments on a temporary basis to meet the expected short-term requirements of the Company’s insurance products. The Company’s
investment philosophy is intended to provide a rate of return for the expected duration of its cemetery and mortuary policies that will
exceed the accruing of liabilities under those policies regardless of future interest rate movements.
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The
Company’s investment policy is also to invest predominantly in fixed maturity securities, real estate, mortgage loans, and warehousing
of mortgage loans held for sale. The warehoused mortgage loans are typically held for sale on a short-term basis before selling the loans
to investors in accordance with the requirements and laws governing the Company’s life insurance subsidiaries. Bonds owned by the
insurance subsidiaries amounted to $362,663,000 (at estimated fair value) and $345,598,000 (at estimated fair value) as of December 31,
2023 and 2022, respectively. This represented 38.7% and 36.4% of the total investments of the Company as of December 31, 2023, and 2022,
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. As of December 31, 2023, 1.8% (or $6,954,000) and as of December
31, 2022, 2.2% (or $7,833,000) of the insurance subsidiaries’ total bond investments were invested in bonds in rating categories
three through six, which are considered non-investment grade.
See
Note 2 of the Notes to Consolidated Financial Statements for the schedule of the maturity of fixed maturity securities available for
sale and for the schedule of principal payments for mortgage loans held for investment.
See
Note 7 of the Notes to Consolidated Financial Statements for a description of the Company’s sources of liquidity.
If
market conditions were to cause interest rates to change, the fair value of the Company’s fixed income portfolio (of approximately
$657,153,000), which includes bonds, preferred stocks and mortgage loans held for investment, could change by the following amounts based
on the respective basis point swing (the change in the fair values were calculated using a modeling technique):
-200
bps
-100
bps
+100
bps
+200
bps
Change in
Fair Value
$ 44,352
$ 20,873
$ (19,034 )
$ (39,027 )
(in
thousands)
The
Company’s life insurance subsidiaries are 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. As of December 31, 2023
and 2022, the life insurance subsidiaries were in compliance with the regulatory criteria.
The
Company’s total capitalization of stockholders’ equity, and bank loans and other loans payable was $418,450,000 as of December
31, 2023, as compared to $454,499,000 as of December 31, 2022. This decrease was primarily due to a decrease of $56,158,000 in bank loans
and other loans payable which was partially offset by a $20,108,000 increase in stockholders’ equity. Stockholders’ equity
as a percent of total capitalization was 74.8% and 64.4% as of December 31, 2023 and 2022, respectively.
Lapse
rates measure the amount of insurance terminated during a particular period. The Company’s lapse rate for life insurance was 4.4%
for 2023 as compared to a rate of 4.3% for 2022.
The
combined statutory capital and surplus of the Company’s life insurance subsidiaries was $107,385,000 and $94,254,000 as of December
31, 2023 and 2022, respectively. The life insurance subsidiaries cannot pay a dividend to their parent company without the approval of
state insurance regulatory authorities.
Forward-Looking
Statements
The
Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements to encourage companies to provide
prospective information about their businesses without fear of litigation so long as those statements are identified as forward-looking
and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially
from those projected in such statements. The Company desires to take advantage of the “safe harbor” provisions of the act.
This
Annual Report on Form 10-K contains forward-looking statements, together with related data and projections, about the Company’s
projected financial results and its plans and strategies. However, the actual results and needs of the Company may vary materially from
forward-looking statements and projections made from time to time by the Company based on management’s then-current expectations.
The business in which the Company is engaged involves changing and competitive markets, which may involve a high degree of risk, and
there can be no assurance that forward-looking statements and projections will prove accurate.
30
Factors
that may cause the Company’s actual results to differ materially from those contemplated or projected, forecast, estimated or budgeted
in such forward looking statements include among others, the following possibilities: (i) heightened competition, including the intensification
of price competition, the entry of new competitors, and the introduction of new products by new and existing competitors; (ii) adverse
state and federal legislation or regulation, including decreases in rates, limitations on premium levels, increases in minimum capital
and reserve requirements, benefit mandates and tax treatment of insurance products; (iii) fluctuations in interest rates causing a reduction
of investment income or increase in interest expense and in the market value of interest rate sensitive investment; (iv) failure to obtain
new customers, retain existing customers or reductions in policies in force by existing customers; (v) higher service, administrative,
or general expenses due to the need for additional advertising, marketing, administrative or management information systems expenditures;
(vi) loss or retirement of key executives or employees; (vii) increases in medical costs; (viii) changes in the Company’s liquidity
due to changes in asset and liability matching; (ix) restrictions on insurance underwriting based on genetic testing and other criteria;
(x) adverse changes in the ratings obtained by independent rating agencies; (xi) failure to maintain adequate reinsurance; (xii) possible
claims relating to sales practices for insurance products and claim denials; (xiii) adverse trends in mortality and morbidity; (xiv)
deterioration of real estate markets; and (xv) lawsuits in the ordinary course of business.
Off-Balance
Sheet Agreements
The
Company has commitments to fund existing construction and land development loans pursuant to the various loan agreements. As of December
31, 2023, the Company’s commitments were approximately $146,953,000 for these loans, of which $104,977,000 had been funded. The
Company advances funds in accordance with the loan agreements once the work has been completed and an independent inspection is made.
The maximum loan commitment ranges between 50% and 80% of appraised value. The Company receives fees and interest for these loans and
the interest rate is generally fixed at 5.25% to 8.50% per annum. Maturities range between six and eighteen months.
Contractual
Obligations
In
the ordinary course of the Company’s operations, the Company enters into certain contractual obligations. Such obligations include
operating leases for office space, agreements with respect to borrowed funds and future policy benefits. See Notes 7, 22, 24 of the Notes
to Consolidated Financial Statements for more information about these obligations.
Captive
Insurance Participation
The
Company has a limited equity interest in a captive insurance entity (the “Captive’) that provides workers compensation, general
liability and automobile insurance . This program permits the Company to pool insurance risks and resources with like-minded companies
in order to obtain more competitive pricing for claims administration, stop loss insurance premiums and to limit its risk of loss in
any particular year. The Captive also provides access to a wide array of safety-related services and regular safety training to help
the Company control claims. The maximum exposure to a loss related to the Company’s involvement in the Captive is limited to approximately
$443,758, which is collateralized under a standby letter of credit issued on the insurance entity’s behalf. See Note 10, “Reinsurance,
Commitments and Contingencies,” for additional discussion of commitments associated with the insurance program. The Company has
been a member of the Captive since 2006 and does not expect any material losses to result from the issuance of the standby letter of
credit given the Company’s past performance.
Item
7A. Quantitative and Qualitative Disclosures about Market Risk
As
a smaller reporting company, the Company is not required to provide information typically disclosed under this item.
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